Realty Income Annual Report 2005

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FY2005 Annual Report · Realty Income

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R E A LTY I N C O M E ’ S
M O NTH LY D IVI D E N D
U N I V E RS ITY

N e w Y o r k S t o c k E x c h a n g e “ O ”

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T H E C O L L E G E F O R I N C O M E I N V E S T O R S

U N I V E R S I T Y M I S S I O N

Monthly Dividend University (MDU) is an

institution of higher learning that is dedicated

to teaching investors about investing for

dividend income and about Realty Income,
The Monthly Dividend Company®. Upon the
completion of course work, students will have

a broad understanding and knowledge of the

operations and performance of Realty Income

during 2005, as well as how investing for

dividend income may fit within their overall

investment objectives.

Undergraduate Curriculum
Bachelor of Arts (BA) in Monthly Dividends

Page 2

Psychology 101

“The Psychology of Investing for Income”

Page 4 Math 101

“The Magic of Yield on Cost”

Page 6

Philosophy 101

“The Philosophy of The Monthly Dividend Company®”

Page 8

History 101

11-year Financial Performance Table

Page 11 History 102

“The History of The Monthly Dividend Company®”

Page 12 Modern History 101B

“2005 Review (the short version)”

Page 13 Objective Setting 101

“2006 Business Plan (the short version)”

Page 14 Accounting 101

“Realty Income’s 2005 Operating Results
and Financial Performance”

Page 16 Real Estate 101

“Identifying and Acquiring Retail Properties”

Page 18 Science 101

“The Science of Portfolio Management”

Page 20 Economics 101

“The Economics of Capital Formation and Investor Returns”

Graduate Curriculum
Masters in Business Administration in Monthly Dividends
(The MDU MBA)

Page 23 Strategy 501

Page 35 Accounting 502

R E A LT Y I N C O M E

P SYC H 1 0 1

“THE PSYCHOLOGY OF
INVESTING FOR INCOME”
BY VISITING STUDENT, MONTHLY DIVIDEND GIRL

That’s not to say that there’s anything wrong with other

investment styles, just as there’s nothing wrong with playing

different sports. At different points in life we may have

approached investing differently, just as we might have played

different sports from the ones we play now. Right now we may

find we’re at the point where we want to use our portfolio to

produce a “retirement paycheck” to fund our income needs,

to provide income while we pursue a new career, or replace

salaried income while we engage in a wide variety of activi-

ties. As such, it may be the time when we’re ready to become

an income investor.

Achieving the goals of the various investment styles

requires a certain discipline. So, what are the goals of each of

these investment strategies? Let’s run through growth and

total return investing for a minute before focusing our atten-

Thank you for attending Psychology 101 today. Class, here’s an

tion on the subject of this class, which is the psychology of

important question. What is the difference between investing for

income investing.

income and investing for other objectives? The simple answer is

Investing for growth can be defined as “An investment

that people who invest for income tend to want to own companies

strategy to increase capital by buying stocks that an investor

that pay dependable dividends, or to own bonds issued by

thinks will go up in price.” Investing for growth can generally

companies or government entities that pay interest. But the

be simplified to the following:

reality is, not only does the payment of income to investors set

investing for income apart from other investing styles, it is

• Buy low

• Sell high

the absolute need for income by these investors, to fund the

• Buy and sell things you think will go up

activities of their daily life, that truly differentiates them.

• Make a lot of money to do something with later in life.

“Investing for income” is where people get to when they have

Investing for total return can be defined as “An investment

spent enough time “paying their investment portfolio” and now

strategy that seeks a return on investment that includes

need “their investment portfolio to pay them!”

income from interest or dividends as well as appreciation or

By definition, income investors desire a cash return

depreciation in the price of a security over a given period of

rather than growth and a high dependable yield rather than an

time.” Investing for total return can generally be simplified

overall total return. Income investing is as different from

to the following:

growth or total return investing as baseball is different from

tennis or golf. In all of these sports the idea is to get a ball

• Buy Low

• Sell High

somewhere and win the game. In investing, the idea is to allo-

• Get a little income while you are doing it

cate capital carefully in order to achieve a certain objective.

• Accumulate money to do something with later in life.

In both cases, it is very important to know which game you are

By contrast then, investing for income can be defined

playing and then to effectively pursue a strategy that will

as “An investment strategy which emphasizes current income

allow you to win that game. Well, you get the idea. Income

in the form of dividends from stocks or interest payments

investors are just playing a different game, with different rules

from bonds, rather than emphasizing growth.” Investing for

than other investors.

income could then be simplified to the following:

R E A LT Y I N C O M E 2

• Buy investments that pay dependable income

• Use the income to fund our current lifestyle

• Receive income that increases over time

• Hold these investments as long as they pay

increasing income.

As you can see, these are three very different invest-

investors we understand that cashing in on that price appreci-

ment styles and sets of goals. In the case of income investing,

ation not only ends the dividend income stream we rely on, but

we’re likely to hold our investments for a very long time. With

also invites the tax man to the table. This is an unwelcome

growth and total return investing, we must pay careful attention

event that takes money out of our pockets and so the fact that

to when we buy and sell so that we accumulate money to do

the stock price has gone up tends to be irrelevant to us

something else with later in life.

because we own the stock for the increasing income it pro-

As income investors, when the goal is to receive income

vides over a prolonged period of time. In other words, we know

for life, we will probably want the company providing the

to stick to our game plan and stay with the program.

income to, not only be in business for the foreseeable future,

This is rather like the dairy farmer who owns a milk cow

but to conduct their business in a manner that gives us a rel-

that he hopes will produce milk for many years to come. He’s

atively high degree of confidence in the dependability of the

unlikely to be very concerned with what the price of beef is

income being paid. We might tend to look for stable busi-

doing after he buys his cow, since he’s in the business of

nesses, generating dependable earnings, from which they

producing milk from the cow he owns. The dairy farmer also

can pay regular dividends or interest payments over a pro-

knows he would just have to go out and buy another cow to

longed period of time. Such performance is more likely to

produce the milk he needs if he sold his milk cow. As income

offer the stability and low degree of volatility that is important

investors we are all like the dairy farmer because we’re in the

to us as investors who rely on our investment income to fund

business of keeping our cows and drinking the milk, rather

our current activities.

than turning our cows into hamburger!

We also might tend to prefer receiving stock dividends

So does this mean that income investing is a better

over fixed interest payments. Dividends have the ability to

investment strategy than any other. Not necessarily. It’s just

grow and keep up with inflation in comparison to fixed interest

different and whether or not we pursue an income strategy

payments, which tend to remain constant through the life of

depends on our needs. Again, we need to consider where we

the investment. We would also, generally, prefer an income

are in life, the risks we want to take and what we want to

stream that consistently grows over time, because the longer

achieve with the money we have to invest. It’s also important

we hold our investment, the more money we receive.

to understand that investing for income is fundamentally

And most importantly, we also should understand that it

different from investing for all other objectives.

will take a certain amount of discipline to stick with our

The secret to passing this class and investing wisely (Time

investment choice. The investment landscape is filled with

to take notes, Class) is to be able to identify which game you’re

opinions, ideas and suggestions that can tempt us to go off

playing, what the goals of that game are and to demonstrate

our “game”. It may sometimes be tempting to follow the idea

how well you achieve these goals. Here at good old Monthly

or investment fad of the week, particularly if we’ve not only

Dividend University (MDU) the answer is, of course, that we

enjoyed steady dividends, but we’ve also seen our principal

are all income investors, and monthly income investors to boot.

increase over the years. But since we’re disciplined income

Remember that and you’re sure to get an A+ on your final.

(Disclosure: Monthly Dividend Girl is a visiting student who is also a shareholder of and head cheerleader for Realty Income.)

R E A LT Y I N C O M E

M A T H 1 0 1

“THE MAGIC OF YIELD ON COST”
BY PROFESSOR TOM A. LEWIS

Welcome Class. I’m pleased that you’re here and interested in

meet their income and financial goals once their earning

learning about something that, I believe, is the “holy grail” of

years are over.

income investing. You’ve already learned the rules and psychol-

“OK then, Investing for Income is for me” you might say.

ogy of income investing, but now we need to get to the “Magic”

But, how exactly can we measure the ongoing success of our

of how to manage your investments so that you can obtain

income investments. The answer is, of course, we measure

investment income that lasts as long as you need it to last.

success differently than how growth and total return investors

The secret is in how we analyze our income investments.

measure success in their portfolios. For income investors,

Conventional financial advice has historically been to put

measuring success involves the use of a great income investing

together a portfolio that involves some income combined with

metric. When this “Magic” metric is used in combination with

a gradual drawing down of one’s principal. All of this is pred-

a long-term outlook and a conservative orientation, we have a

icated on an estimate as to how long one plans to live and how

better chance of accurately measuring our results and obtain-

much the cost of living will increase.

ing the increasing income we need over time. Many Realty

Building a retirement portfolio in this way can be fraught

Income investors have achieved investment success by apply-

with complications. Attempting to predict how long we’ll be

ing this “holy grail” of income investing—Yield on Cost—in

retired or what the cost of maintaining our style of living will

measuring their investment results.

be is difficult at best, particularly since people are living

The formula for calculating Yield on Cost is relatively

much longer than ever before. There is also the constant mon-

simple. Divide your current annual dividend by the original

itoring of the portfolio, making adjustments as needed, worry-

cost you paid for your shares of stock and the result is your

ing over such moves and paying the costs associated with

Yield on Cost. For those of you who took basic algebra in high

them. Add to this the tax ramifications of trading and it is

school the formula would be:

not surprising that a number of investors are challenged to

“I suspect that many more investors will
become shareholders of Realty Income
once the Baby Boomers begin to look for
more secure avenues of depositing their
capital. Annuities are sound, but they
yield too little for someone trying to fight
inflation. Realty Income offers some-
thing wonderful by means of dividends.
Take the $1.11 dividend back in 2000
yielding about 11%. Now that old money
is yielding 13.95% today, something no
annuity or money market fund could
come close to touching.”
Michael Whitten
2nd Lieutenant, U.S. Army, (stationed in Germany),
Shareholder and Yield on Cost Expert

Current Annualized Dividend

__________________________ = Yield on Cost

Original Cost Per Share

Pretty simple, huh? What this metric tells us, on any

given day, is what our dividend yield is today on our original

investment. As owners of Realty Income, for example, the

dividend has been regularly increased over the past eleven

years, so our income (and Yield on Cost) has continued to

increase over time. This means that $10,000 invested in

Realty Income shares in 1994, at $8.56 per share, today has a

Yield on Cost of 16.3%, based on a current annualized dividend

per share amount of $1.395. So, if we use our formula for

Yield on Cost, our calculation would be:

$1.395 (Our current annualized dividend)

__________________________ = 16.3% (current yield

$8.56 share price at 12/31/94

on cost for shares

purchased in 1994)

R E A LT Y I N C O M E 4

E X A M P L E :

The chart above demonstrates the Yield on Cost based

If the Yield on Cost has continually increased over the life of our

on various dates of purchase and gives us an idea of what our

investment, there is very little reason for us to sell our shares.

yield on cost might be. But, more importantly, it demonstrates

With this simple calculation we can easily determine how

that the longer one owns shares of a company, where divi-

well our income investments have performed for us when the

dends are regularly increased, the yield on one’s original

temptation arises to sell our source of dependable income.

investment actually accelerates, over time.

What a great way to measure the success of our invest-

This leads us to a critical investment principle of holding

ments! This is particularly true for an investor whose primary

an income investment for the long-term. As long as the

objective is to receive increasing dividend income over a long

company continues to be a reliable producer of increasing

period of time!

income and maintains a conservative, long-term perspective,

A new income investment paradigm, therefore, is to find

the ideal would be to hold such an investment forever.

investments that pay high quality, increasing income, and keep

The lesson here is that, since our objective is to obtain

them as long as they continue to produce a rising yield on cost

increasing income over time, our best measure of success in

over time. Once you’ve “got” this lesson, you’ll not only receive

achieving this objective is to calculate our current Yield on Cost,

an A in the class, but you’ll also be able to build and maintain

for a specific investment, to see how it has increased over time.

an income portfolio that is designed to last a lifetime.

(Disclosure: Professor Lewis serves as adjunct professor in Math at MDU and moonlights

as Realty Income’s Chief Executive Officer.)

R E A LT Y I N C O M E

PH I LO S O PHY 1 0 1

“THE PHILOSOPHY OF THE
MONTHLY DIVIDEND COMPANY®”
BY PROFESSOR GARY M. MALINO

Welcome to class, students.

20-year, net-lease agreements, where the retailer generally

Today’s subject is the philoso-

pays the property taxes, maintenance costs and property

phy of The Monthly Dividend
Company®. The faculty of

insurance payments, as well as a monthly rental payment to

Realty Income. This rental revenue has been a reliable gen-

Monthly Dividend University

erator of cash to pay monthly dividends to the Company’s

strongly believe that a well

shareholders over a long period of time.

thought-out philosophy, which

a company uses to guide its

A second important point is the conservative operating
focus of The Monthly Dividend Company®. Since the Company

activities and operations, is

was founded, it has never carried a mortgage on any of

critical to its long-term success. I believe that The Monthly
Dividend Company® is one of many such companies that

the properties that it owns. In addition, Realty Income also

focuses on maintaining a conservative balance sheet, prefer-

operate their business in a manner consistent with their overall

ring to fund most of its real estate acquisitions by issuing

philosophy and this is one of the key reasons Realty Income

additional shares of common stock. Keeping the amount of

has been successful for many years.

debt the Company carries at a modest amount, along with

The philosophy of The Monthly Dividend Company® is,

controlling operating expenses, frees up the majority of Realty

quite simply, to provide all of its shareholders with increasing

Income’s rental revenue for the payment of monthly dividends

monthly dividends every month, year after year, for the rest

to its shareholders.

of their lives. This philosophy, simple as it may sound, colors

The success of this methodology is demonstrated by the

every decision the Company makes, dollar it spends, its

payment of over 425 monthly dividends since the Company’s

management discussions, and all of the employee’s activities

founding in 1969, combined with 37 dividend increases since

undertaken each day at Realty Income. Since the guiding

the Company went public in 1994. This consistent record of

principle of the Company is to provide income-focused

dividend payments and increases earned Realty Income a

investors with a check every month for

the rest of their lives, the responsibility

to act prudently and appropriately to

accomplish this mission is the absolute

priority for Realty Income employees.

That being said, how does Realty Income

go about achieving the objectives that

result from this philosophy?

The Company’s strategy of owning a

sizable portfolio of properties, operated

under long-term lease agreements with

large retail chains, is the means to

continuing to provide monthly dividends.

These properties are leased to a large

number of retail chains under 15- to

R E A LT Y I N C O M E 6

spot in Mergent Inc.’s, Dividend Achiever Handbook in 2005

should know the Company is run specifically to meet the needs

(Mergent’s Dividend Achiever is a guidebook that identifies

of income-oriented investors.

companies that have increased their annual dividend pay-

Given all of this, how does the “faculty” of MDU view

ments for ten or more consecutive years.) The Company is one

their investment in Realty Income?

of just 313 public companies that qualified for inclusion in

We enjoy owning shares of Realty Income because it

this prestigious guide to dividend-paying stocks, out of approx-

provides us with increasing, spendable income that we look

imately 10,000 plus North American-listed, dividend-paying

forward to receiving for the rest of our lives. The shares that

common stocks. In fact, Mergent also ranked Realty Income in

we own are, generally, a large portion of our total assets and

the top 50 for compound annual dividend growth.

so we depend on this income to support our families. With

Realty Income’s consistent operating strategy and dividend-

that said, there is risk in any investment and we recommend

paying track record is the day-to-day result of a philosophy

that all shareholders (including MDU’s faculty and Realty

rigorously applied. Since the philosophy of providing depend-

Income’s management team) remain diversified and have a

able monthly dividends is at the center of the Company’s

wide variety of investments to generate the income they need.

activities, a certain “point of view” is present at all times.

We must also make sure that each of the companies we

This point of view mandates that Company employees and

depend upon to generate our income have an overriding phi-

managers understand and place the needs of income

losophy that supports the payment of dividends and that their

investors ahead of all other considerations. This also means

strategy and activities match our income needs.

that, because the Company is focused on providing dependable

That’s it for today’s lecture. Thanks for coming to class!

monthly income over a prolonged period of time, it does

not do other things that may temporarily be popular in

the investment world but could distract them from their core

mission. This philosophy also tends to keep Realty Income

from focusing on activities that might boost short-term growth

prospects at the expense of the Company’s long-term objectives.

Because of this focus, owning shares of The Monthly
Dividend Company® may not be for everyone. Students

and investors should understand that Realty Income

is an income investment and, therefore, pursues the

goals and plays by the rules of income investing.

Other types of investors, such as growth and total

return investors, have much different goals than

income investors. While shareholders, with verifying

investment styles, can own Realty Income shares, they

(Disclosure: Professor Malino is Chairperson of MDU’s Harley Davidson Club (“Lord help us!”) as well as

President and Chief Operating Officer of Realty Income.)

R E A LT Y I N C O M E

H I S T O RY 1 0 1

For the Years Ended December 31,

2005

2004

2003

Total revenue(1)

Net income available to

common stockholders

Funds from operations (“FFO”)(2)

Dividends paid to

common stockholders

Special dividend paid(3)

AT Y E A R E N D

Real estate at cost, before

$ 197,733,000

$ 177,606,000

$ 150,370,000

89,716,000

129,647,000

90,168,000

118,181,000

76,722,000

103,366,000

108,575,000

97,420,000

83,842,000

accumulated depreciation(4)

$ 2,096,156,000

$ 1,691,283,000

$ 1,533,182,000

1,646

13,448,600

156

1,533

11,986,100

194

1,404

11,350,800

302

$ 486,553,000

$ 215,314,000

$ 371,642,000

Number of properties

Gross leasable square feet

Properties acquired(5)

Acquisition cost(5)

Properties sold

Number of retail industries

Number of states

Portfolio occupancy rate

Remaining weighted average

lease term in years

P E R C O M M O N S H A R E D ATA(6)

Net income (diluted)

Funds from operations (“FFO”)

Dividends paid

Special dividend

Annualized dividend amount(7)

98.5%

12.4

1.12

1.62

1.346

1.395

97.9%

12.0

1.15

1.50

1.241

1.32

Common shares outstanding

83,696,647

79,301,630

I N V E S T M E N T R E S U LT S

Closing price on December 31,

21.62

Dividend yield (8)(9)(10)

Total return to stockholder (10)(11)

5.3%

-9.2%

25.29

6.2%

32.7%

98.1%

11.8

1.08

1.45

1.181

1.20

75,818,172

20.00

6.7%

21.0%

(1) Total revenue includes amounts reclassified to income from discontinued operations, but excludes revenue from Crest Net Lease, a subsidiary of Realty Income.

(2) Refer to Management’s Discussion and Analysis for FFO definition and reconciliation to net income available to common stockholders.

(3) The 1994 special dividend reflects the final partnership distributions.

(4) Does not include properties held for sale.

(5) Includes properties acquired by Realty Income and Crest Net Lease.

(6) All share and per share amounts reflect the 2-for-1 stock split on December 31, 2004.

(7) Annualized dividend amount reflects the December declared dividend rate per share multiplied by twelve.

R E A LT Y I N C O M E 8

2002

2001

2000

1999

1998

$ 137,600,000

$ 121,081,000

$ 116,310,000

104,510,000

$ 85,132,000

68,954,000

93,539,000

57,846,000

76,378,000

45,076,000

67,239,000

41,012,000

65,917,000

41,304,000

62,799,000

78,042,000

64,871,000

58,262,000

55,925,000

52,301,000

$ 1,285,900,000

$ 1,178,162,000

$ 1,073,527,000

$ 1,017,252,000

$ 889,835,000

1,197

9,997,700

111

1,124

9,663,000

117

1,068

9,013,200

1,076

8,648,000

110

970

7,824,100

149

$ 139,433,000

$ 156,472,000

98,559,000

$ 181,376,000

$ 193,436,000

97.7%

10.9

1.01

1.38

1.151

1.17

69,749,654

17.50

7.8%

26.9%

98.2%

10.4

0.99

1.30

1.121

1.14

97.7%

9.8

0.84

1.26

1.091

1.11

98.4%

10.7

0.76

1.23

1.043

1.08

99.5%

10.2

0.78

1.18

0.983

1.02

65,658,222

53,127,038

53,644,328

53,634,206

14.70

9.0%

27.2%

12.4375

10.3125

12.4375

10.6%

31.2%

8.4%

–8.7%

7.7%

5.5%

(8) Dividend yield was calculated by dividing the dividend paid per share during the year by the closing share price on December 31 of the previous year.

(9) Dividend yield excludes special dividends.

(10)The 1994 dividend yield is based on the annualized dividends for the period from August 15, 1994 (the date of the consolidation of the predecessors to the

Company) to December 31, 1994. The 1994 total return is based on the price change from the closing on October 18, 1994 (the Company’s first day of trading)

to December 31, 1994 plus the annualized dividend yield.

(11)Total return was calculated by dividing the net change in the share price during the year plus the dividends paid per share during the year by the closing share

price on December 31 of the preceding year.

R E A LT Y I N C O M E

1997

1996

1995

1994

$ 67,897,000

$ 56,957,000

$ 51,555,000

$ 48,863,000

34,770,000

52,188,000

44,367,000

32,223,000

47,139,000

42,794,000

5,285,000

25,600,000

40,414,000

36,710,000

15,224,000

39,050,000

38,816,000

5,850,000

$ 699,797,000

$ 564,540,000

$ 515,426,000

$ 450,703,000

826

6,302,300

740

5,226,700

685

4,673,700

630

4,064,800

$ 142,287,000

$ 55,517,000

$ 65,393,000

3,273,000

99.2%

9.8

0.74

1.11

0.946

0.96

99.1%

9.5

0.70

1.04

0.931

.23

0.95

99.3%

9.2

0.63

1.00

0.913

0.93

99.4%

9.5

0.39

0.98

0.300

0.90

51,396,928

45,959,074

45,952,474

39,004,182

12.719

11.9375

11.25

8.5625

7.9%

14.5%

8.3%

15.4%

10.7%

42.0%

9.9%

28.5%

1 0

R E A LT Y I N C O M E

H I S T O R Y 1 0 2

“THE HISTORY OF THE
MONTHLY DIVIDEND COMPANY®”
BY PROFESSOR TERE H. MILLER

Realty Income, also known as The Monthly Dividend Company®,

was founded in 1969 by William and Joan Clark. The Company

was originally formed to invest in high quality, commercial

properties, leased to regional and national retail chains, under

long-term leases that produced monthly rental income. The

founding ideology, then, was to “preserve capital and to pro-

duce monthly income” by owning these type of properties.

For approximately 25 years, between 1969 and 1994,

investors received regular monthly distributions from Realty

• The Company increased revenues more than 305%,

Income’s investment programs. Then, in August 1994, Realty

from $49 million in 1994 to over $197 million as of the

Income merged 25 programs into one entity, which began

end of 2005.

trading on the New York Stock Exchange in October of that

Realty Income has enjoyed a relationship with many

same year.

shareholders who have owned shares since the early days of

Since that time investors have continued to receive a

the Company’s operations, as well as new income-oriented

monthly dividend check from Realty Income. As you can see,

shareholders who have been attracted to the Company’s

not much has changed in 37 years. Realty Income has

conservative track record and consistent monthly dividend.

continued to pay monthly dividends and still focuses on the

This loyal shareholder base continues to benefit from a strategy

ongoing needs of income-oriented investors. And these divi-

that has proved to be resilient throughout a variety of economic

dends continue to be supported by the income generated

conditions over the years. They’ve weathered everything from

from retail properties that offer goods and services meeting

high inflation to low inflation, recession to double digit

“basic human needs.”

economic growth, high interest rates to low interest rates and

In 2005, Realty Income celebrated over One Billion

high unemployment to strong employment. Through it all, year-

Dollars in cash dividends paid and 11 very successful years of

after year, the monthly check they rely on has been in the mail.

trading on the New York Stock Exchange. The Company

continues its successful operations, maintaining a legacy of

conservative management and a focus on generating depend-

able monthly income. Let’s take a look at the Company’s

progress over the past eleven years:

• Since 1994, the Company has, on average, raised the

dividend approximately 5% every year and has grown the

annualized dividend amount from $0.90 per share to

$1.395 per share, an increase of 55%.

• As of December 31, 2005 Realty Income has paid a total

of $1.1 billion in dividends.

• The size of the Company’s real estate portfolio, at cost,

has grown from $451 million in 1994 to $2.1 billion today.

• The number of retail properties owned has grown from

630 to 1,646.

(Disclosure: Professor Miller heads up MDU’s annual walk-a-thon and serves as Vice President of Corporate Communications

and Investor Relations of Realty Income.)

1 1

R E A LT Y I N C O M E

M O D E R N H I ST O RY 1 0 1 B

2005 REVIEW (THE SHORT VERSION)

GENERAL COMMENT:

Another good year for the operations of
The Monthly Dividend Company®

FINANCIAL PERFORMANCE:

• Revenue increased 13.2% to $196.7 million
• FFO per share increased 8.0% to $1.62

DIVIDEND UPDATE:

SHARE PRICE PERFORMANCE:

RETURNS TO SHAREHOLDERS:

• Paid 12 monthly dividends
• Increased the dividend 5 times
• Paid 425 consecutive monthly dividends since 1970

12/31/04 closing price: $25.29
12/31/05 closing price: $21.62
14.5% decrease

Dividend yield of 5.3%
Share price decrease of 14.5%
Total return of -9.2% for 2005

TOTAL MARKET CAPITALIZATION:

$2.8 billion on 12/31/05

BALANCE SHEET:

Very strong

PROPERTY MORTGAGE DEBT:

Zero ($0)

REAL ESTATE PORTFOLIO:

1,646 retail properties leased to 101 retailers in 29 retail
categories located throughout 48 states

PORTFOLIO OCCUPANCY:

98.5% on 12/31/05

PROPERTY ACQUISITIONS:

156 properties for $486.6 million
Initial average lease term of 15.8 years

R E A LT Y I N C O M E 1 2

O B J E C T I V E S E T T I N G 1 0 1

2006 BUSINESS PLAN *

— PAY 12 MONTHLY DIVIDENDS
— RAISE THE DIVIDEND
— MAINTAIN A CONSERVATIVE BALANCE SHEET
— MAINTAIN HIGH PORTFOLIO OCCUPANCY
— ACQUIRE ADDITIONAL PROPERTIES
— TELL MORE PEOPLE ABOUT THE MONTHLY DIVIDEND COMPANY®
— REMAIN CONSERVATIVE
* THIS BUSINESS PLAN WILL LOOK FAMILIAR TO MDU ALUMNI

1 3

R E A LT Y I N C O M E

A C C O U N T I N G 1 0 1

REALTY INCOME’S 2005 OPERATING RESULTS
AND FINANCIAL PERFORMANCE
BY PROFESSOR MICHAEL R. PFEIFFER

Realty Income’s senior management team is pleased to report

also considered to be a good indicator of a company’s ability

another successful and profitable year for the operations of
The Monthly Dividend Company®. In fact, in many ways 2005

to pay dividends. A reconciliation of net income available to

common shareholders to FFO per common share, is included in

was the best year in the history of the Company. During the

Management’s Discussion and Analysis of Financial Condition

year, the Company enjoyed success in all areas of its business

and Results of Operations on page 60.

operations including, strong overall property portfolio perform-

Net income available to common shareholders, as of

ance, outstanding access to capital at attractive rates, as well

December 31, 2005, was $89.7 million as compared to

as a record number of property acquisitions, the highest in

$90.2 million in 2004. On a diluted per common share basis,

the history of the Company. As a result, Realty Income also

net income was $1.12 per share in 2005 as compared to

ended the year with record revenue, funds from operations

$1.15 per share in 2004. (The calculation to determine net

(FFO) and dividends.

Revenue growth is an important objective of

the Company because it is crucial to Realty

Income’s ability to increase FFO and dividends.

During 2005, revenue increased 13.2% to

$196.7 million, as compared to $173.7 million

during 2004. This revenue growth is primarily

attributable to the high level of property acquisitions

achieved in both 2004 and 2005. As of

December 31, 2005, Realty Income and its

Crest Net Lease subsidiary had acquired 156 new

properties for $486.6 million. Realty Income

invested $430.7 million in 135 properties, to be

held for long-term investment in the Company’s core portfolio,

income for a real estate company includes

gains from the sales of investment properties

and impairments. The amount of gains from

property sales and impairments vary from

year to year according to the timing of prop-

erty sales. This variance can significantly

impact net income.)

Realty Income’s subsidiary company,

Crest Net Lease, Inc., also contributed to

Realty Income’s earnings growth

during 2005. Crest was formed

to capitalize on the oppor-

tunities to acquire and

sell retail properties for

while Crest Net Lease acquired 21 properties for $55.9 million

a profit. Crest’s primary purpose, however, has been to enable

and these properties were marketed for resale. Realty Income’s

Realty Income to complete the acquisition of large portfolios

properties are located in 28 states, have an initial average lease

of properties and then provide the vehicle to subsequently sell

rate of 8.4% and an initial average lease term of 15.6 years.

the properties that the Company does not plan to hold. While

As a result of higher than average acquisition activity, FFO

Crest has been successful in assisting Realty Income in its

available to common shareholders also increased 9.6% to

acquisition efforts, Crest has also added each year to Realty

$129.6 million, as compared to $118.2 million during 2004.

Income’s profitability. During 2005, Crest generated $2.8 million,

On a diluted per common share basis, FFO increased 8.0% to

or $0.03 per share, in FFO for Realty Income, in comparison

$1.62 per share, as compared to $1.50 per share for 2004.

to $7.8 million, or $0.10 per share, in FFO for Realty Income

FFO is a common measurement for a real estate investment

in 2004. At December 31, 2005 Crest held inventory of

trust, or REIT. It is an alternative non-GAAP measure that is

$45.7 million in 17 properties being marketed for sale.

R E A LT Y I N C O M E 1 4

The Company continued to enjoy consistent performance

The ongoing solid operating and financial performance of

on the 1,646 properties that comprise Realty Income’s retail

Realty Income has made possible the payment of 425 consec-

real estate portfolio. Occupancy remained strong throughout

utive dividends since 1969, 33 quarterly dividend increases

2005 and was 98.5% on December 31, 2005. During 37 years

and a total of 37 increases in the amount of the monthly

of operations, and through varying economic situations, the

dividend since 1994. In addition, the amount of the annualized

Company’s occupancy level at the end of each year has never

dividend has increased from $0.90 per share in 1994 to $1.395

fallen below 97%. Such performance speaks to Realty

per share, as of December 31, 2005, an increase of 55%.

Income’s focus on acquiring properties where retailers provide

Shareholders also received $1.34625 in dividends paid during

basic human needs goods and

services that consumers use

every day.

2005 for a yield of 5.3% based on the closing share price of

$25.29 on December 31, 2004.

(Disclosure: Professor Pfeiffer coaches MDU’s swim team and also writes voluminous legal documents as Realty Income’s

Executive Vice President, General Counsel and Secretary.)

(1) Total revenue includes amounts reclassified to income from discontinued operations, but excludes revenue from Crest Net Lease.

1 5

R E A LT Y I N C O M E

R E A L E S T A T E 1 0 1

“IDENTIFYING AND ACQUIRING
RETAIL PROPERTIES”
BY PROFESSOR KIM KUNDRAK

investment criteria of Realty Income. This effort requires the

ability to anticipate when certain retail industries require

financing, to understand the financial requirements of various

retail industries, and a thorough knowledge of the retailer’s

operations and real estate.

Over the years Realty Income has worked with a number

of industries at opportune times, such as fast food restaurants

in the 1970’s, child daycare in the 1980’s, the convenience

store industry in the 1990’s, to mention just a few. Uncovering

such opportunities continues to be a focus of the Company’s

efforts. However, over the past few years, an environment of

increased competition and decreasing lease yields has

demanded greater emphasis on utilizing Realty Income’s size

and cost-of-capital advantages, as well as its transaction

expertise, in order to maintain the Company’s leadership in

the sale-leaseback financing arena.

The Company has also had to continually generate new

strategies for acquiring properties and research additional

When an investor purchases retail real estate for income, that

industries to remain agile and successful in its acquisitions

investor needs to ascertain both the feasibility of the property

efforts. Realty Income’s acquisition officers are the driving

as a retail location, as well as the financial and operational

force in developing the Company’s new business. Seven real

health of the prospective retail chain that will occupy the prop-

estate and finance executives call on various, strategically

erty. This analysis provides the individual real estate investor

identified, retail chains and other entities to generate invest-

with the confidence that lease payments will be made as

ment opportunities throughout the year. Each of these pro-

agreed. For a large real estate investment company like Realty

fessionals is assigned either an area of the country for which

Income, dedicated to providing dependable monthly income for

they are responsible, or a particular industry segment in

thousands of investors, this scrutiny is of the utmost impor-

which they develop specific expertise. In all cases, these

tance for long-term success. It is worth spending some class

calling officers are the eyes and ears of the Company and the

time to discuss how Realty Income identifies and analyzes retail

first line of inquiry and information relative to generating

real estate that will be a reliable generator of income.

transactions for Realty Income.

Acquiring quality retail properties begins with the

Identifying new industries and retailers with whom to do

Company’s ability to uncover a large number of potentially

business every year is just one aspect of remaining competitive

viable transactions from which it can select the properties it

and supporting the Company’s ability to grow the real estate

wishes to purchase. Finding these opportunities is a key

component to Realty Income’s ability to continue to increase

the size of the Company’s real estate portfolio and the rental

revenue it generates. This process involves a tremendous

amount of activity that focuses on identifying which retail

industries will require capital over the coming years and, as

such, wish to sell their properties in order to acquire that

capital. Another activity involves identifying attractive retail

chains, in select industries, that own the type of real estate the

Company would like to purchase. And finally, Realty Income

works with prospective retail chains to structure potential

transactions that fit both the needs of the retailer and the

R E A LT Y I N C O M E 1 6

portfolio. Assessing the feasibility of prospective properties is

$430.7 million in 135 properties to be held for long-term

the other critical function. Realty Income’s real estate

investment in the Company’s core portfolio. These properties

research group does the footwork, performing individual site

are located in 28 states, have an initial average lease rate of

and demographic analysis, assessing traffic flows, monitoring

8.4% and an initial average lease term of 15.6 years. They

competitive operations and meeting with local market experts

are leased to 13 different retail chains in seven retail indus-

for every single property that the Company plans to purchase.

tries. Crest Net Lease acquired 21 properties for $55.9 million

Realty Income’s retail research group provides the com-

and these properties were marketed for resale. These acqui-

petitive, operational and financial review of prospective retail

sitions contributed to increased lease revenue that generat-

tenants. Since the Company is relying on these retailers to

ed FFO per share growth during 2005.

occupy its properties and pay rent for 15 to 20 years, selecting

Realty Income usually counsels investors that this level of

the right retail industries and chains is crucial. The retail

acquisition activity is not something to be taken for granted.

research group follows economic and industry trends on over

The fact that the Company had a record year in 2005 does

29 different retail industries and scrutinizes operations of all

not necessarily establish a trend that can be extrapolated into

101 retail chains in the Company’s current investment portfolio.

the future. The environment for net-lease retail properties has

They also meet with the man-

agement of retail chains the

Company is considering, assess

their business plans, review

their competitive position in

the marketplace and make

recommendations regarding

the suitability of a particular

industry or retail chain for the

Company’s portfolio.

The research assembled by

both the real estate and retail

become increasingly competi-

tive over the years and the

Company projects that this sit-

uation is likely to continue

into the foreseeable future.

Additionally, in any given year

it is the Company’s objective

to buy ONLY the properties that

meet its investment criteria

and are considered suitable

to generate long-term rental

revenue from which to pay

research group, combined with the acquisition prospects

dividends. As such, acquisition volumes will vary considerably

uncovered by the acquisitions team, provide the potential

from year to year, depending on the ability of the Company

investment packages for Realty Income’s Investment

to find and acquire the properties that meet its stringent

Committee to consider. The Investment Committee consists of

investment requirements.

the four senior executive officers of the Company. This

With that said, however, Realty Income has been very active

Committee meets one or more days each week to analyze

in working with large companies that are in the process of

every investment opportunity that has gone through the due

acquiring other retailers, pursuing other growth initiatives, recap-

diligence process. In 2005, the Investment Committee reviewed

italizations, balance sheet restructurings or other financial

about $2.8 billion in potential real estate acquisitions involving

events where Realty Income’s acquisition of properties, to

over 1,700 properties. This was not only the highest volume

generate capital for the retailers, can be useful. The Company’s

of potential transactions ever reviewed by the Company, but

ability to purchase large portfolios of properties within a spe-

this activity ultimately led to a record year for Realty Income’s

cific time frame is a vital competitive advantage in these

portfolio acquisitions department.

types of transactions. So too is Realty Income’s 37 years of

During 2005, Realty Income and its Crest Net Lease

experience in sale-leaseback financing, its sizable resources,

subsidiary acquired 156 properties for $486.6 million. Of

access to capital and experienced management team that

the 156 properties purchased, Realty Income invested

seeks to add value to every transaction for its retail customers.

(Disclosure: Professor Kundrak plays on MDU’s faculty basketball team and serves as Senior Vice President,

Portfolio Acquisitions for Realty Income.)

1 7

R E A LT Y I N C O M E

S C I E N C E 1 0 1

“THE SCIENCE OF PORTFOLIO MANAGEMENT”
BY PROFESSOR RICHARD COLLINS

their 15- to 20-year contractual lease agreements.

The Company has always called this a fairly “simple

concept.” Behind the scenes, however, there is a

great deal that must be done to ensure that the

Company’s portfolio of 1,646 properties continues

to perform as desired. After all, the objective is for

Realty Income to receive lease payments every

month so that it can then pay dividends each

month to its shareholders for a long period of time.

There are several aspects to consistent portfolio

performance that support the payment of monthly

dividends. Effectively managing the portfolio, so

that occupancy remains high, is one factor.

Fortunately, Realty Income has enjoyed more than

97% occupancy throughout its 37 years of opera-

tions. As of December 31, 2005, portfolio occu-

pancy was 98.5% and there were just 25 proper-

ties available for lease out of 1,646 properties in the

portfolio. Diversification across 29 retail industries,

101 retail chains, and across 48 states is one

reason why the Company has been able to maintain

such high occupancy. Another reason is the

Company’s focus on acquiring properties from

retailers who provide basic human needs goods

and services that consumers use every day. Both

of these factors contribute to stable portfolio

operations as well as to the safety of the dividend.

What is the “Science of Portfolio Management”? At first

A vital component to sustaining strong portfolio perform-

glance, managing a net-leased property portfolio appears

ance and high occupancy is retail research. The importance

fairly straightforward. When a net-lease agreement is com-

of such research cannot be overstated. Realty Income’s portfo-

bined with a solid tenant, the result is a reliable income

lio management team, as good as they are, are not magicians.

stream, rather like combining hydrogen and oxygen to form

They can’t turn a challenging retail tenant into a good performing

water. Theoretically then, owning a portfolio of net-leased

tenant, no matter how diligent they are. Thus, the foundation for

properties is a simple proposition, right?

ongoing solid portfolio operations is to purchase good properties

To the extent that Realty Income’s properties and tenants

with sound tenants in the first place. The retail research group

have passed a rigorous due diligence process, the Company

at Realty Income follows economic and industry trends on over

enjoys a certain degree of confidence that its tenants will meet

29 different retail industries and scrutinizes operations of all

R E A LT Y I N C O M E 1 8

PORTFOLIO OCCUPANCY

2005 2004 2003 2002 2001 2000

1999 1998 1997

1996 1995 1994

98.5%

97.9%

98.1%

97.7% 98.2% 97.7% 98.4% 99.5% 99.2% 99.1% 99.3% 99.4%

As of December 31

options. The markets where Realty Income owns properties

with leases scheduled to expire are also closely monitored to

gauge whether or not it would be better to re-lease a property

to the same tenant, to a new tenant or to sell a property when

the lease expires. This proactive management contributed to

the successful administration of 105 lease expirations dur-

ing 2005. In addition, in 2005, same store rent increases

for Realty Income’s portfolio were 0.8%.

As proficient as Realty Income has been in keeping portfolio

occupancy strong over the years, the Company has, once again,

been fortunate that its retailers performed well during another

year of economic uncertainty. As always, Realty Income’s man-

agement stresses that there is the possibility that a tenant, no

101 retail chains in the Company’s portfolio. This research

matter how strong or recession-proof it may seem to be, could

team continuously monitors tenant financial health and pro-

face unexpected financial difficulties and struggle to pay rent.

vides the Company with the regular, in-depth, tenant financial

This has happened in the past and will likely occur again in the

analysis that is required to ensure the consistent payment of

future. Realty Income views this as “business as usual” and

rent every month.

handles such events as routine occurrences when owning a

Another important aspect of managing the Company’s

large portfolio of properties. With 37 years of portfolio man-

real estate assets is to know if a particular property should be

agement experience behind them, however, Realty Income’s

sold. This is not only a strategic option during investment per-

management team has the know-how and resilience to work

formance analysis, but it is also another source of capital for

through a variety of economic challenges that may arise.

the Company. Property sales occur when management believes

sale proceeds can be reinvested at higher returns, the sale of

a property enhances portfolio credit quality, or selling a property

increases the average remaining lease term in the portfolio.

During 2005, Realty Income sold 23 properties for $23.4 million,

all of which met this criteria.

The primary reason that the Company’s real estate portfolio

has continued to perform well over the years, however, is the

proactive management of the portfolio. Instead of waiting for a

lease to expire to discover a retailer’s intentions, the portfolio

management team enters into discussions, considerably in

advance of the expiration date, to determine the Company’s

(Disclosure: Professor Collins is coach of MDU’s racquetball squad and serves as Executive Vice President,

Portfolio Management for Realty Income.)

1 9

R E A LT Y I N C O M E

E C O N O M I C S 1 0 1

“THE ECONOMICS OF
CAPITAL FORMATION AND
INVESTOR RETURNS”
BY PROFESSOR PAUL M. MEURER

C A P I T A L F O R M A T I O N

Realty Income uses its $300 million unsecured acquisi-

tion credit facility, in the short term, to purchase properties so

that the Company can efficiently acquire properties with no

financing contingencies. The Company then permanently

finances these acquisitions by issuing common or preferred

stock or bonds and pays down the balance on its $300 mil-

lion acquisition credit facility. The principle behind this pro-

cedure is that permanently financing transactions on or soon

after closing tends to minimize the amount of variable rate

debt to which the Company is exposed. This strict, long-term

Company policy has been instrumental in minimizing the

impact rising interest rates might otherwise have had on

Realty Income’s cash flow throughout its operating history.

Another important point is that the Company owns all of its

properties free and clear of property level encumbrances, i.e.

without mortgages, so that more of the Company’s cash flow is

available to pay dividends.

During 2005, Realty Income took advantage of favorable

market conditions to permanently fund its recent acquisitions.

Since the Company was able to achieve attractive pricing for

both its common stock and unsecured bonds, Realty Income

found it advantageous to use both of these sources of capital

The primary purpose of Realty Income’s capital markets

during the year.

activities is to permanently fund the Company’s new property

Credit rating upgrades, received in 2003, facilitated the

acquisitions. Since the growth of the Company’s real estate

portfolio is a primary driver of growth in earnings and divi-

dends, access to capital to fund new property acquisitions is

critical to achieving that growth. And, assembling the most

efficient capital structure, so that the company enjoys unin-

terrupted access to cost-effective capital, is rather like select-

advantageous pricing of a March 2005 offering of $100 mil-
lion of 30-year, 5 7/8% unsecured bonds due in March 2035.
Subsequently, a Fitch Ratings agency upgrade of Realty

Income’s credit rating, in September 2005, was instrumental
in attractively pricing a $175 million, 12-year, 5 3/8% unse-
cured bond offering due in 2017. The Company’s senior unse-

ing the right club to use when making an approach shot to the

cured debt ratings from Fitch Ratings Credit Agency rose to

green in golf. Too much club and you’ll overshoot the green,

too little and you come up short, making it difficult to par

the hole. For non-golfers, we’re talking about knowing how to

use certain tools and understanding when to use them so that

the desired outcome is achieved.

Since the objective of a Company like Realty Income is

to maintain the integrity of the cash flow used to pay dividends,

a relatively conservative capital structure, in comparison to many

other real estate companies, is what the Company strives for.

Realty Income has a bias towards using common equity to fund

acquisitions and carefully blends in other forms of capital to seek

a balance between the best cost of capital and a conservative

capital structure. Debt and preferred stock are generally used

only when there are clear, cost-of-capital advantages. The bal-

ance between different capital components is monitored at all

times so that the Company’s conservative structure is maintained.

R E A LT Y I N C O M E 2 0

BBB+ from BBB, and the Company’s preferred stock ratings

decrease. Interestingly, strong performance in the Company’s

increased to BBB from BBB–.

operations every year may not correlate to the movement of

Also in September 2005, Realty Income issued 4.1 million

the stock price over the short term. For instance, since 1999

common shares priced at $23.79 per share raising gross pro-

Realty Income’s annual Funds from Operations (FFO) per

ceeds of approximately $97.5 million. The proceeds from all

share growth rate was: 4.2% in 1999, 2.4% in 2000, 3.2%

of these transactions were used to fund acquisitions and for

in 2001, 6.2% in 2002, 5.1% in 2003, 3.4% in 2004 and

other general corporate purposes.

8.0% in 2005. In comparison, the Company’s stock price per-

The Company’s capital structure at the end of the year

centage change in the same years has been: –17.9% in

consisted of 64.0% in equity, 4.5% in preferred stock and

1999, 20.6% in 2000, 18.2% in 2001, 19.0% in 2002,

31.5% in debt (primarily long-term bonds.) According to

14.3% in 2003, 26.5% in 2004 and –14.5% in 2005. The

certain research analysts, Realty Income ranks among the

point is that over the long term Realty Income believes that

top five in the real estate industry for balance sheet strength

consistent increases in the Company’s operating perform-

in comparison to all other REITs. Maintaining a conservative

ance and dividends should lead to advances in the Company’s

balance sheet is among Realty Income’s core operating

share price over time.

objectives.

I N V E S T O R R E T U R N S

To quote a well-known investor, Warren Buffett, “In the

short run, the market is a voting machine but in the long run,

it is a weighing machine.” In other words, if a company con-

While the Company performed well, in terms of its capital mar-

tinues to perform well over the long term, its share price

kets activities, as well as all other facets of the Company’s

should also tend to perform well over the long term. Thus,

operations, unfortunately the price of its shares on the New

short-term fluctuations, which oftentimes reflect emotional

York Stock Exchange at the end of the year did not reflect the

reactions to news or changes in investor sentiments tend to

Company’s positive operating results. The Company’s closing

even out if price performance is viewed over a longer period of

price at the end of 2004 was $25.29 per share in comparison

time. Since most shareholders generally own Realty Income

to the closing stock price, as of December 31, 2005, of $21.62

in order to receive an increasing monthly dividend check,

per share, a decrease of 14.5%. However, the dividends paid

short-term stock price fluctuations are usually not a great con-

increased 8.5% and shareholders received $1.34625 per

cern, though it’s always more enjoyable to learn that the price

share in dividends during 2005.

went up rather than down for the year.

When dividends paid are combined with the year-end

For income investors, the most important information is

share price, the total return for the year was –9.2%. This

how much was paid in dividends during the year. Since divi-

may be somewhat disappointing, but it’s important to realize

dend increases continued throughout 2005, Realty Income’s

that the Company believes there was no fundamental busi-

annualized dividend amount per share has grown from $.90 per

ness or operational cause for this moderate share price

share in 1994 to $1.395 per share, as of December 31, 2005.

YIELD COMPARISONS

REALTY INCOME

S&P 500

Dow Jones Industrial

Dow Jones Utility Index

10-Year Treasury

1-Year CD

As of December 31, 2005

6.50%

1.86%

2.31%

3.30%

4.40%

3.39%

In addition the annualized dividend yield was 6.5% as of the

end of 2005. By comparison, as of December 31, 2005, the

10-year Treasury was yielding 4.40%, the Dow Jones Utility

Index was yielding 3.30%, the national average for a 1-year

CD was 3.39%, the S&P 500 was yielding 1.86% and the

Dow Jones Industrial average was yielding 2.31%.

In comparison to all of these benchmarks, Realty Income

represented an above average source of income for new

income investors. Furthermore, for existing shareholders, the

Yield on Cost, based on the price they paid for their shares at

the time of purchase, continued to increase as the Company

raised its dividend five times during 2005.

(Disclosure: Professor Meurer also plays on MDU’s faculty basketball team and serves as Chief Financial Officer,

Treasurer, and Executive Vice President of Realty Income.)

2 1

R E A LT Y I N C O M E

F I N A N C I A L I N F O R M A T I O N

BUSINESS DESCRIPTION

THE COMPANY
RECENT DEVELOPMENTS
DISTRIBUTION POLICY
BUSINESS PHILOSOPHY AND STRATEGY
PROPERTIES

CONSOLIDATED BALANCE SHEETS

CONSOLIDATED STATEMENTS OF INCOME

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

CONSOLIDATED STATEMENTS OF CASH FLOWS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REPORTS OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SELECTED FINANCIAL DATA

CONTROLS AND PROCEDURES

CONSOLIDATED QUARTERLY FINANCIAL DATA

FORWARD-LOOKING STATEMENTS

23
23
24
25
26
29

REALTY INCOME CORPORATION AND SUBSIDIARIES
B U S I N E S S D E S C R I P T I O N

T H E C O M P A N Y

In addition, our wholly-owned taxable REIT subsidiary, Crest

Realty Income Corporation, The Monthly Dividend Company®, is a

Net Lease, Inc., owned 17 properties with a total investment of

Maryland corporation organized to operate as an equity real estate

$45.7 million at December 31, 2005, which are classified as

investment trust, or REIT. Our primary business objective is to

held for sale. Crest Net was created to buy, own and sell proper-

generate dependable monthly cash distributions from a consis-

ties, primarily to individual investors, many of whom are involved

tent and predictable level of funds from operations, or FFO per

in tax-deferred exchanges under Section 1031 of the Internal

share. The monthly distributions are supported by the cash flow

Revenue Code of 1986, as amended, the “Code.”

from our portfolio of retail properties leased to regional and

We typically acquire retail store properties under long-term

national retail chains. We have in-house acquisition, leasing,

leases with retail chain store operators. These transactions gener-

legal, retail and real estate research, portfolio management and

ally provide capital to owners of retail real estate and retail chains

capital markets expertise. Over the past 37 years, Realty Income

for expansion or other corporate purposes. Our acquisition and

and its predecessors have been acquiring and owning freestand-
ing retail properties that generate rental revenue under long-term

investment activities are concentrated in well-defined target mar-
kets and generally focus on retailers providing goods and serv-

lease agreements (primarily 15- to 20-years).

ices that satisfy basic consumer needs.

In addition, we seek to increase distributions to stockholders

Our net-lease agreements generally:

and FFO per share through both active portfolio management

• Are for initial terms of 15 to 20 years;

and the acquisition of additional properties. Our portfolio man-

• Require the tenant to pay minimum monthly rents and

agement focus includes:

property operating expenses (taxes, insurance and mainte-

• Contractual rent increases on existing leases;

nance); and

• Rent increases at the termination of existing leases when

• Provide for future rent increases (typically subject to ceil-

market conditions permit; and

ings) based on increases in the consumer price index,

• The active management of our property portfolio, includ-

fixed increases, or to a lesser degree, additional rent cal-

ing re-leasing of vacant properties and selective sales of

culated as a percentage of the tenants’ gross sales above a

properties.

specified level.

Our acquisition of additional properties adheres to a focused

Realty Income commenced operations as a REIT on August 15,

strategy of primarily acquiring properties that are:

1994 through the merger of 25 public and private real estate lim-

• Freestanding, single-tenant, retail locations;

ited partnerships with and into the Company. Each of the partner-

• Leased to regional and national retail chains; and

ships was formed between 1970 and 1989 for the purpose of

• Leased under long-term, net-lease agreements.

acquiring and managing long-term, net-leased properties.

The six senior officers of Realty Income owned 1.3% of our

At December 31, 2005, we owned a diversified portfolio:

outstanding common stock with a market value of $25.1 million at

• Of 1,646 retail properties;

February 10, 2006. The directors and six senior officers of Realty

• With an occupancy rate of 98.5%, or 1,621 properties

Income, as a group, owned 2.7% of our outstanding common stock

occupied of the 1,646 properties in the portfolio;

with a market value of $51.6 million at February 10, 2006.

• Leased to 101 different retail chains doing business in

Realty Income’s common stock is listed on The New York Stock

29 separate retail industries;

• Located in 48 states;

Exchange (“NYSE”) under the ticker symbol “O.” Our central

index key number is 726728 and cusip number is 756109-104.

• With over 13.4 million square feet of leasable space; and

Realty Income’s Class D cumulative redeemable preferred

• With an average leasable retail space of 8,200 square feet.

stock is listed on the NYSE under the ticker symbol “OprD” and

Of the 1,646 properties in the portfolio, 1,641, or 99.7%, are

Realty Income’s 8.25% Monthly Income Senior Notes, due

single-tenant, retail properties and the remaining five are multi-

2008 are listed on the NYSE under the ticker symbol “OUI.”

tenant, distribution and office properties. At December 31, 2005,

The cusip number of these notes is 756109-203.

its cusip number is 756109-609.

1,617, or 98.5%, of the 1,641 single-tenant properties were

leased with a weighted average remaining lease term (excluding

extension options) of approximately 12.4 years.

2 3

R E A LT Y I N C O M E

At February 10, 2006, we had 69 permanent employees and

four temporary employees, as compared to February 15, 2005

when we had 64 permanent employees and six temporary employ-

ees. The temporary employees have been working on a record

Issuance of 30-Year Senior Unsecured Bonds
In March 2005, Realty Income issued $100 million in aggregate
principal amount of 30-year, 57/8% senior unsecured bonds due
2035. The price to the investor for the bonds was 98.296% of

retention project that is expected to conclude during 2006.

the principal amount for an effective yield of 5.998%. The net

We maintain an Internet website at www.realtyincome.com.

proceeds from the offering were used to repay borrowings under

On our website we make available, free of charge, copies of our

our unsecured acquisition credit facility and for other general cor-

annual report on Form 10-K, quarterly reports on Form 10-Q, cur-

porate purposes.

rent reports on Form 8 K, and amendments to those reports, as

soon as reasonably practicable after we electronically file these

reports with the SEC. None of the information on our website is

deemed to be part of this report.

R E C E N T D E V E L O P M E N T S

Credit Facility
In June 2005, Realty Income entered into a new $300 million

Acquisitions During 2005
During 2005, Realty Income and Crest Net invested, in aggre-

gate, $486.6 million in 156 new properties and properties under

development. These 156 properties are located in 30 states and

are 100% leased with an initial average lease term of 15.8 years.

As described below, Realty Income acquired 135 properties and

Crest Net acquired 21 properties.

acquisition credit facility to replace our existing $250 million

Included in the $486.6 million is $430.7 million invested by

acquisition credit facility that expired in October 2005. Under the
terms of the new credit facility, which commenced in October

Realty Income in 135 new properties and properties under devel-
opment with an initial weighted average contractual lease rate of

2005, the borrowing rate was reduced to LIBOR (London

8.4%. These 135 properties are located in 28 states, are 100%

Interbank Offered Rate) plus 65 basis points with a facility fee of

leased with an initial average lease term of 15.6 years and will

15 basis points, for all-in drawn pricing of 80 basis points over

contain over 1.7 million leasable square feet. The 135 new prop-

LIBOR, based on our current credit ratings. The new credit facil-

erties acquired by Realty Income are net-leased to 13 different

ity offers us other interest rate options as well. The term of the

retail chains in the convenience store, drug store, financial serv-

new facility expires in October 2008, unless extended as provided

ices, health and fitness, motor vehicle dealership, restaurant and

in the agreement.

theater industries.

Common Stock Issuance
In September 2005, we issued 4.1 million shares of common

Included in the $486.6 million is $55.9 million invested

by Crest Net in 21 new retail properties and properties under

development.

stock. The net proceeds of $92.7 million were used to fund new

Of the $430.7 million Realty Income invested in real estate

property acquisitions and for other general corporate purposes.

during 2005, $43.9 million was invested in 10 properties that

Credit Ratings Upgrade
In September 2005, our credit ratings were upgraded by Fitch

were leased and under contract for development by the tenant at

December 31, 2005 (with development costs funded by Realty

Income). Rent on these properties is scheduled to begin at vari-

Ratings. Our senior unsecured debt rating was raised to BBB+

ous times during 2006. At December 31, 2005, we also had

from BBB and our preferred stock rating was raised to BBB from

committed to pay estimated unfunded development costs totaling

BBB- with a stable outlook.

$42.2 million.

In February 2006, Moody’s Investors Service, Inc. affirmed its

The initial weighted average contractual lease rate is com-

ratings on our senior unsecured debt rating of Baa2 and our pre-

puted as estimated contractual net operating income (in a net-

ferred stock rating of Baa3 and raised the outlook to “positive”

leased property this is equal to the base rent or, in the case of

from “stable.”

Issuance of 12-Year Senior Unsecured Notes
In September 2005, Realty Income issued $175 million in aggre-
gate principal amount of 12-year, 53/8% senior unsecured notes
due 2017. The price to the public for the notes was 99.974% of

the principal amount for an effective yield of 5.378%. The net

properties under development, the estimated base rent under the

lease) for the first year of each lease, divided by the estimated

total costs. Since it is possible that a tenant could default on the

payment of contractual rent, we cannot assure you that the

actual return on the funds invested will remain at the percent-

ages listed above.

proceeds from the offering were used to repay borrowings under

the Company’s unsecured acquisition credit facility, for property

Investments in Existing Properties
In 2005, we capitalized costs of $1.6 million on existing proper-

acquisitions and for other general corporate purposes. Our out-

ties in our portfolio, consisting of $570,000 for re-leasing costs

standing notes and bonds are rated BBB+ by Fitch Ratings, Baa2

and $1.0 million for building improvements.

by Moody’s Investors Service and BBB by Standard & Poor’s

Ratings Group.

R E A LT Y I N C O M E 2 4

Net Income Available to Common Stockholders
Net income available to common stockholders was $89.7 million

The monthly distribution of $0.11625 per share represents a

current annualized distribution of $1.395 per share, and an

in 2005 versus $90.2 million in 2004, a decrease of $452,000.

annualized distribution yield of approximately 6.1% based on the

On a diluted per common share basis, net income was $1.12 per

last reported sale price of our common stock on the NYSE of

share in 2005 as compared to $1.15 per share in 2004.

$22.78 on February 10, 2006. Although we expect to continue

The calculation to determine net income available to common

our policy of paying monthly distributions, we cannot guarantee

stockholders includes gains from the sale of investment proper-

that we will maintain the current level of distributions, that we

ties. The amount of gains varies from period to period based on

will continue our pattern of increasing distributions per share, or

the timing of property sales and can significantly impact net

what the actual distribution yield will be in any future period.

income available to common stockholders.

The gain recognized from the sales of investment properties

D I S T R I B U T I O N P O L I C Y

during 2005 was $6.6 million as compared to $12.7 million dur-

Distributions are paid monthly to our common stockholders and

ing 2004.

Class D preferred stockholders if, and when declared by our Board

of Directors. The Class D preferred stockholders receive cumula-

Funds from Operations (FFO)
In 2005, our FFO increased by $11.4 million, or 9.6%, to

tive distributions at a rate of 7.375% per annum on the $25 per

share liquidation preference (equivalent to $1.84375 per annum

$129.6 million versus $118.2 million in 2004. On a diluted per

per share).

common share basis, FFO was $1.62 in 2005 compared to
$1.50 for 2004, an increase of $0.12, or 8.0%.

In order to maintain our tax status as a REIT for federal
income tax purposes, we generally are required to distribute div-

See our discussion of FFO in the section entitled “Manage-

idends to our stockholders aggregating annually at least 90% of

ment’s Discussion and Analysis of Financial Condition and Results

our REIT taxable income (determined without regard to the divi-

of Operations” in this annual report, which includes a reconcilia-

dends paid deduction and by excluding net capital gains) and we

tion of net income available to common stockholders to FFO.

are subject to income tax to the extent we distribute less than

100% of our REIT taxable income (including net capital gains).

Crest Net Property Sales
During 2005, Crest Net sold 12 properties from its inventory for

In 2005, our cash distributions totaled $118.0 million, or

approximately 113.2% of our estimated REIT taxable income of

$23.5 million, which resulted in a gain of $3.3 million.

$104.2 million. Our estimated REIT taxable income reflects

non-cash deductions for depreciation and amortization. We

Crest Net’s Property Inventory
Crest Net’s property inventory at December 31, 2005 and

intend to continue to make distributions to our stockholders that

are sufficient to meet this distribution requirement and that will

December 31, 2004 totaled $45.7 million and $10.1 million,

reduce our exposure to income taxes. Our 2005 cash distribu-

respectively, and is included in “real estate held for sale, net”, on

tions to common stockholders totaled $108.6 million, represent-

our consolidated balance sheets.

ing 83.8% of our funds from operations available to common

stockholders of $129.6 million.

Increases in Monthly Cash Distributions
to Common Stockholders
We continue our 36-year policy of paying distributions monthly.

Future distributions will be at the discretion of our Board of

Directors and will depend on, among other things, our results of

operations, FFO, cash flow from operations, financial condition

Monthly distributions per share were increased in April 2005 by

and capital requirements, the annual distribution requirements

$0.000625 to $0.110625, in July 2005 by $0.000625 to

under the REIT provisions of the Code, our debt service require-

$0.11125, in September 2005 by $0.00375 to $0.115, in

ments and any other factors the Board of Directors may deem

October 2005 by $0.000625 to $0.115625 and in January

relevant. In addition, our credit facility contains financial covenants

2006 by $.000625 to $0.11625. The increase in January 2006

that could limit the amount of distributions payable by us in the

was our 33rd consecutive quarterly increase and the 37th

event of a deterioration in our results of operations or financial

increase in the amount of our dividend since our listing on the

condition, and which prohibit the payment of distributions on

NYSE in 1994. In 2005, we paid the following monthly cash

the common or preferred stock in the event that we fail to pay

distributions per share: three in the amount of $0.11, three in the

when due (subject to any applicable grace period) any principal

amount of $0.110625, two in the amount of $0.11125, one in

or interest on borrowings under our credit facility.

the amount of $0.115, and three in the amount of $0.115625

totaling $1.34625. In December 2005, January 2006 and

February 2006, we declared distributions of $0.11625 per share,

which were paid on January 17, 2006, February 15, 2006 and

will be paid on March 15, 2006, respectively.

2 5

R E A LT Y I N C O M E

Distributions of our current and accumulated earnings and

upper market retail chains typically consist of companies with

profits for federal income tax purposes, generally will be taxable

500 or more locations, operating nationally, in a proven, mature

to stockholders as ordinary income, except to the extent that we

retail concept. Upper market retail chains generally have strong

recognize capital gains and declare a capital gains dividend or

operating histories and access to several sources of capital.

that such amounts constitute “qualified dividend income” sub-

Realty Income primarily focuses on acquiring properties

ject to a reduced rate of tax. The maximum tax rate of non-cor-

leased to middle market retail chains that we believe are attrac-

porate taxpayers for “qualified dividend income” has generally

tive for investment because:

been reduced to 15% (for taxable years beginning after

• They generally have overcome many of the operational and

December 31, 2002). In general, dividends payable by REITs are

managerial obstacles that can adversely affect venture

not eligible for the reduced tax rate on corporate dividends,

retailers;

except to the extent the REIT’s dividends are attributable to div-

• They typically require capital to fund expansion but have

idends received from taxable corporations (such as our taxable

more limited financing options;

REIT subsidiary, Crest Net), to income that was subject to tax at

• They generally have provided us with attractive risk-

the corporate or REIT level (for example, if we distribute taxable

adjusted returns over time since their financial strength

income that we retained and paid tax on in the prior taxable year)

has, in many cases, tended to improve as their businesses

or, as discussed above, dividends properly designated by us as

have matured;

“capital gain dividends.” Distributions in excess of earnings

• Their relatively large size allows them to spread corporate

and profits generally will be treated as a non-taxable reduction in
the stockholders’ basis in the stock. Distributions above that

expenses across a greater number of stores; and

• Middle market retailers typically have the critical mass to

basis, generally, will be taxable as a capital gain. Approximately

survive if a number of locations are closed due to under-

10.1% of the distributions, made or deemed to have been made

performance.

in 2005, to our common stockholders were classified as a return

of capital for federal income tax purposes. We are unable to pre-

We also focus on and have selectively made investments in

dict the portion of future distributions that may be classified as

properties of upper market retail chains. We believe upper market

a return of capital.

retail chains can be attractive for investment because:

• They typically are of a higher credit quality;

B U S I N E S S P H I L O S O P H Y A N D S T R A T E G Y

• They usually are larger public and private retailers with

Investment Philosophy
We believe that owning an actively managed, diversified portfolio

more commonly recognized brand names;

• They utilize a larger building ranging in size from 10,000

of retail properties under long-term, net leases produces consis-

to 50,000 square feet; and

tent and predictable income. Under a net-lease agreement, the

• They are able to grow because access to capital facilitates

tenant agrees to pay monthly rent and property operating

larger transaction sizes.

expenses (taxes, maintenance and insurance) plus, typically,

future rent increases (generally subject to ceilings) based on

While our investment strategy focuses primarily on acquiring

increases in the consumer price index, fixed increases, or to a

properties leased to middle and upper market retail chains, we

lesser degree, additional rent calculated as a percentage of the

also selectively seek investment opportunities with venture mar-

tenants’ gross sales above a specified level. We believe that a

ket retail chains. Periodically, venture market opportunities arise

portfolio of properties under long-term leases, coupled with the

where we feel that the real estate used by the tenant is high

tenant’s responsibility for property expenses, generally produces

quality and can be purchased at favorable prices. To meet our

a more predictable income stream than many other types of real

stringent investment standards, however, venture retail compa-

estate portfolios, while continuing to offer the potential for growth

nies must have a well-defined retailing concept and strong finan-

in rental income.

Investment Strategy
In identifying new properties for acquisition, our focus is gen-

cial prospects. These opportunities are examined on a case by

case basis and we are highly selective in making investments in

this area.

Historically, our investment focus has been on retail industries

erally on providing capital to retail chain owners and operators

that have a service component because we believe the lease rev-

by acquiring, then leasing back, retail store locations. We cate-

enue from these types of businesses is more stable. Because of this

gorize retail tenants as: 1) venture market, 2) middle market, and

investment focus, for the quarter ended December 31, 2005,

3) upper market. Venture companies typically offer a new retail

approximately 81.2% of our rental revenue was derived from retail-

concept in one geographic region of the country and operate

ers with a service component in their business. Furthermore, we

between five and 50 retail locations. Middle market retail chains

believe these service-oriented businesses would be difficult to

typically have 50 to 500 retail locations, operations in more than

duplicate over the Internet and that our properties continue to per-

one geographic region, have been successful through one or more

form well relative to competition from Internet businesses.

economic cycles, and have a proven, replicable concept. The

R E A LT Y I N C O M E 2 6

Credit Strategy
We generally provide sale-leaseback financing to less than invest-

The typical profile of companies whose properties have been

approved for acquisition are those with 50 or more retail loca-

ment grade retail chains. We typically acquire and lease back

tions. Generally the properties:

properties to regional and national retail chains and believe that

• Are located in highly visible areas,

within this market we can achieve an attractive risk-adjusted

• Have easy access to major thoroughfares; and

return on the financing we provide to retailers. Since 1970, our

• Have attractive demographics.

overall weighted average occupancy rate at the end of each year

has been 98.5% and the occupancy rate at the end of each year

has never been below 97.5%.

Acquisition Strategy
We seek to invest in industries in which several, well-organized,

We believe the principal financial obligations of most retailers

regional and national chains are capturing market share through

typically include their bank and other debt, payment obligations to

service, quality control, economies of scale, advertising and the

suppliers and real estate lease obligations. Because we typically

selection of prime retail locations. We execute our acquisition

own the land and building in which a tenant conducts its retail

strategy by acting as a source of capital to regional and national

business, we believe the risk of default on a retailers’ lease obli-

retail chain store owners and operators, doing business in a

gations is less than the retailers’ unsecured general obligations. It

variety of industries, by acquiring and leasing back retail store

has been our experience that since retailers must retain their

locations. We undertake thorough research and analysis to

profitable retail locations in order to survive, in the event of reor-

identify appropriate industries, tenants and property locations for

ganization they are less likely to reject a lease for a profitable loca-
tion because this would terminate their right to use the property.

investment. Our research expertise is instrumental to uncovering
net-lease opportunities in markets where our real estate financing

Thus, as the property owner, we believe we will fare better than

program adds value. In selecting real estate for potential invest-

unsecured creditors of the same retailer in the event of reorganiza-

ment, we generally seek to acquire properties that have the

tion. If a property is rejected by the tenant during reorganization,

following characteristics:

we own the property and can either lease it to a new tenant or sell

• Freestanding, commercially-zoned property with a single

the property. In addition, we believe that the risk of default on the

tenant;

real estate leases can be further mitigated by monitoring the per-

• Properties that are important retail locations for regional

formance of the retailers’ individual unit locations and considering

and national retail chains;

whether to sell locations that are weaker performers.

• Properties that are located within attractive demographic

In order to qualify for inclusion in our portfolio, new property

areas relative to the business of their tenants, with high

acquisitions must meet stringent investment and credit require-

visibility and easy access to major thoroughfares; and

ments. The properties must generate attractive current yields and

• Properties that can be purchased with the simultaneous

the tenant must meet our credit profile. We have established a

execution or assumption of long-term, net-lease agree-

three-part analysis that examines each potential investment

ments, offering both current income and the potential for

based on:

rent increases.

•

Industry, company, market conditions and credit profile;

• Location profitability, if profitability data is available; and

• Overall real estate characteristics, including value and

Portfolio Management Strategy
The active management of the property portfolio is an essential

comparative rental rates.

component of our long-term strategy. We continually monitor our

portfolio for changes that could affect the performance of the

industries, tenants and locations in which we have invested. The

portfolio is regularly analyzed with a view toward optimizing its

returns and enhancing its credit quality. Our executives review

industry research, tenant research, property due diligence and

significant portfolio management activities. This monitoring typi-

cally includes regular review and analysis of:

• The performance of various retail industries; and

• The operation, management, business planning and

financial condition of the tenants.

2 7

R E A LT Y I N C O M E

We have an active portfolio management program that incor-

total $300 million credit commitment of the credit facility. The

porates the sale of assets when we believe the reinvestment of the

credit facility has been, and is expected to be, used to acquire

sales proceeds will generate higher returns, enhance the credit

additional retail properties leased to regional and national retail

quality of our real estate portfolio, or extend our average remain-

chains under long-term, net-lease agreements. The credit facility

ing lease term. At December 31, 2005, we classified real estate

has also been used to provide capital to subsidiaries for the pur-

with a carrying amount of $47.1 million as held for sale, which

pose of funding the acquisition of properties. We regularly evalu-

includes $45.5 million in properties owned by Crest Net. In addi-

ate our credit facility and may seek to extend, renew or replace

tion, $219,000 invested by Crest Net in real estate is included in

our credit facility, to the extent we deem appropriate.

other assets and was classified as intangible assets in accordance

We use our credit facility for the short-term financing of new

with Financial Accounting Standards Board Statement No. 141,

property acquisitions. When outstanding borrowings under the

Business Combinations. Additionally, we anticipate selling invest-

credit facility reach a certain level (generally in the range of

ment properties from our portfolio that have not yet been specif-

$100 million to $200 million) and capital is available on accept-

ically identified from which we anticipate receiving between

able terms, we generally seek to refinance those borrowings with

$15 million and $35 million in proceeds during the next

the net proceeds of long-term or permanent financing, which may

12 months. We intend to invest these proceeds into new property

include the issuance of common stock, preferred stock, convert-

acquisitions. However, we cannot guarantee that we will sell prop-

ible preferred stock, debt securities or convertible debt securities.

erties during the next 12 months.

Conservative Capital Structure
We believe that our stockholders are best served by a conservative

We cannot assure you, however, that we will be able to obtain

any such refinancing or that market conditions prevailing at the
time of refinancing will enable us to issue equity or debt securi-

ties upon acceptable terms.

capital structure. Therefore, we seek to maintain a conservative

We are currently assigned investment grade corporate credit

debt level on our balance sheet and solid interest and fixed

ratings, on our senior unsecured notes, from Fitch Ratings,

charge coverage ratios. At February 10, 2006, our total outstand-

Moody’s Investors Service, Inc. and Standard & Poor’s Ratings

ing credit facility borrowings and outstanding notes were

Group. Currently, Fitch Ratings has assigned a rating of BBB+,

$886.6 million or approximately 30.3% of our total market

Moody’s has assigned a rating of Baa2 and Standard & Poor’s has

capitalization of $2.92 billion. We calculate our total market

assigned a rating of BBB to our senior notes. Moody’s rating has a

capitalization at February 10, 2006 as the sum of:

“positive” outlook and the other ratings have a “stable” outlook.

• Shares of our common stock outstanding of 83,880,873

We have also been assigned investment grade credit ratings

multiplied by the last reported sales price of our common

from the same rating agencies on our preferred stock. Fitch

stock on the NYSE of $22.78 per share, or $1.91 billion;

Ratings has assigned a rating of BBB, Moody’s has assigned a rat-

• Aggregate liquidation value of the Class D preferred stock

ing of Baa3 and Standard & Poor’s has assigned a rating of BBB-

of $127.5 million;

to our preferred stock. Moody’s rating has a “positive” outlook and

• Outstanding borrowings of $131.6 million on our credit

the other ratings have a “stable” outlook.

facility; and

The credit ratings assigned to us could change based

• Outstanding notes of $755.0 million.

upon, among other things, our results of operations and finan-

cial condition.

Historically, we have met our long-term capital needs through

We have no mortgage debt on any of our properties.

the issuance of common stock, preferred stock and long-term

unsecured notes and bonds. Over the long term, we believe that

the majority of our future securities issuances should be in the

form of common stock, however, we may issue additional pre-

No Off-Balance Sheet Arrangements
or Unconsolidated Investments
Realty Income and its subsidiaries have no unconsolidated or

ferred stock or debt securities from time to time. We may issue

off-balance sheet investments in “variable interest entities”

common stock when we believe that our share price is at a level

or off-balance sheet financing, nor do we engage in trading

that allows for the proceeds of any offering to be invested into

activities involving energy or commodity contracts or other

additional properties on an accretive basis. In addition, we may

derivative instruments.

issue common stock to permanently finance properties that were

As we have no joint ventures, off-balance sheet entities, or

financed by our credit facility or debt securities. However, we can-

mandatory redeemable preferred stock, our financial position and

not assure you that we will have access to the capital markets at

results of operations are currently not affected by Financial

terms that are acceptable to us.

We have a $300 million revolving, unsecured acquisition

credit facility that expires in October 2008. At February 10,

Accounting Standards Board Interpretation No. 46R, Consolidation

of Variable Interest Entities and Statement of Financial Accounting
Standards No. 150, Accounting for Certain Financial Instruments

2006, the outstanding balance on the credit facility was

with Characteristics of both Liabilities and Equity.

$131.6 million, with an effective interest rate of approximately

5.2%. A commitment fee of 0.15% per annum accrues on the

R E A LT Y I N C O M E 2 8

Competitive Strategy
We believe that to successfully pursue our investment philosophy

• MANAGEMENT SPECIALIZATION: We believe that our man-
agement’s specialization in single-tenant retail properties,

and strategy, we must seek to maintain the following competitive

operated under net-lease agreements, is important to meet-

advantages:

ing our objectives. We plan to maintain this specialization

• SIZE AND TYPE OF INVESTMENT PROPERTIES: We believe

and will seek to employ and train high-quality professionals

smaller ($500,000 to $10,000,000) net-leased retail

in this specialized area of real estate ownership, finance

properties represent an attractive investment opportunity

and management.

in today’s real estate environment. Due to the complexities

•

TECHNOLOGY: We intend to stay at the forefront of technol-

of acquiring and managing a large portfolio of relatively

ogy in our efforts to efficiently and economically carry out

small assets, we believe these types of properties have

our operations. We maintain sophisticated information sys-

not experienced significant institutional ownership interest

tems that allow us to analyze our portfolio’s performance

or the corresponding yield reduction experienced by larger

and actively manage our investments. We believe that

income-producing properties. We believe the less intensive

technology and information-based systems will play an

day-to-day property management required by net-lease

increasingly important role in our competitiveness as an

agreements, coupled with the active management of a

investment manager and source of capital to a variety of

large portfolio of smaller properties, is an effective invest-

industries and tenants.

ment strategy. The tenants of our freestanding retail prop-

erties generally provide goods and services that satisfy
basic consumer needs. In order to grow and expand, they

P R O P E R T I E S

At December 31, 2005, we owned a diversified portfolio:

generally need capital. Since the acquisition of real estate

• Of 1,646 retail properties;

is typically the single largest capital expenditure of many

• With an occupancy rate of 98.5%, or 1,621 properties

of these retailers, our method of purchasing the property

occupied of the 1,646 properties in the portfolio;

and then leasing it back, under a net-lease arrangement,

• Leased to 101 different retail chains doing business in

allows the retail chain to free up capital.
INVESTMENT IN NEW RETAIL INDUSTRIES: Though we spe-

•

29 separate retail industries;

• Located in 48 states;

cialize in single-tenant properties, we will seek to further

• With over 13.4 million square feet of leasable space; and

diversify our portfolio among a variety of retail industries.

• With an average leasable retail space of 8,200 square feet.

We believe diversification will allow us to invest in retail

In addition to our real estate portfolio at December 31, 2005,

industries that currently are growing and have character-

our subsidiary, Crest Net had invested $45.7 million in a portfo-

istics we find attractive. These characteristics include, but

lio of 17 properties located in nine states. These properties are

are not limited to, retail industries that are dominated by

classified as held for sale.

local store operators where regional and national chain

At December 31, 2005, 1,617, or 98.2%, of our 1,646 retail

store operators can increase market share and dominance

properties were owned under net-lease agreements. Net leases

by consolidating local operators and streamlining their

typically require the tenant to be responsible for minimum

operations, as well as capitalizing on major demographic

monthly rent and property operating expenses including property

shifts in a population base.

taxes, insurance and maintenance. In addition, tenants are typi-

• DIVERSIFICATION: Diversification of the portfolio by retail

cally responsible for future rent increases (generally subject to

industry type, tenant, and geographic location is key to our

ceilings) based on increases in the consumer price index, fixed

objective of providing predictable investment results for

increases or, to a lesser degree, additional rent calculated as a

our stockholders, therefore further diversification of our

percentage of the tenants’ gross sales above a specified level.

portfolio is a continuing objective. At December 31, 2005,

Our net-leased retail properties primarily are leased to regional

our retail property portfolio consisted of 1,646 properties

and national retail chain store operators. Most buildings are single-

located in 48 states, leased to 101 retail chains doing

story structures with adequate parking on site to accommodate

business in 29 industry segments. Each of the 29 indus-

peak retail traffic periods. The properties tend to be on major

try segments, represented in our property portfolio, indi-

thoroughfares with relatively high traffic counts and adequate

vidually accounted for no more than 17.8% of our rental

access and proximity to a sufficient population base constituting a

revenue for the quarter ended December 31, 2005.

suitable market or trade area for the retailer’s business.

2 9

R E A LT Y I N C O M E

The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest

Net) classified according to the business of the respective tenants, expressed as a percentage of our total rental revenue:

For the Quarter Ended
Dec. 31,
2005

Percentage of Rental Revenue(1)

For the Years Ended

Dec. 31,
2005

Dec. 31,
2004

Dec. 31,
2003

Dec. 31,
2002

Dec. 31,
2001

Dec. 31,
2000

1.4%

1.6%

1.8%

2.1%

2.3%

2.4%

Industries

Apparel stores

Automotive collision services

Automotive parts

Automotive service

Automotive tire services

Book stores

Business services

Child care

Consumer electronics

Convenience stores

Crafts and novelties

Drug stores

Entertainment

Equipment rental services

Financial services

General merchandise

Grocery stores

Health and fitness

Home furnishings

Home improvement

Motor vehicle dealerships

Office supplies

Pet supplies and services

Private education

Restaurants

Shoe stores

Sporting goods

Theaters

Travel plazas

Video rental

Other

Totals

1.2

3.4

7.0

6.5

0.3

0.1

11.8

1.2

17.8

0.4

3.0

1.9

0.3

0.1

0.5

0.6

3.3

3.4

1.0

2.9

1.6

1.2

0.7

9.9

0.0

3.1

9.9

0.3

2.3

2.9

1.3

3.4

7.6

7.2

0.3

0.1

12.7

1.3

18.7

0.4

2.8

2.1

0.4

0.1

0.5

0.7

3.7

1.1

2.6

1.5

1.3

0.8

9.4

0.3

3.4

5.2

0.3

2.5

3.0

1.0

3.8

7.7

7.8

0.3

0.1

14.4

2.1

19.2

0.5

0.1

2.3

0.3

0.1

0.4

0.8

4.0

4.1

1.0

0.6

1.6

1.4

1.1

9.7

0.3

3.4

3.5

0.4

2.8

3.4

0.3

4.5

8.3

3.1

0.4

0.1

17.8

3.0

13.3

0.6

0.2

2.6

0.2

—

0.5

0.4

3.8

4.9

1.1

—

1.9

1.7

1.2

—

4.9

7.0

2.7

0.4

0.1

—

5.7

2.6

0.4

0.1

—

6.0

5.8

2.3

0.5

0.1

20.8

23.9

24.7

3.3

9.1

0.4

0.2

2.3

—

0.5

3.8

5.4

1.2

—

2.1

1.7

1.3

4.0

8.4

0.4

0.2

1.8

—

0.6

3.6

6.0

1.3

—

2.2

1.6

1.5

4.9

8.4

0.4

0.2

2.0

—

0.6

2.4

5.8

2.0

—

2.3

1.5

1.4

11.8

13.5

12.2

12.3

0.9

3.8

4.1

0.3

3.3

3.8

0.8

4.1

3.9

—

3.3

4.4

0.7

0.9

4.3

—

3.7

5.2

0.8

—

2.7

—

3.9

6.0

100.0%

(1)Includes rental revenue for all properties owned by Realty Income at the end of each period presented, including revenue from properties reclassified to
discontinued operations.

R E A LT Y I N C O M E 3 0

The following table sets forth certain information regarding the properties owned by Realty Income (excluding properties owned by Crest

Net) at December 31, 2005, classified according to the retail business types and the level of services they provide (dollars in thousands):

Industry

Tenants Providing Services

Automotive collision services

Automotive service

Child care

Entertainment

Equipment rental services

Financial services

Health and fitness

Private education

Theaters

Other

Tenants Selling Goods and Services

Automotive parts (with installation)

Automotive tire services

Business services

Convenience stores

Home improvement

Motor vehicle dealerships

Pet supplies and services

Restaurants

Travel plazas

Video rental

Tenants Selling Goods

Apparel stores

Automotive parts

Book stores

Consumer electronics

Crafts and novelties

Drug stores

General merchandise

Grocery stores

Home furnishings

Home improvement

Office supplies

Pet supplies

Shoe stores

Sporting goods

Totals

Number of
Properties

219

270

572

102

394

250

839

235

1,646

Rental Revenue for
the Quarter Ended
Dec. 31, 2005(1)

$ 672

3,757

6,319

1,016

150

1,775

381

5,305

1,532

$ 20,960

583

3,471

9,572

1,566

615

5,292

170

1,235

$ 22,609

775

1,242

149

636

211

1,630

257

347

1,814

465

844

—

1,687

$ 10,094

$ 53,663

Percentage of
of Rental
Revenue

1.2%

7.0

11.8

1.9

0.3

0.1

3.3

0.7

9.9

2.9

39.1

1.1

6.5

0.1

17.8

0.1

2.9

1.1

9.9

0.3

2.3

42.1

1.4

2.3

0.3

1.2

0.4

3.0

0.5

0.6

3.4

0.9

1.6

0.1

0.0

3.1

18.8

100.0%

(1)Includes rental revenue for all properties owned by Realty Income at December 31, 2005, including revenue from properties reclassified to
discontinued operations of $59.

3 1

R E A LT Y I N C O M E

The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest

Net) regarding the timing of the initial lease term expirations (excluding extension options) on our 1,617 net leased, single-tenant and

certain other retail properties as of December 31, 2005 (dollars in thousands):

Total
Number
of Leases
Expiring(1)

109

121

104

126

234

Year

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2028

2030

2033

2034

2037

2043

Total Portfolio

Rental
Revenue for
the Quarter
Ended
12/31/05(2)

% of
Rental
Revenue

Number
of Leases
Expiring

$ 2,373

4.6%

2,265

2,334

1,963

1,527

1,662

1,379

3,251

2,007

1,654

513

1,527

1,090

4,480

2,603

4,082

2,592

6,440

1,707

5,273

357

230

325

4.4

4.5

3.8

2.9

3.2

2.7

6.3

3.9

3.2

1.0

2.9

2.1

8.7

5.0

7.9

5.0

12.4

3.3

10.2

0.2

0.1

0.7

0.4

0.6

126

233

—

Initial Expirations(3)

Subsequent Expirations(4)

Rental
Revenue for
the Quarter
Ended
12/31/05

% of
Total
Rental
Revenue

$ 1,111

2.2%

1,662

1,634

694

1,072

1,439

1,329

3,039

1,752

1,200

431

1,459

1,090

4,342

2,593

4,082

2,591

6,414

1,707

5,273

357

230

325

—

3.2

1.3

2.0

2.8

2.6

5.9

3.4

2.3

0.8

2.8

2.1

8.4

5.0

7.9

5.0

12.4

3.3

10.2

0.2

0.1

0.7

0.4

0.6

—

Rental
Revenue for
the Quarter
Ended
12/31/05

% of
Total
Rental
Revenue

$ 1,262

2.4%

603

700

1,269

455

223

212

255

454

—

138

—

1.2

1.3

2.5

0.9

0.4

0.1

0.4

0.5

0.9

0.2

0.1

—

0.3

—

Number
of Leases
Expiring

—

Totals

1,617

$ 51,811

100.0%

1,338

$ 45,990

88.8%

279

$ 5,821

11.2%

*Less than 0.1%

(1)Excludes four multi-tenant properties and 25 vacant unleased properties, one of which is a multi-tenant property. The lease expirations for
properties under construction are based on the estimated date of completion of those properties.

(2)Includes rental revenue of $59 from properties reclassified to discontinued operations and excludes revenue of $1,852 from four multi-tenant
properties and from 25 vacant and unleased properties at December 31, 2005.

(3)Represents leases to the initial tenant of the property that are expiring for the first time.

(4)Represents lease expirations on properties in the portfolio, which have previously been renewed, extended or re-tenanted.

R E A LT Y I N C O M E 3 2

The following table sets forth certain state-by-state information regarding Realty Income’s property portfolio (excluding properties

owned by Crest Net) as of December 31, 2005 (dollars in thousands):

State

Alabama
Alaska
Arizona
Arkansas
California
Colorado
Connecticut
Delaware
Florida
Georgia
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maryland
Massachusetts
Michigan
Minnesota
Mississippi
Missouri
Montana
Nebraska
Nevada
New Hampshire
New Jersey
New Mexico
New York
North Carolina
North Dakota
Ohio
Oklahoma
Oregon
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming

Totals/Average

*Less than 0.1%

Number of
Properties

17
2
70
8
61
46
16
16
128
103
14
55
37
12
20
15
14
24
37
13
20
38
32
2
13
15
10
26
7
28
50
5
105
20
17
81
1
55
7
98
182
6
1
62
37
2
16
2

Percent
Leased

94%

100
100
88
100
100
100
100
99
99
93
100
95
92
90
100
100
100
100
100
100
89
94
100
100
100
100
100
100
96
100
100
100
95
100
100
100
100
100
100
98
100
100
100
100
0
94
100

Approximate
Leasable
Square Feet

146,600
128,500
335,500
48,800
1,057,100
385,700
245,600
29,100
1,252,600
699,300
91,900
696,200
349,600
63,800
188,300
51,900
65,200
218,800
203,100
81,600
337,100
205,200
244,500
30,000
104,500
191,000
89,600
200,100
53,300
386,300
322,800
31,900
661,500
99,300
253,300
481,300
3,500
215,800
18,300
451,400
1,835,500
35,100
2,500
431,900
243,900
16,800
153,700
9,300

1,646

99%

13,448,600

Rental Revenue
For the Quarter Ended
Dec 31, 2005(1)

Percentage
of Rental
Revenue

$ 419
259
1,900
139
4,044
1,785
929
338
4,958
2,733
371
3,184
1,516
181
515
320
285
1,182
994
300
1,278
711
784
79
436
837
358
1,069
152
1,871
1,470
35
2,520
685
587
2,269
29
1,416
30
2,199
4,859
108
22
2,309
783
—
370
45

$ 53,663

0.8%
0.5
3.5
0.3
7.5
3.3
1.7
0.6
9.2
5.1
0.7
5.9
2.8
0.3
1.0
0.6
0.5
2.2
1.9
0.6
2.4
1.3
1.5
0.1
0.8
1.6
0.7
2.0
0.3
3.5
2.7
*
4.7
1.3
1.1
4.2
0.1
2.6
0.1
4.1
9.1
0.2
*
4.3
1.5
0.0
0.7
0.1

100.0%

(1)Includes rental revenue for all properties owned by Realty Income at December 31, 2005, including revenue from properties reclassified to
discontinued operations of $59.

3 3

R E A LT Y I N C O M E

Description of Leasing Structure
At December 31, 2005, 1,617 single tenant and certain other

Certain Properties Under Development
Of the 135 properties Realty Income acquired in 2005, all were

retail properties or 98.2% of our 1,646 properties were net leased.

occupied at December 31, 2005, except for 10 properties that

In most cases, the leases:

were leased and being developed. In the case of development

• Are for initial terms of 15 to 20 years;

properties, we either enter into an agreement with a retail chain

• Require the tenants to pay minimum monthly rents and

where the retailer retains a contractor to construct the improve-

property operating expenses (taxes, insurance and mainte-

ments and we fund the costs of that development, or we fund a

nance); and

developer who constructs the improvements. In either case, there

• Provide for future rent increases (typically subject to ceil-

is an executed lease with a retail tenant at the time of the land

ings) based on increases in the consumer price index,

purchase (with a fixed rent commencement date) and there is a

fixed increases, or to a lesser degree, additional rent based

requirement to complete the construction in a timely basis and

upon the tenants’ gross sales above a specified level.

within a specific budget, typically within eight months after we

Where leases provide for rent increases based on increases

purchase the land. The tenant or developer generally is required

in the consumer price index, generally these increases

to pay construction cost overruns to the extent that they exceed

become part of the new permanent base rent. Where

the construction budget by more than a predetermined amount.

leases provide for percentage rent, this additional rent is

We also enter into a lease with the tenant at the time we purchase

typically payable only if the tenants’ gross sales, for a

the land, which generally requires the tenant to begin paying base

given period (usually one year), exceed a specified level
and is then typically calculated as a percentage of only the

rent when the store opens for business. The base rent is calcu-
lated by multiplying a predetermined capitalization rate by our

amount of gross sales in excess of that level.

total investment in the property including the land cost for the

Matters Pertaining to Certain Properties and Tenants
Of the 25 properties available for lease or sale at December 31,

property, construction costs and capitalized interest. In 2005,

Realty Income acquired 21 development properties. Crest Net did

not acquire any development property in 2005. Both Realty

2005; all but one are single-tenant properties. At December 31,

Income and Crest Net will continue to pursue development oppor-

2005, 17 of our properties under lease were unoccupied and

tunities under similar arrangements in the future.

available for sublease by the tenants, all of which were current

with their rent and other obligations. During 2005, each of our

tenants accounted for less than 10% of our rental revenue.

Risk Factors
For a full description of the risk factors associated with the

Company, see Item 1A “Risk Factors” in our Form 10-K for the

fiscal year ended December 31, 2005.

R E A LT Y I N C O M E 3 4

REALTY INCOME CORPORATION AND SUBSIDIARIES
C O N S O L I D A T E D B A L A N C E S H E E T S

December 31, 2005 and 2004 (dollars in thousands, except per share data)

2005

2004

Assets

Real estate, at cost:

Land

Buildings and improvements

Less accumulated depreciation and amortization

Net real estate held for investment

Real estate held for sale, net

Net real estate

Cash and cash equivalents

Accounts receivable

Goodwill

Other assets

Total assets

Liabilities and Stockholders’ Equity

Distributions payable

Accounts payable and accrued expenses

Other liabilities

Line of credit payable

Notes payable

Total liabilities

Commitments and contingencies

$ 746,016

1,350,140

2,096,156

(341,193)

1,754,963

47,083

1,802,046

65,704

5,044

17,206

30,988

$ 624,558

1,066,725

1,691,283

(301,728)

1,389,555

17,155

1,406,710

2,141

4,075

17,206

12,183

$ 1,920,988

$ 1,442,315

10,121

20,391

9,562

136,700

755,000

931,774

9,115

9,579

6,286

23,600

480,000

528,580

Stockholders’ equity:

Preferred stock and paid in capital, par value $1.00 per share,

20,000,000 shares authorized, 5,100,000 shares issued

and outstanding

123,804

123,787

Common stock and paid in capital, par value $1.00 per share,

in 2005 there were 200,000,000 shares authorized and

83,696,647 issued and outstanding and in 2004 there

were 100,000,000 shares authorized and 79,301,630

issued and outstanding

Distributions in excess of net income

Total stockholders’ equity

Total liabilities and stockholders’ equity

1,134,300

(268,890)

989,214

$ 1,920,988

1,038,973

(249,025)

913,735

$ 1,442,315

The accompanying notes to consolidated financial statements are an integral part of these statements.

3 5

R E A LT Y I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E

Years Ended December 31, 2005, 2004 and 2003 (dollars in thousands, except per share data)

Revenue

Rental

Other

Expenses

Interest

Depreciation and amortization

General and administrative

Property

Income taxes

Income from continuing operations

Income from discontinued operations:

Real estate acquired for resale by Crest

Real estate held for investment

Net income

Preferred stock cash dividends

Excess of redemption value over carrying

value of preferred shares redeemed

(see note 7C and 7D)

Basic

Diluted

Net income available to common stockholders

per common share:

Basic and diluted

Weighted average common shares outstanding:

Basic

Diluted

2005

2004

2003

$ 196,322

354

196,676

$ 172,714

1,033

173,747

$ 142,888

590

143,478

40,949

46,438

15,421

3,838

813

107,459

89,217

2,781

7,121

9,902

99,119

(9,403)

—

1.00

34,132

39,874

13,119

3,069

699

90,893

82,854

7,847

12,696

20,543

103,397

(9,455)

(3,774)

$ 90,168

0.89

26,413

32,231

10,616

2,439

501

72,200

71,278

4,588

10,569

15,157

86,435

(9,713)

—

$ 76,722

0.87

0.86

1.12

1.15

1.08

79,950,255

80,208,593

78,518,296

78,598,788

71,128,282

71,222,628

Net income available to common stockholders

$ 89,716

Income from continuing operations per common share:

The accompanying notes to consolidated financial statements are an integral part of these statements.

R E A LT Y I N C O M E 3 6

REALTY INCOME CORPORATION AND SUBSIDIARIES
C O N S O L I D A T E D S T A T E M E N T S O F
S T O C K H O L D E R S ’ E Q U I T Y

Years Ended December 31, 2005, 2004 and 2003 (dollars in thousands)

Shares of

Preferred
Stock

Common
Stock

Preferred
Stock and
Paid In
Capital

Common
Stock and
Paid In
Capital

Distributions
In Excess of
Net Income

Total

Balance, December 31, 2002

4,125,700

69,749,654

$ 99,368

$ 855,818

$ (232,731)

$ 722,455

Net income

Distributions paid and payable

Shares issued in stock offerings,

net of offering costs

of $5,854

Deferred stock compensation

—

— 5,750,000

—

318,518

—

86,435

(94,336)

86,435

(94,336)

110,842

2,370

—

110,842

2,370

Balance, December 31, 2003

4,125,700

75,818,172

99,368

969,030

(240,632)

827,766

Net income

Distributions paid and payable

Shares issued in stock offerings,

net of offering costs

of $3,682

Shares issued in stock offerings,

net of offering costs

of $4,187

Preferred shares redeemed

Deferred stock compensation

—

— 3,200,000

—

103,397

(108,016)

67,918

—

67,918

5,100,000

(4,125,700)

—

123,787

(99,368)

—

123,787

(3,774)

(103,142)

—

283,458

—

2,025

—

2,025

Balance, December 31, 2004

5,100,000

79,301,630

123,787

1,038,973

(249,025)

913,735

Net income

Distributions paid and payable

Shares issued in stock offerings,

net of offering costs

of $4,980

Deferred stock compensation

—

— 4,100,000

—

295,017

—

99,119

(118,984)

92,659

2,668

—

92,676

2,668

Balance, December 31, 2005

5,100,000

83,696,647

$ 123,804

$ 1,134,300

$ (268,890)

$ 989,214

The accompanying notes to consolidated financial statements are an integral part of these statements.

3 7

R E A LT Y I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S

Years Ended December 31, 2005, 2004 and 2003 (dollars in thousands)

2005

2004

2003

$ 99,119

$ 103,397

$ 86,435

46,438

39,874

32,231

Cash Flows from Operating Activities
Net income
Adjustments to net income:

Depreciation and amortization
Income from discontinued operations:

Real estate acquired for resale by Crest
Real estate held for investment
Cash from discontinued operations:

Real estate acquired for resale by Crest
Real estate held for investment

Investments in real estate acquired for resale by Crest
Intangibles acquired in connection with acquisition of

real estate acquired for resale by Crest

Proceeds from sales of real estate acquired for resale
Amortization of deferred stock compensation
Amortization of stock option costs
Gain on sale of real estate held for investment
Provision for impairment on real estate

Changes in assets and liabilities:

Accounts receivable and other assets
Accounts payable, accrued expenses and other liabilities

Net cash provided by operating activities

Cash Flows from Investing Activities
Proceeds from sales of investment properties:
Acquisition of and additions to investment properties
Intangibles acquired in connection with acquisition

of real estate held for investment

Net cash used in investing activities

Cash Flows from Financing Activities
Borrowings from lines of credit
Payments under lines of credit
Proceeds from note offerings, net
Proceeds from common stock offerings, net
Cash distributions to common stockholders
Cash dividends to preferred stockholders
Proceeds from preferred stock offerings, net
Redemption of preferred stock
Proceeds from other stock issuances

Net cash provided by (used in) financing activities

Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year

(2,781)
(7,121)

(510)
809
(54,110)

(1,780)
22,195
2,155
12
(18)
151

(3,292)
8,290

109,557

22,300
(417,347)

(9,494)

(404,541)

400,300
(287,200)
270,266
92,659
(108,575)
(9,403)
—
—
500

358,547

63,563
2,141

(7,847)
(12,696)

(2,407)
3,509
(21,787)

—
74,995
1,426
14
(185)
—

1,094
(1,050)

178,337

(4,588)
(10,569)

(1,629)
6,339
(87,384)

—
45,226
940
11
—
—

1,751
5,194

73,957

34,601
(195,470)

20,773
(280,587)

—

(160,869)

(259,814)

280,400
(283,200)
(28)
67,918
(97,420)
(9,063)
123,787
(103,142)
584

(20,164)

(2,696)
4,837

360,600
(443,900)
246,367
110,842
(83,842)
(9,713)
—
—
1,419

181,773

(4,084)
8,921

$ 4,837

Cash and cash equivalents, end of year

$ 65,704

2,141

For supplemental disclosures, see note 12.

The accompanying notes to consolidated financial statements are an integral part of these statements.

R E A LT Y I N C O M E 3 8

REALTY INCOME CORPORATION AND SUBSIDIARIES
N O T E S T O C O N S O L I D A T E D
F I N A N C I A L S T A T E M E N T S

December 31, 2005, 2004 and 2003

Earnings and profits that determine the taxability of distribu-

1 . O R G A N I Z A T I O N A N D O P E R A T I O N

tions to stockholders differ from net income reported for financial

reporting purposes due to differences in the estimated useful

Realty Income Corporation (“Realty Income,” the “Company,”

lives and methods used to compute depreciation and the carry-

“we” or “our”) is organized as a Maryland corporation. We invest

ing value (basis) on the investments in properties for tax purposes,

in commercial retail real estate and have elected to be taxed as a

among other things.

real estate investment trust (“REIT”).

The following reconciles our net income available to common

At December 31, 2005, we owned 1,646 properties in 48

stockholders to taxable income for 2005 (dollars in thousands)

states containing over 13.4 million leasable square feet, plus an

(unaudited):

additional 17 properties owned by our wholly-owned taxable REIT

subsidiary, Crest Net Lease, Inc. (“Crest Net”). Crest Net was cre-

Net income available to common stockholders

$ 89,716

ated to buy, own and sell properties, primarily to individual
investors, many of whom are involved in tax-deferred exchanges,

Tax loss on the sale of real estate less

than book gains

under Section 1031 of the Internal Revenue Code of 1986, as

Elimination of net revenue and expenses

amended (“the Code”).

from Crest Net

A 2-for-1 stock split was declared in November 2004 and

Dividends received from Crest Net

became effective after the market closed on December 31, 2004.

Preferred dividends not deductible for tax

(7,260)

(718)

1,410

9,403

Common stockholders received an additional share of common

Depreciation and amortization timing differences

11,546

stock for each share they owned. The increase in the number of

common shares outstanding and all per common share data has

Impairment losses

Other adjustments

186

(77)

been adjusted for the stock split.

2 . S U M M A R Y O F S I G N I F I C A N T

A C C O U N T I N G P O L I C I E S A N D P R O C E D U R E S

Federal Income Taxes. We have elected to be taxed as a REIT

under the Code. We believe we have qualified and continue to

qualify as a REIT. As a REIT, we will be permitted to deduct dis-

tributions paid to our stockholders and, generally, will not be

required to pay federal corporate income taxes on such income.

Accordingly, no provision has been made for federal income taxes

in the accompanying consolidated financial statements, except

for federal income taxes of Crest Net, which totaled $760,000

in 2005, $2.8 million in 2004 and $1.8 million in 2003. These

taxes are included in “income from discontinued operations, real

estate acquired for resale by Crest.”

Estimated taxable net income, before our

dividend paid deduction

$ 104,206

Net Income Per Common Share. Basic net income per common

share is computed by dividing net income available to common

stockholders by the weighted average number of common shares

outstanding during each period. Diluted net income per common

share is computed by dividing the amount of net income available

to common stockholders for the period by the number of common

shares that would have been outstanding assuming the issuance

of common shares for all potentially dilutive common shares out-

standing during the reporting period.

The following is a reconciliation of the denominator of the

basic net income per common share computation to the denomi-

nator of the diluted net income per common share computation,

for the years ended December 31:

2005

2004

2003

Weighted average shares used for basic net income per share computation

79,950,255

78,518,296

71,128,282

Incremental shares from share based compensation

258,338

80,492

94,346

Adjusted weighted average shares used for diluted net income

per share computation

80,208,593

78,598,788

71,222,628

In 2005, 2004 and 2003, no stock options were anti-dilutive. In 2005, we had 305,476 nonvested shares from share based

compensation that were anti-dilutive. No nonvested shares were anti-dilutive in 2004 or 2003.

3 9

R E A LT Y I N C O M E

Discontinued Operations. In accordance with Financial Accounting

The following is a summary of Realty Income’s “income from

Standards Board Statement No. 144, Accounting for the Impairment

discontinued operations from real estate held for investment” for

or Disposal of Long-Lived Assets (“SFAS 144”), Realty Income’s

the years ended December 31, 2005, 2004 and 2003 (dollars

operations from four investment properties classified as held

in thousands):

for sale at December 31, 2005, plus properties sold in 2005,

2004 and 2003, were reported as discontinued operations.

Their respective results of operations were reclassified to “income

from discontinued operations, real estate held for investment.”

We classify properties as held for sale in accordance with

SFAS 144. We do not depreciate properties that are classified as

held for sale.

Crest Net acquires properties with the intention of reselling

them rather than holding them for investment and operating the

properties. Consequently, we classify properties acquired by Crest

Net as held for sale at the date of acquisition and do not depre-

ciate them. In accordance with SFAS 144, the operations of Crest

Net’s properties are classified as “income from discontinued

operations, real estate acquired for resale by Crest.”

No debt was assumed by buyers of our investment properties

or repaid as a result of our investment property sales and we

have elected not to allocate interest expense to discontinued

operations related to real estate held for investment.

In accordance with Emerging Issues Task Force No. 87-24,

we allocate interest expense related to borrowings specifically

attributable to Crest Net properties. The interest expense

amounts allocated to the Crest Net properties are included in

“income from discontinued operations, real estate acquired for

resale by Crest.”

The following is a summary of Crest Net’s “income from

discontinued operations, real estate acquired for resale” for the

years ended December 31, 2005, 2004 and 2003 (dollars in

thousands):

Crest Net’s income from
discontinued operations,
real estate acquired for resale

Gain on sales of real estate

2005

2004

2003

acquired for resale

$ 3,291 $ 10,254

$ 6,217

Rental revenue

Interest expense

2,085

(1,139)

2,304

(674)

1,724

(561)

General and administrative

expense

Property expenses
Income taxes

Income from discontinued

operations, real estate

acquired for resale

(453)

(60)
(943)

(464)

(93)
(3,480)

(566)

(24)
(2,202)

by Crest

$ 2,781

$ 7,847

$ 4,588

Realty Income’s income from
discontinued operations from
real estate held for investment

Gain on sales of

2005

2004

2003

investment properties

$ 6,573 $ 12,543 $ 7,156

Rental revenue

Other revenue

Depreciation and amortization

Property expenses

1,073

3,927

6,845

(226)

(266)

117

(984)

(534)

(1,684)

(552)

Provisions for impairments

(35)

(2,373)

(1,242)

Income from discontinued

operations, real estate

held for investment

$ 7,121 $ 12,696 $ 10,569

The following is a summary of our total income from discon-

tinued operations for the years ended December 31, 2005, 2004

and 2003 (dollars in thousands):

Total income from
discontinued operations

2005

2004

2003

Income from discontinued operations:

Real estate acquired for

resale by Crest

$ 2,781 $ 7,847 $ 4,588

Real estate held

for investment

7,121

12,696

10,569

Income from discontinued

operations

$ 9,902 $ 20,543 $ 15,157

Per common share,

basic and diluted

$ 0.12

$ 0.26 $ 0.21

Leases. All leases are accounted for as operating leases. Under this

method, lease payments that have fixed and determinable rent

increases are recognized on a straight-line basis over the lease

term. Any rental revenue contingent upon a tenant’s sales is rec-

ognized only after the tenant exceeds their sales breakpoint.

Rental increases based upon changes in the consumer price

indexes are recognized only after the changes in the indexes have

occurred and are then applied according to the lease agreements.

Principles of Consolidation. The accompanying consolidated

financial statements include the accounts of Realty Income, Crest

Net and other entities for which we make operational and

financial decisions (control), after elimination of all material

intercompany balances and transactions. All of Realty Income’s

and Crest Net’s subsidiaries are wholly-owned.

Cash Equivalents. We consider all short-term, highly liquid invest-

ments that are readily convertible to cash and have an original

maturity of three months or less at the time of purchase to be

cash equivalents.

R E A LT Y I N C O M E 4 0

Gain on Sales of Properties. We recognize gains on sales of prop-

The fair value of the tangible assets of an acquired property

erties in accordance with Statement No. 66, Accounting for Sales

(which includes land and buildings/improvements) is determined

of Real Estate.

by valuing the property as if it were vacant, and the “as-if-vacant”

value is then allocated to land and buildings/improvements based

Depreciation and Amortization. Depreciation of buildings and

on our determination of the relative fair value of these assets. Our

improvements are computed using the straight-line method over

determinations are based on a real estate appraisal for each prop-

an estimated useful life of 25 years.

erty, generated by an independent appraisal firm, which considered

estimates of carrying costs during the expected lease-up periods,

Maintenance and Repairs. Expenditures for maintenance and

current market conditions, as well as costs to execute similar

repairs are expensed as incurred. Replacements and betterments

leases. In allocating the fair value to identified intangibles for

are capitalized.

above-market or below-market leases, an amount is recorded

based on the present value of the difference between (i) the

Provisions for Impairments. We review long-lived assets for impair-

contractual amount to be paid pursuant to the in-place lease and

ment whenever events or changes in circumstances indicate that

(ii) our estimate of fair market lease rate for the corresponding

the carrying amount of an asset may not be recoverable.

in-place lease, measured over a period equal to the remaining

Generally, a provision is made for impairment if estimated future

non-cancelable term of the lease.

operating cash flows (undiscounted and without interest charges)

Capitalized above-market lease values are amortized as a

plus estimated disposition proceeds (undiscounted) are less than
the current book value. Impairment loss is measured as the

reduction of rental income over the remaining non-cancelable
terms of the respective leases. Capitalized below-market lease

amount by which the current book value of the asset exceeds the

values are amortized as an increase to rental income over the

fair value of the asset. If a property is held for sale, it is carried

remaining non-cancelable terms of the respective leases and

at the lower of cost or estimated fair value, less cost to sell.

expected below market renewal option periods.

Provisions for impairment of $186,000 were recorded in

The aggregate value of other acquired intangible assets con-

2005 on four retail properties, of which two were sold during

sists of the value of in-place leases and tenant relationships. These

2005. These properties were classified in the following indus-

are measured by the excess of the purchase price paid for a prop-

tries: one in child care and three in restaurant.

erty, after adjusting for above or below market lease value, less the

Provisions for impairment of $2.4 million were recorded in

estimated fair value of the property “as if vacant,” determined as

2004 on six retail properties, of which five were sold during 2004.

set forth above. The value of in-place leases, exclusive of the value

These properties were classified in the following industries: one

of above-market and below-market in-place leases, is amortized

in automotive service, one in child care, two in consumer electron-

to expense over the remaining non-cancelable periods of the

ics, one in convenience store and one in restaurant.

respective leases. If a lease were to be terminated prior to its

Provisions for impairment of $1.2 million were recorded in

stated expiration, all unamortized amounts relating to that lease

2003 on 11 retail properties, all of which were sold during 2003.

would be recorded to revenue or expense as appropriate.

These properties were classified in the following industries: one

in automotive service, three in child care, one in consumer elec-

Stock Option Plan. Effective January 1, 2002, we adopted the

tronics, three in home improvement and three in restaurant.

fair value recognition provisions of FASB Statement No. 123,

All of these provisions for impairment are included in income

Accounting for Stock-Based Compensation, and starting

from discontinued operations, real estate held for investment on

January 1, 2002 expensed costs for all stock option awards

our consolidated statements of income, except for $151,000 in

granted, modified, or settled. Stock option awards under the

2005 which is included in property expenses.

plan vest over periods ranging from one to five years.

Acquired In-place Leases. In accordance with Financial Accounting

Standards Board Statement No. 141, Business Combinations,

(“SFAS 141”) the fair value of the real estate acquired with in-

place operating leases is allocated to the acquired tangible assets,

consisting of land, building and improvements, and identified

intangible assets and liabilities, consisting of the value of above-

market and below-market leases, the value of in-place leases and

tenant relationships, based in each case on their fair values.

4 1

R E A LT Y I N C O M E

The following table illustrates the effect on net income

3 . R E T A I L P R O P E R T I E S A C Q U I R E D

available to common stockholders and earnings per share if the

We acquire land, buildings and improvements that are used by

fair value method had been applied to all outstanding and

retail operators.

unvested stock option awards in each period (dollars in thousands,

except per share amounts):

Net income available to

common stockholders,

2005

2004

2003

as reported

$ 89,716 $ 90,168 $ 76,722

Add: Stock option-based

compensation expense

included in reported

net income

Deduct: Total stock option-

based compensation

expense determined

under fair value
method for all awards

Pro forma net income

available to common

(12)

(14)

(27)

A. During 2005, Realty Income and Crest Net, in aggregate,

invested $486.6 million in 156 new retail properties and proper-

ties under development. These 156 properties are located in 30

states, will contain over 1.9 million leasable square feet and are

100% leased with an average initial lease term of 15.8 years.

Of the $486.6 million invested, $95.1 million was used to

acquire 34 properties with existing leases on the properties. In

accordance with SFAS 141, Realty Income recorded $10.1 mil-

lion and Crest Net recorded $1.8 million as the value of in-place

leases and Realty Income recorded $183,000 as the value of

above-market rents. In addition, Realty Income recorded

$756,000 and Crest Net recorded $66,000 as the value of

below-market rents on these leases. The amounts recorded by

Realty Income are included in “other assets” and “other liabili-
ties” on our consolidated balance sheet and are amortized over

the lives of the respective leases. Due to property sales, of the

amounts recorded by Crest Net, only $219,000 of in-place

stockholders

$ 89,716 $ 90,168 $ 76,706

lease value is included in our consolidated balance sheet at

Net income available to

common stockholders

per common share:

As reported—basic

and diluted

$ 1.12 $ 1.15 $ 1.08

Pro forma—basic

and diluted

$ 1.12 $ 1.15 $ 1.08

Goodwill. Goodwill is tested for impairment annually as well as

when events or circumstances occur indicating that our goodwill

might be impaired. We did not record any new goodwill or impair-

ment on our existing goodwill during 2005, 2004 or 2003.

Use of Estimates. The consolidated financial statements were pre-

pared in conformity with U.S. generally accepted accounting prin-

ciples, which requires management to make estimates and

assumptions that affect the reported amounts of assets and liabil-

ities, the disclosure of contingent assets and liabilities at the date

of the financial statements, and the reported amounts of revenue

and expenses during the reporting period. Actual results could

differ from those estimates.

Reclassifications. Certain of the 2004 and 2003 balances have

been reclassified to conform to the 2005 presentation.

December 31, 2005. Crest Net does not amortize the value of

in-place leases because its properties are held for sale.

In comparison, during 2004, Realty Income and Crest Net, in

aggregate, invested $215.3 million in 194 new retail properties and

properties under development. These 194 properties are located in

19 states, contain approximately 972,000 leasable square feet and

are 100% leased with an average initial lease term of 17.5 years.

B. During 2005, Realty Income invested $430.7 million in 135

new retail properties and properties under development, with an

initial weighted average contractual lease rate of 8.4%. These

135 properties are located in 28 states, will contain over 1.7 mil-

lion leasable square feet and are 100% leased with an average

initial lease term of 15.6 years.

In comparison, during 2004, Realty Income invested

$193.8 million in 172 new retail properties and properties under

development, with an initial weighted average contractual lease

rate of 9.5%. These 172 properties are located in 18 states,

contain over 913,000 leasable square feet and are 100% leased

with an average initial lease term of 17.5 years.

C. During 2005, Crest Net invested $55.9 million in 21 new retail

properties and properties under development.

In comparison, during 2004, Crest Net invested $21.5 million

in 22 new retail properties and properties under development.

D. Crest Net’s property inventory at December 31, 2005 consisted

of 17 properties with a total investment of $45.7 million and at

December 31, 2004 consisted of eight properties with a total

investment of $10.1 million. These amounts are included on our

consolidated balance sheets in “real estate held for sale, net”,

except for $219,000 of intangible assets at December 31, 2005

which are included in other assets.

R E A LT Y I N C O M E 4 2

4 . C R E D I T F A C I L I T Y

In January 1999, we issued $20 million of 8% senior unse-

In June 2005, Realty Income entered into a new $300 million

cured notes due 2009 (the “2009 Notes”). Interest on the 2009

acquisition credit facility to replace our existing $250 million

Notes is payable semiannually.

acquisition credit facility that expired in October 2005. Under the

terms of the new credit facility, which commenced in October

In October 1998, we issued $100 million of 81/4% Monthly
Income Senior Notes due 2008 (the “2008 Notes”). In May

2005, the borrowing rate was reduced to LIBOR (London

1998, we entered into a treasury interest rate lock agreement

Interbank Offered Rate) plus 65 basis points with a facility fee of

associated with the 2008 Notes. In settlement of the agreement,

15 basis points, for all-in drawn pricing of 80 basis points over

we made a payment of $8.7 million in 1998. The payment on the

LIBOR, based on our current credit ratings. The new credit facil-

agreement is being amortized over 10 years (the life of the 2008

ity offers us other interest rate options as well. The term of the

Notes) as a yield adjustment to interest expense. After taking into

new facility expires in October 2008, unless extended as provided

effect the results of a treasury interest rate lock agreement, the

in the agreement.

The average borrowing rate on our credit facilities during

2005 was 4.3%, compared to 2.4% in 2004 and 2.2% in

2003. Our current credit facility is, and previous credit facili-

effective rate to us on the 2008 Notes is 9.12%. Interest on the

2008 Notes is payable monthly. The 2008 Notes are unsecured.
In May 1997, we issued $110 million of 73/4% senior unse-
cured notes due 2007 (the “2007 Notes”). In December 1996,

ties were, subject to various leverage and interest coverage ratio

we entered into a treasury interest rate lock agreement associated

limitations. The Company is and has been in compliance with

with the 2007 Notes. In settlement of the agreement, we received

these covenants.

In 2005, 2004 and 2003, interest of $1.9 million, $531,000

$1.1 million in 1997. The payment received on the agreement
is being amortized over 10 years (the life of the 2007 Notes) as

and $697,000, respectively, was capitalized with respect to prop-

a yield adjustment to interest expense. After taking into effect the

erties under development.

results of a treasury interest rate lock agreement, the effective

Our credit facility is unsecured and accordingly, we have not

interest rate to us on the 2007 Notes is 7.62%. Interest on the

pledged any assets as collateral for this obligation.

2007 Notes is payable semiannually.

5 . N O T E S P A Y A B L E

In September 2005, we issued $175 million in aggregate principal
amount of 5 3/8% senior unsecured notes due 2017 (the “2017
Notes”). The price to the investor for the 2017 Notes was 99.974%

Interest incurred on the 2017 Notes, 2035 Bonds, 2015

Notes, 2013 Notes, 2009 Notes, 2008 Notes and 2007 Notes col-

lectively for each of the years ended December 31, 2005, 2004

and 2003 was $39.5 million, $32.0 million and $23.6 million,

respectively. The interest rate on each of these notes is fixed.

of the principal amount for an effective yield of 5.378%. The net

Our outstanding notes are unsecured and accordingly, we

proceeds of $173.2 million from this offering were used to repay

have not pledged any assets as collateral for these or any other

borrowings under our unsecured acquisition credit facility, to fund

obligations.

new property acquisitions and for other general corporate purposes.

All of these notes contain various covenants, including: (i) a

Interest on the 2017 Notes is paid semiannually.

limitation on incurrence of any debt which would cause our debt

In March 2005, we issued $100 million in aggregate princi-
pal amount of 5 7/8% senior unsecured bonds due 2035 (the
“2035 Bonds”). The price to the investor for the 2035 Bonds was

to total adjusted assets ratio to exceed 60%; (ii) a limitation on

incurrence of any secured debt which would cause our secured

debt to total adjusted assets ratio to exceed 40%; (iii) a limitation

98.296% of the principal amount for an effective yield of

on incurrence of any debt which would cause our debt service cov-

5.998%. The net proceeds of $97.0 million from this offering

erage ratio to be less than 1.5 times; and (iv) the maintenance at

were used to repay borrowings under our acquisition credit facil-

all times of total unencumbered assets not less than 150% of our

ity and for other general corporate purposes. Interest on the 2035

outstanding unsecured debt. We have been in compliance with

Bonds is paid semiannually.

these covenants since each of the notes were issued.

In November 2003, we issued $150 million of 51/2% senior
unsecured notes due 2015 (the “2015 Notes”). The price to the

investor for the 2015 notes was 99.508% of the principal

amount for an effective yield of 5.557%. The net proceeds from

this offering were used to acquire new retail properties and to

repay borrowings under our unsecured acquisition credit facility.

Interest on the 2015 Notes is payable semiannually.

In March 2003, we issued $100 million of 5 3/8% senior
unsecured notes due 2013 (the “2013 Notes”). The price to the

investor for the 2013 notes was 99.509% of the principal

amount for an effective yield of 5.439%. The net proceeds from

this offering were used to repay borrowings under our unsecured

acquisition credit facility. Interest on the 2013 Notes is payable

semiannually.

4 3

R E A LT Y I N C O M E

The following table summarizes the maturity of our notes

The following presents the federal income tax characterization

payable as of December 31, 2005 (dollars in millions):

of distributions paid or deemed to be paid to common stockholders

Year of Maturity

2006

2007

2008

2009

2010

Thereafter

Totals

Notes

$ —

110.0

100.0

20.0

for the years ended December 31:

Ordinary income

$ 1.210091

$ 1.18315

$ 1.10529

2005

2004

2003

Nontaxable

distributions

0.136159

0.05810

0.07596

—

Capital gain

—

525.0

$ 755.0

Totals

$ 1.346250 $ 1.24125

$ 1.18125

6 . C O M M O N S T O C K O F F E R I N G S

At December 31, 2005, a distribution of $0.11625 per com-

mon share was payable and was paid in January 2006. At

A. In September 2005, we issued 4.1 million shares of common

December 31, 2004, a distribution of $0.11 per common share

stock at a price of $23.79 per share. The net proceeds of

was payable and was paid in January 2005.

$92.7 million were used to fund new property acquisitions and

for other general corporate purposes.

B. In May 2004, we issued 4.0 million shares of 7.375% Monthly

Income Class D cumulative redeemable preferred stock, with a

B. In March 2004, we issued 3.2 million shares of common stock

liquidation value of $25 per share. All of these shares are out-

at a price of $22.375 per share. The net proceeds of $67.9 mil-

standing. The net proceeds of $96.4 million from this issuance

lion were used to repay a portion of our acquisition credit facility

were used to redeem a portion of the outstanding Class B and

borrowings, which had been used to acquire 112 convenience

Class C preferred stock, repay borrowings outstanding under our

store properties in March 2004.

$250 million acquisition credit facility and for other general cor-

porate purposes. Beginning May 27, 2009, the Class D preferred

C. In October 2003, we issued 5.75 million shares of common

shares are redeemable at our option for $25 per share. Dividends

stock at a price of $20.295 per share. The net proceeds of

of $0.1536459 per share are paid monthly in arrears on the Class

$110.8 million were used to repay a portion of our acquisition

D preferred stock.

credit facility.

7 . D I S T R I B U T I O N S P A I D A N D P A Y A B L E

In October 2004, we issued an additional 1.1 million shares

of Class D preferred stock for $25.4311 per share. The net pro-

ceeds of $27.4 million were used to repay borrowings under our

A. We pay monthly cash distributions to our common stockhold-

$250 million acquisition credit facility.

ers. The following is a summary of monthly distributions paid per

We paid or accrued dividends to holders of our Class D preferred

common share for the years ended December 31:

stock totaling $9.4 million in 2005 and $4.8 million in 2004.

2005

2004

2003

The dividends paid per share to our Class D preferred stockholders

for 2005 of $1.84375 and for 2004 of $1.01406 were character-

$ 0.110000

$ 0.100000

$ 0.097500

ized for federal income tax purposes as ordinary income.

Month

January

February

March

April

May

June

July

August

September

October

November
December

0.110000

0.110625

0.111250

0.115000

0.115625

0.115625
0.115625

0.100000

0.100625

0.101250

0.108750

0.109375

0.109375
0.109375

0.097500

0.098125

0.098750

0.099375

0.099375
0.099375

Total

$ 1.346250

$ 1.241250

$ 1.181250

C. In May 1999, we issued 2,760,000 shares of 93/8% Class B
cumulative redeemable preferred stock, of which 2,745,700

shares were outstanding in 2003 and a portion of 2004. On

June 6, 2004, all of the outstanding Class B preferred shares

were redeemed. We paid dividends to holders of our Class B

preferred stock totaling $2.8 million during the first two quarters

of 2004 and $6.4 million in 2003. The dividends paid per share

to our Class B Preferred stockholders in 2004 of $1.01563 and

in 2003 of $2.34375 were characterized for federal income tax

purposes as ordinary income.

In addition, when our Class B preferred stock was redeemed

in 2004, we incurred a non-cash charge of $2.4 million repre-

senting the Class B preferred stock original issuance costs that

were paid in 1999.

R E A LT Y I N C O M E 4 4

D. In July 1999, we issued 1,380,000 shares of 91/2% Class C
cumulative redeemable preferred stock, all of which were out-

B. Major Tenants—No individual tenant’s rental revenue, including

percentage rents, represented more than 10% of our total revenue

standing in 2003 and for a portion of 2004. On July 30, 2004,

for each of the years ended December 31, 2005, 2004 or 2003.

all of the outstanding Class C preferred shares were redeemed.

We paid monthly dividends to holders of our Class C preferred

stock totaling $1.9 million during the first seven months of 2004

9 . G A I N O N S A L E S O F R E A L E S T A T E

A C Q U I R E D F O R R E S A L E B Y C R E S T N E T

and $3.3 million in 2003. The dividends paid per share to our

In 2005, Crest Net sold 12 properties for $23.5 million, which

Class C preferred stockholders in 2004 of $1.37882 and in

resulted in a gain of $3.3 million. As part of one sale in 2005, Crest

2003 of $2.375 were characterized for federal income tax pur-

Net provided buyer financing in the form of a $1.3 million promis-

poses as ordinary income.

sory note. This note was paid in full in February 2006. In 2004,

In addition, when our Class C preferred stock was redeemed

Crest Net sold 51 properties for $75.0 million, which resulted in a

in 2004, we incurred a non-cash charge of $1.4 million repre-

gain of $10.3 million. In 2003, Crest Net sold 27 properties for

senting the Class C preferred stock original issuance costs that

$45.2 million, which resulted in a gain of $6.2 million.

were paid in 1999.

8 . O P E R A T I N G L E A S E S

1 0 . G A I N O N S A L E S O F I N V E S T M E N T

P R O P E R T I E S B Y R E A L T Y I N C O M E

A. At December 31, 2005, we owned 1,646 properties in 48

In 2005, we sold 23 investment properties and sold a portion of

states, excluding 17 properties owned by Crest Net. Of these
1,646 properties, 1,641 are single-tenant retail locations and the

the land from two properties for $23.4 million, which resulted in
a gain of $6.6 million. This gain is included in discontinued oper-

remainder are multi-tenant, distribution and office locations. At

ations, except for $18,000 that is included in other revenue.

December 31, 2005, 25 properties were vacant and available

In 2004, we sold or exchanged 43 investment properties and

for lease or sale.

sold a portion of the land from four properties for $35.4 million,

Substantially all leases are net leases where the tenant pays

which resulted in a gain of $12.7 million. Of this gain, $12.5 mil-

property taxes and assessments, maintains the interior and

lion is included in discontinued operations and $185,000 is

exterior of the building and leased premises, and carries insur-

included in other revenue. Included in the 43 properties was one

ance coverage for public liability, property damage, fire and

property leased by one of our tenants that we exchanged for

extended coverage.

another property owned by that tenant (see note 12E).

Percentage rent for 2005, 2004 and 2003 was $1.2 million,

During 2003, we sold or exchanged 35 investment properties

$1.3 million and $1.2 million, respectively, including amounts

and exchanged three excess land parcels (from three properties) for

recorded to discontinued operations.

$23.1 million, which resulted in a gain of $7.2 million. This gain is

At December 31, 2005, minimum future annual rents to be

included in discontinued operations. Included in the 35 properties

received on the operating leases are as follows (dollars in thousands):

was one property leased by one of our tenants that we exchanged

for another property owned by that tenant (see note 12F).

For the years ending December 31,

2006

2007

2008

2009

2010

Thereafter

Total

$ 212,994

1 1 . F A I R V A L U E O F

203,830

194,904

185,524

178,848

F I N A N C I A L I N S T R U M E N T S

We believe that the carrying values reflected in the consolidated

balance sheets at December 31, 2005 and 2004 reasonably

approximate the fair values for cash and cash equivalents,

1,686,908

accounts receivable, and all liabilities, due to their short-term

$ 2,663,008

nature, except for the line of credit payable and notes payable.

In making these assessments, we used estimates. The fair value

of the line of credit payable approximates its carrying value

because its terms are similar to those available in the market

place at December 31, 2005. The estimated fair value of the

notes payable at December 31, 2005 is $755.0 million and at

December 31, 2004 is $500.9 million, based upon the closing

market price per note or indicative price per each note at

December 31, 2005 and 2004, respectively.

4 5

R E A LT Y I N C O M E

1 2 . S U P P L E M E N T A L D I S C L O S U R E S

G. In 2003, non-cash additions to properties resulted in an

O F C A S H F L O W I N F O R M A T I O N

increase in buildings of $1.7 million, an increase in real estate

Interest paid in 2005 was $36.4 million, in 2004 was $31.3 mil-

held for sale, net of $289,000 and an increase in other liabili-

lion and in 2003 was $32.5 million.

ties of $2.0 million.

Income taxes paid by Realty Income and Crest Net in 2005

were $1.4 million, in 2004 were $6.9 million and in 2003 were

H. Stock based compensation resulted in the following (dollars in

$0.8 million.

thousands):

The following non-cash investing and financing activities are

included in the accompanying consolidated financial statements:

2005

2004

2003

A. In 2005, noncash additions to properties resulted in an increase

in buildings of $5.4 million, an increase in accounts payable of

I. Distributions payable on our balance sheets is comprised of

$5.1 million.

the following accrued distributions (dollars in thousands):

Deferred stock compensation

$ 2,168 $ 1,441

$ 951

B. In 2005, Crest Net sold a property for $2.8 million and issued

2005

2004

a mortgage note of $1.3 million, which was paid in full in

Common stock distributions

$ 9,729

$ 8,723

February 2006 and is included in other assets on our consoli-

Preferred stock dividends

392

dated balance sheet.

C. In June 2004, when our Class B preferred stock was redeemed,

we incurred a non-cash charge of $2.4 million for the excess of

redemption value over the carrying value.

D. In July 2004, when our Class C preferred stock was redeemed,

we incurred a non-cash charge of $1.4 million for the excess of

redemption value over the carrying value.

1 3 . E M P L O Y E E B E N E F I T P L A N

We have a 401(k) plan covering substantially all of our employees.

Under our 401(k) plan, employees may elect to make contribu-

tions to the plan up to a maximum of 60% of their compensation,

subject to limits under the IRS Code. We match 50% of our

employee’s contributions, up to 3% of the employee’s compen-

sation. Our aggregate matching contributions each year have been

immaterial to our results of operations.

E. In 2004, we exchanged one of our properties for a different

1 4 . C O M M O N S T O C K I N C E N T I V E P L A N

property that was leased to the same tenant. As part of this

transaction, land was reduced by $160,000, building was

increased by $78,000, and accumulated depreciation was

decreased by $82,000.

F. In 2003, we exchanged excess land parcels from three differ-

ent properties leased by one of our tenants for land (with improve-

ments) owned by that same tenant. In 2003, we also exchanged

one property leased by one of our tenants for another property

owned by that tenant. As part of these transactions, accumu-

lated depreciation was decreased by $64,000 and gain on sale of

$64,000 was recognized.

In 2003, our Board of Directors adopted and our stockholders

approved the 2003 Incentive Award Plan of Realty Income

Corporation to enable us to attract and retain the services of

directors, employees and consultants considered essential to our

long-term success, by offering them an opportunity to own stock

in Realty Income and/or rights that will reflect our growth, devel-

opment and financial success. The 2003 Incentive Award Plan of

Realty Income Corporation was amended and restated by our

Board of Directors on February 21, 2006. Under the terms of this

plan, the aggregate number of shares of our common stock sub-

ject to options, stock purchase rights, stock appreciation rights

and other awards will be no more than 3,428,000 shares. The

maximum number of shares, which may be subject to options,

stock purchase rights, stock appreciation rights and other awards

granted under the plan to any individual in any calendar year may

not exceed 1,600,000 shares. This plan has a term of 10 years

from the date it was adopted by our Board of Directors, which was

March 12, 2003.

In 1993, our Board of Directors approved a stock incentive

plan (the “Stock Plan”), which expired in 2004.

Stock options are granted with an exercise price equal to the

underlying stock’s fair market value at the date of grant. Stock

options expire ten years from the date they are granted and vest

over service periods of one, three, four and five years. No stock

options were granted in 2005, 2004 or 2003.

R E A LT Y I N C O M E 4 6

The following table summarizes our stock option activity for the years 2005, 2004 and 2003:

2005

2004

2003

Number of
Shares

Weighted
Average
Exercise Price

Number of
Shares

Weighted
Average
Exercise Price

Number of
Shares

Weighted
Average
Exercise Price

Outstanding, beginning of year

176,130

$ 13.01

247,756

$ 12.53

380,480

$ 12.01

Options granted

Options exercised

Options canceled

—

(40,352)

(430)

—

12.93

14.70

—

(67,648)

(3,978)

—

11.16

14.70

—

(130,126)

(2,598)

—

10.97

14.70

Outstanding, end of year

135,348

$ 13.02

176,130

$ 13.01

247,756

$ 12.53

Options exercisable, end of year

119,924

153,206

207,324

At December 31, 2005, the options outstanding under the Stock Plan had exercise prices ranging from $10.63 to $14.70, with a

weighted average price of $13.02, and expiration dates ranging from June 2007 to December 2011 with a weighted average remain-

ing term of 3.3 years. At December 31, 2005, the options exercisable under the Stock Plan had exercise prices ranging from $10.63

to $14.70 with a weighted average price of $12.87. Cash received from the exercise of options is included in deferred stock compen-
sation on our consolidated statements of stockholders’ equity.

The following table summarizes our nonvested common stock grant activity for the years 2005, 2004 and 2003. The grants vest over

periods ranging from five to 10 years.

2005

2004

2003

Number of
Shares

626,868

306,241

(92,811)

(51,576)

Weighted
Average
Grant Price

$ 14.98

25.20

16.69

17.31

Number of
Shares

475,174

218,180

(64,116)

(2,370)

Weighted
Average
Grant Price

$ 13.70

19.94

15.16

18.65

Number of
Shares

332,584

189,732

(45,802)

(1,340)

Weighted
Average
Grant Price

$ 12.43

17.59

13.69

16.92

Outstanding nonvested shares,

beginning of year

Shares granted

Shares vested

Shares forfeited

Outstanding nonvested shares,

end of year

788,722

$ 17.83

626,868

$ 14.98

475,174

$ 13.70

4 7

R E A LT Y I N C O M E

1 5 . S T O C K H O L D E R R I G H T S P L A N

Assets

In 1998, our Board of Directors adopted a Stockholder Rights Plan

As of December 31,

2005

2004

(the “Rights Plan”) that was to expire in July 2008. The Rights

Segment net real estate:

Plan was canceled by the Board of Directors in February 2005.

1 6 . S E G M E N T I N F O R M A T I O N

Apparel stores

Automotive parts

Automotive service

We evaluate performance and make resource allocation deci-

Automotive tire services

sions on an industry by industry basis. For financial reporting

Child care

purposes, we have grouped our tenants into 30 industry and

Consumer electronics

activity segments (including properties owned by Crest Net that

Convenience stores

are grouped together). All of the properties are incorporated into

one of the applicable segments. Because almost all of our leases

require the tenant to pay operating expenses, revenue is the only

component of segment profit and loss we measure.

Drug stores

Entertainment

Health and fitness

Home furnishings

The following tables set forth certain information regarding the

Home improvement

properties owned by us, classified according to the business of the

Motor vehicle dealerships

respective tenants as of December 31, 2005 (dollars in thousands):

Office supplies

For the years ended
December 31,

Segment rental revenue:

Revenue

Pet supplies and services
Restaurants

2005

2004

2003

Sporting goods

Theaters

Video rental

11 other non-reportable

Apparel stores

$ 3,100 $

3,100 $ 3,158

Automotive parts

6,718

6,716

6,694

Automotive service

14,970

13,329

12,085

Automotive

tire services

Child care

Consumer electronics

14,112

24,918

2,606

13,510

24,898

3,176

4,528

24,664

3,364

Other intangible assets—

Drug stores

Other intangible assets—

Convenience stores

36,624

33,293

18,492

Theaters

21,688

22,492

39,319

106,833

129,314

102,228

23,408

342,404

65,846

35,402

87,426

55,728

17,846

71,035

22,852

17,152
163,811

57,913

250,214

33,163

41,153

109,836

133,296

109,523

25,320

321,746

2,320

35,400

58,647

57,588

18,156

40,786

22,305

16,795
116,534

59,535

51,837

34,277

Drug stores

Entertainment

Health and fitness

Home furnishings

Home improvement

Motor vehicle

dealerships

Office supplies

Pet supplies

5,593

4,081

7,212

7,346

2,130

5,060

2,996

243

3,997

6,919

7,276

2,115

859

2,868

243

3,869

5,638

7,378

2,265

2,865

and services

2,587

2,511

2,564

Restaurants

Sporting goods

Theaters

Video rental

11 other non-reportable

18,329

16,466

16,264

6,747

10,139

4,942

5,939

6,052

4,959

5,664

6,015

4,806

segments

16,112

14,488

12,281

Reconciling items—
Interest and other

354

1,033

590

Total revenue

$ 196,676 $ 173,747 $ 143,478

segments

158,464

129,164

Total segment net real estate

1,802,046

1,406,710

8,489

1,419

109,034

—

35,605

Other corporate assets

Total assets

$ 1,920,988

$ 1,442,315

1 7 . C O M M I T M E N T S A N D C O N T I N G E N C I E S

In the ordinary course of our business, we are party to various

legal actions which we believe are routine in nature and inciden-

tal to the operation of our business. We believe that the outcome

of the proceedings will not have a material adverse effect upon

our consolidated financial statements taken as a whole.

At December 31, 2005, we have committed to pay estimated

unfunded development costs of $42.2 million on properties

under development. We also have contingent payments for tenant

improvements and leasing costs of $456,000.

In 2004, we recorded impairment of $716,000 on one prop-

erty to reduce its carrying value to zero. This property is classified

as held for sale. This impairment was the result of a title insurance

company failing to timely record a deed on this property. It is likely

that through our tenant’s bankruptcy proceedings, our title to this

property will be divested. We believe that we have a strong claim

against the title insurance company and others for the loss of the

current fair market value of the property, rent which we may be

required to repay to the tenant, and direct and incidental costs

incurred. Our claim against the title insurance company and

others is estimated to be between $750,000 and $1.3 million,

which is not reflected in our consolidated financial statements as

this represents a contingent gain.

R E A LT Y I N C O M E 4 8

REALTY INCOME CORPORATION AND SUBSIDIARIES
R E P O R T S O F I N D E P E N D E N T R E G I S T E R E D
P U B L I C A C C O U N T I N G F I R M

The Board of Directors and Stockholders
Realty Income Corporation:
We have audited the accompanying consolidated balance sheets

In our opinion, the consolidated financial statements referred to

of Realty Income Corporation and subsidiaries as of December 31,

above present fairly, in all material respects, the financial position of

2005 and 2004, and the related consolidated statements of

Realty Income Corporation and subsidiaries as of December 31,

income, stockholders’ equity, and cash flows for each of the years

2005 and 2004, and the results of their operations and their

in the three-year period ended December 31, 2005. These con-

cash flows for each of the years in the three-year period ended

solidated financial statements are the responsibility of Realty

December 31, 2005, in conformity with U.S. generally accepted

Income Corporation’s management. Our responsibility is to express

accounting principles.

an opinion on these consolidated financial statements based on

We also have audited, in accordance with the standards of the

our audits.

Public Company Accounting Oversight Board (United States), the

We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States).

effectiveness of Realty Income Corporation’s internal control
over financial reporting as of December 31, 2005, based on

Those standards require that we plan and perform the audit to

criteria established in Internal Control-Integrated Framework

obtain reasonable assurance about whether the financial state-

issued by the Committee of Sponsoring Organizations of the

ments are free of material misstatement. An audit includes

Treadway Commission (COSO), and our report dated February 21,

examining, on a test basis, evidence supporting the amounts

2006 expressed an unqualified opinion on management’s assess-

and disclosures in the financial statements. An audit also

ment of, and the effective operation of, internal control over

includes assessing the accounting principles used and significant

financial reporting.

estimates made by management, as well as evaluating the

overall financial statement presentation. We believe that our

audits provide a reasonable basis for our opinion.

San Diego, California

February 21, 2006

4 9

R E A LT Y I N C O M E

The Board of Directors and Stockholders
Realty Income Corporation:
We have audited management’s assessment, included in the

Because of its inherent limitations, internal control over finan-

accompanying Management’s Report on Internal Control Over

cial reporting may not prevent or detect misstatements. Also, pro-

Financial Reporting, that Realty Income Corporation main-

jections of any evaluation of effectiveness to future periods are

tained effective internal control over financial reporting as of

subject to the risk that controls may become inadequate because

December 31, 2005, based on criteria established in Internal

of changes in conditions, or that the degree of compliance with

Control-Integrated Framework issued by the Committee of

the policies or procedures may deteriorate.

Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, management’s assessment that Realty Income

Realty Income Corporation’s management is responsible for main-

Corporation maintained effective internal control over financial

taining effective internal control over financial reporting and for

reporting as of December 31, 2005, is fairly stated, in all mate-

its assessment of the effectiveness of internal control over financial

rial respects, based on criteria established in Internal Control-

reporting. Our responsibility is to express an opinion on manage-

Integrated Framework issued by the Committee of Sponsoring

ment’s assessment and an opinion on the effectiveness of Realty

Organizations of the Treadway Commission (COSO). Also, in our

Income Corporation’s internal control over financial reporting

opinion, Realty Income Corporation maintained, in all material

based on our audit.

respects, effective internal control over financial reporting as of

We conducted our audit in accordance with the standards of

December 31, 2005, based on criteria established in Internal

the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to

Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).

obtain reasonable assurance about whether effective internal con-

We also have audited, in accordance with the standards of the

trol over financial reporting was maintained in all material

Public Company Accounting Oversight Board (United States),

respects. Our audit included obtaining an understanding of inter-

the consolidated financial statements of Realty Income

nal control over financial reporting, evaluating management’s

Corporation and subsidiaries as of December 31, 2005 and

assessment, testing and evaluating the design and operating effec-

2004, and for each of the years in the three-year period ended

tiveness of internal control, and performing such other proce-

December 31, 2005, and our report dated February 21, 2006

dures as we considered necessary in the circumstances. We

expressed an unqualified opinion on those consolidated financial

believe that our audit provides a reasonable basis for our opinion.

statements.

San Diego, California

February 21, 2006

A company’s internal control over financial reporting is a

process designed to provide reasonable assurance regarding the

reliability of financial reporting and the preparation of financial

statements for external purposes in accordance with generally

accepted accounting principles. A company’s internal control over

financial reporting includes those policies and procedures that

(1) pertain to the maintenance of records that, in reasonable detail,

accurately and fairly reflect the transactions and dispositions of

the assets of the company; (2) provide reasonable assurance

that transactions are recorded as necessary to permit preparation

of financial statements in accordance with generally accepted

accounting principles, and that receipts and expenditures of the

company are being made only in accordance with authorizations

of management and directors of the company; and (3) provide

reasonable assurance regarding prevention or timely detection of

unauthorized acquisition, use, or disposition of the company’s

assets that could have a material effect on the financial statements.

R E A LT Y I N C O M E 5 0

REALTY INCOME CORPORATION AND SUBSIDIARIES
M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F
F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S

G E N E R A L

intend to retain an appropriate amount of cash as working capi-

Realty Income Corporation, The Monthly Dividend Company®, is a

tal. At December 31, 2005, we had cash and cash equivalents

Maryland corporation organized to operate as an equity real estate

totaling $65.7 million.

investment trust, or REIT. Our primary business objective is to

We believe that our cash and cash equivalents on hand, cash

generate dependable monthly cash distributions from a consis-

provided from operating activities and borrowing capacity is suf-

tent and predictable level of funds from operations, or FFO per

ficient to meet our liquidity needs for the foreseeable future. We

share. The monthly distributions are supported by the cash flow

intend, however, to use additional sources of capital to fund prop-

from our portfolio of retail properties leased to regional and

erty acquisitions and to repay our credit facility.

national retail chains. We have in-house acquisition, leasing,

legal, retail and real estate research, portfolio management and

capital markets expertise. Over the past 37 years, Realty Income

$300 Million Credit Facility
We have a $300 million revolving, unsecured acquisition credit

and its predecessors have been acquiring and owning freestand-
ing retail properties that generate rental revenue under long-term

facility that expires in October 2008. Realty Income’s current
investment grade credit ratings provide for financing under the

lease agreements (primarily 15- to 20-years).

credit facility at the London Interbank Offered Rate, commonly

In addition, we seek to increase distributions to stockholders

referred to as LIBOR, plus 65 basis points with a facility fee of 15

and FFO per share through both active portfolio management

basis points, for all-in drawn pricing of 80 basis points over

and the acquisition of additional properties. At December 31,

LIBOR. At February 10, 2006, we had a borrowing capacity of

2005, we owned a diversified portfolio:

• Of 1,646 retail properties;

$168.4 million available on our credit facility and an outstanding

balance of $131.6 million at an effective interest rate of 5.2%.

• With an occupancy rate of 98.5%, or 1,621 properties

The credit facility is expected to be used to acquire additional

occupied of the 1,646 properties in the portfolio;

retail properties and for other corporate purposes. Any additional

• Leased to 101 different retail chains doing business in

borrowings will increase our exposure to interest rate risk.

29 separate retail industries;

• Located in 48 states;

• With over 13.4 million square feet of leasable space; and

• With an average leasable retail space per property of

8,200 square feet.

Mortgage Debt
We have no mortgage debt on any of our properties.

Universal Shelf Registration of $800 Million
In February 2004, we filed a universal shelf registration state-

Of the 1,646 properties in the portfolio, 1,641, or 99.7%, are

ment with the SEC registering the issuance, from time to time, of

single-tenant, retail properties and the remaining five are multi-

up to $800 million in aggregate value of common stock, preferred

tenant, distribution and office properties. At December 31,

stock and debt securities. At February 10, 2006, $227.9 million

2005, 1,617, or 98.5%, of the 1,641 single-tenant properties

remained available for issuance under our universal shelf registra-

were leased with a weighted average remaining lease term

tion statement.

(excluding extension options) of approximately 12.4 years.

In addition, our wholly-owned taxable REIT subsidiary, Crest

Net Lease, Inc., owned 17 properties with a total investment of

Issuance of Common Stock in 2005
In September 2005, Realty Income issued 4.1 million shares of

$45.7 million at December 31, 2005, which are classified as

common stock. The net proceeds of approximately $92.7 million

held for sale. Crest Net was created to buy, own and sell proper-

from this offering were used to fund new property acquisitions

ties, primarily to individual investors, many of whom are involved

and for other general corporate purposes.

in tax-deferred exchanges under Section 1031 of the Internal

Revenue Code of 1986, as amended.

L I Q U I D I T Y A N D C A P I T A L R E S O U R C E S

Cash Reserves
Realty Income is organized to operate as an equity REIT that

the principal amount for an effective yield of 5.378%. The net pro-

acquires and leases properties and distributes to stockholders, in

ceeds from the offering were used to repay borrowings under the

the form of monthly cash distributions, a substantial portion of its

Company’s unsecured acquisition credit facility, for property acqui-

net cash flow generated from leases on its retail properties. We

sitions and for other general corporate purposes.

5 1

R E A LT Y I N C O M E

the principal amount for an effective yield of 5.998%. The net

proceeds from the offering were used to repay borrowings under

our unsecured acquisition credit facility and for other general cor-

porate purposes.

BBB- to our preferred stock. Moody’s rating has a “positive” out-

look and the other ratings have a “stable” outlook.

The credit ratings assigned to us could change based upon, among

other things, our results of operations and financial condition.

Notes Outstanding
In September 2005, we issued $175 million of 53/8%, 12-year,
senior unsecured notes due 2017. Interest on these notes is

paid semiannually.

Conservative Capital Structure
We believe that our stockholders are best served by a conservative

In March 2005, we issued $100 million of 57/8%, 30-year,
senior unsecured bonds due 2035. Interest on these bonds is

capital structure. Therefore, we seek to maintain a conservative

paid semiannually.

debt level on our balance sheet and solid interest and fixed

charge coverage ratios. At February 10, 2006, our total outstand-

In November 2003, we issued $150 million of 5 1/2%,
12-year, senior unsecured notes due 2015 (the “2015 Notes”).

ing credit facility borrowings and outstanding notes were

Interest on the 2015 Notes is paid semiannually.

$886.6 million or approximately 30.3% of our total market

capitalization of $2.92 billion. We calculate our total market

In March 2003, we issued $100 million of 53/8%, 10-year,
senior unsecured notes due 2013 (the “2013 Notes”). Interest

capitalization at February 10, 2006 as the sum of:

on the 2013 Notes is paid semiannually.

• Shares of our common stock outstanding of 83,880,873

In January 1999, we issued $20 million of 8% senior unse-

multiplied by the last reported sales price of our common

cured notes due 2009 (the “2009 Notes”). Interest on the 2009

stock on the NYSE of $22.78 per share, or $1.91 billion;

Notes is payable semiannually.

• Aggregate liquidation value of the Class D preferred stock

of $127.5 million;

• Outstanding borrowings of $131.6 million on our credit

facility; and

• Outstanding notes of $755.0 million.

In October 1998, we issued $100 million of 81/4% Monthly
Income Senior Notes due 2008 (the “2008 Notes”). Interest on

the 2008 Notes is payable monthly. The 2008 Notes are unsecured.
In May 1997, we issued $110 million of 73/4% senior unse-
cured notes due 2007 (the “2007 Notes”). Interest on the 2007

Notes is payable semiannually.

Historically, we have met our long-term capital needs through

All of these notes contain various covenants, including: (i) a

the issuance of common stock, preferred stock and long-term

limitation on incurrence of any debt which would cause our debt

unsecured notes and bonds. Over the long term, we believe that

to total adjusted assets ratio to exceed 60%; (ii) a limitation on

the majority of our future securities issuances should be in the

incurrence of any secured debt which would cause our secured

form of common stock, however, we may issue additional pre-

debt to total adjusted assets ratio to exceed 40%; (iii) a limitation

ferred stock or debt securities from time to time. We may issue

on incurrence of any debt which would cause our debt service

common stock when we believe that our share price is at a level

coverage ratio to be less than 1.5 times; and (iv) the maintenance

that allows for the proceeds of any offering to be accretively

at all times of total unencumbered assets not less than 150% of

invested into additional properties. In addition, we may issue

our outstanding unsecured debt. We have been in compliance

common stock to permanently finance properties that were

with these covenants since each of the notes were issued.

financed by our credit facility or debt securities. However, we can-

The following is a summary of the key financial covenants

not assure you that we will have access to the capital markets at

to our senior unsecured notes. The actual amounts are as of

terms that are acceptable to us.

December 31, 2005.

Credit Agency Ratings
We are currently assigned investment grade corporate credit rat-

Note Covenants

Required

Actual

Limitation on Incurrence

ings, on our senior unsecured notes, from Fitch Ratings, Moody’s

of Total Debt

≤ 60%

Investors Service, Inc. and Standard & Poor’s Ratings Group.

Limitation on Incurrence

Currently, Fitch Ratings has assigned a rating of BBB+, Moody’s

has assigned a rating of Baa2 and Standard & Poor’s has assigned

a rating of BBB to our senior notes. Moody’s rating has a “positive”

outlook and the other ratings have a “stable” outlook.

We have also been assigned investment grade credit ratings

of Secured Debt

Debt Service Coverage

Maintenance of Total

Unencumbered Assets

≤ 40%
≥ 1.5 x
≥ 150% of
Unsecured Debt

40.0%

0.0%

4.4 x

250%

from the same rating agencies on our preferred stock. Fitch

All of our outstanding notes have fixed interest rates. Our

Ratings has assigned a rating of BBB, Moody’s has assigned a

credit facility interest rate is variable.

rating of Baa3 and Standard & Poor’s has assigned a rating of

R E A LT Y I N C O M E 5 2

The following table summarizes the maturity of each of our obligations as of December 31, 2005 (dollars in millions):

Table of Obligations

Year of Maturity

Credit Facility(1)

2006

2007

2008

2009

2010

Thereafter

Totals

$ —

—

136.7

—

Notes

$ —

110.0

100.0

20.0

—

525.0

$ 136.7

$ 755.0

Interest(2)

$ 54.2

48.6

43.5

29.0

28.9

257.3

$ 461.5

Other(3)

$ 42.7

Totals

96.9

—

158.6

280.2

49.0

28.9

782.3

$ 42.7

$ 1,395.9

(1)The credit facility balance was $131.6 million as of February 10, 2006.

(2)Interest on credit facility and notes has been calculated based on outstanding balances as of December 31, 2005 through their respective maturity dates.

(3)Other consists of $42.2 million of estimated unfunded costs on properties under development and $456,000 of contingent payments for tenant
improvements and leasing costs.

Our credit facility and note obligations are unsecured.
Accordingly, we have not pledged any assets as collateral for

Included in the $486.6 million is $430.7 million invested by
Realty Income in 135 new properties and properties under devel-

these obligations.

opment with an initial weighted average contractual lease rate of

8.4%. These 135 properties are located in 28 states, are 100%

Preferred Stock Outstanding
In May and October 2004, we issued an aggregate of 5.1 million

leased with an initial average lease term of 15.6 years and will

contain over 1.7 million leasable square feet. The 135 new prop-

shares of 7.375% Class D cumulative redeemable preferred

erties acquired by Realty Income are net-leased to 13 different

stock. Beginning May 27, 2009, shares of Class D preferred stock

retail chains in the convenience store, drug store, financial serv-

are redeemable at our option for $25.00 per share, plus any

ices, health and fitness, motor vehicle dealership, restaurant and

accrued and unpaid dividends. Dividends on shares of Class D

theater industries. At December 31, 2005, 10 new properties

preferred are paid monthly in arrears.

No Off-Balance Sheet Arrangements or
Unconsolidated Investment
Realty Income and its subsidiaries have no unconsolidated or

acquired during 2005 were leased and under contract for devel-

opment by the tenant (with development costs funded by Realty

Income) with rent scheduled to begin at various times during the

next 12 months.

Included in the $486.6 million is $55.9 million invested

off-balance sheet investments in “variable interest entities” or

by Crest Net in 21 new retail properties and properties under

off-balance sheet financing, nor do we engage in trading activ-

development.

ities involving energy or commodity contracts or other derivative

Of the $430.7 million Realty Income invested in real estate

instruments.

during 2005, $43.9 million was invested in properties under

As we have no joint ventures, off-balance sheet entities, or

development with rent scheduled to begin at various times during

mandatory redeemable preferred stock, our financial position or

2006. At December 31, 2005, we also had committed to pay

results of operations are currently not affected by Financial

estimated unfunded development costs totaling $42.2 million.

Accounting Standard Board Interpretation No. 46R, Consolidation

The initial weighted average contractual lease rate is com-

of Variable Interest Entitiesand Statement of Financial Accounting

puted as estimated contractual net operating income (in a net-

Standard No. 150, Accounting for Certain Financial Instruments

leased property this is equal to the base rent or, in the case of

with Characteristics of both Liabilities and Equity.

properties under development, the estimated base rent under the

Acquisitions During 2005
During 2005, Realty Income and Crest Net invested, in aggre-

lease) for the first year of each lease, divided by the estimated

total costs. Since it is possible that a tenant could default on the

payment of contractual rent, we cannot assure you that the

gate, $486.6 million in 156 new properties and properties under

actual return on the funds invested will remain at the percent-

development. These 156 properties are located in 30 states and

ages listed above.

are 100% leased with an initial average lease term of 15.8 years.

As described below, Realty Income acquired 135 properties and

Crest Net acquired 21 properties.

Investments in Existing Properties
In 2005, we capitalized costs of $1.6 million on existing proper-

ties in our portfolio, consisting of $570,000 for re-leasing costs

and $1.0 million for building improvements.

5 3

R E A LT Y I N C O M E

Sales of Investment Properties
During 2005, we sold 23 properties and sold a portion of land

2006 by $.000625 to $0.11625. The increase in January 2006

was our 33rd consecutive quarterly increase and the 37th

from two properties for an aggregate of $23.4 million, which

increase in the amount of our dividend since our listing on the

resulted in a gain on sales of $6.6 million. This gain is included

NYSE in 1994. In 2005, we paid the following monthly cash

in discontinued operations, except for $18,000 that is included

distributions per share: three in the amount of $0.11, three in the

in other revenue. The 23 properties sold consisted of one automo-

amount of $0.110625, two in the amount of $0.11125, one in

tive service store, two automotive tire service locations, seven

the amount of $0.115, and three in the amount of $0.115625

child care facilities, two consumer electronics stores, one conven-

totaling $1.34625. In December 2005, January 2006 and

ience store, one motor vehicle dealership, one private education

February 2006, we declared distributions of $0.11625 per share,

facility, seven restaurants, and one property classified as “other.”

which were paid on January 17, 2006 and February 15, 2006

The net proceeds from the sale of these properties were used to

and will be paid on March 15, 2006, respectively.

repay outstanding indebtedness on our credit facility and to invest

The monthly distribution of $0.11625 per share represents a

in new properties.

current annualized distribution of $1.395 per share, and an

annualized distribution yield of approximately 6.1% based on the

Crest Net Property Sales
During 2005, Crest Net, our wholly-owned subsidiary, sold 12

last reported sale price of our common stock on the NYSE of

$22.78 on February 10, 2006. Although we expect to continue

properties from its inventory for $23.5 million, which resulted in

our policy of paying monthly distributions, we cannot guarantee

a gain of $3.3 million.

Crest Net’s Property Inventory
Crest Net’s property inventory totaled $45.7 million at December 31,

that we will maintain the current level of distributions, that we
will continue our pattern of increasing distributions per share, or

what the actual distribution yield will be in any future period.

2005 as compared to $10.1 million at December 31, 2004.

R E S U L T S O F O P E R A T I O N S

Crest Net’s properties are included in “real estate held for sale,

net”, on our consolidated balance sheets.

Critical Accounting Policies
Our consolidated financial statements have been prepared in

The financial statements of Crest Net are consolidated into

accordance with U.S. generally accepted accounting principles

Realty Income’s financial statements. All material intercompany

(“GAAP”). Our consolidated financial statements are the basis for

transactions have been eliminated in consolidation.

our discussion and analysis of financial condition and results of

operations. Preparing our consolidated financial statements

Increases in Monthly Cash Distributions
to Common Stockholders
We continue our 36-year policy of paying distributions monthly.

requires us to make a number of estimates and assumptions that

affect the reported amounts and disclosures in the consolidated

financial statements. We believe that we have made these esti-

Monthly distributions per share were increased in April 2005 by

mates and assumptions in an appropriate manner and in a way

$0.000625 to $0.110625, in July 2005 by $0.000625 to

that accurately reflects our financial condition. We continually

$0.11125, in September 2005 by $0.00375 to $0.115, in

test and evaluate these estimates and assumptions using our

October 2005 by $0.000625 to $0.115625 and in January

historical knowledge of the business, as well as other factors, to

ensure that they are reasonable for reporting purposes. However,

actual results may differ from these estimates and assumptions.

In order to prepare our consolidated financial statements

according to the rules and guidelines set forth by GAAP, many

subjective judgments must be made with regard to critical

accounting polices. One of these judgments is our estimate for

useful lives in determining depreciation expense for our proper-

ties. Depreciation of buildings and improvements is computed

using the straight-line method over an estimated useful life of

25 years. If we use a shorter or longer estimated useful life it

could have a material impact on our results of operations. We

believe that 25 years is an appropriate estimate of useful life. No

depreciation has been recorded on Crest Net’s properties because

they are held for sale.

Another significant judgment that must be made is, if and

when the impairment losses should be taken on our properties

when events or change in circumstances indicate that the carrying

amount of the asset may not be recoverable. Generally, a provision

is made for impairment loss if estimated future operating cash

flows (undiscounted and without interest charges) plus estimated

R E A LT Y I N C O M E 5 4

disposition proceeds (undiscounted) are less than the current

Of the 1,646 properties in the portfolio at December 31,

book value. Impairment losses are measured as the amount by

2005, 1,641, or 99.7%, are single-tenant properties and the

which the current book value of the asset exceeds the fair value

remaining properties are multi-tenant, distribution and office

of the asset. If a property is held for sale, it is carried at the

properties. Of the 1,641 single-tenant properties, 1,617, or

lower of carrying cost or estimated fair value, less costs to sell.

98.5 %, were net leased with a weighted average remaining

The carrying value of our real estate is the largest component

lease term (excluding rights to extend a lease at the option of the

of our consolidated balance sheet. If events should occur that

tenant) of approximately 12.4 years at December 31, 2005. Of

require us to reduce the carrying value of our real estate by

our 1,617 leased single-tenant and certain other properties,

recording provisions for impairment losses, it could have a

1,488, or 92.0%, were under leases that provide for increases in

material impact on our results of operations.

rents through:

• Base rent increases tied to a consumer price index with

The following is a comparison of our results of operations for
the years ended December 31, 2005, 2004 and 2003.

adjustment ceilings;

• Fixed increases;

Rental Revenue
Rental revenue was $196.3 million for 2005 versus $172.7 mil-

lion for 2004, an increase of $23.6 million, or 13.7%. Rental

• To a lesser degree, overage rent based on a percentage of

the tenants’ gross sales; or

• A combination of two or more of the above rent provisions.

revenue was $142.9 million in 2003. The increase in rental rev-
enue in 2005 compared to 2004 is primarily attributable to:

Percentage rent, which is included in rental revenue, was
$1.2 million in 2005, $1.3 million in 2004 and $1.1 million in

• The 135 retail properties acquired by Realty Income in

2003. Percentage rent in 2005 was less than 1% of rental rev-

2005, which generated $12.1 million in 2005;

enue and we anticipate percentage rent to be less than 1% of

• The 172 retail properties acquired by Realty Income in

rental revenue in 2006.

2004, which generated $17.1 million in 2005 compared to

As of February 10, 2006, transactions to lease or sell 6 of

$9.4 million in 2004, an increase of $7.7 million;

the 25 properties available for lease at December 31, 2005 were

• Same store rents generated on 1,269 properties during

under way or completed. We anticipate these transactions will be

2005 and 2004 increased by $1.3 million, or 0.8%, to

completed during the next several months, although we cannot

$158.1 million from $156.8 million. These properties

guarantee that all of these properties can be leased or sold within

were leased during all of both 2005 and 2004;

this period. It has been our experience that approximately 1% to

• An increase in straight-line rent and other non-cash adjust-

3% of our property portfolio will be unleased at any given time,

ments to rent of $1.5 million in 2005 as compared to

however, we cannot assure you that the number of properties

2004; and

available for lease will not exceed these levels.

• An increase of $807,000 relating to the aggregate of (i)

development properties acquired before 2004 that started

paying rent in 2004, (ii) properties that were vacant dur-

ing part of 2005 or 2004 and (iii) lease termination settle-

ments. These items in aggregate totaled $5.2 million in

2005 and $4.4 million in 2004.

Realty Income acquired 135 retail properties in 2005, exclud-

ing Crest Net acquisitions, and as a result, our 2005 operating

results included less than a full year of rental revenue from these

properties. Accordingly, we anticipate that the contribution to

rental revenue from these 135 properties will increase in 2006,

because there will be a full year of rent from these properties.

Our portfolio of retail real estate, leased primarily to regional

and national chains under net leases, continues to perform well

and provides dependable lease revenue supporting the payment

of monthly dividends to our stockholders. At December 31,

2005, our portfolio of 1,646 retail properties was 98.5% leased

with 25 properties available for lease, one of which is a multi-

tenant property.

5 5

R E A LT Y I N C O M E

Interest Expense
Interest expense was $6.8 million higher in 2005 than in

calculation used by other companies and, therefore, comparabil-

ity may be limited. This information should not be considered as

2004 primarily due to higher average outstanding balances.

an alternative to any GAAP liquidity measures.

Interest expense was $26.4 million in 2003. The following

The following is a reconciliation of net cash provided

is a summary of the five components of our interest expense

by operating activities to our interest coverage amount

(dollars in thousands):

2005

2004

2003

2005

2004

2003

Interest on our credit

facility and notes

$ 40,968 $ 32,442 $ 24,962

Interest included in

discontinued

operations from

real estate acquired

for resale by Crest

(1,139)

(674)

(561)

Amortization of settlements

on treasury lock

756

498

756

508

756

507

agreements
Credit facility

commitment fees

Amortization of credit

facility origination

costs and deferred

bond financing costs

Interest capitalized

Net cash provided

by operating

activities

Interest expense

included in

discontinued

operations(1)

Income taxes

Income taxes included
in discontinued

$ 109,557 $ 178,337 $ 73,957

40,949

34,132

26,413

1,139

813

674

699

561

501

operations(1)

943

3,480

2,202

Investment in real

estate acquired

for resale(1)(2)

55,890

21,787

87,384

1,752
(1,886)

1,631
(531)

1,446
(697)

Proceeds from sales

of real estate

Interest expense

$ 40,949 $ 34,132 $ 26,413

acquired for resale(1)

(22,195)

(74,995)

(45,226)

Credit facilities and
notes outstanding

Average outstanding

balances

2005

2004

2003

(in thousands)

$ 647,301 $ 498,220 $ 389,517

Average interest rates

6.33%

6.51%

6.41%

Gain on sales of real

estate acquired

for resale(1)

Amortization of deferred

3,291

10,254

6,217

stock compensation

(2,155)

(1,426)

(940)

Amortization of stock

option costs

(12)

(14)

(11)

Changes in assets and liabilities:

Accounts receivable

Interest on outstanding credit facilities and notes increased by

and other assets

3,292

(1,094)

(1,751)

$8.5 million in 2005 as compared to 2004 primarily due to

Accounts payable,

higher average outstanding note balances in 2005.

accrued expenses

At February 10, 2006 the weighted average interest rate on our:

other liabilities

(8,290)

1,050

(5,194)

• Credit facility borrowings of $131.6 million was 5.2%;

Interest coverage

• Notes payable of $755.0 million was 6.3%; and

amount

$ 183,222 $ 172,884 $ 144,113

• Combined outstanding credit facility and notes of

Divided by interest

$886.6 million was 6.1%.

Interest Coverage Ratio
Our interest coverage ratio for 2005 was 4.4 times, for 2004

was 5.0 times and for 2003 was 5.3 times. Interest coverage

ratio is calculated as: the interest coverage amount (as calculated

in the following table) divided by interest expense, including

interest recorded to discontinued operations. We consider interest

coverage ratio to be an appropriate supplemental measure of a

company’s ability to meet its interest expense obligations. Our

calculation of interest coverage ratio may be different from the

expense(3)

$ 42,088 $ 34,806 $ 26,974

Interest coverage ratio

4.4

5.0

5.3

(1)Crest Net activities.

(2)The 2005 amount includes intangibles recorded in connection with
acquisitions of real estate acquired for resale.

(3)Includes interest expense recorded to “income from discontinued
operations, real estate acquired for resale by Crest.”

R E A LT Y I N C O M E 5 6

Fixed Charge Coverage Ratio
Our fixed charge coverage ratio for 2005 was 3.6 times, for 2004

At February 10, 2006, we had 69 permanent employees and

four temporary employees as compared to February 15, 2005

was 3.9 times and for 2003 was 3.9 times. Fixed charge cover-

when we had 64 permanent employees and six temporary

age ratio is calculated in exactly the same manner as interest

employees. The temporary employees have been working on a

coverage ratio, except that preferred stock dividends are also added

record retention project that is expected to conclude in 2006.

to the denominator. We consider fixed charge coverage ratio to

be an appropriate supplemental measure of a company’s ability

to make its interest and preferred stock dividend payments. Our

Property Expenses
Property expenses are broken down into costs associated with

calculation of the fixed charge coverage ratio may be different

non-net leased multi-tenant properties, unleased single-tenant

from the calculation used by other companies and, therefore,

properties and general portfolio expenses. Expenses related to the

comparability may be limited. This information should not be

multi-tenant and unleased single-tenant properties include, but

considered as an alternative to any GAAP liquidity measures.

are not limited to, property taxes, maintenance, insurance, utili-

ties, property inspections, bad debt expense and legal fees.

General portfolio costs include, but are not limited to, insurance,

2004

2003

legal, property inspections and title search fees. At December 31,

Interest coverage amount divided by
interest expense plus preferred stock
dividends (dollars in thousands)

2005

Interest coverage

amount

$ 183,222 $ 172,884 $ 144,113

Divided by interest
expense plus

preferred stock

dividends(1)(2)

$ 51,491 $ 44,261 $ 36,687

Fixed charge coverage ratio

3.6

3.9

(1)Excludes the Class B and Class C preferred stock non-cash charge of
$3,774 in 2004 for excess of redemption value over carrying value of
preferred shares redeemed.

(2)Includes interest expense recorded to “income from discontinued
operations, real estate acquired for resale by Crest.”

2005, 25 properties were available for lease, as compared to 32

at December 31, 2004 and 26 at December 31, 2003.

Property expenses were $3.8 million in 2005, $3.1 million in
2004 and $2.4 million in 2003. The $769,000 increase in prop-

erty expenses in 2005 is primarily attributable to an increase in

costs associated with vacant properties and bad debt expense.

Income Taxes
Income taxes were $813,000 in 2005 as compared to $699,000

in 2004 and $501,000 in 2003. These amounts are for city and

state income taxes paid by Realty Income. The increases in 2005

and 2004 are due to an increase in rental revenue causing higher

city and state income tax expense.

Depreciation and Amortization
Depreciation and amortization was $46.4 million in 2005 versus

In addition, Crest Net incurred state and federal income taxes

of $943,000 in 2005 as compared to $3.5 million in 2004 and

$39.9 million in 2004 and $32.2 million in 2003. The increases

$2.2 million in 2003. The decrease in 2005 over the 2004 and

in depreciation and amortization in 2005 and 2004 are due to

2003 amounts are due to lower taxable income, primarily attrib-

the acquisition of properties in 2005, 2004 and 2003, which

utable to lower gain on sales of real estate acquired for re-sale.

was partially offset by property sales in these years.

These amounts are included in “income from discontinued oper-

ations from real estate acquired for resale by Crest.”

General and Administrative Expenses
General and administrative expenses increased by $2.3 million to

$15.4 million in 2005 versus $13.1 million in 2004. General

Discontinued Operations
Crest Net acquires properties with the intention of reselling them

and administrative expenses were $10.6 million in 2003. In

rather than holding them as investments and operating the prop-

2005, general and administrative expenses as a percentage of

erties. Consequently, we classify properties acquired by Crest

total revenue increased to 7.8% as compared to 7.6% in 2004

Net as held for sale at the date of acquisition and do not depre-

and 7.4% in 2003. General and administrative expenses

ciate them. The operations of Crest Net’s properties are classified

increased primarily due to increases in costs of corporate insur-

as “income from discontinued operations, real estate acquired for

ance, payroll, employee benefits, corporate governance and

resale by Crest.”

Sarbanes-Oxley Act of 2002 compliance costs.

As our property portfolio has grown and continues to grow, we

have increased, and anticipate that we will continue to increase,

the level of our staffing. We expect general and administrative

expenses to moderately increase due to costs attributable to pay-

roll, staffing costs and corporate governance.

5 7

R E A LT Y I N C O M E

The following is a summary of Crest Net’s “income from discon-

The following is a summary of our total discontinued opera-

tinued operations, real estate acquired for resale” for the years ended

tions for the years ended December 31, 2005, 2004 and 2003

December 31, 2005, 2004 and 2003 (dollars in thousands):

(dollars in thousands):

Crest Net’s income from
discontinued operations,
real estate acquired for resale

Gain on sales of real estate

2005

2004

2003

acquired for resale

$ 3,291 $ 10,254

$ 6,217

2,085

(1,139)

2,304

(674)

1,724

(561)

(453)

(60)

(464)

(93)

(566)

(24)

(943)

(3,480)

(2,202)

Rental revenue

Interest expense

General and

administrative expense

Property expenses

Income taxes

Income from discontinued

operations, real estate

acquired for resale

by Crest

$ 2,781 $ 7,847

$ 4,588

Per common share,

basic and diluted

$ 0.03 $ 0.10

$ 0.06

Total income from
discontinued operations

2005

2004

2003

Income from discontinued operations:

Real estate acquired

for resale by Crest

$ 2,781 $ 7,847 $ 4,588

Real estate held for

investment

7,121

12,696

10,569

Income from discontinued

operations

$ 9,902 $ 20,543 $ 15,157

Per common share,

basic and diluted

$ 0.12 $ 0.26 $ 0.21

Gain on Sales of Real Estate Acquired for Resale by Crest Net
(included in discontinued operations)
In 2005 Crest Net sold 12 properties for $23.5 million, which

resulted in a gain of $3.3 million. In 2004, Crest Net sold

51 properties for $75.0 million, which resulted in a gain of

$10.3 million. In 2003, Crest Net sold 27 properties for

Realty Income’s operations from four properties listed as held

$45.2 million, which resulted in a gain of $6.2 million. All gains

for sale at December 31, 2005, plus properties sold in 2005,

on sales of real estate acquired for resale are reported before

2004 and 2003 have been classified as discontinued operations.

income taxes.

The following is a summary of our discontinued operations from

At December 31, 2005, Crest Net had $45.7 million invested

real estate held for investment for the years ended December 31,

in 17 properties, which are held for sale. Our goal is for Crest

2005, 2004 and 2003 (dollars in thousands):

2005

2004

2003

properties held in inventory and the cost of capital used to

Net to carry an average inventory of approximately $20 to

$25 million in real estate. Crest Net generates an earnings spread

on the difference between the lease payments it receives on the

acquire properties. It is our belief that at this level of inventory,

rental revenue will exceed the ongoing operating expenses of

Crest Net without any property sales.

Realty Income’s income from
discontinued operations from
real estate held for investment

Gain on sales of

investment properties

$ 6,573 $ 12,543 $ 7,156

Rental revenue

Other revenue

Depreciation and amortization

Property expenses

1,073

3,927

6,845

(226)

(266)

117

(984)

(534)

(1,684)

(552)

Provisions for impairments

(35)

(2,373)

(1,242)

Income from discontinued

operations, real estate
held for investment

Per common share,

$ 7,121 $ 12,696 $ 10,569

basic and diluted

$ 0.09 $ 0.16 $ 0.15

R E A LT Y I N C O M E 5 8

Gain on Sales of Investment Properties by Realty Income
(included in discontinued operations)
In 2005, we sold 23 investment properties and sold a portion of

Preferred Stock Cash Dividends and Redemption Charge
We had preferred stock cash dividends of $9.4 million in 2005 as

compared to $9.5 million in 2004 and $9.7 million in 2003.

the land from two properties for $23.4 million and recognized a

When we redeemed our Class B preferred stock in June 2004

gain on sales of $6.6 million. This gain is included in discon-

and our Class C preferred stock in July 2004, we incurred non-

tinued operations, except for $18,000 that is included in other

cash charges of $2.4 million and $1.4 million, respectively, for

revenue. In 2004, we sold or exchanged 43 investment properties

the excess of redemption value over the carrying value. These

and sold a portion of the land from four properties for a total of

non-cash charges represent the Class B and Class C preferred

$35.4 million and recognized a gain of $12.7 million. This gain

stock original issuance costs that were paid in 1999 and recorded

is included in discontinued operations, except for $185,000

as a reduction to net income available to common stockholders

that is included in other revenue. In 2003, we sold or exchanged

when the shares were redeemed. These non-cash charges equated

35 properties and exchanged three excess land parcels (from

to $0.05 per common share in 2004.

three properties) for $23.1 million and recognized a gain of

$7.2 million, which is included in discontinued operations.

We have an active portfolio management program that incor-

Net Income Available to Common Stockholders
Net income available to common stockholders in 2005 decreased

porates the sale of assets when we believe the reinvestment of the

by $452,000 to $89.7 million as compared to $90.2 million in

sale proceeds will generate higher returns, enhance the credit

2004. Net income available to common stockholders in 2003 was

quality of our real estate portfolio or extend our average remain-
ing lease term. At December 31, 2005, we classified real estate

$76.7 million.

The calculation to determine net income available to common

with a carrying amount of $47.1 million as held for sale, which

stockholders includes gains from the sale of properties. The

includes $45.5 million in properties owned by Crest Net. In addi-

amount of gains varies from period to period based on the timing

tion, $219,000 invested by Crest Net in real estate is included in

of property sales and can significantly impact net income avail-

other assets and was classified as intangible assets. Additionally,

able to common stockholders.

we anticipate selling investment properties from our portfolio that

The gain recognized from the sales of investment properties

have not yet been specifically identified from which we anticipate

during 2005 was $6.6 million as compared to $12.7 million dur-

receiving between $15 million and $35 million in proceeds dur-

ing 2004 and $7.2 million in 2003. The gain recognized from

ing the next 12 months. We intend to invest these proceeds into

the sale of properties acquired for re-sale during 2005 was

new property acquisitions. However, we cannot guarantee that

$3.3 million as compared to $10.3 million during 2004 and

we will sell properties during the next 12 months.

$6.2 million during 2003.

Provisions for Impairments
Provisions for impairments of $186,000 were recorded in 2005

on four properties as compared to $2.4 million in 2004 on six

properties and $1.2 million on 11 properties in 2003. These pro-

visions are included in “income from discontinued operations,

real estate held for investment”, except for $151,000 in 2005,

which is included in property expenses.

5 9

R E A LT Y I N C O M E

F U N D S F R O M O P E R A T I O N S ( F F O )
A V A I L A B L E T O C O M M O N S T O C K H O L D E R S

We define FFO, a non-GAAP measure, consistent with the

National Association of Real Estate Investment Trust’s defini-

FFO for 2005 increased by $11.4 million, or 9.6%, to

tion, as net income available to common stockholders, plus

$129.6 million as compared to $118.2 million in 2004 and

depreciation and amortization of real estate assets, reduced by

$103.4 million in 2003. The following is a reconciliation of net

gains on sales of investment property and extraordinary items.

income available to common stockholders (which we believe is

We consider FFO to be an appropriate supplemental measure

the most comparable Generally Accepted Accounting Principles

of a REIT’s operating performance as it is based on a net income

(“GAAP”) measure) to FFO, information regarding cash distribu-

analysis of property portfolio performance that excludes non-cash

tions paid and the diluted weighted average number of shares

items such as depreciation. The historical accounting convention

outstanding for 2005, 2004 and 2003 (dollars in thousands):

used for real estate assets requires straight-line depreciation of

Net income available

to common

stockholders

2005

2004

2003

buildings and improvements, which implies that the value of real

estate assets diminishes predictably over time. Since real estate

values historically rise and fall with market conditions, presenta-

tions of operating results for a REIT, using historical accounting for

$ 89,716 $ 90,168 $ 76,722

depreciation, could be less informative. The use of FFO is recom-

Depreciation and amortization:

mended by the REIT industry as a supplemental performance

Continuing operations

46,438

39,874

32,231

measure. In addition, FFO is used as a measure of our compliance

Discontinued
operations

Depreciation of furniture,

226

984

1,683

Presentation of this information is intended to assist the reader

in comparing the operating performance of different REITs,

with the financial covenants of our credit facility.

fixtures and equipment

(142)

(117)

(114)

although it should be noted that not all REITs calculate FFO the

Gain on sales of

investment properties:

same way, so comparisons with other REITs may not be meaning-

ful. Furthermore, FFO is not necessarily indicative of cash flow

Continuing operations

(18)

(185)

—

available to fund cash needs and should not be considered as

(6,573)

(12,543)

(7,156)

performance. In addition, FFO should not be considered as an

an alternative to net income as an indication of Realty Income’s

Discontinued

operations

Total funds from

alternative to reviewing our cash flows from operating, investing

and financing activities as a measure of liquidity, of our ability to

make cash distributions or of our ability to pay interest payments.

operations

$ 129,647 $ 118,181 $ 103,366

FFO per common

share, basic

1.62 $

1.51 $

1.45

FFO per common

share, diluted

1.62 $

1.50

1.45

Cash distributions

paid to common

stockholders

$ 108,575 $ 97,420 $ 83,842

FFO in excess of

distributions

to common

stockholders

Basic weighted average

number of shares

$ 21,072 $ 20,761 $ 19,524

outstanding

79,950,255 78,518,296 71,128,282

Diluted weighted average

number of shares

outstanding

80,208,593 78,598,788 71,222,628

R E A LT Y I N C O M E 6 0

Other Non-Cash Items and Capitalized Expenditures
The following information includes non-cash items and capital-

I M P A C T O F I N F L A T I O N

Tenant leases generally provide for limited increases in rent as a

ized expenditures on existing properties in our portfolio. These

result of increases in the tenants’ sales volumes, increases in the

items are not included in the adjustments to net income available

consumer price index, and/or fixed increases. We expect that

to common stockholders to arrive at FFO. Analysts and investors

inflation will cause these lease provisions to result in rent

often request this supplemental information.

increases over time. During times when inflation is greater than

increases in rent, as provided for in the leases, rent increases may

For the years ended
(dollars in thousands)

2005

2004

2003

not keep up with the rate of inflation.

Provisions for impairments

$ 186

$ 2,373

$ 1,242

Amortization of settlements on

treasury lock agreements(1)

756

Amortization of deferred note

financing costs(2)

1,034

913

725

Amortization of deferred

stock compensation and

stock option costs

2,167

1,440

951

Capitalized leasing costs

and commissions

(570)

(323)

(392)

Capitalized building

improvements

Straight line rent(3)
Preferred stock origination

(1,017)
(1,360)

(789)
99

(264)
275

costs write-off(4)

—

3,774

—

(1)The settlements on the treasury lock agreements resulted from an inter-
est rate risk prevention strategy that was used by the Company in 1997
and 1998, which correlated to pending issuances of senior note securi-
ties. We have not employed this strategy since 1998.

(2)Amortization of deferred note financing costs includes the amortization
of costs incurred and capitalized when our notes were issued in May
1997, October 1998, January 1999, March 2003, November 2003,
March 2005 and September 2005. These costs are being amortized over
the lives of these notes. No costs associated with our credit facility agree-
ments or annual fees paid to credit rating agencies have been included.

(3)A negative amount indicates that our straight-line rent was greater than
our actual cash rent collected. A positive amount indicates that our
straight-line rent was less than our actual cash rent collected.

(4)Represents the Class B and Class C preferred stock non-cash charges
for the excess of redemption value over the carrying value.

Approximately 98.2%, or 1,617, of the 1,646 properties in

the portfolio are leased to tenants under net leases where the ten-

ant is responsible for property costs and expenses. Net leases

tend to reduce our exposure to rising property expenses due to

inflation. Inflation and increased costs may have an adverse

impact on our tenants if increases in their operating expenses

exceed increases in revenue.

I M P A C T O F A C C O U N T I N G

P R O N O U N C E M E N T S

In December 2004, the FASB issued Statement No. 123R,

Share-Based Payments. Statement No. 123R requires companies

to recognize in the income statement the grant-date fair value of

stock options and other equity-based compensation issued to

employees. We adopted Statement No. 123R on January 1,

2006. The impact of adopting Statement No. 123R was not

material to our financial position or results of operations.

In December 2004, the FASB issued Statement No. 153,

Exchanges of Nonmonetary Assets, an Amendment of APB No. 29.

Statement No. 153 amends APB Opinion No. 29 and states that

companies will no longer be permitted to use the “similar productive

assets” concept to account for nonmonetary exchanges at book value

with no gain being recognized. An exchange must be accounted for

at fair value if the exchange has commercial substance and fair

value is determinable. We adopted Statement No. 153 on January 1,

2006. The impact of adopting Statement No. 153 was not material

to our financial position or results of operations.

In March 2005, the FASB issued Interpretation No. 47,

Accounting for Conditional Asset Retirement Obligations, an

interpretation of Statement No. 143, Accounting for Asset

Retirement Obligations. Interpretation No. 47 requires companies

to recognize a liability for the fair value of a legal obligation to

perform asset-retirement activities that are conditional on a future

event if the amount can be reasonably estimated. We adopted

Interpretation No. 47 in the fourth quarter of 2005. The impact

of adopting Interpretation No. 47 was not material to our finan-

cial position or results of operations.

6 1

R E A LT Y I N C O M E

Q U A N T I T A T I V E A N D Q U A L I T A T I V E D I S C L O S U R E S A B O U T M A R K E T R I S K

We are exposed to interest rate changes primarily as a result of our credit facility and long-term notes used to maintain liquidity and

expand our real estate investment portfolio and operations. Our interest rate risk management objective is to limit the impact of inter-

est rate changes on earnings and cash flow and to lower our overall borrowing costs. To achieve these objectives we issue long-term notes,

primarily at fixed rates, and may selectively enter into derivative financial instruments, such as interest rate lock agreements, interest

rate swaps and caps in order to mitigate our interest rate risk on a related financial instrument. We were not a party to any derivative

financial instruments at December 31, 2005. We do not enter into any transactions for speculative or trading purposes.

Our interest rate risk is monitored using a variety of techniques. The following table presents by year of expected maturity, the prin-

cipal amounts, average interest rates, fair values as of December 31, 2005. This information is presented to evaluate the expected

cash flows and sensitivity to interest rate changes (dollars in millions):

Expected Maturity Data

Year of maturity

2006

2007(1)

2008(2)(3)

2009(4)
2010

Thereafter(5)

Totals

Fair Value(6)

(1) $110 million matures in May 2007.

(2) $100 million matures in October 2008.

Average
interest rate
on fixed rate debt

—

7.75%

8.25%

8.00%
—

5.51%

6.26%

Fixed rate debt

$ —

110.0

100.0

20.0
—

525.0

$ 755.0

Average
interest rate on
variable rate debt

—

5.03%

—
—

—

5.03%

Variable
rate debt

$ —

—

136.7

—
—

—

$ 136.7

(3) The credit facility expires in October 2008. The credit facility balance as of February 10, 2006 was $131.6 million.

(4) $20 million matures in January 2009.

(5) $100 million matures in March 2013, $150 million matures in November 2015, $175 million matures in September 2017 and $100 million matures

in March 2035.

(6) We base the fair value of the fixed rate debt at December 31, 2005 on the closing market price or indicative price per each note. The fair value of the

variable rate debt approximates its carrying value because its terms are similar to those available in the market place at December 31, 2005.

The table incorporates only those exposures that exist as of December 31, 2005; it does not consider those exposures or positions

that could arise after that date. As a result, our ultimate realized gain or loss, with respect to interest rate fluctuations, would depend

on the exposures that arise during the period, our hedging strategies at the time, and interest rates.

All of our outstanding notes and bonds have fixed interest rates. Our credit facility interest rate is variable. Based on our credit

facility balance at December 31, 2005, a 1% change in interest rates would change our interest costs by $1.4 million per year.

R E A LT Y I N C O M E 6 2

REALTY INCOME CORPORATION AND SUBSIDIARIES
S E L E C T E D F I N A N C I A L D A T A

(not covered by Report of Independent Registered Public Accounting Firm)

(dollars in thousands, except for per share data)

As of or for the years ended December 31,

2005

2004

2003

2002

2001

Total assets (book value)

Cash and cash equivalents

Lines of credit and notes payable

Total liabilities

Total stockholders’ equity

Net cash provided by operating activities

Net change in cash and cash equivalents

Total revenue
Income from continuing operations

Income from discontinued operations

Net income

Preferred stock cash dividends

Excess of redemption value over carrying value

of preferred shares redeemed

Net income available to common stockholders

Cash distributions paid to common stockholders

Ratio of earnings to fixed charges(1)

Ratio of earnings to combined

fixed charges and preferred

stock cash dividends(1)

Basic net income per common share

Diluted net income per common share

$ 1,920,988

$ 1,442,315

$ 1,360,257

$ 1,080,230

$ 1,003,708

65,704

891,700

931,774

989,214

109,557

63,563

196,676
89,217

9,902

99,119

(9,403)

—

89,716

108,575

3.2 times

2,141

503,600

528,580

913,735

178,337

(2,696)

173,747
82,854

20,543

103,397

(9,455)

(3,774)

90,168

97,420

4,837

506,400

532,491

827,766

73,957

(4,084)

143,478
71,278

15,157

86,435

(9,713)

—

76,722

83,842

8,921

339,700

357,775

722,455

124,807

6,454

128,145
64,373

14,294

78,667

(9,713)

—

68,954

78,042

2,467

315,300

331,915

671,793

90,035

(1,348)

109,807
56,892

10,666

67,558

(9,712)

—

57,846

64,871

3.9 times

4.1 times

4.3 times

3.5 times

2.6 times

3.1 times

3.0 times

2.6 times

1.12

1.15

1.24125

1.25125

1.08

1.18125

1.18375

1.02

1.01

1.15125

1.15375

0.99

1.12125

1.12375

Cash distributions paid per common share

1.346250

Cash distributions declared per common share

1.352500

Basic weighted average number of

common shares outstanding

79,950,255

78,518,296

71,128,282

67,867,498

58,450,718

Diluted weighted average number of

common shares outstanding

80,208,593

78,598,788

71,222,628

67,976,314

58,562,240

(1)Ratio of Earnings to Fixed Charges is calculated by dividing earnings by fixed charges. For this purpose, earnings consist of net income before
interest expense. Fixed charges are comprised of interest costs (including capitalized interest) and the amortization of debt issuance costs. In computing
the ratio of earnings to combined fixed charges and preferred stock cash dividends, preferred stock cash dividends consist of dividends on our Class B
preferred stock, Class C preferred stock and our outstanding Class D preferred stock. We redeemed our Class B preferred stock in June 2004 and our
Class C preferred stock in July 2004, we issued 4,000,000 shares of our 7 3/8% Class D preferred stock in May 2004 and we issued 1,100,000 shares
of our 73/8% Class D preferred stock in October 2004.

6 3

R E A LT Y I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
C O N T R O L S A N D P R O C E D U R E S

C H A N G E S I N A N D D I S A G R E E M E N T S

W I T H A C C O U N T A N T S O N A C C O U N T I N G

A N D F I N A N C I A L D I S C L O S U R E

Management’s Report on Internal Control
Over Financial Reporting
Internal control over financial reporting refers to the process

We have had no disagreements with our independent auditors on

accountancy or financial disclosure, nor have we changed

Officer and Chief Financial Officer, and effected by our board of

accountants in the two most recent fiscal years.

C O N T R O L S A N D P R O C E D U R E S

directors, management and other personnel, to provide reason-

able assurance regarding the reliability of financial reporting and

the preparation of financial statements for external purposes in

Evaluation of Disclosure Controls and Procedures. We maintain dis-

accordance with generally accepted accounting principles, and

closure controls and procedures (as defined in Securities

includes those policies and procedures that:

Exchange Act 1934 Rules 13a-14(c) and 15d-14(c)) that are

designed to ensure that information required to be disclosed in
our Exchange Act reports is recorded, processed, summarized and

(1) Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of

reported within the time periods specified in the Securities and

the assets of the Company;

Exchange Commission’s rules and forms, and that such informa-

tion is accumulated and communicated to our management,

(2) Provide reasonable assurance that transactions are recorded

including our Chief Executive Officer and Chief Financial Officer,

as necessary to permit preparation of financial statements in

as appropriate, to allow timely decisions regarding required dis-

accordance with generally accepted accounting principles, and

closure. In designing and evaluating the disclosure controls and

that receipts and expenditures of the Company are being made

procedures, management recognized that any controls and proce-

only in accordance with authorizations of management and direc-

dures, no matter how well designed and operated, can provide

tors of the Company; and

only reasonable assurance of achieving the desired control objec-

tives, and management necessarily was required to apply its judg-

(3) Provide reasonable assurance regarding prevention or timely detec-

ment in evaluating the cost-benefit relationship of possible

tion of unauthorized acquisition, use or disposition of the Company’s

controls and procedures.

assets that could have a material effect on the financial statements.

As of and for the year ended December 31, 2005, we carried

out an evaluation, under the supervision and with the participation

Management is responsible for establishing and maintaining

of management, including our Chief Executive Officer and Chief

adequate internal control over financial reporting for the Company.

Financial Officer, of the effectiveness of the design and operation

Management has used the framework set forth in the report

of our disclosure controls and procedures. Based on the foregoing,

entitled “Internal Control—Integrated Framework” published by

our Chief Executive Officer and Chief Financial Officer concluded

the Committee of Sponsoring Organizations (“COSO”) of the

that our disclosure controls and procedures were effective.

Treadway Commission to evaluate the effectiveness of the

Company’s internal control over financial reporting. Management has

concluded that the Company’s internal control over financial report-

ing was effective as of the end of the most recent fiscal year. KPMG

LLP has issued an attestation report on management’s assessment

of the Company’s internal control over financial reporting.

Submitted on February 21, 2006 by,

Thomas A Lewis, Chief Executive Officer and Vice Chairman

Paul M. Meurer, Chief Financial Officer,

Executive Vice President and Treasurer

R E A LT Y I N C O M E 6 4

Changes in Internal Controls. There have not been any significant

Certifications. Tom Lewis, Realty Income’s Chief Executive Officer,

changes in our internal controls or in other factors that could sig-

Certified to the NYSE in 2005, pursuant to Section 303A. 12(a) of

nificantly affect these controls subsequent to the date of their

the NYSE’s Listing Standards, that he was not aware of any viola-

evaluation. There were no material weaknesses, and therefore no

tion of the NYSE corporate governance listing standards by Realty

corrective actions were taken.

Income. Furthermore, Realty Income filed with the SEC, as exhibits

to its Annual Report on Form 10-K for the year ended December 31,

Limitations on the Effectiveness of Controls. Internal control over

2005, the certifications by Tom Lewis and Paul Meurer, Realty

financial reporting cannot provide absolute assurance of achiev-

Income’s Chief Executive Officer and Chief Financial Officer, respec-

ing financial reporting objectives because of its inherent limita-

tively, required under Section 302 of the Sarbanes-Oxley Act.

tions. Internal control over financial reporting is a process that

involves human diligence and compliance and is subject to lapses

in judgment and breakdowns resulting from human failures.

Internal control over financial reporting also can be circumvented

by collusion or improper management override. Because of such

limitations, there is a risk that material misstatements may not be

prevented or detected on a timely basis by internal control over

financial reporting. However, these inherent limitations are known

features of the financial reporting process. Therefore, it is possi-
ble to design into the process safeguards to reduce, though not

eliminate, this risk.

6 5

R E A LT Y I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
C O N S O L I D A T E D Q U A R T E R L Y F I N A N C I A L D A T A

(dollars in thousands, except per share data)

(not covered by Report of Independent Registered Public Accounting Firm)

2005(1)

Total revenue

Interest expense

Depreciation and amortization expense

Other expenses

Income from continuing operations

Income from discontinued operations

Net income

Net income available to common stockholders

Basic and diluted net income

per common share

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

Year(2)

$ 46,579

$ 47,367

$49,080

$ 53,650

$ 196,676

9,058

10,760

5,117

21,644

1,859

23,503

21,152

9,793

11,194

4,900

21,480

3,186

24,666

22,315

10,228

11,266

5,386

22,200

922

23,122

20,771

11,869

13,218

4,670

23,893

3,935

27,828

25,477

40,949

46,438

20,072

89,217

9,902

99,119

89,716

0.27

0.28

0.26

0.31

1.12

Dividends paid per common share

0.330000

0.331875

0.337500

0.346875

1.346250

2004(1)

Total revenue

Interest expense

Depreciation and amortization expense

Other expenses

Income from continuing operations

Income from discontinued operations

Net income

Net income available to common stockholders

Basic and diluted net income

per common share

$ 41,232

$ 43,646

$ 43,563

$ 45,306

$ 173,747

8,476

9,504

4,003

19,249

5,602

24,851

22,423

8,505

9,968

4,190

20,983

5,805

26,788

21,446

8,553

10,120

4,118

20,772

4,431

25,203

21,988

8,599

10,283

4,573

21,851

4,705

26,556

24,312

34,132

39,874

16,887

82,854

20,543

103,397

90,168

0.29

0.27

0.28

0.31

1.15

Dividends paid per common share

0.300000

0.301875

0.311250

0.328125

1.241250

(1)The consolidated quarterly financial data includes revenues and expenses from our continuing and discontinued operations. The results of operations
related to certain properties, that have been classified as held for sale or have been disposed of, have been reclassified to income from discontinued
operations. Therefore, some of the information may not agree to our previously filed 10-Qs.

(2)Amounts for each period are calculated independently. The sum of the quarters may differ from the annual amount.

R E A LT Y I N C O M E 6 6

M A R K E T F O R R E G I S T R A N T ’ S C O M M O N E Q U I T Y

A N D R E L A T E D S T O C K H O L D E R M A T T E R S

Our common stock is traded on the NYSE under the ticker symbol “O.” The following table shows the high and low sales prices per

share for our common stock as reported by the NYSE, and distributions declared per share of common stock for the periods indicated.

2005

First quarter

Second quarter

Third quarter

Fourth quarter

Total

2004

First quarter

Second quarter

Third quarter

Fourth quarter

Total

Price Per Share of Common Stock

High

$ 25.61

25.69

25.65

23.97

$ 22.48

22.33

22.70

26.08

Low

$ 22.00

22.50

22.00

21.08

$ 19.70

17.69

19.71

22.48

Distributions
Declared(1)

$ 0.330625

0.332500

0.341875

0.347500

$ 1.352500

$ 0.300625

0.302500

0.319375

0.328750

$ 1.251250

Common stock cash distributions currently are declared monthly by us based on financial results for the prior months. At December 31,

2005 a distribution of $0.11625 per common share had been declared and was paid in January 2006.

A 2-for-1 stock split was declared in November 2004 and became effective after the market close on December 31, 2004. Common

stockholders received a dividend of an additional share of common stock for each share they owned. The increase in the number of com-

mon shares outstanding after the stock split is reflected for all periods presented and all per share data has been adjusted for the stock split.

There were 10,179 registered holders of record of our common stock as of January 31, 2006. We estimate that our total number of

shareholders is approximately 65,000 when we include both registered and beneficial holders of our common stock.

6 7

R E A LT Y I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
F O R W A R D - L O O K I N G S T A T E M E N T S

This annual report contains forward-looking statements within

Additional factors that may cause risks and uncertainties

the meaning of Section 27A of the Securities Act and Section

include those discussed in the sections entitled “Business”

21E of the Exchange Act. When used in this annual report, the

and “Management’s Discussion and Analysis of Financial

words “estimated”, “anticipated” and similar expressions are

Condition and Results of Operations” in this annual report.

intended to identify forward-looking statements. Forward-looking

Readers are cautioned not to place undue reliance on forward-

statements are subject to risks, uncertainties, and assumptions

looking statements, which speak only as of the date that this

about Realty Income Corporation, including, among other things:

annual report was prepared. We undertake no obligation to pub-

• Our anticipated growth strategies;

licly release the results of any revisions to these forward-looking

• Our intention to acquire additional properties and the tim-

statements that may be made to reflect events or circumstances

ing of these acquisitions;

after the date of this annual report or to reflect the occurrence of

• Our intention to sell properties and the timing of these

unanticipated events. In light of these risks and uncertainties,

the forward-looking events discussed in this annual report might
not occur.

property sales;

• Our intention to re-lease vacant properties;

• Anticipated trends in our business, including trends in

the market for long-term net-leases of freestanding, single-

tenant retail properties;

• Future expenditures for development projects; and

• Profitability of our subsidiary, Crest Net Lease, Inc.

Future events and actual results, financial and otherwise, may

differ materially from the results discussed in the forward-look-

ing statements. In particular, some of the factors that could cause

actual results to differ materially are:

• Our continued qualification as a real estate investment

trust;

• General business and economic conditions;

• Competition;

• Fluctuating interest rates;

• Access to debt and equity capital markets;

• Other risks inherent in the real estate business including

tenant defaults, potential liability relating to environ-

mental matters, illiquidity of real estate investments and

potential damages from natural disasters;

•

Impairments in the value of our real estate assets;

• Changes in the tax laws of the United States of America;

• The outcome of any legal proceeding to which we are a

party; and

• Acts of terrorism and war.

R E A LT Y I N C O M E 6 8

S E N I O R M A N A G E M E N T T E A M

Back row, left to right: Richard G. Collins, Kim S. Kundrak,
Tere H. Miller, Paul M. Meurer, Michael R. Pfeiffer

Front row, left to right: Thomas A. Lewis, Gary M. Malino

B O A R D O F D I R E C T O R S

Back row, left to right: Roger P. Kuppinger, Kathleen R. Allen, Ph.D.,
Willard H. Smith, Jr., Michael D. McKee, Ronald L. Merriman

Front row, left to right: Donald R. Cameron, Thomas A. Lewis,
William E. Clark, Jr.

C O M P A N Y I N F O R M A T I O N

E X E C U T I V E O F F I C E R S
Thomas A. Lewis
Vice Chairman
of the Board of Directors,
Chief Executive Officer

Gary M. Malino
President and
Chief Operating Officer

Paul M. Meurer
Executive Vice President,
Chief Financial Officer
and Treasurer

Michael R. Pfeiffer
Executive Vice President,
General Counsel and Secretary

Richard G. Collins
Executive Vice President,
Portfolio Management

Kim S. Kundrak
Senior Vice President,
Portfolio Acquisitions

Gregory J. Fahey
Vice President,
Controller

Robert J. Israel
Vice President,
Research

Laura S. King
Vice President,
Assistant General Counsel
and Assistant Secretary

Tere H. Miller
Vice President,
Corporate Communications

Michael K. Press
Vice President,
Financial Institutions

Mitchell N. White
Vice President,
Business Development

Cary J. Wenthur
Vice President,
Acquisitions Director

Theresa M. Casey
Associate Vice President,
Information Technologies

Jill M. Cossaboom
Associate Vice President,
Assistant Controller

Kristin K. Ferrell
Associate Vice President,
Portfolio Management

S U B S I D I A R Y C O M P A N Y
Crest Net Lease, Inc.
Richard G. Collins
President

Pete L. Oakley
Senior Vice President,
Chief Operating Officer

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D I R E C T O R S
William E. Clark, Jr.
Chairman of the Board of Directors

Thomas A. Lewis
Vice Chairman of the
Board of Directors
and Chief Executive Officer,
Realty Income Corporation

Kathleen R. Allen, Ph.D.
Director, Center of Technology
Commercialization,
Marshall School of Business
University of Southern California

Donald R. Cameron
Lead Independent Director
President,
Cameron, Murphy & Spangler, Inc.

Roger P. Kuppinger
Private Investment Banker
and Financial Advisor

Michael D. McKee
Vice Chairman,
Chief Operating Officer,
The Irvine Company

Ronald L. Merriman
Consultant,
Merriman Partners

Willard H. Smith, Jr.
Retired Managing Director,
Merrill Lynch & Co.

I N D E P E N D E N T R E G I S T E R E D
P U B L I C A C C O U N T I N G F I R M
KPMG LLP
San Diego, California

T R A N S F E R A G E N T
The Bank of New York
For shareholder administration and
account information please call this
toll-free number:
1-877-218-2434

or email your question to:
shareowner-svcs@bankofny.com

or write to:
Shareholder Relations Department
P.O. Box 11258
Church Street Station
New York, NY 10286

F O R A D D I T I O N A L
C O R P O R A T E I N F O R M A T I O N
Call the Realty Income Investor Hotline:
For automated shareholder information
please call:
888-811-2001

Visit the Realty Income Corporate
web site at:
www.realtyincome.com

Contact your financial advisor or contact
Realty Income at:
telephone: 760-741-2111
email: ir@realtyincome.com

Copies of Realty Income’s 10-K report are
available upon written request to:

R E A L T Y I N C O M E C O R P O R A T I O N
Attention: Investor Relations
220 West Crest Street
Escondido, CA 92025-1707

I I

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