Realty Income Annual Report 2006

FY2006 Annual Report · Realty Income

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REALTY INCOME
2 0 0 6 A N N U A L R E P O R T

What a great year
for the Monthly
Dividend Company!

To mark the end of a truly great year, we submit “The
Monthly Dividend Land Game”, a whimsical way to celebrate
the accomplishments of 2006 and remind us that
accumulating assets to provide for retirement income is a
goal we all share. In the imaginary world of Monthly
Dividend Land, you accumulate Realty Income shares
at every twist and turn on the road that leads to monthly
dividends for life. We hope you enjoy this playful reminder
that we understand how important dependable monthly
income is to our shareholders—many of whom rely on a
monthly dividend check from Realty Income to meet their
monthly financial obligations. And, all kidding aside, we’re
very serious about continuing to be a solid source of
monthly income for our shareholders.

The more shares you have,
the bigger the monthly check!

THE
MONTHLY
DIVIDEND
LAND
G A M E

1. Use 1 die.
2. Person who is youngest at heart goes first.
3. Use the game piece of your choice to proceed around
the game board by using the die and instructions
along the road.

4. Keep track of the share awards along the way.
5. The one who has the most number of shares at the end

of the road wins a lifetime of monthly dividends
(Well, not really, it’s just a game).

6. All players must reach the finish line to determine

I N S T R U C T I O N S

who wins.

G A M E P I E C E S
(Push out at perforation and fold ends back to form a stand)

Monthly Dividend Girl

Paycheck

Bear

Elephant

Tiger

Bull

THE
MONTHLY
DIVIDEND
LAND
G A M E

I N S T R U C T I O N S

R E A LTY I N C O M E

TABLE OF CONTENTS

2 0 0 6 R E V I E W ( T H E S H O R T V E R S I O N )

2 0 0 7 B U S I N E S S P L A N

R E L I A B L E F I N A N C I A L P E R F O R M A N C E

M I S S I O N S TAT E M E N T

C E O L E T T E R TO S H A R E H O L D E R S

W H Y S U C H A G R E AT Y E A R I N 2 0 0 6 ?

A B I G Y E A R F O R A C Q U I S I T I O N S

A D D I T I O N A L M A R K E T P E N E T R AT I O N

T H E C H A L L E N G E TO A DA P T

O P P O R T U N I S T I C A C Q U I S I T I O N S

I N V E S T I N S I Z E

R E S E A R C H D R I V E S O U R E F F O R T S

A C C E S S T O C A P I TA L

W H Y A C C E S S TO C A P I TA L I S C R I T I C A L

G R E AT Y E A R I N T H E C A P I TA L M A R K E T S

A W O R D A B O U T C R E D I T R AT I N G S

T H E I M P O R TA N C E O F C A P I TA L S T R U C T U R E

O U R R E A L E S TAT E P O R T F O L I O T O DAY

L E A S E E X P I R AT I O N S

R E N T I N C R E A S E S

R E TA I L E R O U T L O O K

C R E S T N E T L E A S E

H OW W E P E R F O R M E D — F I N A N C I A L LY S P E A K I N G

R E V E N U E

F U N D S F R O M O P E R AT I O N S

N E T I N C O M E

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

W H O W E A R E A N D W H AT W E F O C U S O N

W H E R E W E F I T I N T H E Q U E S T F O R I N C O M E

S U M M A R Y O F 2 0 0 6 P E R F O R M A N C E

A C O U P L E O F L A S T T H O U G H T S

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

R E A LTY I N C O M E

1 0

1 1

1 2

1 3

1 4

1 5

1 6

1 7

1 9

2 0

REVIEW (THE SHORT VERSION)

GENERAL COMMENT:

Another terrific year for
The Monthly Dividend Company®

DIVIDEND UPDATE:

SHARE PRICE GROWTH:

RETURNS TO SHAREHOLDERS:

• Paid 12 monthly dividends
• Increased the dividend 5 times
• Paid 437 consecutive monthly dividends since 1970

12/31/05 closing price: $21.62
12/31/06 closing price: $27.70
28.1% increase

Dividend yield of 6.7%
Share price appreciation of 28.1%
Total return of 34.8% for 2006

TOTAL MARKET CAPITALIZATION:

$4.1 billion on 12/31/06

BALANCE SHEET:

Very strong

PROPERTY MORTGAGE DEBT:

Zero ($0)

REAL ESTATE PORTFOLIO:

1,955 retail properties leased to 103 retailers in
29 retail categories located throughout 48 states

PORTFOLIO OCCUPANCY:

98.7% on 12/31/06

PROPERTY ACQUISITIONS:

Bought 378 properties for $770 million!

R E A LTY I N C O M E

BUSINESS PLAN

P A Y 1 2 M O N T H LY D I V I D E N D S

R A I S E T H E D I V I D E N D

M A I N T A I N A C O N S E R V A T I V E B A L A N C E S H E E T

M A I N T A I N H I G H P O R T F O L I O O C C U P A N C Y

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

T E L L M O R E P E O P L E A B O U T T H E
M O N T H LY D I V I D E N D C O M P A N Y ®

R E M A I N C O N S E R V A T I V E

3
3

R E A LTY I N C O M E
R E A LTY I N C O M E

RELIABLE FINANCIAL PERFORMANCE

For the Years Ended December 31,

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

Total revenue(1)
Net income available to
common stockholders

Funds from operations (“FFO”)(2)
Dividends paid to

common stockholders

Special dividend paid

AT Y E A R E N D
Real estate at cost, before

accumulated depreciation(3)

Number of properties
Gross leasable square feet
Properties acquired(4)
Acquisition cost(4)
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(5)
Net income (diluted)
Funds from operations (“FFO”)(2)
Dividends paid
Special dividend
Annualized dividend amount(6)

Common shares outstanding

I N V E S T M E N T R E S U LT S
Closing price on December 31,
Dividend yield (7)(8)(9)
Total return to stockholder (9)(10)

$ 2,743,973,000
1,955
16,740,100
378
769,900,000
13
29
48
98.7%

240,627,000

197,733,000

177,606,000

150,370,000

$ 137,600,000

$ 121,081,000

116,310,000

104,510,000

$ 85,132,000

67,897,000

$ 56,957,000

$ 51,555,000

48,863,000

99,419,000
155,799,000

89,716,000
129,647,000

90,168,000
118,181,000

76,722,000

103,366,000

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

34,770,000

52,188,000

25,600,000

40,414,000

15,224,000

39,050,000

129,667,000

108,575,000

97,420,000

83,842,000

78,042,000

64,871,000

58,262,000

55,925,000

52,301,000

44,367,000

36,710,000

38,816,000

$ 2,096,156,000
1,646
13,448,600
156
486,553,000
23
29
48
98.5%

12.4

1.12
1.62
1.346

1.395

$ 1,691,283,000
1,533
11,986,100
194
215,314,000
43
30
48
97.9%

12.0

1.15
1.50
1.241

1.32

$ 1,533,182,000

$ 1,285,900,000

$ 1,178,162,000

$ 1,073,527,000

$ 1,017,252,000

$ 889,835,000

$ 699,797,000

$ 564,540,000

$ 515,426,000

$ 450,703,000

1,404

11,350,800

1,197

9,997,700

1,124

9,663,000

1,068

9,013,200

1,076

8,648,000

7,824,100

826

6,302,300

740

5,226,700

685

4,673,700

630

4,064,800

371,642,000

139,433,000

156,472,000

98,559,000

181,376,000

$ 193,436,000

$ 142,287,000

$ 55,517,000

$ 65,393,000

3,273,000

111

97.7%

10.9

1.01

1.38

1.151

1.17

117

98.2%

10.4

0.99

1.30

1.121

1.14

97.7%

9.8

0.84

1.26

1.091

1.11

110

98.4%

10.7

0.76

1.23

1.043

1.08

970

149

99.5%

10.2

0.78

1.18

0.983

1.02

99.2%

9.8

0.74

1.11

0.946

0.96

302

98.1%

11.8

1.08

1.45

1.181

1.20

20.00

21.0%

32,223,000

47,139,000

42,794,000

99.1%

9.5

0.70

1.04

0.931

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

100,746,226

83,696,647

79,301,630

75,818,172

69,749,654

65,658,222

53,127,038

53,644,328

53,634,206

51,396,928

45,959,074

45,952,474

39,004,182

27.70

6.7%
34.8%

21.62

5.3%
-9.2%

25.29

6.2%
32.7%

17.50

14.70

12.4375

10.3125

12.4375

12.719

11.9375

11.25

8.5625

26.9%

27.2%

31.2%

–8.7%

5.5%

14.5%

15.4%

42.0%

28.5%

12.9

1.11
1.73
1.437

1.518

(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) Does not include properties held for sale.

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

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

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

R E A LTY I N C O M E

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

150,370,000

$ 137,600,000

$ 121,081,000

116,310,000

104,510,000

$ 85,132,000

67,897,000

$ 56,957,000

$ 51,555,000

48,863,000

76,722,000
103,366,000

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

34,770,000

52,188,000

25,600,000

40,414,000

15,224,000

39,050,000

83,842,000

78,042,000

64,871,000

58,262,000

55,925,000

52,301,000

44,367,000

36,710,000

38,816,000

$ 1,533,182,000
1,404
11,350,800
302
371,642,000
35
28
48
98.1%

11.8

1.08
1.45
1.181

1.20

75,818,172

20.00

6.7%
21.0%

$ 1,285,900,000
1,197
9,997,700
111
139,433,000
35
26
48
97.7%

10.9

1.01
1.38
1.151

1.17

69,749,654

17.50

7.8%
26.9%

$ 1,178,162,000
1,124
9,663,000
117
156,472,000
35
25
48
98.2%

$ 1,073,527,000
1,068
9,013,200
22
98,559,000
21
24
46
97.7%

$ 1,017,252,000
1,076
8,648,000
110
181,376,000
3
24
45
98.4%

$ 889,835,000

$ 699,797,000

$ 564,540,000

$ 515,426,000

$ 450,703,000

7,824,100

826

6,302,300

740

5,226,700

685

4,673,700

630

4,064,800

$ 193,436,000

$ 142,287,000

$ 55,517,000

65,393,000

3,273,000

10.4

0.99
1.30
1.121

1.14

9.8

0.84
1.26
1.091

1.11

10.7

0.76
1.23
1.043

1.08

65,658,222

53,127,038

53,644,328

53,634,206

51,396,928

45,959,074

45,952,474

39,004,182

14.70

9.0%
27.2%

12.4375

10.3125

12.4375

12.719

11.9375

11.25

8.5625

10.6%
31.2%

8.4%
–8.7%

7.7%

5.5%

7.9%

14.5%

8.3%

15.4%

10.7%

42.0%

9.9%

28.5%

32,223,000

47,139,000

42,794,000

99.1%

9.5

0.70

1.04

0.931

0.95

970

149

99.5%

10.2

0.78

1.18

0.983

1.02

99.2%

9.8

0.74

1.11

0.946

0.96

99.3%

9.2

0.63

1.00

0.913

0.93

99.4%

9.5

0.39

0.98

0.300

0.90

(7) 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.

(8) Dividend yield excludes special dividends.

(9) 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.

(10)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 LTY I N C O M E

1998

1997

1996

1995

1994

85,132,000

67,897,000

56,957,000

51,555,000

48,863,000

41,304,000
62,799,000

34,770,000
52,188,000

52,301,000

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

$ 889,835,000
970
7,824,100
149
$ 193,436,000
5
22
45
99.5%

10.2

0.78
1.18
0.983

1.02

$ 699,797,000
826
6,302,300
96
$ 142,287,000
10
14
43
99.2%

9.8

0.74
1.11
0.946

0.96

$ 564,540,000
740
5,226,700
62
55,517,000
7
8
42
99.1%

9.5

0.70
1.04
0.931
.23
0.95

$ 515,426,000
685
4,673,700
58
65,393,000
3
7
42
99.3%

9.2

0.63
1.00
0.913

0.93

$ 450,703,000
630
4,064,800
4
3,273,000
5
5
41
99.4%

9.5

0.39
0.98
0.300

0.90

53,634,206

51,396,928

45,959,074

45,952,474

39,004,182

12.4375

12.719

11.9375

11.25

8.5625

7.7%
5.5%

7.9%
14.5%

8.3%
15.4%

10.7%
42.0%

9.9%
28.5%

R E A LTY I N C O M E

MISSION STATEMENT
Realty Income is a New York Stock Exchange listed

company dedicated to providing shareholders with

dependable monthly income. The monthly dividend is

supported by the cash flow from over 1,950 properties

owned under long-term, net-lease agreements with leading

regional and national retail chains. The Company is an

active buyer of net-leased retail properties nationwide.

O p e n H e r e

R E A LTY I N C O M E

CEO LETTER TO SHAREHOLDERS

What a Year!

I am very pleased

W H Y S U C H A G R E AT Y E A R I N 2 0 0 6 ?

DEAR FELLOW SHAREHOLDERS,

to report that The

A Big Year for Acquisitions—

Monthly Dividend

The Same Underwriting Process

Company® had an exceptional year in 2006!

For the year ended December 31, 2006, Realty Income and

During the year we made significant progress in virtually

Crest invested $769.9 million in 378 new properties and

all areas of the Company’s business, including strong

properties under development. Realty Income invested

portfolio performance, outstanding access to capital at

$656.7 million in 322 new properties with an initial weighted

attractive rates and a record number of profitable new

average lease yield of 8.6%. The 322 new properties

property acquisitions in both our core real estate portfolio

acquired by Realty Income are located in 30 states and

and in our Crest Net Lease, Inc. subsidiary (Crest).

are 100% leased under net-lease agreements with an initial

In short, your Company ended 2006 with record revenue,

average lease length of 16.7 years. They are leased to 16

earnings and dividends paid to shareholders. During the

year, revenue rose 22.5% to $240.1 million, funds from

operations increased 20.2% to $155.8 million and common

stock dividends paid increased 19.4% to $129.7 million, as

compared to 2005. We also crossed the historical milestone

of more than $1.2 billion in dividends paid to shareholders.

Additionally, we substantially increased the size of our real

estate portfolio by acquiring 378 new properties for

$770 million and permanently financed these, and other

properties acquired in late 2005, by raising over $900 million

in five common stock, preferred stock and senior unsecured

bond offerings. We also enjoyed healthy portfolio occupancy

at year-end of 98.7%.

different retail chains in 11 separate industries. Crest

During 2006 we paid 12 monthly common stock divi-

invested $113.2 million in 56 properties, all of which are

dends and increased the dividend five times. The dividend

being marketed for sale.

grew from an annualized amount of $1.395 per share, at

Since $770 million in property acquisitions is more

the beginning of the year, to an annualized amount of

than 3 1⁄2 times our average annual property acquisitions

$1.518 as of December 31, 2006. The share

over the last ten years, one might surmise that we did

price of our common stock rose from

something substantially different during 2006. Actually,

$21.62, at the end of 2005, to a closing

our investment strategy and underwriting standards

price of $27.70 on December 31, 2006.

remained exactly the same as in the past. As always, our

Including dividends paid and the share price

mission for each property acquisition is for the new asset

increase, shareholders received an attractive

to provide dependable cash flow to support the payment

total return on their investment of 34.8%, for

of monthly dividends. In order to do that, we perform

the year ended December 31, 2006.

extensive analysis on the individual retailer, their overall

DURING THE YEAR, REVENUE ROSE 22.5% TO $240.1 MILLION, FUNDS FROM OPERATIONS INCREASED 20.2% TO
$155.8 MILLION AND COMMON STOCK DIVIDENDS PAID INCREASED 19.4% TO $129.7 MILLION AS COMPARED TO 2005.

R E A LTY I N C O M E

industry, the profitability of their stores and the individual

react quickly, who deals with buyers in an honest and

properties that we will be purchasing. This analysis is critical

straightforward manner, and who, most importantly, shows

to determining the appropriateness of each property

up on time with cash in hand when it’s time to close. I can’t

acquisition we make.

say enough about how important these factors are to our

As an active buyer of net lease retail real estate, a very

long-term success and what a great job our acquisitions,

large volume of properties for sale come to our attention

research and legal teams have done in this area.

each year. We know most of these opportunities won’t

However, I think the primary reason we are seeing so

meet our acquisition requirements and we attempt to

many property acquisition opportunities right now is due

quickly let the fine people who bring us these opportunities

to the very high level of retail companies being bought

know that they should look for another buyer. The transac-

and sold, as well as the financial world’s realization that

tions we see that might fit our requirements are presented

these companies have a hidden treasure chest on their

to our Research Department for analysis and then to our

balance sheets. That treasure chest is their real estate.

Investment Committee for consideration. During 2006,

Many of these retailers own a large number of the stores

our Investment Committee reviewed over $5 billion of

they operate. Often, the value of their real estate, if sold,

potential transactions and acquired $770 million in new

is worth far more than the retail chain is being given credit

properties, or about 15% of what we reviewed. We believe

for as part of its stock market valuation. Astute manage-

we remained disciplined in our review of each acquisition

ment teams at many retail chains have realized that they can

opportunity so that the properties we ultimately acquired

add substantial value to their shareholders by selling these

will provide us with the consistent cash flow we can use to

properties to us, leasing them back, and then redeploying

pay dividends for many years to come. By the way, the

the capital into other profitable ventures. In addition,

15% purchased this year compares to buying 14%, 8%,

potential buyers of these retail chains, such as private

26% and 11% of what we reviewed in each of the previous

equity firms and other retailers, have realized they can use

four years. In other words, during 2006 we ended up seeing

the real estate of the retail chain they are acquiring to help

a lot more real estate that would potentially meet our

them fund their purchase of the business.

needs, while buying about the same percentage of

Fortunately, a few years back, we determined that

properties we looked at last year and in previous years.

these types of transactions would accelerate and we

Additional Market Penetration—

Large Portfolio Transactions

allocated substantial resources and personnel to working

on these large transactions. During 2006, these efforts

continued to bear fruit and are primarily responsible for

We believe there are several reasons we were presented

our large volume of property acquisitions.

with so many potential transactions last year. As an active

The net-lease retail market continues to be highly

buyer of net lease properties nationwide, with the ability

competitive with multiple buyers for individual properties.

to write checks for several hundred million dollars, we are

Because of this competition, the pricing to acquire these

a pretty good first stop for people looking to sell net-lease

individual assets has been higher and their yields lower in

retail properties. Additionally, our staff has worked

recent years. Whenever we acquire a new property, it

extremely hard to build a reputation as a buyer, who will

comes with a long-term lease that requires monthly rent

DURING 2006, WE INVESTED $770 MILLION IN 378 NEW PROPERTIES.

R E A LTY I N C O M E

price and lease yield are an important component of the

transaction, often, the most critical factor is the ability of

the various parties to arrive at the table with cash and

close the transaction on time. Since the focus in these

transactions is multi-faceted and not just on yield and

price, these larger transactions have offered us more

attractive economics than buying properties one at a time

in the retail marketplace and have allowed us to maintain

profitable margins on new property acquisitions.

The Challenge to Adapt

Our market is always changing. Working with change

to be paid, which gives us a return on our investment. For

means that we must be responsive, agile and flexible. We

example, let’s say that return is about 8 1⁄2% and increases

must constantly adapt to change. This requires us to identify

over time. The money we use to acquire the property is,

new acquisition areas and opportunities so that we remain

obviously, not free to us. Let’s say it costs us about 7%.

competitive and obtain good lease yields. We must also

The spread between the return from the property (8 1⁄2%)

accomplish this while remaining conservative and staying

and our cost of the money to buy it (7%) is how new

true to our mission of providing monthly dividends for life

property acquisitions add to our cash flow. So, if we invest

to our shareholders. In the past, our ability to adapt has

$100 million in new properties at an 8 1⁄2% yield ($8.5 million)

been the secret to our continued growth and the means

and the $100 million used to purchase the properties

for us to acquire good real estate that is reasonably

costs us 7% ($7 million), we end up with approximately

priced, with attractive lease yields.

$1.5 million in new cash flow ($8.5 million - $7 million =

We strive to adapt to this constantly changing market-

$1.5 million). You get the picture.

place by trying many new things on a small level. In other

Since the size of the spread between our yield and

words, we slowly and deliberately investigate new indus-

cost of capital contributes to the earnings growth of the

tries and retailers. We conceive and test new transaction

Company, it is important for us to be able to purchase

structures. We survey the marketplace to determine what

real estate with lease yields that are substantially higher than

our focus should be, from year to year, and respond

our cost of capital. It has been our experience with these

accordingly. Our viewpoint is to always be guided by what

larger, more complicated transactions that there are a

will provide the dependable monthly dividends our

variety of parameters that must be analyzed to determine

shareholders require. Our path to integrating new ideas is

the overall structure, optimal funding required, the source

one of, first crawl, then walk, then run. We believe this

of that funding, and the timing required to finance the

purposeful approach has benefited our shareholders in

final transaction. The sale-leaseback financing that we

the long run, yet still provided us with

provide is just one of many factors that must be

a variety of new business areas

considered. While the real estate purchase

to pursue.

R E A LTY I N C O M E

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Opportunistic Acquisitions

so we must continue to adapt so we

Good examples of retail markets that exemplify this

can keep growing.

adaptive process include restaurants in the 60’s, with the

birth of the fast food industry, child care in the 70’s, as

Invest in Size

many more women entered the work force, and child care,

We have come to believe that

again, in the 90’s, as a wave of consolidation hit the child

when we find attractive areas in

care industry, auto service stores in the 80’s, as the do-it-

which to invest, we should be

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yourself market grew, and convenience stores in the 90’s,

prepared to make large commitments to these sectors.

as the gasoline service station and convenience store

For example, in recent years, we have made substantial

industries realized economies of scale and profitability by

property acquisitions in both the chain restaurant and

combining their goods and services. This process has con-

convenience store industries to capitalize on certain

tinued over the last six years with profitable investments

trends in these sectors. Large investments, like these,

in the entertainment, theater, motor vehicle industry, auto

from time to time may cause an industry to represent a

collision, education, and a number of other new industries.

higher percentage of our lease revenue than we would like

Proactive research in a variety of industries provides us

to sustain over a prolonged period of time. It is our policy

with the in-depth analysis necessary to act quickly when

to take advantage of these opportunities by periodically

markets change and opportunities occur. As mentioned

making large commitments and then to focus in other

earlier, in larger transactions, such as mergers or private

sectors, gradually bringing these concentrations back to

equity transactions, the ability to move quickly and commit

more comfortable levels. The diversification of lease

to closing is critical to getting the transaction done. This

revenue will remain an important part of our strategy so

has been an important competitive advantage for us over

that we have multiple sources of funds to support the

the past several years.

dividends we pay to our shareholders. Our objective is to

This proactive analysis will continue to be important for

keep individual industry levels at no more than 20% of

future acquisitions. While never completely clear, our crystal

total revenue and individual retail chain levels at no more

ball is pointing us in the direction of industries that cater to

than 10% of total revenue. (Actually, we prefer about half

the large baby boomer generation, as well as the continuing

of these amounts over the long term). While we may

consolidation taking place in a number of retail sectors.

slightly exceed these levels at a moment in time, to capitalize

We will continue to dedicate substantial resources to

on a particular opportunity, rest assured, we will then

examining a wide variety of acquisition ideas we may be

shift our investment focus so that we

able to target in the future. You should know, however, that

maintain appropriate diversification of

for every idea that has worked for us, there have been four

our revenue.

or five ideas we have spent time on that went absolutely

nowhere. A primary challenge for our management team,

Research Drives our Efforts

going forward, is to continue to seek out new opportunities

Our research is the primary driver

and ways to invest that will provide us with additional

of all of our acquisition efforts. In particular,

properties to purchase. The market will continue to change

I cannot overstate the importance of this

OUR VIEWPOINT IS TO ALWAYS BE GUIDED BY WHAT WILL PROVIDE THE
DEPENDABLE MONTHLY DIVIDENDS OUR SHAREHOLDERS REQUIRE.

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R E A LTY I N C O M E

research effort when we are underwriting larger

What is almost as

transactions. Since we rely on the retailers that occupy

important as what we

our properties to pay rent for 15 to 20 years, selecting the

bought this year are

right retail chain is crucial. As such, extensive research

the transactions we did

and due diligence on each chain is undertaken, including:

not do. Having a large

company analysis, interviews with the management team,

number of opportunities to

closely examining the chain’s audited financial statements,

choose from allows us to select

along with reviewing a variety of internal operating metrics

only those properties we wish to hold

that can give us insight into the operations of the retailer.

for the long term and will likely be the key

In addition, a survey of all available external research is

to our continued success. As always, the purpose of

completed to augment our internal research expertise.

additional property acquisitions is to increase the size of

Finally, it is imperative that we have a solid understanding

our real estate portfolio, thereby increasing lease revenue,

of the historical financial performance of the industry, the

which leads to higher funds from operations and makes it

outlook for future operating performance, the competitive

possible for us to increase the amount of the monthly

environment within which the industry operates, as well

dividend on a regular basis.

as some indication of the challenges and opportunities

that might impact the industry in the future.

A C C E S S T O C A P I TA L

Another critical metric that we use is to analyze the ratio

Why Access to Capital is Critical

between the cash flow the retailer produces on a particular

As a Real Estate Investment Trust (REIT), Realty Income is

location, divided by the amount of rent they are going to

required to pay out the majority of its cash flow as divi-

pay to us. This provides us with a “cash flow coverage”

dends to shareholders. As such, we typically require access

ratio that gives us insight into the property’s ability to pay

to the public markets in order to generate capital to fund

rent over a prolonged period of time. Strong cash flow

the growth in the size of our real estate portfolio. We also

coverage is fundamental to supporting the payment of

seek to strategically time our issuance of new securities to

monthly dividends and protects the Company in the event

our property purchases so that the funds we raise are

that there is a slowdown in a retailer’s business. In other

promptly put to work and new acquisitions immediately

words, it creates a “margin of safety” to make sure we

contribute to our cash flow growth.

receive our rent. Our experience has been that our

We initially fund our purchases by utilizing our

properties with strong cash flow coverage of rent have

$300 million unsecured acquisition credit facility because

been better able to weather the economic ups and downs

this allows us to efficiently purchase properties without any

that are inevitable.

financing contingencies. When the credit facility reaches a

As a final part of our research, our real estate research

certain level, we then permanently finance these acquisitions,

staff visits every single property under consideration,

by issuing common or preferred stock or bonds, and pay

compiling market analysis, competitor profiles, traffic

down the balance on the short-term credit facility. This

flows, economic data and comparative purchase price and

tends to minimize the amount of variable rate debt we are

rent studies for each location. Before we make the final

exposed to and has been instrumental in

decision to purchase a property, all of this research at

the industry, retail chain and property level, is analyzed

by our Investment Committee. (As a matter of fact,

our 4-person Investment Committee, which includes

the CEO, President, CFO and General Counsel spends

most Fridays watching hundreds and hundreds and

minimizing the impact rising interest rates

might otherwise have had on our cash

flow throughout our operating history.

Great Year in the Capital Markets

During 2006, Realty Income issued

hundreds of videos of the properties we might acquire).

16.8 million common shares, 8.8 million

R E A LTY I N C O M E

1 2

• In December 2006, we issued 8.8 million shares of

6.75% Monthly Income Class E perpetual preferred

stock, generating gross proceeds of $220 million

The capital we raised in 2006 permanently funded all

of our property acquisitions and has positioned us well

going into 2007. At year end, we have all of our $300 million

acquisition credit facility available to fund acquisitions

that we uncover throughout 2007.

We would be remiss if we did not say how much we

appreciate the hard work of the underwriters who helped

us raise all of this capital. They included: Merrill Lynch as

sole book-running manager and A.G. Edwards, Raymond

preferred shares and $275 million in senior unsecured notes,

James, and Wachovia as co-lead managers, Robert W.

generating over $900 million in capital that immediately

Baird & Co., Banc of America, Credit Suisse and JPMorgan

adds to the Company’s earnings.

as senior co-managers for our common stock offerings;

This capital funded $770 million in acquisitions during

Citigroup, Merrill Lynch, and Wachovia as co-books, A.G.

2006, the redemption of our $110 million, 7 3⁄4% unsecured

Edwards and UBS Investment Bank as co-leads, and Banc

notes due in 2007, and acquisitions made at the end of

of America, Credit Suisse, Raymond James and RBC

2005. There was strong demand for all of these securities

Capital Markets as senior co-managers for our preferred

offerings and, in the case of the common and preferred

stock offering; and Banc of America, Citigroup and Credit

stock offerings, strong demand allowed us to issue more

Suisse as joint book-running managers for our senior

shares than originally targeted.

unsecured notes offering. Other participants in our offerings

Here is a brief summary of our capital markets activities

throughout the year included: BB&T Capital Markets, Bank

in 2006:

of Montreal, Stifel Nicolaus, Bank of New York, and Wells

• In March 2006, we issued 5.2 million shares of

Fargo Securities.

common stock priced at $24.39 per share, generating

gross proceeds from the offering of approximately

A Word about Credit Ratings

$126.8 million

We are pleased to report the following credit ratings on

• In September 2006, we redeemed our $1 10 million,

our corporate credit and senior unsecured debt: Fitch

7 3⁄4% unsecured notes due May 2007

Ratings Credit Agency: BBB+ stable outlook, Moody’s

• In September 2006, we issued $275 million of 5.95%,

Investors Services: Baa2 positive outlook and Standard &

10-year senior unsecured notes

Poor’s Ratings Services: BBB positive outlook. During

• In September 2006, we issued 4.7 million shares of

2006, both Moody’s Investors Services and Standard &

common stock priced at $24.32, generating gross

Poor’s Ratings Services revised Realty Income’s outlook

to positive from

stable. The rating

agencies cited our

proceeds from the offering of approximately

$114.7 million

• In October 2006, we issued 6.0 million shares of

common stock priced at $26.40 per share, generating

gross proceeds of approximately $158.4 million

• In November 2006, our underwriters exercised the over-

allotment option to purchase 900,000 shares of additional

common stock related to the October 2006 offering,

generating gross proceeds of approximately $23.8 million

(1) Total revenue includes amounts reclassified to income from discontinued

operations, but excludes revenue from Crest.

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improved capacity to absorb

The size of our real estate portfolio increased 19.0%, as

larger, more concentrated

compared to the size of the portfolio at the end of 2005.

investments without com-

This substantial increase was the result of $770 million

promising our strong balance

invested in 378 additional properties acquired by Realty

sheet. As part of our capital markets activities,

Income and its Crest subsidiary during the year. Of the

we spend a good deal of time working with the various

total 378 properties purchased, Realty Income invested

rating agencies to keep them informed about the latest

$656.7 million in 322 properties to be held for long-term

developments of the Company. This is important as our

investment in the Company’s core portfolio. These

credit ratings determine the pricing of our preferred stock

properties are located in 30 states, have an initial weighted

and notes offerings.

average lease rate of 8.6% and an initial average lease term

of 16.7 years. They are leased to 16 different retail chains in

The Importance of Capital Structure

11 retail industries.

As of December 31, 2006, Realty Income’s capital

During 2006, we also continued to proactively manage

structure consisted of $2.8 billion, or 69% of common stock,

our real estate portfolio. As part of our active portfolio

$347.5 million, or 8% of preferred stock and $920 million,

management, we sold 13 properties for $10.7 million, for

or 23% of senior unsecured notes, for a total capitalization

the year ended December 31, 2006.

of approximately $4.1 billion. We had zero ($0) borrowings on

An important aspect of effectively managing our assets

our $300 million acquisition credit facility. This conservative

is determining if a particular property we own should be

capital structure has earned Realty Income the distinction

sold. While our primary focus is to hold properties for the

of being one of the top five in the real estate industry for

income they produce, there are times when it is advanta-

balance sheet strength during all of the years that research

geous to sell a particular property. Property sales occur

analysts have been reviewing and reporting these metrics.

when we believe the sales proceeds can be reinvested at

An important consideration in our capital raising activities

higher returns, the sale of a property enhances portfolio

is maintaining an optimum capital structure that facilitates

credit quality, or selling a property increases the average

a low cost-of-capital, while preserving the Company’s con-

remaining lease term in the portfolio. All of the property

servative balance sheet. Since our core objective is to

sales completed in 2006 met these criteria.

maintain the integrity of the cash flow used to pay divi-

dends, we continue to believe that a conservative capital

Lease Expirations

structure is the best means to achieve this objective. This

During 2006, 97 properties reached the end of their lease

is why we have a bias towards using common equity to

term, 77 properties had their leases renewed, 10 properties

fund acquisitions. However, we attempt to carefully blend

were leased to another tenant, 2 properties were sold at the

in modest amounts of other types of capital when there

end of the lease term and 8 properties are being marketed

are clear, cost-of-capital advantages. This balance requires

for lease or sale.

constant monitoring so that we can maintain a conservative

Fifteen to twenty-year leases, while longer than many

capital structure over the long term.

real estate leases, eventually do expire. With the real

estate portfolio growth we’ve enjoyed in the past ten

O U R R E A L E S TAT E P O R T F O L I O T O DAY

years, our lease expirations are likely to increase in future

As of December 31, 2006, we owned 1,955 retail properties

years. We’ve had a good deal of experience with these

located in 48 states leased to 103 different retail chains

lease expirations, or lease rollovers, as

doing business in 29 separate retail industries. Portfolio

occupancy as of the end of the year was 98.7% and the

average remaining lease term for properties in our

portfolio was 12.9 years.

we usually call them. Historically, the

majority of leases that have come up

for renewal have been in the child

care industry, which was one of

R E A LTY I N C O M E

1 4

our opportunistic acquisition discoveries back in the 80’s.

we are just beginning to experi-

If our past experience with lease renewals is a prologue

ence the rent increases that were

for the future, we can anticipate that:

contractually agreed upon at

If a property is profitable and performing well, the

lease origination and

retailer will likely renew the lease at the existing rate

we believe, over the

or higher

next several years,

2. If a property is a more marginal performer, the retailer

our same store rent

will likely renew the lease but ask for a slight

increases will return to

reduction in rent, or

their historical level of

3. The retailer may opt not to renew the lease, in which

increases.

case we will either find another tenant or decide to

sell the property.

Retailer Outlook

As in the past, our analysis and final decision, as to

Our portfolio of retail real estate is currently performing

which path to take, is based upon our desire to hold

very well. We have no significant issues with the perform-

properties for the long term to generate the highest

ance of any of our current tenants and their ongoing ability

amount of income possible in order to pay increasing

to pay the rent they owe us. From time to time, however,

monthly dividends.

Rent Increases

a particular retailer may hit a rough spot and struggle to

pay rent. We view these occasional episodes as “business

as usual” for an owner of a very large portfolio of single-

Same store rents on 1,421 properties under lease for the

tenant properties. In each of our 38 years of experience in

entire year ended December 31, 2006 increased 0.7% to

handling such situations, we have been fortunate to have

$175.3 million from $174.0 million in 2005. To break down

continually maintained portfolio occupancy above 97%.

the same store rent increase results during 2006, we had

In terms of what we see on the horizon for the broader

22 industries with increases in rents, five with flat same

retail market, our crystal ball is a bit cloudy, but our best

store rents and two with declining same store rents—so a

guess, as of now, is that the retail market could experience

pretty good result for 2006.

some slowing during 2007. However, our long-term leases,

Same store rent increases are comprised of a specific,

strong cash-flow coverages at the store level, and focus

identical, number of properties that are tracked quarter to

on service-oriented retailers providing basic human needs

quarter and year to year. Generally, we look for same store

goods and services, should continue to serve us well.

rents to increase 1% to 2% each year. This year we were

Should the economy take a turn for the worse, which is

obviously below that number. Generally, rent increases

not widely anticipated by most pundits at this point in

on our properties occur every five years. As such, there is

time, there is always the possibility that some of our retail

usually a considerable lag time between when we purchase

operators could be impacted. This is something that we

a property, when the rent increases occur and when the

diligently monitor and are prepared to proactively manage

property qualifies to be included in the

should such situations arise.

same store rent calculation. Given the

large amount of property

Crest Net Lease

acquisitions we have

Crest Net Lease, Inc. is Realty Income’s wholly-owned

completed in recent

subsidiary that was formed in 2000 for the purpose of

years, the vast majority of

acquiring properties for resale. The properties are primarily

our properties have now

sold in the 1031 tax-deferred exchange market. Crest

been acquired since

provides Realty Income with an important competitive

1997. Because of that

advantage since its primary function is to assist Realty

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R E A LTY I N C O M E

Income in completing large portfolio transactions so that

Realty Income can manage tenant level concentrations.

During 2006, Crest acquired 56 properties for

$113.2 million. These properties are being marketed for sale

in accordance with Crest’s operating strategy. During 2006

Crest sold 13 properties for a gain on sales of $2.2 million.

Crest’s inventory at December 31, 2006 was $137.5 million,

which consists of 60 properties that are held for sale.

While Crest helps Realty Income complete large port-

folio transactions and does contribute to Realty Income’s

earnings, its earnings contributions are relatively small

and we do not rely on this more volatile income stream

to pay our monthly dividends.

H OW W E P E R F O R M E D —

F I N A N C I A L LY S P E A K I N G

Revenue

common share, is included in Management’s Discussion

and Analysis of Financial Condition and Results of

Operations on page 60.

Realty Income’s subsidiary company, Crest, also con-

tributed to Realty Income’s earnings growth during 2006.

During 2006, revenue increased 22.5% to $240.1 million,

Crest generated $1.4 million, or $0.02 per share, in FFO for

as compared to $196.0 million during 2005. Revenue

Realty Income, in comparison to $2.8 million, or $0.03 per

growth, driven by portfolio acquisition growth, is an

share, in FFO for Realty Income in 2005.

important objective of ours because it is crucial to our

ability to increase funds from operations and dividends.

Net Income

This year’s revenue growth is primarily attributable to the

Net income available to common shareholders, as of

high level of property acquisitions achieved in both 2005

December 31, 2006, was $99.4 million as compared to

and 2006.

Funds from Operations (FFO)

$89.7 million in 2005. On a diluted per common share

basis, net income was $1.1 1 per share in 2006 as compared

to $1.12 per share in 2005. (The calculation to determine

In 2006, FFO available to common shareholders also

net income for a real estate company includes gains from

increased 20.2% to $155.8 million, as compared to

property sales and impairments, which vary from year to

$129.6 million during 2005. On a diluted per common

year according to the timing of property sales. This

share basis, FFO increased 6.8% to $1.73 per share, as

variance can significantly impact net income).

compared to $1.62 per share for 2005. This increase in FFO

and FFO per share is the result of higher than average

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

acquisition activity throughout the year.

Through December 31, 2006, Realty Income had paid

FFO is a common measure-

a total of 437 consecutive monthly dividends and

ment for a REIT. It is an alternative

$1.2 billion in dividends since 1970. We have also increased

non-GAAP measure that is

the amount of the monthly dividend 42 times, of which

considered to be a good

37 have been consecutive quarterly increases. This con-

indicator of a company’s

sistent record of dividend increases has resulted in a total

ability to pay dividends. A rec-

increase in our monthly dividend of 68.7%. In comparison,

onciliation of net income

Realty Income increased the amount of dividends paid

available

to common

from $1.346 in 2005 to $1.437 in 2006, a total increase of

shareholders to FFO per

6.8%.

R E A LTY I N C O M E

1 6

In addition, we enjoyed an increase in the price of our

environment in which we operate. Remaining conservative

shares this year. At the end of 2005, our share price was

in our operations and capital structure is vitally important

$21.62 as compared to the closing price of $27.70 on

December 31, 2006. Based on a share price increase of

to realizing the mission of The Monthly Dividend
Company®. We are guided by the need to generate

28.1% and a 2006 dividend yield of 6.7%, shareholders

reliable revenue in every decision we make, whether it’s a

enjoyed a total return during 2006 of 34.8%.

decision to acquire a single property or a portfolio of

properties, a decision as to what type of capital we use to

W H O W E A R E A N D W H AT W E F O C U S O N

fund property acquisitions or a decision as to how to

The most important result of our accomplishments over the

structure lease agreements so

course of the year is that we were able to pay 12 monthly

that our properties generate

dividends and increase the dividend five times during 2006.

increasing lease revenue over

We know that the majority of our shareholders look to us to

the long term. These day-to-

provide monthly dividends that increase over time. Equally

day operating decisions are all

important is the fact that our efforts during 2006 also bode

made with you, the monthly

well for strong operating performance and further dividend

dividend recipient, in mind. You

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increases in 2007, as we receive a full year of lease pay-

should also gain some comfort in knowing that this is also

ments on the newly acquired properties.

very much self serving as we own a lot of shares ourselves!

Today, investors can choose from a variety of investments

that produce income, but few of them are structured to

W H E R E W E F I T I N T H E Q U E S T F O R I N CO M E

pay dependable monthly dividends. Since we are one of

Conversations on how to produce income are becoming

the few remaining purveyors of monthly dividends, we

increasingly prevalent as the “Baby Boomer” generation

feel a certain responsibility to manage the Company so

rapidly approaches traditional retirement age. These days,

that we can continue to offer the monthly income upon

more people are asking how to get income and taking the

which so many of you have come to rely. This is always

time to learn about income investments as they begin to

uppermost in our minds as we navigate the competitive

shift from growth-oriented investment portfolios to

income-oriented investment portfolios. As
The Monthly Dividend Company®, we

believe it is important for people to under-

stand the investment characteristics of our

particular company, both in comparison to

other income vehicles, and within our

particular investment type.

Investors can receive income from

corporate bonds, preferred stocks,

income-focused mutual funds, utility

stocks, dividend-paying common stocks,

annuities as well as from private real

estate ownership and REITs, to mention

just a few of the options available. In

looking at these various sources of

income, we believe that determining the

reliability and safety of the source of the

income is imperative.

1 7

R E A LTY I N C O M E

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Since we are a REIT, our

someone holds shares of Realty Income (or any other

operating structure is specif-

company that regularly increases their dividend), the

ically designed to provide

higher the yield on their original cost will be. This means

dividend income. As a REIT, we are required to pay

that regular dividend increases typically motivate long-

out 90% of our income as dividends to shareholders.

term ownership because it becomes increasingly difficult

Since all REITs have this dividend requirement, does that

to duplicate the income stream at one’s current yield on

mean that all REIT dividends are alike? Not likely.

cost. (Example: shares purchased on December 31, 2000

have a yield on cost of 12.2% on

December 31, 2006).

Dependable and rising dividends,

provided by companies with a

dedicated focus on maintaining a

low-risk profile, could be of increasing

importance to income investors in

the coming years. We believe that

companies with this focus and a

disciplined management style could

be in great demand. We also believe

that the demand for monthly income

is on the rise, based on the rising

number of investment products

being advertised today that promise

dependable monthly income.

Just as there are many types of real estate that REITs

own, there are varying degrees of stability associated with

While there are very few absolute certainties in life, it
is the goal of The Monthly Dividend Company® to provide

the lease revenue that supports the payment of dividends.

shareholders with increasing monthly dividends every

In Realty Income’s case, we generally have 15 to 20-year

month, year after year, for the rest of their lives. Our

lease contracts. Thus, we receive contractually agreed

strategy of owning a sizable portfolio of retail properties,

upon, long-term rents, which, if the properties are under-

operated under long-term lease agreements with large

written properly, tend to provide very stable lease revenue

retail chains, is the means to continuing to provide monthly

from which to pay dividends. This parallel between stable,

dividends. This rental revenue has been a reliable generator

long-term leases and dependable dividends is exemplified

of cash to pay monthly dividends for the past 37 years. In

by the Company’s 37-year dividend-paying history. As of

addition, we have never carried a mortgage on any of the

the end of 2006, we have paid 437 consecutive monthly

properties that we own and we are focused on main-

dividends.

taining a conservative balance sheet. Keeping the amount

In addition, Realty Income also has a history of providing

of debt we carry at a modest amount and our properties

shareholders with regular dividend increases. Most of our

mortgage-free, along with controlling

shareholders consider this to be the main

reason to own shares. The metric

that is commonly used to

demonstrate the power of

rising dividends is “Yield on

Cost”. Simply stated, the longer

expenses, frees up the majority of our

rental revenue for the payment of

monthly dividends to shareholders. We

believe this operating philosophy distinguishes

Realty Income as a conservative provider of

monthly dividends.

R E A LTY I N C O M E

1 8

S U M M A R Y O F 2 0 0 6 P E R F O R M A N C E

Company®) will continue to be an important component

• Portfolio occupancy remained high at 98.7%

of our ability to access capital at attractive prices. We

• Same store rents rose 0.7%

will continue to work hard in this area as well.

• Total acquisitions for Realty Income and Crest,

As always, we’re grateful to the thousands of loyal

combined, increased to 378 properties purchased for

shareholders who, like us, have enjoyed years of monthly

$769.9 million

dividend checks. Again, we’d like to caution all investors

— Realty Income acquired 322 properties for

to remain diversified and rely on us for only a portion of

$656.7 million at an 8.6% weighted average lease

yield and an average lease length of 16.7 years

their income needs. We will do our best to operate your

Company in a prudent fashion so that the monthly

— Crest acquired 56 properties for $113.2 million

dividend checks keep on coming.

• Accessed over $900 million in additional capital in

five public market transactions

• Properties continue to be held without mortgage debt

Sincerely,

• Property sales provided $10.7 million in additional

Tom A. Lewis

Chief Executive Officer

proceeds for investment

• Revenue increased 22.5% and FFO per diluted share

increased 6.8%

• The monthly dividend was increased five times during

the year

• Yield on cost continued to increase

• Dividends paid increased 6.8%

• Share price rose 28.1%

• Total return to shareholders was 34.8%

A C O U P L E O F L A S T T H O U G H T S

This has been a very good year for The Monthly Dividend
Company®. I’d like to caution you, however, that one year

does not a trend make. The type of business transactions

we did this year are notoriously difficult to execute, and

they tend to be unpredictable and lumpy. We’ve made

good progress in getting our name out to the private

equity markets and various investment banking firms,

but 2006 was a banner year for such transactions

because of the waves of consolidation that are sweeping

certain industries. It could be that this was only a moment

in time. As such, we are already hard at work identifying

new areas for investment. In addition, the record access to

capital we enjoyed in 2006 was also a notable event in our

Company’s history. The popularity of The Monthly
Dividend Company® was evident amidst the solid

demand for income in the overall marketplace. Our effort

to keep the investing public informed about the benefit

of monthly dividends (and The Monthly Dividend

1 9

R E A LTY I N C O M E

FINANCIAL INFORMATION

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 PA N Y

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

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

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

P R O P E R T I E S

C O N S O L I DAT E D B A L A N C E S H E E T S

C O N S O L I DAT E D S TAT E M E N T S O F I N C O M E

C O N S O L I DAT E D S TAT E M E N T S O F S TO C K H O L D E R S ’ E Q U I T Y

C O N S O L I DAT E D S TAT E M E N T S O F C A S H F L OW S

N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

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

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 LY 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 LT S O F O P E R AT I O N S

S E L E C T E D F I N A N C I A L DATA

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

C O N S O L I DAT E D Q U A R T E R LY F I N A N C I A L DATA

M A R K E T P E R F O R M A N C E I N F O R M AT I O N

F O R WA R D - L O O K I N G S TAT E M E N T S

2 1

2 2

2 4

2 8

3 4

3 5

3 6

3 7

3 8

4 9

5 1

6 3

6 4

6 6

6 7

6 8

R E A LTY I N C O M E

2 0

FINANCIAL INFORMATION

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 PA N Y

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

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

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

P R O P E R T I E S

C O N S O L I DAT E D B A L A N C E S H E E T S

C O N S O L I DAT E D S TAT E M E N T S O F I N C O M E

C O N S O L I DAT E D S TAT E M E N T S O F S TO C K H O L D E R S ’ E Q U I T Y

C O N S O L I DAT E D S TAT E M E N T S O F C A S H F L OW S

N OT E S TO C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S

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

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 LY 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 LT S O F O P E R AT I O N S

S E L E C T E D F I N A N C I A L DATA

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

C O N S O L I DAT E D Q U A R T E R LY F I N A N C I A L DATA

M A R K E T P E R F O R M A N C E I N F O R M AT I O N

F O R WA R D - L O O K I N G S TAT E M E N T S

2 1

2 2

2 4

2 8

3 4

3 5

3 6

3 7

3 8

4 9

5 1

6 3

6 4

6 6

6 7

6 8

R E A LTY I N C O M E

2 0

REALTY INCOME CORPORATION AND SUBSIDIARIES
BUSINESS DESCRIPTION

THE COMPANY
Realty Income Corporation, The Monthly Dividend Company®,

remaining lease term (excluding extension options) of

approximately 12.9 years.

is a Maryland corporation organized to operate as an equity

In addition, at December 31, 2006, our wholly-owned

real estate investment trust, or REIT. Our primary business

taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had

objective is to generate dependable monthly cash distribu-

invested $137.5 million in 60 properties, which are classified

tions from a consistent and predictable level of funds from

as held for sale. Crest was created to buy and sell properties,

operations, or FFO per share. The monthly distributions are

supported by the cash flow from our portfolio of retail prop-

primarily to individual investors, many of whom are involved
in tax-deferred exchanges under Section 1031 of the Internal

erties leased to regional and national retail chains. We have

Revenue Code of 1986, as amended (the “Tax Code”).

in-house acquisition, leasing, legal, retail and real estate

We typically acquire retail store properties under long-term

research, portfolio management and capital markets expert-

leases with retail chain store operators. These transactions

ise. Over the past 38 years, Realty Income and its predeces-
sors have been acquiring and owning freestanding retail

generally provide capital to owners of retail real estate and
retail chains for expansion or other corporate purposes.

properties that generate rental revenue under long-term

Our acquisition and investment activities are concentrated

lease agreements (primarily 15 to 20 years).

in well-defined target markets and generally focus on retail

In addition, we seek to increase distributions to stock-

chains providing goods and services that satisfy basic

holders and FFO per share through both active portfolio

consumer needs.

management and the acquisition of additional properties.

Our net-lease agreements generally:

Our portfolio management focus includes:

• Are for initial terms of 15 to 20 years;

• Contractual rent increases on existing leases;

• Require the tenant to pay minimum monthly rents and

• Rent increases at the termination of existing leases

property operating expenses (taxes, insurance and

when market conditions permit; and

maintenance); and

• Active management of our property portfolio, including

• Provide for future rent increases based on increases

re-leasing vacant properties and selectively selling

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

properties.

In acquiring additional properties, we adhere to a focused

strategy of primarily acquiring properties that are:

• Freestanding, single-tenant, retail locations;

Leased to regional and national retail chains; and

•

lesser degree, additional rent calculated as a percent-

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

Realty Income commenced operations as a REIT on
August 15, 1994 through the merger of 25 public and private
real estate limited partnerships with and into the Company.

Leased under long-term, net-lease agreements.

Each of the partnerships was formed between 1970 and 1989

for the purpose of acquiring and managing long-term,

At December 31, 2006, we owned a diversified portfolio

net-leased properties.

of 1,955 retail properties:

• With an occupancy rate of 98.7%, or 1,929 properties
occupied of the 1,955 properties in the portfolio;
Leased to 103 different retail chains doing business in

•

29 separate retail industries;

•

Located in 48 states;

The eight senior officers of Realty Income owned 1.3%

of our outstanding common stock with a market value of

$37.4 million at February 13, 2007. The directors and eight

senior officers of Realty Income, as a group, owned 2.5%

of our outstanding common stock with a market value of

$72.6 million at February 13, 2007.

• With over 16.7 million square feet of leasable space;

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

and

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

• With an average leasable retail space per property of

central index key number is 726728 and cusip number is

8,600 square feet.

756109-104.

Realty Income’s Class D cumulative redeemable preferred

Of the 1,955 properties in the portfolio, 1,948, or 99.6%,

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

are single-tenant, retail properties and the remaining seven

and its cusip number is 756109-609.

are multi-tenant, distribution and office properties. At

Realty Income’s Class E cumulative redeemable preferred

December 31, 2006, 1,923, or 98.7%, of the 1,948 single-

stock is listed on the NYSE under the ticker symbol “OprE”

tenant properties were leased with a weighted average

and its cusip number is 756109-708.

2 1

R E A LTY I N C O M E

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

Acquisition of $349 million of Buffets/Ryan’s

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

Restaurants on November 1, 2006

The cusip number of these notes is 756109-203.

The 2006 acquisition amounts include Realty Income and

In February 2007, we had 70 permanent employees as

Crest’s aggregate investment of $349 million to acquire 144

compared to February 2006 when we had 69 permanent

Buffets/Ryan’s restaurant properties. The properties are

employees and four temporary employees.

leased under 20-year, triple-net lease agreements. These

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

properties were acquired subsequent to a merger between

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

Buffets, Inc. and Ryan’s Restaurant Group.

our annual report on Form 10-K, quarterly reports on Form

Of the 144 restaurant properties, 116 were acquired by

10-Q, current reports on Form 8 K, and amendments to those

Realty Income and 28 were acquired by Crest. The rest-

reports, as soon as reasonably possible after we electronically

aurants have, on average, approximately 10,300 leasable

file these reports with the SEC. None of the information on

square feet and are situated on an average lot size of approx-

our website is deemed to be part of this report.

imately 2.86 acres. The properties are existing locations that,

RECENT DEVELOPMENTS
Acquisitions during 2006
During 2006, Realty Income and Crest invested $769.9 million,
in aggregate, in 378 new properties and properties under
development. These 378 properties are located in 30 states

and are 100% leased with an initial average lease term of

on average, have been operating for 11 years.

Investments in Existing Properties

In 2006, we capitalized costs of $964,000 on existing properties

in our portfolio, consisting of $761,000 for re-leasing costs

and $203,000 for building improvements.

17.1 years. As described below, Realty Income acquired 322

Net Income Available to Common Stockholders

properties and Crest acquired 56 properties.

Net income available to common stockholders was $99.4 million

Included in the $769.9 million is $656.7 million invested

in 2006 versus $89.7 million in 2005, an increase of $9.7 million.

by Realty Income in 322 new properties and properties under

On a diluted per common share basis, net income was $1.11

development, with an initial weighted average contractual

per share in 2006 and $1.12 per share in 2005.

lease rate of 8.6%. These 322 properties are located in 30

The calculation to determine net income available to

states, are 100% leased with an initial average lease term of

common stockholders includes gains from the sale of prop-

16.7 years and will contain over 3.3 million leasable square

erties. The amount of gains varies from period to period

feet. The 322 new properties acquired by Realty Income are

based on the timing of property sales and can significantly

net-leased to 16 different retail chains in the following 11

impact net income available to common stockholders.

industries: automotive collision services, automotive tire

The gain recognized from the sales of investment prop-

services, convenience store, drug store, general merchan-

erties during 2006 was $3.0 million as compared to $6.6 million

dise, health and fitness, home improvement, motor vehicle

for 2005.

dealership, private education, restaurant, and theater. Also

included in the $769.9 million is $113.2 million invested by
Crest in 56 new retail properties.

Funds from Operations (FFO)

In 2006, our FFO increased by $26.2 million, or 20.2%, to

At December 31, 2006, Realty Income had invested

$155.8 million versus $129.6 million in 2005. On a diluted per

$15.9 million in four properties that were leased and being

common share basis, FFO was $1.73 in 2006 compared to

developed by the tenant (with development costs funded by

$1.62 for 2005, an increase of $0.11, or 6.8%.

Realty Income). Rent on these properties is scheduled to

See our discussion of FFO in the section entitled

begin at various times during 2007. At December 31, 2006,

“Management’s Discussion and Analysis of Financial Condition

we had outstanding commitments to pay estimated unfunded

development costs totaling approximately $16.4 million.

The initial weighted average contractual lease rate is

computed as estimated contractual net operating income (in

a net-leased property this is equal to the base rent or, in the

case of 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 percentages listed above.

and Results of Operations” in this annual report, which
includes a reconciliation of net income available to common
stockholders to FFO.

Issuances of Common Stock
In October and November 2006, we issued an aggregate of
6.9 million shares of common stock at a price of $26.40 per
share. The net proceeds of approximately $173.2 million
were used to fund a portion of the purchase price of the
Buffets/Ryan’s properties and for other general corporate
purposes.

In September 2006, we issued 4.715 million shares of com-
mon stock at a price of $24.32 per share. The net proceeds
of approximately $109 million from this offering were used to

R E A LTY I N C O M E

2 2

fund new property acquisitions, repay borrowings under our

Crest Property Inventory

credit facility and for other general corporate purposes.

Crest’s property inventory at December 31, 2006 and

In March 2006, we issued 5.2 million shares of common

December 31, 2005 totaled $137.5 million and $45.7 million,

stock at a price of $24.39 per share. The net proceeds of

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

approximately $120.5 million were used to fund new prop-

net”, on our consolidated balance sheets.

erty acquisitions and for other general corporate purposes.

Issuance of Preferred Stock

Increases in Monthly Distributions

to Common Stockholders

In December 2006, we issued 8.8 million shares of 63⁄4%

We continue our 37-year policy of paying distributions

Monthly Income Class E cumulative redeemable preferred

monthly to our common stockholders. Monthly distributions

stock, with a liquidation value of $25 per share. The net pro-

per share were increased in April 2006 by $0.000625 to

ceeds of $214 million from this issuance were used to repay

$0.116875, in July 2006 by $0.000625 to $0.1175, in

borrowings under our credit facility and for other general

September 2006 by $0.00775 to $0.12525, in October 2006

corporate purposes. Beginning December 7, 2011, the Class

by $0.000625 to $0.125875 and in January 2007 by

E preferred shares are redeemable at our option for $25 per

$0.000625 to $0.1265. The increase in January 2007 was our

share. Dividends of $0.140625 per share are paid monthly in

37th consecutive quarterly increase and the 42nd increase in

arrears on the Class E preferred stock.

the amount of our dividend since our listing on the New York

Stock Exchange, or NYSE, in 1994. In 2006, we paid the

Credit Ratings Upgrades
In February 2006, Moody’s Investors Service, Inc. affirmed

following monthly cash distributions per share: three in the

amount of $0.11625, three in the amount of $0.116875, two

our senior unsecured debt rating of Baa2 and our preferred

in the amount of $0.1175, one in the amount of $0.12525

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

and three in the amount of $0.125875, totaling $1.43725.

from “stable.”

In December 2006, January 2007 and February 2007, we

In December 2006, Standard & Poor’s Ratings Group

declared distributions of $0.1265 per share, which were paid

affirmed our senior unsecured debt rating of BBB and our

on January 16, 2007 and February 15, 2007 and will be paid

preferred stock rating of BBB- and raised the outlook to

on March 15, 2007, respectively.

“positive” from “stable.”

Redemption of 2007 Notes

The monthly distribution of $0.1265 per share represents

a current annualized distribution of $1.518 per share, and an

annualized distribution yield of approximately 5.2% based on

In September 2006, we redeemed all of our outstanding

the last reported sale price of our common stock on the

$110 million, 73⁄4%, unsecured notes due May 2007 (the

NYSE of $29.09 on February 13, 2007. Although we expect

“2007 Notes”). The 2007 Notes were redeemed at a

to continue our policy of paying monthly distributions, we

redemption price equal to 100% of the principal amount,

cannot guarantee that we will maintain the current level of

plus accrued and unpaid interest of $3.2 million and a make-

distributions, that we will continue our pattern of increasing

whole payment of $1.6 million. We recorded a loss on extin-

distributions per share, or what the actual distribution yield

guishment of debt totaling $1.6 million related to the

will be in any future period.

make-whole payment associated with the 2007 Notes. For

2006, the make-whole payment represented approximately

$0.017 per share.

Issuance of 10-Year Senior Unsecured Notes

In September 2006, we issued $275 million, in aggregate
principal amount of 5.95% senior unsecured notes due 2016
(the “2016 Notes”). The price to the investor for the 2016
Notes was 99.74% of the principal amount, for an effective
yield of 5.985%. The net proceeds of approximately
$271.9 million from this offering were used to redeem the
2007 Notes and for other general corporate purposes.
Interest on the 2016 Notes is paid semiannually.

Crest Property Sales
During 2006, Crest sold 13 properties from its inventory for an
aggregate of $22.4 million, which resulted in a gain of
$2.2 million. Crest’s gains are included in “income from discon-
tinued operations, real estate acquired for resale by Crest.”

2 3

R E A LTY I N C O M E

DISTRIBUTION POLICY
Distributions are paid monthly to our common stockholders

received from taxable corporations (such as our taxable REIT

subsidiary, Crest), to income that was subject to tax at the

and Class D and Class E preferred stockholders if, and when

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

declared by our Board of Directors.

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

In order to maintain our tax status as a REIT for federal

year) or, as discussed above, dividends properly designated

income tax purposes, we generally are required to distribute

by us as “capital gain dividends.” Distributions in excess of

dividends to our stockholders aggregating annually at least

earnings and profits generally will be treated as a non-taxable

90% of our REIT taxable income (determined without regard

reduction in the stockholders’ basis in the stock. Distributions

to the dividends paid deduction and by excluding net capital

above that basis, generally, will be taxable as a capital gain.

gains) and we are subject to income tax to the extent we

Approximately 9.9% of the distributions to our common

distribute less than 100% of our REIT taxable income (includ-

stockholders, made or deemed to have been made in 2006,

ing net capital gains). In 2006, our cash distributions totaled

were classified as a return of capital for federal income tax

$139.1 million, or approximately 113.3% of our estimated

purposes. We are unable to predict the portion of future

REIT taxable income of $122.8 million. Our estimated REIT

distributions that may be classified as a return of capital.

taxable income reflects non-cash deductions for depreciation
and amortization. We intend to continue to make distri-

butions to our stockholders that are sufficient to meet this

distribution requirement and that will reduce our exposure to

income taxes. Our 2006 cash distributions to common stock-

BUSINESS PHILOSOPHY AND STRATEGY
Investment Philosophy
We believe that owning an actively managed, diversified
portfolio of retail properties under long-term, net leases

holders totaled $129.7 million, representing 83.2% of our

produces consistent and predictable income. Net leases

funds from operations available to common stockholders of

typically require the tenant to be responsible for minimum

$155.8 million.

monthly rent and property operating expenses including

The Class D preferred stockholders receive cumulative

property taxes, insurance and maintenance. In addition, ten-

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

ants are typically responsible for future rent increases based

share liquidation preference (equivalent to $1.84375 per

on increases in the consumer price index, fixed increases or,

annum per share). The Class E preferred stockholders receive

to a lesser degree, additional rent calculated as a percentage

cumulative distributions at a rate of 6.75% per annum on the

of the tenants’ gross sales above a specified level. We believe

$25 per share liquidation preference (equivalent to $1.6875

that a portfolio of properties under long-term leases, coupled

per annum per share).

with the tenant’s responsibility for property expenses, gener-

Future distributions will be at the discretion of our Board

ally produces a more predictable income stream than many

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

other types of real estate portfolios, while continuing to offer

results of operations, FFO, cash flow from operations, financial

the potential for growth in rental income.

condition and capital requirements, the annual distribution

requirements under the REIT provisions of the Tax Code, our

Investment Strategy

debt service requirements and any other factors the Board of
Directors may deem relevant. In addition, our credit facility
contains financial covenants that could limit the amount of

distributions payable by us in the event of a deterioration in

our results of operations or financial condition, and which

prohibit the payment of distributions on the common or

In identifying new properties for acquisition, our focus is
generally on providing capital to retail chain owners and
operators by acquiring, then leasing back, retail store loca-

tions. We categorize retail tenants as: 1) venture market,
2) middle market, and 3) upper market. Venture companies
typically offer a new retail concept in one geographic region

preferred stock in the event that we fail to pay when due

of the country and operate between five and 50 retail

(subject to any applicable grace period) any principal or

locations. Middle market retail chains typically have 50 to

interest on borrowings under our credit facility.

500 retail locations, operations in more than one geographic

Distributions of our current and accumulated earnings

region, have been successful through one or more economic

and profits for federal income tax purposes, generally will

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

be taxable to stockholders as ordinary income, except to

market retail chains typically consist of companies with 500 or

the extent that we recognize capital gains and declare a
capital gains dividend or that such amounts constitute

more locations, operating nationally, in a proven, mature

retail concept. Upper market retail chains generally have

“qualified dividend income” subject to a reduced tax rate.

strong operating histories and access to several sources

The maximum tax rate of non-corporate taxpayers for
“qualified dividend income” has generally been reduced to
15% (for taxable years beginning after December 31, 2002).
In general, dividends payable by REITs are not eligible for the
reduced tax rate on corporate dividends, except to the
extent the REIT’s dividends are attributable to dividends

of capital.

R E A LTY I N C O M E

2 4

Realty Income primarily focuses on acquiring properties

Historically, our investment focus has been on retail

leased to middle market retail chains that we believe are

industries that have a service component because we believe

attractive for investment because:

the lease revenue from these types of businesses is more

• They generally have overcome many of the opera-

stable. Because of this investment focus, for the quarter

tional and managerial obstacles that can adversely

ended December 31, 2006, approximately 80.9% of our

affect venture retailers;

rental revenue was derived from retailers with a service

• They typically require capital to fund expansion but

component in their business. Furthermore, we believe these

have more limited financing options;

service-oriented businesses would be difficult to duplicate

• They generally have provided us with attractive risk-

over the Internet and that our properties continue to perform

adjusted returns over time since their financial

well relative to competition from Internet businesses.

strength has, in many cases, tended to improve as

their businesses have matured;

Credit Strategy

• Their relatively large size allows them to spread corpo-

We generally provide sale-leaseback financing to less than

rate expenses across a greater number of stores; and

investment grade retail chains. We typically acquire and lease

• Middle market retailers typically have the critical mass

back properties to regional and national retail chains and

to survive if a number of locations are closed due to

believe that within this market we can achieve an attractive

underperformance.

risk-adjusted return on the financing we provide to retailers.

Since 1970, our overall weighted average occupancy rate at

We also focus on, and have selectively made investments

the end of each year has been 98.6%, and the occupancy rate

in, properties of upper market retail chains. We believe upper

at the end of each year has never been below 97.5%.

market retail chains can be attractive for investment because:

We believe the principal financial obligations of most

• They typically are of a higher credit quality;

retailers typically include their bank and other debt, payment

• They usually are larger public and private retailers with

obligations to suppliers and real estate lease obligations.

more commonly recognized brand names;

Because we typically own the land and building in which a

• They utilize a larger building ranging in size from

tenant conducts its retail business, we believe the risk of

10,000 to 50,000 square feet; and

default on a retailers’ lease obligations is less than the retail-

• They are able to grow because access to capital facili-

ers’ unsecured general obligations. It has been our experi-

tates larger transaction sizes.

ence that since retailers must retain their profitable retail

locations in order to survive, in the event of reorganization

While our investment strategy focuses primarily on acquir-

they are less likely to reject a lease for a profitable location

ing properties leased to middle and upper market retail

because this would terminate their right to use the property.

chains, we also selectively seek investment opportunities with

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

venture market retail chains. Periodically, venture market

than unsecured creditors of the same retailer in the event of

opportunities arise where we feel that the real estate used by

reorganization. If a property is rejected by the tenant during

the tenant is high quality and can be purchased at favorable

reorganization, we own the property and can either lease it

prices. To meet our stringent investment standards, however,

to a new tenant or sell the property. In addition, we believe

venture retail companies must have a well-defined retailing

that the risk of default on the real estate leases can be further

concept and strong financial prospects. These opportunities

mitigated by monitoring the performance of the retailers’

are examined on a case by case basis and we are highly selec-
tive in making investments in this area.

individual unit locations and considering whether to sell
locations that are weaker performers.

In order to qualify for inclusion in our portfolio, new

property acquisitions must meet stringent investment and
credit requirements. The properties must generate attractive
current yields and the tenant must meet our credit profile.
We have established a three-part analysis that examines each
potential investment based on:

•

Industry, company, market conditions and credit profile;
Location profitability, if profitability data is available;
and

• Overall real estate characteristics, including value and

comparative rental rates.

2 5

R E A LTY I N C O M E

The typical profile of companies whose properties have

Portfolio Management Strategy

been approved for acquisition are those with 50 or more

The active management of the property portfolio is an

retail locations. Generally the properties:

• Are located in highly visible areas,

essential component of our long-term strategy. We continually

monitor our portfolio for any changes that could affect the

• Have easy access to major thoroughfares; and

performance of the industries, tenants and locations in which

• Have attractive demographics.

Acquisition Strategy

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

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

research, property due diligence and significant portfolio

regional and national chains are capturing market share

management activities. This monitoring typically includes

through service, quality control, economies of scale, advertis-

regular review and analysis of:

ing and the selection of prime retail locations. We execute our

• The performance of various retail industries; and

acquisition strategy by acting as a source of capital to regional

• The operation, management, business planning and

and national retail chain store owners and operators, doing

financial condition of the tenants.

business in a variety of industries, by acquiring and leasing

back retail store locations. We undertake thorough research

We have an active portfolio management program that

and analysis to identify appropriate industries, tenants and

incorporates the sale of assets when we believe the reinvest-

property locations for investment. Our research expertise is

ment of the sales proceeds will generate higher returns,

instrumental to uncovering net-lease opportunities in markets

enhance the credit quality of our real estate portfolio, or

where our real estate financing program adds value. In select-

extend our average remaining lease term. At December 31,

ing real estate for potential investment, we generally seek to

2006, we classified real estate with a carrying amount of

acquire properties that have the following characteristics:

$138 million as held for sale, which includes $137.5 million in

• Freestanding, commercially-zoned property with a

properties owned by Crest. Additionally, we anticipate selling

single tenant;

investment properties from our portfolio that have not yet

• Properties that are important retail locations for

been specifically identified from which we anticipate receiving

regional and national retail chains;

between $10 million and $35 million in proceeds during the

• Properties that are located within attractive demo-

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

graphic areas relative to the business of their tenants,

property acquisitions. However, we cannot guarantee that we

with high visibility and easy access to major thorough-

will sell properties during the next 12 months.

fares; and

• Properties that can be purchased with the simultane-

Universal Shelf Registration

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

In April 2006, we filed a shelf registration statement with the

agreements, offering both current income and the

SEC, which is effective for a term of three years. In accordance

potential for rent increases.

with the SEC rules, the amount of securities to be issued

pursuant to this shelf registration statement was not specified

when it was filed. The securities covered by this registration

statement include common stock, preferred stock, debt

securities, or any combination of such securities. Realty

Income may periodically offer one or more of these securities
in amounts, prices and on terms to be announced when and
if the securities are offered. The specifics of any future offerings,

along with the use of proceeds of any securities offered, will
be described in detail in a prospectus supplement, or other
offering materials, at the time of any offering. As such, there
is no specific limit to the dollar amount of new securities that
can be issued under this new shelf registration before it
expires in April 2009. The common stock issued in September
2006, October 2006 and November 2006, the 2016 Notes
issued in September 2006 and the Class E preferred stock
issued in December 2006 were issued pursuant to our universal
shelf registration statement.

R E A LTY I N C O M E

2 6

Conservative Capital Structure

on acceptable terms, we generally seek to refinance those

We believe that our stockholders are best served by a

borrowings with the net proceeds of long-term or permanent

conservative capital structure. Therefore, we seek to maintain

financing, which may include the issuance of common stock,

a conservative debt level on our balance sheet and solid

preferred stock, convertible preferred stock, debt securities

interest and fixed charge coverage ratios. At February 13,

or convertible debt securities. We cannot assure you, however,

2007, our total outstanding credit facility borrowings and

that we will be able to obtain any such refinancing or that

outstanding notes were $920 million or approximately 21.9%

market conditions prevailing at the time of refinancing will

of our total market capitalization of $4.21 billion. We calculate

enable us to issue equity or debt securities upon acceptable

our total market capitalization at February 13, 2007 as the

terms.

sum of:

We are currently assigned investment grade corporate

• Shares of our common stock outstanding of

credit ratings, on our senior unsecured notes, from Fitch

101,000,536 multiplied by the last reported sales price

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

of our common stock on the NYSE of $29.09 per

Poor’s Ratings Group. Currently, Fitch Ratings has assigned

share, or $2.94 billion;

a rating of BBB+, Moody’s has assigned a rating of Baa2

• Aggregate liquidation value of the Class D preferred

and Standard & Poor’s has assigned a rating of BBB to our

stock of $127.5 million;

senior notes. Moody’s and Standard & Poor’s ratings have

• Aggregate liquidation value of the Class E preferred

“positive” outlooks and Fitch has a “stable” outlook.

stock of $220 million; and

We have also been assigned investment grade credit

• Outstanding notes of $920 million.

ratings from the same rating agencies on our preferred stock.

Fitch Ratings has assigned a rating of BBB, Moody’s has

Historically, we have met our long-term capital needs

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

through the issuance of common stock, preferred stock and

a rating of BBB- to our preferred stock. Moody’s and

long-term unsecured notes and bonds. Over the long term,

Standard & Poor’s ratings have “positive” outlooks and Fitch

we believe that the majority of our future securities issuances

has a “stable” outlook.

should be in the form of common stock, however, we may

The credit ratings assigned to us could change based

issue additional preferred stock or debt securities from time

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

to time. We may issue common stock when we believe that

cial condition. These ratings are subject to ongoing evaluation

our share price is at a level that allows for the proceeds of any

by credit rating agencies and we cannot assure you that any

offering to be accretively invested into additional properties.

such rating will not be changed or withdrawn by a rating

In addition, we may issue common stock to permanently

agency in the future if, in its judgment, circumstances warrant.

finance properties that were financed by our credit facility or

Moreover, a rating is not a recommendation to buy, sell or

debt securities. However, we cannot assure you that we will

hold our debt securities, preferred stock or common stock.

have access to the capital markets at terms that are accept-

We have no mortgage debt on any of our properties.

able to us.

We have a $300 million revolving, unsecured credit facility

No Off-Balance Sheet Arrangements or

that expires in October 2008. Realty Income’s current invest-

Unconsolidated Investments

ment grade credit ratings provide for financing under

Realty Income and its subsidiaries have no unconsolidated

the credit facility at the London Interbank Offered Rate,

or off-balance sheet investments in “variable interest entities”

commonly referred to as LIBOR, plus 65 basis points with a

facility fee of 15 basis points, for all-in drawn pricing of

80 basis points over LIBOR. At February 13, 2007, we had

borrowing capacity of $300 million available on our credit
facility and no outstanding balance.

The credit facility is expected to be used to acquire addi-
tional retail properties and for other corporate purposes. Any
additional borrowings will increase our exposure to interest
rate risk. We have the right to request an increase in the
borrowing capacity of the credit facility by up to $100 million,
to a total borrowing capacity of $400 million. Any increase in
the borrowing capacity is subject to approval by the lending
banks of our credit facility.

We use our credit facility for the short-term financing of
new property acquisitions. When outstanding borrowings
under the credit facility reach a certain level (generally in the
range of $100 million to $200 million) and capital is available

or off-balance sheet financing, nor do we engage in trading
activities involving energy or commodity contracts or other
derivative instruments.

As we have no joint ventures, off-balance sheet entities,
or mandatory redeemable preferred stock, our financial posi-
tion and results of operations are currently not affected by
Financial Accounting Standards Board Interpretation No. 46R,
Consolidation of Variable Interest Entities and Statement of
Financial Accounting Standards No. 150, Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity.

2 7

R E A LTY I N C O M E

Competitive Strategy

We believe that to successfully pursue our investment

• MANAGEMENT SPECIALIZATION: We believe that our
management’s specialization in single-tenant retail

philosophy and strategy, we must seek to maintain the

properties, operated under net-lease agreements, is

following competitive advantages:

important to meeting our objectives. We plan to main-

•

SIZE AND TYPE OF INVESTMENT PROPERTIES: We believe

tain this specialization and will seek to employ and

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

train high-quality professionals in this specialized area

properties represent an attractive investment oppor-

of real estate ownership, finance and management.

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

• TECHNOLOGY: We intend to stay at the forefront of

complexities of acquiring and managing a large port-

technology in our efforts to efficiently and economi-

folio of relatively small assets, we believe these types

cally carry out our operations. We maintain sophisti-

of properties have not experienced significant institu-

cated information systems that allow us to analyze

tional ownership interest or the corresponding yield

our portfolio’s performance and actively manage

reduction experienced by larger income-producing

our investments. We believe that technology and

properties. We believe the less intensive day-to-day

information-based systems will play an increasingly

property management required by net-lease agree-

important role in our competitiveness as an invest-

ments, coupled with the active management of a large

ment manager and source of capital to a variety of

portfolio of smaller properties, is an effective invest-

industries and tenants.

ment strategy. The tenants of our freestanding retail

properties generally provide goods and services that

satisfy basic consumer needs. In order to grow and

PROPERTIES
At December 31, 2006, we owned a diversified portfolio:

expand, they generally need capital. Since the acqui-

• Of 1,955 retail properties;

sition of real estate is typically the single largest

• With an occupancy rate of 98.7%, or 1,929 properties

capital expenditure of many of these retailers, our

occupied of the 1,955 properties in the portfolio;

method of purchasing the property and then leasing it

•

Leased to 103 different retail chains doing business in

back, under a net-lease arrangement, allows the retail

29 separate retail industries;

chain to free up capital.
INVESTMENT IN NEW RETAIL INDUSTRIES: Though we

•

Located in 48 states;

• With over 16.7 million square feet of leasable space; and

specialize in single-tenant properties, we will seek to

• With an average leasable retail space per property of

further diversify our portfolio among a variety of retail

approximately 8,600 square feet.

industries. We believe diversification will allow us to

invest in retail industries that currently are growing

In addition to our real estate portfolio at December 31,

and have characteristics we find attractive. These

2006, our subsidiary, Crest had invested $137.5 million in

characteristics include, but are not limited to, retail

60 properties located in 15 states. These properties are

industries that are dominated by local store operators

classified as held for sale.

where regional and national chain store operators can

increase market share and dominance by consolidat-

ing local operators and streamlining their operations,

as well as capitalizing on major demographic shifts in

a population base.

• DIVERSIFICATION: Diversification of the portfolio by
retail industry type, tenant, and geographic location

is key to our objective of providing predictable invest-
ment results for our stockholders, therefore further
diversification of our portfolio is a continuing objective.
At December 31, 2006, our retail property portfolio
consisted of 1,955 properties located in 48 states,
leased to 103 retail chains doing business in 29
industry segments. Each of the 29 industry segments,
represented in our property portfolio, individually
accounted for no more than 17.8% of our rental revenue
for the quarter ended December 31, 2006.

At December 31, 2006, 1,923, or 98.4%, of our 1,955 retail
properties were leased under net-lease agreements. Net
leases typically require the tenant to be responsible for

minimum monthly rent and property operating expenses
including property taxes, insurance and maintenance. In addi-
tion, tenants are typically responsible for future rent increases

based on increases in the consumer price index, fixed

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

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

Our net-leased retail properties primarily are leased

to regional and national retail chain store operators. Most

buildings are single-story structures with adequate parking

on site to accommodate peak retail traffic periods. The

properties tend to be on major thoroughfares with relatively

high traffic counts, adequate access and proximity to a

sufficient population base to constitute a suitable market or

trade area for the retailer’s business.

R E A LTY I N C O M E

2 8

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

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

For the Quarter Ended
Dec. 31,
2006

Percentage of Rental Revenue(1)

For the Years Ended

Dec. 31,
2006

Dec. 31,
2005

Dec. 31,
2004

Dec. 31,
2003

Dec. 31,
2002

Dec. 31,
2001

2.3%

1.7%

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

*Less than 0.1%

1.2

2.7

5.4

6.2

0.2

*
8.9

1.0

14.1

0.3

2.8

1.4

0.2

0.1

0.8

4.1

2.8

4.2

3.4

1.2

0.9

0.8

1.3

2.8

6.9

6.1

0.2

0.1
10.3

1.1

16.1

0.4

2.9

1.6

0.2

0.1

0.6

0.7

4.3

3.1

3.4

1.3

1.1

0.8

17.8

11.9

—

2.6

9.4

0.3
1.8
2.3

—

2.9

9.6

0.3
2.1
2.7

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
20.8

3.3

9.1

0.4

0.2

2.3

—

0.5

3.8

5.4

1.2

—

2.1

1.7

1.3

—

5.7

2.6

0.4

0.1
23.9

4.0

8.4

0.4

0.2

1.8

—

0.6

3.6

6.0

1.3

—

2.2

1.6

1.5

11.8

13.5

12.2

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

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.

2 9

R E A LTY I N C O M E

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

Crest) at December 31, 2006, 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

Sporting goods

Totals

*Less than 0.1%

Number of
Properties

Rental Revenue for
the Quarter Ended
Dec. 31, 2006(1)

Percentage of
of Rental
Revenue

219

268

2
4

577

149

393

471

1,110

268

1,955

825

1.2%

3,689

6,063

970

150
84

2,760

574

6,409

1,531

23,055

583

4,229

9,611

1,154

2,348

595

12,158

170

1,235

32,115

1,567

1,214

159

678

212

1,943

518

557

1,905

1,684

788

1,769

13,031

$ 68,201

5.4

8.9

1.4

0.2
0.1

4.1

0.8

9.4

2.3

33.8

0.9

6.2

14.1

1.7

3.4

0.9

17.8

0.3

1.8

47.1

2.3

1.8

0.2

1.0

0.3

2.8

0.8

2.8

2.5

1.2

2.6

19.1

100.0%

(1)Includes rental revenue for all properties owned by Realty Income at December 31, 2006, including revenue from properties reclassified to
discontinued operations of $8.

R E A LTY I N C O M E

3 0

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

regarding the timing of the initial lease term expirations (excluding extension options) on our 1,923 net leased, single-tenant retail

properties as of December 31, 2006 (dollars in thousands):

Total Portfolio

Rental
Revenue for
the Quarter
Ended

% of
Total
Rental
12/31/06(2) Revenue

Total
Number
of Leases
Expiring(1)

139

117

107
74

112

145

233

182

2
1

$ 2,624

4.0%

2,568

2,330
2,680

3,175

1,407

3,411

1,996

1,968

1,823

1,638

1,068

4,651

3,200

5,977

2,597

6,453

1,851

6,317

6,810

440

240

357

230

325
13

3.9

3.5
4.1

4.8

2.1

5.1

3.0

2.8

2.5

1.6

7.0

4.8

9.0

3.9

9.7

2.8

9.5

10.3

0.7

0.1

0.4

0.5

0.4

0.5
*

Year

2007

2008

2009
2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2030

2033

2034

2037
2043

Initial Expirations(3)

Subsequent Expirations(4)

Rental
Revenue for
the Quarter
Ended

% of
Total
Rental
12/31/06 Revenue

Number
of Leases
Expiring

33
36

111

144

232

180

2
—

$ 1,795

2.7%

1,551

789
2,011

1,672

1,354

3,196

1,755

1,409

1,796

1,570

1,068

4,457

3,167

5,240

2,597

6,427

1,851

6,254

6,771

440

240

357

230

325
—

2.4

1.2
3.1

2.5

2.0

4.8

2.6

2.2

2.7

2.4

1.6

6.7

4.8

7.9

3.9

9.7

2.8

9.4

10.2

0.7

0.1

0.4

0.5

0.4

0.5
—

74
38

—

—
1

Rental
Revenue for
the Quarter
Ended

% of
Total
Rental
12/31/06 Revenue

$ 829

1.3%

1,017

1,541
669

1,503

215

241

559

—

194

737

—

—
13

1.5

2.3
1.0

2.3

0.1

0.3

0.4

0.8

0.1

—

0.3

1.1

—

0.1

—

—
*

Totals

1,923

$ 66,244

100.0%

1,607

$ 58,417

88.2%

316

$ 7,827

11.8%

*Less than 0.1%

(1)Excludes six multi-tenant properties and 26 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 $8 from properties reclassified to discontinued operations and excludes revenue of $1,957 from six multi-tenant
properties and from 26 vacant unleased properties at December 31, 2006.

(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.

3 1

R E A LTY I N C O M E

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

owned by Crest) as of December 31, 2006 (dollars in thousands):

Approximate

Rental Revenue
Leasable For the Quarter Ended
Dec 31, 2006(1)

Square Feet

Number of
Properties

61
2
71
15
61
47
16
15
151
127
14
62
46
19
29
22
32
25
37
20
21
70
61
2
17
15
10
25
7
28
60
5
109
24
19
84
1
59
7
126
202
6
1
67
37
2
17
1

Percent
Leased

98%

100
100
100
98
96
100
100
99
99
100
100
96
100
90
95
100
100
100
100
100
96
98
100
100
100
100
100
100
96
100
100
100
100
100
100
100
100
100
100
98
83
100
100
100
50
94
100

422,900
128,500
344,500
94,500
1,101,900
418,200
245,600
27,700
1,374,600
910,700
91,900
769,200
471,500
138,600
562,200
111,500
186,600
230,000
203,100
158,300
359,200
353,800
634,800
30,000
190,100
191,000
95,400
194,500
53,300
419,400
433,000
31,900
704,900
133,300
294,800
521,500
3,500
250,700
18,300
607,800
2,274,700
35,100
2,500
485,900
243,900
23,200
157,400
4,200

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%

Percentage
of Rental
Revenue

1.8%
0.4
2.9
1.5
5.8
2.6
1.5
0.5
8.1
5.0
0.5
5.1
2.8
0.6
1.4
0.9
1.1
1.8
1.5
0.8
1.9
1.9
2.8
0.1
0.9
1.3
0.6
2.1
0.2
3.0
2.8
0.1
3.9
0.8
1.2
3.6
*
2.3
0.1
4.1
13.9
0.1
*
3.7
1.1
*
0.9
*

100.0%

$ 1,255
271
1,989
1,041
3,929
1,776
1,019
316
5,509
3,430
369
3,501
1,878
391
947
600
757
1,197
999
573
1,278
1,317
1,919
77
608
849
383
1,440
159
2,022
1,874
68
2,671
552
842
2,449
29
1,531
76
2,816
9,480
96
22
2,497
751
30
600
18

$ 68,201

1,955

99%

16,740,100

(1)Includes rental revenue for all properties owned by Realty Income at December 31, 2006, including revenue from properties reclassified to
discontinued operations of $8.

R E A LTY I N C O M E

3 2

Description of Leasing Structure
At December 31, 2006, 1,923 single tenant and certain other

Certain Properties Under Development
Of the 322 properties Realty Income acquired in 2006, all

retail properties, or 98.4% of our 1,955 properties were net

were occupied at December 31, 2006, except for four prop-

leased. In most cases, the leases:

• Are for initial terms of 15 to 20 years;
• Require the tenants to pay minimum monthly rents
and property operating expenses (taxes, insurance

and maintenance); and

erties that were leased and being developed. In the case of

development properties, we either enter into an agreement
with a retail chain where the retailer retains a contractor to
construct the building and we fund the costs of that devel-

opment, or we fund a developer who constructs the building.

• Provide for future rent increases based on increases in

In either case, there is an executed lease with a retail tenant

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

at the time of the land purchase (with a fixed rent com-

degree, additional rent calculated as a percentage of

mencement date) and there is a requirement to complete the

the tenants’ gross sales above a specified level. Where

construction in a timely basis and within a specific budget,

leases provide for rent increases based on increases
in the consumer price index, generally these increases

typically within eight months after we purchase the land. The
tenant or developer generally is required to pay construction

become part of the new permanent base rent. Where

cost overruns to the extent that they exceed the construction

leases provide for percentage rent, this additional rent

budget by more than a predetermined amount. We also

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

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

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

land, which generally requires the tenant to begin paying
base rent when the store opens for business. The base rent

only the amount of gross sales in excess of that level.

is calculated by multiplying a predetermined capitalization

rate by our total investment in the property including the

Matters Pertaining to Certain Properties and Tenants

land cost for the property, construction costs and capitalized

Of the 26 properties available for lease or sale at December

interest. In 2006, Realty Income acquired 15 development

31, 2006, all are single-tenant properties except one. At

properties. Crest did not acquire any development property

December 31, 2006, 16 of our properties under lease were

in 2006. Both Realty Income and Crest will continue to pursue

unoccupied and available for sublease by the tenants, all of

development opportunities under similar arrangements in

which were current with their rent and other obligations.

the future.

During 2006, 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, 2006.

3 3

R E A LTY I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31, 2006 and 2005 (dollars in thousands, except per share data)

2006

2005

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, net

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

$ 958,770

1,785,203

2,743,973

(396,854)

2,347,119

137,962

2,485,081

10,573

5,953

17,206
27,695

$ 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

$ 2,546,508

$ 1,920,988

15,096

27,004

8,416

—
920,000

970,516

10,121

20,391

9,562

136,700
755,000

931,774

Stockholders’ equity:
Preferred stock and paid in capital, par value $1.00 per share,

20,000,000 shares authorized, 13,900,000 and 5,100,000 shares

issued and outstanding in 2006 and 2005, respectively
Common stock and paid in capital, par value $1.00 per share,

200,000,000 shares authorized, 100,746,226 and 83,696,647 shares

issued and outstanding in 2006 and 2005, respectively

Distributions in excess of net income

Total stockholders’ equity

Total liabilities and stockholders’ equity

337,781

123,804

1,540,365
(302,154)

1,575,992

$ 2,546,508

1,134,300
(268,890)

989,214

$ 1,920,988

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

R E A LTY I N C O M E

3 4

REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2006, 2005 and 2004 (dollars in thousands, except per share data)

Revenue

Rental

Other

Expenses

Interest

Depreciation and amortization

General and administrative

Property

Income taxes

Provisions for impairment
Loss on extinguishment of debt

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)

Net income available to common stockholders

Amounts available to common stockholders

per common share, basic and diluted:

Income from continuing operations

Net income

Weighted average common shares outstanding:

Basic
Diluted

2006

2005

2004

$ 238,058

2,042

240,100

$ 195,666

354

196,020

$ 172,033

1,029

173,062

51,363

59,492

17,539

3,339

747

—
1,555

134,035

106,065

1,402
3,314

4,716

110,781

(11,362)

—

$ 99,419

1.05

1.11

89,766,714

89,917,554

40,949

46,206

15,421

3,731

813

151
—

107,271

88,749

2,781
7,589

10,370

99,119

(9,403)

—

$ 89,716

0.99

1.12

79,950,255

80,208,593

34,132

39,696

13,119

3,058

699

716
—

91,420

81,642

7,847
13,908

21,755

103,397

(9,455)

(3,774)

$ 90,168

0.87

1.15

78,518,296

78,598,788

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

3 5

R E A LTY I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY

Years Ended December 31, 2006, 2005 and 2004 (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, 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

Share-based compensation

—

3,200,000

—

103,397

(108,016)

67,918

—

67,918

5,100,000
(4,125,700)

—
—

—

283,458

123,787
(99,368)

—

—
—

2,025

—
(3,774)

—

123,787
(103,142)

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

Share-based compensation

—

—
—

—

4,100,000
295,017

—

17
—

—

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

Net income

Distributions paid and payable

Shares issued in stock offerings,

—

net of offering costs of $20,911

— 16,815,000

—

Shares issued in stock offering,

net of offering costs of $6,023

Share-based compensation

8,800,000
—

—
234,579

213,977
—

—

110,781

(144,045)

402,745

—
3,320

—

—
—

402,745

213,977
3,320

Balance, December 31, 2006

13,900,000

100,746,226

$ 337,781

$ 1,540,365

$ (302,154)

$ 1,575,992

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

R E A LTY I N C O M E

3 6

REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2006, 2005 and 2004 (dollars in thousands)

2006

2005

2004

$ 110,781

$ 99,119

$ 103,397

59,492

46,206

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

Depreciation and amortization
Income from discontinued operations:
Real estate acquired for resale
Real estate held for investment

Gain on reinstatement of property carrying value
Gain on sale of real estate held for investment
Amortization of stock compensation
Amortization of stock option costs
Provisions for impairment on real estate held for investment

Cash from discontinued operations:
Real estate acquired for resale
Real estate held for investment
Investment in real estate acquired for resale
Intangibles acquired in connection with acquisition of

real estate acquired for resale

Proceeds from sales of real estate acquired for resale
Collection of mortgage note receivable by Crest

Change 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:

Continuing operations
Discontinued operations

Acquisition of and additions to investment properties
Intangibles acquired in connection with acquisitions of

investment properties

Net cash used in investing activities

Cash Flows from Financing Activities
Borrowings from lines of credit
Payments under lines of credit
Proceeds from common stock offerings, net
Proceeds from notes issued, net
Principal payment on notes
Proceeds from preferred stock offerings, net
Redemption of preferred stock
Cash distributions to common stockholders
Cash dividends to preferred stockholders
Proceeds from other common 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

(1,402)
(3,314)
(716)
—
2,928
23
—

371
410
(113,166)

—
22,405
1,333

4,418
3,382

86,945

2
9,804
(654,149)

(937)

(645,280)

523,200
(659,900)
402,745
271,883
(110,000)
213,977
—
(129,667)
(9,403)
369

503,204

(55,131)
65,704

Cash and cash equivalents, end of year

$ 10,573

For supplemental disclosures, see note 13.

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

3 7

R E A LTY I N C O M E

(2,781)
(7,589)
—
(18)
2,155
12
151

(510)
1,509
(54,110)

(1,780)
22,195
—

(3,292)
8,290

109,557

109
22,191
(417,347)

(9,494)

(404,541)

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

358,547

63,563
2,141

$ 65,704

39,696

(7,847)
(13,908)
—
(185)
1,426
14
716

(2,407)
4,184
(21,787)

—
74,995
—

1,094
(1,051)

178,337

426
34,175
(195,470)

—

(160,869)

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

(20,164)

(2,696)
4,837

2,141

REALTY INCOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006, 2005 and 2004

1. ORGANIZATION AND OPERATION
Realty Income Corporation (“Realty Income,” the “Company,”

Earnings and profits that determine the taxability of

distributions to stockholders differ from net income reported

for financial reporting purposes due to differences in the

estimated useful lives and methods used to compute

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

depreciation and the carrying value (basis) on the investments

invest in commercial retail real estate and have elected to be

in properties for tax purposes, among other things.

taxed as a real estate investment trust (“REIT”).

At December 31, 2006, we owned 1,955 properties,

located in 48 states, containing over 16.7 million leasable
square feet, along with 60 properties owned by our wholly-

owned taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”).

Crest was created to buy and sell properties, primarily to
individual investors, many of whom are involved in tax-

deferred exchanges, under Section 1031 of the Internal

Revenue Code of 1986, as amended (the “Tax Code”).

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

became effective after the market closed on December 31,

2004. Common stockholders received an additional share

of common stock for each share they owned. The increase

in the number of common shares outstanding and all per

common share data has been adjusted for the stock split.

Information with respect to number of properties, square

feet, average initial lease term and weighted average

contractual lease rate is unaudited.

2. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES AND PROCEDURES
Federal Income Taxes. We have elected to be taxed as a

Real Estate Investment Trust (“REIT”) under the Tax Code.
We believe we have qualified and continue to qualify as a
REIT. Under the REIT operating structure, we are permitted
to deduct distributions paid to our stockholders and gener-
ally 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 consoli-
dated financial statements, except for federal income taxes

of Crest, which totaled $396,000 in 2006, $760,000 in 2005
and $2.8 million in 2004 and are included in “income from
discontinued operations, real estate acquired by Crest.”

The following reconciles our net income available to
common stockholders to taxable income for 2006 (dollars in

thousands) (unaudited):

Net income available to common stockholders $ 99,419

Tax loss on the sale of real estate less

than book gains

Elimination of net revenue and expenses

from Crest

Dividends received from Crest

Preferred dividends not deductible for tax

(3,529)

2,440

500

11,362

Depreciation and amortization timing differences

16,612

Adjustment for straight-line rent

Adjustment for a decrease in prepaid rent
Other adjustments

Estimated taxable net income, before our

(1,515)

(1,681)
(816)

dividend paid deduction

$ 122,792

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 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 outstanding during the

reporting period.

The following is a reconciliation of the denominator of the

basic net income per common share computation to the

denominator of the diluted net income per common share

computation, for the years ended December 31:

2006

2005

2004

Weighted average shares used for the basic net income per share computation

89,766,714

79,950,255

78,518,296

Incremental shares from share-based compensation

150,840

258,338

80,492

Adjusted weighted average shares used for diluted net income

per share computation

89,917,554

80,208,593

78,598,788

In 2006, 2005 and 2004, no stock options were anti-dilutive. We had nonvested shares from share-based compensation that were

anti-dilutive of 235,035 in 2006 and 305,476 in 2005. No nonvested shares were anti-dilutive in 2004.

R E A LTY I N C O M E

3 8

Discontinued Operations. In accordance with Financial
Accounting Standards Board Statement No. 144, Accounting

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

from discontinued operations, from real estate held for

for the Impairment or Disposal of Long-Lived Assets (“SFAS

investment” for the years ended December 31 (dollars

144”), Realty Income’s operations from one investment

in thousands):

property classified as held for sale at December 31, 2006, plus
investment properties sold in 2006, 2005 and 2004, are
reported as discontinued operations. Their respective results

of operations have been reclassified to “income from discon-

tinued 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 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 as held for sale at the date of acquisition and do not

depreciate them. In accordance with SFAS 144, the operations

of Crest’s properties are classified as “income from discontin-

ued operations, real estate acquired for resale by Crest.”

No debt was assumed by buyers of our investment prop-

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

we have elected not to allocate interest expense to discon-

tinued operations related to real estate held for investment.

We allocate interest expense related to borrowings

specifically attributable to Crest’s properties. The interest

expense amounts allocated to the Crest properties are

included in “income from discontinued operations, real

estate acquired for resale by Crest.”

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

discontinued operations, real estate acquired for resale” for

the years ended December 31 (dollars in thousands):

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

Gain on sales of

investment properties

$ 3,036
492

Rental revenue
Other revenue
Depreciation and amortization (116)

Property expenses

Provisions for impairment

(116)

(16)

Income from discontinued
operations, real estate

2006

2005

2004

$ 6,573 $ 12,543
4,608

1,729

(458)

(222)

(35)

121

(1,162)

(545)

(1,657)

held for investment

$ 3,314

$ 7,589 $ 13,908

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

continued operations for the years ended December 31 (dol-

lars in thousands, except per share data):

Total income from
discontinued operations

2006

2005

2004

Income from discontinued operations:

Real estate acquired for

resale by Crest

$ 1,402 $ 2,781 $ 7,847

Real estate held

for investment

Income from discontinued

3,314

7,589

13,908

operations

$ 4,716 $ 10,370 $ 21,755

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

Gain on sales of real

estate acquired

for resale

Rental revenue

Interest expense

General and

2006

2005

2004

Per common share,

basic and diluted

$ 0.05 $

0.13 $

0.28

$ 2,219

$ 3,291 $ 10,254

5,080

2,085

(3,708)

(1,139)

2,304

(674)

The per share amounts for “income from discontinued
operations” above and the “income from continuing opera-
tions” and “net income” reported on the consolidated state-
ment of income have each been calculated independently.

administrative expense

Property expenses

(440)

(67)

Provisions for impairment

(1,188)

(453)

(60)

—

(464)

(93)

—

Income taxes

(494)

(943)

(3,480)

Income from discontinued

operations, real estate

acquired for resale

by Crest

$ 1,402

$ 2,781 $ 7,847

Revenue Recognition and Accounts Receivable. 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 recognized 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.

3 9

R E A LTY I N C O M E

We recognize an allowance for doubtful accounts relating
to accounts receivable for amounts deemed uncollectible.

Provisions for Impairment. We review long-lived assets for

impairment whenever events or changes in circumstances

We consider tenant specific issues such as financial stability

indicate that the carrying amount of an asset may not be

and ability to pay rent when determining collectibility of

recoverable. Generally, a provision is made for impairment if

accounts receivable and appropriate allowances to record.
The allowance for doubtful accounts was $705,000 and
$577,000 at December 31, 2006 and 2005, respectively.

Principles of Consolidation. The accompanying consoli-

dated financial statements include the accounts of Realty

Income, Crest and their wholly-owned subsidiaries, after

estimated future operating cash flows (undiscounted and

without interest charges) plus estimated disposition proceeds

(undiscounted) are less than the current book value.

Impairment loss is measured as the amount by which the

current book value of the asset exceeds the fair value of the
asset. If a property is held for sale, it is carried at the lower
of cost or estimated fair value, less estimated cost to sell.

elimination of all material intercompany balances and

Realty Income recorded a provision for impairment of

transactions. All of Realty Income’s and Crest’s subsidiaries are
wholly-owned.

$16,000 in 2006 on one retail investment property in the

restaurant industry. The provision for impairment is included

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

investments 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.

in discontinued operations.

Realty Income recorded provisions for impairment of
$186,000 in 2005 on four retail properties, of which two have
been sold. These properties were classified in the following
industries: one in child care and three in restaurant.

Realty Income recorded provisions for impairment of

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

$2.4 million in 2004 on six retail properties, of which five

properties in accordance with Statement No. 66, Accounting

have been sold. These properties were classified in the

for Sales of Real Estate.

following industries: one in automotive service, one in child

care, two in consumer electronics, one in convenience store

Depreciation and Amortization. Lands, buildings and

and one in restaurant.

improvements are recorded at cost and stated at cost. Major

Provisions for impairment recorded on investment

replacements and betterments, which improve or extend the

properties by Realty Income are included on our consolidated

life of the asset, are capitalized and depreciated over their

statements of income in “income from discontinued opera-

estimated useful lives, while ordinary repairs and mainte-

tions, real estate held for investment”, except for $151,000 in

nance are expensed as incurred. Buildings and improvements

2005 and $716,000 in 2004 which are included in provisions

that are under redevelopment, or are being developed, are

for impairment.

carried at cost and no depreciation is recorded on these

Crest recorded provisions for impairment of $1.2 million

assets. Additionally, amounts essential to the development of

in 2006 on three retail properties, which are held for resale

the property, such as pre-construction costs, development
costs, construction costs, interest costs and other costs
incurred during the period of development are capitalized.

We cease capitalization when the property is available for

at December 31, 2006. No provisions for impairment were

recorded by Crest in 2005 and 2004. Provisions for impair-
ment recorded by Crest are included in “income from discon-
tinued operations, real estate acquired for resale by Crest”

occupancy upon substantial completion of tenant improve-

on our consolidated statements of income.

ments, but in any event no later than one year from the

completion of major construction activity.

Acquired In-place Leases. In accordance with Financial

Properties are depreciated using the straight-line method

Accounting Standards Board Statement No. 141, Business

over the estimated useful lives of the assets. The estimated

Combinations (“SFAS 141”), the fair value of the real estate

useful lives are as follows:

Buildings
Building improvements
Tenant improvements and

25 years
4 to 15 years

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

The shorter of the term of the

leases, the value of in-place leases and tenant relationships,

lease commissions

related lease or useful life

based in each case on their fair values.

The fair value of the tangible assets of an acquired

property (which includes land and buildings/improvements)

is determined by valuing the property as if it were vacant,

and the “as-if-vacant” value is then allocated to land and

buildings/improvements based on our determination of the

relative fair value of these assets. Our determinations are

R E A LTY I N C O M E

4 0

based on a real estate appraisal for each property, generated
by an independent appraisal firm, which consider estimates

of carrying costs during the expected lease-up periods,

current market conditions, as well as costs to execute similar

leases. In allocating the fair value to identified intangibles
for above-market or below-market leases, an amount is
recorded based on the present value of the difference

between (i) the contractual amount to be paid pursuant to

the in-place lease and (ii) our estimate of fair market lease

rate for the corresponding in-place lease, measured over a

Other Assets. Other assets consist of the following at

December 31 (in thousands):

Deferred bond financing costs

$ 10,868

$ 8,999

2006

2005

Value of in-place and

above-market leases

Prepaid expenses

Settlements on treasury

lock agreements

period equal to the remaining term of the lease.

Unamortized credit line fees

Capitalized above-market lease values are amortized as a

Corporate assets, net of accumulated

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

depreciation and amortization

463

454

Escrow deposits for Section 1031

amortized as an increase to rental income over the remaining

tax-deferred exchanges

terms of the respective leases and expected below market

Other items

10,430

3,271

1,629

954

9,909

3,379

2,346

1,473

—

3,070

1,358

$ 27,695

$ 30,988

renewal option periods.

The aggregate value of other acquired intangible assets
consists of the value of in-place leases and tenant relation-

ships. These are measured by the excess of the purchase

price paid for a property, after adjusting for above or below

market lease value, less the estimated fair value of the prop-

erty “as if vacant,” determined as set forth above. The value

of in-place leases, exclusive of the value of above-market and

below-market in-place leases, is amortized to expense over

the remaining periods of the respective leases. If a lease were

to be terminated prior to its stated expiration, all unamortized

amounts relating to that lease would be recorded to revenue

or expense as appropriate.

Share-Based Compensation. Effective January 1, 2002, we

adopted the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, and
starting January 1, 2002, expensed costs for all stock option
awards granted, modified, or settled. Stock option awards
under the plan vest over periods ranging from one to five

years. For the years ended December 31, 2006, 2005 and

2004, respectively, there is no difference between the stock

option-based compensation expense included in reported

net income and that expense determined under the fair value

method for all awards.

Effective January 1, 2006, we adopted FASB 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.

Goodwill. Goodwill is tested for impairment during the
second quarter of each year as well as when events or
circumstances occur indicating that our goodwill might be

impaired. We did not record any new goodwill or impairment

on our existing goodwill during 2006, 2005 or 2004.

Use of Estimates. The consolidated financial statements were

prepared in conformity with U.S. generally accepted account-

ing principles, which requires management to make estimates

and assumptions that affect the reported amounts of assets

and liabilities, the disclosure of contingent assets and liabili-

ties 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 2005 and 2004 balances

have been reclassified to conform to the 2006 presentation.

3. RETAIL PROPERTIES ACQUIRED
We acquire land, buildings and improvements that are used

by retail operators.

A. During 2006, Realty Income and Crest invested
$769.9 million, in aggregate, in 378 new retail properties and
properties under development. These 378 properties are
located in 30 states, will contain over 3.8 million leasable
square feet, and are 100% leased with an average initial lease
term of 17.1 years. Of the $769.9 million invested in 2006,
$6.0 million was used to acquire one property with an existing
lease already in-place with a retail tenant. In accordance with
SFAS 141, Realty Income recorded $1.6 million as the value of
the in-place lease and $628,000 as the value of below-market
rents. These amounts are recorded to “other assets” and
“other liabilities”, respectively, on our consolidated balance
sheet and are amortized over the lives of the respective lease.
In comparison, during 2005, Realty Income and Crest
invested $486.6 million, in aggregate, in 156 new retail proper-
ties and properties under development. These 156 new retail
properties are located in 30 states, contain over 1.9 million
leasable square feet and are 100% leased with an average
lease term of 15.8 years. Of the $486.6 million invested in
2005, $95.1 million was used to acquire 34 properties with

4 1

R E A LTY I N C O M E

existing leases already in-place with existing retail tenants.
In accordance with SFAS 141, Realty Income recorded

October 2005. The increase in the average borrowing rate

is due to an increase in LIBOR since the beginning of 2005.

$10.1 million and Crest recorded $1.8 million as the value of

Our current credit facility is subject to various leverage and

in-place leases and Realty Income recorded $183,000 as the

interest coverage ratio limitations. The Company is and has

value of above-market rents. In addition, Realty Income
recorded $756,000 and Crest recorded $66,000 as the value
of below-market rents on these leases. These amounts were

recorded to “other assets” and “other liabilities”, respectively,

on our consolidated balance sheet and are amortized over the

lives of the respective leases. The amounts recorded by Crest

been in compliance with these covenants.

Our credit facility is unsecured and accordingly, we have

not pledged any assets as collateral for this obligation.

5. NOTES PAYABLE
In September 2006, we issued $275 million in aggregate

are included in the calculation of gain on sales of real estate

principal amount of 5.95% senior unsecured notes due 2016

when the properties were sold during 2006 and 2005.

B. During 2006, Realty Income invested $656.7 million in 322

new retail properties and properties under development, with

an initial weighted average contractual lease rate of 8.6%.

(the “2016 Notes”). The price to the investor for the 2016

Notes was 99.74% of the principal amount for an effective

yield of 5.985%. Interest on the 2016 Notes is paid semiannu-
ally. The net proceeds of approximately $271.9 million from
this offering were used for other general corporate purposes

These 322 properties are located in 30 states, will contain

and to redeem the outstanding $110 million 7 3⁄4% unsecured

over 3.3 million leasable square feet and are 100% leased
with an average initial lease term of 16.7 years. The initial

notes due May 2007 (the “2007 Notes”), which were issued
in May 1997.

weighted average contractual lease rate is computed by

In September 2006, we redeemed all of our outstanding

dividing the estimated aggregate base rent for the first year

2007 Notes at a redemption price equal to 100% of the

of each lease by the estimated total cost of the properties.

principal amount, plus accrued and unpaid interest of

In comparison, during 2005, Realty Income invested

$3.2 million and a make-whole payment of $1.6 million.

$430.7 million in 135 new retail properties and properties

We recorded a loss on extinguishment of debt totaling

under development, with an initial weighted average con-

$1.6 million related to the make-whole payment associated

tractual lease rate of 8.4%. These 135 properties are located

with the 2007 Notes. For 2006, the make-whole payment

in 28 states, contain over 1.7 million leasable square feet

represented approximately $0.017 per share.

and are 100% leased with an average initial lease term of

In September 2005, we issued $175 million in aggregate

15.6 years.

principal amount of 5 3⁄8% senior unsecured notes due 2017

(the “2017 Notes”). The price to the investor for the 2017

C. During 2006, Crest invested $113.2 million in 56 new

Notes was 99.974% of the principal amount for an effec-

retail properties and properties under development. In

tive yield of 5.378%. The net proceeds of approximately

comparison, during 2005, Crest invested $55.9 million in 21

$173.2 million from this offering were used to repay borrow-

new retail properties and properties under development.

ings under our unsecured acquisition credit facility, to fund

D. Crest’s property inventory at December 31, 2006

purposes. Interest on the 2017 Notes is paid semiannually.

consisted of 60 properties with a total investment of

In March 2005, we issued $100 million in aggregate

$137.5 million and at December 31, 2005 consisted of 17

principal amount of 5 7⁄8% senior unsecured bonds due 2035

properties with a total investment of $45.7 million. These

(the “2035 Bonds”). The price to the investor for the 2035

amounts are included on our consolidated balance sheets

Bonds was 98.296% of the principal amount for an effective

new property acquisitions and for other general corporate

in “real estate held for sale, net.”

4. CREDIT FACILITY
We have a $300 million revolving acquisition credit facility
that expires in October 2008, unless extended as provided
for in the agreement. Under the terms of the credit facility,

which commenced in October 2005, the borrowing rate is
LIBOR (London Interbank Offered Rate) plus 65 basis points
with a facility fee of 15 basis points, for all-in drawn pricing

of 80 basis points over LIBOR, based on our current credit
ratings. The credit facility offers us other interest rate options
as well.

The average borrowing rate on our credit facilities during
2006 was 5.7%, compared to 4.3% in 2005 and 2.4% in 2004
on our previous $250 million credit facility, which expired in

yield of 5.998%. The net proceeds of approximately $97 million

from this offering were used to repay borrowings under our

acquisition credit facility and for other general corporate pur-

poses. Interest on the 2035 Bonds is paid semiannually.

In November 2003, we issued $150 million of 5 1⁄2% senior
unsecured notes due 2015 (the “2015 Notes”). 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”). Interest on

the 2013 Notes is payable semiannually.

In January 1999, we issued $20 million of 8% senior

unsecured notes due 2009 (the “2009 Notes”). Interest on

the 2009 Notes is payable semiannually.

R E A LTY I N C O M E

4 2

In October 1998, we issued $100 million of 8 1⁄4% Monthly
Income Senior Notes due 2008 (the “2008 Notes”). In May

B. In September 2006, we issued 4.715 million shares of common

stock at a price of $24.32 per share. The net proceeds of

1998, we entered into a treasury interest rate lock agreement

approximately $109 million from this offering were used to

associated with the 2008 Notes. In settlement of the agree-

fund new property acquisitions, repay borrowings under our

ment, we made a payment of $8.7 million in 1998. The payment
on the agreement is being amortized over 10 years (the life
of the 2008 Notes) as a yield adjustment to interest expense.

credit facility and for other general corporate purposes.

C. In March 2006, we issued 5.2 million shares of common

After taking into effect the results of a treasury interest rate

stock at a price of $24.39 per share. The net proceeds of

lock agreement, the effective rate to us on the 2008 Notes is

9.12%. Interest on the 2008 Notes is payable monthly. The

approximately $120.5 million were used to fund new prop-
erty acquisitions and for other general corporate purposes.

2008 Notes are unsecured.

Interest incurred on the 2016 Notes, 2017 Notes, 2035

D. In September 2005, we issued 4.1 million shares of common

Bonds, 2015 Notes, 2013 Notes, 2009 Notes, 2008 Notes
and 2007 Notes (redeemed in September 2006) collectively

stock at a price of $23.79 per share. The net proceeds of

$92.7 million were used to fund new property acquisitions

for each of the years ended December 31, 2006, 2005 and

and for other general corporate purposes.

2004 was $49.6 million, $39.5 million and $32.0 million,

respectively. In addition, when the 2007 Notes were

redeemed, we paid a $1.6 million make-whole payment,
which is classified as “loss on extinguishment of debt” on our

E. In March 2004, we issued 3.2 million shares of common
stock at a price of $22.375 per share. The net proceeds of
$67.9 million were used to repay a portion of our acquisition

consolidated statements of income. The interest rate on each

credit facility borrowings, which had been used to acquire

of these notes is fixed.

112 convenience store properties in March 2004.

Our outstanding notes are unsecured and accordingly, we

have not pledged any assets as collateral for these or any

other obligations.

All of these notes contain various covenants, including:

7. PREFERRED STOCK OFFERINGS
AND REDEMPTIONS
A. In December 2006, we issued 8.8 million shares of 6 3⁄4%

(i) a limitation on incurrence of any debt which would cause

Monthly Income Class E cumulative redeemable preferred

our debt to total adjusted assets ratio to exceed 60%;

stock, with a liquidation value of $25 per share. The net

(ii) a limitation on incurrence of any secured debt which

proceeds of $214 million from this issuance were used to

would cause our secured debt to total adjusted assets ratio

repay borrowings under our credit facility and for other

to exceed 40%; (iii) a limitation on incurrence of any debt

general corporate purposes. Beginning December 7, 2011,

which would cause our debt service coverage ratio to be less

the Class E preferred shares are redeemable at our option for

than 1.5 times; and (iv) the maintenance at all times of total

$25 per share. Dividends of $0.140625 per share are paid

unencumbered assets not less than 150% of our outstanding

monthly in arrears on the Class E preferred stock.

unsecured debt. We have been in compliance with these

covenants since each of the notes were issued.

The following table summarizes the maturity of our notes

payable as of December 31, 2006 (dollars in millions):

Year of Maturity (1)

2008

2009

After 2011

Totals

Notes

$ 100.0

20.0

800.0

$ 920.0

(1)There are no maturities in 2007, 2010 or 2011.

6. COMMON STOCK OFFERINGS
A. In October and November 2006, we issued an aggregate

of 6.9 million shares of common stock at a price of $26.40 per
share. The net proceeds of approximately $173.2 million
were used to fund a portion of the purchase price of the

Buffets/Ryan’s properties and for other general corporate

purposes.

B. In May 2004, we issued 4.0 million shares of 7 3⁄8% Monthly
Income Class D cumulative redeemable preferred stock, with
a liquidation value of $25 per share. The net proceeds of
$96.4 million from this issuance were used to redeem a
portion of the outstanding Class B and Class C preferred
stock, repay borrowings outstanding under our $250 million

acquisition credit facility and for other general corporate
purposes. Beginning May 27, 2009, the Class D preferred
shares are redeemable at our option for $25.00 per share.

Dividends of $0.1536459 per share are paid monthly in
arrears on the Class D preferred stock.

In October 2004, we issued an additional 1.1 million

shares of Class D preferred stock for $25.4311 per share. The
net proceeds of $27.4 million were used to repay borrowings
under our $250 million acquisition credit facility.

C. When our Class B preferred stock was redeemed in 2004,
we incurred a non-cash charge of $2.4 million representing

the Class B preferred stock original issuance costs that were

paid in 1999.

4 3

R E A LTY I N C O M E

D. When our Class C preferred stock was redeemed in 2004,
we incurred a non-cash charge of $1.4 million representing

the Class C preferred stock original issuance costs that were

paid in 1999.

8. DISTRIBUTIONS PAID AND PAYABLE
A. Common Stock. We pay monthly cash distributions to

$1.01406 were characterized for federal income tax purposes

as ordinary income.

In May 1999, we issued 2.76 million shares of 9 3⁄8% Class
B cumulative redeemable preferred stock, of which 2,745,700

shares were outstanding for 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

our common stockholders. The following is a summary of

preferred stock totaling $2.8 million during the first two

monthly distributions paid per common share for the years

ended December 31:

Month

January

February

March

April

May

June
July

August

September

October

November
December

2006

2005

2004

$ 0.116250

$ 0.110000

$ 0.100000

0.116250

0.116875

0.116875
0.117500

0.117500

0.125250

0.125875

0.125875
0.125875

0.110000

0.110625

0.110625
0.111250

0.111250

0.115000

0.115625

0.115625
0.115625

0.100000

0.100625

0.100625
0.101250

0.101250

0.108750

0.109375

0.109375
0.109375

Total

$ 1.437250

$ 1.346250

$ 1.241250

The following presents the federal income tax charac-

terization of distributions paid or deemed to be paid per

common share for the years ended December 31:

quarters of 2004. The dividends paid per share to our Class B
preferred stockholders in 2004 of $1.01563 were character-
ized for federal income tax purposes as ordinary income.

In July 1999, we issued 1.38 million shares of 9 1⁄2% Class C
cumulative redeemable preferred stock, all of which were

outstanding for a portion of 2004. On July 30, 2004, 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. The dividends paid per share to our Class C preferred
stockholders in 2004 of $1.37882 were characterized for

federal income tax purposes as ordinary income.

9. OPERATING LEASES
A. At December 31, 2006, we owned 1,955 properties in
48 states, excluding 60 properties owned by Crest. Of

these 1,955 properties, 1,948, or 99.6%, are single-tenant,

retail properties and the remaining seven are multi-tenant,

distribution and office properties. At December 31, 2006, 26

properties were vacant and available for lease or sale.

Substantially all leases are net leases where the tenant

pays property taxes and assessments, maintains the interior

Ordinary

2006

2005

2004

and exterior of the building and leased premises, and carries

insurance coverage for public liability, property damage, fire

income

$ 1.2945466

$ 1.210091

$ 1.18315

and extended coverage.

Nontaxable

distributions 0.1427034

0.136159

0.05810

Capital gain

—

Totals

$ 1.4372500

$ 1.346250

$ 1.24125

Percentage rent for 2006, 2005 and 2004 was $1.1 million,

$1.2 million and $1.3 million, respectively, including amounts
recorded to discontinued operations.

At December 31, 2006, minimum future annual rents to
be received on the operating leases are as follows (dollars

in thousands):

At December 31, 2006, a distribution of $0.1265 per

common share was payable and was paid in January 2007. At

For the years ending December 31,

December 31, 2005, a distribution of $0.11625 per common

share was payable and was paid in January 2006.

B. Preferred Stock. Dividends of $0.140625 per share are

paid monthly in arrears on the Class E preferred stock. We

declared dividends to holders of our Class E preferred stock

totaling $1.6 million in 2006. The first Class E dividend was

paid in January 2007.

Dividends of $0.1536459 per share are paid monthly

in arrears on the Class D preferred stock. We declared

dividends to holders of our Class D preferred stock totaling

$9.8 million in 2006, $9.4 million in 2005 and $4.8 million in

2004. The dividends paid per share to our Class D preferred

stockholders for 2006 and 2005 of $1.84375 and for 2004 of

2007
2008

2009

2010

2011
Thereafter

Total

$ 268,536
257,072
246,422

238,635

231,051

2,252,524

$ 3,494,240

B. Major Tenants—No individual tenant’s rental revenue,
including percentage rents, represented more than 10% of
our total revenue for each of the years ended December 31,
2006, 2005 or 2004.

R E A LTY I N C O M E

4 4

10. GAIN ON SALES OF REAL ESTATE
ACQUIRED FOR RESALE BY CREST
In 2006, Crest sold 13 properties for $22.4 million, which

13. SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
Interest paid in 2006 was $52.4 million, in 2005 was

resulted in a gain of $2.2 million. In 2005, Crest sold 12 prop-

$36.4 million and in 2004 was $31.3 million.

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

As part of one sale in 2005, Crest provided buyer financing in

the form of a $1.3 million promissory note. This note was paid

Interest capitalized to properties under development in
2006 was $2.2 million, in 2005 was $1.9 million and in 2004
was $531,000.

in full in February 2006. In 2004, Crest sold 51 properties for

Income taxes paid by Realty Income and Crest in 2006

$75 million, which resulted in a gain of $10.3 million. Crest’s

were $775,000, in 2005 were $1.4 million and in 2004 were

gains on sales are reported before income taxes and are

$6.9 million.

included in discontinued operations.

11. GAIN ON SALES OF INVESTMENT
PROPERTIES BY REALTY INCOME
In 2006, we sold or exchanged 13 investment properties for

The following non-cash investing and financing activities

are included in the accompanying consolidated financial

statements:

A. Stock based compensation for 2006 was $3.0 million, for

$10.7 million, which resulted in a gain of $3.0 million, which

2005 was $2.2 million and for 2004 was $1.4 million.

is included in discontinued operations.

In 2005, we sold 23 investment properties and sold a
portion of the land from two properties for $23.4 million,

B. In 2006, we exchanged one of our properties for a different

property that was leased to the same tenant. As part of this

which resulted in a gain of $6.6 million. This gain is included

transaction, accumulated depreciation was reduced by

in discontinued operations, except for $18,000 that is

$67,000 and a gain of $67,000 was recorded. The original

included in other revenue.

cost of, and the value received for, the property exchanged

In 2004, we sold or exchanged 43 investment properties

was $900,000. This transaction had no impact to land or

and sold a portion of the land from four properties for

building and improvements.

$35.4 million, which resulted in a gain of $12.7 million. Of this

gain, $12.5 million is included in discontinued operations and

C. In 2006, we received shares of a public company as

$185,000 is included in other revenue. Included in the 43

settlement of a bankruptcy claim associated with a former

properties was one property leased by one of our tenants

tenant. We recorded a value of $207,000, which is in other

that we exchanged for another property owned by that

revenue, based on the closing market price of these shares

tenant (see note 13-H).

12. FAIR VALUE OF FINANCIAL INSTRUMENTS
We believe that the carrying values reflected in the consoli-

on December 31, 2006 and included them in other assets on

our consolidated balance sheet at December 31, 2006. The

shares were sold in January 2007.

dated balance sheets at December 31, 2006 and 2005

reasonably approximate the fair values for cash and cash

D. In 2005, Crest sold a property for $2.8 million and issued
a mortgage note of $1.3 million, which was paid in full in

equivalents, accounts receivable, and all liabilities, due to

February 2006 and is included in other assets on our

their short-term nature, except for the line of credit payable

December 31, 2005 consolidated balance sheet.

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 the balance
sheet date. The estimated fair value of the notes payable at

E. In 2004, we recorded an impairment of $716,000 on one

property to reduce its carrying value to zero. This loss was the

result of a dispute with the original owner and tenant in their

bankruptcy proceeding. Our title insurance company failed

December 31, 2006 is $921.9 million and at December 31,

to timely record the deed on this property upon our original

2005 is $755.0 million, based upon the closing market price

acquisition, which resulted in a claim by the bankruptcy

per note, or indicative price per each note, at December 31,
2006 and 2005, respectively.

trustee that Realty Income did not have legal title to the

property. In the second quarter of 2006, this issue was

resolved and we obtained title to the property. At that time,

we reinstated the original carrying value adjusted for depre-

ciation on our balance sheet and recorded other revenue of

$716,000. We also reversed accrued liabilities and property

expenses of $133,000 associated with this property. As part

of the settlement, these costs became the responsibility of

the title insurance company.

4 5

R E A LTY I N C O M E

F. In June 2004, when our Class B preferred stock was
redeemed, we incurred a non-cash charge of $2.4 million for

14. EMPLOYEE BENEFIT PLAN
We have a 401(k) plan covering substantially all of our

the excess of redemption value over the carrying value.

employees. Under our 401(k) plan, employees may elect to

G. 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.

make contributions 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 compensation. Our aggregate matching

contributions each year have been immaterial to our results

H. In 2004, we exchanged one of our properties for a different

of operations.

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.

15. COMMON STOCK INCENTIVE PLAN
In 2003, our Board of Directors adopted, and our stockholders

approved, the 2003 Incentive Award Plan of Realty Income

Corporation (the “Stock Plan”) to enable us to attract and

I. Accrued costs on properties under development resulted

retain the services of directors, employees and consultants,

in an increase in buildings and accounts payable of $1.7 million

considered essential to our long-term success, by offering

in 2006. In 2005, non-cash additions to properties resulted

them an opportunity to own stock in Realty Income and/or

in an increase in buildings of $5.4 million and an increase in
accounts payable of $5.1 million.

rights that will reflect our growth, development and financial
success. The Stock Plan was amended and restated by our

Board of Directors in February 2006. Under the terms of

J. Distributions payable on our balance sheets is comprised

this plan, the aggregate number of shares of our common

of the following declared distributions (dollars in thousands):

stock subject to options, stock purchase rights (SPR), stock

Common stock distributions

$ 12,745

$ 9,729

Preferred stock dividends

2,351

392

2006

2005

appreciation rights (SAR) and other awards will be no more

than 3,428,000 shares. The maximum number of shares that

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. To date, we have not issued any SPR or SAR.

The amount of share-based compensation costs charged

against income during 2006 were $3.0 million, during 2005

were $2.2 million and during 2004 were $1.4 million.

Stock options were 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 2006, 2005
or 2004.

R E A LTY I N C O M E

4 6

The following table summarizes our stock option activity for the years ended December 31:

2006

2005

Number of
shares

Weighted
average
exercise price

Number of
shares

Weighted
average
exercise price

Outstanding options, beginning of year

135,348

$ 13.02

Options exercised

Options forfeited

(28,696)

(284)

12.86

14.70

176,130

(40,352)

(430)

$ 13.01

12.93

14.70

2004

Weighted
average
exercise price

$ 12.53

11.16

14.70

Number of
shares

247,756

(67,648)

(3,978)

Outstanding options, end of year

106,368

$ 13.06

135,348

$ 13.02

176,130

$ 13.01

Options exercisable, end of year

106,368

$ 13.06

119,924

$ 12.87

153,206

$ 12.75

At December 31, 2006, the options outstanding and exercisable had exercise prices ranging from $10.63 to $14.70, with a

weighted average price of $13.06, and expiration dates ranging from June 2007 to December 2011 with a weighted average remaining
term of 2.6 years.

The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was $268,000, $377,000

and $480,000, respectively. The total intrinsic value of options vested during the years ended December 31, 2006, 2005 and 2004
was $143,000, $67,000 and $101,000, respectively. The aggregate intrinsic value of options outstanding was $1.6 million, $1.2 million

and $2.2 million at December 31, 2006, 2005 and 2004, respectively. The aggregate intrinsic value of options exercisable at

December 31, 2006, 2005 and 2004 was $1.6 million, $1.1 million and $1.9 million, respectively. The intrinsic value of a stock option

is the amount by which the market value of the underlying stock at December 31 of each year exceeds the price of the option. The

market value of the Company’s stock was $27.70, $21.62 and $25.29 at December 31, 2006, 2005 and 2004, respectively.

The following table summarizes our common stock grant activity under our Stock Plan for the years 2006, 2005 and 2004. The

grants vest over periods ranging from immediately to 10 years.

2006

2005

Number of
shares

Weighted
average
grant price(1)

Number of
shares

Weighted
average
grant price(1)

Number of
shares

2004

Weighted
average
grant price(1)

788,722

210,332

(125,879)

(4,449)

$ 17.83

21.72

20.39

21.35

626,868

306,241

(92,811)

(51,576)

$ 14.98

25.20

16.69

17.31

475,174

218,180

(64,116)

(2,370)

$ 13.70

19.94

15.16

18.65

868,726

$ 17.96

788,722

$ 17.83

626,868

$ 14.98

Outstanding nonvested shares,

beginning of year

Shares granted

Shares vested

Shares forfeited

Outstanding nonvested shares,

end of year

(1)Grant date fair value.

During 2006, we granted 210,332 shares of common

The effect of pre-vesting forfeitures on our recorded

stock under the Stock Plan. These shares vest over the following

expense has historically been negligible. Any future pre-vesting

service periods: 16,000 vested upon issuance, 4,000 vest

forfeitures are also expected to be negligible, and we will

over a service period of one year, 4,000 vest over a service

record the benefit related to such forfeitures as they occur.

period of four years, 15,000 vest over a service period of five

Under the terms of the Stock Plan, we pay non-refundable

years and 171,332 vest over a service period of 10 years.

dividends to the holders of our nonvested shares. Under

As of December 31, 2006, the remaining unamortized

Statement No. 123R, the dividends paid to holders of these

stock compensation expense totaled $15.6 million, which is

nonvested shares should be charged as compensation

being amortized on a straight-line basis over the service
period of each applicable award. The amount of share-based
compensation is based on the fair value of the stock at the

grant date. We define the grant date as the date the recipient

and the Company have a mutual understanding of the key

terms and conditions of the award and the recipient of the

grant begins to benefit from, or be adversely affected by,
subsequent changes in the price of the shares.

expense to the extent that they relate to nonvested shares
that do not, or are not, expected to vest. Given the negligible
historical and prospective forfeiture rate determined by us,

we did not record any amount to compensation expense,
related to dividends paid, for 2006, nor do we expect to
record any amounts in future periods.

4 7

R E A LTY I N C O M E

16. SEGMENT INFORMATION
We evaluate performance and make resource allocation

decisions on an industry by industry basis. For financial

reporting purposes, we have grouped our tenants into 30

industry and activity segments (including properties owned

by Crest that 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.

The following tables set forth certain information regarding

the properties owned by us, classified according to the

business of the respective tenants as of December 31, 2006

(dollars in thousands):

For the years ended
December 31,

Segment rental revenue:
$
Automotive parts

Revenue

2006

2005

2004

As of December 31,

2006

2005

Segment net real estate:

Automotive parts

37,608

39,550

Assets

Automotive service

Automotive tire services

Child care

Convenience stores

Drug stores

Health and fitness

Home furnishings

Home improvement

Motor vehicle dealerships

Restaurants

Sporting goods

Theaters

Crest

17 other non-reportable

104,089

211,784

96,263

335,169

78,347

102,718

54,376

71,474

104,122

540,136

56,291

272,135

137,439

108,036

127,879

101,950

342,734

65,846

87,426

56,218

17,846

71,035

166,231

57,913

250,214

45,509

6,716

6,750

6,744

segments

283,130

263,659

Automotive service

16,495

15,083

13,320

Total segment net real estate

2,485,081

1,802,046

Automotive

tire services

Child care

Convenience stores

Drug stores

Health and fitness

Home furnishings

Home improvement

Motor vehicle

dealerships

Restaurants

Sporting goods

Theaters

17 non-reportable

segments(1)

Other revenue

14,501

24,649

38,284

6,986

10,212

7,463

7,996

8,217

28,292

6,829

22,905

38,513

2,042

13,821

24,819

36,712

5,593

7,212

7,346

2,129

5,060

17,988

6,747

10,139

36,267

354

13,346

24,787

33,409

243

6,919

7,327

2,115

859

16,196

5,939

6,052

34,777

1,029

Total revenue

$ 240,100

$ 196,020

$ 173,062

(1)Crest’s revenues appear in “income from discontinued operations,
real estate acquired for resale by Crest” and is not included in
this table.

Other intangible assets—

Drug stores

7,629

8,489

Other intangible assets—

Theaters

Other corporate assets

2,801
50,997

1,419
109,034

Total assets

$ 2,546,508

$ 1,920,988

17. COMMITMENTS AND CONTINGENCIES
In the ordinary course of our business, we are party to various

legal actions which we believe are routine in nature and

incidental 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 position or
results of operations.

At December 31, 2006, we have committed to pay
estimated unfunded development costs of $16.4 million on
properties under development. In addition, we have contingent
payments for tenant improvements and leasing costs of

$806,000 as well as a $6.0 million commitment to fund the
construction costs of two buildings, which are not currently
under construction, and for which construction is dependent
upon the tenant’s commitment to build the buildings prior
to September 30, 2007.

R E A LTY I N C O M E

4 8

REALTY INCOME CORPORATION AND SUBSIDIARIES
REPORTS OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Realty Income Corporation:

We have audited the accompanying consolidated balance

In our opinion, the consolidated financial statements

sheets of Realty Income Corporation and subsidiaries as of

referred to above present fairly, in all material respects, the

December 31, 2006 and 2005, and the related consolidated

financial position of Realty Income Corporation and subsidiaries

statements of income, stockholders’ equity, and cash flows

as of December 31, 2006 and 2005, and the results of their

for each of the years in the three-year period ended
December 31, 2006. These consolidated financial statements

operations and their cash flows for each of the years in the
three-year period ended December 31, 2006, in conformity

are the responsibility of Realty Income Corporation’s manage-

with U.S. generally accepted accounting principles.

ment. Our responsibility is to express an opinion on these

We also have audited, in accordance with the standards of

consolidated financial statements based on our audits.

the Public Company Accounting Oversight Board (United

We conducted our audits in accordance with the standards
of the Public Company Accounting Oversight Board (United

States), the effectiveness of Realty Income Corporation’s
internal control over financial reporting as of December 31,

States). Those standards require that we plan and perform

2006, based on criteria established in Internal Control—

the audit to obtain reasonable assurance about whether the

Integrated Framework issued by the Committee of Sponsoring

financial statements are free of material misstatement. An

Organizations of the Treadway Commission (COSO), and our

audit includes examining, on a test basis, evidence supporting

report dated February 20, 2007 expressed an unqualified

the amounts and disclosures in the financial statements.

opinion on management’s assessment of, and the effective

An audit also includes assessing the accounting principles

operation of, internal control over financial reporting.

used and significant 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 20, 2007

4 9

R E A LTY I N C O M E

The Board of Directors and Stockholders

Realty Income Corporation:

We have audited management’s assessment, included in the

principles, and that receipts and expenditures of the company

accompanying Management’s Report on Internal Control

are being made only in accordance with authorizations of

over Financial Reporting, that Realty Income Corporation

maintained effective internal control over financial reporting

as of December 31, 2006, based on criteria established in

management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of

Internal Control-Integrated Framework issued by the

the company’s assets that could have a material effect on

Committee of Sponsoring Organizations of the Treadway

the financial statements.

Commission (COSO). Realty Income Corporation’s manage-

Because of its inherent limitations, internal control over

ment is responsible for maintaining effective internal control

financial reporting may not prevent or detect misstatements.

over financial reporting and for its assessment of the

Also, projections of any evaluation of effectiveness to future

effectiveness of internal control over financial reporting. Our

responsibility is to express an opinion on management’s

periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the

assessment and an opinion on the effectiveness of Realty

degree of compliance with the policies or procedures

Income Corporation’s internal control over financial reporting

may deteriorate.

based on our audit.

In our opinion, management’s assessment that Realty

We conducted our audit in accordance with the standards

of the Public Company Accounting Oversight Board (United

Income Corporation maintained effective internal control
over financial reporting as of December 31, 2006, is fairly

States). Those standards require that we plan and perform

stated, in all material respects, based on criteria established

the audit to obtain reasonable assurance about whether

in Internal Control—Integrated Framework issued by the

effective internal control over financial reporting was main-

Committee of Sponsoring Organizations of the Treadway

tained in all material respects. Our audit included obtaining

Commission (COSO). Also, in our opinion, Realty Income

an understanding of internal control over financial reporting,

Corporation maintained, in all material respects, effective

evaluating management’s assessment, testing and evaluating

internal control over financial reporting as of December 31,

the design and operating effectiveness of internal control,

2006, based on criteria established in Internal Control—

and performing such other procedures as we considered

Integrated Framework issued by the Committee of Sponsoring

necessary in the circumstances. We believe that our audit

Organizations of the Treadway Commission (COSO).

provides a reasonable basis for our opinion.

We also have audited, in accordance with the standards of

A company’s internal control over financial reporting is a

the Public Company Accounting Oversight Board (United

process designed to provide reasonable assurance regarding

States), the consolidated financial statements of Realty

the reliability of financial reporting and the preparation of

Income Corporation and subsidiaries as of December 31,

financial statements for external purposes in accordance with

2006 and 2005, and for each of the years in the three-year

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

period ended December 31, 2006, and our report dated
February 20, 2007 expressed an unqualified opinion on those
consolidated financial statements.

San Diego, California

February 20, 2007

R E A LTY I N C O M E

5 0

REALTY INCOME CORPORATION AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL
Realty Income Corporation, The Monthly Dividend Company®,

LIQUIDITY AND CAPITAL RESOURCES
Cash Reserves

is a Maryland corporation organized to operate as an equity

Realty Income is organized to operate as an equity REIT

real estate investment trust, or REIT. Our primary business

that acquires and leases properties and distributes to

objective is to generate dependable monthly cash distribu-

stockholders, in the form of monthly cash distributions, a

tions from a consistent and predictable level of funds from

substantial portion of its net cash flow generated from leases

operations, or FFO per share. The monthly distributions are

on its retail properties. We intend to retain an appropriate

supported by the cash flow from our portfolio of retail

amount of cash as working capital. At December 31, 2006,

properties leased to regional and national retail chains. We

we had cash and cash equivalents totaling $10.6 million.

have in-house acquisition, leasing, legal, retail research, real

We believe that our cash and cash equivalents on hand,

estate research, portfolio management and capital markets

cash provided from operating activities and borrowing

expertise. Over the past 38 years, Realty Income and its
predecessors have been acquiring and owning freestanding

capacity, is sufficient to meet our liquidity needs for the
foreseeable future. We intend, however, to use additional

retail properties that generate rental revenue under long-term

sources of capital to fund property acquisitions and to repay

lease agreements (primarily 15 to 20 years).

our credit facility.

In addition, we seek to increase distributions to stock-

holders and FFO per share through both active portfolio

$300 Million Acquisition Credit Facility

management and the acquisition of additional properties. At

We have a $300 million revolving, unsecured credit facility

December 31, 2006, we owned a diversified portfolio:

that expires in October 2008. Realty Income’s current invest-

• Of 1,955 retail properties;

ment grade credit ratings provide for financing under the

• With an occupancy rate of 98.7%, or 1,929 properties

credit facility at the London Interbank Offered Rate, com-

occupied of the 1,955 properties in the portfolio;

monly referred to as LIBOR, plus 65 basis points with a

•

Leased to 103 different retail chains doing business in

facility fee of 15 basis points, for all-in drawn pricing of

29 separate retail industries;

•

Located in 48 states;

80 basis points over LIBOR. At February 13, 2007, we had

borrowing capacity of $300 million available on our credit

• With over 16.7 million square feet of leasable space;

facility and no outstanding balance.

and

The credit facility is expected to be used to acquire addi-

• With an average leasable retail space per property of

tional retail properties and for other corporate purposes. Any

approximately 8,600 square feet.

additional borrowings will increase our exposure to interest

rate risk. We have the right to request an increase in the

Of the 1,955 properties in the portfolio, 1,948, or 99.6%,

borrowing capacity of the credit facility by up to $100 million,

are single-tenant, retail properties and the remaining seven

to a total borrowing capacity of $400 million. Any increase in

are multi-tenant, distribution and office properties. At

the borrowing capacity is subject to approval by the lending

December 31, 2006, 1,923, or 98.7%, of the 1,948 single-

banks of our credit facility.

tenant properties were leased with a weighted average
remaining lease term (excluding extension options) of
approximately 12.9 years.

In addition, at December 31, 2006, our wholly-owned
taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had
invested $137.5 million in 60 properties, which are classified

Mortgage Debt
We have no mortgage debt on any of our properties.

Universal Shelf Registration

In April 2006, we filed a shelf registration statement with the

as held for sale. Crest was created to buy and sell properties,

SEC, which is effective for a term of three years. In accor-

primarily to individual investors, many of whom are involved

dance with the SEC rules, the amount of securities to be

in tax-deferred exchanges under Section 1031 of the Internal

issued pursuant to this shelf registration statement was not

Revenue Code of 1986, as amended (the “Tax Code”).

specified when it was filed. The securities covered by this

registration statement include common stock, preferred

stock, debt securities, or any combination of such securities.

Realty Income may periodically offer one or more of these

securities in amounts, prices and on terms to be announced

when and if the securities are offered. The specifics of any

5 1

R E A LTY I N C O M E

future offerings, along with the use of proceeds of any

2007 Notes and for other general corporate purposes.

securities offered, will be described in detail in a prospectus

Interest on the 2016 Notes is paid semiannually.

supplement, or other offering materials, at the time of any

offering. As such, there is no specific limit to the dollar

Conservative Capital Structure

amount of new securities that can be issued under this new

We believe that our stockholders are best served by a con-

shelf registration before it expires in April 2009.

servative capital structure. Therefore, we seek to maintain a

The common stock issued in September 2006, October

conservative debt level on our balance sheet and solid interest

2006 and November 2006, the 2016 Notes issued in

and fixed charge coverage ratios. At February 13, 2007, our

September 2006 and the Class E preferred stock issued in

total outstanding credit facility borrowings and outstanding

December 2006 were issued pursuant to our universal shelf

notes were $920 million, or approximately 21.9%, of our total

registration statement.

Issuances of Common Stock

market capitalization of $4.21 billion. We define our total

market capitalization at February 13, 2007 as the sum of:

• Shares of our common stock outstanding of

In October and November 2006, we issued an aggregate of

101,000,536 multiplied by the last reported sales price

6.9 million shares of common stock at a price of $26.40 per

of our common stock on the NYSE of $29.09 per

share. The net proceeds of approximately $173.2 million

share, or $2.94 billion;

were used to fund a portion of the purchase price of the

• Aggregate liquidation value of the Class D preferred

Buffets/Ryan’s properties and for other general corporate

stock of $127.5 million;

purposes.

• Aggregate liquidation value of the Class E preferred

In September 2006, we issued 4.715 million shares of

stock of $220 million; and

common stock at a price of $24.32 per share. The net proceeds

• Outstanding notes of $920 million.

of approximately $109 million from this offering were used to

fund new property acquisitions, repay borrowings under our

Historically, we have met our long-term capital needs

credit facility and for other general corporate purposes.

through the issuance of common stock, preferred stock and

In March 2006, we issued 5.2 million shares of common

long-term unsecured notes and bonds. Over the long term,

stock at a price of $24.39 per share. The net proceeds of

we believe that the majority of our future securities issuances

approximately $120.5 million were used to fund new property

should be in the form of common stock; however, we may

acquisitions and for other general corporate purposes.

issue additional preferred stock or debt securities from time

Issuance of Preferred Stock

to time. We may issue common stock when we believe that

our share price is at a level that allows for the proceeds of any

In December 2006, we issued 8.8 million shares of 6 3⁄4%

offering to be accretively invested into additional properties.

Class E cumulative redeemable preferred stock, with a liquida-

In addition, we may issue common stock to permanently

tion value of $25 per share. The net proceeds of $214 million

finance properties that were financed by our credit facility

from this issuance were used to repay borrowings under our

or debt securities. However, we cannot assure you that we

credit facility and for other general corporate purposes.

will have access to the capital markets at terms that are

Redemption of 2007 Notes

In September 2006, we redeemed all of our outstanding

Credit Agency Ratings

acceptable to us.

$110 million, 7 3⁄4%, unsecured notes due May 2007 (the
“2007 Notes”). The 2007 Notes were redeemed at a
redemption price equal to 100% of the principal amount,

plus accrued and unpaid interest of $3.2 million and a make-
whole payment of $1.6 million. We recorded a loss on
extinguishment of debt totaling $1.6 million related to the
make-whole payment associated with the 2007 Notes. For
2006, the make-whole payment represented approximately
$0.017 per share.

Issuance of 10-Year Senior Unsecured Notes
In September 2006, we issued $275 million in aggregate
principal amount of 5.95% senior unsecured notes due 2016
(the “2016 Notes”). The price to the investor for the 2016

Notes was 99.74% of the principal amount for an effective
yield of 5.985%. The net proceeds of approximately
$271.9 million from this offering were used to redeem the

We are currently assigned investment grade corporate credit
ratings on our senior unsecured notes from Fitch Ratings,
Moody’s Investors Service, Inc. and Standard & Poor’s Ratings

Group. 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
and Standard & Poor’s ratings have “positive” outlooks and
Fitch has a “stable” outlook.

We have also been assigned investment grade credit
ratings from the same rating agencies on our preferred stock.
Fitch Ratings has assigned a rating of BBB, Moody’s has
assigned a rating of Baa3 and Standard & Poor’s has assigned
a rating of BBB- to our preferred stock. Moody’s and
Standard & Poor’s ratings have “positive” outlooks and Fitch
has a “stable” outlook.

The credit ratings assigned to us could change based
upon, among other things, our results of operations and

R E A LTY I N C O M E

5 2

financial condition. These ratings are subject to ongoing

Interest on all of the senior note obligations is paid

evaluation by credit rating agencies, and we cannot assure

semiannually, with the exception of the interest on the 81⁄4%

you that any such rating will not be changed or withdrawn

senior notes issued in October 1998, which is paid monthly.

by a rating agency in the future if, in its judgment, circum-

All of these notes contain various covenants, including:

stances warrant. Moreover, a rating is not a recommendation

(i) a limitation on incurrence of any debt which would cause

to buy, sell or hold our debt securities, preferred stock or

our debt to total adjusted assets ratio to exceed 60%; (ii) a

common stock.

Notes Outstanding

limitation on incurrence of any secured debt which would

cause our secured debt to total adjusted assets ratio to

exceed 40%; (iii) a limitation on incurrence of any debt which

Senior note obligations consist of the following (dollars in

would cause our debt service coverage ratio to be less than

thousands), sorted by maturity date:

At December 31, 2006

8 1⁄4% senior notes, issued in

1.5 times; and (iv) the maintenance at all times of total

unencumbered assets not less than 150% of our outstanding

unsecured debt. We have been in compliance with these

covenants since each of the notes were issued.

October 1998 and due in 2008

$ 100,000

The following is a summary of the key financial covenants

8% senior unsecured notes, issued in

January 1999 and due in 2009
5 3⁄8% senior unsecured notes, issued
in March 2003 and due in 2013

5 1⁄2% senior unsecured notes, issued

to our senior unsecured notes. The actual amounts are as of

20,000

December 31, 2006.

100,000

Note Covenants

Required

Actual

Limitation on Incurrence

in November 2003 and due in 2015

150,000

of Total Debt

≤ 60%

5.95% senior unsecured notes, issued

Limitation on Incurrence

in September 2006 and due in 2016

275,000

of Secured Debt

5 3⁄8% senior unsecured notes, issued

Debt Service Coverage

in September 2005 and due in 2017

175,000

Maintenance of Total

Unencumbered Assets

5 7⁄8% senior unsecured bonds, issued

in March 2005 and due in 2035

100,000

$ 920,000

31.6%

0.0%

4.0 x

316%

≤ 40%
≥ 1.5 x
≥ 150% of
Unsecured Debt

All of our outstanding notes and bonds have fixed

interest rates. Our credit facility interest rate is variable.

The following table summarizes the maturity of each of our obligations as of December 31, 2006 (dollars in millions):

Table of Obligations

Year of Maturity

Credit Facility(1)

2007

2008
2009

2010

2011
Thereafter

Totals

$ —

—
—

—

—
—

Notes

$ —

100.0
20.0

—

—
800.0

Interest(2)

$ 55.1

54.1
45.3

45.3

45.3
305.5

Other(3)

$ 17.2

—
—

—

—
—

Totals

72.3

154.1
65.3

45.3

45.3
1,105.5

$ —

$ 920.0

$ 550.6

$ 17.2

$ 1,487.8

(1)There was no outstanding credit facility balance on December 31, 2006 or February 13, 2007.

(2)Interest on credit facility and notes has been calculated based on outstanding balances as of December 31, 2006 through their respective
maturity dates.

(3)Other consists of $16.4 million of estimated unfunded costs on properties under development and $806,000 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 these obligations.

5 3

R E A LTY I N C O M E

Preferred Stock Outstanding

is scheduled to begin at various times during 2007. At

In May and October 2004, we issued an aggregate of

December 31, 2006, we had outstanding commitments

5.1 million shares of 7 3⁄8% Class D cumulative redeemable

to pay estimated unfunded development costs totaling

preferred stock. Beginning May 27, 2009, shares of Class D

$16.4 million.

preferred stock are redeemable at our option for $25.00 per

The initial weighted average contractual lease rate is

share, plus any accrued and unpaid dividends. Dividends on

computed as estimated contractual net operating income (in

shares of Class D preferred stock are paid monthly in arrears.

a net-leased property this is equal to the base rent or, in the

In December 2006, we issued 8.8 million shares of 63⁄4%

case of properties under development, the estimated base

Class E cumulative redeemable preferred stock. Beginning

rent under the lease) for the first year of each lease, divided

December 7, 2011, shares of Class E preferred stock are

by the estimated total costs. Since it is possible that a tenant

redeemable at our option for $25 per share, plus any accrued

could default on the payment of contractual rent, we cannot

and unpaid dividends. Dividends on shares of Class E preferred

assure you that the actual return on the funds invested will

stock are paid monthly in arrears.

remain at the percentages listed above.

No Off-Balance Sheet Arrangements or

Acquisition of $349 million of Buffets/Ryan’s

Unconsolidated Investments

Restaurants on November 1, 2006

Realty Income and its subsidiaries have no unconsolidated

The 2006 acquisition amounts include Realty Income and

or off-balance sheet investments in “variable interest entities”

Crest’s aggregate investment of $349 million to acquire 144

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

Buffets/Ryan’s restaurant properties. The properties are

activities involving energy or commodity contracts or other

leased under 20-year, triple-net lease agreements. These

derivative instruments.

properties were acquired subsequent to a merger between

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

Buffets, Inc. and Ryan’s Restaurant Group.

or mandatory redeemable preferred stock, our financial posi-

Of the 144 restaurant properties, 116 were acquired by

tion or results of operations are currently not affected by

Realty Income and 28 were acquired by Crest. The restaurants

Financial Accounting Standard Board Interpretation No. 46R,
Consolidation of Variable Interest Entities and Statement of

have, on average, approximately 10,300 leasable square

feet and are situated on an average lot size of approximately

Financial Accounting Standard No. 150, Accounting for

2.86 acres. In general, the properties are existing locations

Certain Financial Instruments with Characteristics of both
Liabilities and Equity.

that, on average, have been operating for 11 years.

Investments in Existing Properties

Acquisitions During 2006

In 2006, we capitalized costs of $964,000 on existing properties

During 2006, Realty Income and Crest invested $769.9 million,

in our portfolio, consisting of $761,000 for re-leasing costs

in aggregate, in 378 new properties and properties under

and $203,000 for building improvements.

development. These 378 properties are located in 30 states

and are 100% leased with an initial average lease term of

Sales of Investment Properties

17.1 years. As described below, Realty Income acquired 322

During 2006, we sold or exchanged 13 properties for

properties and Crest acquired 56 properties.

$10.7 million, which resulted in a gain of $3.0 million. This gain

Included in the $769.9 million is $656.7 million invested

is included in discontinued operations. The 13 properties

by Realty Income in 322 new properties and properties under

development, with an initial weighted average contractual

lease rate of 8.6%. These 322 properties are located in 30

states, are 100% leased with an initial average lease term of
16.7 years and will contain over 3.3 million leasable square
feet. The 322 new properties acquired by Realty Income
are net-leased to 16 different retail chains in the following
11 industries: automotive collision services, automotive tire
services, convenience store, drug store, general merchan-
dise, health and fitness, home improvement, motor vehicle
dealership, private education, restaurant and theater. Also
included in the $769.9 million is $113.2 million invested by
Crest in 56 new retail properties.

At December 31, 2006, Realty Income had invested

$15.9 million in four properties that were leased and under

contract for development by the tenant (with development
costs funded by Realty Income). Rent on these properties

sold or exchanged consisted of one automotive parts store,
one automotive service facility, one child care facility, two
convenience stores, and eight restaurants. The net proceeds

from the sale of these properties were used to repay
outstanding indebtedness on our credit facility and to invest
in new properties.

Crest Property Sales
During 2006, Crest, our wholly-owned subsidiary, sold
13 properties from its inventory for an aggregate of
$22.4 million, which resulted in a gain of $2.2 million. Crest’s
gains are included in “income from discontinued operations,
real estate acquired for resale by Crest.”

R E A LTY I N C O M E

5 4

Crest Property Inventory

are reasonable for reporting purposes. However, actual

Crest’s property inventory at December 31, 2006 and 2005

results may differ from these estimates and assumptions.

totaled $137.5 million and $45.7 million, respectively, and is

In order to prepare our consolidated financial statements

included in “real estate held for sale, net”, on our consolidated

according to the rules and guidelines set forth by GAAP,

balance sheets.

many subjective judgments must be made with regard to

The financial statements of Crest are consolidated into

critical accounting policies. One of these judgments is our

Realty Income’s financial statements. All material intercom-

estimate for useful lives in determining depreciation expense

pany transactions have been eliminated in consolidation.

for our properties. Depreciation of buildings and improve-

ments is generally computed using the straight-line method

Increases in Monthly Cash Distributions

over an estimated useful life of 25 years. If we use a shorter

to Common Stockholders

or longer estimated useful life it could have a material impact

We continue our 37-year policy of paying distributions

on our results of operations. We believe that 25 years is an

monthly to our common stockholders. Monthly distributions

appropriate estimate of useful life. No depreciation has been

per share were increased in April 2006 by $0.000625

recorded on Crest’s properties because they are held for sale.

to $0.116875, in July 2006 by $0.000625 to $0.1175, in

Another significant judgment must be made as to if, and

September 2006 by $0.00775 to $0.12525, in October 2006

when, impairment losses should be taken on our properties

by $0.000625 to $0.125875 and in January 2007 by

when events or a change in circumstances indicate that the

$0.000625 to $0.1265. The increase in January 2007 was our

carrying amount of the asset may not be recoverable.

37th consecutive quarterly increase and the 42nd increase in

Generally, a provision is made for impairment loss if estimated

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

future operating cash flows (undiscounted and without

1994. In 2006, we paid the following monthly cash distribu-

interest charges) plus estimated disposition proceeds

tions per share: three in the amount of $0.11625, three in

(undiscounted) are less than the current book value.

the amount of $0.116875, two in the amount of $0.1175, one

Impairment losses are measured as the amount by which the

in the amount of $0.12525, and three in the amount of

current book value of the asset exceeds the fair value of the

$0.125875 totaling $1.43725. In December 2006, January

asset. If a property is held for sale, it is carried at the lower

2007 and February 2007, we declared distributions of

of carrying cost or estimated fair value, less cost to sell. The

$0.1265 per share, which were paid on January 16, 2007 and

carrying value of our real estate is the largest component of

February 15, 2007 and will be paid on March 15, 2007,

our consolidated balance sheet. If events should occur that

respectively.

require us to reduce the carrying value of our real estate by

The monthly distribution of $0.1265 per share represents

recording provisions for impairment losses, it could have a

a current annualized distribution of $1.518 per share, and an

material impact on our results of operations.

annualized distribution yield of approximately 5.2% based on

the last reported sale price of our common stock on the

The following is a comparison of our results

NYSE of $29.09 on February 13, 2007. Although we expect

of operations for the years ended December 31,

to continue our policy of paying monthly distributions, we

2006, 2005 and 2004.

cannot guarantee that we will maintain the current level of

distributions, that we will continue our pattern of increasing

Rental Revenue

distributions per share, or what the actual distribution yield

Rental revenue was $238.1 million for 2006 versus $195.7 million

will be in any future period.

RESULTS OF OPERATIONS
Critical Accounting Policies

Our consolidated financial statements have been prepared in

accordance with U.S. generally accepted accounting principles

(“GAAP”). Our consolidated financial statements are the

basis for our discussion and analysis of financial condition and

results of operations. Preparing our consolidated financial

statements requires us to make a number of estimates and

assumptions that affect the reported amounts and disclo-

sures in the consolidated financial statements. We believe

that we have made these estimates and assumptions in an

appropriate manner and in a way that accurately reflects our

financial condition. We continually test and evaluate these

for 2005, an increase of $42.4 million, or 21.7%. Rental revenue
was $172 million in 2004. The increase in rental revenue in
2006 compared to 2005 is primarily attributable to:

• The 322 retail properties acquired by Realty Income
in 2006, which generated $15.7 million of rent in 2006;
• The 135 retail properties acquired by Realty Income
in 2005, which generated $33.5 million of rent in 2006
compared to $12.1 million in 2005, an increase of
$21.4 million;

• Same store rents generated on 1,421 properties
leased during the entire years of 2006 and 2005
increased by $1.3 million, or 0.7%, to $175.3 million
from $174.0 million.

• An increase in straight-line rent and other non-cash
adjustments to rent of $155,000 in 2006 as compared

estimates and assumptions using our historical knowledge

to 2005; and

of the business, as well as other factors, to ensure that they

5 5

R E A LTY I N C O M E

• An increase of $4.0 million relating to the aggregate of

Interest Expense

(i) development properties acquired before 2005 that

Interest expense was $10.4 million higher in 2006 than in

started paying rent in 2005, (ii) properties that were

2005. Interest expense increased in 2006 primarily due to

vacant during part of 2006 or 2005 and (iii) lease termi-

higher average outstanding balances, which was partially

nation settlements. These items totaled $9.7 million in

offset by slightly lower interest rates related to our average

aggregate in 2006 compared to $5.7 million in 2005.

outstanding borrowings. We issued $275 million of 10-year

notes in September 2006, $175 million of 12-year notes in

Of the 1,955 properties in the portfolio at December 31,

September 2005 and $100 million of 30-year bonds in March

2006, 1,948, or 99.6%, are single-tenant properties and the

2005, which contributed to the increase in average out-

remaining seven are multi-tenant properties. Of the 1,948

standing balances and slightly lower average interest rates

single-tenant properties, 1,923, or 98.7%, were net leased

on our debt.

with a weighted average remaining lease term (excluding

The following is a summary of the components of our

rights to extend a lease at the option of the tenant) of

interest expense (dollars in thousands):

approximately 12.9 years at December 31, 2006. Of our

1,923 leased single-tenant properties, 1,713, or 89.1%, were

under leases that provide for increases in rents through:

• Primarily base rent increases tied to a consumer price

index;

• Fixed increases;

• To a lesser degree, overage rent based on a percentage

of the tenants’ gross sales; or

Interest on our credit

facility and notes
Interest included in
discontinued

operations from

real estate acquired

2006

2005

2004

$ 54,068

$ 40,968

$ 32,442

• A combination of two or more of the above rent

for resale by Crest

(3,708)

(1,139)

(674)

provisions.

Percentage rent, which is included in rental revenue, was

$1.1 million in 2006, $1.2 million in 2005 and $1.3 million

Amortization of

settlements on

treasury lock

agreements

717

in 2004. Percentage rent in 2006 was less than 1% of rental

Credit facility

revenue and we anticipate percentage rent to be less than

commitment fees

456

756

498

756

508

1% of rental revenue in 2007.

Our portfolio of retail real estate, leased primarily to

regional and national chains under net leases, continues

to perform well and provide dependable lease revenue

supporting the payment of monthly dividends to our stock-

holders. At December 31, 2006, our portfolio of 1,955 retail

properties was 98.7% leased with 26 properties available for

lease, one of which is a multi-tenant property.

Amortization of

credit facility

origination costs

and deferred bond

financing costs
Interest capitalized

2,014
(2,184)

1,752
(1,886)

1,631
(531)

Interest expense

$ 51,363

$ 40,949

$ 34,132

As of February 13, 2007, transactions to lease or sell four

of the 26 properties available for lease at December 31, 2006

Credit facilities and
notes outstanding

were underway or completed. We anticipate these transac-

Average outstanding

2006

2005

2004

tions will be completed during the next several months,

although we cannot guarantee that all of these properties

can be leased or sold within this period. It has been our
experience that approximately 1% to 3% of our property
portfolio will be unleased at any given time; however, we
cannot assure you that the number of properties available
for lease will not exceed these levels.

balances (dollars

in thousands)

Average interest rates

$ 881,669
6.13%

$ 647,301
6.33%

$ 498,220
6.51%

At February 13, 2007, the weighted average interest rate
on our notes payable of $920 million was 5.99% and the
average interest rate on our credit line was 5.97%. There was
no balance on our credit line at February 13, 2007.

R E A LTY I N C O M E

5 6

Interest Coverage Ratio

Our interest coverage ratio for 2006 was 4.1 times, for 2005 was 4.4 times and for 2004 was 5.0 times. Interest coverage ratio is calcu-

lated 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 calculation used by

other companies and, therefore, comparability may be limited. This information should not be considered as an alternative to any

GAAP liquidity measures.

The following is a reconciliation of net cash provided by operating activities to our interest coverage amount (dollars in thousands):

Net cash provided by operating activities

Interest expense

Interest expense included in discontinued operations (1)

Income taxes

Income taxes included in discontinued operations (1)

Investment in real estate acquired for resale(1)(2)

Proceeds from sales of real estate acquired for resale (1)
Collection of a mortgage note receivable by Crest(1)
Crest provisions for impairment losses(1)

Gain on sales of real estate acquired for resale(1)

Amortization of deferred stock compensation

Amortization of stock option costs

Changes in assets and liabilities:

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

Interest coverage amount

Divided by interest expense(3)

Interest coverage ratio

(1)Crest activities.

2006

$ 86,945

51,363

3,708

747

494

113,166

(22,405)

(1,333)
(1,188)

2,219

(2,928)

(23)

(4,418)
(3,208)

$ 223,139

$ 55,071

4.1

2005

$ 109,557

40,949

1,139

813

943

55,890

(22,195)
—

—

3,291

(2,155)

(12)

3,292
(8,290)

$ 183,222

$ 42,088

4.4

2004

$ 178,337

34,132

674

699

3,480

21,787

(74,995)
—

—

10,254

(1,426)

(14)

(1,094)
1,051

$ 172,885

$ 34,806

5.0

(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.”

Fixed Charge Coverage Ratio

Our fixed charge coverage ratio for 2006 was 3.4 times, for
2005 was 3.6 times and for 2004 was 3.9 times. Fixed charge
coverage ratio is calculated in exactly the same manner as
interest coverage ratio, except that preferred stock dividends
are also added 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 calculation of the fixed charge
coverage ratio may be different from the calculation used by
other companies and, therefore, comparability may be
limited. This information should not be considered as an
alternative to any GAAP liquidity measures.

Interest coverage amount divided by interest expense

plus preferred stock dividends (dollars in thousands):

2006

2005

2004

Interest coverage

amount

$ 223,139

$ 183,222

$ 172,885

Divided by interest

expense plus

preferred stock

dividends(1)(2)

$ 66,433

$ 51,491

$ 44,261

Fixed charge

coverage ratio

3.4

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.”

5 7

R E A LTY I N C O M E

Depreciation and Amortization

In addition, Crest incurred state and federal income taxes

Depreciation and amortization was $59.5 million in 2006

of $494,000 in 2006 as compared to $943,000 in 2005 and

versus $46.2 million in 2005 and $39.7 million in 2004. The

$3.5 million in 2004. The decrease in Crest’s 2006 income

increases in depreciation and amortization in 2006 and 2005

taxes over the 2005 and 2004 income taxes are due to lower

were due to the acquisition of properties in 2006, 2005 and

taxable income, primarily attributable to lower gain on sales

2004, which were partially offset by property sales during

of real estate acquired for re-sale. These amounts are

these years.

General and Administrative Expenses

included in “income from discontinued operations, from real

estate acquired for resale by Crest.”

General and administrative expenses increased by $2.1 million

Loss on Extinguishment of Debt

to $17.5 million in 2006 versus $15.4 million in 2005. General

In September 2006, we redeemed all of our outstanding

and administrative expenses were $13.1 million in 2004. In

$110 million, 7 3⁄4%, unsecured notes due May 2007. The 2007

2006, general and administrative expenses as a percentage

Notes were redeemed at a redemption price equal to 100%

of total revenue decreased to 7.3% as compared to 7.9% in

of the principal amount, plus accrued and unpaid interest of

2005 and 7.6% in 2004. General and administrative expenses

$3.2 million and a make-whole payment of $1.6 million. We

increased in total dollars primarily due to increases in payroll

recorded a loss on extinguishment of debt totaling

and employee benefit costs.

$1.6 million related to the make-whole payment associated

As our property portfolio has grown and continues to

with the 2007 Notes. For 2006, the make-whole payment

grow, we have increased, and anticipate that we will continue

represented approximately $0.017 per share.

to gradually increase, the level of our staffing. We expect

general and administrative expenses to moderately increase

Discontinued Operations

due to costs attributable to payroll, staffing costs and

Crest acquires properties with the intention of reselling them

corporate governance.

rather than holding them as investments and operating the

In February 2007, we had 70 permanent employees as

properties. Consequently, we classify properties acquired

compared to February 2006 when we had 69 permanent

by Crest as held for sale at the date of acquisition and do

employees and four temporary employees.

not depreciate them. The operation of Crest’s properties is

classified as “income from discontinued operations, real

Property Expenses

estate acquired for resale by Crest.”

Property expenses are broken down into costs associated

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

with non-net leased multi-tenant properties, unleased single-

discontinued operations, real estate acquired for resale” for

tenant properties and general portfolio expenses. Expenses

the years 2006, 2005 and 2004 (dollars in thousands, except

related to the multi-tenant and unleased single-tenant

per share data):

properties include, but are not limited to, property taxes,

maintenance, insurance, utilities, property inspections, bad

debt expense and legal fees. General portfolio costs include,

but are not limited to, insurance, legal, bad debt expense,

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

property inspections and title search fees. At December 31,

Gain on sales of

2006, 26 properties were available for lease, as compared to

real estate acquired

2006

2005

2004

25 at December 31, 2005 and 32 at December 31, 2004.

for resale

$ 2,219

$ 3,291

$ 10,254

Property expenses were $3.3 million in 2006, $3.7 million
in 2005 and $3.1 million in 2004. The $392,000 decrease in

property expenses in 2006 is primarily attributable to a
decrease in costs associated with bad debt expense, legal
fees, and property taxes.

Income Taxes
Income taxes were $747,000 in 2006 as compared to
$813,000 in 2005 and $699,000 in 2004. These amounts are
for city and state income taxes paid by Realty Income.

Rental revenue

Interest expense

General and

5,080

(3,708)

2,085

(1,139)

2,304

(674)

administrative expense

Property expenses

(440)

(67)

Provisions for impairment

(1,188)

(453)

(60)

—

(464)

(93)

—

Income taxes

(494)

(943)

(3,480)

Income from discontinued

operations, real estate

acquired for resale

by Crest

$ 1,402

$ 2,781

$ 7,847

Per common share,

basic and diluted

$ 0.02

$ 0.03

0.10

R E A LTY I N C O M E

5 8

Realty Income’s operations from one property listed as held

At December 31, 2006, Crest had $137.5 million invested

for sale at December 31, 2006, plus properties sold in 2006,

in 60 properties, which are held for sale. Crest generally

2005 and 2004 have been classified as discontinued operations.

carries a real estate inventory in excess of $20 million. Crest

The following is a summary of our discontinued operations

generates an earnings spread on the difference between the

from real estate held for investment for the years 2006, 2005

lease payments it receives on the properties held in inventory

and 2004 (dollars in thousands, except per share data):

and the cost of capital used to acquire properties. It is our

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

Gain on sales of

belief that at this level of inventory, rental revenue will

exceed the ongoing operating expenses of Crest without any

2006

2005

2004

property sales.

Gain on Sales of Investment Properties

investment properties $ 3,036

$ 6,573

$ 12,543

by Realty Income

2006

2005

2004

classified real estate with a carrying amount of $138 million

Rental revenue

Other revenue

Depreciation and

amortization

Property expenses
Provisions for impairment

Income from discontinued

operations, real estate

492

(116)

(116)
(16)

1,729

4,608

121

(458)

(222)
(35)

(1,162)

(545)
(1,657)

held for investment

$ 3,314

$ 7,589

$ 13,908

Per common share,

basic and diluted

$ 0.04

$ 0.09

0.18

The following is a summary of our total discontinued

operations for the years 2006, 2005 and 2004 (dollars in

thousands, except per share data):

Total income from
discontinued operations

Real estate acquired

for resale by Crest

$ 1,402

$ 2,781

$ 7,847

Real estate held
for investment

Income from discontinued

3,314

7,589

13,908

operations

$ 4,716

$ 10,370

$ 21,755

In 2006, we sold or exchanged 13 investment properties for

$10.7 million, which resulted in a gain of $3.0 million, which

is included in discontinued operations. In 2005, we sold

23 investment properties and sold a portion of the land

from two properties for $23.4 million and recognized a gain

on sales of $6.6 million, which is included in discontinued

operations, except for $18,000 that is included in other

revenue. In 2004, we sold or exchanged 43 investment

properties and sold a portion of the land from four properties

for a total of $35.4 million and recognized a gain of

$12.7 million, which is included in discontinued operations,

except for $185,000 that is included in other revenue.

We have an active portfolio management program that

incorporates the sale of assets when we believe the reinvest-

ment of the sale proceeds will generate higher returns,

enhance the credit quality of our real estate portfolio or extend

our average remaining lease term. At December 31, 2006, we

as held for sale on our balance sheet, which includes proper-

ties owned by Crest. Additionally, we anticipate selling

investment properties from our portfolio that have not

yet been specifically identified, from which we anticipate

receiving between $10 million and $35 million in proceeds

during the next 12 months. We intend to invest these

proceeds into new property acquisitions. However, we

cannot guarantee that we will sell properties during the next

Per common share,
basic and diluted

$ 0.05

0.13

0.28

12 months.

The above per share amounts have each been calculated

Provisions for Impairment on Real Estate

independently.

Gain on Sales of Real Estate Acquired
for Resale by Crest
In 2006, Crest sold 13 properties for $22.4 million, which
resulted in a gain of $2.2 million. In 2005, Crest sold 12
properties for $23.5 million, which resulted in a gain of
$3.3 million. In 2004, Crest sold 51 properties for $75 million,
which resulted in a gain of $10.3 million. Crest’s gains on
sales are reported before income taxes and are included in
“income from discontinued operations, real estate acquired
for resale by Crest.”

Acquired for Resale by Crest
Provisions for impairment of $1.2 million were recorded by
Crest on three properties in 2006. No provisions for impair-
ment were recorded by Crest in 2005 and 2004. Crest’s
properties are held for sale and the provisions for impair-
ment recorded in 2006 reduced the carrying costs to the
estimated fair-market value of those properties, net of
estimated selling costs.

5 9

R E A LTY I N C O M E

Provisions for Impairment on Realty Income

were paid in 1999 and recorded as a reduction to net income

Investment Properties

available to common stockholders when the shares were

In 2006, a provision for impairment of $16,000 was recorded

redeemed. These non-cash charges equated to $0.05 per

on one property. In 2005, we recorded provisions for impair-

common share in 2004.

ment totaling $186,000 on four properties. In 2004, we

recorded provisions for impairment totaling $2.4 million on

Net Income Available to Common Stockholders

six properties. These provisions are included in “income from

Net income available to common stockholders was

discontinued operations, real estate held for investment”

$99.4 million in 2006, an increase of $9.7 million as compared

except for $151,000 in 2005 and $716,000 in 2004 which are

to $89.7 million in 2005. Net income available to common

included in “provisions for impairment.”

stockholders in 2004 was $90.2 million.

The calculation to determine net income available to

Preferred Stock Cash Dividends and Redemption Charge

common stockholders includes gains from the sale of

Preferred stock cash dividends totaled $11.4 million in 2006

properties. The amount of gains varies from period to period

as compared to $9.4 million in 2005 and $9.5 million in 2004.

based on the timing of property sales and can significantly

When we redeemed our Class B preferred stock in June

impact net income available to common stockholders.

2004 and our Class C preferred stock in July 2004, we

During 2006, the gain recognized from the sales of invest-

incurred non-cash charges of $2.4 million and $1.4 million,

ment properties was $3.0 million as compared to $6.6 million

respectively, for the excess of redemption value over the

during 2005 and $12.7 million in 2004. Crest’s gain recognized

carrying value. These non-cash charges represent the Class

from the sale of properties during 2006 was $2.2 million as com-

B and Class C preferred stock original issuance costs that

pared to $3.3 million during 2005 and $10.3 million during 2004.

FUNDS FROM OPERATIONS AVAILABLE TO COMMON STOCKHOLDERS (FFO)
FFO for 2006 increased by $26.2 million, or 20.2%, to $155.8 million as compared to $129.6 million in 2005 and $118.2 million in 2004.

The following is a reconciliation of net income available to common stockholders (which we believe is the most comparable Generally

Accepted Accounting Principles (“GAAP”) measure) to FFO. Also presented is information regarding distributions paid to common

stockholders and the weighted average number of shares outstanding for the years ended December 31 (dollars in thousands,

except per share amounts):

Net income available to common stockholders

Depreciation and amortization:

Continuing operations

Discontinued operations

Depreciation of furniture, fixtures and equipment

Gain on sales of investment properties:

Continuing operations

Discontinued operations

2006

$ 99,419

2005

$ 89,716

59,492

116

(192)

—
(3,036)

46,206

458

(142)

(18)
(6,573)

FFO available to common stockholders

$ 155,799

$ 129,647

FFO per common share:

Basic

Diluted

Distributions paid to common stockholders
FFO in excess of distributions to common stockholders
Weighted average number of common shares:

Basic

Diluted

1.74
1.73

$
$
$ 129,667

$ 26,132

89,766,714

89,917,554

1.62
$
$
1.62
$ 108,575

$ 21,072

79,950,255

80,208,593

2004

$ 90,168

39,696

1,162

(117)

(185)
(12,543)

$ 118,181

1.51
$
$
1.50
$ 97,420

$ 20,761

78,518,296

78,598,788

We define FFO, a non-GAAP measure, consistent with the National Association of Real Estate Investment Trust’s definition,
as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on
sales of investment property and extraordinary items.

R E A LTY I N C O M E

6 0

We consider FFO to be an appropriate supplemental

Other Non-cash Items and Capitalized Expenditures

measure of a REIT’s operating performance as it is based on

The following information includes non-cash items and

a net income analysis of property portfolio performance that

capitalized expenditures on existing properties in our

excludes noncash items such as depreciation. The historical

portfolio. These items are not included in the adjustments to

accounting convention used for real estate assets requires

net income available to common stockholders to arrive at

straight-line depreciation of buildings and improvements,

FFO. Analysts and investors often request this supplemental

which implies that the value of real estate assets diminishes

information.

predictably over time. Since real estate values historically rise

and fall with market conditions, presentations of operating

results for a REIT, using historical accounting for depreciation,

could be less informative. The use of FFO is recommended

by the REIT industry as a supplemental performance measure.

In addition, FFO is used as a measure of our compliance with

the financial covenants of our credit facility.

Presentation of this information is intended to assist the

reader in comparing the operating performance of different

REITs, although it should be noted that not all REITs calculate

FFO the same way, so comparisons with other REITs may not

be meaningful. Furthermore, FFO is not necessarily indicative

of cash flow available to fund cash needs and should not be

considered as an alternative to net income as an indication of

Realty Income’s performance. In addition, FFO should not be

considered as an 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.

For the years ended
December 31
(dollars in thousands)

Provisions for

2006

2005

2004

impairment losses

$ 16

$ 186

$ 2,373

Gain on reinstatement of

property carrying value

(716)

Crest provisions for

impairment losses

1,188

Amortization of settlements

—

on treasury lock

agreements(1)

Amortization of deferred

note financing costs(2)
Amortization of deferred

stock compensation

717

756

1,287

1,034

—

756

913

and stock option costs

2,951

2,167

1,440

Capitalized leasing costs

and commissions

(761)

(570)

(323)

Capitalized building

improvements

Straight line rent(3)
Preferred stock origination

(203)
(1,515)

(1,017)
(1,360)

(789)
99

costs write-off(4)

—

3,774

(1)The settlements on the treasury lock agreements resulted from an
interest rate risk prevention strategy that was used by the Company
in 1997 and 1998, which correlated to pending issuances of senior
note securities. We have not employed this strategy since 1998.

(2)Amortization of deferred note financing costs includes the amorti-
zation of costs incurred and capitalized when our notes were issued
in May 1997, October 1998, January 1999, March 2003, November
2003, March 2005, September 2005 and September 2006. These
costs are being amortized over the lives of these notes. No costs
associated with our credit facility agreements 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.

IMPACT OF INFLATION
Tenant leases generally provide for limited increases in rent

as a result of increases in the tenants’ sales volumes,

increases in the consumer price index, and/or fixed increases.
We expect that inflation will cause these lease provisions to

result in rent increases over time. During times when inflation

is greater than increases in rent, as provided for in the leases,

rent increases may not keep up with the rate of inflation.

6 1

R E A LTY I N C O M E

Approximately 98.4%, or 1,923, of the 1,955 properties in

Interpretation 48 is effective for us at the beginning of 2007.

the portfolio are leased to tenants under net leases where

The impact of adopting Interpretation No. 48 is not expected

the tenant is responsible for property costs and expenses.

to have a material effect on our financial position or results

Net leases tend to reduce our exposure to rising property

of operations.

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.

IMPACT OF ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement No. 157, Fair

QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate changes primarily as a result

of our credit facility and long-term notes used to maintain liq-

uidity and expand our real estate investment portfolio and

Value Measurements. Statement No. 157 sets out a framework

operations. Our interest rate risk management objective is to

for measuring fair value, and requires additional disclosures

limit the impact of interest rate changes on earnings and cash

about fair-value measurements. Statement No. 157 becomes

flow and to lower our overall borrowing costs. To achieve

effective for us at the beginning of 2008. The impact of adopt-

these objectives we issue long-term notes, primarily at fixed

ing Statement No. 157 is not expected to have a material

rates, and may selectively enter into derivative financial

effect on our financial position or results of operations.

In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, an interpretation
of FASB Statement No. 109. Interpretation No. 48 applies

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, 2006.

to all tax positions accounted for under Statement No. 109,

We do not enter into any derivative transactions for specula-

including tax positions acquired in a business combination.

tive or trading purposes.

Our interest rate risk is monitored using a variety of techniques. The following table presents by year of expected maturity, the

principal amounts, average interest rates and fair values as of December 31, 2006. This information is presented to evaluate the

expected cash flows and sensitivity to interest rate changes (dollars in millions):

Expected Maturity Data as of December 31, 2006

Year of maturity

Fixed rate debt

Average
interest rate
on fixed rate debt

2007

2008(1)(2)

2009(3)
2010

2011

Thereafter(4)

Totals

Fair Value(5)

$ —

100.0

20.0

—

800.0

$ 920.0

$ 921.9

—

8.25%

8.00

—

5.66

5.99%

Average
interest rate on
variable rate debt

5.98%

—

5.98%

Variable
rate debt

$ —

—

$ —

(1)$100 million matures in November 2008.

(2)The credit facility expires in October 2008. The credit facility balance as of December 31, 2006 and February 13, 2007 was zero.

(3)$20 million matures in January 2009.

(4)$100 million matures in March 2013, $150 million matures in November 2015, $275 million matures in September 2016, $175 million matures in
September 2017 and $100 million matures in March 2035.

(5)We base the fair value of the fixed rate debt at December 31, 2006 on the closing market price or indicative price per each note.

The table incorporates only those exposures that exist as of December 31, 2006; 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. At December 31, 2006,

our credit facility balance was zero; however, we intend to borrow funds on our credit facility in the future. Based on a hypothetical
credit facility borrowing of $50 million, a 1% change in interest rates would change our interest costs by $500,000 per year.

R E A LTY I N C O M E

6 2

REALTY INCOME CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL DATA

(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,

2006

2005

2004

2003

2002

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

$ 2,546,508

$ 1,920,988

$ 1,442,315

$ 1,360,257

$ 1,080,230

10,573

920,000

970,516

1,575,992
86,945

(55,131)

240,100
106,065

4,716

110,781

(11,362)

—

99,419

129,667
2.9 times

65,704

891,700

931,774

989,214
109,557

63,563

196,020
88,749

10,370

99,119

(9,403)

—

89,716

108,575
3.2 times

2,141

503,600

528,580

913,735
178,337

(2,696)

173,062
81,642

21,755

103,397

(9,455)

(3,774)

90,168

97,420
3.9 times

4,837

506,400

532,491

827,766
73,957

(4,084)

142,656
70,947

15,488

86,435

(9,713)

—

76,722

83,842
4.1 times

8,921

339,700

357,775

722,455
124,807

6,454

127,337
63,800

14,867

78,667

(9,713)

—

68,954

78,042
4.3 times

and preferred stock cash dividends(1)

2.4 times

2.6 times

3.1 times

3.0 times

Basic net income per common share

Diluted net income per common share

Cash distributions paid per common share

Cash distributions declared per common share

Basic weighted average number of

1.11

1.43725

1.44750

1.12

1.34625

1.35250

1.15

1.24125

1.25125

1.08

1.18125

1.18375

1.02

1.01

1.15125

1.15375

common shares outstanding

89,766,714

79,950,255

78,518,296

71,128,282

67,867,498

Diluted weighted average number

of common shares outstanding

89,917,554

80,208,593

78,598,788

71,222,628

67,976,314

(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, including the amortization of debt issuance costs and interest classified to discontinued operations. Fixed charges are comprised of
interest costs (including capitalized interest), the amortization of debt issuance costs and interest classified to discontinued operations. 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 and Class E 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 73⁄8% Class D preferred stock in May 2004, 1,100,000
shares of our 73⁄8% Class D preferred stock in October 2004, and 8,800,000 shares of our 6.75% Class E preferred stock in December 2006.

6 3

R E A LTY I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
CONTROLS AND PROCEDURES

CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
We have had no disagreements with our independent

Management’s Report on Internal Control

Over Financial Reporting.

Internal control over financial reporting refers to the process

registered public accounting firm on accountancy or financial

Officer and Chief Financial Officer, and effected by our board

disclosure, nor have we changed accountants in the two most

of directors, management and other personnel, to provide

recent fiscal years.

CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. We

reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for

external purposes in accordance with generally accepted

accounting principles, and includes those policies and

maintain disclosure controls and procedures (as defined in

procedures that:

Securities Exchange Act 1934 Rules 13a-14(c) and 15d-14(c))
that are designed to ensure that information required to be

(1) Pertain to the maintenance of records that, in reasonable

disclosed in our Exchange Act reports is recorded,

detail, accurately and fairly reflect the transactions and

processed, summarized and reported within the time periods

dispositions of the assets of the Company;

specified in the Securities and Exchange Commission’s rules

and forms, and that such information is accumulated and

(2) Provide reasonable assurance that transactions are

communicated to our management, including our Chief

recorded as necessary to permit preparation of financial

Executive Officer and Chief Financial Officer, as appropriate,

statements in accordance with generally accepted accounting

to allow timely decisions regarding required disclosure.

principles, and that receipts and expenditures of the Company

In designing and evaluating the disclosure controls and

are being made only in accordance with authorizations of

procedures, management recognized that any controls

management and directors of the Company; and

and procedures, no matter how well designed and operated,

can provide only reasonable assurance of achieving the

(3) Provide reasonable assurance regarding prevention or

desired control objectives, and management necessarily was

timely detection of unauthorized acquisition, use or disposi-

required to apply its judgment in evaluating the cost-benefit

tion of the Company’s assets that could have a material effect

relationship of possible controls and procedures.

on the financial statements.

As of and for the year ended December 31, 2006, we

carried out an evaluation, under the supervision and with the

participation of management, including our Chief Executive

Management is responsible for establishing and main-
taining adequate internal control over financial reporting

Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and
procedures. Based on the foregoing, our Chief Executive

Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective and were operating
at a reasonable assurance level.

for the Company.

Management has used the framework set forth in the

report entitled “Internal Control—Integrated Framework”

published by the Committee of Sponsoring Organizations

(“COSO”) of the 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 reporting 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 20, 2007 by,
Thomas A Lewis, Chief Executive Officer

and Vice Chairman

Paul M. Meurer, Chief Financial Officer,

Executive Vice President and Treasurer

R E A LTY I N C O M E

6 4

Changes in Internal Controls. There have not been any

significant changes in our internal controls or in other factors

Certifications. Tom Lewis, Realty Income’s Chief Executive
Officer, certified to the NYSE in 2006, pursuant to Section

that could significantly affect these controls subsequent to

303A. 12(a) of the NYSE’s Listing Standards, that he was not

the date of their evaluation. There were no material weak-

aware of any violation of the NYSE corporate governance list-

nesses, and therefore no corrective actions were taken.

Limitations on the Effectiveness of Controls. Internal

ing standards by Realty Income. Furthermore, Realty Income
filed with the SEC, as exhibits to its Annual Report on Form 10-K
for the year ended December 31, 2006, the certifications by

control over financial reporting cannot provide absolute

Tom Lewis and Paul Meurer, Realty Income’s Chief Executive

assurance of achieving financial reporting objectives because

Officer and Chief Financial Officer, respectively, required under

of its inherent limitations. Internal control over financial

Section 302 of the Sarbanes-Oxley Act.

reporting is a process that involves human diligence and

compliance and is subject to lapses in judgment and break-

downs 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 possible to design into the process safeguards

to reduce, though not eliminate, this risk.

6 5

R E A LTY I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED QUARTERLY FINANCIAL DATA

(dollars in thousands, except per share data)

(not covered by Report of Independent Registered Public Accounting Firm)

2006(1)

Total revenue

Interest expense

Depreciation and amortization expense

Other expenses

Income from continuing operations

Income (loss) from discontinued operations

Net income

Net income available to common stockholders

Net income per common share:

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

Year(2)

$ 55,156

$ 56,509

$ 59,297

$ 69,139

$ 240,100

13,198

13,512

5,336

23,110

1,778

24,888

22,537

11,930

14,791

5,270

24,518

2,122

26,640

24,289

12,530

14,632

6,521

25,614

944

26,558

24,207

13,706

16,557

6,052

32,824

(128)

32,696

28,386

51,363

59,492

23,180

106,065

4,716

110,781

99,419

Basic

Diluted

Dividends paid per common share

0.27

0.27
0.348750

0.28

0.27
0.350625

0.27

0.27
0.360250

0.29

0.29
0.377625

1.11

1.11
1.437250

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

Dividends paid per common share

$ 46,431

$ 47,219

$ 48,877

$ 53,492

$ 196,020

9,058

10,709

5,120

21,544

1,959

23,503

21,152

9,793

11,146

4,917

21,363

3,303

24,666

22,315

10,228

11,218

5,370

22,061

1,061

23,122

20,771

11,869

13,133

4,709

23,781

4,047

27,828

25,477

40,949

46,206

20,116

88,749

10,370

99,119

89,716

0.27
0.330000

0.28
0.331875

0.26
0.337500

0.31
0.346875

1.12
1.346250

(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 LTY I N C O M E

6 6

MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
A. 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.

2006

First quarter

Second quarter

Third quarter

Fourth quarter

Total

2005

First quarter

Second quarter

Third quarter

Fourth quarter

Total

Price Per Share of Common Stock

High

$ 24.93

24.06

25.10

28.43

$ 25.61

25.69

25.65

23.97

Low

$ 21.57

21.25

21.65

24.40

$ 22.00

22.50

22.00

21.08

Distributions
Declared(1)

$ 0.349375

0.351250

0.368625

0.378250

$ 1.447500

$ 0.330625

0.332500

0.341875

0.347500

$ 1.352500

(1)Common stock cash distributions currently are declared monthly by us based on financial results for the prior months. At December 31, 2006,
a distribution of $0.1265 per common share had been declared and was paid in January 2007.

There were 9,737 registered holders of record of our common stock as of January 31, 2007. We estimate that our total number

of shareholders is approximately 78,000 when we include both registered and beneficial holders of our common stock.

TOTAL RETURN PERFORMANCE

s
l

e
u
a
V
x
e
d
n
I

300

250

200

150

100

l
s

Realty Income Corporation

Russell 2000

Realty Income Peer Group*

SNL Triple Net REITS Index

12/31/01

12/31/02

12/31/03

12/31/04

12/31/05

12/31/06

Period Ending

Index

12/31/01

12/31/02

12/31/03

12/31/04

12/31/05

12/31/06

Realty Income Corporation

Russell 2000

Realty Income Peer Group*
SNL Triple Net REITS Index

100.00

100.00
100.00

127.47

79.52

99.70
109.49

155.01

117.09

138.63
155.72

207.56

138.55

179.85
195.60

187.93

144.86

195.10
203.64

255.60

171.47

250.33
270.09

*Realty Income Peer Group consists of 33 companies (excluding Realty Income) with an implied market capitalization between $1.5 billion to
$3.0 billion as of September 30, 2006.

6 7

R E A LTY I N C O M E

REALTY INCOME CORPORATION AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS

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,

and “Management’s Discussion and Analysis of Financial

the words “estimated”, “anticipated”, “expect”, “believe”,

Condition and Results of Operations” in this annual report.

“intend” and similar expressions are intended to identify

Readers are cautioned not to place undue reliance on

forward-looking statements. Forward-looking statements are

forward-looking statements, which speak only as of the date

subject to risks, uncertainties, and assumptions about Realty
Income Corporation, including, among other things:

that this annual report was filed with the Securities and
Exchange Commission, or SEC. We undertake no obligation

• Our anticipated growth strategies;

to publicly release the results of any revisions to these

• Our intention to acquire additional properties and the

forward-looking statements that may be made to reflect

timing of these acquisitions;

• Our intention to sell properties and the timing of

these property sales;

events or circumstances after the date of this annual report

or to reflect the occurrence of unanticipated events. In light
of these risks and uncertainties, the forward-looking events

• Our intention to re-lease vacant properties;

discussed in this annual report might not occur.

• 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.

(“Crest”).

Future events and actual results, financial and otherwise,

may differ materially from the results discussed in the forward-

looking 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

environmental matters, illiquidity of real estate invest-

ments 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 proceedings to which we are

a party; and

• Acts of terrorism and war.

R E A LTY I N C O M E

6 8