why do we exist? why are we here? what the heck is going on these days? 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 A LT Y I N C O M E 2 0 0 8 A N N U A L R E P O R T N Y S E ” O ” w h y d o w e e x i s t ? monthly dividends ..... monthly dividends ..... monthly dividends monthly dividends ..... monthly dividends ..... monthly dividends monthly dividends ..... monthly dividends ..... monthly dividends w h y a r e w e h e r e ? monthly dividends ..... monthly dividends ..... monthly dividends monthly dividends ..... monthly dividends ..... monthly dividends w h a t t h e h e c k i s g o i n g o n t h e s e d a y s ? monthly dividends ..... monthly dividends ..... monthly dividends These are strange times in the economic world. Just about everybody has been surprised by the scope and magnitude of the credit crisis and confidence in the financial markets has been severely weakened. However, we just wanted you to know . . . We are OK. We’re doing OK because: • We are liquid—$46.8 million in cash on hand and $355 million available on our credit facility • We have no debt maturing until 2013 • We have no mortgages on any of our properties • Our portfolio of 2,348 properties, under long-term leases, provides solid cash flow to support dividend payments • We have a commitment that compels us to continue to work hard for the benefit of our shareholders What is that Commitment? We are The Monthly Dividend Company® Monthly dividends are . . . Our Mission. Our Passion. Our Reason to Be. Why? Monthly dividends give our shareholders the freedom to Reinvent Themselves. Engage Others. Pursue their Dreams. O L D B U S I N E S S P L A N > Pay 12 Monthly Dividends > Raise the Dividend > Maintain a Conservative Balance Sheet > Maintain High Portfolio Occupancy > Acquire Additional Properties > Tell More People About The Monthly Dividend Company® > Remain Conservative N E W R E C E S S I O N A N D C R E D I T C R I S I S P L A N Pay 12 Monthly Dividends < Raise the Dividend < Maintain a Conservative Balance Sheet < Maintain High Portfolio Occupancy < Acquire Additional Properties < Tell More People About The Monthly Dividend Company® < Remain Conservative < H i s t o r i c a l F i n a n c i a l P e r f o r m a n c e For the Years Ended December 31, 2008 2007 2006 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 $ 331,701,000 $ 297,396,000 $ 240,626,000 $ 107,588,000 $ 185,524,000 $ 116,156,000 $ 189,675,000 $ 99,419,000 $ 155,799,000 $ 169,655,000 $ 157,659,000 $ 129,667,000 accumulated depreciation (3) $ 3,408,910,000 $ 3,238,794,000 $ 2,743,973,000 Number of properties Gross leasable square feet Properties acquired (4) 2,348 19,106,700 108 2,270 18,504,800 357 1,955 16,740,100 378 Cost of properties acquired (4) $ 189,627,000 $ 533,726,000 $ 769,900,000 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 stockholders (9) (10) 29 30 49 97.0% 11.9 1.06 1.83 1.662 1.701 104,211,541 23.15 6.1% –8.2% $ $ $ $ $ 10 30 49 97.9% 13.0 1.16 1.89 1.560 1.641 101,082,717 27.02 5.6% 3.2% $ $ $ $ $ 13 29 48 98.7% 12.9 1.11 1.73 1.437 1.518 100,746,226 27.70 6.7% 34.8% $ $ $ $ $ (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. 2005 2004 2003 2002 $ 197,751,000 $ 177,606,000 $ 150,370,000 $ 137,600,000 $ $ $ 89,716,000 129,647,000 $ 90,168,000 $ 118,181,000 108,575,000 $ 97,420,000 $ $ $ 76,722,000 103,366,000 83,842,000 $ $ $ 68,954,000 93,539,000 78,042,000 $ 2,096,156,000 $ 1,691,283,000 $ 1,533,182,000 $ 1,285,900,000 1,646 13,448,600 156 1,533 11,986,100 194 1,404 11,350,800 302 1,197 9,997,700 111 $ 486,553,000 $ 215,314,000 $ 371,642,000 $ 139,433,000 23 29 48 98.5% 12.4 1.12 1.62 1.346 1.395 83,696,647 21.62 5.3% –9.2% $ $ $ $ $ 43 30 48 97.9% 12.0 1.15 1.50 1.241 1.32 79,301,630 25.29 6.2% 32.7% $ $ $ $ $ 35 28 48 98.1% 11.8 1.08 1.45 1.181 1.20 75,818,172 20.00 6.7% 21.0% $ $ $ $ $ 35 26 48 97.7% 10.9 1.01 1.38 1.151 1.17 69,749,654 17.50 7.8% 26.9% $ $ $ $ $ (6) Annualized dividend amount reflects the December declared dividend rate per share multiplied by twelve. (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. 2001 2000 1999 121,081,000 $ 116,310,000 $ 104,510,000 57,846,000 76,378,000 64,871,000 $ $ $ 45,076,000 67,239,000 58,262,000 $ $ $ 41,012,000 65,917,000 55,925,000 $ $ $ $ 1998 85,132,000 41,304,000 62,799,000 52,301,000 $ $ $ $ $ 1,178,162,000 $ 1,073,527,000 $ 1,017,252,000 $ 889,835,000 1,124 9,663,000 117 1,068 9,013,200 22 1,076 8,648,000 110 970 7,824,100 149 $ 156,472,000 $ 98,559,000 $ 181,376,000 $ 193,436,000 35 25 48 98.2% 10.4 0.99 1.30 1.121 1.14 21 24 46 97.7% 9.8 0.84 1.26 1.091 1.11 3 24 45 98.4% 10.7 0.76 1.23 1.043 1.08 $ $ $ $ $ $ $ $ 5 22 45 99.5% 10.2 0.78 1 . 1 8 0.983 1.02 $ $ $ $ 65,658,222 53,127,038 53,644,328 53,634,206 14.70 9.0% 27.2% $ 12.4375 $ 10.3125 $ 12.4375 10.6% 31.2% 8.4% –8.7% 7.7% 5.5% $ $ $ $ $ (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 opening 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. 1 1997 1996 1995 1994 $ 67,897,000 $ 56,957,000 $ 51,555,000 $ 48,863,000 $ 34,770,000 $ 52,188,000 $ 32,223,000 $ 47,139,000 $ 25,600,000 $ 40,414,000 $ 15,224,000 $ 39,050,000 $ 44,367,000 $ 42,794,000 $ 5,285,000 $ 36,710,000 $ 38,816,000 $ 5,850,000 $ 699,797,000 $ 564,540,000 $ 515,426,000 $ 450,703,000 826 6,302,300 96 740 5,226,700 62 685 4,673,700 58 630 4,064,800 4 $ 142,287,000 $ 55,517,000 $ 65,393,000 $ 3,273,000 10 14 43 99.2% 9.8 0.74 1 . 1 1 0.946 0.96 7 8 42 99.1% 9.5 0.70 1.04 0.931 0.23 0.95 $ $ $ $ $ 51,396,928 45,959,074 12.719 7.9% 14.5% $ 11.9375 8.3% 15.4% $ $ $ $ $ 3 7 42 99.3% 9.2 0.63 1.00 0.913 0.93 45,952,474 11.25 10.7% 42.0% $ $ $ $ $ 5 5 41 99.4% 9.5 0.39 0.98 0.300 0.90 39,004,182 8.5625 9.9% 28.5% $ $ $ $ $ C E O L e t t e r t o S h a r e h o l d e r s Dear fellow shareholders, I am very pleased to report . . . On second thought, let’s just say I’m kind of pleased to report . . . Well, to be frank, I’m actually more relieved than anything else, to report our results for 2008. In an extraordinarily challenging economic environment, we are doing OK. Our numbers aren’t quite as good as last year, which was our best year ever (though they’re pretty close), but relative to what is being reported by the majority of other public companies, we are just fine. H I G H L I G H T S O F 2 0 0 8 ( A S C O M PA R E D T O 2 0 0 7 ) • Revenue rose 12.2% to $330.2 million shareholders who purchased shares ten years ago (12/31/98), now enjoy a current yield on the original cost of their shares of 13.7% and have • Funds from operations (FFO) decreased 2.2% received back 103.2% of their original dollars invested to $185.5 million because of consistent and increasing dividend payments • Core FFO increased 2.9% to $184.2 million (See “The Magic of Rising Dividends Over Time” table • Common stock dividends paid increased 7.6% on the next page). to $169.7 million During 2008, the price of Realty Income’s shares • Portfolio occupancy was 97.0% at year-end decreased $3.87, or 14.3%, from $27.02 to $23.15. • Maintained a large and diverse portfolio of 2,348 When you add to that the $1.662 in dividends we paid properties located in 49 states occupied by 119 last year, that works out to a total return to share- different retailers in 30 different retail industries holders of –8.2%. While this is disappointing, I think it • Same store rents increased 1.1% is useful to look at our “relative performance” versus • 108 new properties were acquired for $189.6 million other real estate companies and the overall stock • Zero balance on our $355 million credit facility market. The total return, including dividends, on the Dow Jones Industrial average for 2008 was –31.9%, for Total Returns (for the year ended December 31, 2008) and $46.8 million in cash on hand • No mortgages on any of our properties • No debt maturities due until 2013 I N V E S T O R R E T U R N S During 2008, we paid 12 monthly dividends on our common stock and increased the amount of the divi- Dow Jones Industrial Average dend five times. Dividends paid per share increased Standard & Poor’s 500 Average 6.5% and shareholders who owned our stock for the NASDAQ Composite entire year received $1.662 per share in dividends during 2008, compared to $1.560 per share in 2007. Investors who have owned Realty Income for many years also benefited from the regular payment of dividends and dividend increases. For example, Equity REIT Index Realty Income 12 –31.9% –37.0% –40.5% –37.7% –8.2% the Standard & Poor’s 500 index it was –37.0%, for the NASDAQ it was -40.5% and for the Equity REIT Index (other real estate companies) it was –37.7%. I think it W H AT W E N E E D T O TA L K A B O U T T H I S Y E A R Now that I’ve gone over the highlights of 2008 and is safe to say that we held up much better than most provided some perspective on our investment results other public companies during 2008. However, I would for the year, let’s turn to what, I believe, is of chief also note that, while I actually know how to put stock concern to our shareholders. That is, how the current gains and cash dividends in my pocket, I still haven’t credit crisis, rapidly decelerating economy, and the figured out how to pay my bills with “relative performance.” dramatic changes in the financial markets have impacted As such, we prefer the stock price to go up along with us this year and how these factors might affect us going the increases we have had in our dividends. forward. The Magic of Rising Dividends Over Time (through December 31, 2008) Yield on Cost The Cumulative Dividend Effect 1,000 Shares Purchase Date Original Investment Original Dividends(1) Original Yield Current Yield on Cost (2) Dividends Received to Date % of Original Investment Paid Back 900.00 11.3% 900.00 10.5% 10/18/94 $ 8,000.00 12/31/94 $ 8,562.50 12/31/95 $ 11,250.00 12/31/96 $ 11,937.50 12/31/97 $ 12,719.00 $ $ $ $ $ 930.00 945.00 960.00 12/31/98 $ 12,437.50 $ 1,020.00 8.3% 7.9% 7.5% 8.2% 12/31/99 $ 10,312.50 $ 1,080.00 10.5% 12/31/00 $ 12,437.50 $ 1,110.00 12/31/01 $ 14,700.00 $ 1,140.00 12/31/02 $ 17,500.00 $ 1,170.00 12/31/03 $ 20,000.00 $ 1,200.00 12/31/04 $ 25,290.00 $ 1,320.00 12/31/05 $ 21,620.00 $ 1,395.00 12/31/06 $ 27,700.00 $ 1,518.00 12/31/07 $ 27,020.00 $ 1,641.00 12/31/08 $ 23,150.00 $ 1,701.00 8.9% 7.8% 6.7% 6.0% 5.2% 6.5% 5.5% 6.1% 7.3% (1) Based on annualized dividend amount on purchase date (2) Based on annualized dividend amount of $1.701 per share on 12/31/08 21.3% 19.9% 15.1% 14.2% 13.4% 13.7% 16.5% 13.7% 11.6% 9.7% 8.5% 6.7% 7.9% 6.1% 6.3% 7.3% $ 17,022.25 $ 16,722.25 $ 15,809.75 $ 14,763.50 $ 13,817.25 $ 12,834.75 $ 11,792.25 $ 10,701.00 $ 9,579.75 $ 8,428.50 $ 7,247.25 $ 6,006.00 $ 4,659.75 $ 3,222.50 $ 1,662.25 212.8% 195.3% 140.5% 123.7% 108.6% 103.2% 114.3% 86.0% 65.2% 48.2% 36.2% 23.7% 21.6% 11.6% 6.2% 13 Here’s what we will cover: today. Let’s take a moment to review what we were 1. We will examine the current credit crisis, the thinking and what we did about the economic economy, and its impact on your Company, environment we thought might be coming. 2. We will review our operations during 2008, Since our business is to provide capital to other 3. We will give our view of what we believe the future businesses by buying their real estate and leasing it back holds for your Company and, to them, we are, in essence, a provider of credit. That 4. Most importantly, we will renew our commitment means our competition is often other sources of capital, to the ideals of The Monthly Dividend Company® such as the debt markets, and we try to maintain an and assure you, once again, that we are passionate awareness of what is going on in those markets. From about providing monthly dividends for all of us as 2003 to 2006, we noticed that less creditworthy shareholders. borrowers were being charged rates of interest very close to the interest rates being charged to the best borrowers, 1 . T h e C r e d i t C r i s i s a n d R e a l t y I n c o m e which was unusual. This encouraged the more risky In last year’s Annual Report, we said, “We believe borrowers to add a significant amount of debt to their that many companies (us included) have had a fairly operations. We observed this not only in the retail industry, easy operating environment in recent years. Interest but also throughout the overall economy. There seemed rates have been historically low, which has allowed to be too much leverage (borrowed dollars) in almost all businesses, consumers and investors to finance their areas of the economy. Additionally, living in San Diego, purchasesofassetswithhigherlevelsofdebt.Thishas we had a front row seat to view the incredible increases led to increased values in the stock market, bond in the prices of residential real estate. We observed that market, residential real estate, commercial real estate a lot of the real estate being bought and sold in our and almost all other asset classes. At the same time, community was being financed by “nothing down,” wehaveseenhistoricallylowdefaultratesonmortgages, “interest-only,” “sub-prime,” “limited documentation,” bonds,consumerloans,andvirtuallyallothertypesof and “negative amortization” mortgages. As a result, we credit. It has been our experience that all ‘good runs’ came to believe that a housing market bubble was eventuallyend,assetvaluesgetabitoverdoneand,at building very quickly. However, we also knew, from somepoint,thingsslowdown.Wewouldn’tbesurprised experience, that excesses in any market can last a long if2008isayearthat,atbest,weallmovetowardsamore time and our ability to time the end of the cycle is limited. normaloperatingenvironment,and,atworst,wefacemore In late 2006, we also came to believe we might be challengingconditionsthroughoutthe economy.Webelieve at the beginning of the end of the rapid rise in the wearepreparedforsuchanenvironmentandshouldbeable housing market. “Grant’s Interest Rate Advisor,” a great tomakeprogressinouroperationsin2008.” publication to which I subscribe, noted that the cost That’s an understatement! As a conservative for an institution to insure against a default in a Company, we were becoming very concerned with what $100 million residential mortgage bond was only about we were observing in the financial markets and where 40 basis points (4/10 of 1%), or $400,000. In a matter we thought the economy might be headed. Thinking of a few weeks, the pricing for the insurance went to over that there might be substantial excesses in the overall 300+ basis points ($3 million), and by February it went market, we made a number of moves, over the past to over 1,000 basis points ($10 million), which meant couple of years, that are serving us extremely well that one or more institutions in the market thought they 14 needed insurance on their residential mortgage bonds By August 2007, the bond market had, for the most and were willing to pay up for that insurance. “Grant’s” part, effectively closed. We thought we might be at the very accurately interpreted these, and other events, as the beginning of a very restrictive securities market, and end of the housing bubble, and I thought their analysis so we decided (with our Board’s strong support) to try to made sense. This also caused us to speculate that, if the access the bond market and raise capital. residential mortgage bond market collapsed, the Over the last 10 years or so, whenever we issued commercial mortgage bond market might not be far bonds to raise capital, the demand for our bonds usually behind, and then the REIT bond market might soon exceeded the amount we wanted to sell. We could have follow. Eventually, the overall debt market could be used this position to shave a little interest off of our negatively impacted and so it occurred to us that capital borrowing costs, or reduced the covenant protections might become more difficult to obtain in the future. for our bond buyers and sold to a few more marginal Based on these events, in early 2007, we began to buyers, which would have lessened the protection for plan what we should be doing to protect the Company. all of our bond buyers. Instead, we sought the best At the time, we felt a potential risk could exist for us quality holders of our bonds, kept the terms of the with Crest Net Lease, Inc. (Crest), our subsidiary that bonds very attractive and allocated the majority of the buys and sells properties to other investors. Most Crest available bonds to these good buyers. Most of the buyers are investors who have sold properties for a gain buyers were large insurance companies that tended to and want to reinvest the proceeds in tax deferred buy bonds all the time and hold them to maturity. We exchanges. We thought that if financing became difficult thought that if we took care of them during the good for Crest buyers, lease rates might rise, prices might times, they might be more likely to buy our bonds and decline and, with a lot of properties held for sale, we give us fresh capital during tougher markets. might have a large inventory of properties that would be Thus, when we went to the market with our bonds in difficult to sell. Unlike the properties we hold for long August 2007, (during a very difficult market) we were term investment, if the value of the properties we hold trying to see if we could raise $100 million. We went to for sale were to decline, the accounting rules would these same insurance companies and were very gratified force us to write down the values against our earnings. to learn that they did, indeed, remember we had taken That is a long-winded way to say we could have care of them. We launched our bond offering in the taken some hefty losses on what is really only a small part morning and, by midday, had almost $1 billion in demand of our business, if the market slowed substantially. We had for the bonds. Ultimately, we were able to increase the about $120 million in inventory in Crest at that time, and transaction size to raise $550 million of 12-year, senior so we decided that we would stop buying any additional unsecured notes at a 6.75% interest rate. This very properties in Crest, sell the properties we had, and close attractively priced capital has served us well during the down Crest’s operations. As a result, over the last two years, last 18 months of this credit crisis, and we have been we have taken inventory from $120 million down to about able to put all of it to work. Today, it would be quite difficult $6 million, effectively exiting that small part of our to do the same transaction and, if you could, the interest business, for now. This cost us $0.10 per share in funds from rate would likely be over 12.0%, or an additional operations during 2008, but we believe this was the right $29 million per year in interest. (Think of what that would action to take. Had we not undertaken these changes, we mean to your bottom line if you were an investment grade would feel a lot worse about the state of our business today. company looking to refinance debt today.) 15 By February of 2008, we felt that, after a brief confidence in our business and continued support. opening of the debt market in the fall, albeit at higher Today, the bank credit facility market, for many prices, the debt market was really starting to fall apart. companies, is very limited, or closed, and so we are quite As such, we felt much stronger about the fact that the relieved to have our new facility in place. Additionally, property market would cool, which would result in for the time being, we have also decided to maintain a property prices dropping. That led us to temporarily zero balance on the credit facility so that we have shut down our efforts to acquire properties for long- maximum liquidity in this market (all $355 million if term investment because we felt that potential property we need it). purchases would be cheaper later. We continue to view Last September, we saw an opportunity to issue potential acquisitions in this way, and I believe this has common stock to build cash, which was used to pay served us well. In addition, the selling off of Crest’s off the $100 million of notes we had coming due in inventory and ceasing all new property acquisitions in November and the $20 million of notes due in January Crest has also contributed to our current, fortunate 2009. We quickly raised the capital by issuing common position of being awash in liquidity in a market where stock priced at $26.82 per share. Our success with this liquidity is highly valued. offering, and the subsequent repayment of debt, leaves Another decision we made was to sell some assets us with no debt maturities whatsoever until 2013. This out of our core portfolio to both increase our level is likely one of our most favorable attributes in this of liquidity, and to reduce our restaurant exposure. In environment. Again, we would like to thank Raymond 2008, we sold 29 properties for $27.8 million at James & Associates, UBS Securities LLC, Robert W. attractive lease rates, with the majority of the property Baird & Co. Incorporated, Credit Suisse Securities sales occurring earlier in the year. Towards the end of (USA) LLC, J.P. Morgan Securities Inc., RBC Capital 2008, and into 2009, it has becoming increasingly Markets Corporation, Stifel Nicolaus & Company difficult to sell properties at attractive lease rates, so Incorporated, Janney Montgomery Scott LLC and our timing turned out to be fortunate. Morgan Keegan & Company, Inc. for helping us to raise In March of last year, we also began to see limitations this capital in a very difficult market. in the market for bank credit facilities. In light of this, we Finally, over the last few years, with the real estate decided to restructure our credit facility early. Some banks, and securities markets becoming increasingly at the time, suggested that the interest we would have to overheated, we have sought to acquire the more prof- pay would be higher than during the last few years and, itable stores of our retailers, since this is our primary if we just extended the existing agreement for a year, the protection and “margin of safety” in our real estate pricing might be better in 2009. Feeling the economy investments, should the retailers in our portfolio see and credit markets were further eroding, we elected to their sales decline. That margin of safety is turning push ahead and we were able to obtain a new, three- out to be absolutely invaluable, as almost all retailers year credit facility (plus two, one-year extension today are suffering from a marked decline in consumer options) with borrowing capacity of up to $355 million spending. (plus a $100 million expansion feature). We are grateful To say the least, all of these activities have to our banks (Wells Fargo Bank, Bank of America, significantly enhanced Realty Income’s position in this Regions Bank, The Bank of New York, Wachovia Bank, very difficult economy and credit crisis. Quite frankly, Raymond James Bank, and Chevy Chase Bank) for their I don’t know how I would sleep at night had we not 16 recognized what was going on and actually taken the environment, though, no public company seems to be steps we have taken to mitigate a good part of the immune to the economic turbulence. Let’s take a look impact on Realty Income. I am reminded of the Noah at how we fared during the year. rule: “It is not enough to know it’s going to rain, you actually have to build the ark!” 2 . O p e r a t i n g a n d F i n a n c i a l With that said, seeing now the severity of the P e r f o r m a n c e R e s u l t s f o r 2 0 0 8 economic downturn, I wish we could have done even REAL ESTATE PORTFOLIO PERFORMANCE AND OUTLOOK more to prepare the Company for this extraordinarily Our portfolio of net-leased retail properties continues difficult economy and market. I do believe we did to provide the lease revenue from which we pay enough so that today we are well positioned financially, monthly dividends. As of December 31, 2008, portfolio and we are certainly in a better position than many other occupancy was 97.0% (yes, that surprises me too) with companies. To summarize our strengths in this very just 70 properties available for lease or sale. The difficult economy: weighted average remaining lease term for properties Balance Sheet: Our balance sheet is very strong in our portfolio was approximately 11.9 years. In and we are rated by industry analysts as one of the top addition, our portfolio continues to be well diversified 10 real estate companies for balance sheet health. We by individual retail chain, retail industry and by have no mortgage debt on any of our 2,348 properties geographic region. At the end of December 2008, we and have no near-term debt maturities or requirement owned 2,348 properties located in 49 states leased to access the credit markets for several years. to 119 different retail chains doing business in 30 Liquidity: We also have cash on hand, which is separate retail industries. where you want to be in this environment, and we have Same store rents on 1,772 properties under lease, a zero balance on our $355 million credit facility, for 2008, increased 1.1% to $258.7 million from which further contributes to our liquidity. This provides $255.9 million in 2007. To break down the same store us with a great deal of flexibility and the potential fire rent increases during 2008, we had 23 industries with power we would need should compelling investment increases in rents, two with flat same store rents, and opportunities arise. five with declining same store rents. The increase Occupancy: Our occupancy was 97%, at the end in same store rents in 2008 was a bit smaller than in of the year, and the vast majority of the retailers in 2007. That is not surprising given the state of the our portfolio continue to pay us full rents and provide economy and the retail environment, and I think you us with dependable lease revenue. It’s important to should expect more moderate increases again in 2009. note that these properties generate a great deal of cash We also selectively sold 29 properties for ($330 million) from which to pay dividends. $27.8 million during 2008. These are properties that Dividends: We’ve paid 461 consecutive monthly had been targeted for sale based on specific asset dividends, as of the end of the year and, during 2008, sale criteria. In general, Realty Income’s business we increased the dividend five times and paid share- model is to hold properties for the long-term cash that holders $1.662 in dividends per share. is generated to pay dividends. However, we like to In short, we are in pretty decent shape at the end sell properties out of the portfolio when we believe: of the year and are faring better than most other 1. Reinvesting sale proceeds will generate higher companies in our industry. In today’s operating returns, 2. Asset sales will enhance the credit quality of 17 our real estate portfolio, 3. Asset sales will extend our their more profitable properties, is the key to keeping average remaining lease term, or 4. Specific tenant or the buildings leased whenever the consumer reduces industry concentration levels will be reduced. spending, or the retailer hits a tough patch. We work With respect to lease expirations during 2008, very hard on the initial underwritings on our properties the portfolio management group handled 168 lease and it is in times like these where the margin of safety expirations, of which 127 of the leases were the result we build into our underwriting process gets tested. of normal lease expiration and the remaining 41 Having the right properties really pays off. It is also were the result of properties that had to be re-leased pretty evident, by the way, when we miss something as a result of tenant financial difficulties. Needless to because we end up with vacant buildings. We inevitably say, this was a much tougher year to lease vacant make some mistakes and a market like this one space. I think our portfolio management group did does a good job of pointing these mistakes out to us. a great job, that resulted in 97% occupancy at the I suspect there may be a fair amount of “pointing out” end of the year, and my thanks go out to Dawn to us in 2009. Nguyen, Elizabeth Cate, Kristin Ferrell, Janeen As part of the due diligence process, and our Bedard, and the rest of the staff, for the hustle they ability to generate a margin of safety, before we pur- showed in 2008. Wisely, their boss, Richard Collins, chase any property, we send our real estate research mostly just tells them how great they are and tries to people to analyze every location. This provides us with stay out of their way. Good job, Richard! a first-hand analysis of operations and a feel for the I think this solid portfolio performance is particularly likelihood of long-term profitability in a particular trade noteworthy given the stress in the consumer retail area. Each site and its surrounding area is video-taped market during the year. The downward spiral of so that our Investment Committee can see the consumer spending continues into 2009 and our property while they listen to the analyst’s presentation portfolio management team is working overtime to on the area demographics, economics, property proactively manage lease expirations and selectively values, traffic flow and a host of other information. All prune out weaker performers from the portfolio. As we of this data is carefully considered prior to moving begin 2009, we continue to monitor the operations of forward with any real estate transaction. our retailers, looking for the areas of weakness that may The depth of our research and the strength of our need to be addressed so that our real estate portfolio underwriting processes do not mean, however, that performs as well as possible. It is a tough market out we’ve found a recession-proof methodology for acquiring there. I hope we get a little lucky again this year, in this properties. Trust me on this one, folks! But it does part of the business. mean that we make every attempt to underwrite our Keeping the vast majority of the buildings leased, properties sensibly so as to moderate the degree to year after year, is the key to generating dependable which our lease revenue is impacted during difficult lease revenue. I believe our ability to maintain financial times. consistently high occupancy has largely been the result A key metric we use when determining whether or of rigorous due diligence and careful initial under- not a property makes economic sense is a property’s writing. Since we rely on the retailers, with whom we do cash flow coverage ratio. The equation for this is: business, to make lease payments for 15 to 20 years, cash flow of the store we buy ÷ rent. This metric helps we know that finding the right tenants, and owning us determine our “margin of safety,” or how bad things 18 have to get before the operations of a particular retail PORTFOLIO ACQUISITIONS AND OUTLOOK location won’t be able to support rent payments. We During 2008, we acquired 108 properties for have seen a few of our retail tenants come under $190 million, with an initial weighted average lease financial pressure this past year, but, fortunately, the yield of 8.7%. The 108 new properties are located majority of the properties we owned were some of their in 14 states and are 100% leased under net-lease most profitable locations, so our lease revenue has agreements with an initial average lease length of not been impacted as much as it might have been. 20.6 years. They are leased to eight different retail We also believe that the diversification of our retail chains in seven separate industries. tenant base, by both industry and the individual retail The 2008 portfolio acquisitions were lower than chain, provides us with another measure of protection. in prior years. This is because we had decided early When all of these factors are combined, we believe on in the year that, with the uncertainty in the that the odds of profitably managing our portfolio, commercial retail real estate market, it would be during recessionary periods like this, are markedly prudent for us to wait on the sidelines for most of the enhanced. Portfolio Occupancy (as of the end of each year) 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 97.0% 97.9% 98.7% 98.5% 97.9% 98.1% 97.7% 98.2% 97.7% 98.4% 99.5% 99.2% 99.1% 99.3% 99.4% 1969–1993 >99.0% year. As we observed the market throughout the year, we saw property prices continue to decline and lease rates rise. We believed that by being patient we would very likely be rewarded with more attractively priced retail real estate in the future. We continue in that stance today. The retail consumer continues to struggle as I write this letter and the outlook for the near-term growth of the majority of our retailers appears challenging. Come to think of it, I think most of them would be very happy with just moderate declines in their sales, given the exodus of the US consumer from the market. Though the future may seem somewhat bleak for a lot of the retail chains out there today, we believe there are retail chains, with solid operating concepts, that will need to access capital in the near future. We think they may find that capital difficult to obtain through the traditional debt and equity markets. Some of these retailers may look to unlock the capital they have tied up in their real estate through a sale-leaseback transaction. Since our efforts have focused this past year on strengthening our balance sheet and increasing our liquidity, we believe we are in a very good financial position to capitalize on some of the more attractive opportunities down the road. But for 19 now, we are being patient and have our capital where AS WE END 2008 we can keep an eye on it. We are doing OK. Your Company continues to perform pretty well and begins 2009 with: ACCESS TO CAPITAL • A strong balance sheet with just 33% debt to total In an environment where access to capital is mostly capitalization, no debt maturities until 2013 and non-existent for the majority of companies, we are no mortgages on any properties pleased to report the following transactions: • Good liquidity with ample cash on hand from • Just the other day, we paid off $20 million in operations and a zero balance on our $355 million 8.0% Senior Notes due January 2009. Prior to credit facility that, in November 2008, we retired $100 million • Occupancy at the end of 2008 of 97% in 8.25% Monthly Income Senior Notes due • $330 million in lease revenue November 2008. Both of these notes were retired • A solid dividend track record: with cash on hand from operations and property - Dividends paid per common share during 2008 sales, as well as from proceeds received from increased 6.5% securities offerings. - The amount of the monthly dividend was • In September of 2008, we issued 2,925,000 increased five times during 2008 shares of common stock, raising approximately - We’ve paid 461 consecutive monthly dividends $74 million in net proceeds to fund the retirement through 2008 of our senior notes and for other corporate purposes. - We’ve paid over $1.5 billion in dividends since Despite challenges in the stock market at the time 1969. of the offering, our shares were very well received by the firms that participated in the offering. 3 . W h a t t h e F u t u r e H o l d s f o r Yo u r C o m p a n y Again, thanks to our investment bankers and a Oh, ok, I know I have to take a shot at this. Let me bit of good fortune with the timing on this one. be perfectly frank. We are in the midst of a terrible • In May of 2008, we announced a new and recession and a continuing, significant, credit crisis. expanded $355 million acquisition credit facility that replaced our $300 million credit facility, which was due to expire in October 2008. It was our belief, at that time, that the credit markets would become more difficult and perhaps might ultimately be closed to companies seeking to extend their credit lines. Thus, we elected to restructure our credit facility well ahead of its scheduled expiration date. These capital market activities have reduced the amount of debt on our balance sheet and increased our liquidity. Balance sheet health and liquidity are the two areas that are most carefully scrutinized in the current investment environment. 20 Dividend Yields (as of December 31, 2008) Dow Jones Utility Index Standard & Poor’s 500 10-Year Treasury 1-year CD Realty Income* 4.4% 3.2% 2.8% 1.7% 7.4% *Based on annualized dividend amount of $1.701 per share on 12/31/08 Job losses are mounting, the consumer has reduced likely to have periods of both economic growth and spending and many retailers are struggling. The recession, easy access to capital and periods when the Government (that’s you and me) is spending a huge capital markets are closed, high inflation and low inflation, amount of money trying to bring some sense of high interest rates and low interest rates, and periods of normalcy to the credit markets, capital markets and our time when events that few expected would occur in our banking system and, through that, attempting to stem economy, suddenly do occur. We believe quite strongly the tide of a downward spiral in the economy. I believe that it is our job to operate the Company in a manner it is going to take awhile to right our economic ship and where we can accomplish our mission of paying monthly I don’t see an ebullient environment returning for quite dividends in all of these environments. This is not awhile. The amount of debt that has permeated our to say that when the 100-year flood hits it won’t be economy, in recent years, will need to be reduced and uncomfortable for us. We operate in the same economy that reduction will likely continue to inflict pain on our as everyone else, and the current environment will economy. In past reports, I have spoken about one of certainly make our task much more difficult during our core beliefs at Realty Income. It is that we own 2009. However, we continue to believe that your our properties under leases that typically last 15 to 20 Company is positioned to withstand this market and years and seek to pay monthly dividends to our share- succeed in future years. Very thankfully, we are well holders over many years. capitalized, quite liquid, have high occupancy, and a well As such, we take a long-term view of the business. We diversified portfolio. As such, I believe we should weather realize that, over the long terms of these leases, we are the storm better than many others. Annualized Dividends and Dividend Increases* • 461 Consecutive Monthly Dividends Paid $0.90 94 $0.93 95 $0.95 96 $0.96 97 $1.02 98 $1.08 99 $1.11 00 $1.14 01 $1.17 02 $1.20 03 $1.32 04 $1.395 $1.518 $1.641 $1.701 05 06 07 08 *as of December 31 of each year 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0 21 4 . M o n t h l y D i v i d e n d s a r e o u r P a s s i o n ! . . . economic need, and because of the sheer number O u r C o m m i t m e n t a n d P o i n t o f Vi e w of people who will be looking for income in the I think it is important to reiterate both our commitment coming years. to providing monthly dividends, as well as our point of view concerning the payment of dividends to our shareholders. First of all, we are The Monthly Dividend I N C L O S I N G 2008 was a challenging year, and I believe 2009 will be Company®! We’ve been The Monthly Dividend Company® at least as challenging, and maybe more so. As we have ever since the Company was founded in 1969. The only said many times, we are committed to our objective of reason for us to be in business is to pay monthly paying you monthly dividends that increase over time. dividends to our shareholders by owning properties, Once again, we are grateful for the support of the holding them, collecting rent, and then using the cash thousands of loyal shareholders who, like us, have flow to pay dividends. We’re not in the business of trading enjoyed years of monthly dividends. As always, there real estate or maximizing long term growth at the are no guarantees we will be successful in our efforts expense of current cash flow. Our primary goal is to during 2009 and we recommend that all investors manage our real estate assets that generate the revenue remain diversified and rely on us for only a portion of from which we pay dividends and, secondarily, to their income needs. We will do our best to operate your increase the number of assets we own and their cash Company in a prudent fashion so that the monthly flow so that we can, hopefully, increase the amount of dividends just keep on coming. dividends we pay over time. Sounds simple, perhaps even boring, but believe Sincerely, me, we are passionate about this. Since we’re all share- holders, we’ve experienced for ourselves the benefit of having that monthly dividend check show up in our Tom A. Lewis mailbox, or deposited directly into our account. Chief Executive Officer Producing these dividends over the long term is why Vice Chairman of the Board of Directors we are here, period. We will continue to operate the Company for those shareholders that are seeking a monthly dividend. We also think the demand for that income will continue to grow. As the first members of the Baby Boomer generation approach 65, the traditional age when one begins to examine retirement options, there is increasing interest in how and where to get income. While many Baby Boomers may not be able to retire completely from the workforce, they may decide to pursue other interests and need to replace salaried income in order to do so. For these and other reasons, we believe our focus on providing monthly income is good business, both because it fulfills an unmet 22 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S I n f o r m a t i o n F i n a n c i a l Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Consolidated Quarterly Financial Data Report of Independent Registered Public Accounting Firm Business Description Properties Forward-Looking Statements Management’s Discussion and Analysis of Financial Condition and Results of Operations General Liquidity and Capital Resources Results of Operations Funds from Operations Available to Common Stockholders (FFO) Impact of Inflation Impact of Recent Accounting Pronouncements Quantitative and Qualitative Disclosures About Market Risk Selected Financial Data Controls and Procedures Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, including Total Return Performance No, no, nothing in here for anyone who paid down their mortgage, saved their money, paid their taxes and adequately saved for retirement. 24 25 26 27 28 45 46 47 56 61 62 62 62 67 73 74 74 74 76 77 78 23 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S C o n s o l i d a t e d B a l a n c e S h e e t s (dollars in thousands, except per share data) December 31, 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 Lines of credit payable Notes payable Total liabilities Commitments and contingencies Stockholders’ equity: 2008 2007 $ 1,157,885 2,251,025 3,408,910 (553,417) 2,855,493 6,660 2,862,153 46,815 10,624 17,206 57,381 $ 1,110,897 2,127,897 3,238,794 (470,695) 2,768,099 56,156 2,824,255 193,101 7,142 17,206 35,648 $ 2,994,179 $ 3,077,352 $ 16,793 38,027 14,698 — 1,370,000 1,439,518 $ 15,844 38,112 15,304 — 1,470,000 1,539,260 Preferred stock and paid in capital, par value $1.00 per share, 20,000,000 shares authorized, 13,900,000 shares issued and outstanding in 2008 and 2007 Common stock and paid in capital, par value $1.00 per share, 200,000,000 shares authorized, 104,211,541 and 101,082,717 shares issued and outstanding in 2008 and 2007, respectively Distributions in excess of net income Total stockholders’ equity Total liabilities and stockholders’ equity 337,790 337,790 1,624,622 (407,751) 1,554,661 $ 2,994,179 1,545,037 (344,735) 1,538,092 $ 3,077,352 The accompanying notes to consolidated financial statements are an integral part of these statements. 24 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S C o n s o l i d a t e d S t a t e m e n t s o f (dollars in thousands, except per share data) I n c o m e Years Ended December 31, 2008 2007 2006 Revenue Rental Other Expenses Interest Depreciation and amortization General and administrative Property Income taxes 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 Net income available to common stockholders $ 328,266 1,934 330,200 93,956 90,732 21,618 5,818 1,230 — 213,354 116,846 575 14,420 14,995 131,841 (24,253) $ 107,588 $ 287,965 6,352 294,317 64,331 76,686 22,694 3,471 1,392 — 168,574 125,743 10,703 3,963 14,666 140,409 (24,253) $ 116,156 Amounts available to common stockholders per common share: Income from continuing operations: Basic Diluted Net income, basic and diluted Weighted average common shares outstanding: Basic Diluted $ $ $ 0.92 0.91 1.06 $ $ $ 1.01 1.01 1.16 101,178,191 101,209,883 100,195,031 100,333,966 The accompanying notes to consolidated financial statements are an integral part of these statements. $ 235,374 2,042 237,416 51,363 58,783 17,539 3,300 747 1,555 133,287 104,129 1,402 5,250 6,652 110,781 (11,362) $ 99,419 $ $ $ 1.03 1.03 1.11 89,766,714 89,917,554 25 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S C o n s o l i d a t e d S t a t e m e n t s o f S t o c k h o l d e r s ’ E q u i t y (dollars in thousands) Years Ended December 31, 2008, 2007 and 2006 Shares of Preferred stock Shares of Common stock Preferred stock and paid in capital Common stock and paid in capital Distributions in excess of net income Total 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 8,800,000 — 213,977 Share-based compensation — 234,579 — — — 110,781 110,781 (144,045) (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 Net income Distributions paid and payable Preferred stock issuance cost Share-based compensation — — — — — — — 336,491 — — 9 — — — — 4,672 140,409 (182,990) 140,409 (182,990) — — 9 4,672 Balance, December 31, 2007 13,900,000 101,082,717 337,790 1,545,037 (344,735) 1,538,092 Net income Distributions paid and payable Shares issued in stock offering, net of offering costs of $4,024 Share-based compensation — — — — — — 2,925,000 203,824 — — — — — — 131,841 131,841 (194,857) (194,857) 74,425 5,160 — — 74,425 5,160 Balance, December 31, 2008 13,900,000 104,211,541 $ 337,790 $ 1,624,622 $ (407,751) $ 1,554,661 The accompanying notes to consolidated financial statements are an integral part of these statements. World Financial System Well that was unexpected . . . 26 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S C o n s o l i d a t e d S t a t e m e n t s o f C a s h F l o w s (dollars in thousands) 2008 2007 2006 $ 131,841 $ 140,409 $ 110,781 90,732 76,686 58,783 Years Ended December 31, 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 sales of land and improvements Gain on reinstatement of property carrying value Amortization of share-based compensation Provisions for impairment on real estate held for investment Cash provided by (used in) discontinued operations: Real estate acquired for resale Real estate held for investment Investment in real estate acquired for resale Proceeds from sales of real estate acquired for resale Collection of notes 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 improvements to investment properties (575) (14,420) (236) — 5,049 — 78 1,408 (9) 31,455 87 (930) 1,675 246,155 439 24,191 (194,106) Intangibles acquired in connection with acquisitions of investment properties (397) Restricted escrow funds acquired in connection with acquisitions of investment properties Net cash used in investing activities Cash Flows from Financing Activities Cash distributions to common stockholders Cash dividends to preferred stockholders Proceeds from common stock offerings, net Credit facility origination costs Principal payment on notes payable Proceeds from notes issued, net Borrowings from lines of credit Payments under lines of credit Proceeds from preferred stock offerings, net Proceeds from other stock issuances Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year — (169,873) (169,655) (24,253) 74,425 (3,196) (100,000) — — — — 111 (222,568) (146,286) 193,101 (10,703) (3,963) (1,835) — 3,857 138 (1,610) 3,009 (29,886) 119,790 651 (49) 21,675 318,169 4,370 7,014 (506,360) (997) (2,648) (498,621) (157,659) (24,583) — — — 544,397 407,800 (407,800) 9 816 362,980 182,528 10,573 (1,402) (5,250) — (716) 2,951 — 371 3,055 (113,166) 22,405 1,333 4,418 3,382 86,945 2 9,804 (654,149) (937) — (645,280) (129,667) (9,403) 402,745 — (110,000) 271,883 523,200 (659,900) 213,977 369 503,204 (55,131) 65,704 Cash and cash equivalents, end of year $ 46,815 $ 193,101 $ 10,573 For supplemental disclosures, see note 13. The accompanying notes to consolidated financial statements are an integral part of these statements. 27 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S N o t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s December 31, 2008, 2007 and 2006 1. ORGANIZATION AND OPERATION Realty Income Corporation (“Realty Income,” the “Company,” “we” or “our”) is organized as a Maryland corporation. We invest 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES Federal Income Taxes. We have elected to be taxed as a real estate in commercial retail real estate and have elected to be taxed as investment trust (“REIT”) under the Tax Code. We believe we a real estate investment trust (“REIT”). have qualified and continue to qualify as a REIT. Under the REIT At December 31, 2008, we owned 2,348 properties, located operating structure, we are permitted to deduct distributions in 49 states, containing over 19.1 million leasable square feet, paid to our stockholders and generally will not be required to along with five properties owned by our wholly-owned taxable REIT pay federal corporate income taxes on such income. Accordingly, subsidiary, Crest Net Lease, Inc. (“Crest”). Crest was created to no provision has been made for federal income taxes in the buy and sell properties, primarily to individual investors who are accompanying consolidated financial statements, except for involved in tax-deferred exchanges under Section 1031 of the federal income taxes of Crest, which totaled $181,000 in 2008, Internal Revenue Code of 1986, as amended (the “Tax Code”). $2.5 million in 2007 and $396,000 in 2006 and are included in Information with respect to number of properties, square feet, discontinued operations. average initial lease term and weighted average contractual lease rate is unaudited. Earnings and profits that determine the taxability of distribu- tions to stockholders differ from net income reported for financial reporting purposes due to differences in the estimated useful lives and methods used to compute depreciation and the carrying value (basis) of the investments in properties for tax purposes, among other things. The following reconciles our net income available to common stockholders to taxable income (dollars in thousands): Net income available to common stockholders $ 107,588 $ 116,156 $ 99,419 2008 (1) 2007 2006 Preferred dividends Depreciation and amortization timing differences Tax gain on the sales of real estate less than book gain Tax loss on the sale of real estate less than book gain Dividends received from Crest Elimination of net revenue and expenses from Crest Adjustment for share-based compensation Adjustment for straight-line rent Adjustment for an increase (decrease) in prepaid rent Other adjustments 24,253 28,624 (3,925) — 2,500 270 2,270 (1,997) (1,226) (358) 24,583 22,668 — (3,839) 3,300 (6,677) 314 (1,217) 5,608 (453) 11,362 16,612 — (3,529) 500 2,440 (63) (1,515) (1,681) (718) Taxable net income, before our dividends paid deduction $ 157,999 $ 160,443 $ 122,827 (1) The 2008 information presented is a reconciliation of our net income available to common stockholders to estimated taxable net income. This doesn’t look like much of an ark. That’s OK, the CEO isn’t much of a Noah either. 28 In June 2006, the Financial Accounting Standards Board C corporation that owned real property. At the time of acquisition, (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty the C corporation became a Qualified REIT Subsidiary, was in Income Taxes, an interpretation of FASB Statement No. 109. deemed to be liquidated for Federal income tax purposes, and the Interpretation No. 48 applies to all tax positions accounted for real property was deemed to be transferred to us with a carryover under Statement No. 109 and clarifies the accounting for uncer- tax basis. As of December 31, 2008, we have built-in gains of tainty in income taxes by defining criteria that a tax position on an $59 million with respect to such property. We do not expect that individual matter must meet before that position is recognized in we will be required to pay income tax on the built-in gains in these the financial statements. We were subject to the provisions of properties during the ten-year period ending August 28, 2017. Interpretation No. 48 since January 2007 and from that time we It is our intent, and we have the ability, to defer any dispositions have analyzed our various federal and state filing positions. We of these properties to periods when the related gains would not be believe that our income tax positions would more likely than not subject to the built-in gain income tax or otherwise to defer the be sustained upon examination by all relevant taxing authorities. recognition of the built-in gain related to these properties. Therefore, no reserves for uncertain income tax positions have However, our plans could change and it may be necessary to been recorded pursuant to Interpretation No. 48 and we did not dispose of one or more of these properties in a taxable transaction record a cumulative effect adjustment related to its adoption. before August 28, 2017, in which case we would be required to Absent an election to the contrary, if a REIT acquires property pay corporate level tax with respect to the built-in gains on these that is or has been owned by a C corporation in a transaction in properties as described above. which the tax basis of the property in the hands of the REIT is determined by reference to the tax basis of the property in the Net Income Per Common Share. Basic net income per common hands of the C corporation, and the REIT recognizes gain on the share is computed by dividing net income available to common disposition of such property during the 10 year period beginning stockholders by the weighted average number of common shares on the date on which it acquired the property, then the REIT will outstanding during each period. Diluted net income per common be required to pay tax at the highest regular corporate tax rate share is computed by dividing net income available to common on this gain to the extent of the excess of the fair market value stockholders for the period by the weighted average number of of the property over the REIT’s adjusted basis in the property, in common shares that would have been outstanding assuming the each case determined as of the date the REIT acquired the issuance of common shares for all potentially dilutive common property. In August 2007, we acquired 100% of the stock of a 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: Weighted average shares used for the basic net income per share computation Incremental shares from share-based compensation Adjusted weighted average shares used for diluted net income 2008 2007 2006 101,178,191 100,195,031 31,692 138,935 89,766,714 150,840 per share computation 101,209,883 100,333,966 89,917,554 Unvested shares from share-based compensation that were anti-dilutive 614,917 243,631 235,035 No stock options were anti-dilutive in 2008, 2007 or 2006. 29 Discontinued Operations. In accordance with FASB Statement sale, adjusted for any depreciation expense that would have No. 144, Accounting for the Impairment or Disposal of Long- been recognized had the property been continuously classified Lived Assets, Realty Income’s operations from two investment as held for investment, and (ii) the fair value at the date of the properties classified as held for sale at December 31, 2008, subsequent decision not to sell. plus properties sold in 2008, 2007 and 2006, are reported as The following is a summary of Crest’s “income from discontinued discontinued operations. Their respective results of operations operations, real estate acquired for resale” on our consolidated have been reclassified to “income from discontinued operations, statements of income (dollars in thousands): Crest’s income from discontinued operations, real estate acquired for resale 2008 2007 2006 Gain on sales of real estate acquired for resale $ 4,642 $ 12,319 $ 2,219 real estate held for investment” on our consolidated statements of income. We do not depreciate properties once they 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 typically classify properties acquired by Crest as held for sale at the date of acquisition and do not depreciate them. In accordance with Statement No. 144, the operations of Crest’s properties are classified as “income from Rental revenue Other revenue Interest expense General and discontinued operations, real estate acquired for resale by Crest” administrative expense on our consolidated statements of income. No debt was assumed by buyers of our investment properties or repaid as a result of our investment property sales, and we do not allocate interest expense to discontinued 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 held for sale are included in “income from discontinued opera- Property expenses Provisions for impairment Depreciation (1) Income taxes Income from discontinued operations, real estate acquired for resale by Crest 1,830 914 (1,797) (511) (133) (3,374) (771) (225) 8,165 190 (6,201) (691) (40) — — (3,039) 5,065 15 (3,708) (440) (67) (1,188) — (494) $ 575 $ 10,703 $ 1,402 tions, real estate acquired for resale by Crest” on our consolidated (1) Depreciation was recorded on one property that was classified as held for statements of income. If circumstances arise, which were previously considered unlikely and, as a result, we decide not to sell a property previously classified as held for sale, the property is reclassified as real estate held for investment. A property that is reclassified to held for investment is measured and recorded at the lower of (i) its carrying amount before the property was classified as held for Turns out leverage works both ways. investment. This property was sold in 2008. The following is a summary of Realty Income’s “income from discontinued operations, from real estate held for investment” on our consolidated statements of income (dollars in thousands): Realty Income’s income from discontinued operations, real estate held for investment Gain on sales of 2008 2007 2006 investment properties $ 13,314 $ 1,724 $ 3,036 Rental revenue Other revenue Depreciation and amortization Property expenses Provisions for impairment 1,461 40 3,075 4 3,177 34 (302) (93) — (636) (70) (134) (825) (156) (16) Income from discontinued operations, real estate held for investment $ 14,420 $ 3,963 $ 5,250 30 The following is a summary of our total income from discontinued Cash Equivalents. We consider all short-term, highly liquid operations (dollars in thousands, except per share data): investments that are readily convertible to cash and have an Total discontinued operations 2008 2007 2006 Real estate acquired for resale by Crest $ 575 $ 10,703 $ 1,402 original maturity of three months or less at the time of purchase to be cash equivalents. Our cash equivalents are primarily investments in United States Treasury or government money market funds. Real estate held for investment Income from discontinued 14,420 3,963 5,250 Gain on Sales of Properties. We recognize gains on sales of properties in accordance with FASB Statement No. 66, Accounting for Sales of Real Estate. operations $ 14,995 $ 14,666 $ 6,652 Per common share, basic and diluted $ 0.15 $ 0.15 $ 0.07 The per share amounts for “income from discontinued opera- tions” above and the “income from continuing operations” and “net income” reported on the consolidated statements of income Allocation of the Purchase Price of Real Estate Acquisitions. When we acquire a property for investment purposes, we allocate the purchase price to the various components of the acquisition based upon the fair value of each component. The components typically include (i) land, (ii) building and improvements, (iii) intangible assets related to above and below market leases, and have each been calculated independently. (iv) value of costs to obtain tenants. 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. We recognize an allowance for doubtful accounts relating to accounts receivable for amounts deemed uncollectible. We consider tenant specific issues, such as financial stability and ability to pay rent, when determining collectibility of accounts receivable and appropriate allowances to record. The allowance for doubtful accounts was $637,000 at December 31, 2008 and $795,000 at December 31, 2007. Depreciation and Amortization. Land, buildings and improvements are recorded and stated at cost. Major replacements and betterments, which improve or extend the life of the asset, are capitalized and depreciated over their estimated useful lives, while ordinary repairs and maintenance are expensed as incurred. Buildings and improvements that are under redevelopment, or are being developed, are carried at cost and no depreciation is recorded on these assets. Additionally, amounts essential to the development of the property, such as pre-construction, development, construction, interest and any other costs incurred during the period of development are capitalized. We cease capitalization when the property is available for occupancy upon substantial completion of tenant improvements, but in any event no later than one year from the completion of major construction activity. Properties are depreciated using the straight-line method over the estimated useful lives of the assets. The estimated useful Other revenue includes non-operating interest earned from lives are as follows: investments in money market funds and other notes of $1.4 million in 2008, $3.6 million in 2007 and $1.2 million in 2006. Buildings 25 years Building improvements 4 to 15 years Principles of Consolidation. The accompanying consolidated financial statements include the accounts of Realty Income, Crest Tenant improvements and lease commissions The shorter of the term of the related lease or useful life and other entities for which we make operating and financial Acquired in-place decisions (i.e. control), after elimination of all material inter- operating leases Remaining terms of the respective leases company balances and transactions. All of Realty Income’s and Crest’s subsidiaries are wholly-owned. We have no unconsolidated or off-balance sheet investments in variable interest entities. 31 Provisions for Impairment. We review long-lived assets for The fair value of the tangible assets of an acquired property impairment whenever events or changes in circumstances (which includes land and buildings/improvements) is determined indicate that the carrying amount of an asset may not be by valuing the property as if it were vacant, and the “as-if-vacant” recoverable. Generally, a provision is made for impairment value is then allocated to land and buildings/improvements based if estimated future operating cash flows (undiscounted and on our determination of the relative fair value of these assets. Our without interest charges) plus estimated disposition proceeds determinations are based on a real estate appraisal for each (undiscounted) are less than the current book value. Impairment property, generated by an independent appraisal firm, and consider loss is measured as the amount by which the current book value estimates of carrying costs during the expected lease-up periods, of the asset exceeds the fair value of the asset. If a property is current market conditions, as well as costs to execute similar held for sale, it is carried at the lower of cost or estimated fair leases. In allocating the fair value to identified intangibles for value, less estimated cost to sell. In 2008, Crest recorded above-market or below-market leases, an amount is recorded provisions for impairment of $3.4 million on three retail based on the present value of the difference between (i) the properties, which were held for sale at December 31, 2008. contractual amount to be paid pursuant to the in-place lease These provisions for impairment are included in “income from and (ii) our estimate of fair market lease rate for the corresponding discontinued operations, real estate acquired for resale by Crest” in-place lease, measured over a period equal to the remaining on our consolidated statements of income. term of the lease. In 2007, we recorded a provision for impairment of $134,000 Capitalized above-market lease values are amortized as a on one retail investment property in the motor vehicle industry. reduction of rental income over the remaining terms of the This provision for impairment is included in “income from respective leases. Capitalized below-market lease values are discontinued operations, real estate held for investment” on our amortized as an increase to rental income over the remaining consolidated statement of income (“Discontinued Operations”). terms of the respective leases and expected below-market renewal In 2007, we also recorded a provision for impairment of option periods. $138,000 on one retail investment property in the consumer The aggregate value of other acquired intangible assets electronics industry. This provision for impairment is included consists of the value of in-place leases and tenant relationships. in property expense on our consolidated statement of income. These are measured by the excess of the purchase price paid for No provisions for impairment were recorded by Crest in 2007. a property, after adjusting for above or below-market lease In 2006, we recorded a provision for impairment of $16,000 value, less the estimated fair value of the property “as if vacant,” on one retail investment property in the restaurant industry. This determined as set forth above. The value of in-place leases, provision for impairment is included in Discontinued Operations. exclusive of the value of above-market and below-market in-place Additionally, in 2006, Crest recorded provisions for impairment of leases, is amortized to expense over the remaining periods of the $1.2 million on three retail properties. One was sold in 2007 respective leases. If a lease were to be terminated prior to its and two were sold in 2008. The provisions for impairment stated expiration, all unamortized amounts relating to that lease recorded by Crest are included in “income from discontinued would be recorded to revenue or expense as appropriate. operations, real estate acquired for resale by Crest” on our consolidated statements of income. Share-based Compensation. Effective January 1, 2006, we The provisions for impairment recorded in 2008, 2007 and adopted FASB Statement No. 123R, Share-Based Payments. 2006 reduced the carrying values to the estimated fair-market Statement No. 123R requires companies to recognize in the value of those properties, net of estimated selling costs. income statement the grant-date fair value of stock options and Acquired In-place Leases. In accordance with FASB Statement January 1, 2002, we adopted the fair value recognition provisions No. 141, Business Combinations, the fair value of the real estate of FASB Statement No. 123, Accounting for Stock-Based acquired with in-place operating leases is allocated to the Compensation, and starting January 1, 2002 expensed costs for acquired tangible assets, consisting of land, building and all stock option awards granted, modified, or settled. other equity-based compensation issued to employees. Effective improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, Goodwill. Goodwill is tested for impairment during the second the value of in-place leases and tenant relationships, based in quarter of each year as well as when events or circumstances each case on their fair values. occur indicating that our goodwill might be impaired. We did not record any new goodwill or impairment on our existing goodwill during 2008, 2007 or 2006. 32 Other Assets. Other assets consist of the following (dollars in Sales Taxes. We collect and remit sales taxes assessed by different thousands) at: December 31, governmental authorities that are both imposed on and concurrent with a revenue-producing transaction between us and our tenants. 2008 2007 We report the collection of these taxes on a net basis (excluded Notes receivable issued in conjunction from revenues). The amounts of these taxes are not significant with Crest property sales $ 22,344 $ 3,132 Deferred bond financing costs, net 13,249 14,940 Value of in-place and above-market leases, net Prepaid expenses 10,534 4,244 11,211 3,803 Escrow deposits for Section 1031 tax-deferred exchanges Credit facility organization costs, net Corporate assets, net of accumulated depreciation and amortization Settlements on treasury lock agreements Other items 3,174 2,552 1,277 — 7 — 434 1,356 759 13 $ 57,381 $ 35,648 Distributions Payable. Distributions payable consist of the following declared distributions (dollars in thousands) at: December 31, 2008 2007 Common stock distributions $ 14,772 $ 13,823 Preferred stock dividends 2,021 2,021 to our financial position or results of operations. Use of Estimates. The consolidated financial statements were prepared in conformity with U.S. generally accepted accounting principles, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Impact of Recent Accounting Pronouncements. In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. Statement No. 157 sets out a framework for measuring fair value, and requires additional disclosures about fair-value measurements. Statement No. 157 became effective for us at the beginning of 2008 and did not have an impact on our financial position or results of operations. In February 2008, the FASB delayed the effective date of Statement No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or $ 16,793 $ 15,844 disclosed at fair value in the financial statements on a recurring basis, to the beginning of 2009. For additional discussion of Accounts Payable and Accrued Expenses. Accounts payable and Statement No. 157, see note 12. accrued expenses consist of the following (dollars in thousands) at: In February 2007, the FASB issued Statement No. 159, The December 31, 2008 2007 including an Amendment of FASB Statement No. 115. Statement Bond interest payable $ 26,706 $ 24,987 No. 159 permits entities to choose to measure many financial Other items 11,321 13,125 instruments and certain other items at fair value. We have elected $ 38,027 $ 38,112 not to use the fair value measurement provisions of Statement Fair Value option for Financial Assets and Financial Liabilities— Other Liabilities. Other liabilities consist of the following (dollars in thousands) at: December 31, Rent received in advance Security deposits Value of in-place below-market leases, net 2008 2007 $ 9,083 $ 10,626 3,937 2,818 1,678 1,860 $ 14,698 $ 15,304 No. 159. In December 2007, the FASB issued Statement No. 141R (revised 2007), Business Combinations. Effective January 1, 2009, Statement No. 141R changes the accounting treatment and disclosures for certain specific items in a business combi- nation. Under Statement No. 141R, a company that acquires another entity is required to recognize all the assets acquired and liabilities assumed at the acquisition-date fair value with limited exceptions. Statement 141R requires transaction costs to be expensed as incurred, rather than capitalized. Statement No. 141R is not expected to have a significant impact on our financial position or results of operations. 33 In December 2007, the FASB issued Statement No. 160, Of the $533.7 million invested during 2007, Realty Income Noncontrolling Interest in Consolidated Financial Statements. invested $503.8 million in 325 new retail properties and Effective January 1, 2009, Statement No. 160 clarifies that a properties under development with an initial weighted average noncontrolling interest in a subsidiary is an ownership interest in contractual lease rate of 8.6%. These 325 properties are located the consolidated entity that should be reported as equity in the in 38 states, contain over 1.8 million leasable square feet, and consolidated financial statements. This statement also requires are 100% leased with an average lease term of 19.2 years. consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling B. During 2008, Crest did not invest in any new retail properties. interest and requires disclosure, on the face of the consolidated In comparison, during 2007, Crest invested $29.9 million in 32 statement of income, of the amounts of the consolidated net retail properties. income attributable to the parent and to the noncontrolling interest. We currently do not have any minority or noncontrolling C. Crest’s property inventory at December 31, 2008 consisted interest in a subsidiary, and, therefore, Statement No. 160 will of five properties for $6.0 million and at December 31, 2007 not have an impact on our consolidated financial statements. consisted of 30 properties for $56.2 million. These amounts are In June 2008, the FASB issued FASB Staff Position (“FSP”) included on our consolidated balance sheets in “real estate held EITF No. 03-6-1, Determining Whether Instruments Granted in for sale, net.” Share-Based Payment Transactions Are Participating Securities. Effective January 1, 2009, FSP EITF No. 03-6-1 clarifies D. Of the $189.6 million invested by Realty Income in 2008, that all outstanding nonvested share-based payment awards $10.0 million was used to acquire two retail properties with that contain rights to nonforfeitable dividends are considered existing leases. In accordance with FASB Statement No. 141, “participating securities,” as defined by FSP EITF No. 03-6-1, Business Combinations, Realty Income recorded $397,000 as which requires the two-class method of computing basic and the intangible value of the in-place leases. This amount is diluted earnings per share to be applied. FSP EITF No. 03-6-1 recorded to “other assets” on our consolidated balance sheets is not expected to have a significant impact on our calculation of and amortized over the life of the respective leases. basic and diluted earnings per share. Of the $533.7 million invested in 2007, $14.7 million was used to acquire five properties with existing leases already in-place Reclassifications. Certain of the 2007 and 2006 balances have with retail tenants. In accordance with Statement No. 141, Realty been reclassified to conform to the 2008 presentation. Income recorded $1.8 million as the intangible value of the in-place 3. RETAIL PROPERTIES ACQUIRED We acquire land, buildings and improvements that are used by leases. These amounts are recorded to “other assets” and “other liabilities,” respectively, on our consolidated balance sheets and retail operators. are amortized over the life of the respective leases. leases and $784,000 as the intangible value of below-market A. During 2008, Realty Income invested $189.6 million in 108 new retail properties and properties under development with an 4. CREDIT FACILITY In May 2008, we entered into a new $355 million acquisition initial weighted average contractual lease rate of 8.7%. These credit facility which replaced our existing $300 million acquisi- 108 properties are located in 14 states, contain over 714,000 tion credit facility that was scheduled to expire in October 2008. leasable square feet, and are 100% leased with an average lease The term of the new credit facility is for three years, until May term of 20.6 years. The initial weighted average contractual lease 2011, plus two, one-year extension options. Under the new credit rate is computed by dividing the estimated aggregate base rent facility, our investment grade credit ratings provide for financing for the first year of each lease by the estimated total cost of at LIBOR (London Interbank Offered Rate) plus 100 basis points the properties. with a facility commitment fee of 27.5 basis points, for all-in In comparison, during 2007, Realty Income and Crest drawn pricing of 127.5 basis points over LIBOR. We also have invested $533.7 million, in aggregate, in 357 new retail other interest rate options available to us. Our credit facility is properties and properties under development. These 357 retail unsecured and accordingly, we have not pledged any assets as properties are located in 38 states, contain over 1.9 million collateral for this obligation. leasable square feet, and are 100% leased with an average lease In May 2008, as a result of entering into our new credit term of 19.3 years. 34 facility, we incurred $3.2 million of credit facility origination costs which were capitalized to other assets. Also, we expensed $235,000 of unamortized credit facility origination costs from our prior credit facility, which are included in interest expense. We did not utilize our credit facility during 2008. Our effective borrowing rate at December 31, 2008 was 1.4% and at December 31, 2007 was 5.2%. Our average borrowing rate on our credit facility during 2007 was 6.0%, compared to 5.7% in 2006. Our current and prior credit facilities are subject to various leverage and interest coverage ratio limitations. We are and have been in compliance with these covenants. 5. NOTES PAYABLE A. General Our senior unsecured note obligations consist of the following, sorted by maturity date, (dollars in millions): December 31, 8.25% notes, issued in October 1998 and due in November 2008 $ 8% notes, issued in January 1999 and due in January 2009 5.375% notes, issued in March 2003 and due in March 2013 5.5% notes, issued in November 2003 and due in November 2015 5.95% notes, issued in September 2006 and due in September 2016 5.375% notes, issued in September 2005 and due in September 2017 6.75% notes, issued in September 2007 and due in August 2019 5.875% bonds, issued in March 2005 and due in March 2035 2008 — 20.0 100.0 150.0 275.0 175.0 550.0 100.0 2007 $ 100.0 20.0 100.0 150.0 275.0 175.0 550.0 100.0 $ 1,370.0 $ 1,470.0 The following table summarizes the maturity of our notes Interest incurred on all of the notes for 2008 was $91.2 million, payable as of December 31, 2008 (dollars in millions): for 2007 was $67.1 million and for 2006 was $49.6 million. The Year of Maturity (1) 2009 (2) 2013 After 2013 Totals (1) There are no maturities in 2010, 2011 and 2012. (2) $20.0 million matured and was paid off in January 2009. Notes 20.0 $ 100.0 1,250.0 $ 1,370.0 interest rate on each of these notes is fixed. Our outstanding notes are unsecured and; accordingly, we have not pledged any assets as collateral for these or any other obligations. Interest on all of the senior note obligations is paid semiannually. All of these notes contain various covenants, including: (i) a limitation on incurrence of any debt which would cause our debt to total adjusted assets ratio to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause our secured It’s either a light at the end of the tunnel or . . . Don’t even say it. 35 Everybody trying to get in on this Federal Bailout TARP program, sounds fishy to me. The Federal Reserve announced today that Mrs. Paul’s Fish Sticks has become a bank holding company and will be accessing funds from the Federal Bailout TARP program. debt to total adjusted assets ratio to exceed 40%; (iii) a limitation on incurrence of any debt which would cause our debt service coverage ratio to be less than 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. B. Note Redemptions In January 2009 on their maturity date, we redeemed all of our outstanding 8.00% notes issued in January 1999 at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest using cash on hand. In November 2008 on their maturity date, we redeemed all of our outstanding 8.25% senior notes issued in October 1998 (the “2008 Notes”) at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest, using proceeds from our September 2008 common stock offering and cash on hand. In May 1998, we entered into a treasury interest rate lock agreement associated with the 2008 Notes. In settlement of the agreement, we made a payment of $8.7 million in 1998. The payment on the agreement was amortized over 10 years (the life of the notes) as a yield adjustment to interest expense. After taking into effect the results of the treasury lock settlement, the effective rate to us on the 2008 Notes was 9.12%. In September 2006, we redeemed all of our outstanding 2007 Notes at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest and a make-whole payment of $1.6 million. The make-whole payment was recorded as a “loss on extinguishment of debt” on our 2006 consolidated statement of income. For 2006, the make-whole payment represented approximately $0.017 per share. C. Note Issuances In September 2007, we issued $550 million in aggregate principal amount of 6.75% senior unsecured notes due 2019 (the “2019 Notes”). The price to the investor for the 2019 Notes was 99.827% of the principal amount for an effective yield of 6.772%. The net proceeds of approximately $544.4 million from this offering were used to fund certain property acquisitions, repay borrowings under our acquisition credit facility and for general corporate purposes, including additional property acquisitions. 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 for general corporate purposes and to redeem the outstanding $110 million 7.75% unsecured notes due May 2007 (the “2007 Notes”), which were issued in May 1997. 36 6. COMMON STOCK OFFERINGS A. In September 2008, we issued 2.925 million shares of 2007, we paid twelve monthly dividends to holders of our Class E preferred stock totaling $1.725 per share, or $15.2 million. common stock at a price of $26.82 per share. The net proceeds In January 2007, we paid the first Class E preferred dividend of of approximately $74.4 million were used, along with our $0.178125 per share, which covered a period of 38 days. available cash on hand, to redeem the $100 million outstanding principal amount of our 2008 Notes in November 2008. 8. DISTRIBUTIONS PAID AND PAYABLE A. Common Stock B. In October and November 2006, we issued an aggregate of We pay monthly distributions to our common stockholders. The 6.9 million shares of common stock at a price of $26.40 per following is a summary of monthly distributions paid per common share. The net proceeds of approximately $173.2 million were share for the years: used to fund new property acquisitions and for other general corporate purposes. C. In September 2006, we issued 4.715 million shares of common stock at a price of $24.32 per share. The net proceeds of approximately $109 million from this offering were used to fund new property acquisitions, repay borrowings under our credit facility and for other general corporate purposes. D. In March 2006, we issued 5.2 million shares of common stock at a price of $24.39 per share. The net proceeds of approximately $120.5 million were used to fund new property acquisitions and for other general corporate purposes. 7. PREFERRED STOCK A. In 2004, we issued 5.1 million shares of 7.375% Monthly Income Class D cumulative redeemable preferred stock. The net proceeds of $123.8 million from this issuance were used to Month January February March April May June July August September October November December 2008 2007 2006 $ 0.136750 $ 0.126500 $ 0.116250 0.136750 0.136750 0.137375 0.137375 0.137375 0.138000 0.138000 0.140500 0.141125 0.141125 0.141125 0.126500 0.126500 0.127125 0.127125 0.127125 0.127750 0.127750 0.135500 0.136125 0.136125 0.136125 0.116250 0.116250 0.116875 0.116875 0.116875 0.117500 0.117500 0.125250 0.125875 0.125875 0.125875 Total $ 1.662250 $ 1.560250 $ 1.437250 The following presents the federal income tax characterization of distributions paid or deemed to be paid per common share for redeem a portion of the outstanding Class B and Class C preferred stock, repay borrowings outstanding under our acquisition credit the years: facility and for other general corporate purposes. Beginning May 27, 2009, the Class D preferred shares are redeemable, at our option, for $25 per share. During 2008, 2007 and 2006, Ordinary income $ 1.2681285 $ 1.3847719 $ 1.2945466 2008 2007 2006 Nontaxable we paid twelve monthly dividends to holders of our Class D distributions 0.3121490 0.1754781 0.1427034 preferred stock totaling $1.8437508 per share, or $9.4 million, Capital gain 0.0819725 — — and at December 31, 2008 a monthly dividend of $0.1536459 per share was payable and was paid in January 2009. Totals $ 1.6622500 $ 1.5602500 $ 1.4372500 At December 31, 2008, a distribution of $0.14175 per common share was payable and was paid in January 2009. At December 31, 2007, a distribution of $0.13675 per common share was payable and was paid in January 2008. B. In 2006, we issued 8.8 million shares of 6.75% Monthly Income Class E cumulative redeemable preferred stock. The net proceeds of $214 million from this issuance were used to repay borrowings under our credit facility and for other general corporate purposes. Beginning December 7, 2011, the Class E preferred shares are redeemable, at our option, for $25 per share. During 2008, we paid twelve monthly dividends to holders of our Class E preferred stock totaling $1.6875 per share, or $14.9 million, and at December 31, 2008 a monthly dividend of $0.140625 per share was payable and was paid in January 2009. During 37 B. Class D Preferred Stock Dividends of $0.1536459 per share are paid monthly in arrears 9. OPERATING LEASES A. At December 31, 2008, we owned 2,348 properties in on the Class D preferred stock. We declared dividends to holders 49 states, plus an additional five properties owned by Crest. Of of our Class D preferred stock totaling $9.4 million in 2008, the 2,348 properties, 2,337, or 99.5%, are single-tenant, retail $9.4 million in 2007, and $9.8 million in 2006. properties and the remaining 11 are multi-tenant properties. At The following presents the federal income tax characterization December 31, 2008, 70 properties were vacant and available of dividends paid per share to our Class D preferred stockholders for lease or sale. for the years: 2008 2007 2006 Substantially all leases are net leases where the tenant pays property taxes and assessments, maintains the interior and exterior of the building and leased premises, and carries Ordinary income $ 1.7528280 $ 1.8437508 $ 1.8437508 insurance coverage for public liability, property damage, fire and Capital gain 0.0909228 — — extended coverage. Totals $ 1.8437508 $ 1.8437508 $ 1.8437508 Rent based on a percentage of a tenants’ gross sales (percentage rents) for 2008 was $1.3 million, for 2007 was $851,000 and for 2006 was $1.1 million, including amounts recorded to discontinued operations. At December 31, 2008, minimum future annual rents to be received on the operating leases for the next five years and there- after are as follows (dollars in thousands): C. Class E 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 $14.9 million in 2008, $14.9 million in 2007 and $1.6 million in 2006. The first Class E dividend was paid in January 2007. The following presents the federal income tax characterization of dividends paid per share to our Class E preferred stockholders 2009 2010 2011 2012 2013 2008 2007 $ 1.6042824 $ 1.7250000 Thereafter 0.0832176 — Total $ 1.6875000 $ 1.7250000 $ 318,175 307,087 297,390 285,142 269,336 2,416,358 $ 3,893,488 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, 2008, 2007 or 2006. I think I saw him on CNBC once. for the years: Ordinary income Capital gain Totals Everything is just fine . . . 38 10. GAIN ON SALES OF REAL ESTATE ACQUIRED FOR RESALE BY CREST In 2008, Crest sold 25 properties for $50.7 million, which discontinued operations. Additionally, we received proceeds of $439,000 from the sale of excess land from one property, which resulted in a gain of $236,000. This gain is included in “other resulted in a gain of $4.6 million. As part of two sales during revenue” on our consolidated statements of income because this 2008, Crest provided partial financing to the buyers of $19.2 million. excess land was associated with a property that continues to be In 2007, Crest sold 62 properties for $123.6 million, which owned as part of our core operations. resulted in a gain of $12.3 million. In 2007, as part of two sales, In 2007, we sold ten investment properties for $7.0 million, Crest provided partial financing to the buyer of $3.8 million, of which resulted in a gain of $1.7 million. The results of operations which $619,000 was paid in full in November 2007. In 2006, for these properties have been reclassified as discontinued Crest sold 13 properties for $22.4 million, which resulted in a operations. In addition, we sold excess land and improvements gain of $2.2 million. Partial buyer financing of $1.3 million, from five properties for an aggregate of $4.4 million, which related to one 2005 property sale, was paid in full in February resulted in a gain of $1.8 million. This gain from the land and 2006. Crest’s gains on sales are reported before income taxes and improvements sales is reported in “other revenue” on our are included in discontinued operations. 11. GAIN ON SALES OF INVESTMENT PROPERTIES BY REALTY INCOME In 2008, we sold 29 investment properties for an aggregate of consolidated statements of income because these improvements and excess land were associated with properties that continue to be owned as part of our core operations. In 2006, we sold or exchanged 13 investment properties for $10.7 million, which resulted in a gain of $3.0 million which is $27.4 million, which resulted in a gain of $13.3 million. The included in discontinued operations. results of operations for these properties have been reclassified as 12. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement No. 157 defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, and establishes a framework for measuring fair value. Statement No. 157 also establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement. This statement applies to fair value measurements and disclosures that are already required or permitted by most existing FASB accounting standards. We believe that the carrying values reflected in the consolidated balance sheets, at December 31, 2008 and 2007, respectively, reasonably approximate the fair values for cash and cash equivalents, accounts receivable, and all liabilities, due to their short-term nature, except for the notes payable and the notes receivable issued in conjunction with Crest property sales, which are disclosed below (dollars in millions): At December 31, 2008 Notes receivable issued in conjunction with Crest property sales Notes payable At December 31, 2007 Notes receivable issued in conjunction with Crest property sales Notes payable Carrying value per balance sheet $ 22.3 $ 1,370.0 Carrying value per balance sheet $ 3.1 $ 1,470.0 Estimated fair market value $ 21.9 $ 949.4 Estimated fair market value $ 2.8 $ 1,412.5 The estimated fair value of the notes receivable issued in conjunction with Crest property sales has been calculated by discounting the future cash flows using an interest rate based upon the current 7-year or 10-year Treasury Yield Curve plus an applicable credit- adjusted spread. Because this methodology includes unobservable inputs that reflect our own internal assumptions and calculations, the measurement of fair value related to these notes receivable issued in conjunction with Crest property sales is categorized as level 3 on the three-level valuation hierarchy as defined by Statement No. 157. 39 The estimated fair value of the notes payable is based upon These asset retirement obligations account for the difference the closing market price per note or indicative price per note. between our obligations to the landlord under the two land leases Because these note prices represent inputs that are less observ- and our subtenant’s obligations to us under the subleases. able by the public and are not necessarily reflected in active markets, the measurement of the fair value related to these notes G. In connection with the acquisition of seven properties during payable is categorized as level 2 on the three-level valuation 2007, we acquired restricted escrow funds totaling $2.6 million. hierarchy as defined by Statement No. 157. During the remainder of 2007, all of these funds were invested in improvements to these properties. 13. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Interest paid in 2008 was $90.3 million, H. In 2006, we exchanged one of our properties for a different in 2007 was property that was leased to the same tenant. As part of this trans- $56.7 million and in 2006 was $52.4 million. action, accumulated depreciation was reduced by $67,000 and Interest capitalized to properties under development in a gain of $67,000 was recorded. The original cost of and the 2008 was $92,000, in 2007 was $993,000 and in 2006 was value received for the property exchanged was $900,000. This $2.2 million. transaction had no impact on land or building and improvements. Income taxes paid by Realty Income and Crest in 2008 were $1.7 million, in 2007 were $4.3 million and in 2006 were I. In 2006, we received shares of a public company as settle- $775,000. ment of a bankruptcy claim associated with a former tenant. We recorded a value of $207,000, which is in “other revenue” on our The following non-cash investing and financing activities are 2006 consolidated income statement. The shares were sold in included in the accompanying consolidated financial statements: January 2007. A. Share-based compensation expense for 2008 was $5.0 million, J. Accrued costs on properties under development resulted in an for 2007 was $3.9 million and for 2006 was $3.0 million. increase in buildings and improvements and accounts payable of $1.7 million in 2006. B. See “Provisions for Impairment” in note 2 for a discussion of impairments recorded by Realty Income and Crest. K. In 2004, we recorded an impairment of $716,000 on one property to reduce its carrying value to zero. This loss was the C. In 2008, Crest sold two properties for $23.5 million and result of a dispute with the original owner and tenant in their received notes totaling $19.2 million from the buyers, which are bankruptcy proceeding. Our title insurance company failed to included in “other assets” on our consolidated balance sheet at timely record the deed on this property upon our original acqui- December 31, 2008. sition, which resulted in a claim by the bankruptcy trustee that Realty Income did not have legal title to the property. In the D. In 2007, Crest sold two properties for an aggregate of second quarter of 2006, this issue was resolved and we obtained $5.5 million and received notes totaling $3.8 million from title to the property. At that time we reinstated the original the buyers, of which $619,000 was paid in full in November carrying value adjusted for depreciation on our balance sheet 2007. The remaining note is included in “other assets” on and recorded other revenue of $716,000. We also reversed our consolidated balance sheets at December 31, 2008 and accrued liabilities and property expenses of $133,000 associated December 31, 2007. with this property. As part of the settlement, these costs became the responsibility of the title insurance company. E. At December 31, 2008, Realty Income has escrow deposits of $3.2 million held for tax-deferred exchanges under Section 1031 of the Tax Code. The $3.2 million is included in “other assets” on 14. EMPLOYEE BENEFIT PLAN We have a 401(k) plan covering substantially all of our our consolidated balance sheet at December 31, 2008. employees. Under our 401(k) plan, employees may elect to make F. In accordance with FASB Statement No. 143, Accounting for compensation, subject to limits under the IRS Code. We match Asset Retirement Obligations, we recorded an additional $335,000 50% of our employee’s contributions, up to 3% of the employee’s in 2008 of estimated legal obligations related to asset retire- compensation. Our aggregate matching contributions each year ment obligations on two land leases and an additional $239,000 have been immaterial to our results of operations. in 2007 of estimated legal obligations on these two land leases. contributions to the plan up to a maximum of 60% of their 40 15. COMMON STOCK INCENTIVE PLAN In 2003, our Board of Directors adopted, and stockholders approved, the 2003 Incentive Award Plan of Realty Income Corporation (the “Stock Plan”) to enable us to attract and retain the services of directors, employees and consultants, considered essential to our long-term success. The Stock Plan offers our directors, employees and consultants an opportunity to own stock in Realty Income and/or 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 and in May 2007. Under the terms of this plan, the aggregate number of shares of our common stock subject to options, stock purchase rights (SPR), stock 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 2008 was $5.0 million, during 2007 was $3.9 million and during 2006 was $3.0 million. No stock options were granted after January 1, 2002 and all outstanding options were fully vested as of December 31, 2006. 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 vested over service periods of one, three, four or five years. The following table summarizes our stock option activity for the years: 2008 2007 2006 Number of shares 45,007 (23,713) — Weighted average exercise price $ 12.71 12.15 — Number of shares 106,368 (61,361) — Weighted average exercise price $ 13.06 13.32 — Number of shares 135,348 (28,696) (284) Weighted average exercise price $ 13.02 12.86 14.70 Outstanding options, beginning of year Options exercised Options forfeited Outstanding and exercisable options, end of year 21,294 $ 13.33 45,007 $ 12.71 106,368 $ 13.06 At December 31, 2008, the options outstanding and exercisable had exercise prices ranging from $11.78 to $14.70, with a weighted average price of $13.33, and expiration dates ranging from May 2009 to December 2011 with a weighted average remaining term of 3.8 years. 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 exercise price of the option. The market value of the Company’s stock was $23.15, $27.02 and $27.70 at December 31, 2008, 2007 and 2006, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was $319,000, $904,000 and $268,000, respectively. The total intrinsic value of options vested during the year ended December 31, 2006 was $143,000. The aggregate intrinsic value of options outstanding and exercisable was $209,000, $644,000 and $1.6 million at December 31, 2008, 2007 and 2006, respectively. The following table summarizes our common stock grant activity under our Stock Plan for the years 2008, 2007 and 2006. Our common stock grants vest over periods ranging from immediately to 10 years. Outstanding nonvested shares, beginning of year Shares granted Shares vested Shares forfeited 2008 2007 2006 Number of shares 994,572 249,447 (188,215) (61,351) Weighted average price (1) $ 19.46 26.63 21.96 22.13 Number of shares 868,726 276,631 (149,284) (1,501) Weighted average price (1) $ 17.96 27.64 20.94 24.81 Number of shares 788,722 210,332 (125,879) (4,449) Weighted average price (1) $ 17.83 21.72 20.39 21.35 Outstanding nonvested shares, end of year 994,453 $ 19.70 994,572 $ 19.46 868,726 $ 17.96 (1) Grant date fair value. 41 During 2008, we issued 249,447 shares of common stock In addition, after they have been employed for six full months, under our Stock Plan. These shares vest over the following service all non-executive employees receive 200 shares of nonvested periods: 24,350 vested immediately, 16,000 vest over a service stock which vests over a five year period. period of one year, 156 vest over a service period of two years, As of December 31, 2008, the remaining unamortized share- 12,000 vest over a service period of three years, 3,681 vest over based compensation expense totaled $19.6 million, which is being a service period of four years, 92,553 vest over a service period of amortized on a straight-line basis over the service period of each five years and 100,707 vest over a service period of 10 years. applicable award. The amount of share-based compensation is The vesting schedule for shares granted to non-employee based on the fair value of the stock at the grant date. We define directors is as follows: the grant date as the date the recipient and Realty Income have • Shares vest in 33.33% increments on each of the first a mutual understanding of the key terms and condition of the three anniversaries of the date the shares of stock are award and the recipient of the grant begins to benefit from, or granted to directors with less than six years of service at be adversely affected by, subsequent changes in the price of the date of grant; the shares. • Shares vest in 50% increments on each of the first two The effect of pre-vesting forfeitures on our recorded expense anniversaries of the date the shares of stock are granted has historically been negligible. Any future pre-vesting forfeitures to directors with six years of service at the date of grant; are also expected to be negligible and we will record the benefit • Shares are 100% vested on the first anniversary of the related to such forfeitures as they occur. Under the terms of our date the shares of stock are granted to directors with seven Stock Plan, we pay non-refundable dividends to the holders of our years of service at the date of grant; and nonvested shares. Under Statement No. 123R, the dividends • There is immediate vesting as of the date the shares of paid to holders of these nonvested shares should be charged as stock are granted to directors with eight or more years of compensation expense to the extent that they relate to nonvested service at the date of grant. shares that do not or are not expected to vest. Given the negligi- ble historical and prospective forfeiture rate determined by us, The vesting schedule for shares granted to employees in 2008 we did not record any amount to compensation expense related to is as follows: dividends paid in 2008, 2007 or 2006. Somehow if the check keeps showing up every month, I think we are all going to be ok. • For employees age 49 and below at the grant date, shares vest in 10% increments on each of the first ten anniver- saries of the grant date; • For employees age 50 through 55 at the grant date, shares vest in 20% increments on each of the first five anniver- saries of the grant date; • For employees age 56 at the grant date, shares vest in 25% increments on each of the first four anniversaries of the grant date; • For employees age 57 at the grant date, shares vest in 33.33% increments on each of the first three anniver- saries of the grant date; • For employees age 58 at the grant date, shares vest in 50% increments on each of the first two anniversaries of the grant date; • For employees age 59 at the grant date, shares are 100% vested on the first anniversary of the grant date; and • For employees age 60 and above at the grant date, shares vest immediately on the grant date. 42 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 31 industry and activity segments (including properties owned by Crest that are grouped together as a segment). 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, 2008 (dollars in thousands): Assets, as of December 31: Segment net real estate: Automotive service Automotive tire services Child care Convenience stores Drug stores Health and fitness Home furnishings Home improvement Motor vehicle dealerships Restaurants Theaters 20 non-reportable segments Total segment net real estate Other intangible assets – Automotive tire service Other intangible assets – Drug stores Other intangible assets – Grocery stores Other intangible assets – Theaters Goodwill – Automotive service Goodwill – Child care Goodwill – Convenience stores Goodwill – Home furnishings Goodwill – Restaurants Goodwill – non reportable segments Other corporate assets Total assets 2008 2007 $ 106,581 $ 110,100 208,770 85,120 472,588 145,919 167,658 51,910 57,664 105,087 751,466 299,690 409,700 212,747 90,757 408,119 100,154 169,109 55,503 59,497 101,887 776,715 267,413 472,254 2,862,153 2,824,255 706 6,727 911 2,190 1,338 5,353 2,074 1,557 3,779 3,105 765 6,988 962 2,496 1,338 5,353 2,074 1,557 3,779 3,105 104,286 $ 2,994,179 224,680 $ 3,077,352 I don’t understand this currency thing. Toyota’s prices go down and BMW’s go up? I think it means somebody had a Yen for a Deutschmark. 43 For the Years Ended For the Years Ended December 31, Segment rental revenue (1): Automotive service Automotive tire services Child care Convenience stores Drug stores Health and fitness Home furnishings Home improvement Motor vehicle dealerships Restaurants Theaters 20 non-reportable segments Total rental revenue Other revenue Total revenue 2008 Revenue 2007 2006 $ 15,819 $ 15,051 $ 16,415 22,165 24,848 52,027 13,323 18,390 7,879 6,108 10,358 71,508 29,640 56,201 328,266 1,934 $ 330,200 21,235 23,895 40,727 7,830 14,874 7,786 6,116 9,540 59,585 26,121 55,205 287,965 6,352 $ 294,317 14,501 24,207 38,283 6,986 10,212 7,629 7,127 7,890 26,945 22,905 52,274 235,374 2,042 $ 237,416 (1) Crest’s revenue appears in “income from discontinued operations, real estate acquired for resale by Crest” and is not included in this table, which covers revenue but does not include revenue classified as part of income from discontinued operations. 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, 2008, we have committed $208,000 under construction contracts. These costs are expected to be paid in the next six months. In addition, we also have contingent payments for tenant improvements and leasing costs of $977,000. We have certain properties that are subject to ground leases which are accounted for as operating leases. At December 31, 2008, minimum future rental payments for the next five years and thereafter are as follows (dollars in thousands): 2009 2010 2011 2012 2013 Thereafter Total Ground Leases Paid by Realty Income (1) $ 92 82 69 69 69 900 $ 1,281 Ground Leases Paid by Our Tenants (2) $ 3,791 3,680 3,667 3,563 3,420 40,801 $ 58,922 Total $ 3,883 3,762 3,736 3,632 3,489 41,701 $ 60,203 (1) Realty Income currently pays the ground lessors directly for the rent under the ground leases. A majority of this rent is reimbursed to Realty Income as additional rent from our tenants. (2) Our tenants, who are generally sub-tenants under the ground leases, are responsible for paying the rent under these ground leases. In the event a tenant fails to pay the ground lease rent, we are primarily responsible. 44 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S C o n s o l i d a t e d Q u a r t e r l y F i n a n c i a l D a t a (dollars in thousands, except per share data) (not covered by Report of Independent Registered Public Accounting Firm) Dividends paid per common share 0.410250 0.412125 0.416500 0.423375 0.24 0.27 0.29 0.27 1.06 1.66225 2008 (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 Net income per common share: Basic and diluted 2007 (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 Net income per common share: Basic and diluted First Quarter Second Quarter Third Quarter Fourth Quarter Year (2) $ 82,776 $ 82,177 $ 82,521 $ 82,726 $ 330,200 23,386 22,848 7,188 29,354 407 29,761 23,929 22,080 7,237 28,931 4,120 33,051 23,915 22,869 7,170 28,567 6,130 34,697 22,726 22,935 7,071 29,994 4,338 34,332 93,956 90,732 28,666 116,846 14,995 131,841 23,698 26,988 28,634 28,269 107,588 $ 70,642 $ 70,030 $ 73,530 $ 80,115 $ 294,317 12,420 17,956 6,193 34,073 2,250 36,323 13,029 18,349 7,148 31,504 5,432 36,936 16,163 19,433 7,442 30,492 3,481 33,973 22,719 20,948 6,774 29,674 3,502 33,176 64,331 76,686 27,557 125,743 14,666 140,409 30,260 30,873 27,910 27,113 116,156 Dividends paid per common share 0.379500 0.381375 0.391000 0.408375 0.30 0.31 0.28 0.27 1.16 1.56025 (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. All he said is that he wanted to be where his portfolio is now. 45 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S R e p o r t o f P u b l i c A c c o u n t i n g F i r m I n d e p e n d e n t R e g i s t e r e d The Board of Directors and Stockholders Realty Income Corporation: We have audited the accompanying consolidated balance sheets reliability of financial reporting and the preparation of financial of Realty Income Corporation and subsidiaries as of December 31, statements for external purposes in accordance with generally 2008 and 2007, and the related consolidated statements of accepted accounting principles. A company’s internal control over income, stockholders’ equity, and cash flows for each of the years financial reporting includes those policies and procedures that in the three-year period ended December 31, 2008. We have (1) pertain to the maintenance of records that, in reasonable also audited Realty Income Corporation’s internal control over detail, accurately and fairly reflect the transactions and dispo- financial reporting as of December 31, 2008, based on criteria sitions of the assets of the company; (2) provide reasonable established in Internal Control-Integrated Framework issued by assurance that transactions are recorded as necessary to permit the Committee of Sponsoring Organizations of the Treadway preparation of financial statements in accordance with generally Commission (COSO). Realty Income Corporation’s management is accepted accounting principles, and that receipts and expendi- responsible for these consolidated financial statements, for tures of the company are being made only in accordance with maintaining effective internal control over financial reporting, and authorizations of management and directors of the company; for its assessment of the effectiveness of internal control over and (3) provide reasonable assurance regarding prevention or financial reporting, included in the accompanying Management’s timely detection of unauthorized acquisition, use, or disposition Report on Internal Control Over Financial Reporting. Our respon- of the company’s assets that could have a material effect on the sibility is to express an opinion on these consolidated financial financial statements. statements and on Realty Income Corporation’s internal control Because of its inherent limitations, internal control over over financial reporting based on our audits. financial reporting may not prevent or detect misstatements. Also, We conducted our audits in accordance with the standards of projections of any evaluation of effectiveness to future periods are the Public Company Accounting Oversight Board (United States). subject to the risk that controls may become inadequate because Those standards require that we plan and perform the audits to of changes in conditions, or that the degree of compliance with obtain reasonable assurance about whether the financial state- the policies or procedures may deteriorate. ments are free of material misstatement and whether effective In our opinion, the consolidated financial statements referred internal control over financial reporting was maintained in all to above present fairly, in all material respects, the financial material respects. Our audits of the consolidated financial state- position of Realty Income Corporation and subsidiaries as of ments included examining, on a test basis, evidence supporting December 31, 2008 and 2007, and the results of their operations the amounts and disclosures in the financial statements, assess- and their cash flows for each of the years in the three-year period ing the accounting principles used and significant estimates ended December 31, 2008, in conformity with U.S. generally made by management, and evaluating the overall financial state- accepted accounting principles. Also in our opinion, Realty ment presentation. Our audit of internal control over financial Income Corporation maintained, in all material respects, effective reporting included obtaining an understanding of internal control internal control over financial reporting as of December 31, over financial reporting, assessing the risk that a material weak- 2008, based on criteria established in Internal Control-Integrated ness exists, and testing and evaluating the design and operating Framework issued by the Committee of Sponsoring Organizations effectiveness of internal control based on the assessed risk. Our of the Treadway Commission. audits also included performing such procedures as we consid- ered necessary in the circumstances. We believe that our audits / provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a San Diego, California process designed to provide reasonable assurance regarding the February 10, 2009 46 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S B u s i n e s s D e s c r i p t i o n THE COMPANY Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate In addition, at December 31, 2008, our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had an inventory of five properties with a carrying value of $6.0 million, which are investment trust, or REIT. Our primary business objective is to classified as held for sale. Crest was created to buy and sell generate dependable monthly cash distributions from a consistent properties, primarily to individual investors who are involved in and predictable level of funds from operations, or FFO per share. tax-deferred exchanges under Section 1031 of the Internal Our monthly distributions are supported by the cash flow from our Revenue Code of 1986, as amended (the “Tax Code”). We portfolio of retail properties leased to regional and national retail anticipate Crest will not acquire any properties in 2009. chains. We have in-house acquisition, leasing, legal, retail and We typically acquire retail store properties under long-term real estate research, portfolio management and capital markets leases with retail chain store operators. These transactions expertise. Over the past 39 years, Realty Income and its prede- generally provide capital to owners of retail real estate and retail cessors have been acquiring and owning freestanding retail chains for expansion or other corporate purposes. Our acquisition properties that generate rental revenue under long-term lease and investment activities are concentrated in well-defined target agreements (primarily 15 to 20 years). markets and generally focus on retail chains providing goods and In addition, we seek to increase distributions to common services that satisfy basic consumer needs. stockholders and FFO per share through both active portfolio Our net-lease agreements generally: management and the acquisition of additional properties. Our • Are for initial terms of 15 to 20 years; portfolio management focus includes: • Contractual rent increases on existing leases; • Require the tenant to pay minimum monthly rent and property operating expenses (taxes, insurance and • Rent increases at the termination of existing leases, when maintenance); and market conditions permit; and • Provide for future rent increases based on increases in • The active management of our property portfolio, including the consumer price index (typically subject to ceilings), re-leasing vacant properties, and selectively selling fixed increases, or to a lesser degree, additional rent properties, thereby mitigating our exposure to certain calculated as a percentage of the tenants’ gross sales tenants and markets. above a specified level. In acquiring additional properties, we adhere to a focused We commenced operations as a REIT on August 15, 1994 strategy of primarily acquiring properties that are: • Freestanding, single-tenant, retail locations; through the merger of 25 public and private real estate limited partnerships. Each of the partnerships was formed between 1970 • Leased to regional and national retail chains; and and 1989 for the purpose of acquiring and managing long-term, • Leased under long-term, net-lease agreements. net-leased properties. The eight senior officers of Realty Income owned 1.2% of our At December 31, 2008, we owned a diversified portfolio: outstanding common stock with a market value of $25.9 million at • Of 2,348 retail properties; February 9, 2009. The directors and eight senior officers of Realty • With an occupancy rate of 97.0%, or 2,278 properties Income, as a group, owned 2.5% of our outstanding common stock occupied of the 2,348 properties in the portfolio; with a market value of $52.1 million at February 9, 2009. • With only 70 properties available for lease; Our common stock is listed on The New York Stock Exchange • Leased to 119 different retail chains doing business in (“NYSE”) under the ticker symbol “O” with a cusip number of 30 separate retail industries; • Located in 49 states; 756109-104. Our central index key number is 726728. Our Class D cumulative redeemable preferred stock is listed • With over 19.1 million square feet of leasable space; and on the NYSE under the ticker symbol “OprD” with a cusip number • With an average leasable retail space per property of of 756109-609. approximately 8,130 square feet. Our Class E cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprE” with a cusip number Of the 2,348 properties in the portfolio, 2,337, or 99.5%, are of 756109-708. single-tenant, retail properties and the remaining 11 are multi- In February 2009, we had 69 permanent employees as tenant, distribution and office properties. At December 31, 2008, compared to 75 permanent employees in February 2008. 2,268 of the 2,337 single-tenant properties were leased with a weighted average remaining lease term (excluding extension options) of approximately 11.9 years. 47 We maintain an Internet website at www.realtyincome.com. Our 2008 portfolio acquisitions were lower than in recent years On our website we make available, free of charge, copies of our primarily due to uncertainty in the commercial retail real estate annual report on Form 10-K, quarterly reports on Form 10-Q, market. Property prices continued to decline and lease rates rose current reports on Form 8-K, and amendments to those reports, throughout 2008. We continue to monitor the acquisition market as soon as reasonably practicable after we electronically file these carefully and will acquire properties for long-term investment when reports with the Securities and Exchange Commission, or SEC. we believe the transactions are accretive to our shareholders. None of the information on our website is deemed to be part of The initial weighted average contractual lease rate is this report. RECENT DEVELOPMENTS Increases in Monthly Distributions to Common Stockholders We continue our 39-year policy of paying distributions monthly. 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 Monthly distributions per share increased in January 2009 by the payment of contractual rent, we cannot assure you that the $0.000625 to $0.14175. The increase in January 2009 was actual return on the funds invested will remain at the percentages our 45th consecutive quarterly increase and the 52nd increase listed above. in the amount of our dividend since our listing on the NYSE in 1994. In 2008, we paid three monthly cash distributions per share in the amount of $0.13675, three in the amount of Investments in Existing Properties In 2008, we capitalized costs of $2.8 million on existing $0.137375, two in the amount of $0.138, one in the amount properties in our portfolio, consisting of $956,000 for re-leasing of $0.1405 and three in the amount of $0.141125, totaling costs and $1.5 million for building improvements. $1.66225. In December 2008 and January 2009, we declared distributions of $0.14175 per share, which were paid in January 2009 and will be paid in February 2009, respectively. $355 Million Acquisition Credit Facility In May 2008, we entered into a new $355 million acquisition The monthly distribution of $0.14175 per share represents a credit facility which replaced our existing $300 million acquisi- current annualized distribution of $1.701 per share, and an tion credit facility that was scheduled to expire in October 2008. annualized distribution yield of approximately 8.4% based on The term of the new credit facility is for three years until May the last reported sale price of our common stock on the NYSE of 2011, plus two, one-year extension options. Under the new credit $20.19 on February 9, 2009. Although we expect to continue our facility, our investment grade credit ratings provide for financing policy of paying monthly distributions, we cannot guarantee that at the London Interbank Offered Rate, commonly referred to as we will maintain our current level of distributions, that we will LIBOR, plus 100 basis points with a facility fee of 27.5 basis continue our pattern of increasing distributions per share, or what points, for all-in drawn pricing of 127.5 basis points over LIBOR. our actual distribution yield will be in any future period. We also have other interest rate options available to us. Acquisitions During 2008 During 2008, Realty Income invested $189.6 million in 108 new Issuance of Common Stock In September 2008, we issued 2,925,000 shares of common retail properties and properties under development with an initial stock at a price of $26.82 per share. The net proceeds of weighted average contractual lease rate of 8.7%. $181.4 million $74.4 million were used, along with our available cash on hand, of these acquisitions occurred in the first quarter of 2008 while to repay the $100 million outstanding principal amount of only $8.2 million was invested during the remainder of 2008. our 8.25% Monthly Income Senior Notes (“2008 Notes”) in These 108 properties are located in 14 states, contain over November 2008 and the $20 million outstanding principal 714,000 leasable square feet, and are 100% leased with an amount of our 8% Notes (“2009 Notes”) in January 2009. average lease term of 20.6 years. The 108 new properties acquired by Realty Income are net-leased to eight different retail chains in the following seven industries: automotive tire service, Note Redemptions In November 2008, we redeemed the $100 million outstanding convenience store, drug store, financial services, motor vehicle principal amount of our 2008 Notes. In January 2009, we dealership, restaurant and theater. There were no acquisitions by redeemed the $20 million outstanding principal amount of our Crest in 2008. 48 2009 Notes. The 2008 Notes and 2009 Notes were redeemed at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest. We now have no debt maturities until 2013. Retirement of Chairman of the Board of Directors William E. Clark, our previous non-executive chairman, retired Crest’s Property Inventory Crest’s had an inventory of five properties with a carrying value from the Board of Directors effective February 10, 2009. Our of $6.0 million at December 31, 2008, which is included in “real Corporate Governance and Nominating Committee recommended, estate held for sale, net” on our consolidated balance sheet. and the Board of Directors elected, Donald R. Cameron as the new non-executive chairman effective upon Mr. Clark’s retirement. Mr. Cameron has served on Realty Income’s Board of Directors DISTRIBUTION POLICY Distributions are paid monthly to our common, Class D preferred since 1994, and has been Realty Income’s lead independent and Class E preferred stockholders if, and when, declared by our director since May 2004. Board of Directors. In order to maintain our tax status as a REIT for federal Net Income Available to Common Stockholders Net income available to common stockholders was $107.6 million income tax purposes, we generally are required to distribute dividends to our stockholders aggregating annually at least 90% in 2008 versus $116.2 million in 2007, a decrease of $8.6 million. of our REIT taxable income (determined without regard to the On a diluted per common share basis, net income was $1.06 per share in 2008 as compared to $1.16 per share in 2007. dividends paid deduction and excluding net capital gains), and we are subject to income tax to the extent we distribute less than The calculation to determine net income available to common 100% of our REIT taxable income (including net capital gains). stockholders includes gains from the sales of properties. The In 2008, our cash distributions totaled $193.9 million, or amount of gains varies from period to period based on the timing approximately 122.7% of our estimated REIT taxable income of of property sales and can significantly impact net income $158.0 million. Our estimated REIT taxable income reflects available to common stockholders. non-cash deductions for depreciation and amortization. Our The gain recognized during 2008 from the sales of investment estimated REIT taxable income is presented to show our compli- properties and from the additional proceeds received from a sale ance with REIT distribution requirements and is not a measure of excess land was $13.6 million, as compared to a $3.6 million of our liquidity or performance. gain recognized from the sales of investment properties and We intend to continue to make distributions to our stock- excess land during 2007. holders that are sufficient to meet this distribution requirement and that will reduce our exposure to income taxes. Our 2008 cash Funds from Operations (FFO) In 2008, our FFO decreased by $4.2 million, or 2.2%, to distributions to common stockholders totaled $169.7 million, representing 91.5% of our funds from operations available to $185.5 million versus $189.7 million in 2007. On a diluted per common stockholders of $185.5 million. common share basis, FFO was $1.83 in 2008 compared to $1.89 in 2007, a decrease of $0.06, or 3.2%. See our discussion of FFO in the section entitled “Manage- ment’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report, which includes a reconciliation of net income available to common stockholders to FFO. Crest’s Property Sales During 2008, Crest sold 25 properties from its inventory for an aggregate of $50.7 million, which resulted in a gain of $4.6 million. Crest’s gains are included in “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. I think this is gonna be my definition of an early retirement. 49 The Class D preferred stockholders receive cumulative distributions at a rate of 7.375% per annum on the $25 per share liquidation preference (equivalent to $1.84375 per annum per BUSINESS PHILOSOPHY AND STRATEGY Investment Philosophy We believe that owning an actively managed, diversified portfolio share). The Class E preferred stockholders receive cumulative of retail properties under long-term, net leases produces consistent distributions at a rate of 6.75% per annum on the $25 per and predictable income. Net leases typically require the tenant to share liquidation preference (equivalent to $1.6875 per annum be responsible for monthly rent and property operating expenses per share). including property taxes, insurance and maintenance. In addition, Future distributions will be at the discretion of our Board of tenants are typically responsible for future rent increases based on Directors and will depend on, among other things, our results of increases in the consumer price index (typically subject to ceilings), operations, FFO, cash flow from operations, financial condition fixed increases or, to a lesser degree, additional rent calculated and capital requirements, the annual distribution requirements as a percentage of the tenants’ gross sales above a specified level. under the REIT provisions of the Tax Code, our debt service We believe that a portfolio of properties under long-term leases, requirements and any other factors the Board of Directors may coupled with the tenant’s responsibility for property expenses, deem relevant. In addition, our credit facility contains financial covenants that could limit the amount of distributions payable generally produces a more predictable income stream than many other types of real estate portfolios, while continuing to offer the by us in the event of a deterioration in our results of operations potential for growth in rental income. or financial condition, and which prohibit the payment of distributions on the common or preferred stock in the event that we fail to pay when due (subject to any applicable grace period) Investment Strategy In identifying new properties for acquisition, our focus is generally any principal or interest on borrowings under our credit facility. on providing capital to retail chain owners and operators by Distributions of our current and accumulated earnings and acquiring, then leasing back, retail store locations. We catego- profits for federal income tax purposes generally will be taxable to rize retail tenants as: 1) venture market, 2) middle market, and stockholders as ordinary income, except to the extent that we 3) upper market. Venture companies typically offer a new retail recognize capital gains and declare a capital gains dividend, or concept in one geographic region of the country and operate that such amounts constitute “qualified dividend income” between five and 50 retail locations. Middle market retail chains subject to a reduced tax rate. The maximum tax rate of non- typically have 50 to 500 retail locations, operations in more than corporate taxpayers for “qualified dividend income” has generally one geographic region, have been successful through one or more been reduced to 15% (until it “sunsets” or reverts to the economic cycles, and have a proven, replicable concept. The provisions of prior law, which under current law will occur with upper market retail chains typically consist of companies with respect to taxable years beginning after December 31, 2010). In 500 or more locations, operating nationally, in a proven, mature general, dividends payable by REITs are not eligible for the retail concept. Upper market retail chains generally have strong reduced tax rate on corporate dividends, except to the extent the operating histories and access to several sources of capital. REIT’s dividends are attributable to dividends received from We primarily focus on acquiring properties leased to middle taxable corporations (such as our taxable REIT subsidiary, Crest), market retail chains that we believe are attractive for investment to income that was subject to tax at the corporate or REIT level because: (for example, if we distribute taxable income that we retained and • They generally have overcome many of the operational paid tax on in the prior taxable year) or, as discussed above, and managerial obstacles that can adversely affect venture dividends properly designated by us as “capital gain dividends.” retailers; Distributions in excess of earnings and profits generally will be • They typically require capital to fund expansion but have treated as a non-taxable reduction in the stockholders’ basis in more limited financing options than upper market retail their stock. Distributions above that basis, generally, will be chains; taxable as a capital gain to stockholders who hold their shares as • They generally have provided us with attractive risk- a capital asset. Approximately 18.8% of the distributions to our adjusted returns over time since their financial strength common stockholders, made or deemed to have been made in has, in many cases, tended to improve as their businesses 2008, were classified as a return of capital for federal income have matured; tax purposes. We are unable to predict the portion of future • Their relatively large size allows them to spread corporate distributions that may be classified as a return of capital. expenses across a greater number of stores; and • Middle market retailers typically have the critical mass to survive if a number of locations are closed due to under- performance. 50 We also focus on, and have selectively made investments in, We believe the principal financial obligations of most retailers properties of upper market retail chains. We believe upper market typically include their bank and other debt, payment obligations retail chains can be attractive for investment because: to suppliers and real estate lease obligations. Because we • They typically are of a higher credit quality; typically own the land and building in which a tenant conducts its • They usually are larger public and private retailers with retail business, we believe the risk of default on a retailers’ lease more commonly recognized brand names; obligations is less than the retailers’ unsecured general obliga- • They utilize a larger building ranging in size from 10,000 tions. It has been our experience that since retailers must retain to 50,000 square feet; and their profitable retail locations in order to survive, in the event of • They are able to grow because access to capital facilitates reorganization they are less likely to reject a lease for a profitable larger transaction sizes. location because this would terminate their right to use the property. Thus, as the property owner, we believe we will fare While our investment strategy focuses primarily on acquiring better than unsecured creditors of the same retailer in the event properties leased to middle and upper market retail chains, we of reorganization. If a property is rejected by the tenant during also selectively seek investment opportunities with venture reorganization, we own the property and can either lease it to a market retail chains. Periodically, venture market opportunities new tenant or sell the property. In addition, we believe that the arise where we feel that the real estate used by the tenant is high risk of default on the real estate leases can be further mitigated quality and can be purchased at favorable prices. To meet our by monitoring the performance of the retailers’ individual unit stringent investment standards, however, venture retail companies locations and considering whether to sell locations that are must have a well-defined retailing concept and strong financial weaker performers. prospects. These opportunities are examined on a case by case In order to qualify for inclusion in our portfolio, new property basis and we are highly selective in making investments in acquisitions must meet stringent investment and credit require- this area. ments. The properties must generate attractive current yields Historically, our investment focus has been on retail indus- and the tenant must meet our credit profile. We have established tries that have a service component because we believe the lease a three-part analysis that examines each potential investment revenue from these types of businesses is more stable. Because based on: of this investment focus, for the quarter ended December 31, • Industry, company, market conditions and credit profile; 2008, approximately 83.2% of our rental revenue was derived • Store profitability, if profitability data is available; and from retailers with a service component in their business. • Overall real estate characteristics, including property value Furthermore, we believe these service-oriented businesses would and comparative rental rates. be difficult to duplicate over the Internet and that our proper- ties continue to perform well relative to competition from The typical profile of companies whose properties have Internet businesses. been approved for acquisition are those with 50 or more retail Credit Strategy We generally provide sale-leaseback financing to less than invest- locations. Generally the properties: • Are located in highly visible areas; • Have easy access to major thoroughfares; and ment grade retail chains. We typically acquire and lease back • Have attractive demographics. properties to regional and national retail chains and believe that within this market we can achieve an attractive risk-adjusted return on the financing we provide to retailers. Since 1970, our overall weighted average occupancy rate at the end of each year has been 98.4%, and the occupancy rate at the end of each year has never been below 97%. 51 Acquisition Strategy We seek to invest in industries in which several, well-organized, Portfolio Management Strategy The active management of the property portfolio is an essential regional and national retail chains are capturing market share component of our long-term strategy. We continually monitor our through service, quality control, economies of scale, advertising portfolio for any changes that could affect the performance of and the selection of prime retail locations. We execute our the industries, tenants and locations in which we have invested. acquisition strategy by acting as a source of capital to regional We also regularly analyze our portfolio with a view toward and national retail chain store owners and operators, doing optimizing its returns and enhancing its credit quality. Our business in a variety of industries, by acquiring and leasing back executives review industry research, tenant research, property due retail store locations. We undertake thorough research and diligence and significant portfolio management activities. This analysis to identify appropriate industries, tenants and property monitoring typically includes regular review and analysis of: locations for investment. Our research expertise is instrumental to • The performance of various retail industries; and uncovering net-lease opportunities in markets where our real • The operation, management, business planning and estate financing program adds value. In selecting real estate for financial condition of the tenants. potential investment, we generally seek to acquire properties that have the following characteristics: We have an active portfolio management program that • Freestanding, commercially-zoned property with a single incorporates the sale of assets when we believe the reinvestment tenant; of the sale proceeds will generate higher returns, enhance the • Properties that are important retail locations for regional credit quality of our real estate portfolio, or extend our average and national retail chains; remaining lease term. At December 31, 2008, we classified real • Properties that we deem to be profitable for the retailers; estate with a carrying amount of $6.7 million as held for sale on • Properties that are located within attractive demographic our balance sheet, which includes $6.0 million for properties areas relative to the business of their tenants, with high owned by Crest. Additionally, we anticipate selling investment visibility and easy access to major thoroughfares; and properties in our portfolio that have not yet been specifically • Properties that can be purchased with the simultaneous identified, from which we anticipate receiving between $10 million execution or assumption of long-term, net-lease agree- and $35 million in proceeds during the next 12 months. We ments, offering both current income and the potential for intend to invest these proceeds into new property acquisitions. rent increases. However, we cannot guarantee that we will sell properties during Tell me, o swami, what 2 investment rules work in every market? The ball says, #1, it is always something and, #2, you never know. 52 the next 12 months. Universal Shelf Registration In April 2006, we filed a shelf registration statement with the SEC, which is effective for a term of three years. In accordance 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 combina- tion of such securities. We 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. There is no specific limit to the dollar amount of new securities that can be issued under this shelf registration before it expires in April 2009, and our common stock, preferred stock and notes issued after April 2006 were all issued pursuant to this universal shelf registration statement. Our plan is to file a new shelf registration statement prior to April 2009, when our existing shelf registration state- ment expires. Conservative Capital Structure We believe that our stockholders are best served by a conservative We expect to use our credit facility to acquire additional retail properties and for other corporate purposes. Any additional capital structure. Therefore, we seek to maintain a conservative borrowings will increase our exposure to interest rate risk. We debt level on our balance sheet and solid interest and fixed have the right to request an increase in the borrowing capacity charge coverage ratios. At February 9, 2009, our total outstanding of the credit facility up to $100 million, to a total borrowing borrowings were $1.35 billion of senior unsecured notes, or approx- capacity of $455 million. Any increase in the borrowing capacity imately 35.5% of our total market capitalization of $3.80 billion. is subject to the approval of our credit facility’s lending banks. We had no borrowings on our $355 million credit facility. We use our credit facility for the short-term financing of We define our total market capitalization at February 9, 2009 new property acquisitions. When outstanding borrowings under as the sum of: the credit facility reach a certain level (generally in the range of • Shares of our common stock outstanding of 104,319,051 $100 million to $200 million) and capital is available on accept- multiplied by the last reported sales price of our common able terms, we generally seek to refinance those borrowings with stock on the NYSE of $20.19 per share on February 9, the net proceeds of long-term or permanent financing, which may 2009, or $2.11 billion; include the issuance of common stock, preferred stock, convert- • Aggregate liquidation value (par value of $25 per share) ible preferred stock, debt securities or convertible debt securities. of the Class D preferred stock of $127.5 million; We cannot assure you, however, that we will be able to obtain • Aggregate liquidation value (par value of $25 per share) any such refinancing or that market conditions prevailing at of the Class E preferred stock of $220 million; and the time of refinancing will enable us to issue equity or debt • Outstanding notes of $1.35 billion. securities upon acceptable terms. Historically, we have met our long-term capital needs through the issuance of common stock, preferred stock and long-term Credit Agency Ratings We are currently assigned investment grade corporate credit unsecured notes and bonds. Over the long term, we believe that ratings on our senior unsecured notes. Fitch Ratings has assigned common stock should be the majority of our capital structure, a rating of BBB+, Moody’s Investors Service has assigned a rating however, we may issue additional preferred stock or debt of Baa1 and Standard & Poor’s Ratings Group has assigned a securities from time to time. We may issue common stock when rating of BBB to our senior notes. All of these ratings have we believe that our share price is at a level that allows for the “stable” outlooks. proceeds of any offering to be accretively invested into additional We have also been assigned credit ratings on our preferred properties. In addition, we may issue common stock to stock. Fitch Ratings has assigned a rating of BBB, Moody’s has permanently finance properties that were financed by our credit assigned a rating of Baa2 and Standard & Poor’s has assigned a facility or debt securities. However, we cannot assure you that rating of BB+ to our preferred stock. All of these ratings have we will have access to the capital markets at terms that are “stable” outlooks. acceptable to us. The credit ratings assigned to us could change based upon, among other things, our results of operations and financial $355 Million Acquisition Credit Facility In May 2008, we entered into a new $355 million revolving, condition. These ratings are subject to ongoing evaluation by credit rating agencies and we cannot assure you that our ratings unsecured credit facility which replaced our existing $300 million will not be changed or withdrawn by a rating agency in the future acquisition credit facility that was scheduled to expire in October if, in its judgment, circumstances warrant. Moreover, a rating is 2008. The term of the new credit facility is for three years until not a recommendation to buy, sell or hold our debt securities, May 2011, plus two, one-year extension options. Under the new preferred stock or common stock. credit facility, our investment grade credit ratings provided for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 100 basis points with a facility fee of 27.5 basis points, for all-in drawn pricing of 127.5 basis points over LIBOR. We also have other interest rate options available to us. At February 9, 2009, we had a borrowing capacity of $355 million available on our new credit facility and no outstanding balance. Mortgage Debt We have no mortgage debt on any of our properties. 53 No Off-Balance Sheet Arrangements or Unconsolidated Investments We have no unconsolidated or off-balance sheet investments in • INVESTMENT IN NEW RETAIL INDUSTRIES: Though we specialize in single-tenant properties, we will seek to further diversify our portfolio among a variety of retail “variable interest entities” or off-balance sheet financing, nor do industries. We believe diversification will allow us to invest we engage in trading activities involving energy or commodity in retail industries that currently are growing and have contracts or other derivative instruments. characteristics we find attractive. These characteristics As we have no joint ventures, off-balance sheet entities, or include, but are not limited to, retail industries that are mandatory redeemable preferred stock, our financial position or dominated by local store operators where regional and results of operations are currently not affected by Financial national chain store operators can increase market share Accounting Standards Board Interpretation No. 46R, Consolida- and dominance by consolidating local operators and tion of Variable Interest Entities and Statement of Financial streamlining their operations, as well as capitalizing on Accounting Standards No. 150, Accounting for Certain Financial major demographic shifts in a population base. Instruments with Characteristics of both Liabilities and Equity. • DIVERSIFICATION: Diversification of the portfolio by retail Competitive Strategy We believe that to successfully pursue our investment philosophy industry type, tenant, and geographic location is key to our objective of providing predictable investment results for our stockholders; therefore, further diversification of our and strategy, we must seek to maintain the following competitive portfolio is a continuing objective. At December 31, 2008, advantages: our retail property portfolio consisted of 2,348 properties • SIZE AND TYPE OF INVESTMENT PROPERTIES: We believe located in 49 states, leased to 119 retail chains doing smaller ($500,000 to $10,000,000) net-leased retail business in 30 industry segments. Each of the 30 industry properties represent an attractive investment opportunity segments, represented in our property portfolio, individu- in today’s real estate environment. Due to the complexities ally accounted for no more than 20.8% of our rental of acquiring and managing a large portfolio of relatively revenue for the quarter ended December 31, 2008. small assets, we believe these types of properties have • MANAGEMENT SPECIALIZATION: We believe that our not experienced significant institutional ownership interest management’s specialization in single-tenant retail or the corresponding yield reduction experienced by larger properties, operated under net-lease agreements, is income-producing properties. We believe the less intensive important to meeting our objectives. We plan to maintain day-to-day property management required by net-lease this specialization and will seek to employ and train agreements, coupled with the active management of a high-quality professionals in this specialized area of real large portfolio of smaller properties, is an effective invest- estate ownership, finance and management. ment strategy. The tenants of our freestanding retail • TECHNOLOGY: We intend to stay at the forefront of properties generally provide goods and services that satisfy technology in our efforts to efficiently and economically basic consumer needs. In order to grow and expand, they carry out our operations. We maintain sophisticated generally need capital. Since the acquisition of real estate information systems that allow us to analyze our portfolio’s is typically the single largest capital expenditure of many performance and actively manage our investments. We of these retailers, our method of purchasing the property believe that technology and information-based systems will and then leasing it back, under a net-lease arrangement, play an increasingly important role in our competitiveness allows the retail chain to free up capital. as an investment manager and source of capital to a variety of industries and tenants. 54 Description of Leasing Structure At December 31, 2008, 2,268 of our 2,348 retail properties were Certain Properties under Development Of the 108 properties Realty Income acquired in 2008, four were leased under net-lease agreements. Our net-lease agreements development properties, all of which were occupied and paying rent generally: at December 31, 2008. In the case of development properties, we • Are for initial terms of 15 to 20 years; either enter into an agreement with a retail chain where the retailer • Require the tenant to pay minimum monthly rents and property retains a contractor to construct the building and we fund the operating expenses (taxes, insurance and maintenance); and costs of that development, or we fund a developer who constructs • Provide for future rent increases based on increases in the the building. In either case, there is an executed lease with a consumer price index (typically subject to ceilings), fixed retail tenant at the time of the land purchase (with a fixed rent increases, or to a lesser degree, additional rent calculated commencement date) and there is a requirement to complete the as a percentage of the tenants’ gross sales above a speci- construction in a timely basis and within a specific budget, typically fied level. Where leases provide for rent increases based on within eight months after we purchase the land. The tenant or increases in the consumer price index, generally these developer generally is required to pay construction cost overruns increases become part of the new permanent base rent. Where leases provide for percentage rent, this additional to the extent that they exceed the construction budget by more than a predetermined amount. We also enter into a lease with the tenant rent is typically payable only if the tenants’ gross sales, at the time we purchase the land, which generally requires the for a given period (usually one year), exceed a specified tenant to begin paying base rent when the store opens for business. level and is then typically calculated as a percentage of The base rent is calculated by multiplying a predetermined only the amount of gross sales in excess of that level. capitalization rate by our total investment in the property including I am restocking shelves for the new era in investing. the land cost for the property, construction costs and capitalized interest. Crest did not acquire any development property in 2008. Both Realty Income and Crest will continue to pursue develop- ment opportunities under similar arrangements in the future. 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, 2008. UNRESOLVED STAFF COMMENTS There are no unresolved staff comments. 55 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S P r o p e r t i e s At December 31, 2008, we owned a diversified portfolio: At December 31, 2008, 2,268 of our 2,348 retail properties • Of 2,348 retail properties; were leased under net-lease agreements. A net lease typically • With an occupancy rate of 97.0%, or 2,278 properties requires the tenant to be responsible for minimum monthly rent occupied of the 2,348 properties in the portfolio; and property operating expenses including property taxes, • With only 70 properties available for lease; insurance and maintenance. In addition, our tenants are typically • Leased to 119 different retail chains doing business in responsible for future rent increases based on increases in 30 separate retail industries; • Located in 49 states; the consumer price index (typically subject to ceilings), fixed increases or, to a lesser degree, additional rent calculated as a • With over 19.1 million square feet of leasable space; and percentage of the tenants’ gross sales above a specified level. • With an average leasable retail space per property of Our net-leased retail properties primarily are leased to regional approximately 8,130 square feet. and national retail chain store operators. Most buildings are In addition to our real estate portfolio, our subsidiary, Crest modate peak retail traffic periods. The properties tend to be on had an inventory of five properties located in five states at major thoroughfares with relatively high traffic counts, adequate December 31, 2008. These properties have a carrying value of access and proximity to a sufficient population base to consti- $6.0 million and are classified as held for sale. tute a suitable market or trade area for the retailer’s business. single-story structures with adequate parking on site to accom- It says here a recession is two or more quarters of declining economic activity. I think a recession is when a decline in economic activity causes you to have two or less quarters. 56 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: 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 Distribution and office 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 For the Quarter Ended December 31, 2008 Percentage of Rental Revenue (1) For the Years Ended Dec 31, 2008 Dec 31, 2007 Dec 31, 2006 Dec 31, 2005 Dec 31, 2004 Dec 31, 2003 1.1% 1.1% 1.2% 1.7% 1.6% 1.8% 2.1% 1.0 1.6 4.7 6.8 0.2 * 7.5 0.8 1.0 1.6 4.8 6.7 0.2 * 7.6 0.8 1.1 2.1 5.2 7.3 0.2 0.1 8.4 0.9 16.4 15.8 14.0 0.3 1.0 4.2 1.2 0.2 0.3 0.8 0.7 5.7 2.6 1.8 3.1 1.0 0.9 0.8 0.3 1.0 4.1 1.2 0.2 0.2 0.8 0.7 5.6 2.4 1.9 3.1 1.0 0.8 0.8 0.3 0.6 2.7 1.4 0.2 0.2 0.7 0.7 5.1 2.6 2.1 3.1 1.1 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 3.4 1.3 1.1 0.8 20.8 21.8 21.2 11.9 — 2.3 9.1 0.2 1.0 1.9 — 2.3 9.0 0.2 1.1 1.9 — 2.6 9.0 0.2 1.7 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 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 11.8 0.9 3.8 4.1 0.3 3.3 3.8 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% *Less than 0.1% (1) Includes rental revenue for all properties owned by Realty Income at the end of each period presented, including revenue from properties reclassified as discontinued operations. 57 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, 2008, 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 Distribution and office 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 Number of Properties Rental Revenue for the Quarter Ended December 31, 2008 (1) Percentage of Rental Revenue 13 235 263 8 3 13 26 7 34 9 611 26 155 1 574 3 3 21 10 642 1 32 1,468 6 51 2 13 5 51 33 9 44 29 10 2 14 269 2,348 $ 852 1.0% 3,908 6,201 999 158 209 4,685 631 7,507 1,557 26,707 510 5,647 13 13,518 847 108 2,603 666 17,217 187 829 42,145 902 842 156 686 242 3,481 694 577 2,127 1,420 788 43 1,877 4.7 7.5 1.2 0.2 0.3 5.7 0.8 9.1 1.9 32.4 0.6 6.8 * 16.4 1.0 0.1 3.1 0.8 20.8 0.2 1.0 50.8 1.1 1.0 0.2 0.8 0.3 4.2 0.8 0.7 2.6 1.7 1.0 0.1 2.3 13,835 $ 82,687 16.8 100.0% * Less than 0.1% (1) Includes rental revenue for all properties owned by Realty Income at December 31, 2008, including revenue from properties reclassified as discontinued operations of $44. 58 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 lease term expirations (excluding extension options) on our 2,268 net leased, single-tenant retail properties as of December 31, 2008 (dollars in thousands): Total Portfolio Initial Expirations (3) Subsequent Expirations (4) Rental Revenue for the Quarter Ended of Leases December 31, 2008 (2) Expiring (1) Number % of Total Rental Revenue 148 102 105 113 140 55 108 114 49 42 100 82 170 101 245 62 70 122 152 82 45 20 27 2 7 2 2 1 $ 3,084 3.9% 2,197 3,137 2,681 5,316 2,125 2,857 2,015 1,894 1,888 4,856 2,987 7,503 2,951 7,754 1,815 5,466 6,866 4,622 4,009 1,099 924 649 57 422 230 354 13 2.7 3.9 3.3 6.7 2.7 3.6 2.5 2.4 2.4 6.1 3.7 9.4 3.7 9.7 2.3 6.9 8.6 5.8 5.0 1.4 1.2 0.8 0.1 0.5 0.3 0.4 * Rental Revenue for the Quarter Ended of Leases December 31, 2008 Expiring Number % of Total Rental Revenue Rental Revenue for the Quarter Ended of Leases December 31, 2008 Expiring Number % of Total Rental Revenue 36 48 57 75 99 36 85 112 41 34 94 79 169 100 243 62 66 120 151 80 45 20 27 2 7 2 2 — $ 787 1.0% 112 $ 2,297 2.9% 1,227 2,055 1,864 4,329 1,780 2,318 1,987 1,745 1,689 4,526 2,923 7,448 2,903 7,680 1,815 5,398 6,809 4,605 3,938 1,099 924 649 57 422 230 354 — 1.5 2.6 2.3 5.4 2.2 2.9 2.5 2.2 2.1 5.7 3.6 9.3 3.6 9.6 2.3 6.8 8.5 5.8 4.9 1.4 1.2 0.8 0.1 0.5 0.3 0.4 — 54 48 38 41 19 23 2 8 8 6 3 1 1 2 — 4 2 1 2 — — — — — — — 1 970 1,082 817 987 345 539 28 149 199 330 64 55 48 74 — 68 57 17 71 — — — — — — — 13 1.2 1.3 1.0 1.3 0.5 0.7 * 0.2 0.3 0.4 0.1 0.1 0.1 0.1 — 0.1 0.1 * 0.1 — — — — — — — * 2,268 $ 79,771 100.0% 1,892 $ 71,561 89.5% 376 $ 8,210 10.5% Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2037 2043 Totals * Less than 0.1% (1) Excludes ten multi-tenant properties and 70 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 $44 from properties reclassified as discontinued operations and excludes revenue of $2,916 from ten multi-tenant properties and from 70 vacant and unleased properties at December 31, 2008. (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. 59 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, 2008 (dollars in thousands): Approximate Leasable Square Feet Rental Revenue for the Quarter Ended December 31, 2008 (1) Percentage of Rental Revenue State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine 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 Number of Properties 63 2 80 18 64 53 24 17 168 132 13 74 82 22 33 22 33 3 29 66 52 21 71 62 2 19 15 14 33 8 40 96 6 137 25 18 99 3 100 9 135 214 5 4 104 35 2 20 1 Percent Leased 98% 100 98 100 100 96 100 100 98 98 92 97 96 95 94 100 94 100 97 100 98 100 97 97 100 100 93 100 100 100 95 99 100 98 96 100 100 100 98 100 96 92 80 100 99 91 100 90 100 425,400 128,500 395,800 98,500 1,160,700 486,300 276,600 33,300 1,449,300 926,900 85,400 877,800 689,600 296,100 579,100 110,600 190,400 22,500 271,200 580,400 257,300 392,100 347,600 640,100 30,000 196,300 191,000 109,900 261,300 56,400 502,700 548,300 36,600 852,200 145,900 297,300 683,800 11,000 374,400 24,900 635,500 2,241,700 30,600 12,700 637,100 230,300 23,000 248,100 4,200 $ 1,893 277 2,418 417 4,505 1,902 1,310 428 6,786 3,992 338 4,211 3,213 1,006 1,121 673 877 161 1,587 2,618 1,243 1,572 1,478 2,076 76 645 883 557 1,930 191 2,493 2,865 73 3,377 582 885 3,527 57 2,190 102 2,920 7,814 87 125 3,496 792 121 774 23 $ 82,687 2.3% 0.3 2.9 0.5 5.4 2.3 1.6 0.5 8.2 4.8 0.4 5.1 3.9 1.2 1.4 0.8 1.1 0.2 1.9 3.2 1.5 1.9 1.8 2.5 0.1 0.8 1.1 0.7 2.3 0.2 3.0 3.5 0.1 4.1 0.7 1.1 4.3 0.1 2.6 0.1 3.5 9.5 0.1 0.2 4.2 1.0 0.1 0.9 * 100.0% 2,348 97% 19,106,700 * Less than 0.1% (1) Includes rental revenue for all properties owned by Realty Income at December 31, 2008, including revenue from properties reclassified as discontinued operations of $44. 60 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S F o r w a r d - L o o k i n g S t a t e m e n t s This annual report contains forward-looking statements within the Additional factors that may cause risks and uncertainties meaning of Section 27A of the Securities Act of 1933 and include those discussed in the sections entitled “Business”, “Risk Section 21E of the Exchange Act of 1934. When used in this Factors” and “Management’s Discussion and Analysis of Financial annual report, the words “estimated”, “anticipated”, “expect”, Condition and Results of Operations” in this annual report. “believe”, “intend” and similar expressions are intended to Readers are cautioned not to place undue reliance on forward- identify forward-looking statements. Forward-looking statements looking statements, which speak only as of the date that this are subject to risks, uncertainties, and assumptions about Realty annual report was filed with the SEC. We undertake no obligation Income Corporation, including, among other things: to publicly release the results of any revisions to these forward- • Our anticipated growth strategies; looking statements that may be made to reflect events or • Our intention to acquire additional properties and the circumstances after the date of this annual report or to reflect the timing of these acquisitions; occurrence of unanticipated events. In light of these risks and • Our intention to sell properties and the timing of these uncertainties, the forward-looking events discussed in this annual property sales; report might not occur. • Our intention to re-lease vacant properties; • Anticipated trends in our business, including trends in the market for long-term net-leases of freestanding, single- tenant retail properties; • Future expenditures for development projects; and • Profitability of our subsidiary, Crest Net Lease, Inc. (“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; • Continued volatility and uncertainty in the credit markets and broader financial markets; • Other risks inherent in the real estate business including tenant defaults, potential liability relating to environmental matters, illiquidity of real estate investments, and potential damages from natural disasters; • Impairments in the value of our real estate assets; • Changes in the tax laws of the United States of America; • The outcome of any legal proceedings to which we are a party; and • Acts of terrorism and war. It says here they are bringing “Jeopardy” back on TV as a financial show. 61 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S M a n a g e m e n t ’ s D i s c u s s i o n a n d A n a l y s i s o f F i n a n c i a l C o n d i t i o n a n d R e s u l t s o f O p e r a t i o n s GENERAL Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate LIQUIDITY AND CAPITAL RESOURCES Cash Reserves We are organized to operate as an equity REIT that acquires and investment trust, or REIT. Our primary business objective is to leases properties and distributes to stockholders, in the form of generate dependable monthly cash distributions from a consistent monthly cash distributions, a substantial portion of our net cash and predictable level of funds from operations, or FFO per share. flow generated from leases on our retail properties. We intend The monthly distributions are supported by the cash flow from our to retain an appropriate amount of cash as working capital. At portfolio of retail properties leased to regional and national retail December 31, 2008, we had cash and cash equivalents totaling chains. We have in-house acquisition, leasing, legal, retail $46.8 million. We used $20 million of this amount to retire our research and real estate research, portfolio management and 8.0% notes that matured in January 2009. capital markets expertise. Over the past 39 years, Realty Income We believe that our cash and cash equivalents on hand, cash and its predecessors have been acquiring and owning freestanding retail properties that generate rental revenue under long-term lease provided from operating activities and borrowing capacity is sufficient to meet our liquidity needs for the foreseeable future. agreements (primarily 15 to 20 years). We intend, however, to use additional sources of capital to fund In addition, we seek to increase distributions to stockholders property acquisitions and to repay future borrowings under our and FFO per share through both active portfolio management credit facility. and the acquisition of additional properties. At December 31, 2008, we owned a diversified portfolio: • Of 2,348 retail properties; $355 Million Acquisition Credit Facility In May 2008, we entered into a new $355 million revolving, • With an occupancy rate of 97.0%, or 2,278 properties unsecured credit facility which replaced our existing $300 million occupied of the 2,348 properties in the portfolio; acquisition credit facility that was scheduled to expire in October • With only 70 properties available for lease; 2008. The term of the new credit facility is for three years until • Leased to 119 different retail chains doing business in May 2011, plus two, one-year extension options. Under the new 30 separate retail industries; • Located in 49 states; credit facility, our investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly • With over 19.1 million square feet of leasable space; and referred to as LIBOR, plus 100 basis points with a facility fee of • With an average leasable retail space per property of 27.5 basis points, for all-in drawn pricing of 127.5 basis points approximately 8,130 square feet. over LIBOR. We also have other interest rate options available to us. At February 9, 2009, we had a borrowing capacity of Of the 2,348 properties in the portfolio, 2,337, or 99.5%, are $355 million available on our new credit facility and no single-tenant, retail properties and the remaining 11 are multi- outstanding balance. tenant properties. At December 31, 2008, 2,268 of the 2,337 We expect to use the credit facility to acquire additional retail single-tenant properties were leased with a weighted average properties and for other corporate purposes. Any additional remaining lease term (excluding extension options) of approxi- borrowings will increase our exposure to interest rate risk. We mately 11.9 years. have the right to request an increase in the borrowing capacity In addition, at December 31, 2008, our wholly-owned taxable of the credit facility up to $100 million, to a total borrowing REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had an inventory capacity of $455 million. Any increase in the borrowing capacity of five properties with a carrying value of $6.0 million, which are is subject to approval by the lending banks on our credit facility. classified as held for sale. Crest was created to buy and sell properties, primarily to individual investors who are involved in tax-deferred exchanges under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Tax Code”). In addition to the five properties, Crest also holds notes receivable of $22.3 million at December 31, 2008. We anticipate Crest will not acquire any properties in 2009. 62 Issuance of Common Stock In September 2008, we issued 2,925,000 shares of common We define our total market capitalization at February 9, 2009 as the sum of: stock at a price of $26.82 per share. The net proceeds of • Shares of our common stock outstanding of 104,319,051 $74.4 million were used, along with our available cash on hand, multiplied by the last reported sales price of our common to repay the $100 million outstanding principal amount of stock on the NYSE of $20.19 per share on February 9, our 8.25% Monthly Income Senior Notes (“2008 Notes”) in 2009, or $2.11 billion; November 2008 and the $20 million outstanding principal • Aggregate liquidation value (par value of $25 per share) amount of our 8% Notes (“2009 Notes”) in January 2009. of the Class D preferred stock of $127.5 million; Note Redemptions In November 2008, we redeemed the $100 million outstanding principal amount of our 2008 Notes. In January 2009, we • Aggregate liquidation value (par value of $25 per share) of the Class E preferred stock of $220 million; and • Outstanding notes of $1.35 billion. redeemed the $20 million outstanding principal amount of our Historically, we have met our long-term capital needs through 2009 Notes. The 2008 Notes and 2009 Notes were redeemed at a redemption price equal to 100% of the principal amount, the issuance of common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that plus accrued and unpaid interest. We now have no debt maturities common stock should be the majority of our capital structure; until 2013. Mortgage Debt We have no mortgage debt on any of our properties. however, we may issue additional preferred stock or debt securi- ties from time 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 offering to be accretively invested into additional properties. In addition, we may issue common stock to perma- Universal Shelf Registration In April 2006, we filed a shelf registration statement with the SEC, nently finance properties that were financed by our credit facility or debt securities. However, we cannot assure you that we will which is effective for a term of three years. In accordance with the have access to the capital markets at terms that are acceptable SEC rules, the amount of securities to be issued pursuant to this to us. 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 Credit Agency Ratings We are currently assigned investment grade corporate credit securities. We may periodically offer one or more of these securities ratings on our senior unsecured notes. Fitch Ratings has assigned in amounts, prices and on terms to be announced when and if the a rating of BBB+, Moody’s Investors Service has assigned a rating securities are offered. The specifics of any future offerings, along of Baa1 and Standard & Poor’s Ratings Group has assigned with the use of proceeds of any securities offered, will be described a rating of BBB to our senior notes. All of these ratings have in detail in a prospectus supplement, or other offering materials, “stable” outlooks. at the time of any offering. There is no specific limit to the dollar We have also been assigned credit ratings on our preferred amount of new securities that can be issued under this shelf reg- stock. Fitch Ratings has assigned a rating of BBB, Moody’s has istration before it expires in April 2009, and our common stock, assigned a rating of Baa2 and Standard & Poor’s has assigned a preferred stock and notes issued after April 2006 were all issued rating of BB+ to our preferred stock. All of these ratings have pursuant to this universal shelf registration statement. Our plan is “stable” outlooks. to file a new shelf registration statement prior to April 2009, when The credit ratings assigned to us could change based upon, our existing shelf registration statement expires. Conservative Capital Structure We believe that our stockholders are best served by a conservative among other things, our results of operations and financial condition. These ratings are subject to ongoing evaluation by credit rating agencies and we cannot assure you that our ratings will not be changed or withdrawn by a rating agency in the future capital structure. Therefore, we seek to maintain a conservative if, in its judgment, circumstances warrant. Moreover, a rating debt level on our balance sheet and solid interest and fixed charge is not a recommendation to buy, sell or hold our debt securities, coverage ratios. At February 9, 2009, our total outstanding credit preferred stock or common stock. facility borrowings and outstanding notes were $1.35 billion or approximately 35.5% of our total market capitalization of $3.80 billion. 63 Notes Outstanding Our senior unsecured note obligations consist of the following as of December 31, 2008, sorted by maturity date (dollars in millions): 8% notes, issued in January 1999 and due in January 2009 (1) 5.375% notes, issued in March 2003 and due in March 2013 5.5% notes, issued in November 2003 and due in November 2015 5.95% notes, issued in September 2006 and due in September 2016 5.375% notes, issued in September 2005 and due in September 2017 6.75% notes, issued in September 2007 and due in August 2019 5.875% bonds, issued in March 2005 and due in March 2035 $ 20.0 100.0 150.0 275.0 175.0 550.0 100.0 $ 1,370.0 (1) In January 2009, the 8% notes were paid off and the balance of our outstanding notes was reduced to $1.35 billion. All of our outstanding notes and bonds have fixed interest rates. Interest on all of the senior note obligations is paid semiannually. All of these notes contain various covenants, including: (i) a limitation on incurrence of any debt which would cause our debt to total adjusted assets ratio to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause our secured debt to total adjusted assets ratio to exceed 40%; (iii) a limitation on incurrence of any debt which would cause our debt service coverage ratio to be less than 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. The following is a summary of the key financial covenants to our senior unsecured notes, as defined and calculated per the terms of our notes. These calculations, which are not based on GAAP measurements, are presented to investors to show our ability to incur additional debt under the terms of our notes only and are not measures of our liquidity or performance. The actual amounts as of December 31, 2008 are: Note Covenants Limitation on incurrence of total debt Limitation on incurrence of secured debt Debt service coverage (trailing 12 months) Maintenance of total unencumbered assets Required ≤ 60% ≤ 40% ≥ 1.5 x ≥ 150% of unsecured debt Actual 39.0% 0.0% 3.4 x 256% 64 The following table summarizes the maturity of each of our obligations as of December 31, 2008 (dollars in millions): Table of Obligations Year of Maturity 2009 2010 2011 2012 2013 Thereafter Totals Credit Facility (1) Notes (2) $ — $ 20.0 — — — — — — — — 100.0 1,250.0 $ — $ 1,370.0 Interest (3) $ 82.5 82.4 82.4 82.4 78.1 427.9 $ 835.7 Ground Leases Paid by Realty Income (4) $ 0.1 0.1 0.1 0.1 0.1 0.9 $ 1.4 Ground Leases Paid by Our Tenants (5) $ 3.8 3.7 3.7 3.6 3.4 40.8 $ 59.0 Other (6) $ 1.2 Totals $ 107.6 — — — — — 86.2 86.2 86.1 181.6 1,719.6 $ 1.2 $ 2,267.3 (1) There was no outstanding credit facility balance on February 9, 2009. (2) The $20.0 million outstanding principal amount of our 8% notes was paid off in January 2009. (3) Interest on the credit facility and notes has been calculated based on outstanding balances as of December 31, 2008 through their respective maturity dates. (4) Realty Income currently pays the ground lessors directly for the rent under the ground leases. A majority of this rent is reimbursed to Realty Income as additional rent from our tenants. (5) Our tenants, who are generally sub-tenants under the ground leases, are responsible for paying the rent under these ground leases. In the event a tenant fails to pay the ground lease rent, we are primarily responsible. (6) “Other” consists of $208,000 of commitments under construction contracts and $977,000 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. Dad, what’s an oxymoron? You know, 2 things that probably shouldn’t go together like jumbo shrimp, found missing, unbiased opinion, original copies, act naturally, real estate loan. 65 Preferred Stock Outstanding In 2004, we issued 5.1 million shares of 7.375% Class D The initial weighted average contractual lease rate is computed as estimated contractual net operating income (in a cumulative redeemable preferred stock. Beginning May 27, net-leased property that is equal to the base rent or, in the case of 2009, shares of Class D preferred stock are redeemable at our properties under development, the estimated base rent under option for $25 per share, plus any accrued and unpaid dividends. the lease) for the first year of each lease, divided by the estimated Dividends on shares of Class D preferred stock are paid monthly total costs. Since it is possible that a tenant could default on in arrears. the payment of contractual rent, we cannot assure you that the In December 2006, we issued 8.8 million shares of 6.75% actual return on the funds invested will remain at the percentages Class E cumulative redeemable preferred stock. Beginning listed above. December 7, 2011, shares of Class E preferred stock are redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class E preferred stock Increases in Monthly Distributions to Common Stockholders We continue our 39-year policy of paying distributions monthly. are paid monthly in arrears. Monthly distributions per share were increased in January 2009 by $0.000625 to $0.14175. The increase in January 2009 was No Off-Balance Sheet Arrangements or Unconsolidated Investments We have no unconsolidated or off-balance sheet investments in our 45th consecutive quarterly increase and the 52nd increase in the amount of our dividend since our listing on the New York Stock Exchange, or NYSE, in 1994. In 2008, we paid three “variable interest entities” or off-balance sheet financing, nor do monthly cash distributions per share in the amount of $0.13675, we engage in trading activities involving energy or commodity three in the amount of $0.137375, two in the amount of $0.138, contracts or other derivative instruments. one in the amount of $0.1405 and three in the amount of As we have no joint ventures, off-balance sheet entities, or $0.141125, totaling $1.66225. In December 2008 and January mandatory redeemable preferred stock, our financial position or 2009, we declared distributions of $0.14175 per share, which results of operations are currently not affected by Financial were paid in January 2009 and will be paid in February 2009, Accounting Standard Board Interpretation No. 46R, Consolida- respectively. tion of Variable Interest Entities and Statement of Financial The monthly distribution of $0.14175 per share represents a Accounting Standard No. 150, Accounting for Certain Financial current annualized distribution of $1.701 per share, and an Instruments with Characteristics of both Liabilities and Equity. annualized distribution yield of approximately 8.4% based on Acquisitions During 2008 During 2008, Realty Income invested $189.6 million in 108 new the last reported sale price of our common stock on the NYSE of $20.19 on February 9, 2009. Although we expect to continue our policy of paying monthly distributions, we cannot guarantee that retail properties and properties under development with an initial we will maintain our current level of distributions, that we will weighted average contractual lease rate of 8.7%. $181.4 million continue our pattern of increasing distributions per share, or what of these acquisitions occurred in the first quarter of 2008 while our actual distribution yield will be in any future period. only $8.2 million was invested during the remainder of 2008. These 108 properties are located in 14 states, contain over 714,000 leasable square feet, and are 100% leased with an average lease term of 20.6 years. The 108 new properties acquired by Realty Income are net-leased to eight different retail chains in the following seven industries: automotive tire service, convenience store, drug store, financial services, motor vehicle dealership, restaurant and theater. There were no acquisitions by Crest in 2008. Our 2008 portfolio acquisitions were lower than in recent years primarily due to uncertainty in the commercial retail real estate market. Property prices continued to decline and lease rates rose throughout 2008. We continue to monitor the acquisi- tion market carefully and will acquire properties for long-term investment when we believe the transactions are accretive to our shareholders. 66 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 The following is a comparison of our results of operations for the years ended December 31, 2008, 2007 and 2006. Rental Revenue Rental revenue was $328.3 million for 2008 versus our discussion and analysis of financial condition and results $288.0 million for 2007, an increase of $40.3 million, or 14.0%. of operations. Preparing our consolidated financial statements Rental revenue was $235.4 million in 2006. The increase in rental requires us to make a number of estimates and assumptions that revenue in 2008 compared to 2007 is primarily attributable to: affect the reported amounts and disclosures in the consolidated • The 108 retail properties acquired by Realty Income in financial statements. We believe that we have made these esti- 2008, which generated $13.1 million of rent in 2008; mates and assumptions in an appropriate manner and in a way • The 325 retail properties acquired by Realty Income that accurately reflects our financial condition. We continually in 2007, which generated $41.1 million of rent in test and evaluate these estimates and assumptions using our 2008 compared to $13.6 million in 2007, an increase of historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, $27.5 million; • Same store rents generated on 1,772 properties during actual results may differ from these estimates and assumptions. the entire years of 2008 and 2007, which includes rent In order to prepare our consolidated financial statements modifications on some of the 104 leases to Buffets, Inc., according to the rules and guidelines set forth by GAAP, many increased by $2.7 million, or 1.1%, to $258.7 million subjective judgments must be made with regard to critical from $255.9 million; and accounting policies. One of these judgments is our estimate for • An increase in straight-line rent and other non-cash useful lives in determining depreciation expense for our proper- adjustments to rent of $766,000 in 2008 as compared ties. Depreciation of buildings and improvements is generally to 2007; net of computed using the straight–line method over an estimated use- • A net decrease of $3.9 million relating to the aggregate ful life of 25 years. If we use a shorter or longer estimated useful of (i) development properties acquired before 2007 that life it could have a material impact on our results of operations. started paying rent in 2007, (ii) properties that were We believe that 25 years is an appropriate estimate of useful vacant during part of 2008 or 2007, (iii) properties sold life. No depreciation has been recorded on properties that are during 2008 and 2007 and (iv) lease termination settle- classified as held for sale. ments. These items totaled $13.24 million, in aggregate, When we acquire a property for investment purposes, we in 2008 compared to $17.18 million in 2007. allocate the purchase price to the various components of the acquisition based upon the fair value of each component. The Excluding 104 leases with Buffets Holdings, Inc., same store components typically include (i) land, (ii) building and improve- rents generated on 1,668 properties during the entire years of ments, (iii) intangible assets related to above and below market 2008 and 2007 increased in 2008 by $3.2 million, or 1.4%, to leases, and (iv) value of costs to obtain tenants. $237.1 million from $233.9 million in 2007. Another significant judgment must be made as to if, and Of the 2,348 properties in the portfolio at December 31, 2008, when, impairment losses should be taken on our properties when 2,337, or 99.5%, are single-tenant properties and the remaining events or a change in circumstances indicate that the carrying 11 are multi-tenant properties. Of the 2,337 single-tenant amount of the asset may not be recoverable. Generally, a provision properties, 2,268, or 97.0%, were net leased with a weighted is made for impairment loss if estimated future operating cash average remaining lease term (excluding rights to extend a flows (undiscounted and without interest charges) plus estimated lease at the option of the tenant) of approximately 11.9 years disposition proceeds (undiscounted) are less than the current at December 31, 2008. Of our 2,268 leased single-tenant book value. Impairment losses are measured as the amount by properties, 2,066 or 91.1% were under leases that provide for which the current book value of the asset exceeds the fair value of increases in rents through: the asset. If a property is held for sale, it is carried at the lower • Primarily base rent increases tied to a consumer price of carrying cost or estimated fair value, less cost to sell. The index (typically subject to ceilings); carrying value of our real estate is the largest component of our • Fixed increases; consolidated balance sheet. If events should occur that require • To a lesser degree, overage rent based on a percentage of us to reduce the carrying value of our real estate by recording the tenants’ gross sales; or provisions for impairment losses, it could have a material impact • A combination of two or more of the above rent provisions. on our results of operations. 67 Percentage rent, which is included in rental revenue, was 3% of our property portfolio will be unleased at any given time; $1.3 million in 2008, $831,000 in 2007 and $1.1 million in however, we cannot assure you that the number of properties 2006. Percentage rent in 2008 was less than 1% of rental available for lease will not exceed these levels. revenue and we anticipate percentage rent to be less than 1% of rental revenue in 2009. Our portfolio of retail real estate, leased primarily to regional Interest Expense Interest expense was $94.0 million in 2008 versus $64.3 million and national chains under net leases, continues to perform well in 2007 and $51.4 million in 2006. Interest expense increased and provide dependable lease revenue supporting the payment in 2008 primarily due to higher average senior notes outstand- of monthly dividends to our stockholders. At December 31, 2008, ing and, to a lesser extent, due to higher interest rates. We issued our portfolio of 2,348 retail properties was 97.0% leased with 70 $550 million of 12-year notes in September 2007, which properties available for lease, one of which is a multi-tenant contributed to the increase in average outstanding balances and property. higher average interest rates on our debt. As of February 9, 2009, transactions to lease or sell 13 of In May 2008, as a result of entering into our new credit the 70 properties available for lease at December 31, 2008 were facility, we incurred $3.2 million of credit facility origination underway or completed. We anticipate these transactions will be costs which were capitalized to other assets. Also, we expensed completed during the next several months, although we cannot $235,000 of unamortized credit facility origination costs from guarantee that all of these properties can be leased or sold within our prior credit facility, which are included in amortization of this period. It has been our experience that approximately 1% to credit facility origination costs in the table below. The following is a summary of the components of our interest expense (dollars in thousands): Interest on our credit facility and notes Interest included in discontinued operations from real estate acquired for resale by Crest Amortization of settlements on treasury lock agreement Credit facility commitment fees Amortization of credit facility origination costs and deferred bond financing costs Interest capitalized Interest expense 2008 $ 91,213 2007 $ 67,964 2006 $ 54,068 (1,797) 759 795 3,078 (92) (6,201) 870 456 2,235 (993) (3,708) 717 456 2,014 (2,184) $ 93,956 $ 64,331 $ 51,363 Credit facility and notes outstanding Average outstanding balances (dollars in thousands) Average interest rates 2008 $ 1,457,222 6.26% 2007 $ 1,111,914 6.11% 2006 $ 881,669 6.13% At February 9, 2009, the weighted average interest rate on our notes payable of $1.35 billion was 6.10% and the average interest rate on our credit line was 1.45%. There was no outstanding balance on our credit line at February 9, 2009. 68 Interest Coverage Ratio Our interest coverage ratio for 2008 was 3.2 times and for 2007 and 2006 was 4.1 times. Interest coverage ratio is calculated as: the interest coverage amount (as calculated in the following table) divided by interest expense, including interest recorded as 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 on our consolidated statements of cash flow 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) Proceeds from sales of real estate acquired for resale (1) Collection of a note receivable by Crest (1) Crest provisions for impairment (1) Gain on sales of real estate acquired for resale (1) Amortization of share-based compensation Changes in assets and liabilities: Accounts receivable and other assets Accounts payable, accrued expenses and other liabilities Interest coverage amount Divided by interest expense (2) Interest coverage ratio 2008 $ 246,155 93,956 1,797 1,230 225 9 (31,455) (87) (3,374) 4,642 (5,049) 930 (1,675) $ 307,304 $ 95,753 3.2 2007 $ 318,169 64,331 6,201 1,392 3,039 29,886 (119,790) (651) — 12,319 (3,857) 49 (21,675) $ 289,413 $ 70,532 4.1 2006 $ 86,945 51,363 3,708 747 494 113,166 (22,405) (1,333) (1,188) 2,219 (2,951) (4,418) (3,208) $ 223,139 $ 55,071 4.1 (1) Crest activities. (2) Includes interest expense recorded to “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. Fixed Charge Coverage Ratio Our fixed charge coverage ratio for 2008 was 2.6 times, for 2007 was 3.1 times and for 2006 was 3.4 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): Interest coverage amount Divided by interest expense plus preferred stock dividends (1) Fixed charge coverage ratio 2008 $ 307,304 $ 120,006 2.6 2007 $ 289,413 $ 94,785 3.1 2006 $ 223,139 $ 66,433 3.4 (1) Includes interest expense recorded to “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. 69 Depreciation and Amortization Depreciation and amortization was $90.7 million in 2008 versus Income Taxes Income taxes were $1.2 million in 2008 as compared to $76.7 million in 2007 and $58.8 million in 2006. The increases $1.4 million in 2007 and $747,000 in 2006. These amounts are in depreciation and amortization in 2008 and 2007 were due to for city and state income taxes paid by Realty Income. the acquisition of properties in 2008, 2007 and 2006, which was In addition, Crest incurred state and federal income taxes of partially offset by property sales in these years. As discussed in $225,000 in 2008 as compared to $3.0 million in 2007 and the section entitled “Funds from Operations Available to Common $494,000 in 2006. These amounts are included in “income from Stockholders,” depreciation and amortization is a non-cash item discontinued operations, real estate acquired for resale by Crest” that is excluded from our calculation of FFO. on our consolidated statements of income. General and Administrative Expenses General and administrative expenses decreased by $1.1 million to Loss on Extinguishment of Debt In September 2006, we redeemed all of our outstanding $21.6 million in 2008 as compared to $22.7 million in 2007. $110 million, 7.75%, unsecured notes due May 2007 (the General and administrative expenses were $17.5 million in 2006. In 2008, general and administrative expenses as a percentage “2007 Notes”). The 2007 Notes were redeemed at a redemp- tion price equal to 100% of the principal amount of the 2007 of total revenue were 6.5% as compared to 7.7% in 2007 and Notes, plus accrued and unpaid interest, as well as a make-whole 7.4% in 2006. General and administrative expenses decreased payment of $1.6 million. The make-whole payment was recorded during 2008 primarily due to decreases in employee costs. as a loss on extinguishment of debt on our 2006 consolidated In February 2009, we had 69 permanent employees as statement of income. For 2006, the make-whole payment compared to 75 permanent employees in February 2008. represented approximately $0.017 per share. Property Expenses Property expenses are broken down into costs associated with Discontinued Operations Crest acquires properties with the intention of reselling them non-net leased multi-tenant properties, unleased single-tenant rather than holding them as investments and operating the properties and general portfolio expenses. Expenses related to the properties. Consequently, we classify properties acquired by Crest multi-tenant and unleased single-tenant properties include, but as held for sale at the date of acquisition and do not depreciate are not limited to, property taxes, maintenance, insurance, them. The operation of Crest’s properties is classified as “income utilities, property inspections, bad debt expense and legal fees. from discontinued operations, real estate acquired for resale by General portfolio costs include, but are not limited to, insurance, Crest” on our consolidated statements of income. legal, bad debt expense, property inspections and title search If we decide not to sell a property previously classified as fees. At December 31, 2008, 70 properties were available for held for sale, the property is reclassified as real estate held for lease, as compared to 48 at December 31, 2007 and 26 at investment. A property that is reclassified to held for investment December 31, 2006. is measured and recorded at the lower of (i) its carrying amount Property expenses were $5.8 million in 2008, $3.5 million before the property was classified as held for sale, adjusted for in 2007 and $3.3 million in 2006. The increase in property any depreciation expense that would have been recognized had expenses in 2008 is primarily attributable to an increase in the property been continuously classified as held for investment, property taxes, maintenance, utilities, legal fees and bad debt and (ii) the fair value at the date of the subsequent decision not expense associated with properties available for lease. In 2007, to sell. property expenses included provisions for impairment of $138,000 recorded for one property. 70 The following is a summary of Crest’s “income from discontinued operations, real estate acquired for resale” on our consolidated statements of income (dollars in thousands, except per share data): Crest’s income from discontinued operations, real estate acquired for resale Gain on sales of real estate acquired for resale Rental revenue Other revenue Interest expense General and administrative expense Property expenses Provisions for impairment Depreciation (1) Income taxes Income from discontinued operations, real estate acquired for resale by Crest Per common share, basic and diluted 2008 $ 4,642 1,830 914 (1,797) (511) (133) (3,374) (771) (225) $ 575 $ 0.01 2007 $ 12,319 8,165 190 (6,201) (691) (40) — — (3,039) $ 10,703 $ 0.11 2006 $ 2,219 5,065 15 (3,708) (440) (67) (1,188) — (494) $ 1,402 $ 0.02 (1) Depreciation was recorded on one property that was classified as held for investment. This property was sold in 2008. Realty Income’s operations from two investment properties classified as held for sale at December 31, 2008, plus properties sold in 2008, 2007 and 2006 have been classified as discontinued operations. The following is a summary of Realty Income’s “income from discontinued operations, real estate held for investment” on our consolidated statements of income (dollars in thousands, except per share data): Realty Income’s income from discontinued operations, real estate held for investment Gain on sales of investment properties Rental revenue Other revenue Depreciation and amortization Property expenses Provisions for impairment Income from discontinued operations, real estate held for investment Per common share, basic and diluted 2008 $ 13,314 1,461 40 (302) (93) — $ 14,420 $ 0.14 2007 $ 1,724 3,075 4 (636) (70) (134) $ 3,963 $ 0.04 2006 $ 3,036 3,177 34 (825) (156) (16) $ 5,250 $ 0.06 The following is a summary of our total income from discontinued operations (dollars in thousands, except per share data): Real estate acquired for resale by Crest Real estate held for investment Income from discontinued operations Per common share, basic and diluted 2008 575 $ 14,420 $ 14,995 $ 0.15 2007 $ 10,703 3,963 $ 14,666 $ 0.15 2006 $ 1,402 5,250 $ 6,652 $ 0.07 The above per share amounts have each been calculated independently. 71 Crest’s Property Sales In 2008, Crest sold 25 properties for $50.7 million, which We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment resulted in a gain of $4.6 million. As part of two sales during 2008, of the sale proceeds will generate higher returns, enhance the Crest provided partial financing to the buyers of $19.2 million. In credit quality of our real estate portfolio or extend our average 2007, Crest sold 62 properties for $123.6 million, which remaining lease term. At December 31, 2008, we classified real resulted in a gain of $12.3 million. In 2007, as part of two sales, estate with a carrying amount of $6.7 million as held for sale on Crest provided partial financing to the buyer of $3.8 million, of our balance sheet, which includes five properties owned by Crest, which $619,000 was paid in full in November 2007. In 2006, with a carrying value of $6.0 million. Additionally, we anticipate Crest sold 13 properties for $22.4 million, which resulted in a selling investment properties from our portfolio that we have not gain of $2.2 million. In 2005, as part of one sale, Crest provided yet been specifically identified, from which we anticipate partial buyer financing of $1.3 million, which was paid in full in receiving between $10 million and $35 million in proceeds February 2006. Crest’s gains on sales are reported before income during the next 12 months. We intend to invest these proceeds taxes and are included in discontinued operations. into new property acquisitions. However, we cannot guarantee that we will sell properties during the next 12 months. Crest’s Property Inventory At December 31, 2008, Crest had an inventory of five properties with a carrying value of $6.0 million, all of which are classified as held for sale. At December 31, 2007, Crest had a property inven- Provisions for Impairment on Real Estate Acquired for Resale by Crest In 2008, provisions for impairment of $3.4 million were recorded tory of 30 properties with a carrying value of $56.2 million. by Crest on three properties held for sale. In February 2008, Gain on Sales of Investment Properties by Realty Income In 2008, we sold 29 investment properties for an aggregate of Buffets Holdings elected to reject the leases for two of these three properties. No provisions for impairment were recorded by Crest in 2007. In 2006, provisions for impairment of $1.2 million were $27.4 million, which resulted in a gain of $13.3 million. The recorded by Crest on three properties. One of the three proper- results of operations for these properties have been reclassified as ties was sold in 2007 and the other two properties were sold in discontinued operations. Additionally, we received proceeds of 2008. The above provisions for impairment reduced the carrying $439,000 from the sale of excess land from one property, which costs to the estimated fair-market value of those properties, net of resulted in a gain of $236,000. This gain is included in “other estimated selling costs, and are included in “income from revenue” on our consolidated statements of income because this discontinued operations, real estate acquired for resale by Crest.” excess land was associated with a property that continues to be owned as part of our core operations. In 2007, we sold ten investment properties for $7.0 million, which resulted in a gain of $1.7 million. The results of operations Provisions for Impairment on Realty Income Investment Properties No provisions for impairment were recorded in 2008. In 2007, we for these properties have been reclassified as discontinued oper- recorded a provision for impairment of $134,000 on one property, ations. In addition, we sold excess land and improvements from which is included in “income from discontinued operations, real five properties for an aggregate of $4.4 million, which resulted estate held for investment” on our consolidated statements of in a gain of $1.8 million. This gain from the land and improve- income, as the property was subsequently sold. Additionally, we ments sales is reported in “other revenue” on our consolidated recorded a provision for impairment of $138,000 on another statements of income because these improvements and excess property in 2007, which is included in property expense on our land were associated with properties that continue to be owned as consolidated statements of income. In 2006, we recorded a part of our core operations. provision for impairment of $16,000 on one property, which is In 2006, we sold or exchanged 13 investment properties for included in “income from discontinued operations, real estate $10.7 million, which resulted in a gain of $3.0 million, which is held for investment.” included in discontinued operations. Preferred Stock Dividends Preferred stock cash dividends totaled $24.3 million in 2008 and 2007 as compared to $11.4 million in 2006. 72 Net Income Available to Common Stockholders Net income available to common stockholders was $107.6 million During 2008, the gain recognized from the sales of invest- ment properties and from the additional proceeds received from a in 2008, a decrease of $8.6 million as compared to $116.2 million sale of excess land was $13.6 million, as compared to gains in 2007. Net income available to common stockholders in 2006 recognized from the sales of investment properties of $3.6 million was $99.4 million. during 2007 and $3.0 million during 2006. Crest’s gain recog- The calculation to determine net income available to com- nized from the sale of properties during 2008 was $4.6 million mon stockholders includes gains from the sales of properties. The as compared to $12.3 million during 2007 and $2.2 million amount of gains varies from period to period based on the timing during 2006. of property sales and can significantly impact net income avail- able to common stockholders. FUNDS FROM OPERATIONS AVAILABLE TO COMMON STOCKHOLDERS (FFO) FFO for 2008 decreased by $4.2 million, or 2.2%, to $185.5 million as compared to $189.7 million in 2007 and $155.8 million in 2006. The following is a reconciliation of net income available to common stockholders (which we believe is the most comparable GAAP measure) to FFO. Also presented is information regarding distributions paid to common stockholders and the weighted average number of shares used for the basic and diluted computation per share (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 land and investment properties: Continuing operations Discontinued operations 2008 $ 107,588 2007 $ 116,156 2006 $ 99,419 90,732 1,073 (319) (236) (13,314) 76,686 636 (244) (1,835) (1,724) 58,783 825 (192) — (3,036) FFO available to common stockholders $ 185,524 $ 189,675 $ 155,799 FFO per common share: Basic Diluted Distributions paid to common stockholders FFO in excess of distributions paid to $ $ 1.83 1.83 $ 169,655 $ $ 1.89 1.89 $ 157,659 $ $ 1.74 1.73 $ 129,667 common stockholders $ 15,869 $ 32,016 $ 26,132 Weighted average number of common shares used for computation per share: Basic Diluted 101,178,191 101,209,883 100,195,031 100,333,966 89,766,714 89,917,554 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 properties and extraordinary items. We consider FFO to be an appropriate supplemental measure of a REIT’s operating performance as it is based on a net income analysis of property portfolio performance that excludes non-cash items such as depreciation. The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time. Since real estate values historically rise and fall with market conditions, 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. 73 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 our 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. Other Non-Cash Items and Capitalized Expenditures The following information includes non-cash items and capitalized expenditures on existing properties in our portfolio. These items are not included in the adjustments to net income available to common stockholders to arrive at FFO. Analysts and investors often request this supplemental information. (dollars in thousands) Amortization of settlements on treasury lock agreements (1) Amortization of deferred note financing costs (2) Amortization of share-based compensation Capitalized leasing costs and commissions Capitalized building improvements Straight-line rent revenue (3) Provisions for impairment Crest provisions for impairment Gain on reinstatement of property carrying value 2008 $ 759 1,748 5,049 (956) (1,498) (1,997) — 3,374 — 2007 $ 870 1,494 3,857 (614) (1,258) (1,217) 272 — — 2006 $ 717 1,287 2,951 (761) (203) (1,515) 16 1,188 (716) (1) The settlement on the treasury lock agreements resulted from an interest rate risk prevention strategy that we used 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 amortization 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, September 2006 and September 2007. 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. IMPACT OF INFLATION Tenant leases generally provide for limited increases in rent as a result of increases in the tenants’ sales volumes, increases in QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to interest rate changes primarily as a result of the consumer price index (typically subject to ceilings), and/or our credit facility and long-term notes used to maintain liquidity fixed increases. We expect that inflation will cause these lease and expand our real estate investment portfolio and operations. provisions to result in rent increases over time. During times when Our interest rate risk management objective is to limit the impact inflation is greater than increases in rent, as provided for in the of interest rate changes on earnings and cash flow and to lower leases, rent increases may not keep up with the rate of inflation. our overall borrowing costs. To achieve these objectives we issue Approximately 96.6% or 2,268 of our 2,348 retail properties long-term notes, primarily at fixed rates, and may selectively enter in the portfolio are leased to tenants under net leases where the into derivative financial instruments, such as interest rate lock tenant is responsible for property expenses. Net leases tend to agreements, interest rate swaps and caps in order to mitigate our reduce our exposure to rising property expenses due to inflation. interest rate risk on a related financial instrument. We were not a Inflation and increased costs may have an adverse impact on our party to any derivative financial instruments at December 31, tenants if increases in their operating expenses exceed increases 2008. We do not enter into any derivative transactions for specu- in revenue. lative or trading purposes. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS For information on the impact of recent accounting pronounce- ments on our business, see note 2 of the Notes to Consolidated Financial Statements. 74 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, 2008. This information is presented to evaluate the expected cash flows and sensitivity to interest rate changes (dollars in millions): Expected Maturity Data Year of maturity 2009 (1) 2010 2011(2) 2012 2013 (3) Thereafter (4) Totals Fair Value(5) Average interest rate on fixed rate debt 8.000% — — — 5.375 6.162 6.131% Fixed rate debt $ 20.0 — — — 100.0 1,250.0 $ 1,370.0 $ 949.4 Average interest rate on variable rate debt —% — — — — — —% Variable rate debt $ — — — — — — $ — $ — (1) $20 million matured and was retired in January 2009. (2) The credit facility expires in May 2011. There was no outstanding credit facility balance as of February 9, 2009. (3) $100 million matures in March 2013. (4) $150 million matures in November 2015, $275 million matures in September 2016, $175 million matures in September 2017, $550 million matures in August 2019 and $100 million matures in March 2035. (5) We base the fair value of the fixed rate debt at December 31, 2008 on the closing market price or indicative price per each note. The table incorporates only those exposures that exist as of December 31, 2008. 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, 2008, 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. The article says “Hedge Fund,” Arthur, not “Hedge Fun.” 75 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S S e l e c t e d F i n a n c i a l D a t a (not covered by Report of Independent Registered Public Accounting Firm) (dollars in thousands, except for per share data) As of or for the years ended December 31, 2008 2007 2006 2005 2004 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 $ 2,994,179 $ 3,077,352 $ 2,546,508 $ 1,920,988 $ 1,442,315 46,815 1,370,000 1,439,518 1,554,661 246,155 (146,286) 330,200 116,846 14,995 131,841 193,101 1,470,000 1,539,260 1,538,092 318,169 182,528 294,317 125,743 14,666 140,409 (24,253) (24,253) 10,573 920,000 970,516 1,575,992 86,945 (55,131) 237,416 104,129 6,652 110,781 (11,362) 65,704 891,700 931,774 989,214 109,557 63,563 193,285 86,784 12,335 99,119 (9,403) 2,141 503,600 528,580 913,735 178,337 (2,696) 170,474 79,663 23,734 103,397 (9,455) — — — — (3,774) stockholders 107,588 116,156 99,419 89,716 90,168 Cash distributions paid to common stockholders 169,655 157,659 129,667 108,575 97,420 Basic and diluted net income per common share 1.06 Cash distributions paid per common share 1.66225 Cash distributions declared per 1.16 1.56025 1.11 1.43725 1.12 1.34625 1.15 1.24125 common share 1.66725 1.57050 1.44750 1.35250 1.25125 Basic weighted average number of common shares outstanding 101,178,191 100,195,031 89,766,714 79,950,255 78,518,296 Diluted weighted average number of common shares outstanding 101,209,883 100,333,966 89,917,554 80,208,593 78,598,788 76 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S C o n t r o l s a n d P r o c e d u r e s CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE We have had no disagreements with our independent registered (3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the public accounting firm on accountancy or financial disclosure, nor financial statements. have we changed accountants in the two most recent fiscal years. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures. We maintain Management has used the framework set forth in the report entitled “Internal Control—Integrated Framework” published disclosure controls and procedures (as defined in Securities by the Committee of Sponsoring Organizations (“COSO”) of Exchange Act 1934 Rules 13a-15(e) and 15d-15(e)) that are the Treadway Commission to evaluate the effectiveness of the designed to ensure that information required to be disclosed in our Company’s internal control over financial reporting. Management Exchange Act reports is recorded, processed, summarized and has concluded that the Company’s internal control over financial reported within the time periods specified in the Securities and reporting was effective as of the end of the most recent fiscal year. Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, KPMG LLP has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting. to allow timely decisions regarding required disclosure. In designing Submitted on February 10, 2009 by, and evaluating the disclosure controls and procedures, management Thomas A Lewis, recognized that any controls and procedures, no matter how well Chief Executive Officer and Vice Chairman designed and operated, can provide only reasonable assurance of Paul M. Meurer, Chief Financial Officer, achieving the desired control objectives, and management necessarily Executive Vice President and Treasurer was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Changes in Internal Controls. There have not been any significant As of and for the year ended December 31, 2008, we carried changes in our internal controls or in other factors that could out an evaluation of the effectiveness of the design and operation significantly affect these controls subsequent to the date of their of our disclosure controls and procedures, under the supervision evaluation. There were no material weaknesses in our internal and with the participation of management, including our Chief controls, and therefore no corrective actions were taken. Executive Officer and Chief Financial Officer. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer Limitations on the Effectiveness of Controls. Internal control over concluded that our disclosure controls and procedures were effective financial reporting cannot provide absolute assurance of achieving and were operating at a reasonable assurance level. financial reporting objectives because of its inherent limitations. MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Internal control over financial reporting refers to the process Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judg- ment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or designed by, or under the supervision of, our Chief Executive improper management override. Because of such limitations, there Officer and Chief Financial Officer, and effected by our board is a risk that material misstatements may not be prevented or of directors, management and other personnel, to provide detected on a timely basis by internal control over financial report- reasonable assurance regarding the reliability of financial ing. However, these inherent limitations are known features of the reporting and the preparation of financial statements for external financial reporting process. Therefore, it is possible to design into purposes in accordance with generally accepted accounting the process safeguards to reduce, though not eliminate, this risk. principles, and includes those policies and procedures that: (1) Pertain to the maintenance of records that in reasonable detail certified to the NYSE in 2008, pursuant to Section 303A. 12(a) accurately and fairly reflect the transactions and dispositions of of the NYSE’s Listing Standards, that he was not aware of any Certifications. Tom Lewis, Realty Income’s Chief Executive Officer, the assets of the Company; violation of the NYSE corporate governance listing standards by Realty Income. Furthermore, Realty Income filed with the SEC, (2) Provide reasonable assurance that transactions are recorded as as exhibits to its Annual Report on Form 10-K for the year ended necessary to permit preparation of financial statements in accordance December 31, 2008, the certifications by Tom Lewis and with generally accepted accounting principles, and that receipts and Paul Meurer, Realty Income’s Chief Executive Officer and Chief expenditures of the Company are being made only in accordance with Financial Officer, respectively, required under Section 302 of authorizations of management and directors of the Company; and the Sarbanes-Oxley Act. 77 R E A L T Y I N C O M E C O R P O R A T I O N A N D S U B S I D I A R I E S M a r k e t R e l a t e d S t o c k h o l d e r M a t t e r s a n d I s s u e r P u r c h a s e s o f E q u i t y S e c u r i t i e s f o r t h e R e g i s t r a n t ’ s C o m m o n E q u i t y , 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. Price Per Share of Common Stock 2008 First quarter Second quarter Third quarter Fourth quarter Total 2007 First quarter Second quarter Third quarter Fourth quarter Total High $ 27.16 28.15 34.86 26.50 $ 30.36 29.13 28.79 30.70 Low Distributions Declared (1) $ 20.27 22.67 21.38 15.00 $ 26.02 24.53 22.87 26.31 $ 0.410875 0.412750 0.419625 0.424000 $ 1.667250 $ 0.380125 0.382000 0.399375 0.409000 $ 1.570500 (1) Common stock cash distributions currently are declared monthly by us based on financial results for the prior months. At December 31, 2008, a distribution of $0.14175 per common share had been declared and was paid in January 2009. There were 9,046 registered holders of record of our common stock as of January 1, 2009. We estimate that our total number of shareholders is approximately 80,000 when we include both registered and beneficial holders of our common stock. TOTAL RETURN PERFORMANCE 200 175 150 125 e u l a V x e d n I (cid:2) 100 75 (cid:4) (cid:3) (cid:1) (cid:2) (cid:3) (cid:1) (cid:2) (cid:4) (cid:3) (cid:1) (cid:4) (cid:2) (cid:4) (cid:1) (cid:3) (cid:2) (cid:4) (cid:1) (cid:3) (cid:2) (cid:4) (cid:2) (cid:3) (cid:1) Realty Income Corporation Russell 2000 Realty Income Peer Group* SNL Triple Net REIT Index 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08 Index Realty Income Corporation Russell 2000 Realty Income Peer Group* SNL Triple Net REIT Index 12/31/03 100.00 100.00 100.00 100.00 12/31/04 133.90 118.33 129.62 125.61 12/31/05 121.24 123.72 141.94 130.77 12/31/06 164.89 146.44 191.13 173.45 12/31/07 170.31 144.15 147.75 160.92 12/31/08 156.42 95.44 101.19 110.99 *Realty Income Peer Group consists of twenty-eight companies (excluding Realty Income) with an implied market capitalization between $1.5 billion to $3 billion Period Ending as of September 30, 2008. 78 C o m p a n y I n f o r m a t i o n BOARD OF DIRECTORS Front row: Donald R. Cameron, Dr. Kathleen R. Allen, Thomas A. Lewis, Priya Cherian Huskins, Roger P. Kuppinger, William E. Clark, Jr. Back row: Gregory T. McLaughlin, Ronald L. Merriman, Michael D. McKee, Willard H Smith Jr SENIOR MANAGEMENT TEAM Front row: Gary M. Malino, Laura S. King, Thomas A. Lewis Back row: Michael K. Press, Robert J. Israel, Richard G. Collins, Paul M. Meurer, Michael R. Pfeiffer EXECUTIVE OFFICERS Thomas A. Lewis Vice Chairman of the Board of Directors, Chief Executive Officer Gary M. Malino President and Chief Operating Officer Paul M. Meurer Executive Vice President, Chief Financial Officer and Treasurer Michael R. Pfeiffer Executive Vice President, General Counsel and Secretary Richard G. Collins Executive Vice President, Portfolio Management OTHER OFFICERS Robert J. Israel Senior Vice President, Research Laura S. King Senior Vice President, Assistant General Counsel and Assistant Secretary Michael K. Press Senior Vice President, Head of Acquisitions Theresa M. Casey Vice President, Information Technologies Gregory J. Fahey Vice President, Controller Tere H. Miller Vice President, Corporate Communications Dawn Nguyen Vice President, Portfolio Management MDG (Monthly Dividend Girl) Vice President, Corporate Cheerleader Stephen D. Burchett Associate Vice President, Senior Legal Counsel Elizabeth Cate Associate Vice President, Portfolio Management Jill M. Cossaboom Associate Vice President, Assistant Controller Kristin K. Ferrell Associate Vice President, Portfolio Management Benjamin N. Fox Associate Vice President, Director, Strategic Initiatives Teresa M. Glenn Associate Vice President, Human Resources & Operations Mark Manheimer Associate Vice President, Research Sean P. Nugent Associate Vice President, Accounting Manager Jenette S. O’Brien Associate Vice President, Senior Legal Counsel SUBSIDIARY COMPANY Crest Net Lease, Inc. Cary J. Wenthur President and Chief Operating Officer A I N R O F I L A C , O G E I D N A S , A R E T A P Y B D E C U D O R P D N A D E N G I S E D DIRECTORS Donald R. Cameron Chairman of the Board of Directors and President, Cameron, Murphy & Spangler, Inc. INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM KPMG LLP San Diego, California TRANSFER AGENT Wells Fargo Shareowner Services P.O. Box 64873 St. Paul, MN 55164 For shareholder administration and account information please visit Wells Fargo’s website at: www.shareowneronline.com or call this toll-free number: 1-877-218-2434 or email your questions to: stocktransfer@wellsfargo.com FOR ADDITIONAL CORPORATE INFORMATION For automated shareholder information call the Realty Income Investor Hotline at: 888-811-2001 Visit the Realty Income corporate web site at: www.realtyincome.com Contact your financial advisor, or contact Realty Income at: telephone: 760-741-2111 email: ir@realtyincome.com Copies of Realty Income’s Annual Report on Form 10-K are available upon written request to: Realty Income Corporation Attention: Investor Relations 600 La Terraza Boulevard Escondido, CA 92025 Thomas A. Lewis Vice Chairman of the Board of Directors and Chief Executive Officer, Realty Income Corporation Kathleen R. Allen, Ph.D. Director, Center of Technology Commercialization, Marshall School of Business University of Southern California Priya Cherian Huskins Partner, Woodruff-Sawyer & Co. Roger P. Kuppinger Private Investment Banker and Financial Advisor Michael D. McKee Former Vice Chairman, Chief Executive Officer, The Irvine Company Gregory T. McLaughlin President, Tiger Woods Foundation Ronald L. Merriman Consultant, Merriman Partners Willard H Smith Jr Retired Managing Director, Merrill Lynch & Co. William E. Clark Retired Chairman of the Board of Directors 600 La Terraza Boulevard, Escondido, CA 92025 www.realtyincome.com