Realty Income Annual Report 2010

Plain-text annual report

Realty Income 2010 Annual Report Imagine the Possibilities What have Monthly Dividends Explore Learn made possible for you? Travel Engage Wish List • Learn to do something new. • Travel more. • Spend more time with family. • Give back to the community. • Live comfortably and work part-time. • Start a new business. • Get closer to your financial goals. We’d love to hear from you. Let us know how you use your monthly dividends by visiting www.realtyincome.com/dividendpossibilities to share your dividend possibilities. R e a lty Inco me 2 2010 Annual Report 2010 Contents Our Mission 4 Our Long-Term Business Plan 5 Historical Financial Performance 6 Letter to Fellow Shareholders 10 Investor Returns 11 2010 Summary of Operations 12 Investments for Now and the Future 14 Widening the Investment Net 14 Diageo — The Tenant and the Wine Business 21 What We Own 22 What’s Next? 23 More Details About Our 2010 Real Estate and Financial Performance 23 Stable Financial Performance and Conservative Balance Sheet 24 Renewing Our Monthly Dividend Commitment 25 Charts of Interest Dividends Paid per Common Share 10 Yield Comparisons 11 Total Return Comparisons 11 The Magic of Rising Dividends Over Time 12 Realty Income Historical Performance vs. Major Stock Indices 13 Number of Properties 22 Portfolio Occupancy 23 Total Revenue 24 FFO Per Common Share 25 Comparison of $100 Invested in Realty Income in 1994 vs. Major Stock Indices 26 We Are The Monthly Dividend Company® Monthly dividends are our mission, our passion, our reason to be. Monthly dividends give our shareholders the freedom to reinvent themselves, engage others and pursue their dreams. R e a lty Income 4 2010 Annual Report OUR LONG-TERM BUSINESS PLAN • Pay 12 Monthly Dividends • Raise the Dividend • Maintain a Conservative Balance Sheet • Maintain High Portfolio Occupancy • Acquire Additional Properties • Tell More People about The Monthly Dividend Company® • Remain Conservative THE RESULTS SO FAR ... • 485 Consecutive Monthly Dividends • 60 Dividend Increases • $1.9 Billion in Dividends Paid 2010 RESULTS • 2,496 Properties Owned • 96.6% Occupancy • 186 Properties Acquired for $713.5 Million • $182.5 Million in Monthly Dividends Paid • Four Dividend Increases • 38.6% Return to Shareholders R ealty Inco me 5 2 010 Annual Report Historical Financia For the Years Ended December 31, 2010 2009 2 2 2 2 2 2 2 2 2 1 1 1 1 1 1 Total revenue (1) $ 346,709,000 $ 328,794,000 $ $ 2 $ $ 1 $ $ 1 $ $ 1 $ 1 $ 1 $ 8 $ 6 $ $ 5 $ 4 Net income available to common stockholders $ 106,531,000 $ 106,874,000 $ 1 Funds from operations (“FFO”)(2) $ 193,713,000 $ 190,444,000 $ Adjusted funds from operations (“AFFO”)(2) $ 197,256,000 $ 192,739,000 $ Dividends paid to common stockholders $ 182,500,000 $ 178,008,000 $ 1 $ $ $ 1 1 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 6 6 5 $ $ $ $ $ $ $ 5 $ $ 3 $ 5 $ 5 $ 4 $ $ $ $ $ 2 $ 4 $ 3 $ 3 $ $ 3 $ 3 $ Special dividend paid $ 5 $ 5 AT YEA R END Real estate at cost, before accumulated depreciation(3) $ 4,112,862,000 $ 3,439,456,000 $ $ 3 $ $ 2 $ $ 1 $ 1 $ 1 $ 1 $ 1 $ $ 6 $ $ 5 $ 4 Number of properties 2,496 2,339 2 2 1 1 1 1 1 1 1 1 9 8 7 6 6 Gross leasable square feet 21,215,800 19,182,000 1 1 1 1 1 1 9 9 9 8 7 6 5 4 4 Properties acquired (4) 186 16 1 3 3 1 1 3 1 1 2 1 1 9 6 5 4 Cost of properties acquired(4) $ 713,534,000 $ 57,937,000 $ $ 5 $ 7 $ 4 $ 2 $ 3 $ 1 $ 1 $ 9 $ 1 $ 1 $ 1 $ 5 $ 6 $ 3 Properties sold 28 25 2 1 1 2 4 3 3 3 2 3 5 1 7 3 5 Number of retail industries 32 30 3 3 2 2 3 2 2 2 2 2 2 1 8 7 5 Number of states 49 49 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 Portfolio occupancy rate 96.6% 96.8% 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 Remaining weighted average lease term in years 11.4 11.2 1 1 1 1 1 1 1 1 9 1 1 9 9 9 9 PER CO MMO N SHA RE DATA(5) Net income (diluted) $ Funds from operations (“FFO”)(2) $ Adjusted funds from operations (“AFFO”)(2) $ 1.01 $ 1.83 $ 1.86 $ 1.03 $ 1 $ 1 $ 1 $ 1 $ 1 $ 1 $ 0 $ $ 0 $ 0 $ 0 $ 1.84 $ $ $ $ $ $ 1.86 $ $ $ $ $ $ Dividends paid $ 1.722 $ 1.707 $ $ $ $ $ 1 $ $ 0 $ Special dividend $ Annualized dividend amount(6) $ 1.731 $ 1.716 $ $ 1 $ $ $ $ 1 $ $ $ $ $ 1 $ $ $ $ 0 0 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 0 1 1 $ $ $ $ $ $ $ $ $ $ $ $ 0 0 0 Common shares outstanding 118,058,988 104,286,705 1 7 7 5 5 5 4 4 3 INVESTMENT RESULTS Closing price on December 31, $ 34.20 $ 25.91 $ 2 $ 2 $ $ $ $ 8 Dividend yield(7) (8) (9) 6.6% 7.4% 6 5 6 5 6 6 7 9 1 8 7 7 8 1 9 Total return to stockholders(9) (10) 38.6% 19.3% – 3 3 –9 3 2 2 2 3 – 5 1 1 4 2 (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 and AFFO definition and reconciliation to net income available to common stockholders. (3) Does not include properties held for sale. (4) Includes properties acquired by Realty Income and Crest Net Lease. (5) All share and per share amounts reflect the 2-for-1 stock split on December 31, 2004. (6) Annualized dividend amount reflects the December declared dividend rate per share multiplied by twelve. Real ty Inco me 6 2010 Annual Repo rt 2 2 al Performance 2008 2007 2006 2005 2004 2 2 2 2 1 1 1 1 1 1 $ $ $ 331,701,000 $ 297,396,000 $ 240,626,000 $ 197,751,000 $ 177,606,000 $ 1 $ $ 1 $ 1 $ 1 $ 8 $ 6 $ $ 5 $ 4 $ 1 $ 1 $ 107,588,000 $ 116,156,000 $ 99,419,000 $ 89,716,000 $ 90,168,000 $ $ $ $ $ $ 185,524,000 $ 189,675,000 $ 155,799,000 $ 129,647,000 $ 118,181,000 $ $ 192,003,000 $ 193,079,000 $ 158,763,000 $ 130,843,000 $ 126,424,000 $ $ 1 $ 1 $ 169,655,000 $ 157,659,000 $ 129,667,000 $ 108,575,000 $ 97,420,000 $ $ $ $ $ $ $ $ $ $ $ $ $ 6 6 5 $ $ $ $ $ $ $ 5 $ $ 3 $ 5 $ 5 $ 4 $ $ $ $ $ 2 $ 4 $ 3 $ 3 $ $ 3 $ 3 $ $ 5 $ 5 $ $ $ 3,408,910,000 $ 3,238,794,000 $ 2,743,973,000 $ 2,096,156,000 $ 1,691,283,000 $ 1 $ 1 $ 1 $ 1 $ 1 $ $ 6 $ $ 5 $ 4 2 2 2,348 2,270 1,955 1,646 1,533 1 1 1 1 1 9 8 7 6 6 2 1 19,106,700 18,504,800 16,740,100 13,448,600 11,986,100 1 9 9 9 8 7 6 5 4 4 1 1 108 357 378 156 194 3 1 1 2 1 1 9 6 5 4 $ $ $ 189,627,000 $ 533,726,000 $ 769,900,000 $ 486,553,000 $ 215,314,000 $ 3 $ 1 $ 1 $ 9 $ 1 $ 1 $ 1 $ 5 $ 6 $ 3 2 2 29 10 13 23 43 3 3 3 2 3 5 1 7 3 5 3 3 30 30 29 29 30 2 2 2 2 2 2 1 8 7 5 4 4 49 49 48 48 48 4 4 4 4 4 4 4 4 4 4 9 9 97.0% 97.9% 98.7% 98.5% 97.9% 9 9 9 9 9 9 9 9 9 9 C N N 1 1 11.9 13.0 12.9 12.4 12.0 1 1 1 9 1 1 9 9 9 9 $ 1 $ 1 $ 1.06 $ 1.16 $ 1.11 $ 1.12 $ 1.15 $ 1 $ 1 $ 0 $ $ 0 $ $ $ $ $ 1.83 $ 1.89 $ 1.73 $ 1.62 $ 1.50 $ $ 1.90 $ 1.92 $ 1.77 $ 1.63 $ 1.61 $ $ 1 $ 1 $ 1.662 $ 1.560 $ 1.437 $ 1.346 $ 1.241 $ 1 $ $ 0 $ $ 0 A $ $ 1.701 $ 1.641 $ 1.518 $ 1.395 $ 1.32 $ 1 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 0 1 1 $ $ $ $ $ $ $ 0 $ $ $ $ $ $ $ 0 0 0 1 1 104,211,541 101,082,717 100,746,226 83,696,647 79,301,630 7 6 6 5 5 5 5 4 4 3 $ 3 $ 2 $ 23.15 $ 27.02 $ 27.70 $ 21.62 $ 25.29 $ 2 $ 1 $ 1 $ $ $ 1 $ 1 $ $ $ 8 6 7 6.1% 5.6% 6.7% 5.3% 6.2% 3 1 –8.2% 3.2% 34.8% –9.2% 32.7% 9 1 2 3 7 5 8 1 1 4 (7) Dividend yield was calculated by dividing the dividend paid per share, during the year, by the closing share price on December 31 of the previous year. (8) Dividend yield excludes special dividends. (9) The 1994 dividend yield is based on the annualized dividends for the period from August 15, 1994 (the date of the consolidation of the predecessors to the Company) to December 31, 1994. The 1994 total return is based on the price change from the opening on October 18, 1994 (the Company’s first day of trading) to December 31, 1994 plus the annualized dividend yield. R ealty Inco me 7 2 010 Annual Repo rt 2 2 2 2 2 2 2 2003 2002 2001 2000 1999 1 1 1 1 1 $ $ $ $ 2 $ $ 1 $ $ 150,370,000 $ 137,600,000 $ 121,081,000 $ 116,310,000 $ 104,510,000 $ 8 $ 6 $ $ 5 $ 4 c $ 1 $ 1 $ 1 $ $ $ 76,722,000 $ 68,954,000 $ 57,846,000 $ 45,076,000 $ 41,012,000 $ $ 5 $ 5 $ 103,366,000 $ 93,539,000 $ 76,378,000 $ 67,239,000 $ 65,917,000 $ $ 106,659,000 $ 95,844,000 $ 78,504,000 $ 67,836,000 $ 66,330,000 $ $ 83,842,000 $ 78,042,000 $ 64,871,000 $ 58,262,000 $ 55,925,000 $ $ $ $ $ $ $ $ 1 $ 1 $ 1 $ $ $ 1 1 $ $ $ $ $ $ $ $ $ $ $ $ 3 $ 5 $ 5 $ $ $ $ $ 2 $ 4 $ 3 $ 3 $ $ 3 $ 3 $ a $ $ $ $ 3 $ $ 2 $ $ 1,533,182,000 $ 1,285,900,000 $ 1,178,162,000 $ 1,073,527,000 $ 1,017,252,000 $ $ 6 $ $ 5 $ 4 2 2 2 2 1 1 1 1,404 1,197 1,124 1,068 1,076 9 8 7 6 6 2 1 1 1 1 1 1 11,350,800 9,997,700 9,663,000 9,013,200 8,648,000 7 6 5 4 4 1 1 1 3 3 1 1 302 111 117 22 110 1 9 6 5 4 C $ $ $ $ 5 $ 7 $ 4 $ 2 $ 371,642,000 $ 139,433,000 $ 156,472,000 $ 98,559,000 $ 181,376,000 $ 1 $ 1 $ 5 $ 6 $ 3 2 2 2 1 1 2 4 35 35 35 21 3 5 1 7 3 5 3 3 3 3 2 2 3 28 26 25 24 24 2 1 8 7 5 4 4 4 4 4 4 4 48 48 48 46 45 4 4 4 4 4 9 9 9 9 9 9 9 98.1% 97.7% 98.2% 97.7% 98.4% 9 9 9 9 9 1 1 1 1 1 1 1 11.8 10.9 10.4 9.8 10.7 1 9 9 9 9 N N l $ 1 $ 1 $ 1 $ $ 1 $ 1 $ 1 $ 1.08 $ 1.01 $ 0.99 $ 0.84 $ 0.76 $ 0 $ $ $ $ $ $ $ $ $ $ $ $ $ 1.45 $ 1.38 $ $ 1.50 $ 1.41 $ 1.30 $ 1.34 $ 1.26 $ 1.23 $ 1.27 $ 1.24 $ $ 1 $ 1 $ $ $ $ $ $ 1.181 $ 1.151 $ 1.121 $ 1.091 $ 1.043 $ $ A $ $ $ $ 1 $ $ $ $ 1.20 $ 1.17 $ 1.14 $ 1.11 $ 1.08 $ 1 $ $ $ $ $ $ $ 0 1 1 0 $ $ $ $ 0 $ $ $ $ $ $ $ 0 0 0 0 0 1 1 1 1 1 8 7 75,818,172 69,749,654 65,658,222 53,127,038 53,644,328 5 5 4 4 3 $ 3 $ 2 $ 2 $ 2 $ 2 $ 2 $ 2 $ 20.00 $ 17.50 $ 14.70 $ 12.4375 $ 10.3125 $ 1 $ 1 $ $ $ 8 6 7 6 5 6 5 6 6.7% 7.8% 9.0% 10.6% 8.4% 7 7 8 1 9 3 1 – 3 3 –9 3 21.0% 26.9% 27.2% 31.2% –8.7% 5 1 1 4 2 (10) Total return was calculated by dividing the net change in the share price, during the year, plus the dividends paid per share, during the year, by the closing share price on December 31 of the preceding year. R e a lty Inco me 8 2010 Annual Report 2 2 2 2 2 2 2 2 2 2 2 1 1998 1997 1996 1995 1994 $ $ $ $ 2 $ $ 1 $ $ 1 $ $ 1 $ 1 $ 1 $ 85,132,000 $ 67,897,000 $ 56,957,000 $ 51,555,000 $ 48,863,000 c $ 1 $ 1 $ 1 $ $ $ $ $ $ $ $ $ 1 $ 1 $ 1 $ $ $ 1 1 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 6 6 5 $ $ $ $ 41,304,000 $ 34,770,000 $ 32,223,000 $ 25,600,000 $ 15,224,000 $ 62,799,000 $ 52,188,000 $ 47,139,000 $ 40,414,000 $ 39,050,000 $ 62,364,000 $ 52,077,000 $ 47,430,000 $ 39,668,000 $ 39,185,000 $ 5 $ 52,301,000 $ 44,367,000 $ 42,794,000 $ 36,710,000 $ 38,816,000 $ 5,285,000 $ 5,850,000 a $ $ $ $ 3 $ $ 2 $ $ 1 $ 1 $ 1 $ 1 $ 1 $ 889,835,000 $ 699,797,000 $ 564,540,000 $ 515,426,000 $ 450,703,000 2 2 2 2 1 1 1 1 1 1 1 1 970 826 740 685 630 2 1 1 1 1 1 1 1 9 9 9 8 7,824,100 6,302,300 5,226,700 4,673,700 4,064,800 1 1 1 3 3 1 1 3 1 1 2 1 149 96 62 58 4 C $ $ $ $ 5 $ 7 $ 4 $ 2 $ 3 $ 1 $ 1 $ 9 $ 1 $ 193,436,000 $ 142,287,000 $ 55,517,000 $ 65,393,000 $ 3,273,000 2 2 2 1 1 2 4 3 3 3 2 3 5 10 7 3 5 3 3 3 3 2 2 3 2 2 2 2 2 22 14 8 7 5 4 4 4 4 4 4 4 4 4 4 4 4 45 43 42 42 41 9 9 9 9 9 9 9 9 9 9 9 9 99.5% 99.2% 99.1% 99.3% 99.4% 1 1 1 1 1 1 1 1 1 1 9 1 10.2 9.8 9.5 9.2 9.5 N N l $ 1 $ 1 $ 1 $ $ 1 $ 1 $ 1 $ 1 $ 1 $ 0 $ $ 0.78 $ 0.74 $ 0.70 $ 0.63 $ 0.39 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1.18 $ 1.11 $ 1.03 $ 1.00 $ $ $ 1.17 $ 1.10 $ 1.03 $ 0.98 $ 0.98 0.98 $ 1 $ 1 $ $ $ $ $ $ 1 $ $ 0.983 $ 0.946 $ 0.931 $ 0.913 $ 0.300 $ 0.23 A $ $ $ $ 1 $ $ $ 1 $ $ $ $ $ 1.02 $ 0.96 $ 0.945 $ 0.93 $ 0.90 $ $ $ $ $ $ $ $ $ $ 1 1 1 1 1 8 7 7 6 6 5 5 53,634,206 51,396,928 45,959,074 45,952,474 39,004,182 $ 3 $ 2 $ 2 $ 2 $ 2 $ 2 $ 2 $ 2 $ 1 $ 1 $ $ $ 12.4375 $ 12.719 $ 11.9375 $ 11.25 $ 8.5625 6 7 6 5 6 5 6 6 7 9 1 8 7.7% 7.9% 8.3% 10.7% 9.9% 3 1 – 3 3 –9 3 2 2 2 3 – 5.5% 14.5% 15.4% 42.0% 28.5% R e a lty I n come 9 2010 Annual Report Dear Fellow Shareholders, As the introductory pages to this year’s report suggest, we would like to hear from you about what you actually do with the monthly dividends generated by our Company. Over the years, investors have sent us To summarize our results for 2010: letters, or shared stories with us, about • Shareholders received 12 monthly their experiences as a shareholder receiving dividends monthly dividends. These stories get passed • Dividends per common share increased around to our staff and inspire us to continue 0.9% to focus our efforts on those activities that • Investors achieved a 38.6% total return will generate the cash ﬂow to pay and increase • Revenue grew to over $346 million the monthly dividends we all rely on. Now • Funds from operations increased to we’ve set aside a section of our new, updated, $193.7 million website at www.realtyincome.com so that • We maintained a large and diverse you can easily email us and tell us what portfolio of 2,496 properties located in monthly dividends do for you. For our part, 49 states occupied by 122 retail and we’ll look forward to hearing all of the ways other consumer businesses in 32 that monthly dividends from Realty Income different industries are used by our shareholders. • Portfolio occupancy remained high I am pleased to report that, during 2010, at 96.6% at year-end your Company continued to collect more • Same store rents increased 0.6% rent, maintain stable funds from operations and raise the dividend. Once again, The Monthly Dividend Company®’s strategy of owning a portfolio of properties under long-term leases that have been carefully underwritten, coupled with a conservative balance sheet, enabled us to deliver consis- tent results. We also added new employees during the year to assist us with our goal of accelerating our growth. In addition, we widened the net, in terms of the type of industries with which we do business (more on that later). In short, I believe we did a good job of setting the stage for additional earnings and dividend growth during 2011. DIVIDENDS PAID PER COMM ON SHARE $ 1.80 $ 1.70 $ 1.60 $ 1.50 $ 1.40 $ 1.30 $ 1.20 $ 1.10 $ 1.00 $ 0.90 $ 0.80 d e z i l a u n n A 4 9 0 9 . 0 $ 5 9 1 9 . 0 $ 6 9 3 9 . 0 $ 7 9 5 9 . 0 $ 8 9 8 9 . 0 $ 9 9 4 0 . 1 $ 0 0 9 0 . 1 $ 1 0 2 1 . 1 $ 2 0 5 1 . 1 $ 3 0 8 1 . 1 $ 4 0 4 2 . 1 $ 5 0 5 3 . 1 $ 6 0 4 4 . 1 $ 7 0 6 5 . 1 $ 8 0 6 6 . 1 $ 9 0 1 7 . 1 $ 0 1 2 7 . 1 $ R e a lty Income 10 2010 Annual Report • 186 new properties were acquired dividend income in a low interest rate for $713.5 million environment. When you add the $1.722 per • We raised approximately $679 million common share in dividends we paid last of attractively priced new capital year, this works out to a total return to • We arranged a new $425 million credit shareholders of 38.6%, as compared to the facility for property acquisitions, Equity REIT Index at 27.9%, the Dow Jones ended the year with a zero balance Industrial Average at 14.0%, the Standard & on the facility and we had $18 million Poor’s 500 Index at 15.1%, and the NASDAQ in cash on hand Composite Average at 16.9%. While our main focus is on providing INVESTOR RETURNS dependable monthly dividends to shareholders, We increased the amount of the monthly we know that investors regularly compare dividend four times during 2010. Dividends Realty Income to other investments in terms paid per common share increased 0.9% and of total return. Since the calculation of total common shareholders, who owned the stock return can rely on the whims of stock market for the entire year, received $1.722 per share pricing, it does not always mirror a company’s in dividends during 2010, as compared to actual operating results in a given year. With $1.707 per share in 2009. that said, the chart on page 13 shows Realty During 2010, the price of our shares rose Income’s compounded average annual return 32.0% to $34.20 from $25.91, largely due, since 1994, when we were listed on the New we believe, to the increasing demand for York Stock Exchange, in comparison to other YIELD COMPAR ISONS (as of December 31, 2010 ) TOTA L RET URN CO MPA RIS ONS (as of December 31, 2010 ) 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% % 9 . 3 DJ Utility Index % 9 . 1 S&P 500 % 1 . 5 % 5 . 3 % 6 . 2 DJ Industrial Average Realty Income Equity REIT % 9 . 7 2 % 1 . 5 1 % 9 . 6 1 % 0 . 4 1 DJ Industrial Average S&P 500 Nasdaq Composite Equity REIT Realty Income % 6 . 8 3 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% R e a lty Income 11 2 010 Annual Report major stock indices. For that 16-year period, on the Dow Jones Industrial Average was our compounded average annual return to 2.6%, Standard & Poor’s 500 Index was 1.9%, shareholders was 17.9%, as compared to the Dow Jones Utility Index was 3.9% and Equity Equity REIT Index at 10.7%, the Dow Jones REIT Index was 3.5% (see Yield Comparisons Industrial Average at 9.3%, the Standard & on page 11). Poor’s 500 Index at 8.3%, and the NASDAQ Composite Average at 8.0%. 2010 SUMMARY OF OPERATIONS The dividend yield on our shares at During 2010, we succeeded in maintaining a December 31, 2010, was 5.1% based on healthy and stable company, while positioning the annualized dividend amount of $1.731 ourselves for future earnings growth. Our per common share and a closing share price portfolio of net-leased commercial properties of $34.20. This compares favorably to other continues to perform well and provide the investments as measured by the various lease revenue from which we pay monthly indices. For example, at year end, the yield dividends. As of December 31, 2010, portfolio THE MAGI C OF RISING DIVIDENDS OVER TI ME Yield on Cost The Cumulative Dividend Effect 1000 Shares Original Original Original Current Yield Dividends % of Original Purchase Date Investment Dividends(1) Yield On Cost(2) Received to Date Investment Paid Back 10/18/94 $ 8,000.00 $ 900.00 11.3% 21.6% $ 20,450.50 255.6% 12/31/94 8,562.50 900.00 10.5% 20.2% 20,150.50 235.3% 12/31/95 11,250.00 930.00 8.3% 15.4% 19,238.00 171.0% 12/31/96 11,937.50 945.00 7.9% 14.5% 18,191.75 152.4% 12/31/97 12,719.00 960.00 7.5% 13.6% 17,245.50 135.6% 12/31/98 12,437.50 1,020.00 8.2% 13.9% 16,263.00 130.8% 12/31/99 10,312.50 1,080.00 10.5% 16.8% 15,220.50 147.6% 12/31/00 12,437.50 1,110.00 8.9% 13.9% 14,129.25 113.6% 12/31/01 14,700.00 1,140.00 7.8% 11.8% 13,008.00 88.5% 12/31/02 17,500.00 1,170.00 6.7% 9.9% 11,856.75 67.8% 12/31/03 20,000.00 1,200.00 6.0% 8.7% 10,675.50 53.4% 12/31/04 25,290.00 1,320.00 5.2% 6.8% 9,434.25 37.3% 12/31/05 21,620.00 1,395.00 6.5% 8.0% 8,088.00 37.4% 12/31/06 27,700.00 1,518.00 5.5% 6.2% 6,650.75 24.0% 12/31/07 27,020.00 1,641.00 6.1% 6.4% 5,090.50 18.8% 12/31/08 23,150.00 1,701.00 7.3% 7.5% 3,428.25 14.8% 12/31/09 25,910.00 1,716.00 6.6% 6.7% 1,721.63 6.6% 12/31/10 34,200.00 1,731.00 5.1% 5.1% (1) Based on annualized dividend per share on the purchase date (2) Based on 12/31/10 annualized dividend per share amount of $1.731 R e a lty Income 12 2010 Annual Report occupancy was 96.6% with just 84 properties acquiring 186 new properties for $713.5 million available for lease or sale out of 2,496 during 2010. We permanently funded these properties in the portfolio. The weighted acquisitions through two common stock average remaining lease term for properties offerings, generating approximately in our portfolio was 11.4 years, and our $433 million in net proceeds, and a 10-year, portfolio continues to be well diversiﬁed by senior notes offering of $250 million, which industry, geographic region and individual generated net proceeds of $246.1 million. tenant. We were also able to capitalize on In addition, we entered into a new and our excellent liquidity and substantially expanded credit facility that increased our increase the size of our real estate portfolio by access to short-tem acquisition funding REALTY I NCOME H IS TORICAL PERFORMANC E VS. MA JOR STOCK IN D ICE S Equity Dow Jones Standard & Poor’s NASDAQ Realty Income REIT Index(1) Industrial Average 500 Composite Dividend Total Dividend Total Dividend Total Dividend Total Dividend Total Yield Return(2) Yield Return(3) Yield Return(3) Yield Return(3) Yield Return(4) 1995 8.3% 42.0% 7.4% 15.3% 2.4% 36.9% 2.3% 37.6% 0.6% 39.9% 1996 7.9% 15.4% 6.1% 35.3% 2.2% 28.9% 2.0% 23.0% 0.2% 22.7% 1997 7.5% 14.5% 5.5% 20.3% 1.8% 24.9% 1.6% 33.4% 0.5% 21.6% 1998 8.2% 5.5% 7.5% (17.5%) 1.7% 18.1% 1.3% 28.6% 0.3% 39.6% 1999 10.5% (8.7%) 8.7% (4.6%) 1.3% 27.2% 1.1% 21.0% 0.2% 85.6% 2000 8.9% 31.2% 7.5% 26.4% 1.5% (4.7%) 1.2% (9.1%) 0.3% (39.3%) 2001 7.8% 27.2% 7.1% 13.9% 1.9% (5.5%) 1.4% (11.9%) 0.3% (21.1%) 2002 6.7% 26.9% 7.1% 3.8% 2.6% (15.0%) 1.9% (22.1%) 0.5% (31.5%) 2003 6.0% 21.0% 5.5% 37.1% 2.3% 28.3% 1.8% 28.7% 0.6% 50.0% 2004 5.2% 32.7% 4.7% 31.6% 2.2% 5.6% 1.8% 10.9% 0.6% 8.6% 2005 6.5% (9.2%) 4.6% 12.2% 2.6% 1.7% 1.9% 4.9% 0.9% 1.4% 2006 5.5% 34.8% 3.7% 35.1% 2.5% 19.0% 1.9% 15.8% 0.8% 9.5% 2007 6.1% 3.2% 4.9% (15.7%) 2.7% 8.8% 2.1% 5.5% 0.8% 9.8% 2008 7.3% (8.2%) 7.6% (37.7%) 3.6% (31.8%) 3.2% (37.0%) 1.3% (40.5%) 2009 6.6% 19.3% 3.7% 28.0% 2.6% 22.6% 2.0% 26.5% 1.0% 43.9% 2010 5.1% 38.6% 3.5% 27.9% 2.6% 14.0% 1.9% 15.1% 1.2% 16.9% Compounded Average Annual Total Return(5) 17.9% 10.7% 9.3% 8.3% 8.0% Note: All of these Dividend Yields are calculated as annualized dividend based on last dividend paid in applicable time period divided by closing price as of period end. Dividend Yield sources: NAREIT website and Bloomberg. (1) FTSE NAREIT US Equity REIT Index, as per NAREIT website. (2) Calculated as closing stock price as of period end plus dividends paid in period divided by closing stock price as of end of previous period. Does not include reinvestment of dividends. (3) Includes reinvestment of dividends. Sources: NAREIT website and Factset. (4) Price only index, does not include dividends. Source: Factset. (5) All of these Compounded Average Annual Total Return rates are calculated in the same manner: from Realty Income’s NYSE listing on October 18, 1994 through December 31, 2010, and assuming reinvestment of dividends, except for NASDAQ. Past performance does not guarantee future performance. Realty Income presents this data for informational purposes only and makes no representation about its future performance or how it will compare in performance to other indices in the future. R e a lty Income 13 2 010 Annual Report from $355 million to $425 million (with an agent, Wells Fargo Shareowner Services, additional $200 million expansion feature). a division of Wells Fargo Bank, N.A. The site Our ability to access public capital to also features a “Connect” section that allows permanently fund property acquisitions shareholders to contact us in a variety of provides us with a healthy balance sheet and ways to share information, get answers to plenty of liquidity as we begin 2011. As such, their questions, or to sign up to receive we believe we are well positioned to fund various types of email communications from additional property acquisitions during 2011. us. Our goal in launching this new website is to build an online bridge between the INVESTMENTS FOR NOW Company and its owners that will enhance our AND THE FUTURE communications and enrich the experience New property investments weren’t the only of being a Realty Income shareholder. investments we made in 2010. We also invested in additional personnel in key areas of WIDENING THE INVESTMENT NET the company (research, acquisitions, investor Likely the most important activity we communications) and in company operations commenced in the past year-and-a-half was to maintain continued access to the high our effort to broaden our areas of investment quality tools and resources required to manage by expanding the types of businesses in a large portfolio of commercial real estate. which we invest. But, before I get into that, All of these new associates and operating perhaps I should talk a bit about the history improvements are in accordance with our of our investment process. Most of you will strategic plan to increase our property portfolio recall that virtually all of the Company’s footprint and enhance revenue growth, to acquisitions over the last 42 years have been widen our industry net and further diversify the structured as sale-leasebacks. A sale-lease- cash ﬂow supporting dividends, and to expand back is where a retailer, or other business our connection with the individual investor. that uses real estate to conduct their In early 2011, we launched a new corporate business, elects to sell their real estate to website and added a dividend reinvestment a company like ours and then lease it back and direct stock purchase plan. The new under a long-term lease agreement. In this website provides a wealth of information transaction, the seller is able to take their that has been organized so investors can cash out of their real estate and reallocate get the information they need quickly and it for additional growth in other areas, while efﬁciently. The new site also provides informa- still maintaining the use of the property tion about and access to our new dividend where they operate their business and reinvestment plan and direct stock purchase generate their proﬁts. For Realty Income, plan that is administered by our transfer we are able to acquire a property operated R e a lty Income 14 2010 Annual Report by a large tenant, under a long-term lease horizons to include other retail industries agreement, that will generate the cash ﬂow that had similar characteristics such as auto we use to pay monthly dividends. This is very parts, auto service and the child day care much a win-win situation for Realty Income business. Expanding into these areas fueled and the seller of the property, and we believe the growth of the Company and enabled this will continue to be our focus for many us to build a track record of consistent years to come. dividends to our investors over a prolonged period of time. Real Estate Investment History Perspective Early in our history, we mostly bought the Most of the investments we have made over new stores that retailers were opening. This the years have been sale-leasebacks to retail worked out pretty well as we selected the chains where we have acquired the stores up-and-coming retailers, in growing segments in which they sell their goods and services. of the retail industry, and the majority of the Acquiring these stores turned out to be a stores we acquired proved to be proﬁtable to very attractive area of investment as consumer the retailers. Over time, however, we noticed spending continued to increase fairly rapidly that, at the end of the 15 to 20-year lease over the last 40 years and retailers were term, there were usually a number of the constantly opening new stores. stores that the retailer no longer wanted to In the Company’s ﬁrst decade, we invested use because the stores had proven to be only primarily in growing companies in the fast marginally proﬁtable. Once the initial lease food restaurant business, as that industry was terms expired, on the less proﬁtable stores, developing in the 1970s. Realty Income’s we did not do as well since we often had to founders, Bill and Joan Clark, identiﬁed that re-lease the store to another tenant, some- these growing companies needed their store times at a lower rental rate. As a result, about locations in order to produce their proﬁts, and 15 years ago, we changed our focus to they also needed capital to open new stores. acquiring existing, seasoned stores that were They concluded that sale-leaseback was the already proﬁtable and stores where proﬁts perfect answer for these growing retailers. far exceeded the rent the retailer paid to us. The Clarks also focused our business on In these more proﬁtable stores, the retailer is purchasing properties from companies selling making a signiﬁcant proﬁt and is more likely basic consumer goods and services at low to want to stay in the property and extend price points, which people buy and use the lease when the initial long-term lease is regularly, since they felt that these businesses completed. We believe this adjustment to would be more likely to produce stable cash our acquisitions strategy, many years ago, ﬂow and be able to pay rent over the long term. is a key reason for our real estate portfolio’s In the 1980s, the Company expanded its stability and continued high occupancy. R e a lty Income 15 2 010 Annual Report Another important aspect of our investment invested, I also believe that we will ﬁnd new history is the fact that, after going public in opportunities that will provide us with the 1994, we invested in building our research consistent cash ﬂow we need to generate in capacity by adding staff in both industry and order to pay monthly dividends. real estate research. We did this so that we While looking to identify and invest in new could continue to ﬁnd new areas in which to industries we are careful to make sure that invest. In 1994, we owned 630 properties in the core concepts and characteristics of the 5 different industries that generated about investments we make should generally $49 million in revenue. Utilizing our increased remain as follows: research capacity, over the last 16 years, we • The acquisition of well located commer- have grown dramatically to where we are cial properties under long-term, today, with approximately 2,500 properties net-lease agreements where the tenant in 32 different industries and annualized is responsible for paying the operating revenue exceeding $380 million. I think it is expenses of the property and paying fair to say that these adjustments to our increasing rent over time investment strategy have been vital to our • The tenant is a signiﬁcant commercial success and are likely to continue to be enterprise with multiple cash ﬂows important for many years to come. and revenue sources • The tenant is a large owner and user How We’re Thinking about Investments Today of real estate to operate its business Last year, in my letter to shareholders, I wrote • The real estate is important to the about “retail consumer shifts” that we are tenant’s business and is necessary keeping our eyes on, stating that the “deci- in the production of its earnings sions we make over the next few years with • The tenant is in a business that we respect to investment opportunities will be can understand and is in a business very important.” While our general focus on we believe will be sustainable over consumer retail has served us well over the a prolonged period of time years, I believe we must continue to widen the • Our decision to invest will continue to net and look for new areas of investment to be based on a three-pronged research continue to fuel our growth. It is likely that the approach that analyzes: growth in retail spending, and the resulting 1. The tenant’s industry, ﬁnancial growth in new retail stores, will be more strength, competitors and business muted in the future than over the last decade operations or two. I think we will continue to ﬁnd the 2. The real estate attributes of the property majority of our acquisition opportunities 3. The proﬁtability to the tenant of the in the areas in which we have previously property we acquire R e a lty Income 16 2010 Annual Report Additionally, our approach has generally dividends. It also has allowed us to diversify been to seek areas of investment that aren’t our real estate portfolio over time. Today we being efﬁciently ﬁnanced or that aren’t on are in 32 different industries, and we would the radar screen of other potential buyers. like to continue to expand into new areas Often these areas are considered “out of the with the goal of being in 40 to 50 different ﬁnancial mainstream” by many investors, industries a decade from now. As always, they may currently be harder to ﬁnance than the objective when we invest in new proper- other areas, or they are in a business area ties and industries is to generate an ongoing, that may be new to the use of sale-leaseback stable cash ﬂow that will allow us to continue transaction to generate capital. If we can to pay increasing monthly dividends. manage to be “first to invest” (or at least early) in these areas we are more likely Source and Research New to receive a higher return on investment. Investment Opportunities History has also shown us that, over time, Uncovering new acquisition opportunities these “new” types of sale-leaseback is the responsibility of our acquisition calling ﬁnancing opportunities tend to become ofﬁcers who maintain relationships with a wide more mainstream, which means competition variety of private equity ﬁrms, commercial and increases and investment returns tend to investment banking contacts and over 1,100 decline. As in many things, the early bird often retailers throughout the US. Their goal is to gets the worm (or at least a few bigger ones). generate a constant stream of opportunities Some examples of new areas of investment for us to analyze for potential investment. that we uncovered in the past that became The amount of work involved is daunting, but very proﬁtable for us are: it is absolutely key to our success. To give • Fast food in the 60s and 70s you an idea of the volume of opportunities • Child day care in the 70s and 80s we have analyzed, since 2002 the acquisi- • Auto service in the 80s and 90s tions department has brought us over 840 • Convenience stores and multi-plex transactions, representing 15,426 individual theaters 10-12 years ago properties with an approximate value of • Entertainment venues like family $27.5 billion. Wow! Out of this, we then entertainment centers and water acquired 1,808 properties with an approximate parks ten years ago value of $3.5 billion, or about 12.7% of what • Health and ﬁtness centers over the we evaluated. last six years. Once our calling ofﬁcers have uncovered Our ability to innovate and ﬁnd new areas a viable opportunity, the important task of of investment has allowed us to expand underwriting begins. This involves researching our portfolio and grow our earnings and 1) the tenant’s industry, ﬁnancial strength R e a lty Income 17 2 010 Annual Report and operations, 2) the speciﬁc real estate Typically, we obtain data on property values, locations we are being offered and 3) the and we review area demographics, trafﬁc proﬁtability and cash ﬂow coverage of the ﬂow, regional economic data, as well as properties we are acquiring. When examining comparative purchase and lease prices for a potential tenant and industry, we attempt each location. to ascertain competitive conditions of the The ﬁnal key analysis is the individual industry, how the particular tenant we are unit proﬁtability that is shown by the cash considering ﬁts within their industry, the ﬂow coverage metric. This is calculated by historical performance of the industry, the dividing the cash ﬂow of a particular location outlook for future operating performance, we’re considering for purchase by the rent as well as some indication of the challenges that would have to be paid. This measure and opportunities that might impact the helps us ﬁgure out how much cushion we industry in the future. We also meet with have before the tenant may experience the prospective tenant’s management team, difﬁculty in paying rent. We also call this review audited ﬁnancial statements and a our “margin of safety.” variety of internal operating metrics that can The research compiled in this underwriting give us insight into the tenant’s performance. process is reviewed by our investment The real estate analysis consists of committee that consists of ﬁve senior sending our real estate research people to members of the Company. The path to visit every property and review the trade approval of a potential tenant, generally, area in which the business operates. goes something like this (see table below): Initial research to determine a viable opportunity Preliminary credit research report Meet with management team Final credit research report Presentation of real estate research Legal review of potential transaction Approve, close and fund transaction > > > > > > > Committee Meeting—Decide whether or not to allocate time and resources to the opportunity Committee Meeting—Decide whether the potential tenant warrants further due diligence Trip by research and committee member— More in-depth ﬁnancial review and assessment of operations expertise Committee meeting—Decide whether or not the potential tenant is approved based on credit review Committee meeting—Determine whether or not the real estate meets our investment guidelines Legal team meeting—Determine whether lease provisions and property conditions are acceptable The tenant and real estate is approved and transaction is funded and closed R e a lty Income 18 2010 Annual Report As evidenced by the number of times a investing in a new industry is one of our potential transaction is analyzed, reviewed acquisitions this year. It is a story of how and discussed in our investment committee we were able to get comfortable with an before it is approved, we make every effort investment in the beverage industry (speciﬁ- to determine that a potential tenant offers cally the wine segment), culminating in over the reliable and sustainable cash ﬂow that $300 million in investments during 2010. is required before we make an investment. A few years ago, we undertook a look at Historically, our approach to sourcing investing in the wine industry and set about tenants that represent new industry learning everything we could about the opportunities has been that we tend to ﬁrst business, but we made no acquisitions at crawl, then walk, and occasionally run. that time. However, this background research This is because new industries require even was helpful in determining what we would more research than those in which we have require in order for us to invest in this area. already developed expertise. In addition During that research, we identiﬁed several to the standard research process just potential hurdles to our acquiring properties described, we also have to do a great deal in this industry. First, there were only a limited more research into the competition, the number of large owners and operators, with types of properties that are important to multiple cash ﬂows (one of our requirements a new industry, and to what extent certain for investment). Most winery and vineyard demographic proﬁles are related to the operators are “one-off” operators consisting industry. Often, we may conduct a research of a single winery and a few vineyards. project on a new industry for a year or more, Second, we had some difﬁculty assessing with no business coming in during that time. how consistently the earnings, generated However, the initial research has been done from a winemaker’s business of making and and often we have developed a certain selling wine to the consumer, could be tied amount of expertise in the new industry, to the vineyards and wine production, as well as some important relationships that storage and distribution buildings. Third, may prove useful to us in the future. This it was even harder to tie the vineyards legwork sets us up so that when an oppor - themselves to the earnings of the winemaker tunity does arise, in this new area, we are since, often, the winemakers purchased their ready to move forward. We intend to accel- grapes from one or more growers, as well as erate our efforts to ﬁnd new investment using grapes from their own vineyards. In areas in the years ahead. other words, grapes are easily bought from A New Industry Investment Story necessarily have to grow their own grapes. A very good example of our approach to This could potentially be a problem for a variety of growers, so winemakers don’t R e a lty Income 19 2 010 Annual Report whoever owns the wine company’s real areas in the state and one of those areas, estate. Should the winemaker get into the Napa Valley, produces about 4% of the ﬁnancial difﬁculty and enter Chapter 11, wine that comes from California. The price the wine company in bankruptcy could differential, for grapes grown in these different potentially accept the lease on the winery areas, can be substantial. For instance, and reject the lease on the vineyards them- according to the 2010 Crush Report, US selves, continuing on in the wine-making Department of Agriculture, the price of a ton business by buying grapes from third parties. of cabernet sauvignon grapes, from the 2010 This would reduce the amount of rent the harvest in California, averaged $1,025 per landlord could collect and negatively impact ton with the lowest of the sixteen regions the anticipated return on investment. getting $357 per ton and the highest region, The possible exception we identiﬁed to the Napa Valley, commanding $4,478 per this scenario was towards the premium end ton. Where the grapes are grown matters a of the wine business, where the winemaker’s great deal when considering the value of the brand may well be closely tied to estate property and the price you can get for the wine. bottling (growing the grapes on site) or a Finally, wine is a consumer product and speciﬁc region where the grapes are grown. analyzing a consumer product involves a (For example: the Rutherford, Oakville, wide variety of additional factors that include; Stag’s Leap, or Carneros areas in Napa the branding of the product, its production, Valley). The premium wine consumer often its marketing and, in this particular industry, values and seeks out the wines from these its distribution through wholesalers and speciﬁc regions and the vintners producing distributors to the stores and restaurants wine from grapes in these areas. Thus, the where it is sold. This has been especially consumer may be willing to pay a higher true over the last couple of years, during the price for these appellations and it is some- recession, as many stores and restaurants what easier to tie the premium winemaker’s culled their lists of premium wine offerings earnings to both the winery operations and and kept those brands that could be the the vineyards themselves. most meaningful to their sales. The research also conﬁrmed our knowledge Our conclusion, after analyzing the that the prices that can be charged for wine industry, was that there would most likely can be heavily impacted by a number of fac- be a limited number of potential tenants tors: the brand of the wine, the winemaker that would meet our criteria, and that it and, most importantly, where the grapes are would be unlikely that we would structure grown. California produces approximately transactions in this industry. To reiterate, 94% of the wine produced in the United we felt the tenant would need to meet the States. There are 17 different wine producing following criteria: R e a lty Income 20 2010 Annual Report • A large entity with multiple cash ﬂows premium spirits, beer and wines, satisﬁed our and strong ﬁnancials investment requirement for multiple sources • Premium vineyards in premium areas of reliable and sustainable cash ﬂow. In (Napa Valley) addition, the Sterling and Beaulieu (BV) wine • Vineyards that are critical to the brands proved to be businesses where real production of the particular brand estate was tied to the generation of earnings and the proﬁtability of the winery for the wineries. Diageo also has, arguably, the • An excellent track record of good best distribution and marketing in the business. operations Its impact and/or inﬂuence with distributors is • A well-known, quality brand with a unparalleled so that its wine brands generally large consumer following command prized shelf space at the retail level. • Strong operations with the ability Diageo also represented a high-quality, to market the brand year after year credit tenant that would enhance the overall • Solid relationships with distributors credit quality of our real estate portfolio. willing to put the winemaker’s products Based in London, and traded on the London on the shelf and New York stock exchanges, Diageo has As frequently happens, as we look at new investment grade credit ratings, a market industries, there is a lot of work with little to capitalization of $49 billion, and annual show for it in terms of attractive property revenue of about $16 billion. acquisitions. DIAGEO — THE TENANT AND THE WINE BUSINESS We were able to become quite comfortable with both Diageo as our tenant and the cash ﬂow sources, so our next step was to learn more about the Sterling and Beaulieu wineries, When a transaction with Diageo arose this the competitive landscape for these brands, year, we suspected that this would likely be an and the real estate. investment that met all of our investment criteria Beaulieu Vineyards (BV) is 100 years old. since Diageo is the world’s leading global pre- It is located in the heart of the Napa wine mium drinks company. Diageo brands are sold region and about 40,000 visitors come to the in approximately 180 markets worldwide and winery each year. It is known for its Cabernet include names like: Smirnoff, Johnnie Walker, Sauvignon, Chardonnay and premium wine Captain Morgan, Jose Cuervo, Tanqueray, blends, of which 1.6 million cases of wine Gordon’s, Crown Royal, (spirit brands); are produced annually. BV wines are widely Guinness, Red Stripe, Harp, (beer brands); distributed in retail stores, restaurants and Sterling and Beaulieu (BV) (wine brands). hospitality venues throughout the US. The Diageo business model, with a 100% Sterling Vineyards is 39 years old and the focus on producing, distributing and marketing winery is as well known for its architecture R e a lty Income 21 2 010 Annual Report and scenic surroundings as it is for its that offer several renewal options, since premium Cabernet Sauvignon, Merlot and Diageo intends to operate these wineries Chardonnay wines. About 150,000 people into the foreseeable future. The real estate is visit this winery every year. The 1.4 million in the Napa Valley with two vineyards in the cases of wine that Sterling produces every Carneros area of the valley, and nine in the year are also widely distributed in retail Rutherford, Oakville and Calistoga areas stores, restaurants and hospitality venues of the north valley, some of the premier throughout the US. growing areas in the Napa Valley. These two wineries are among the most visited and recognized destinations in the WHAT WE OWN Napa Valley and feature some of the best This acquisition is a bit different from many real estate locations in the area. As we of the other real estate assets that we own in already noted, the grapes grown in this that the revenue and earnings are not primarily region command higher prices compared generated by a “storefront” operation. True, to grapes grown elsewhere in California. The we do own land and buildings, but the vineyards have been producing the highest revenue and earnings that are generated quality grapes for 25 to 100 years and the by Diageo are most closely tied to the grapes grown on the land are directly tied consumer brands that they sell at a variety to the production of the Sterling and BV of locations other than the winery. A well- wines and the premium brand recognition deﬁned, brand-building strategy, superbly inherent in the region’s appellation. In other executed, has been key to Diageo’s success. words, the fact that Sterling and BV wineries The company has great distributors and produce wine from grapes that are primarily grown in their own vineyards means that the earnings derived from the wine production are directly related to the grapes grown on their land. You may recall that this was an important criterion for us in order to acquire both the buildings and the land. What we acquired in this transaction are 11 vineyards on approximately 2,000 acres, of which 68% are plantable land, and the two wineries, consisting of wine production facilities, storage, shipping and tourist properties for $269 million. We acquired these assets under 20-year, triple-net leases NU MBER OF PR OPERT IES (at the end of each year) 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 4 9 0 3 6 5 9 5 8 6 6 9 0 4 7 7 9 6 2 8 8 9 0 7 9 9 9 6 7 0 , 1 0 0 8 6 0 , 1 1 0 4 2 1 , 1 2 0 7 9 1 , 1 3 0 4 0 4 , 1 4 0 3 3 5 , 1 5 0 6 4 6 , 1 6 0 5 5 9 , 1 7 0 0 7 2 , 2 8 0 8 4 3 , 2 9 0 9 3 3 , 2 0 1 6 9 4 , 2 R e a lty Income 22 2010 Annual Report wholesalers and they market the spirits, beer With that said, we will look to existing areas and wine with the same sales force through for our real estate acquisitions in 2011. But, the same channels. This provides convenient, we will remain open to considering new areas one-stop shopping for the retailer, restaurant and committing the resources to investigate chain, or hotel since they can buy multiple them. If, a few years from now, we have been products from a single source. successful in securing a good piece of our Bottom line, our analysis and due diligence revenue from other areas, that would be ﬁne. convinced us that Diageo is an expert in the But only after we have carefully researched, wine business and they will be a valuable discussed and analyzed something new, will tenant, generating reliable cash ﬂow that we make an investment. Again, the expansion should allow them to meet their long-term into new investment areas has been the key lease obligations with us. So now we are all to our growth for over 30 years. owners of two of the largest wineries and vineyards in Napa Valley that are operated MORE DETAILS ABOUT OUR 2010 REAL by the experts at Diageo. ESTATE AND FINANCIAL PERFORMANCE WHAT’S NEXT? Consistent Real Estate Portfolio Performance At the end of 2010, we owned 2,496 proper- This has been a good example of what we ties located in 49 states leased to 122 different will be trying to do as we seek to invest in retail chains and other businesses in 32 additional industries now and in the future. separate consumer-oriented industries. What I hope I’ve conveyed is the methodical, Our goal for 2011 and forward is to continue analytical and measured approach we took to diversify our sources of lease revenue and in order to make the Diageo transaction a reality, and that this is the approach that we will take when venturing into new industry territory. We walk a ﬁne line between remaining ﬂexible about investing in new areas and being disciplined about our approach. It can sometimes be difﬁcult to put a great deal of work into an area and then have to wait for months, or years, for our work to pay off in terms of attractive acquisitions. However, we believe this is the right approach and that it reﬂects the manner in which our shareholders expect us to go about making investments in new areas. PORT FOLIO O CC UPANCY (as of December 31) 3 9 9 1 – 0 7 9 1 y c n a p u c c O e g a r e v A 4 9 5 9 6 9 7 9 8 9 9 9 0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 0 0 1 % 7 . 9 9 % 4 . 9 9 % 3 . 9 9 % 1 . 9 9 % 2 . 9 9 % 5 . 9 9 % 4 . 8 9 % 7 . 7 9 % 2 . 8 9 % 7 . 7 9 % 1 . 8 9 % 9 . 7 9 % 5 . 8 9 % 7 . 8 9 % 9 . 7 9 % 0 . 7 9 % 8 . 6 9 % 6 . 6 9 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% R e a lty Income 23 2 010 Annual Report increase the credit quality of our portfolio occupancy was 96.6%. As I’ve said before, of net-leased real estate assets. keeping the majority of our properties leased, Same store rents on 2,131 properties year after year, is the key to generating under lease for 2010 increased 0.6% as dependable lease revenue to support compared to 2009. To break down same your monthly dividend payments. store rent increases for 2010, we had 23 industries with rent increases, 3 with ﬂat STABLE FINANCIAL PERFORMANCE rents, and 3 with declining rents. We think AND CONSERVATIVE BALANCE SHEET that same store rent increases will probably Revenue, funds from operations (FFO), be a bit higher in 2011 than they were in and net income results for the year ended 2010 given the fact that the economy is December 31, 2010, as compared to the improving and we have no tenants on same period in 2009 were as follows: our ﬁnancial performance watch list. • Revenue was $345.0 million as We also selectively sold 28 properties for compared to $325.2 million in 2009 $27.2 million during 2010. These properties • FFO available to common shareholders had been targeted for sale based on very was $193.7 million as compared to speciﬁc asset sale guidelines. In general, our $190.4 million in 2009 business model is to hold properties for the • FFO per diluted common share was long-term cash ﬂow that is generated to pay $1.83 as compared to $1.84 in 2009 dividends. However, we will pursue the sale • Net income available to common of properties out of the portfolio when we believe that reinvesting the sales proceeds will generate higher returns, that the asset sales will enhance the credit quality of our real estate portfolio, or that speciﬁc tenant or industry concentration levels will be reduced. Looking at lease expirations during 2010, the portfolio management group continued to be diligent in proactively anticipating lease expirations and did a tremendous job of handling 105 leases that expired during the year. Their efforts allowed us to maintain our historical occupancy rate that has never fallen below 96% since the company was founded in 1969. As of December 31, 2010, we had just 84 properties available for lease and TOTAL R EVENUE ( 1 ) For the years ended (dollars in millions) $ 350 $ 340 $ 320 $ 300 $ 280 $ 260 $ 240 $ 220 $ 200 $ 180 $ 160 $ 140 $ 120 $ 100 $ 80 $ 60 $ 40 4 9 9 . 8 4 $ 5 9 6 . 1 5 $ 6 9 0 . 7 5 $ 7 9 9 . 7 6 $ 8 9 1 . 5 8 $ 9 9 5 . 4 0 1 $ 0 0 3 . 6 1 1 $ 1 0 1 . 1 2 1 $ 2 0 6 . 7 3 1 $ 3 0 4 . 0 5 1 $ 4 0 6 . 7 7 1 $ 5 0 8 . 7 9 1 $ 6 0 6 . 0 4 2 $ 7 0 4 . 7 9 2 $ 8 0 7 . 1 3 3 $ 9 0 8 . 8 2 3 $ 0 1 7 . 6 4 3 $ (1) Includes amounts reclassified to income from discontinued operations, but excludes revenue from Crest Net Lease, Inc., a subsidiary of Realty Income R e a lty Income 24 2010 Annual Report shareholders was $106.5 million as tions, should continue to contribute to compared to $106.9 million in 2009 increased productivity and positively Funds from operations per share were impact our 2011 earnings. lower, in comparison to 2009, due to our With respect to our capital structure, it deliberate cessation of acquisition activities remains very conservative and we have one during 2008 and 2009, which means the of the strongest balance sheets in our industry, revenue contributing to our earnings has according to many research analysts. Our been essentially ﬂat during this period. Even capital structure consisted of 67.5% in though we had a very successful year of common shares, 5.8% in preferred shares, acquisitions in 2010, the majority of the 26.7% in notes outstanding, and $17.6 million transactions closed during the third and fourth in cash on hand, and no mortgages on any quarter, limiting the positive contribution the of our properties, at the end of 2010. additional revenue might otherwise have had on our earnings. In addition, I already RENEWING OUR MONTHLY mentioned the fact that we added staff in DIVIDEND COMMITMENT the acquisitions, research and investor As we begin 2011, we’ve crossed the communications areas during the year, which threshold for $1.9 billion in monthly dividends increased our administrative expenses. We paid. We also celebrated our 42nd birthday anticipate that the high level of acquisition on February 28, 2011. During all these years, activity in 2010, along with our staff addi- we’ve been committed to being The Monthly FFO PER COMMON SHARE For the years ended 4 9 8 9 . 0 $ 5 9 0 0 . 1 $ 6 9 4 0 . 1 $ 7 9 1 1 . 1 $ 8 9 8 1 . 1 $ 9 9 3 2 . 1 $ 0 0 6 2 . 1 $ 1 0 0 3 . 1 $ 2 0 8 3 . 1 $ 3 0 5 4 . 1 $ 4 0 0 5 . 1 $ 5 0 2 6 . 1 $ 6 0 3 7 . 1 $ 7 0 9 8 . 1 $ 8 0 3 8 . 1 $ 9 0 4 8 . 1 $ 0 1 3 8 . 1 $ $ 1.90 $ 1.80 $ 1.70 $ 1.60 $ 1.50 $ 1.40 $ 1.30 $ 1.20 $ 1.10 $ 1.00 $ .90 Dividend Company®. I’m particularly pleased with the fact that, even during the troubled economic times we’ve all endured in the past two to three years, we’ve still been able to not only continue paying the monthly dividend, but also increase it a bit each year. Our primary goal is, and always has been, to manage our real estate assets so that they continue to provide the lease revenue to support monthly dividend payments. Secondarily, we hope to manage our operations, and effectively plan for the future, so that we also have the resources to increase the number of assets we own and to continue to increase our revenue and the amount of the dividend over time. R e a lty Income 25 2 010 Annual Report While we’re not 100% out of the woods, their income. I would also highly recommend in terms of the ﬁnancial challenges that face that all of you visit the “Risk” section of our our nation and the millions of people still new corporate website where you can unemployed, we are seeing some improvement watch a video that discusses risk and read in the broader economy. Our view is that, a helpful summary of the risks involved in as we begin 2011, we have a somewhat owning our shares. improved operating environment as compared We will do our best, this year, to operate to the last few years, and that we should be your Company in a prudent fashion so that successful in achieving our objective of the monthly dividends just keep on coming. paying 12 monthly dividends and increasing Also, please be sure to go to the new website the dividend over time. and, if you care to do so, email us a sentence We remain grateful for the support of or two about what monthly dividends do thousands of loyal shareholders (nearly for you. We’d love to hear from you. 100,000) many of whom, like us, have enjoyed years of monthly dividends. As always, there are no guarantees we will be as successful in our efforts during 2011 as we Sincerely, have been in the past and, for that reason, Tom A. Lewis we recommend that all investors remain Chief Executive Ofﬁcer diversiﬁed and rely on us for only a portion of Vice Chairman of the Board of Directors COMPARISON OF $100 INVESTED IN REALTY INCOME IN 1994 VS. MAJOR STOCK INDICES 1,300 1,100 900 700 500 300 100 Realty Income Corporation Equity REIT Index Dow Jones Industrial Average Standard & Poors 500 NASDAQ Composite 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 R e a lty Income 26 2010 Annual Report REALTy INCOME CORPORATION AND SuBSIDIARIES Financial Information 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 Reports of Independent Registered Public Accounting Firm Business Description Property Portfolio Information 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) Adjusted Funds from Operations Available to Common Stockholders (AFFO) Impact of Inﬂation Impact of Recent Accounting Pronouncements Quantitative and Qualitative Disclosures About Market Risk Selected Financial Data Controls and Procedures Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, including Total Return Performance 28 29 30 31 32 48 49 51 59 64 65 65 65 69 76 77 78 78 78 79 80 82 R e a l t y I n c o m e 27 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Consolidated Balance Sheets (dollars in thousands, except per share data) December 31, Assets Real estate, at cost: Land Buildings and improvements Total real estate, at cost 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, net 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: 2010 2009 $ 1,520,413 2,592,449 4,112,862 (711,615) 3,401,247 3,631 3,404,878 17,607 11,301 17,206 84,598 $ 1,169,295 2,270,161 3,439,456 (630,840) 2,808,616 8,266 2,816,882 10,026 10,396 17,206 60,277 $ 3,535,590 $ 2,914,787 $ 19,051 $ 16,926 47,019 22,555 — 1,600,000 1,688,625 38,445 16,807 4,600 1,350,000 1,426,778 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 2010 and 2009 337,790 337,790 Common stock and paid in capital, par value $1.00 per share, 200,000,000 shares authorized, 118,058,988 and 104,286,705 shares issued and outstanding as of December 31, 2010 and 2009, respectively Distributions in excess of net income Total stockholders’ equity Total liabilities and stockholders’ equity The accompanying notes to consolidated ﬁnancial statements are an integral part of these statements. 2,066,287 (557,112) 1,846,965 1,629,237 (479,018) 1,488,009 $ 3,535,590 $ 2,914,787 R e a l t y I n c o m e 28 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Consolidated Statements of Income (dollars in thousands, except per share data) years Ended December 31, 2010 2009 2008 Revenue Rental Other Total revenue Expenses Depreciation and amortization Interest General and administrative Property Income taxes Provisions for impairment Total expenses Income from continuing operations Income from discontinued operations: Real estate acquired for resale by Crest Real estate held for investment Total income from discontinued operations Net income Preferred stock cash dividends Net income available to common stockholders Amounts available to common stockholders per common share: Income from continuing operations: Basic Diluted Net income: Basic Diluted $ 344,080 929 345,009 95,513 93,237 25,311 7,332 1,393 807 223,593 121,416 946 8,422 9,368 130,784 (24,253) $ 106,531 $ 0.92 $ 0.92 $ 1.01 $ 1.01 $ 323,819 1,426 325,245 90,519 85,528 20,946 6,601 677 199 204,470 120,775 1,172 9,180 10,352 131,127 (24,253) $ 106,874 $ 0.93 $ 0.93 $ 1.03 $ 1.03 $ 323,164 1,877 325,041 89,104 93,956 21,618 5,458 1,230 3,374 214,740 110,301 3,819 17,721 21,540 131,841 (24,253) $ 107,588 $ 0.85 $ 0.85 $ 1.06 $ 1.06 Weighted average common shares outstanding: Basic Diluted 105,869,637 105,942,721 103,577,507 103,581,053 101,178,191 101,209,883 The accompanying notes to consolidated ﬁnancial statements are an integral part of these statements. R e a l t y I n c o m e 29 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Consolidated Statements of Stockholders’ Equity (dollars in thousands) years Ended December 31, 2008, 2009, 2010 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, 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 — — — — — — 74,425 5,160 Balance, December 31, 2008 13,900,000 104,211,541 337,790 1,624,622 Net income Distributions paid and payable Share-based compensation — — — — — 75,164 — — — — — 4,615 Balance, December 31, 2009 13,900,000 104,286,705 337,790 1,629,237 Net income Distributions paid and payable Shares issued in stock offerings, net of offering costs of $22,471 Share-based compensation — — — — — — 13,558,500 213,783 — — — — — — 432,591 4,459 131,841 (194,857) — — (407,751) 131,127 (202,394) — (479,018) 130,784 (208,878) — — 131,841 (194,857) 74,425 5,160 1,554,661 131,127 (202,394) 4,615 1,488,009 130,784 (208,878) 432,591 4,459 Balance, December 31, 2010 13,900,000 118,058,988 $ 337,790 $ 2,066,287 $ (557,112) $ 1,846,965 The accompanying notes to consolidated ﬁnancial statements are an integral part of these statements. R e a l t y I n c o m e 30 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Consolidated Statements of Cash Flows (dollars in thousands) years Ended December 31, 2010 2009 2008 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 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 Restricted escrow deposit for Section 1031 tax-deferred exchange Acquisition of and improvements to investment properties Intangibles 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 Borrowings from lines of credit Payments under lines of credit Proceeds from notes issued, net Proceeds from common stock offerings, net Debt issuance costs Principal payment on notes payable Other items Net cash provided by (used in) ﬁnancing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year $ 130,784 $ 131,127 $ 131,841 95,513 90,519 (946) (8,422) (271) 6,166 807 946 866 — — 138 5,270 12,517 243,368 — 25,779 (6,361) (701,391) (15,385) (697,358) (182,500) (24,253) 612,200 (616,800) 246,131 432,591 (4,091) — (1,707) 461,571 7,581 10,026 (1,172) (9,180) (15) 4,726 199 1,250 2,674 — 1,987 129 3,607 856 226,707 170 19,904 (4,479) (60,459) (860) (45,724) (178,008) (24,253) 4,600 — — — — (20,000) (111) (217,772) (36,789) 46,815 89,104 (3,819) (17,721) (236) 5,049 3,374 (52) 6,336 (9) 31,455 87 (930) 1,676 246,155 439 27,365 (3,174) (194,106) (397) (169,873) (169,655) (24,253) — — — 74,425 (3,196) (100,000) 111 (222,568) (146,286) 193,101 Cash and cash equivalents, end of year $ 17,607 $ 10,026 $ 46,815 For supplemental disclosures, see note 13. The accompanying notes to consolidated ﬁnancial statements are an integral part of these statements. R e a l t y I n c o m e 31 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements December 31, 2010, 2009 and 2008 1. ORgANIzATION AND OPERATION Realty Income Corporation (“Realty Income,” the “Company,” “we”, “our” or “us”) is organized as a Maryland corporation. We invest in commercial real estate and have elected to be taxed as a real estate investment trust, or REIT. At December 31, 2010, we owned 2,496 properties, located in 49 states, containing over 21.2 million leasable square feet, along with three properties owned by our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc., or Crest. 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, or the Code. Information with respect to number of properties, square feet, average initial lease term and weighted average contractual lease rate is unaudited. 2. SuMMARy OF SIgNIFICANT ACCOuNTINg POLICIES AND PROCEDuRES AND RECENT ACCOuNTINg PRONOuNCEMENTS Federal Income Taxes. We have elected to be taxed as a REIT under the Code. We believe we have qualiﬁed and continue to qualify as a REIT. Under the REIT operating structure, we are permitted to deduct distributions paid to our stockholders and generally will not be required to pay federal corporate income taxes on such income. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated ﬁnancial statements, except for the federal income taxes of Crest, which are included in discontinued operations. The income taxes recorded on our consolidated statements of income represent amounts paid by Realty Income for city and state income and franchise taxes. Earnings and proﬁts that determine the taxability of distributions to stockholders differ from net income reported for ﬁnancial reporting purposes due to differences in the estimated useful lives and methods used to compute 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 Preferred stock cash 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 2010(1) $ 106,531 24,253 22,905 — (10,063) — 1,337 562 (1,613) 4,223 3,579 2009 $ 106,874 2008 $ 107,588 24,253 27,094 (5,436) — — 378 1,824 (1,117) 1,273 (752) 24,253 28,624 (4,518) — 2,500 270 2,270 (1,997) (1,226) (321) Taxable net income, before our dividends paid deduction $ 151,714 $ 154,391 $ 157,443 (1) The 2010 information presented is a reconciliation of our net income available to common stockholders to estimated taxable net income. We regularly analyze our various federal and state ﬁling positions and only recognize the income tax effect in our ﬁnancial statements when certain criteria regarding uncertain income tax positions have been met. We believe that our income tax positions would more likely than not be sustained upon examination by all relevant taxing authorities. Therefore, no reserves for uncertain income tax positions have been recorded in our ﬁnancial statements. Absent an election to the contrary, if a REIT acquires property that is or has been owned by a C corporation in a transaction in 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 hands of the C corporation, and the REIT recognizes gain on the disposition of such property during the 10 year period beginning on the date on which it acquired the property, then the REIT will be required to pay tax at the highest regular corporate tax rate on this gain to the extent of the excess of the fair market value of the property over the REIT’s adjusted basis in the property, in each case determined as of the date the REIT acquired the property. In August 2007, we acquired 100% of the stock of a C corporation that owned real property. At the time of acquisition, the C corporation became a Qualiﬁed REIT Subsidiary, was deemed to be liquidated for Federal income tax purposes, and the real property was deemed to be transferred to us with a carry- over tax basis. As of December 31, 2010, we have built-in gains of $60 million with respect to such property. We do not expect that we will be R e a l t y I n c o m e 32 2 0 1 0 A n n u a l R e p o r t required to pay income tax on the built-in gains in these properties during the ten-year period ending August 28, 2017. It is our intent, and we have the ability, to defer any dispositions of these properties to periods when the related gains would not be subject to the built-in gain income tax or otherwise to defer the recognition of the built-in gain related to these properties. However, our plans could change and it may be necessary to dispose of one or more of these properties in a taxable transaction before August 28, 2017, in which case we would be required to pay corporate level tax with respect to the built-in gains on these properties as described above. Net Income Per Common Share. Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income per common share is computed by dividing net income available to common stockholders for the period by the weighted average number of common shares that would have been outstanding assuming the issuance of common shares for all potentially dilutive common shares outstanding during the reporting period. The following is a reconciliation of the denominator of the basic net income per common share computation to the denominator of the diluted net income per common share computation: 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 2010 2009 2008 105,869,637 73,084 103,577,507 3,546 101,178,191 31,692 per share computation 105,942,721 103,581,053 101,209,883 Unvested shares from share-based compensation that were anti-dilutive 87,600 542,368 614,917 Other Assets. Other assets consist of the following (dollars in thousands) at: December 31, Value of in-place and above-market leases, net Notes receivable issued in connection with Crest property sales Deferred bond ﬁnancing costs, net Prepaid expenses Escrow deposits for Section 1031 tax-deferred exchanges Credit facility organization costs, net Corporate assets, net of accumulated depreciation and amortization Other items 2010 $ 26,221 22,075 14,203 8,431 6,361 4,619 827 1,861 2009 $ 10,928 22,214 11,899 7,738 4,479 1,470 1,058 491 Distributions Payable. Distributions payable consist of the following declared distributions (dollars in thousands) at: $ 84,598 $ 60,277 December 31, Common stock distributions Preferred stock dividends 2010 $ 17,030 2,021 $ 19,051 2009 $ 14,905 2,021 $ 16,926 Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses consist of the following (dollars in thousands) at: December 31, Bond interest payable Other items 2010 $ 33,240 13,779 $ 47,019 2009 $ 25,972 12,473 $ 38,445 R e a l t y I n c o m e 33 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. 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 2010 $ 14,564 4,539 3,452 $ 22,555 2009 $ 10,341 4,334 2,132 $ 16,807 Discontinued Operations. Operations from nine of our investment properties were classiﬁed as held for sale at December 31, 2010, plus properties sold in 2010, 2009 and 2008, are reported as discontinued operations. Their respective results of operations have been reclassiﬁed to “income from discontinued operations, real estate held for investment” on our consolidated statements of income. We do not depreciate properties that are classiﬁed as held for sale. Crest acquires properties with the intention of reselling them rather than holding them for investment and operating the properties. Consequently, we typically classify Crest’s assets as held for sale at the date of acquisition and do not depreciate them. As a result, the operations of Crest’s property assets are typically classiﬁed as “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. However, if we determine we have no plans to sell a property asset in the near term (i.e. within the next 12 months), and this property was 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 sale, adjusted for any depreciation expense that would have been recognized had the property been continuously classiﬁed as held for investment, or (ii) the fair value at the date of the subsequent decision not to sell. At December 31, 2010, we determined that three property assets, acquired by Crest in 2006, no longer met the held for sale criteria because we decided to lease rather than sell these properties in the near term. As a result, investment in real estate of $3.0 million was reclassiﬁed from real estate held for sale to real estate held for investment on our consolidated balance sheet at December 31, 2010. At December 31, 2009, Crest’s property inventory consisted of three properties valued at $3.8 million, all of which was held for sale and included on our consolidated balance sheet at December 31, 2009, in “real estate held for sale, net.” The results of operations for these properties are included in “income from continuing operations” on our consolidated statements of income. As a result of this reclassiﬁcation, $911,000, $214,000 and $3.2 million in operating loss was reclassiﬁed from discontinued operations to continuing operations for 2010, 2009 and 2008, respectively. 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 operations, real estate acquired for resale by Crest” on our consolidated statements of income. The following is a summary of Crest’s “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income (dollars in thousands): Crest’s income from discontinued operations, real estate acquired for resale 2010 Rental revenue Interest revenue Gain on sales of real estate acquired for resale Interest expense General and administrative expense Property expenses Provisions for impairment Depreciation(1) Income tax beneﬁt (expense) Income from discontinued operations, real estate acquired for resale by Crest $ — 1,397 — (557) (226) (12) — — 344 2009 $ 157 1,403 — (595) (336) (24) (78) — 645 2008 $ 1,595 899 4,642 (1,797) (511) (13) — (771) (225) $ 946 $ 1,172 $ 3,819 (1) Depreciation was recorded on one property that was classiﬁed as held for investment. This property was sold in 2008. R e a l t y I n c o m e 34 2 0 1 0 A n n u a l R e p o r t 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 investment properties Rental revenue Other revenue Depreciation and amortization Property expenses Provisions for impairment 2010 $ 8,405 1,771 32 (636) (937) (213) 2009 $ 8,044 3,592 45 (1,428) (963) (110) 2008 $ 13,314 6,813 96 (1,929) (573) — Income from discontinued operations, real estate held for investment $ 8,422 $ 9,180 $ 17,721 The following is a summary of our total income from discontinued operations (dollars in thousands, except per share data): Total discontinued operations Real estate acquired for resale by Crest Real estate held for investment Income from discontinued operations Per common share, basic and diluted 2010 $ 946 8,422 $ 9,368 $ 0.09 2009 $ 1,172 9,180 $ 10,352 $ 0.10 2008 $ 3,819 17,721 $ 21,540 $ 0.21 The per share amounts for “income from discontinued operations” above and the “income from continuing operations” and “net income” reported on the consolidated statements of income have each been calculated independently. 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, when determining collectibility of accounts receivable and appropriate allowances to record. Our allowance for doubtful accounts at December 31, 2010 was $1.1 million and at December 31, 2009 was $865,000. Other revenue includes non-operating interest earned from investments in money market funds and other notes of $96,000 in 2010, $51,000 in 2009 and $1.4 million in 2008. Principles of Consolidation. The accompanying consolidated ﬁnancial statements include the accounts of Realty Income, Crest and other entities for which we make operating and ﬁnancial decisions (i.e. control), after elimination of all material intercompany balances and transactions. All of Realty Income’s subsidiaries are wholly-owned. We have no unconsolidated or off-balance sheet investments in variable interest entities. Cash Equivalents. We consider all short-term, highly liquid investments that are readily convertible to cash and have an original maturity of three months or less at the time of purchase to be cash equivalents. Our cash equivalents are primarily investments in United States Treasury or government money market funds. Gain on Sales of Properties. When real estate is sold, the related net book value of the applicable assets is removed and a gain from the sale is recognized in our consolidated statements of income. We record a gain from the sale of real estate provided that various criteria, relating to the terms of the sale and any subsequent involvement by us with the real estate, have been met. Allocation of the Purchase Price of Real Estate Acquisitions. When acquiring a property for investment purposes, we allocate the fair value of real estate acquired to: 1) land and 2) building and improvements, based in each case on their estimated fair values. R e a l t y I n c o m e 35 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. For properties acquired with in-place operating leases, the fair value of real estate is allocated to: 1) land, 2) building and improvements, and 3) identiﬁed intangible assets and liabilities, based in each case on their estimated fair values. Intangible assets and liabilities consist of above- market and below-market leases, the value of in-place leases and tenant relationships. Our estimated fair value determinations are based on management’s judgment, which is based on various factors, including: (1) market conditions, (2) industry that tenant operates in, (3) characteristics of the real estate, i.e.: location, size, demographics, value and comparative rental rates, (4) tenant credit proﬁle, (5) store proﬁtability and the importance of the location of the real estate to the operations of the tenant’s business, and/or (6) real estate appraisals, prepared by an independent appraisal ﬁrm. When real estate appraisals are utilized, the measurement of fair value related to the allocation of the purchase price of real estate acquisitions is derived principally from observable market data that is not readily available to the public (and thus should be categorized as level 2 on FASB’s three-level valuation hierarchy). Our other methodologies for measuring fair value related to the allocation of the purchase price of real estate acquisitions (except for independent third-party real estate appraisals) include unobservable inputs that reﬂect our own internal assumptions and calculations (and thus should be categorized as level 3 on FASB’s three-level valuation hierarchy). The fair value of the tangible assets of an acquired property (which includes land and buildings/improvements) is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land and buildings/improvements based on our determination of the relative fair value of these assets. Our fair value determinations are based on a real estate appraisal for each property, prepared by an independent appraisal ﬁrm, and consider estimates of carrying costs during the expected lease-up periods, current market conditions, as well as costs to execute similar leases. In allocating the fair value to identiﬁed intangibles for above-market or below-market leases, an amount is recorded based on the present value of the difference between (i) the contractual amount to be paid pursuant to the in-place lease and (ii) our estimate of fair market lease rate for the corresponding in-place lease, measured over a period equal to the remaining term of the lease. Capitalized above-market lease values are amortized as a reduction of rental income over the remaining terms of the respective leases. Capitalized below-market lease values are amortized as an increase to rental income over the remaining terms of the respective leases and expected below- market renewal option periods. The aggregate value of other acquired intangible assets consists of the value of in-place leases and tenant relationships. These are measured by the excess of the purchase price paid for a property, after adjusting for above or below-market lease value, less the estimated fair value of the property “as if vacant,” determined as set forth above. The value of in-place leases, exclusive of the value of above-market and below-market in-place leases, is amortized to expense over the remaining periods of the respective leases. If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be recorded to revenue or expense as appropriate. 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 lives are as follows: Buildings Building improvements Typically 25 years 4 to 15 years Tenant improvements and lease commissions The shorter of the term of the related lease or useful life Acquired in-place leases Remaining terms of the respective leases Provisions for Impairment. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment is recorded if estimated future operating cash ﬂows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key factors that we use in this analysis include: projected rental rates, capital expenditures and property sales capitalization rates. Additionally, a property classiﬁed as held for sale is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell. R e a l t y I n c o m e 36 2 0 1 0 A n n u a l R e p o r t In 2010, Realty Income recorded total provisions for impairment of $213,000 on three properties in the restaurant industry and one property in the child care industry. These provisions for impairment are included in “income from discontinued operations, real estate held for investment” on our consolidated statement of income for 2010, as three of the properties were subsequently sold and one is anticipated to be sold in the ﬁrst quarter of 2011. During 2010, Crest recorded total provisions for impairment of $807,000 on three properties held for investment at December 31, 2010. These provisions for impairment are included in “income from continuing operations” on our consolidated statement of income for 2010. In 2009, we recorded a provision for impairment of $110,000 on one property in the convenience store industry, which was sold during 2010. This provision for impairment is included in “income from discontinued operations, real estate held for investment” on our consolidated statement of income for 2009. Additionally, in 2009, Crest recorded total provisions for impairment of $199,000 on three properties classiﬁed as held for investment at December 31, 2010. These provisions for impairment are included in “income from continuing operations” on our consolidated statement of income for 2009. Additionally, Crest recorded total provisions for impairment of $78,000 on two properties which were sold in 2009. These provisions for impairment are included in “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statement of income for 2009. No provisions for impairment were recorded by Realty Income in 2008. In 2008, Crest recorded total provisions for impairment of $3.4 million on three properties, which were held for investment at December 31, 2010. These provisions for impairment are included in “income from continuing operations” on our consolidated statement of income for 2008. Asset Retirement Obligations. We analyze our future legal obligations associated with the other-than-temporary removal of tangible long-lived assets, also referred to as asset retirement obligations. When we determine that we have a legal obligation to provide services upon the retirement of a tangible long-lived asset, we record a liability for this obligation based on the estimated fair market value of this obligation and adjust the carrying amount of the related long-lived asset by the same amount. This asset is amortized over its estimated useful life. The estimated fair value of the asset retirement obligation is calculated by discounting the future cash ﬂows using a credit-adjusted risk-free interest rate. Goodwill. Goodwill is tested for impairment during the second quarter of each year as well as when events or circumstances occur indicating that our goodwill might be impaired. During our tests for impairment of goodwill, during the second quarters of 2010, 2009 and 2008, we determined that the estimated fair values of our reporting units exceeded their carrying values. We did not record any new goodwill or impairment on our existing goodwill during 2010, 2009 or 2008. Sales Taxes. We collect and remit sales taxes assessed by different governmental authorities that are both imposed on and concurrent with a revenue-producing transaction between us and our tenants. We report the collection of these taxes on a net basis (excluded from revenues). The amounts of these taxes are not signiﬁcant 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, or GAAP, 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 December 2010, the Financial Accounting Standards Board issued Accounting Standards Update, or ASU, No. 2010-29, Business Combinations (Topic 805), Disclosure of Supplementary Pro Forma Information for Business Combinations. Effective for periods beginning after December 15, 2010, ASC No. 2010-29 speciﬁes that if a public entity enters into business combinations that are material on an individual or aggregate basis and presents comparative ﬁnancial statements, the entity must present pro forma revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU No. 2010-29 only applies to our disclosures in note 3 related to acquisitions and is not expected to have a signiﬁcant impact on our footnote disclosures. Reclassiﬁcations. Certain of the 2009 and 2008 balances have been reclassiﬁed to conform to the 2010 presentation. R e a l t y I n c o m e 37 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. 3. PROPERTIES ACQuIRED We acquire the land, buildings and improvements that are necessary for the successful operations of retail and other commercial enterprises. A. During 2010, Realty Income invested $713.5 million in 186 new properties with an initial weighted average contractual lease rate of 7.9%. These 186 properties are located in 14 states, contain over 2.2 million leasable square feet, and are 100% leased with an average lease term of 15.7 years. The initial weighted average contractual lease rate is computed by dividing the estimated aggregate base rent for the ﬁrst year of each lease by the estimated total cost of the properties. In accordance with GAAP, acquisition transaction costs of $368,000 were recorded to “general and administrative” expense on our consolidated statement of income for 2010. Included in the $713.5 million invested during 2010 are the following acquisitions: (1) The acquisition and lease-back of approximately $304.1 million of winery and vineyard properties under 20-year, triple-net lease arrangements with Diageo Chateau & Estates Wine Company, guaranteed by Diageo plc (NYSE: ADR: DEO), or, together with its subsidiaries, Diageo. The properties are primarily located in California’s Napa Valley and include two wineries that produce wines for Diageo’s Sterling Vineyards, or Sterling, and Beaulieu Vineyards, or BV, brands and 14 vineyards producing grapes for their Sterling, BV and other brands. The properties include approximately 3,600 acres and 426,000 square feet of winery, production, storage, shipping and tourist buildings. Diageo will continue to operate the wineries and vineyards. (2) The acquisition of 23 retail properties leased to 13 tenants in six states, for approximately $126.5 million, under long-term, net lease agreements. The properties are in eight different industries, all of which are already in our portfolio. All of the properties acquired have in-place leases. (3) The acquisition of 135 SuperAmerica convenience stores and one support facility, for approximately $247.6 million, under long-term, triple-net lease agreements. The stores are located in Minnesota and Wisconsin, and average approximately 3,500 leasable square feet on approximately 1.14 acres. (4) The remaining 11 properties acquired totaled approximately $35.3 million. The 2010 aggregate acquisitions were allocated as follows: $358.3 million to land, $339.8 million to buildings and improvements, $17.0 million to intangible assets and $1.6 million to intangible liabilities. All of the acquisitions were cash purchases and there were no contingent considerations associated with these acquisitions. Total revenues of $16.0 million and income from continuing operations of $12.1 million are included in the 2010 consolidated income statement for the aggregate 2010 acquisitions. The following pro forma total revenue and income from continuing operations of the 2010 acquisitions in aggregate, assumes the acquisitions had taken place on January 1, 2010 for the 2010 pro forma information, and on January 1, 2009 for the 2009 pro forma information (in millions): Supplemental pro forma for the year ended December 31, 2010(1) Supplemental pro forma for the year ended December 31, 2009(1) Total Revenue $ 385.4 $ 381.6 Income from Continuing Operations $ 137.7 $ 142.3 (1) This unaudited pro forma supplemental information does not purport to be indicative of what our operating results would have been had the acquisitions occurred on January 1, 2010 or January 1, 2009, and may not be indicative of future operating results. In comparison, during 2009, Realty Income invested $57.9 million in 16 new properties with an initial weighted average contractual lease rate of 9.7%. These 16 properties are located in ﬁve states, contain over 278,000 leasable square feet, and are 100% leased with an average lease term of 17.9 years. In accordance with GAAP, acquisition transaction costs of $62,000 were recorded to “general and administrative” expense on our consolidated statement of income for 2009. B. During 2010 and 2009, Crest did not invest in any new properties. C. Of the $713.5 million invested by Realty Income in 2010, approximately $126.5 million was used to acquire 23 properties with existing leases. Realty Income recorded $12.6 million as the intangible value of the in-place leases, $4.4 million as the intangible value of above-market leases and $1.6 million as the intangible value of below-market leases for 2010. The value of the in-place and above-market leases are recorded to “other R e a l t y I n c o m e 38 2 0 1 0 A n n u a l R e p o r t assets” on our consolidated balance sheet, as of December 31, 2010, and the value of the below-market leases are recorded to “other liabilities” on our consolidated balance sheet as of December 31, 2010. All of these amounts are amortized over the life of the respective leases. Of the $57.9 million invested by Realty Income in 2009, $10.5 million was used to acquire three properties with existing leases. Realty Income recorded $1.4 million as the intangible value of the in-place leases, $150,000 as the intangible value of above-market leases and $655,000 as the intangible value of below-market leases for 2009. The value of the in-place and above-market leases are recorded to “other assets” on our consolidated balance sheet, as of December 31, 2009, and the value of the below-market leases are recorded to “other liabilities” on our consolidated balance sheet as of December 31, 2009. All of these amounts are amortized over the life of the respective leases. 4. CREDIT FACILITy In December 2010, we entered into a new $425 million revolving, unsecured credit facility that replaced our previous $355 million acquisition credit facility that was scheduled to expire in May 2011. The initial term of the new credit facility expires in March 2014 and includes two, one-year extension options. Under the new credit facility, our investment grade credit ratings provide for ﬁnancing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. We also have other interest rate options available to us. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation. In December 2010, as a result of entering into our current credit facility, we incurred $4.2 million of credit facility origination costs that were classiﬁed as part of “other assets” on our consolidated balance sheet at December 31, 2010 and are being amortized over the term of the credit facility. The remaining credit facility origination costs that were incurred as a result of entering into our previous $355 million credit facility, which were $452,000 at December 31, 2010, are included in “other assets” and are being amortized over the remaining term of our current $425 million credit facility. The average borrowing rate on our credit facility was 1.3% during 2010. During 2009, we did not utilize our credit facility until December and, during 2008, we did not utilize our credit facility. Our effective borrowing rate at December 31, 2010 was 2.1% and at December 31, 2009 was 1.2%. Our current and prior credit facilities are and were 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, 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 5.75% notes, issued in June 2010 and due in January 2021 5.875% bonds, issued in March 2005 and due in March 2035 2010 $ 100 150 275 175 550 250 100 2009 $ 100 150 275 175 550 — 100 $ 1,600 $ 1,350 The following table summarizes the maturity of our notes payable as of December 31, 2010 (dollars in millions): year of Maturity 2011 2012 2013 2014 2015 Thereafter Totals Notes $ — — 100 — 150 1,350 $ 1,600 R e a l t y I n c o m e 39 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. Interest incurred on all of the notes for 2010 was $89.7 million, for 2009 was $82.5 million and for 2008 was $91.2 million. The interest rate on each of these notes is ﬁxed. Our outstanding notes are unsecured; 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 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 Issuance In June 2010, we issued $250 million in aggregate principal amount of 5.75% senior unsecured notes due January 2021, or the 2021 Notes. The price to the investor for the 2021 Notes was 99.404% of the principal amount for an effective yield of 5.826%. The net proceeds of approximately $246.1 million from this offering were used to repay borrowings under our acquisition credit facility, which were used to ﬁnance the acquisition of the Diageo properties in June 2010. Interest is paid semiannually on the 2021 Notes. C. Note Redemptions On their maturity date in January 2009, we redeemed, using cash on hand, all of our outstanding 8.00% notes issued in January 1999 at a redemption price equal to 100% of the principal amount of $20 million, plus accrued and unpaid interest. On their maturity date in November 2008, we redeemed, using proceeds from our September 2008 common stock offering and cash on hand, all of our outstanding 8.25% senior notes issued in October 1998, or the 2008 Notes, at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest. 6. COMMON STOCk OFFERINgS In December 2010, we issued 7,360,000 shares of common stock at a price of $33.70 per share. The net proceeds of approximately $235.7 million were used to repay borrowings of $179.8 million under our acquisition credit facility and to fund property acquisitions during December 2010. The remaining net proceeds were used for general corporate purposes and working capital. In September 2010, we issued 6,198,500 shares of common stock at a price of $33.40 per share. The net proceeds of approximately $196.9 million were used to repay borrowings of $49.7 million under our acquisition credit facility and to fund $126.5 million of property acquisitions during October 2010. The remaining net proceeds were used for general corporate purposes and working capital. In September 2008, we issued 2,925,000 shares of common stock at a price of $26.82 per share. The net proceeds of approximately $74.4 million were used, along with our available cash on hand, to redeem the $100 million outstanding principal amount of our 2008 Notes in November 2008. 7. PREFERRED STOCk A. In 2004, we issued 5.1 million shares of 7.375% Monthly Income Class D cumulative redeemable preferred stock. In May 2009, the Class D preferred shares became redeemable, at our option, for $25 per share. During 2010, 2009 and 2008, we paid twelve monthly dividends to holders of our Class D preferred stock totaling $1.8437508 per share, or $9.4 million, and at December 31, 2010, a monthly dividend of $0.1536459 per share was payable and was paid in January 2011. B. In 2006, we issued 8.8 million shares of 6.75% Monthly Income Class E cumulative redeemable preferred stock. Beginning December 7, 2011, the Class E preferred shares are redeemable, at our option, for $25 per share. During 2010, 2009 and 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, 2010, a monthly dividend of $0.140625 per share was payable and was paid in January 2011. We are current in our obligations to pay dividends on our Class D and Class E preferred stock. R e a l t y I n c o m e 40 2 0 1 0 A n n u a l R e p o r t 8. DISTRIBuTIONS PAID AND PAyABLE A. Common Stock We pay monthly distributions to our common stockholders. The following is a summary of monthly distributions paid per common share for the years: Month January February March April May June July August September October November December Total 2010 2009 2008 $ 0.1430000 $ 0.1417500 $ 0.136750 0.1430000 0.1430000 0.1433125 0.1433125 0.1433125 0.1436250 0.1436250 0.1436250 0.1439375 0.1439375 0.1439375 0.1417500 0.1417500 0.1420625 0.1420625 0.1420625 0.1423750 0.1423750 0.1423750 0.1426875 0.1426875 0.1426875 0.136750 0.136750 0.137375 0.137375 0.137375 0.138000 0.138000 0.140500 0.141125 0.141125 0.141125 $ 1.7216250 $ 1.7066250 $ 1.662250 The following presents the federal income tax characterization of distributions paid or deemed to be paid per common share for the years: Ordinary income Nontaxable distributions Capital gain Totals 2010 2009 2008 $ 1.2598879 0.4617371 — $ 1.7216250 $ 1.2739214 0.4113034 0.0214002 $ 1.7066250 $ 1.2681285 0.3121490 0.0819725 $ 1.6622500 At December 31, 2010, a distribution of $0.14425 per common share was payable and was paid in January 2011. At December 31, 2009, a distribution of $0.143 per common share was payable and was paid in January 2010. B. Class D Preferred Stock Dividends of $0.1536459 per share are paid monthly in arrears on the Class D preferred stock. We declared dividends to holders of our Class D preferred stock totaling $9.4 million in 2010, 2009 and 2008, respectively. The following presents the federal income tax characterization of dividends paid per share to our Class D preferred stockholders for the years: Ordinary income Capital gain Totals C. Class E Preferred Stock 2010 2009 2008 $ 1.8437508 — $ 1.8437508 $ 1.8206316 0.0231192 $ 1.8437508 $ 1.7528280 0.0909228 $ 1.8437508 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 2010, 2009 and 2008. The following presents the federal income tax characterization of dividends paid per share to our Class E preferred stockholders for the years: Ordinary income Capital gain Totals 2010 2009 2008 $ 1.6875000 — $ 1.6875000 $ 1.6663392 0.0211608 $ 1.6875000 $ 1.6042824 0.0832176 $ 1.6875000 R e a l t y I n c o m e 41 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. 9. OPERATINg LEASES A. At December 31, 2010, we owned 2,496 properties in 49 states, plus an additional three properties owned by Crest. Of the 2,496 properties, 2,485, or 99.6%, are single-tenant, properties and the remaining 11 are multi-tenant, distribution and ofﬁce properties. At December 31, 2010, 84 properties were vacant and available for lease or sale. Substantially all leases are net leases where the tenant pays property taxes and assessments, maintains the interior and exterior of the building and leased premises, and carries insurance coverage for public liability, property damage, ﬁre and extended coverage. Rent based on a percentage of a tenants’ gross sales (percentage rents) for 2010 was $1.4 million, for 2009 was $1.3 million and for 2008 was $1.3 million, including amounts recorded to discontinued operations of $56,000 in 2010, $90,000 in 2009 and $61,000 in 2008. At December 31, 2010, minimum future annual rents to be received on the operating leases for the next ﬁve years and thereafter are as follows (dollars in thousands): 2011 2012 2013 2014 2015 Thereafter Total $ 373,787 360,338 346,073 328,318 314,855 2,637,944 $ 4,361,315 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, 2010, 2009 or 2008. 10. gAIN ON SALES OF REAL ESTATE ACQuIRED FOR RESALE By CREST During 2010, Crest did not sell any properties. During 2009, Crest sold two properties for $2.0 million, which resulted in no gain. During 2008, Crest sold 25 properties for $50.7 million, which resulted in a gain of $4.6 million. In 2008, as part of two sales, Crest provided buyer ﬁnancing of $19.2 million. Crest’s gains on sales are reported before income taxes and are included in discontinued operations. 11. gAIN ON SALES OF INvESTMENT PROPERTIES By REALTy INCOME During 2010, we sold 28 investment properties for $26.6 million, which resulted in a gain of $8.4 million. The results of operations for these properties have been reclassiﬁed as discontinued operations. Additionally, we sold excess land from one property for $600,000, which resulted in a gain of $271,000. This gain is included in “other revenue” on our consolidated statement of income for 2010 because this excess land was associated with a property that continues to be owned as part of our core operations. During 2009, we sold 25 investment properties for $20.3 million, which resulted in a gain of $8.0 million. The results of operations for these properties have been reclassiﬁed as discontinued operations. Additionally, we received proceeds of $170,000 from the sale of excess land from one property, which resulted in a gain of $15,000. This gain is included in “other revenue” on our consolidated statement of income for 2009 because this excess land was associated with a property that continues to be owned as part of our core operations. During 2008, we sold 29 investment properties for $27.4 million, which resulted in a gain of $13.3 million. The results of operations for these properties have been reclassiﬁed as 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 revenue” on our consolidated statement of income for 2008 because this excess land was associated with a property that continues to be owned as part of our core operations. 12. FAIR vALuE OF FINANCIAL INSTRuMENTS Fair value is deﬁned 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. The disclosure for assets and liabilities measured at fair value requires allocation to a three-level valuation hierarchy. This valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Categorization within this hierarchy is based upon the lowest level of input that is signiﬁcant to the fair value measurement. R e a l t y I n c o m e 42 2 0 1 0 A n n u a l R e p o r t We believe that the carrying values reﬂected in our consolidated balance sheets reasonably approximate the fair values for cash and cash equivalents, accounts receivable, and all liabilities, due to their short-term nature, except for our notes receivable issued in connection with property sales and our notes payable, which are disclosed below (dollars in millions): At December 31, 2010 Notes receivable issued in connection with Crest property sales Notes payable At December 31, 2009 Notes receivable issued in connection with Crest property sales Notes payable Carrying value per balance sheet $ 22.1 $ 1,600.0 Carrying value per balance sheet $ 22.2 $ 1,350.0 Estimated fair market value $ 23.2 $ 1,707.1 Estimated fair market value $ 20.0 $ 1,276.4 The estimated fair value of our notes receivable, issued in connection with property sales, has been calculated by discounting the future cash ﬂows using an interest rate based upon the current 5-year or 7-year Treasury Yield Curve, plus an applicable credit-adjusted spread. These notes receivable were issued in connection with the sale of three Crest properties. Payments to us on these notes receivable are current and no allowance for doubtful accounts has been recorded for them. The estimated fair value of our notes payable is based upon indicative market prices and recent trading activity of our notes payable. 13. SuPPLEMENTAL DISCLOSuRES OF CASh FLOw INFORMATION Interest paid in 2010 was $82.6 million, in 2009 was $83.2 million and in 2008 was $90.3 million. Interest capitalized to properties under development in 2010 was $10,000, in 2009 was $5,000 and in 2008 was $92,000. Income taxes paid by Realty Income and Crest in 2010 were $907,000, in 2009 were $1.2 million and in 2008 were $1.7 million. The following non-cash investing and ﬁnancing activities are included in the accompanying consolidated ﬁnancial statements: A. Share-based compensation expense for 2010 was $6.2 million, for 2009 was $4.7 million and for 2008 was $5.0 million. B. See “Provisions for Impairment” in note 2 for a discussion of provisions for impairments recorded by Realty Income and Crest. C. At December 31, 2010, Realty Income had escrow deposits of $6.4 million held for tax-deferred exchanges under Section 1031 of the Code. The $6.4 million is included in “other assets” on our consolidated balance sheet at December 31, 2010. D. At December 31, 2009, Realty Income had escrow deposits of $4.5 million held for tax-deferred exchanges under Section 1031 of the Code. The $4.5 million is included in “other assets” on our consolidated balance sheet at December 31, 2009. E. At December 31, 2008, Realty Income had escrow deposits of $3.2 million held for tax-deferred exchanges under Section 1031 of the Code. The $3.2 million is included in “other assets” on our consolidated balance sheet at December 31, 2008. F. In 2010, Realty Income recorded a $799,000 receivable for the sale of an investment property as a result of an eminent domain action and recorded a $600,000 receivable for the sale of excess land from an investment property. These receivables are included in “other assets” on our consolidated balance sheet at December 31, 2010. G. At December 31, 2009, Realty Income recorded $1.5 million for a new environmental insurance policy, which supplements its primary insurance policy. The $1.5 million is included in “other assets” and “accounts payable and accrued expenses” on our consolidated balance sheet at December 31, 2009. R e a l t y I n c o m e 43 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. H. In 2009, Realty Income and Crest amended certain prior year state tax returns and determined that it is more-likely-than-not that we will be collecting refunds in the future as a result of these amendments. As a result of this, in 2009, Realty Income recorded a tax receivable of $454,000 and Crest recorded a tax receivable of $303,000. I. In 2008, Crest sold two properties for $23.5 million and received notes totaling $19.2 million from the buyers, which are included in “other assets” on our consolidated balance sheets. J. In accordance with our policy, we recorded adjustments to our estimated legal obligations related to asset retirement obligations on two land leases in the following amounts: an increase of $82,000 in 2010, a reduction of $63,000 in 2009 and an increase of $335,000 in 2008. These asset retirement obligations account for the difference between our obligations to the landlord under the two land leases and our subtenant’s obligations to us under the subleases. K. Accrued costs on properties under development resulted in an increase in buildings and improvements and accounts payable of $337,000 at December 31, 2010. 14. EMPLOyEE BENEFIT PLAN We have a 401(k) plan covering substantially all of our employees. Under our 401(k) plan, employees may elect to make contributions to the plan up to a maximum of 60% of their compensation, subject to limits under the Code. We match 50% of our employee’s contributions, up to 3% of the employee’s compensation. Our aggregate matching contributions each year have been immaterial to our results of operations. 15. COMMON STOCk INCENTIvE PLAN In 2003, our Board of Directors adopted, and stockholders approved, the 2003 Incentive Award Plan of Realty Income Corporation, or 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, or SPR, stock appreciation rights, or SAR, and other awards will be no more than 3,428,000 shares. The maximum number of shares that may be subject to options, SPR, SAR 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 recognized in “general and administrative expense” on our consolidated statements of income during 2010 was $6.2 million, during 2009 was $4.7 million and during 2008 was $5.0 million. The following table summarizes our common stock grant activity under our Stock Plan. 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 Outstanding nonvested shares, end of year (1) Grant date fair value. 2010 2009 2008 Number of shares 853,234 278,200 (206,153) (987) weighted average price(1) $ 19.14 28.99 23.70 26.03 Number of shares 994,453 142,860 (214,521) (69,558) weighted average price(1) $ 19.70 22.86 23.14 25.95 Number of shares 994,572 249,447 (188,215) (61,351) weighted average price(1) $ 19.46 26.63 21.96 22.13 924,294 $ 19.69 853,234 $ 19.14 994,453 $ 19.70 R e a l t y I n c o m e 44 2 0 1 0 A n n u a l R e p o r t During 2010, we issued 278,200 shares of common stock under our Stock Plan. These shares vest over the following service periods: 32,000 vested immediately, 5,000 vest over a service period of two years, 12,000 vest over a service period of three years, 50,000 vest over a service period of four years and 179,200 vest over a service period of ﬁve years. The vesting schedule for shares granted to non-employee directors is as follows: • For directors with less than six years of service at the date of grant, shares vest in 33.33% increments on each of the ﬁrst three anniversaries of the date the shares of stock are granted; • For directors with six years of service at the date of grant, shares vest in 50% increments on each of the ﬁrst two anniversaries of the date the shares of stock are granted; • For directors with seven years of service at the date of grant, shares are 100% vested on the ﬁrst anniversary of the date the shares of stock are granted; and • For directors with eight or more years of service at the date of grant, there is immediate vesting as of the date the shares of stock are granted. The vesting schedule for shares granted to employees is as follows: • For employees age 55 and below at the grant date, shares vest in 20% increments on each of the ﬁrst ﬁve anniversaries 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 anniversaries 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. In addition, after they have been employed for six full months, all non-executive employees receive 200 shares of nonvested stock which vests over a ﬁve year period. As of December 31, 2010, the remaining unamortized share-based compensation expense totaled $18.2 million, which is being amortized on a straight-line basis over the service period of each applicable award. The amount of share-based compensation is based on the fair value of the stock at the grant date. We define the grant date as the date the recipient and Realty Income have a mutual understanding of the key terms and condition of the award, and the recipient of the grant begins to benefit from, or be adversely affected by, subsequent changes in the price of the shares. Due to a historically low turnover rate, we do not estimate a forfeiture rate for our nonvested shares. Accordingly, unexpected forfeitures will lower share-based compensation expense during the applicable period. Under the terms of our Stock Plan, we pay non-refundable dividends to the holders of our nonvested shares. Applicable accounting guidance requires that the dividends paid to holders of these nonvested shares be charged as compensation expense to the extent that they relate to nonvested shares that do not or are not expected to vest. However, since we do not estimate forfeitures given our historical trends, we did not record any amount to compensation expense related to dividends paid in 2010, 2009 or 2008. No stock options were granted after January 1, 2002, all outstanding options were fully vested as of December 31, 2006, and 2006 represented the last year for which we recorded expense on our stock option awards. Stock options were granted with an exercise price equal to the underlying stock’s fair value at the date of grant. The outstanding stock options expire on December 31, 2011, ten years from the date they were granted and have an exercise price of $14.70. The following table summarizes our stock option activity for the years: Outstanding options, beginning of year Options exercised Outstanding and exercisable options, end of year 2010 2009 2008 Number of shares 5,846 (3,392) weighted average exercise price $ 14.70 14.70 Number of shares 21,294 (15,448) weighted average exercise price $ 13.33 12.81 Number of shares 45,007 (23,713) weighted average exercise price $ 12.71 12.15 2,454 $ 14.70 5,846 $ 14.70 21,294 $ 13.33 R e a l t y I n c o m e 45 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Notes to Consolidated Financial Statements, cont’d. 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 our stock was $34.20, $25.91 and $23.15 at December 31, 2010, 2009 and 2008, respectively. The total intrinsic value of options exercised during the years ended December 31, 2010, 2009 and 2008 was $61,000, $157,000 and $319,000, respectively. The aggregate intrinsic value of options outstanding and exercisable was $48,000, $66,000 and $209,000 at December 31, 2010, 2009 and 2008, respectively. 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 33 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, 2010 (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 Restaurants Theaters Wine and spirits 24 non-reportable segments Total segment net real estate Other intangible assets - Apparel Other intangible assets - Automotive tire service Other intangible assets - Drug stores Other intangible assets - Grocery stores Other intangible assets - Health and ﬁtness Other intangible assets - Ofﬁce supplies Other intangible assets - Theaters Other intangible assets - Sporting goods Other intangible assets - Other Goodwill - Automotive service Goodwill - Child care Goodwill - Convenience stores Goodwill - Home furnishings Goodwill - Restaurants Goodwill - non reportable segments Other corporate assets Total assets 2010 2009 $ 106,669 $ 105,085 195,064 72,827 706,173 143,739 220,296 709,523 281,072 302,159 667,356 3,404,878 3,644 588 5,938 6,031 1,707 390 1,579 5,786 558 1,338 5,353 2,074 1,557 3,779 3,105 201,233 77,987 477,640 141,057 200,316 730,460 290,386 — 592,718 2,816,882 — 647 6,066 860 845 — 1,885 — 625 1,338 5,353 2,074 1,557 3,779 3,105 87,285 $ 3,535,590 69,771 $ 2,914,787 R e a l t y I n c o m e 46 2 0 1 0 A n n u a l R e p o r t For the years ended December 31, 2010 Revenue 2009 2008 Segment rental revenue: Automotive service Automotive tire services Child care Convenience stores Drug stores Health and ﬁtness Restaurants Theaters Wine and spirits 24 non-reportable segments Total rental revenue Other revenue Total revenue $ 16,123 $ 15,797 $ 15,853 21,859 22,417 58,883 13,962 23,768 69,923 30,634 10,292 76,219 344,080 929 $ 345,009 22,616 23,408 55,136 13,727 18,787 69,181 30,078 — 75,089 323,819 1,426 $ 325,245 22,040 23,758 51,971 13,125 18,419 70,763 29,640 — 77,595 323,164 1,877 $ 325,041 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, 2010, we have contingent payments of $4.2 million for tenant improvements and leasing costs. In addition, we have committed $420,000 under construction contracts, which is expected to be paid in the next three months. We have certain properties that are subject to ground leases which are accounted for as operating leases. 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. At December 31, 2010, minimum future rental payments for the next ﬁve years and thereafter under these ground leases are as follows (dollars in thousands): 2011 2012 2013 2014 2015 Thereafter Total $ 3,631 3,527 3,385 3,150 3,096 31,933 $ 48,722 18. SuBSEQuENT EvENTS In January 2011 and February 2011, we declared the following dividends, which will be paid in February 2011 and March 2011, respectively: • $0.14425 per share to our common stockholders; • $0.1536459 per share to our Class D preferred stockholders; and • $0.140625 per share to our Class E preferred stockholders. R e a l t y I n c o m e 47 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Consolidated Quarterly Financial Data (dollars in thousands, except per share data) (not covered by Report of Independent Registered Public Accounting Firm) 2010(1) Total revenue Depreciation and amortization expense Interest 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) $ 82,725 $ 83,047 $ 87,018 $ 92,219 $ 345,009 23,060 21,395 8,932 29,338 867 30,205 24,142 23,353 21,576 8,615 29,503 1,545 31,048 24,985 24,045 25,135 8,276 29,562 2,092 31,654 25,591 25,055 25,131 9,020 33,013 4,864 37,877 31,814 95,513 93,237 34,843 121,416 9,368 130,784 106,531 0.23 0.24 0.25 0.28 1.01 Dividends paid per common share 0.4290000 0.4299375 0.4308750 0.4318125 1.7216250 2009(1) Total revenue Depreciation and amortization expense Interest 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 $ 81,906 $ 80,776 $ 81,276 $ 81,286 $ 325,245 22,578 21,410 8,428 29,490 594 30,084 24,021 22,611 21,367 7,089 29,709 2,851 32,560 26,497 22,626 21,374 6,537 30,739 2,413 33,152 27,089 22,704 21,377 6,369 30,836 4,495 35,331 29,268 90,519 85,528 28,423 120,775 10,352 131,127 106,874 0.23 0.26 0.26 0.28 1.03 Dividends paid per common share 0.4252500 0.4261875 0.4271250 0.4280625 1.7066250 (1) The consolidated quarterly ﬁnancial data includes revenues and expenses from our continuing and discontinued operations. The results of operations related to certain properties, classiﬁed as held for sale or disposed of, have been reclassiﬁed to income from discontinued operations. Therefore, some of the information may not agree to our previously ﬁled 10-Qs. (2) Amounts for each period are calculated independently. The sum of the quarters may differ from the annual amount. R e a l t y I n c o m e 48 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Reports of Independent Registered Public Accounting Firm ThE BOARD OF DIRECTORS AND STOCkhOLDERS REALTy INCOME CORPORATION: We have audited the accompanying consolidated balance sheets of Realty Income Corporation and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity, and cash ﬂows for each of the years in the three-year period ended December 31, 2010. These consolidated ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated ﬁnancial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated ﬁnancial statements referred to above present fairly, in all material respects, the ﬁnancial position of Realty Income Corporation and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash ﬂows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Realty Income Corporation’s internal control over ﬁnancial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 10, 2011 expressed an unqualiﬁed opinion on the effectiveness of the Company’s internal control over ﬁnancial reporting. San Diego, California February 10, 2011 R e a l t y I n c o m e 49 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Reports of Independent Registered Public Accounting Firm, cont’d. ThE BOARD OF DIRECTORS AND STOCkhOLDERS REALTy INCOME CORPORATION: We have audited Realty Income Corporation’s internal control over ﬁnancial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Realty Income Corporation’s management is responsible for maintaining effective internal control over ﬁnancial reporting and for its assessment of the effectiveness of internal control over ﬁnancial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over ﬁnancial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁnancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over ﬁnancial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over ﬁnancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁnancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the ﬁnancial statements. Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Realty Income Corporation maintained, in all material respects, effective internal control over ﬁnancial reporting as of December 31, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Realty Income Corporation and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity, and cash ﬂows for each of the years in the three-year period ended December 31, 2010, and our report dated February 10, 2011 expressed an unqualiﬁed opinion on those consolidated ﬁnancial statements. San Diego, California February 10, 2011 R e a l t y I n c o m e 50 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Business Description ThE COMPANy Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate investment trust, or REIT. Our primary business objective is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations, or FFO, per share. Our monthly distributions are supported by the cash ﬂow from our portfolio of properties leased to retail and other commercial enterprises. We have in-house acquisition, leasing, legal, credit research, real estate research, portfolio management and capital markets expertise. Over the past 42 years, Realty Income and its predecessors have been acquiring and owning freestanding retail and other commercial properties that generate rental revenue under long-term lease agreements (primarily 15 to 20 years). In addition, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties. Our portfolio management generally includes seeking: • Contractual rent increases on existing leases; • Rent increases at the termination of existing leases, when market conditions permit; and • The active management of our property portfolio, including re-leasing vacant properties, and selectively selling properties, thereby mitigating our exposure to certain tenants and markets. In acquiring additional properties, our strategy is primarily to acquire properties that are: • Freestanding, single-tenant locations; • Leased to regional and national commercial enterprises; and • Leased under long-term, net-lease agreements. At December 31, 2010, we owned a diversiﬁed portfolio: • Of 2,496 properties; • With an occupancy rate of 96.6%, or 2,412 properties occupied and only 84 properties available for lease; • Leased to 122 different retail and other commercial enterprises doing business in 32 separate industries; • Located in 49 states; • With over 21.2 million square feet of leasable space; and • With an average leasable space per property of approximately 8,500 square feet. Of the 2,496 properties in the portfolio, 2,485, or 99.6%, are single-tenant properties, and the remaining 11 are multi-tenant, distribution and ofﬁce properties. At December 31, 2010, of the 2,485 single-tenant properties, 2,402 were leased with a weighted average remaining lease term (excluding extension options) of approximately 11.4 years. In addition, at December 31, 2010, our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc., or Crest, had an inventory of three properties valued at $3.0 million, which are classiﬁed as held for investment. No Crest properties are classiﬁed as held for sale at December 31, 2010. 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, or the Code. In addition to the three properties, Crest also holds notes receivable of $22.1 million at December 31, 2010. We typically acquire properties under long-term leases with regional and national retailers and other commercial enterprises. Our acquisition and investment activities generally focus on businesses providing goods and services that satisfy basic consumer and business needs. Our net-lease agreements generally: • Are for initial terms of 15 to 20 years; • Require the tenant to pay minimum monthly rent and property operating expenses (taxes, insurance and maintenance); and • Provide for future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants’ gross sales above a speciﬁed level, or ﬁxed increases. We commenced operations as a REIT on August 15, 1994 through the merger of 25 public and private real estate limited partnerships. Each of the partnerships was formed between 1970 and 1989 for the purpose of acquiring and managing long-term, net-leased properties. Our eight senior ofﬁcers owned 1.1% of our outstanding common stock with a market value of $44.5 million at February 1, 2011. Our directors and eight senior ofﬁcers, as a group, owned 1.3% of our outstanding common stock with a market value of $53.9 million at February 1, 2011. Our common stock is listed on The New York Stock Exchange, or NYSE, under the ticker symbol “O” with a cusip number of 756109-104. Our central index key number is 726728. R e a l t y I n c o m e 51 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Business Description, cont’d. Our Class D cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprD” with a cusip number of 756109-609. Our Class E cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprE” with a cusip number of 756109-708. In February 2011, we had 79 employees as compared to 72 employees in February 2010. We maintain an Internet website at www.realtyincome.com. On our website we make available, free of charge, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, Forms 3, 4, 5, current reports on Form 8-K, and amendments to those reports, as soon as reason- ably practicable after we electronically ﬁle these reports with the Securities and Exchange Commission, or SEC. None of the information on our website is deemed to be part of this report. RECENT DEvELOPMENTS Increases in Monthly Distributions to Common Stockholders We have continued our 42-year policy of paying distributions monthly. Monthly distributions per share increased in April 2010 by $0.0003125 to $0.1433125, in July 2010 by $0.0003125 to $0.143625, in October 2010 by $0.0003125 to $0.1439375 and in January 2011 by $0.0003125 to $0.14425. The increase in January 2011 was our 53rd consecutive quarterly increase and the 60th increase in the amount of our dividend since our listing on the NYSE in 1994. In 2010, we paid three monthly cash distributions per share in the amount of $0.143, three in the amount of $0.1433125, three in the amount of $0.143625 and three in the amount of $0.1439375, totaling $1.721625. In December 2010, January 2011 and February 2011, we declared distributions of $0.14425 per share, which were paid in January 2011 and will be paid in February 2011 and March 2011, respectively. The current monthly distribution of $0.14425 per share represents an annualized distribution of $1.731 per share, and an annualized distribution yield of approximately 5.1% based on the last reported sale price of our common stock on the NYSE of $34.20 on December 31, 2010. Although we expect to continue our policy of paying monthly distributions, we cannot guarantee that we will maintain our current level of distributions, that we will continue our pattern of increasing distributions per share, or what our actual distribution yield will be in any future period. Acquisitions During 2010 During 2010, we invested $713.5 million in 186 new properties with an initial weighted average contractual lease rate of 7.9%. These 186 properties are located in 14 states, contain over 2.2 million leasable square feet, and are 100% leased with an average lease term of 15.7 years. The 186 new properties we acquired are net-leased to commercial enterprises in the following 13 industries: apparel stores, automotive collision services, automotive service, crafts and novelties, consumer electronics, convenience store, drug stores, grocery stores, health and ﬁtness, ofﬁce supplies, restaurants, sporting goods and wine and spirits. There were no acquisitions by Crest in 2010. The initial weighted average contractual lease rate is computed as estimated contractual net operating income (in a net-leased property that is equal to the aggregate base rent) for the ﬁrst year of each lease, divided by the estimated total cost of the properties. Since it is possible that a tenant could default on the payment of contractual rent, we cannot assure you that the actual return on the funds invested will remain at the percentages listed above. Included in the $713.5 million invested during 2010 are the following acquisitions: • The acquisition and leaseback of approximately $304.1 million of winery and vineyard properties under 20-year, triple-net lease agreements with Diageo Chateau & Estates Wine Company, guaranteed by Diageo plc, or, together with its subsidiaries, Diageo. The properties are primarily located in California’s Napa Valley and include two wineries that produce wines for Diageo’s Sterling Vineyards, or Sterling, and Beaulieu Vineyards, or BV, brands and 14 vineyards producing grapes for their Sterling, BV and other brands. The properties include approximately 3,600 acres and 426,000 square feet of winery, production, storage, shipping and tourist buildings. Diageo will continue to operate the wineries and vineyards. As a result of this acquisition of properties, Diageo has become our largest tenant based on rental revenue. Headquartered in London, Diageo is a global premium drinks company with a well-known portfolio of international brands of spirits, beer and wine. Diageo ordinary shares trade on the London Stock Exchange under the symbol “DGE.L” and on the NYSE under the symbol “DEO.” • The acquisition of 23 retail properties leased to 13 tenants in six states, for approximately $126.5 million, under long-term, net lease agreements. The properties are in eight different industries, including apparel stores, consumer electronics, crafts and novelties, drug stores, grocery stores, health and ﬁtness, ofﬁce supplies, and sporting goods. All of the properties acquired have in-place leases. • The acquisition of 135 SuperAmerica convenience stores and one support facility, for approximately $247.6 million, under long-term, triple- net lease agreements. The stores are located in Minnesota and Wisconsin, and average approximately 3,500 leasable square feet on approximately 1.14 acres. • The remaining 11 properties acquired totaled approximately $35.3 million. R e a l t y I n c o m e 52 2 0 1 0 A n n u a l R e p o r t Investments in Existing Properties In 2010, we capitalized costs of $3.6 million on existing properties in our portfolio, consisting of $1.5 million for re-leasing costs and $2.1 million for building improvements. $425 Million Acquisition Credit Facility In December 2010, we entered into a new $425 million acquisition credit facility that replaced our previous $355 million acquisition credit facility that was scheduled to expire in May 2011. The initial term of the new credit facility expires in March 2014 and includes two, one-year extension options. Under the new credit facility, our investment grade credit ratings provide for ﬁnancing at London Interbank Offered Rate, commonly referred to as LIBOR, plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. We also have other interest rate options available to us. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation. At December 31, 2010, there were no borrowings on our credit facility, but if there were, the effective borrowing rate would have been 2.1%. Issuance of Common Stock In December 2010, we issued 7,360,000 shares of common stock at a price of $33.70 per share. The net proceeds of approximately $235.7 million were used to repay borrowings of $179.8 million under our acquisition credit facility and to fund property acquisitions during December 2010. The remaining net proceeds were used for general corporate purposes and working capital. In September 2010, we issued 6,198,500 shares of common stock at a price of $33.40 per share. The net proceeds of approximately $196.9 million were used to repay borrowings of $49.7 million under our acquisition credit facility and to fund $126.5 million of property acquisitions during October 2010. The remaining net proceeds were used for general corporate purposes and working capital. Note Issuance In June 2010, we issued $250.0 million aggregate principal amount of 5.75% senior unsecured notes due January 2021, or the 2021 Notes. The price to the investor for the 2021 Notes was 99.404% of the principal amount for an effective yield of 5.826%. The net proceeds of approximately $246.1 million from this offering were used to repay borrowings under our acquisition credit facility, which were used to ﬁnance the acquisition of the Diageo properties. Interest is paid semiannually on the 2021 Notes. Net Income Available to Common Stockholders Net income available to common stockholders was $106.5 million in 2010 versus $106.9 million in 2009, a decrease of $343,000. On a diluted per common share basis, net income was $1.01 in 2010 as compared to $1.03 in 2009. The calculation to determine net income available to common stockholders includes gains from the sale of properties. The amount of gains varies from period to period based on the timing of property sales and can signiﬁcantly impact net income available to common stockholders. The gain from the sale of properties during 2010 was $8.7 million, as compared to $8.1 million during 2009. Funds from Operations Available to Common Stockholders (FFO) In 2010, our FFO increased by $3.3 million, or 1.7%, to $193.7 million versus $190.4 million in 2009. On a diluted per common share basis, FFO was $1.83 in 2010 compared to $1.84 in 2009, a decrease of $0.01, or 0.5%. See our discussion of FFO in the section entitled “Management’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. Adjusted Funds from Operations Available to Common Stockholders (AFFO) In 2010, our AFFO increased by $4.6 million, or 2.4%, to $197.3 million versus $192.7 million in 2009. On a diluted per common share basis, AFFO was $1.86 in 2010 and 2009. See our discussion of AFFO in the section entitled “Management’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 and AFFO. DISTRIBuTION POLICy Distributions are paid monthly to our common, Class D preferred and Class E preferred stockholders if, and when, declared by our Board of Directors. R e a l t y I n c o m e 53 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Business Description, cont’d. In order to maintain our tax status as a REIT for federal income tax purposes, we generally are required to distribute dividends to our stockholders aggregating annually at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and excluding net capital gains), and we are subject to income tax to the extent we distribute less than 100% of our REIT taxable income (including net capital gains). In 2010, our cash distributions totaled $206.8 million, or approximately 136.3% of our estimated REIT taxable income of $151.7 million. Our estimated REIT taxable income reﬂects non-cash deductions for depreciation and amortization. Our estimated REIT taxable income is presented to show our compliance with REIT distribution requirements and is not a measure of our liquidity or performance. We intend to continue to make distributions to our stockholders that are sufﬁcient to meet this distribution requirement and that will reduce our exposure to income taxes. Furthermore, we believe our funds from operations are more than sufficient to support our current level of cash distributions to our stockholders. Our 2010 cash distributions to common stockholders totaled $182.5 million, representing 94.2% of our funds from operations available to common stockholders of $193.7 million. 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 share). The Class E preferred stockholders receive cumulative distributions at a rate of 6.75% per annum on the $25 per share liquidation preference (equivalent to $1.6875 per annum per share). Dividends on our Class D and Class E preferred stock are current. Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, cash ﬂow from operations, ﬁnancial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Code, our debt service requirements and any other factors the Board of Directors may deem relevant. In addition, our credit facility contains ﬁnancial covenants that could limit the amount of distributions payable by us in the event of a default, 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) any principal or interest on borrowings under our credit facility. Distributions of our current and accumulated earnings and proﬁts for federal income tax purposes generally will be taxable to stockholders as ordinary income, except to the extent that we recognize capital gains and declare a capital gains dividend, or that such amounts constitute “qualiﬁed dividend income” subject to a reduced rate of tax. The maximum tax rate of non-corporate taxpayers for “qualiﬁed dividend income” has generally been reduced to 15% (until it “sunsets” or reverts to the provisions of prior law, which under current law will occur with respect to taxable years beginning after December 31, 2012). In general, dividends payable by REITs are not eligible for the reduced tax rate on corporate dividends, except to the extent the REIT’s dividends are attributable to dividends received from taxable corporations (such as our taxable REIT subsidiary, Crest), to income that was subject to tax at the corporate or REIT level (for example, if we distribute taxable income that we retained and paid tax on in the prior taxable year) or, as discussed above, dividends properly designated by us as “capital gain dividends.” Distributions in excess of earnings and proﬁts generally will be treated as a non-taxable reduction in the stockholders’ basis in their stock. Distributions above that basis, generally, will be taxable as a capital gain to stockholders who hold their shares as a capital asset. Approximately 26.8% of the distributions to our common stockholders, made or deemed to have been made in 2010, were classiﬁed as a return of capital for federal income tax purposes. We are unable to predict the portion of future distributions that may be classiﬁed as a return of capital. BuSINESS PhILOSOPhy AND STRATEgy Capital Philosophy Historically, we have met our long-term capital needs by issuing common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that common stock should be the majority of our capital structure. However, we may issue additional preferred stock or debt securities 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 permanently ﬁnance properties that were ﬁnanced by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at times and at terms that are acceptable to us. Conservative Capital Structure We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and ﬁxed charge coverage ratios. At December 31, 2010, our total outstanding borrowings were $1.6 billion of senior unsecured notes, or approximately 26.7% of our total market capitalization of $5.99 billion. There were no outstanding borrowings on our credit facility at December 31, 2010. R e a l t y I n c o m e 54 2 0 1 0 A n n u a l R e p o r t We deﬁne our total market capitalization at December 31, 2010 as the sum of: • Shares of our common stock outstanding of 118,058,988 multiplied by the last reported NYSE sales price of $34.20 per share on December 31, 2010, or $4.04 billion; • Aggregate liquidation value (par value of $25 per share) of the Class D preferred stock of $127.5 million; • Aggregate liquidation value (par value of $25 per share) of the Class E preferred stock of $220 million; and • Outstanding notes of $1.6 billion. Investment Philosophy We believe that owning an actively managed, diversiﬁed portfolio of commercial properties under long-term, net leases produces consistent and predictable income. Net leases typically require the tenant to be responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants are typically responsible for future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants’ gross sales above a speciﬁed level, or ﬁxed increases. We believe that a portfolio of properties under long-term leases, coupled with the tenant’s responsibility for property expenses, generally produces a more predictable income stream than many other types of real estate portfolios, while continuing to offer the potential for growth in rental income. Investment Strategy When identifying new properties for acquisition, our focus is generally on providing capital to owners and operators of retail and other commercial enterprises by acquiring, then leasing back, the real estate they consider important to the successful operation of their business. We categorize tenants as: 1) venture market, 2) middle market, and 3) upper market. Venture companies typically offer a newer concept, generally in one geographic region of the country and operate between ﬁve and 50 locations. Middle market companies typically have 50 to 500 locations, operations in more than one geographic region, have been successful through one or more economic cycles, and have a proven, replicable concept. The upper market tenants typically consist of companies with 500 or more locations, operating a proven, mature concept. Upper market tenants generally have strong operating histories and access to several sources of capital. We primarily focus on acquiring properties leased to middle market retail and other commercial enterprises that we believe are attractive for investment because: • They generally have overcome many of the operational and managerial obstacles that can adversely affect new venture companies; • They typically require capital to fund expansion but have more limited ﬁnancing options than upper market tenants; • They generally have provided us with attractive risk-adjusted returns over time since their ﬁnancial strength has, in many cases, tended to improve as their businesses have grown; • Their relatively large size allows them to spread corporate expenses across a greater number of locations; and • Middle market tenants typically have the critical mass to survive during economic or market dislocations. Historically, our investment focus has primarily been on retail and other commercial enterprises that have a service component because we believe the lease revenue from these types of businesses is more stable. Because of this investment focus, for the quarter ended December 31, 2010, approxi- mately 78% of our rental revenue was derived from tenants with a service component in their business. We believe these service-oriented businesses would be difﬁcult to duplicate over the Internet and that our properties continue to perform well relative to competition from Internet-based businesses. Credit Strategy We primarily provide sale-leaseback ﬁnancing to less than investment grade tenants. We typically acquire and lease back properties to regional and national commercial enterprises and believe that within this market we can achieve an attractive risk-adjusted return. Since 1970, our overall weighted average occupancy rate at the end of each year has been 98.2%, and our occupancy rate at the end of each year has never been below 96%. We believe the principal ﬁnancial obligations of most commercial enterprises typically include their bank and other debt, payment obligations to suppliers and real estate lease obligations. Because we typically own the land and building in which a tenant conducts its business, we believe the risk of default on a tenants’ lease obligations is less than the tenants’ unsecured general obligations. It has been our experience that since tenants must retain their proﬁtable locations in order to survive, in the event of reorganization they are less likely to reject a lease for a proﬁtable location because this would terminate their right to use the property. Thus, as the property owner, we believe we will fare better than unsecured creditors of the same tenant in the event of reorganization. If a property is rejected by the tenant during reorganization, we own the property and can either lease it to a new tenant or sell the property. In addition, we believe that the risk of default on the real estate leases can be further mitigated by monitoring the performance of the tenants’ individual unit locations and considering whether to sell locations that are weaker performers. R e a l t y I n c o m e 55 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Business Description, cont’d. In order to qualify for inclusion in our portfolio, new property acquisitions must meet stringent investment and credit requirements. The properties must generate attractive current yields and the tenant must meet our credit proﬁle. We have established a three-part analysis that examines each potential investment based on: • Industry, company, market conditions and credit proﬁle; • Store proﬁtability, if proﬁtability data is available, and the importance of the location of the real estate to the operations of the company’s business; and • Overall real estate characteristics, including property value and comparative rental rates. The typical proﬁle of companies whose properties have been approved for acquisition are those with 50 or more locations. Generally the properties: • Are located in highly visible areas; • Have easy access to major thoroughfares; and • Have attractive demographics. Acquisition Strategy We seek to invest in industries in which several, well-organized, regional and national retailers and other commercial enterprises are capturing market share through service, quality control, economies of scale, strong consumer brands, advertising, and the selection of prime locations. We execute our acquisition strategy by acting as a source of capital to regional and national commercial enterprises by acquiring and leasing back their real estate locations. We undertake thorough research and analysis to identify what we consider to be appropriate industries, tenants and property locations for investment. Our research expertise is instrumental to uncovering net-lease opportunities in markets where our real estate ﬁnancing program adds value. In selecting real estate for potential investment, we generally seek to acquire properties that have the following characteristics: • Freestanding, commercially-zoned property with a single tenant; • Properties that are important locations for regional and national commercial enterprises; • Properties that we deem to be proﬁtable for the tenants and/or can generally be characterized as important to the operations of the company’s business; • Properties that are located within attractive demographic areas relative to the business of our tenants, with high visibility and easy access to major thoroughfares; and • Properties that can be purchased with the simultaneous execution or assumption of long-term, net-lease agreements, offering both current income and the potential for rent increases. Impact of Real Estate and Credit Markets In the commercial real estate market, property prices generally continue to fluctuate. Likewise, the U.S. credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which sometimes impact our access to and cost of capital. We continue to monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly. See Item 1A entitled “Risk Factors” in our Form 10-K for the ﬁscal year ended December 31, 2010. Portfolio Management Strategy The active management of the property portfolio is an essential component of our long-term strategy. We continually monitor our portfolio for any changes that could affect the performance of the industries, tenants and locations in which we have invested. We also regularly analyze our portfolio with a view toward optimizing its returns and enhancing our credit quality. Our executives regularly review and analyze: • The performance of the various industries of our tenants; and • The operation, management, business planning, and ﬁnancial condition of our tenants. We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment of the sale proceeds will: • Generate higher returns; • Enhance the credit quality of our real estate portfolio; • Extend our average remaining lease term; or • Decrease tenant or industry concentration. R e a l t y I n c o m e 56 2 0 1 0 A n n u a l R e p o r t At December 31, 2010, we classiﬁed real estate with a carrying amount of $3.6 million as held for sale on our balance sheet. Additionally, we anticipate selling investment properties from our portfolio that have not yet been speciﬁcally identiﬁed, from which we anticipate receiving between $10 million and $35 million in proceeds during the next 12 months. We intend to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during the next 12 months or be able to invest the proceeds from the sales of any properties in new properties. Universal Shelf Registration In March 2009, we ﬁled a shelf registration statement with the SEC, which expires in March 2012. 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 and there is no speciﬁc dollar limit. The securities covered by this registration statement include common stock, preferred stock, debt securities, or any combination of these 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. $425 Million Acquisition Credit Facility In December 2010, we entered into a new $425 million revolving, unsecured credit facility that replaced our previous $355 million acquisition credit facility that was scheduled to expire in May 2011. The initial term of the new credit facility expires in March 2014 and includes two, one-year extension options. Under the new credit facility, our investment grade credit ratings provide for ﬁnancing at LIBOR, plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. We also have other interest rate options available to us. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation. At December 31, 2010, we had a borrowing capacity of $425 million available on our credit facility and no outstanding balance. If there were outstanding borrowings, the effective borrowing rate would have been 2.1%. We expect to use our credit facility to acquire additional properties and for other corporate purposes. Any additional borrowings will increase our exposure to interest rate risk. We have the right to request an increase in the borrowing capacity of the credit facility, up to $200 million, to a total borrowing capacity of $625 million. Any increase in the borrowing capacity is subject to approval by the banks participating in our credit facility. We generally use our credit facility for the short-term ﬁnancing of new property acquisitions. Thereafter, when capital is available on acceptable terms, we generally seek to reﬁnance those borrowings with the net proceeds of long-term or permanent ﬁnancing, which may include the issuance of common stock, preferred stock or debt securities. We cannot assure you, however, that we will be able to obtain any such reﬁnancing, or that market conditions prevailing at the time of reﬁnancing will enable us to issue equity or debt securities upon acceptable terms. Credit Agency Ratings The borrowing rates under our credit facility are based upon our credit ratings. We are currently assigned the following investment grade credit ratings on our senior unsecured notes: Fitch Ratings has assigned a rating of BBB+, Moody’s Investors Service has assigned a rating of Baa1 and Standard & Poor’s Ratings Group has assigned a rating of BBB to our senior notes. All of these ratings have “stable” outlooks. Based on our current ratings, the current facility interest rate is LIBOR plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. The credit facility provides that the interest rate can range between: (i) LIBOR plus 300 basis points if our credit facility is lower than BBB-/Baa3 and (ii) LIBOR plus 175 basis points if our credit rating is A-/A3 or higher. In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which ranges from: (i) 50 basis points for a rating lower than BBB-/Baa3, and (ii) 30 basis points for a credit rating of A-/A3 or higher. We also issue senior debt securities from time to time and our credit ratings can impact the interest rates charged in those transactions. If our credit ratings or ratings outlook change, our cost to obtain debt ﬁnancing could increase or decrease. The credit ratings assigned to us could change based upon, 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 if, in its judgment, circumstances warrant. Moreover, a rating is not a recommendation to buy, sell or hold our debt securities, preferred stock or common stock. R e a l t y I n c o m e 57 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Business Description, cont’d. Mortgage Debt We have no mortgage debt on any of our properties. No Off-Balance Sheet Arrangements or Unconsolidated Investments We have no unconsolidated or off-balance sheet investments in “variable interest entities” or off-balance sheet ﬁnancing, nor do we engage in trading activities involving energy or commodity contracts or other derivative instruments. Additionally, we have no joint ventures or mandatorily redeemable preferred stock. As such, our ﬁnancial position and results of operations are not affected by accounting regulations regarding the consolidation of off-balance sheet entities and classiﬁcation of ﬁnancial instruments with characteristics of both liabilities and equity. Competitive Strategy We believe that to successfully pursue our investment philosophy and strategy, we must seek to maintain the following competitive advantages: • Size and Type of inveSTmenT properTieS: We believe smaller ($500,000 to $10,000,000) net-leased properties, whether purchased individually or as part of larger portfolio purchases, represent an attractive investment opportunity in today’s real estate environment. Due to the complexities of acquiring and managing a large portfolio of relatively small assets, we believe these types of properties have not experienced significant institutional ownership interest or the corresponding yield reduction experienced by larger income-producing properties. We believe the less intensive day-to-day property management required by net-lease agreements, coupled with the active management of a large portfolio of smaller properties, is an effective investment strategy. The tenants of our freestanding properties generally provide goods and services that satisfy basic consumer needs. In order to grow and expand, they generally need capital. Since the acquisition of real estate is typically the single largest capital expenditure of many of these tenants, our method of purchasing the property and then leasing it back, under a net-lease arrangement, allows the commercial enterprise to free up capital. • INVESTMENT IN NEW INDUSTRIES: We will seek to further diversify our portfolio among a variety of industries. We believe diversiﬁcation will allow us to invest in industries that currently are growing and have characteristics we ﬁnd attractive. When analyzing new industries, we seek to acquire properties which are critical to the success of a commercial enterprise, through its distribution of the product or service. Other characteristics may include, but are not limited to, industries that are dominated by local store operators where regional and national store operators and other commercial enterprises can increase market share and dominance by consolidating local operators and stream- lining their operations, as well as capitalizing on major demographic shifts in a population base. • DIVERSIFICATION: Diversification of the portfolio by industry type, tenant, and geographic location is key to our objective of providing predictable investment results for our stockholders, therefore further diversiﬁcation of our portfolio is a continuing objective. At December 31, 2010, we owned a diversiﬁed property portfolio that consisted of 2,496 properties located in 49 states, leased to 122 different retail and other commercial enterprises doing business in 32 industry segments. Each of the 32 industry segments, represented in our property portfolio, individually accounted for no more than 19.1% of our rental revenue for the quarter ended December 31, 2010. • MANAGEMENT SPECIALIZATION: We believe that our management’s specialization in acquiring and managing single-tenant properties, operated under net-lease agreements, purchased individually or as part of a larger portfolio, is important to meeting our objectives. We plan to maintain this specialization and will seek to employ and train high-quality professionals in this specialized area of real estate ownership, ﬁnance and management. • TECHNOLOGY: We intend to stay at the forefront of technology in our efforts to carry out our operations efﬁciently and economically. We maintain sophisticated information systems that allow us to analyze our portfolio’s performance and actively manage our investments. We believe that technology and information-based systems play an important role in our competitiveness as an investment manager and source of capital to a variety of industries and tenants. RISk FACTORS For 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, 2010. uNRESOLvED STAFF COMMENTS There are no unresolved staff comments. R e a l t y I n c o m e 58 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Property Portfolio Information At December 31, 2010, we owned a diversiﬁed portfolio: • Of 2,496 properties; • With an occupancy rate of 96.6%, or 2,412 properties occupied and only 84 properties available for lease; • Leased to 122 different retail and other commercial enterprises doing business in 32 separate industries; • Located in 49 states; • With over 21.2 million square feet of leasable space; and • With an average leasable space per property of approximately 8,500 square feet. In addition to our real estate portfolio, our subsidiary, Crest, had an inventory of three properties located in three states at December 31, 2010. These properties are valued at $3.0 million and are classiﬁed as held for investment. No Crest properties are classiﬁed as held for sale at December 31, 2010. At December 31, 2010, of our 2,496 properties, 2,402 were leased under net-lease agreements. A net lease typically requires the tenant to be responsible for minimum monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, our tenants are typically responsible for future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants’ gross sales above a speciﬁed level, or ﬁxed increases. Our net-lease agreements generally: • Are for initial terms of 15 to 20 years; • Require the tenant to pay minimum monthly rents and property operating expenses (taxes, insurance and maintenance); and • Provide for future rent increases based on increases in the consumer price index (typically subject to ceilings), additional rent calculated as a percentage of the tenants’ gross sales above a speciﬁed level, or ﬁxed increases. Where leases provide for rent increases based on increases in the consumer price index, generally these increases become part of the new permanent base rent. Where leases provide for percentage rent, this additional rent is typically payable only if the tenants’ gross sales, for a given period (usually one year), exceed a speciﬁed level and is then typically calculated as a percentage of only the amount of gross sales in excess of that level. R e a l t y I n c o m e 59 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Property Portfolio Information, cont’d. Industry Diversiﬁcation The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest) classiﬁed according to the business of the respective tenants, expressed as a percentage of our total rental revenue: For the Quarter Ended December 31, 2010 Percentage of Rental Revenue(1) For the years Ended Dec 31, 2010 Dec 31, 2009 Dec 31, 2008 Dec 31, 2007 Dec 31, 2006 Dec 31, 2005 1.5% 1.2% 1.1% 1.1% 1.2% 1.7% 1.6% 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 Wine and spirits Other Totals 1.0 1.5 4.5 5.9 0.1 * 5.9 0.6 1.0 1.4 4.7 6.4 0.1 * 6.5 0.6 1.1 1.5 4.8 6.9 0.2 * 7.3 0.7 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 17.4 17.1 16.9 15.8 14.0 0.3 1.0 3.9 1.1 0.2 0.2 0.7 1.5 6.7 1.2 1.6 2.4 1.0 0.8 0.8 0.3 1.0 4.1 1.2 0.2 0.2 0.8 0.9 6.9 1.3 1.7 2.6 0.9 0.9 0.8 0.3 1.0 4.3 1.3 0.2 0.2 0.8 0.7 5.9 1.3 1.9 2.7 1.0 0.9 0.9 19.1 20.4 21.3 0.2 2.9 8.6 0.2 0.0 5.6 1.6 0.1 2.7 8.9 0.2 0.2 3.0 1.7 — 2.6 9.2 0.2 1.0 — 1.8 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 21.8 — 2.3 9.0 0.2 1.1 — 1.9 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 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 21.2 11.9 — 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 — 3.0 100.0% 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. R e a l t y I n c o m e 60 2 0 1 0 A n n u a l R e p o r t 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, 2010, classiﬁed according to the 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 Shoe stores Sporting goods Wine and spirits Totals Number of Properties Rental Revenue for the Quarter Ended December 31, 2010(1) Percentage of Rental Revenue 14 240 250 8 2 12 34 11 34 13 618 25 154 1 720 4 1 17 12 631 1 15 1,581 11 43 1 9 5 52 33 21 42 28 11 3 1 21 16 $ 893 4,113 5,467 1,064 150 193 6,182 730 7,944 1,456 28,192 449 5,468 5 16,046 919 27 2,228 709 17,601 187 0 43,639 1,365 898 128 521 234 3,619 691 1,397 1,149 1,464 880 33 168 2,650 5,134 1.0% 4.5 5.9 1.1 0.2 0.2 6.7 0.8 8.6 1.6 30.6 0.5 5.9 * 17.4 1.0 * 2.4 0.8 19.1 0.2 0.0 47.3 1.5 1.0 0.1 0.6 0.3 3.9 0.7 1.5 1.2 1.6 1.0 * 0.2 2.9 5.6 297 2,496 20,331 $ 92,162 22.1 100.0% * Less than 0.1% (1) Includes rental revenue for all properties owned by Realty Income at December 31, 2010, including revenue from properties reclassiﬁed as discontinued operations of $98. Excludes revenue of $80 for properties owned by Crest. R e a l t y I n c o m e 61 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Property Portfolio Information, cont’d. 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 2,402 net leased, single-tenant properties as of December 31, 2010 (dollars in thousands): Total Portfolio Initial Expirations(3) Subsequent Expirations(4) Rental Revenue for the Quarter Ended Dec 31, 2010(2) $ 4,144 % of Total Rental Revenue 4.6% 2,908 4,947 3,489 3,768 2,516 1,904 2,230 5,089 4,208 7,592 3,072 8,779 2,348 7,684 6,378 5,572 4,119 1,290 6,163 663 655 460 281 354 13 3.2 5.5 3.8 4.2 2.8 2.1 2.5 5.6 4.6 8.4 3.4 9.7 2.6 8.5 7.1 6.1 4.5 1.4 6.8 0.7 0.7 0.5 0.3 0.4 * Total Number of Leases Expiring(1) 164 127 147 111 147 130 51 46 98 86 177 100 253 64 208 109 169 81 49 43 27 2 7 3 2 1 year 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 Rental Revenue for the Quarter Ended Dec 31, 2010 Number of Leases Expiring % of Total Rental Revenue Number of Leases Expiring Rental Revenue for the Quarter Ended Dec 31, 2010 % of Total Rental Revenue 58 37 65 41 78 111 40 38 90 75 176 99 251 64 203 107 168 79 48 43 27 2 7 3 2 — $ 1,975 2.2% 106 $ 2,169 2.4% 1,031 2,961 1,861 2,205 2,107 1,681 2,027 4,659 3,605 7,538 3,024 8,706 2,348 7,557 6,319 5,555 4,069 1,275 6,163 663 655 460 281 354 — 1.1 3.3 2.0 2.5 2.3 1.9 2.3 5.1 4.0 8.3 3.3 9.6 2.6 8.4 7.0 6.1 4.4 1.4 6.8 0.7 0.7 0.5 0.3 0.4 — 90 82 70 69 19 11 8 8 11 1 1 2 — 5 2 1 2 1 — — — — — — 1 1,877 1,986 1,628 1,563 409 223 203 430 603 54 48 73 — 127 59 17 50 15 — — — — — — 13 2.1 2.2 1.8 1.7 0.5 0.2 0.2 0.5 0.6 0.1 0.1 0.1 — 0.1 0.1 * 0.1 * — — — — — — * Totals 2,402 $ 90,626 100.0% 1,912 $ 79,079 87.2% 490 $ 11,547 12.8% * Less than 0.1% (1) Excludes ten multi-tenant properties and 84 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 $98 from properties reclassiﬁed as discontinued operations and excludes revenue of $1,536 from ten multi-tenant properties and from 84 vacant and unleased properties at December 31, 2010. Excludes revenue of $80 from properties owned by Crest. (3) Represents leases to the initial tenant of the property that are expiring for the ﬁrst time. (4) Represents lease expirations on properties in the portfolio, which have previously been renewed, extended or re-tenanted. R e a l t y I n c o m e 62 2 0 1 0 A n n u a l R e p o r t 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, 2010 (dollars in thousands): State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii 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 Percent Leased Approximate Leasable Square Feet Rental Revenue for the Quarter Ended December 31, 2010(1) Percentage of Rental Revenue 62 2 82 17 82 51 23 17 169 131 — 12 84 81 21 31 22 32 3 28 64 52 150 72 61 2 19 14 14 33 9 39 94 6 136 35 18 98 3 99 10 129 213 4 4 104 34 2 27 1 2,496 97% 100 98 94 98 94 96 100 93 95 — 100 99 95 100 90 95 100 100 100 98 100 99 97 95 100 95 93 100 100 100 97 99 100 94 100 94 99 100 100 100 95 95 100 100 95 94 100 93 0 97% 420,200 128,500 509,300 92,400 1,675,500 471,400 269,100 33,300 1,621,000 905,500 — 80,700 998,500 729,900 290,600 562,500 110,600 184,900 22,500 266,600 575,400 257,300 894,700 360,700 634,900 30,000 196,300 153,200 109,900 261,300 58,400 495,000 531,700 36,600 846,200 755,300 297,300 677,200 11,000 372,500 89,800 592,400 2,357,200 25,200 12,700 636,500 276,500 23,000 269,200 5,400 21,215,800 $ 1,861 287 2,740 380 9,987 1,804 1,156 431 6,903 3,809 — 339 5,107 3,512 1,018 1,043 647 947 162 1,661 2,558 1,287 3,240 1,563 2,174 77 488 720 588 1,944 211 2,553 2,896 69 3,224 1,305 929 3,556 59 2,271 165 2,758 8,074 94 129 3,410 1,036 121 869 0 $ 92,162 2.0% 0.3 3.0 0.4 10.8 2.0 1.3 0.5 7.5 4.1 — 0.4 5.5 3.8 1.1 1.1 0.7 1.0 0.2 1.8 2.8 1.4 3.5 1.7 2.4 0.1 0.5 0.8 0.6 2.1 0.2 2.8 3.1 0.1 3.5 1.4 1.0 3.9 0.1 2.5 0.2 3.0 8.8 0.1 0.1 3.7 1.1 0.1 0.9 0.0 100.0% (1) Includes rental revenue for all properties owned by Realty Income at December 31, 2010, including revenue from properties reclassiﬁed as discontinued operations of $98. Excludes revenue of $80 from properties owned by Crest. R e a l t y I n c o m e 63 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Forward-Looking Statements This annual report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended. When used in this annual report, the words “estimated”, “anticipated”, “expect”, “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Forward- looking statements include discussions of strategy, plans or intentions of management. Forward-looking statements are subject to risks, uncertainties, and assumptions about Realty Income Corporation, including, among other things: • Our anticipated growth strategies; • Our intention to acquire additional properties and the timing of these acquisitions; • Our intention to sell properties and the timing of these property sales; • Our intention to re-lease vacant properties; • Anticipated trends in our business, including trends in the market for long-term net-leases of freestanding, single-tenant properties; • Future expenditures for development projects; and • Proﬁtability of our subsidiary, 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. Additional factors that may cause risks and uncertainties include those discussed in the sections entitled “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date that this annual report was ﬁled with the SEC. While forward-looking statements reﬂect our good faith beliefs, they are not guarantees of future performance. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reﬂect events or circumstances after the date of this annual report or to reﬂect the occurrence of unanticipated events. In light of these risks and uncertainties, the forward-looking events discussed in this annual report might not occur. R e a l t y I n c o m e 64 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations gENERAL Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate investment trust, or REIT. Our primary business objective is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations, or FFO, per share. Our monthly distributions are supported by the cash ﬂow from our portfolio of properties leased to retail and other commercial enterprises. We have in-house acquisition, leasing, legal, credit research, real estate research, portfolio management and capital markets expertise. Over the past 42 years, Realty Income and its predecessors have been acquiring and owning freestanding retail and other commercial properties that generate rental revenue under long-term lease agreements (primarily 15 to 20 years). In addition, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties. At December 31, 2010, we owned a diversiﬁed portfolio: • Of 2,496 properties; • With an occupancy rate of 96.6%, or 2,412 properties occupied and only 84 properties available for lease; • Leased to 122 different retail and other commercial enterprises doing business in 32 separate industries; • Located in 49 states; • With over 21.2 million square feet of leasable space; and • With an average leasable space per property of approximately 8,500 square feet. Of the 2,496 properties in the portfolio, 2,485, or 99.6%, are single-tenant properties, and the remaining 11 are multi-tenant, distribution and ofﬁce properties. At December 31, 2010, of the 2,485 single-tenant properties, 2,402 were leased with a weighted average remaining lease term (excluding extension options) of approximately 11.4 years. In addition, at December 31, 2010, our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had an inventory of three properties valued at $3.0 million, which are classiﬁed as held for investment. No Crest properties are classiﬁed as held for sale at December 31, 2010. 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 “Code”). In addition to the three properties, Crest also holds notes receivable of $22.1 million at December 31, 2010. Crest did not acquire any properties in 2010. LIQuIDITy AND CAPITAL RESOuRCES Capital Philosophy Historically, we have met our long-term capital needs by issuing common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that common stock should be the majority of our capital structure. However, we may issue additional preferred stock or debt securities 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 invested on an accretive basis into additional properties. In addition, we may issue common stock to permanently ﬁnance properties that were ﬁnanced by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at times and at terms that are acceptable to us. Conservative Capital Structure We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and ﬁxed charge coverage ratios. At December 31, 2010, our total outstanding borrowings were $1.6 billion of senior unsecured notes, or approximately 26.7% of our total market capitalization of $5.99 billion. There were no outstanding borrowings on our credit facility at December 31, 2010. We deﬁne our total market capitalization at December 31, 2010 as the sum of: • Shares of our common stock outstanding of 118,058,988 multiplied by the last reported NYSE sales price of $34.20 per share on December 31, 2010, or $4.04 billion; • Aggregate liquidation value (par value of $25 per share) of the Class D preferred stock of $127.5 million; • Aggregate liquidation value (par value of $25 per share) of the Class E preferred stock of $220 million; and • Outstanding notes of $1.6 billion. Mortgage Debt We have no mortgage debt on any of our properties. R e a l t y I n c o m e 65 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. $425 Million Acquisition Credit Facility In December 2010, we entered into a new $425 million acquisition credit facility that replaced our previous $355 million acquisition credit facility that was scheduled to expire in May 2011. The initial term of the new credit facility expires in March 2014 and includes two, one-year extension options. Under the new credit facility, our investment grade credit ratings provide for ﬁnancing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. The borrowing rate is not subject to a LIBOR ﬂoor. We also have other interest rate options available to us. At December 31, 2010, we had a borrowing capacity of $425 million available on our credit facility and no outstanding balance. If there were outstanding borrowings, the effective borrowing rate would have been 2.1%. We expect to use our credit facility to acquire additional properties and for other corporate purposes. Any additional borrowings will increase our exposure to interest rate risk. We have the right to request an increase in the borrowing capacity of the credit facility, up to $200 million, to a total borrowing capacity of $625 million. Any increase in the borrowing capacity is subject to approval by the lending banks participating in our credit facility. Cash Reserves We are organized to operate as an equity REIT that acquires and leases properties and distributes to stockholders, in the form of monthly cash distributions, a substantial portion of our net cash ﬂow generated from leases on our properties. We intend to retain an appropriate amount of cash as working capital. At December 31, 2010, we had cash and cash equivalents totaling $17.6 million. We believe that our cash and cash equivalents on hand, cash provided from operating activities and borrowing capacity is sufﬁcient to meet our liquidity needs for the foreseeable future. We intend, however, to use additional sources of capital to fund property acquisitions and to repay future borrowings under our credit facility. Acquisitions During 2010 During 2010, we invested $713.5 million in 186 new properties with an initial weighted average contractual lease rate of 7.9%. These 186 properties are located in 14 states, contain over 2.2 million leasable square feet, and are 100% leased with an average lease term of 15.7 years. The 186 new properties we acquired are net-leased to commercial enterprises in the following 13 industries: apparel stores, automotive collision services, automotive service, crafts and novelties, consumer electronics, convenience stores, drug stores, grocery stores, health and ﬁtness, ofﬁce supplies, restaurants, sporting goods and wine and spirits. There were no acquisitions by Crest in 2010. The initial weighted average contractual lease rate is computed as estimated contractual net operating income (in a net-leased property that is equal to the aggregate base rent) for the ﬁrst year of each lease, divided by the estimated total cost of the properties. Since it is possible that a tenant could default on the payment of contractual rent, we cannot assure you that the actual return on the funds invested will remain at the percentages listed above. Included in the $713.5 million invested during 2010 are the following acquisitions: • The acquisition and leaseback of approximately $304.1 million of winery and vineyard properties under 20-year, triple-net lease agreements with Diageo Chateau & Estates Wine Company, guaranteed by Diageo plc, or, together with its subsidiaries, Diageo. The properties are primarily located in California’s Napa Valley and include two wineries that produce wines for Diageo’s Sterling Vineyards, or Sterling, and Beaulieu Vineyards, or BV, brands and 14 vineyards producing grapes for their Sterling, BV and other brands. The properties include approximately 3,600 acres and 426,000 square feet of winery, production, storage, shipping and tourist buildings. Diageo will continue to operate the wineries and vineyards. As a result of this acquisition of properties, Diageo has become our largest tenant based on rental revenue. Headquartered in London, Diageo is a global premium drinks company with a well-known portfolio of international brands of spirits, beer and wine. Diageo ordinary shares trade on the London Stock Exchange under the symbol “DGE.L” and on the NYSE under the symbol “DEO.” • The acquisition of 23 retail properties leased to 13 tenants in six states, for approximately $126.5 million, under long-term, net lease agreements. The properties are in eight different industries, including apparel stores, consumer electronics, crafts and novelties, drug stores, grocery stores, health and ﬁtness, ofﬁce supplies, and sporting goods. All of the properties acquired have in-place leases. • The acquisition of 135 SuperAmerica convenience stores and one support facility, for approximately $247.6 million, under long-term, triple-net lease agreements. The stores are located in Minnesota and Wisconsin, and average approximately 3,500 leasable square feet on approximately 1.14 acres. • The remaining 11 properties acquired totaled approximately $35.3 million. R e a l t y I n c o m e 66 2 0 1 0 A n n u a l R e p o r t Impact of Real Estate and Credit Markets In the commercial real estate market, property prices generally continue to fluctuate. Likewise, the U.S. credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which sometimes impact our access to and cost of capital. We continue to monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly. See our discussion of “Risk Factors” in this annual report. Increases in Monthly Distributions to Common Stockholders We have continued our 42-year policy of paying distributions monthly. Monthly distributions per share increased in April 2010 by $0.0003125 to $0.1433125, in July 2010 by $0.0003125 to $0.143625, in October 2010 by $0.0003125 to $0.1439375 and in January 2011 by $0.0003125 to $0.14425. The increase in January 2011 was our 53rd consecutive quarterly increase and the 60th increase in the amount of our dividend since our listing on the New York Stock Exchange, or NYSE, in 1994. In 2010, we paid three monthly cash distributions per share in the amount of $0.143, three in the amount of $0.1433125, three in the amount of $0.143625 and three in the amount of $0.1439375, totaling $1.721625. In December 2010, January 2011 and February 2011, we declared distributions of $0.14425 per share, which were paid in January 2011 and will be paid in February 2011 and March 2011, respectively. The monthly distribution of $0.14425 per share represents an annualized distribution of $1.731 per share, and an annualized distribution yield of approximately 5.1% based on the last reported sale price of our common stock on the NYSE of $34.20 on December 31, 2010. Although we expect to continue our policy of paying monthly distributions, we cannot guarantee that we will maintain our current level of distributions, that we will continue our pattern of increasing distributions per share, or what our actual distribution yield will be in any future period. Issuance of Common Stock In December 2010, we issued 7,360,000 shares of common stock at a price of $33.70 per share. The net proceeds of approximately $235.7 million were used to repay borrowings of $179.8 million under our acquisition credit facility and to fund property acquisitions during December 2010. The remaining net proceeds were used for general corporate purposes and working capital. In September 2010, we issued 6,198,500 shares of common stock at a price of $33.40 per share. The net proceeds of approximately $196.9 million were used to repay borrowings of $49.7 million under our acquisition credit facility and to fund $126.5 million of property acquisitions during October 2010. The remaining net proceeds were used for general corporate purposes and working capital. Note Issuance In June 2010, we issued $250.0 million aggregate principal amount of 5.75% senior unsecured notes due January 2021 (the “2021 Notes”). The price to the investor for the 2021 Notes was 99.404% of the principal amount for an effective yield of 5.826%. The net proceeds of approximately $246.1 million from this offering were used to repay borrowings under our acquisition credit facility, which were used to ﬁnance the acquisition of the Diageo properties. Interest is paid semiannually on the 2021 Notes. Universal Shelf Registration In March 2009, we ﬁled a shelf registration statement with the SEC, which expires in March 2012. In accordance with the SEC rules, the amount of the securities to be issued pursuant to this shelf registration statement was not speciﬁed when it was ﬁled and there is no speciﬁc dollar limit. The securities covered by this registration statement include common stock, preferred stock, debt securities, or any combination 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. Credit Agency Ratings The borrowing rates under our credit facility are based upon our credit ratings. We are currently assigned the following investment grade credit ratings on our senior unsecured notes: Fitch Ratings has assigned a rating of BBB+, Moody’s Investors Service has assigned a rating of Baa1 and Standard & Poor’s Ratings Group has assigned a rating of BBB to our senior notes. All of these ratings have “stable” outlooks. R e a l t y I n c o m e 67 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. Based on our current ratings, the current facility interest rate is LIBOR plus 185 basis points with a facility commitment fee of 35 basis points, for all-in drawn pricing of 220 basis points over LIBOR. The credit facility provides that the interest rate can range between: (i) LIBOR plus 300 basis points if our credit facility is lower than BBB-/Baa3 and (ii) LIBOR plus 175 basis points if our credit rating is A-/A3 or higher. In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which ranges from: (i) 50 basis points for a rating lower than BBB-/Baa3, and (ii) 30 basis points for a credit rating of A-/A3 or higher. We also issue senior debt securities from time to time and our credit ratings can impact the interest rates charged in those transactions. If our credit ratings or ratings outlook change, our cost to obtain debt ﬁnancing could increase or decrease. The credit ratings assigned to us could change based upon, 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 if, in its judgment, circumstances warrant. Moreover, a rating is not a recommendation to buy, sell or hold our debt securities, preferred stock or common stock. Notes Outstanding Our senior unsecured note obligations consist of the following as of December 31, 2010, sorted by maturity date (dollars in millions): 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 5.75% notes, issued in June 2010 and due in January 2021 5.875% bonds, issued in March 2005 and due in March 2035 $ 100 150 275 175 550 250 100 $ 1,600 All of our outstanding notes and bonds have ﬁxed interest rates. Interest on all of our senior note and bond obligations is paid semiannually. All of these notes and bonds 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 and bonds was issued. The following is a summary of the key ﬁnancial covenants for 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, 2010 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% of adjusted assets ≤ 40% of adjusted assets ≥ 1.5 x ≥ 150% of unsecured debt Actual 38.2% 0.0% 3.5 x 262.0% R e a l t y I n c o m e 68 2 0 1 0 A n n u a l R e p o r t The following table summarizes the maturity of each of our obligations as of December 31, 2010 (dollars in millions): Table of Obligations year of Maturity 2011 2012 2013 2014 2015 Thereafter Totals Credit Facility $ — — — — — — Notes Interest(1) $ — $ 96.8 — 100.0 — 150.0 1,350.0 96.8 92.5 91.4 90.4 347.5 $ 815.4 $ — $ 1,600.0 ground Leases Paid by Our Tenants(2) $ 3.6 3.5 3.4 3.2 3.1 31.9 $ 48.7 Other(3) $ 4.6 — — — — — $ 4.6 Totals $ 105.0 100.3 195.9 94.6 243.5 1,729.4 $ 2,468.7 (1) Interest on the credit facility and notes has been calculated based on outstanding balances as of December 31, 2010 through their respective maturity dates. (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. (3) “Other” consists of $420,000 of commitments under construction contracts and $4.2 million 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. Preferred Stock Outstanding In 2004, we issued 5.1 million shares of 7.375% Class D cumulative redeemable preferred stock. In May 2009, shares of Class D preferred stock became redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class D preferred stock are paid monthly in arrears. In 2006, we issued 8.8 million shares of 6.75% Class E cumulative redeemable preferred stock. Beginning December 7, 2011, shares of Class E preferred stock become redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class E preferred stock are paid monthly in arrears. We are current in our obligations to pay dividends on our Class D and Class E preferred stock. No Off-Balance Sheet Arrangements or Unconsolidated Investments We have no unconsolidated or off-balance sheet investments in “variable interest entities” or off-balance sheet ﬁnancing, nor do we engage in trading activities involving energy or commodity contracts or other derivative instruments. Additionally, we have no joint ventures or mandatorily redeemable preferred stock. As such, our ﬁnancial position and results of operations are not affected by accounting regulations regarding the consolidation of off-balance sheet entities and classiﬁcation of ﬁnancial instruments with characteristics of both liabilities and equity. RESuLTS OF OPERATIONS Critical Accounting Policies Our consolidated ﬁnancial statements have been prepared in accordance with GAAP. Our consolidated ﬁnancial statements are the basis for our discussion and analysis of ﬁnancial condition and results of operations. Preparing our consolidated ﬁnancial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated ﬁnancial statements. We believe that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reﬂects our ﬁnancial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. This summary should be read in conjunction with the more complete discussion of our accounting policies and procedures included in note 2 to our consolidated ﬁnancial statements. In order to prepare our consolidated ﬁnancial statements according to the rules and guidelines set forth by GAAP, many subjective judgments must be made with regard to critical accounting policies. One of these judgments is our estimate for useful lives in determining depreciation expense for our properties. Depreciation on a majority of our buildings and improvements is computed using the straight–line method over an estimated useful life of 25 years. If we use a shorter or longer estimated useful life, it could have a material impact on our results of operations. We believe that 25 years is an appropriate estimate of useful life. R e a l t y I n c o m e 69 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. When acquiring a property for investment purposes, we allocate the fair value of real estate acquired to: 1) land and 2) building and improvements, based in each case on their estimated fair values. For properties acquired with in-place operating leases, the fair value of real estate is allocated to: (1) land, (2) building and improvements, and (3) identiﬁed intangible assets and liabilities, based in each case on their estimated fair values. Intangible assets and liabilities consist of above- market and below-market leases, the value of in-place leases and tenant relationships. Another signiﬁcant judgment must be made as to if, and when, impairment losses should be taken on our properties when events or a change in circumstances indicate that the carrying amount of the asset may not be recoverable. A provision is made for impairment if estimated future operating cash ﬂows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key inputs that we estimate in this analysis include projected rental rates, capital expenditures, and property sales capitalization rates. If a property is held for sale, it is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell. The carrying value of our real estate is the largest component of our consolidated balance sheet. If events should occur that require us to reduce the carrying value of our real estate by recording provisions for impairment, it could have a material impact on our results of operations. The following is a comparison of our results of operations for the years ended December 31, 2010, 2009 and 2008. Rental Revenue Rental revenue was $344.1 million for 2010 versus $323.8 million for 2009, an increase of $20.3 million, or 6.3%. Rental revenue was $323.2 million in 2008. The increase in rental revenue in 2010 compared to 2009 is primarily attributable to: • The 186 properties acquired by Realty Income in 2010, which generated $15.9 million of rent in 2010; • The 16 properties acquired by Realty Income in 2009, which generated $5.6 million of rent in 2010 compared to $490,000 in 2009, an increase of $5.1 million; • Same store rents generated on 2,131 properties during the entire years of 2010 and 2009, increased by $1.8 million, or 0.6%, to $313.8 million from $312.0 million; and • An increase in straight-line rent and other non-cash adjustments to rent of $442,000 in 2010 as compared to 2009; net of • A net decrease of $3.1 million relating to the aggregate of (i) development properties acquired before 2009 that started paying rent in 2009, (ii) properties that were vacant during part of 2010 or 2009, (iii) properties sold during 2010 and 2009 and (iv) lease termination settlements, which, in aggregate, totaled $7.16 million in 2010 compared to $10.23 million in 2009. Of the 2,496 properties in the portfolio at December 31, 2010, 2,485, or 99.6%, are single-tenant properties and the remaining 11 are multi-tenant, distribution and ofﬁce properties. Of the 2,485 single-tenant properties, 2,402, or 96.7%, were net leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 11.4 years at December 31, 2010. Of our 2,402 leased single-tenant properties, 2,217 or 92.3% were under leases that provide for increases in rents through: • Primarily base rent increases tied to a consumer price index (typically subject to ceilings); • Overage rent based on a percentage of the tenants’ gross sales; • Fixed increases; or • A combination of two or more of the above rent provisions. Percentage rent, which is included in rental revenue, was $1.3 million in 2010, $1.3 million in 2009 and $1.2 million in 2008 (excluding percentage rent reclassiﬁed to discontinued operations of $56,000 in 2010, $90,000 in 2009 and $61,000 in 2008). Percentage rent in 2010 was less than 1% of rental revenue, and we anticipate percentage rent to be less than 1% of rental revenue in 2011. Our portfolio of real estate, leased primarily to regional and national commercial enterprises under net leases, continues to perform well and provides dependable lease revenue supporting the payment of monthly dividends to our stockholders. At December 31, 2010, our portfolio of 2,496 properties was 96.6% leased with 84 properties available for lease as compared to 75 at December 31, 2009. It has been our experience that approximately 2% to 4% of our property portfolio will be unleased at any given time; however, we cannot assure you that the number of properties available for lease will not exceed these levels. R e a l t y I n c o m e 70 2 0 1 0 A n n u a l R e p o r t Depreciation and Amortization Depreciation and amortization was $95.5 million in 2010 versus $90.5 million in 2009 and $89.1 million in 2008. The increases in depreciation and amortization in 2010 and 2009 were primarily due to the acquisition of properties in 2010, 2009 and 2008, which was partially offset by property sales in those same years. As discussed in the section entitled “Funds from Operations Available to Common Stockholders,” depreciation and amortization is a non-cash item that is added back to net income available to common stockholders for our calculation of FFO and AFFO. Interest Expense Interest expense was $93.2 million in 2010 versus $85.5 million in 2009 and $94.0 million in 2008. The increase in interest expense from 2009 to 2010 was primarily due to an increase in borrowings attributable to the issuance of our $250 million of 5.75% senior unsecured notes in June 2010 and utilization of our credit facility in 2010, which was partially offset by lower average interest rates. The decrease in interest expense from 2008 to 2009 was primarily due to lower average outstanding balances and, to a lesser extent, lower interest rates. We redeemed, in November 2008, the $100 million outstanding principal amount of our 8.25% Monthly Income Senior Notes and, in January 2009, the $20 million outstanding principal amount of our 8% Notes, both of which contributed to the decrease in average outstanding balances and lower average interest rates on our debt in 2009. In December 2010, as a result of entering into our $425 million credit facility, we incurred $4.2 million of credit facility origination costs that were classified in “other assets” on our consolidated balance sheet at December 31, 2010, and are being amortized over the term of the credit facility. The remaining credit facility origination costs that were incurred as a result of entering into our previous $355 million credit facility, which were $452,000 at December 31, 2010, are included in “other assets” and are being amortized over the remaining term of our current $425 million credit facility. The following is a summary of the components of our interest expense (dollars in thousands): Interest on our credit facility and notes $ 89,916 $ 82,460 $ 91,213 2010 2009 2008 Interest included in discontinued operations from real estate acquired for resale by Crest Credit facility commitment fees Amortization of credit facility origination costs and deferred bond ﬁnancing costs Amortization of settlements on treasury lock agreement Interest capitalized Interest expense (557) 1,017 2,871 — (10) (595) 990 2,678 — (5) (1,797) 795 3,078 759 (92) $ 93,237 $ 85,528 $ 93,956 Credit facility and notes outstanding Average outstanding balances (dollars in thousands) Average interest rates 2010 $ 1,496,150 6.01% 2009 $ 1,350,791 6.10% 2008 $ 1,457,222 6.26% At December 31, 2010, the weighted average interest rate on our notes payable of $1.6 billion was 6.05%. There was no outstanding balance on our credit facility at December 31, 2010, but if there was, the effective borrowing rate would have been 2.11%. Interest Coverage Ratio Our interest coverage ratio for 2010 was 3.3 times, for 2009 was 3.5 times and for 2008 was 3.2 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. R e a l t y I n c o m e 71 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. 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 (beneﬁt) 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 note receivables 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 2010 $ 243,368 93,237 557 1,393 (344) — — (138) (807) — (6,166) (5,270) (12,517) $ 313,313 $ 93,794 3.3 2009 $ 226,707 85,528 595 677 (645) — (1,987) (129) (277) — (4,726) (3,607) (856) $ 301,280 $ 86,123 3.5 2008 $ 246,155 93,956 1,797 1,230 225 9 (31,455) (87) (3,374) 4,642 (5,049) 930 (1,676) $ 307,303 $ 95,753 3.2 (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 2010 was 2.7 times, for 2009 was 2.7 times and for 2008 was 2.6 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 or information presented in Exhibit 12.1 to this Annual Report. 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 2010 $ 313,313 $ 118,047 2.7 2009 $ 301,280 $ 110,376 2.7 2008 $ 307,303 $ 120,006 2.6 (1) Includes interest expense recorded to “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. R e a l t y I n c o m e 72 2 0 1 0 A n n u a l R e p o r t General and Administrative Expenses General and administrative expenses increased by $4.4 million to $25.3 million in 2010 as compared to $20.9 million in 2009. General and administrative expenses were $21.6 million in 2008. In 2010, general and administrative expenses as a percentage of total revenue were 7.3% as compared to 6.4% in 2009 and 6.7% in 2008. General and administrative expenses increased during 2010 primarily because of increases in employee costs, particularly in the acquisitions and research departments. In February 2011, we had 79 employees as compared to 72 employees in February 2010. In accordance with GAAP, 2010 general and administrative expenses also include transaction costs of $368,000 related to the acquisition of 186 new properties during 2010, as compared to $62,000 related to the acquisition of 16 new properties during 2009. Prior to 2009, GAAP required these transaction costs to be capitalized as part of the property investments. Property Expenses Property expenses are broken down into costs associated with non-net leased multi-tenant properties, unleased single-tenant properties and general portfolio expenses. Expenses related to the multi-tenant and unleased single-tenant properties include, but are not limited to, property taxes, maintenance, insurance, utilities, property inspections, bad debt expense and legal fees. General portfolio costs include, but are not limited to, insurance, legal, bad debt expense, property inspections and title search fees. At December 31, 2010, 84 properties were available for lease, as compared to 75 at December 31, 2009 and 70 at December 31, 2008. Property expenses were $7.3 million in 2010, $6.6 million in 2009 and $5.5 million in 2008. The increase in property expenses in 2010 is primarily attributable to an increase in maintenance, utilities and property taxes associated with properties available for lease, partially offset by a decrease in bad debt expense. Income Taxes Income taxes were $1.4 million in 2010 as compared to $677,000 in 2009 and $1.2 million in 2008. These amounts are for city and state income and franchise taxes paid by Realty Income. Income taxes for 2009 are lower primarily a result of a prior year review of our state tax ﬁlings, where we determined that it was appropriate to amend some prior year tax returns from which we realized a tax beneﬁt of $308,000 in 2009. In addition, Crest recorded state and federal income tax beneﬁts of $344,000 in 2010 as compared to income tax beneﬁts of $645,000 in 2009 and income tax expense of $225,000 in 2008. These amounts are included in “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. The Crest 2009 tax beneﬁt includes a beneﬁt of $303,000 attributable to amendments of certain prior year state tax returns. Discontinued Operations Crest acquires properties with the intention of reselling them rather than holding them as investments and operating the properties. Consequently, we typically classify Crest’s assets as held for sale at the date of acquisition and do not depreciate them. As a result, the operations of Crest’s property assets are typically classiﬁed as “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income. However, if we determine we have no plans to sell a property asset in the near term (i.e. within the next 12 months), and this property was previously classiﬁed as held for sale, the property is reclassiﬁed as real estate held for investment. A property that is reclassiﬁed as held for investment is measured and recorded at the lower of (i) its carrying amount before the property was classiﬁed as held for sale, adjusted for any depreciation expense that would have been recognized had the property been continuously classiﬁed as held for investment, or (ii) the fair value at the date of the subsequent decision not to sell. At December 31, 2010, we determined that three property assets, acquired by Crest in 2006, no longer met the held for sale criteria because we decided to lease rather than sell these properties in the near term. As a result, investment in real estate of $3.0 million was reclassiﬁed from real estate held for sale to real estate held for investment on our consolidated balance sheet at December 31, 2010. The results of operations for these properties are included in income from continuing operations on our consolidated statements of income. As a result of this reclassiﬁcation, $911,000, $214,000 and $3.2 million in operating loss was reclassiﬁed from discontinued operations to continuing operations for 2010, 2009 and 2008, respectively. R e a l t y I n c o m e 73 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. The following is a summary of Crest’s “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statements of income (dollars in thousands, except per share data): Crest’s income from discontinued operations, real estate acquired for resale Rental revenue Interest revenue Gain on sales of real estate acquired for resale Interest expense General and administrative expense Property expenses Provisions for impairment Depreciation(1) Income tax beneﬁt (expense) Income from discontinued operations, real estate acquired for resale by Crest Per common share, basic and diluted 2010 $ — 1,397 — (557) (226) (12) — — 344 $ 946 $ 0.01 2009 $ 157 1,403 — (595) (336) (24) (78) — 645 $ 1,172 $ 0.01 2008 $ 1,595 899 4,642 (1,797) (511) (13) — (771) (225) $ 3,819 $ 0.04 (1) Depreciation was recorded on one property that was classiﬁed as held for investment. This property was sold in 2008. Operations from nine of our investment properties were classiﬁed as held for sale at December 31, 2010, plus properties sold in 2010, 2009 and 2008 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 2010 $ 8,405 1,771 32 (636) (937) (213) $ 8,422 $ 0.08 2009 $ 8,044 3,592 45 (1,428) (963) (110) $ 9,180 $ 0.09 The following is a summary of our total income from discontinued operations (dollars in thousands, except per share data): Total discontinued operations Real estate acquired for resale by Crest Real estate held for investment Income from discontinued operations Per common share, basic and diluted 2010 $ 946 8,422 $ 9,368 $ 0.09 2009 $ 1,172 9,180 $ 10,352 $ 0.10 The above per share amounts have each been calculated independently. 2008 $ 13,314 6,813 96 (1,929) (573) — $ 17,721 $ 0.18 2008 $ 3,819 17,721 $ 21,540 $ 0.21 R e a l t y I n c o m e 74 2 0 1 0 A n n u a l R e p o r t Crest’s Property Sales During 2010, Crest did not sell any properties. During 2009, Crest sold two properties for $2.0 million, which resulted in no gain. In 2008, Crest sold 25 properties for $50.7 million, which resulted in a gain of $4.6 million. During 2008, as part of two sales, Crest provided buyer ﬁnancing of $19.2 million. Crest’s gains on sales are reported before income taxes and are included in discontinued operations. Gain on Sales of Investment Properties by Realty Income During 2010, we sold 28 investment properties for $26.6 million, which resulted in a gain of $8.4 million. The results of operations for these properties have been reclassiﬁed as discontinued operations. Additionally, we sold excess land from one property for $600,000, which resulted in a gain of $271,000. This gain is included in “other revenue” on our consolidated statement of income for 2010 because this excess land was associated with a property that continues to be owned as part of our core operations. During 2009, we sold 25 investment properties for $20.3 million, which resulted in a gain of $8.0 million. The results of operations for these properties have been reclassiﬁed as discontinued operations. Additionally, we received proceeds of $170,000 from the sale of excess land from one property, which resulted in a gain of $15,000. This gain is included in “other revenue” on our consolidated statement of income for 2009 because this excess land was associated with a property that continues to be owned as part of our core operations. During 2008, we sold 29 investment properties for $27.4 million, which resulted in a gain of $13.3 million. The results of operations for these properties have been reclassiﬁed as 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 revenue” on our consolidated statement of income for 2008 because this excess land was associated with a property that continues to be owned as part of our core operations. We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment of the sale proceeds will: • Generate higher returns; • Enhance the credit quality of our real estate portfolio; • Extend our average remaining lease term; or • Decrease tenant or industry concentration. At December 31, 2010, we classiﬁed real estate with a carrying amount of $3.6 million as held for sale on our balance sheet. Additionally, we anticipate selling investment properties from our portfolio that have not yet been speciﬁcally identiﬁed, from which we anticipate receiving between $10 million and $35 million in proceeds during the next 12 months. We intend to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during the next 12 months or be able to invest the proceeds from the sales of any properties in new properties. Provisions for Impairment on Real Estate Acquired for Resale by Crest During 2010, Crest recorded total provisions for impairment of $807,000 on three properties held for investment at December 31, 2010. These provisions for impairment are included in continuing operations on our consolidated statement of income for 2010. During 2009, Crest recorded total provisions for impairment of $199,000 on three properties classiﬁed as held for investment at December 31, 2010. These provisions for impairment are included in continuing operations on our consolidated statement of income for 2009. Additionally, in 2009, Crest recorded total provisions for impairment of $78,000 on two properties which were sold in 2009. These provisions for impairment are included in “income from discontinued operations, real estate acquired for resale by Crest” on our consolidated statement of income for 2009. During 2008, Crest recorded total provisions for impairment of $3.4 million on three properties which were held for investment at December 31, 2010. These provisions for impairment are included in continuing operations on our consolidated statement of income for 2008. Provisions for Impairment on Realty Income Investment Properties During 2010, we recorded provisions for impairment of $213,000 on four properties, three which were sold in 2010 and the other is anticipated to be sold in the ﬁrst quarter of 2011. These provisions for impairment are included in “income from discontinued operations, real estate held for investment” on our consolidated statement of income for 2010. During 2009, we recorded a provision for impairment of $110,000 on one property, which is included in “income from discontinued operations, real estate held for investment” on our consolidated statement of income for 2009, and the property was sold in 2010. No provisions for impairment were recorded in 2008. Preferred Stock Dividends Preferred stock cash dividends totaled $24.3 million in 2010, 2009 and 2008. R e a l t y I n c o m e 75 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. Net Income Available to Common Stockholders Net income available to common stockholders was $106.5 million in 2010, a slight decrease of $343,000 as compared to $106.9 million in 2009. Net income available to common stockholders in 2008 was $107.6 million. The calculation to determine net income available to common stockholders includes gains from the sale of properties. The amount of gains varies from period to period based on the timing of property sales and can signiﬁcantly impact net income available to common stockholders. Gain from the sale of investment properties and the sale of excess land recognized during 2010 was $8.7 million, as compared to a $8.1 million gain recognized during 2009 and a $13.6 million gain recognized during 2008. Crest recognized no gain from the sale of properties during 2010 or 2009 as compared to $4.6 million during 2008. FuNDS FROM OPERATIONS AvAILABLE TO COMMON STOCkhOLDERS (FFO) FFO for 2010 increased by $3.3 million, or 1.7%, to $193.7 million, as compared to $190.4 million in 2009 and $185.5 million in 2008. 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 common shares used for the basic and diluted computation per share (dollars in thousands, except per share amounts): 2008 $ 107,588 89,104 2,701 (319) (236) (13,314) $ 185,524 $ 1.83 $ 1.83 $ 169,655 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 2010 $ 106,531 2009 $ 106,874 95,513 636 (291) (271) (8,405) 90,519 1,428 (318) (15) (8,044) FFO available to common stockholders $ 193,713 $ 190,444 FFO per common share: Basic Diluted Distributions paid to common stockholders FFO in excess of distributions paid to common stockholders Weighted average number of common shares used for computation per share: Basic Diluted $ 1.83 $ 1.83 $ 182,500 $ 1.84 $ 1.84 $ 178,008 $ 11,213 $ 12,436 $ 15,869 105,869,637 105,942,721 103,577,507 103,581,053 101,178,191 101,209,883 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 adds back 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. 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. R e a l t y I n c o m e 76 2 0 1 0 A n n u a l R e p o r t ADJuSTED FuNDS FROM OPERATIONS AvAILABLE TO COMMON STOCkhOLDERS (AFFO) AFFO for 2010 increased by $4.6 million, or 2.4%, to $197.3 million as compared to $192.7 million in 2009 and $192.0 million in 2008. We consider AFFO to be an appropriate supplemental measure of our performance because it provides analysts and investors with an additional indicator of our ability to pay dividends. Most companies in our industry use a similar measurement, but they may use the term “CAD” (for Cash Available for Distribution) or “FAD” (for Funds Available for Distribution). AFFO further adjusts FFO by adding back non-cash items that reduce net income in accordance with GAAP, and deducting such items as capitalized expenditures and straight-line rent revenue. The following is a reconciliation of net income available to common stockholders (which we believe is the most comparable GAAP measure) to FFO and AFFO. Also presented is information regarding distributions paid to common stockholders and the weighted average number of common shares used for the basic and diluted computation per share (dollars in thousands, except per share amounts): Net income available to common stockholders Cumulative adjustments to calculate FFO(1) FFO available to common stockholders Amortization of share-based compensation Amortization of deferred note ﬁnancing costs(2) Amortization of settlements on treasury lock agreements(3) Provisions for impairment Capitalized leasing costs and commissions Capitalized building improvements Straight-line rent revenue(4) Total AFFO available to common stockholders AFFO per common share: Basic Diluted Distributions paid to common stockholders AFFO in excess of distributions paid to common stockholders Weighted average number of common shares used for computation per share: Basic Diluted 2010 $ 106,531 87,182 193,713 6,166 1,548 — 1,020 (1,501) (2,077) (1,613) 2009 $ 106,874 83,570 190,444 4,726 1,363 — 387 (1,185) (1,879) (1,117) 2008 $ 107,588 77,936 185,524 5,049 1,748 759 3,374 (956) (1,498) (1,997) $ 197,256 $ 192,739 $ 192,003 $ 1.86 $ 1.86 $ 182,500 $ 1.86 $ 1.86 $ 178,008 $ 1.90 $ 1.90 $ 169,655 $ 14,756 $ 14,731 $ 22,348 105,869,637 105,942,721 103,577,507 103,581,053 101,178,191 101,209,883 (1) See reconciling items for FFO presented on the previous page. (2) Amortization of deferred note ﬁnancing costs includes the amortization of costs incurred and capitalized when our notes were issued in January 1999, March 2003, November 2003, March 2005, September 2005, September 2006, September 2007 and June 2010. 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) 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. (4) A negative amount indicates that our straight-line rent revenue was greater than our actual cash rent collected. Presentation of the information regarding FFO and AFFO 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 and AFFO in the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and AFFO are 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 and AFFO should not be considered as an alternative to reviewing our cash ﬂows from operating, investing, and ﬁnancing activities. In addition, FFO and AFFO should not be considered as a measure of liquidity, of our ability to make cash distributions, or of our ability to pay interest payments. R e a l t y I n c o m e 77 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Management’s Discussion and Analysis of Financial Condition and Results of Operations, cont’d. IMPACT OF INFLATION Tenant leases generally provide for limited increases in rent as a result of increases in the tenants’ sales volumes, increases in the consumer price index (typically subject to ceilings), and/or ﬁxed increases. We expect that inﬂation will cause these lease provisions to result in rent increases over time. During times when inﬂation is greater than increases in rent, as provided for in the leases, rent increases may not keep up with the rate of inﬂation. Of our 2,496 properties in our portfolio, approximately 96.2% or 2,402 are leased to tenants under net leases where the tenant is responsible for property expenses. Net leases tend to reduce our exposure to rising property expenses due to inﬂation. Inﬂation and increased costs may have an adverse impact on our tenants if increases in their operating expenses exceed increases in revenue. IMPACT OF RECENT ACCOuNTINg PRONOuNCEMENTS For information on the impact of recent accounting pronouncements on our business, see note 2 of the Notes to Consolidated Financial Statements. QuANTITATIvE AND QuALITATIvE DISCLOSuRES ABOuT MARkET RISk We are exposed to interest rate changes primarily as a result of our credit facility and long-term notes and bonds used to maintain liquidity and expand our real estate investment portfolio and operations. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash ﬂow and to lower our overall borrowing costs. To achieve these objectives we issue long-term notes and bonds, primarily at ﬁxed rates. We were not a party to any derivative ﬁnancial instruments at December 31, 2010. We do not enter into any derivative transactions for speculative or trading purposes. The following table presents by year of expected maturity, the principal amounts, average interest rates and estimated fair values of our ﬁxed and variable debt as of December 31, 2010. 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 Fixed rate debt Average interest rate on fixed rate debt variable rate debt Average interest rate on variable rate debt 2011 2012 2013(1) 2014(2) 2015(3) Thereafter(4) Totals/Average Fair Value(5) $ — — 100.0 — 150.0 1,350.0 $ 1,600.0 $ 1,707.1 —% — 5.38 — 5.50 6.16 6.05% $ — — — — — — $ — $ — —% — — — — — —% (1) $100 million matures in March 2013. (2) The credit facility expires in March 2014. (3) $150 million matures in November 2015. (4) $275 million matures in September 2016, $175 million matures in September 2017, $550 million matures in August 2019, $250 million matures in January 2021 and $100 million matures in March 2035. (5) We base the fair value of the ﬁxed rate debt at December 31, 2010 on indicative market prices and recent trading activity of our notes payable. The table incorporates only those exposures that exist as of December 31, 2010. 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. Interest on our credit facility balance is variable. At December 31, 2010, our credit facility balance was zero; however, we intend to borrow funds on our credit facility in the future. Based on a hypothetical credit facility borrowing of $50 million, a 1% change in interest rates would change our interest costs by $500,000 per year. R e a l t y I n c o m e 78 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Selected Financial Data (not covered by Report of Independent Registered Public Accounting Firm) (dollars in thousands, except for per share data) As of or for the years ended December 31, 2010 2009 2008 2007 2006 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 Net income available to common stockholders Cash distributions paid to common stockholders Basic and diluted net income per common share $ 3,535,590 $ 2,914,787 $ 2,994,179 $ 3,077,352 $ 2,546,508 17,607 1,600,000 1,688,625 1,846,965 243,368 7,581 345,009 121,416 9,368 130,784 (24,253) 10,026 1,354,600 1,426,778 1,488,009 226,707 (36,789) 325,245 120,775 10,352 131,127 (24,253) 46,815 1,370,000 1,439,518 1,554,661 246,155 (146,286) 325,041 110,301 21,540 131,841 (24,253) 193,101 1,470,000 1,539,260 1,538,092 318,169 182,528 288,650 121,871 18,538 140,409 (24,253) 10,573 920,000 970,516 1,575,992 86,945 (55,131) 230,940 99,551 11,230 110,781 (11,362) 106,531 106,874 107,588 116,156 99,419 182,500 178,008 169,655 157,659 129,667 Cash distributions paid per common share 1.721625 1.01 1.03 1.706625 1.06 1.662250 1.16 1.560250 1.11 1.437250 Cash distributions declared per common share Basic weighted average number of common shares outstanding Diluted weighted average number of common shares outstanding 1.722875 1.707875 1.667250 1.570500 1.447500 105,869,637 103,577,507 101,178,191 100,195,031 89,766,714 105,942,721 103,581,053 101,209,883 100,333,966 89,917,554 R e a l t y I n c o m e 79 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Controls and Procedures ChANgES IN AND DISAgREEMENTS wITh ACCOuNTANTS ON ACCOuNTINg AND FINANCIAL DISCLOSuRE We have had no disagreements with our independent registered public accounting ﬁrm on accounting matters or ﬁnancial disclosure, nor have we changed accountants in the two most recent ﬁscal years. CONTROLS AND PROCEDuRES Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures (as deﬁned in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and 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, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-beneﬁt relationship of possible controls and procedures. As of and for the year ended December 31, 2010, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, under the supervision and with the participation of management, including our Chief Executive Ofﬁcer and Chief Financial Ofﬁcer. Based on the foregoing, our Chief Executive Ofﬁcer and Chief Financial Ofﬁcer concluded that our disclosure controls and procedures were effective and were operating at a reasonable assurance level. MANAgEMENT’S REPORT ON INTERNAL CONTROL OvER FINANCIAL REPORTINg Internal control over ﬁnancial reporting refers to the process designed by, or under the supervision of, our Chief Executive Ofﬁcer and Chief Financial Ofﬁcer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that: (1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reﬂect the transactions and dispositions of the assets of the Company; (2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the ﬁnancial statements. Management is responsible for establishing and maintaining adequate internal control over ﬁnancial reporting for the Company. Management has used the framework set forth in the report entitled “Internal Control—Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission to evaluate the effectiveness of the Company’s internal control over ﬁnancial reporting. Management has concluded that the Company’s internal control over ﬁnancial reporting was effective as of the end of the most recent ﬁscal year. KPMG LLP has issued an attestation report on the effectiveness of the Company’s internal control over ﬁnancial reporting. Submitted on February 10, 2011 by, Thomas A Lewis, Chief Executive Ofﬁcer and Vice Chairman Paul M. Meurer, Chief Financial Ofﬁcer, Executive Vice President and Treasurer R e a l t y I n c o m e 80 2 0 1 0 A n n u a l R e p o r t Changes in Internal Controls There have not been any signiﬁcant changes in our internal controls or in other factors that could signiﬁcantly affect these controls subsequent to the date of their evaluation in the fourth quarter of 2010. As of December 31, 2010, there were no material weaknesses in our internal controls, and therefore, no corrective actions were taken. Limitations on the Effectiveness of Controls Internal control over ﬁnancial reporting cannot provide absolute assurance of achieving ﬁnancial reporting objectives because of its inherent limitations. Internal control over ﬁnancial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over ﬁnancial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over ﬁnancial reporting. However, these inherent limitations are known features of the ﬁnancial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Certiﬁcations Tom Lewis, Realty Income’s Chief Executive Ofﬁcer, certiﬁed to the NYSE in 2010, pursuant to Section 303A.12(a) of the NYSE’s Listing Standards, that he was not aware of any violation of the NYSE corporate governance listing standards by Realty Income. Furthermore, Realty Income ﬁled with the SEC as exhibits to its Annual Report on Form 10-K for the year ended December 31, 2010, the certiﬁcations by Tom Lewis and Paul M. Meurer, Realty Income’s Chief Executive Ofﬁcer and Chief Financial Ofﬁcer, respectively, required under Section 302 of the Sarbanes-Oxley Act. R e a l t y I n c o m e 81 2 0 1 0 A n n u a l R e p o r t REALTy INCOME CORPORATION AND SuBSIDIARIES Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 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 2010 First quarter Second quarter Third quarter Fourth quarter Total 2009 First quarter Second quarter Third quarter Fourth quarter Total high $ 31.18 34.53 34.79 35.97 $ 23.41 23.23 28.20 27.53 Low Distributions Declared(1) $ 25.30 28.42 29.12 32.92 $ 14.26 17.90 19.83 22.17 $ 0.4293125 0.4302500 0.4311875 0.4321250 $ 1.7228750 $ 0.4255625 0.4265000 0.4274375 0.4283750 $ 1.7078750 (1) Common stock cash distributions currently are declared monthly by us based on ﬁnancial results for the prior months. At December 31, 2010, a distribution of $0.14425 per common share had been declared and was paid in January 2011. There were 8,396 registered holders of record of our common stock as of December 31, 2010. We estimate that our total number of shareholders is approximately 100,000 when we include both registered and beneﬁcial holders of our common stock. During the fourth quarter of 2010, no shares of stock were withheld for state and federal payroll taxes on the vesting of stock awards, as permitted under the 2003 Incentive Award Plan of Realty Income Corporation. TOTAL RETuRN PERFORMANCE 220 200 180 160 140 120 l e u a V x e d n I 100 u 80 60 u l s n u n s l u l n s u n s l u l n s u Realty Income Corporation n Russell 2000 s Realty Income Peer Group* l SNL Triplenet REIT Index 12/31/05 12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 Index 12/31/05 12/31/06 12/31/07 Realty Income Corporation Russell 2000 Realty Income Peer Group* SNL Triplenet REIT Index 100.00 100.00 100.00 100.00 136.01 118.37 133.17 132.63 140.48 116.51 110.49 123.05 12/31/08 129.02 77.15 67.04 84.88 12/31/09 12/31/10 155.96 98.11 91.85 113.89 217.26 124.46 120.85 143.30 * Realty Income Peer Group consists of thirteen companies (excluding Realty Income) with an implied market capitalization between $3 billion-$5 billion as of September 30, 2010. Period Ending R e a l t y I n c o m e 82 2 0 1 0 A n n u a l R e p o r t Company Information Dawn Nguyen Vice President, Portfolio Management Joel Tomlinson Vice President, Director of Acquisitions Cary J. Wenthur Vice President, Acquisitions Stephen D. Burchett Associate Vice President, Senior Legal Counsel Jill M. Cossaboom Associate Vice President, Assistant Controller Kristin K. Ferrell Associate Vice President, Portfolio Management Teresa M. Glenn Associate Vice President, Human Resources & Operations Sean P. Nugent Associate Vice President, Accounting Manager Jenette S. O’Brien Associate Vice President, Senior Legal Counsel Patrick Rea Associate Vice President, Property Management DIRECTORS Donald R. Cameron Chairman of the Board of Directors and President, Cameron, Murphy & Spangler, Inc. 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. Michael D. McKee Chief Executive Officer, Bentall Kennedy Gregory T. McLaughlin President, Tiger Woods Foundation Ronald L. Merriman Retired Vice Chair, KPMG, LLP 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 website 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 Realty Income’s Senior Management - front row: Tom Lewis, second row: Rob Israel, Paul Meurer, Laura King, third row: Gary Malino, Richard Collins, top row: John Case and Mike 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 John P. Case Executive Vice President, Chief Investment Officer Richard G. Collins Executive Vice President, Portfolio Management ADDITIONAL OFFICERS Robert J. Israel Senior Vice President, Research Laura S. King Senior Vice President, Assistant General Counsel and Assistant Secretary Theresa M. Casey Vice President, Information Technologies Elizabeth Cate Vice President, Portfolio Management Gregory J. Fahey Vice President, Controller Benjamin N. Fox Vice President, Director, Strategic Initiatives Tere H. Miller Vice President, Corporate Communications 600 La Terraza Boulevard, Escondido, CA 92025-3873 www.realtyincome.com

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