UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K/A
(Amendment No. 1)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended
December 31, 2018
Commission File Number 1-13374
REALTY INCOME CORPORATION
(Exact name of registrant as specified in its charter)
Maryland | 33-0580106 | |
(State or Other Jurisdiction of | (IRS Employer | |
Incorporation or Organization) | Identification Number) | |
11995 El Camino Real, San Diego, California, 92130
(Address of Principal Executive Offices)
Registrant’s telephone number, including area code: (858) 284-5000
Securities registered pursuant to Section 12 (b) of the Act:
Name of Each Exchange | ||
Title of Each Class | On Which Registered | |
Common Stock, $0.01 Par Value Class F Preferred Stock, $0.01 Par Value | New York Stock Exchange New York Stock Exchange | |
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x NO o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o NO x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
At June 30, 2018, the aggregate market value of the Registrant’s shares of common stock, $0.01 par value, held by non-affiliates of the Registrant was $15.6 billion based upon the last reported sale price of $53.79 per share on the New York Stock Exchange on June 29, 2018, the last business day of the Registrant’s most recently completed second fiscal quarter. The determination of affiliate status for purposes of this calculation is not necessarily a conclusive determination for other purposes.
At February 13, 2019, the number of shares of common stock outstanding was 303,791,717.
DOCUMENTS INCORPORATED BY REFERENCE
Part III, Items 10, 11, 12, 13, and 14 incorporate by reference certain specific portions of the definitive Proxy Statement for Realty Income Corporation’s Annual Meeting to be held on May 14, 2019, to be filed pursuant to Regulation 14A. Only those portions of the proxy statement which are specifically incorporated by reference herein shall constitute a part of this annual report.
EXPLANATORY NOTE
This Amendment No. 1 to the Annual Report on Form 10-K (this “Amended Form 10-K”) of Realty Income Corporation amends and restates in its entirety (including exhibits) our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on February 22, 2019 (the “Original Form 10-K”). This Amended Form 10-K is being filed solely to correct an inadvertent immaterial error, which occurred during the EDGARization process, in Schedule III of our audited financial statements contained in the Original Form 10-K, which has been revised in the Amended Form 10-K to correct this immaterial error.
Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, this Amended Form 10-K also contains new certifications as required by Section 302 and Section 906 of the Sarbanes-Oxley Act of 2002. Accordingly, Item 15(b) of Part IV is amended to include the currently dated certifications as exhibits.
Except as described above, no other amendments are being made to the Original Form 10-K. For ease of reference, we have elected to file the entire contents of the Original Form 10-K, except as described above, even though the error was only contained in Schedule III of our audited financial statements. This Amended Form 10-K does not reflect events occurring after the Original Form 10-K or modify or update the disclosure contained therein in any other way other than as required to reflect the amendments discussed above.
REALTY INCOME CORPORATION
Index to Form 10-K
Page | |||
PART I
Item 1: Business
THE COMPANY
Realty Income, The Monthly Dividend Company®, is an S&P 500 company dedicated to providing stockholders with dependable monthly dividends that increase over time. The company is structured as a real estate investment trust, or REIT, requiring it annually to distribute at least 90% of its taxable income (excluding net capital gains) in the form of dividends to its stockholders. The monthly dividends are supported by the cash flow generated from real estate owned under long-term, net lease agreements with regional and national commercial tenants.
Realty Income was founded in 1969, and listed on the New York Stock Exchange (NYSE: O) in 1994. Over the past 50 years, Realty Income has been acquiring and managing freestanding commercial properties that generate rental revenue under long-term net lease agreements. The company is a member of the S&P High Yield Dividend Aristocrats® index for having increased its dividend every year for more than 20 consecutive years.
At December 31, 2018, we owned a diversified portfolio:
• | Of 5,797 properties; |
• | With an occupancy rate of 98.6%, or 5,717 properties leased and 80 properties available for lease; |
• | Leased to 262 different commercial tenants doing business in 48 separate industries; |
• | Located in 49 states and Puerto Rico; |
• | With over 93.3 million square feet of leasable space; and |
• | With an average leasable space per property of approximately 16,110 square feet; approximately 11,260 square feet per retail property and 229,000 square feet per industrial property. |
Of the 5,797 properties in the portfolio, 5,769, or 99.5%, are single-tenant properties, and the remaining are multi-tenant properties. At December 31, 2018, of the 5,769 single-tenant properties, 5,692 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 9.2 years.
Our seven senior officers owned 0.1% of our outstanding common stock with a market value of $12.2 million at January 31, 2019. Our directors and seven senior officers, as a group, owned 0.2% of our outstanding common stock with a market value of $34.9 million at January 31, 2019.
Our common stock is listed on the NYSE under the ticker symbol “O” with a CUSIP number of 756109-104. Our central index key number is 726728.
In January 2019, we had 165 employees, as compared to 152 employees in January 2018.
We maintain a corporate 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, Form 3s, Form 4s, Form 5s, current reports on Form 8-K, and amendments to those reports, as soon as reasonably 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.
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RECENT DEVELOPMENTS
Increases in Monthly Dividends to Common Stockholders
We have continued our 50-year policy of paying monthly dividends. In addition, we increased the dividend five times during 2018 and twice during 2019. As of February 2019, we have paid 85 consecutive quarterly dividend increases and increased the dividend 100 times since our listing on the NYSE in 1994.
Month | Month | Dividend | Increase | |||||||||
2018 Dividend increases | Declared | Paid | per share | per share | ||||||||
1st increase | Dec 2017 | Jan 2018 | $ | 0.2125 | $ | 0.0005 | ||||||
2nd increase | Jan 2018 | Feb 2018 | $ | 0.2190 | $ | 0.0065 | ||||||
3rd increase | Mar 2018 | Apr 2018 | $ | 0.2195 | $ | 0.0005 | ||||||
4th increase | Jun 2018 | Jul 2018 | $ | 0.2200 | $ | 0.0005 | ||||||
5th increase | Sep 2018 | Oct 2018 | $ | 0.2205 | $ | 0.0005 | ||||||
2019 Dividend increases | ||||||||||||
1st increase | Dec 2018 | Jan 2019 | $ | 0.2210 | $ | 0.0005 | ||||||
2nd increase | Jan 2019 | Feb 2019 | $ | 0.2255 | $ | 0.0045 | ||||||
The dividends paid per share during 2018 totaled approximately $2.6305, as compared to approximately $2.5270 during 2017, an increase of $0.1035, or 4.1%.
The monthly dividend of $0.2255 per share represents a current annualized dividend of $2.706 per share, and an annualized dividend yield of approximately 4.3% based on the last reported sale price of our common stock on the NYSE of $63.04 on December 31, 2018. Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period.
Acquisitions During 2018
During 2018, we invested $1.8 billion in 764 new properties and properties under development or expansion, with an initial weighted average contractual lease rate of 6.4%. The 764 new properties and properties under development or expansion are located in 39 states, will contain approximately 5.2 million leasable square feet, and are 100% leased with a weighted average lease term of 14.8 years. The tenants occupying the new properties operate in 21 industries and the property types are 96.3% retail and 3.7% industrial, based on rental revenue. During 2018, none of our real estate investments caused any one tenant to be 10% or more of our total assets at December 31, 2018.
The initial weighted average contractual lease rate for a property is generally computed as estimated contractual first year cash net operating income, which, in the case of a net leased property, is equal to the aggregate cash base rent for the first full year of each lease, divided by the total cost of the property. Since it is possible that a tenant could default on the payment of contractual rent, we cannot provide assurance that the actual return on the funds invested will remain at the percentages listed above.
In the case of a property under development or expansion, the contractual lease rate is generally fixed such that rent varies based on the actual total investment in order to provide a fixed rate of return. When the lease does not provide for a fixed rate of return on a property under development or expansion, the initial weighted average contractual lease rate is computed as follows: estimated cash net operating income (determined by the lease) for the first full year of each lease, divided by our projected total investment in the property, including land, construction and capitalized interest costs. Of the $1.8 billion we invested during 2018, $80.3 million was invested in 14 properties under development or expansion with an initial weighted average contractual lease rate of 6.9%. We may continue to pursue development or expansion opportunities under similar arrangements in the future.
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Portfolio Discussion
Leasing Results
At December 31, 2018, we had 80 properties available for lease out of 5,797 properties in our portfolio, which represents a 98.6% occupancy rate based on the number of properties in our portfolio. Since December 31, 2017, when we reported 83 properties available for lease out of 5,172 and a 98.4% occupancy rate, we:
• | Had 267 lease expirations; |
• | Re-leased 228 properties; and |
• | Sold 42 vacant properties. |
Of the 228 properties re-leased during 2018, 215 properties were re-leased to existing tenants, three were re-leased to new tenants without vacancy, and ten were re-leased to new tenants after a period of vacancy. The annual rent on these 228 leases was $46.15 million, as compared to the previous rent on these same properties of $44.66 million, which represents a rent recapture rate of 103.3% on the properties re-leased during 2018.
As part of our re-leasing costs, we pay leasing commissions to unrelated, third party real estate brokers consistent with the commercial real estate industry standard, and sometimes provide tenant rent concessions. We do not consider the collective impact of the leasing commissions or tenant rent concessions to be material to our financial position or results of operations.
At December 31, 2018, our average annualized rental revenue was approximately $14.24 per square foot on the 5,717 leased properties in our portfolio. At December 31, 2018, we classified 17 properties, with a carrying amount of $16.6 million, as held for sale on our balance sheet. The expected sale of these properties does not represent a strategic shift that will have a major effect on our operations and financial results and is consistent with our existing disposition strategy to further enhance our real estate portfolio and maximize portfolio returns.
Investments in Existing Properties
In 2018, we capitalized costs of $17.9 million on existing properties in our portfolio, consisting of $3.9 million for re-leasing costs, $1.1 million for recurring capital expenditures, and $12.9 million for non-recurring building improvements. In 2017, we capitalized costs of $12.7 million on existing properties in our portfolio, consisting of $1.6 million for re-leasing costs, $912,000 for recurring capital expenditures, and $10.2 million for non-recurring building improvements.
The majority of our building improvements relate to roof repairs, HVAC improvements, and parking lot resurfacing and replacements. The amounts of our capital expenditures can vary significantly, depending on the rental market, tenant credit worthiness, the lease term and the willingness of tenants to pay higher rents over the terms of the leases.
We define recurring capital expenditures as mandatory and repetitive landlord capital expenditure obligations that have a limited useful life. We define non-recurring capital expenditures as property improvements where we invest additional capital that extend the useful life of the properties.
Sumit Roy Appointed Chief Executive Officer (CEO)
On October 16, 2018, we announced that our Board of Directors had appointed Sumit Roy to the position of our CEO and to our Board of Directors. Mr. Roy, who previously served as Chief Operating Officer, succeeds John P. Case, our previous CEO. Mr. Roy continues to serve as our President.
Tau Operating Partnership Buyout and Term Loan Payoff
In January 2019, we redeemed all of the outstanding 317,022 common units of Tau Operating Partnership, L.P., which reduced our total common units outstanding to 373,797 as of January 3, 2019. Additionally, in January 2019, we paid off the outstanding balance and interest on the $70.0 million senior unsecured term loan entered in January 2013 in conjunction with our acquisition of ARCT. Following the redemption, we hold 100% of the ownership interests of Tau Operating Partnership, L.P., and continue to consolidate the entity.
New, Expanded Credit Facility
In October 2018, we entered into a new $3.25 billion unsecured credit facility to replace our previous $2.25 billion unsecured credit facility, of which $2.0 billion was due to expire in June 2019. This new credit facility includes a $3.0 billion unsecured revolving credit facility and a new $250.0 million unsecured term loan due March 2024. The new revolving credit facility matures in March 2023 and includes two six-month extensions that can be exercised at our
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option. The new revolving credit facility, or our revolving credit facility, also has a $1.0 billion expansion feature. As of December 31, 2018, we had a balance of $252.0 million on our credit facility. Under our revolving credit facility, our current investment grade credit ratings provide for financing at LIBOR plus 0.775% with a facility commitment fee of 0.125%, for all-in drawn pricing of 0.90% over LIBOR. Our previous $2.25 billion unsecured credit facility had all-in drawn pricing of 0.975% over LIBOR.
In conjunction with our new revolving credit facility, we entered into a new $250.0 million senior unsecured term loan, which matures in March 2024. Borrowing under this term loan bears interest at the current one-month LIBOR plus 0.85%. In conjunction with this term loan, we also entered into an interest rate swap which effectively fixes our per annum interest on this term loan at 3.89%.
S&P Upgrade to A-
In August 2018, S&P Global Ratings raised our credit rating to A- with a "stable" outlook from BBB+ with a "positive" outlook.
Note Issuance
In April 2018, we issued $500.0 million of 3.875% senior unsecured notes due 2025, or the 2025 Notes. The public offering price for the 2025 Notes was 99.50% of the principal amount, for an effective yield to maturity of 3.957%. The net proceeds of approximately $493.1 million from this offering were used to repay borrowings outstanding under our credit facility, to fund investment opportunities, and for other general corporate purposes.
Capital Raising
During 2018, we raised $1.1 billion from the sale of common stock, primarily through the use of our at-the-market (ATM) programs, at a weighted average price of $58.77 per share.
Net Income Available to Common Stockholders
Net income available to common stockholders was $363.6 million in 2018, as compared to $301.5 million in 2017, an increase of $62.1 million. On a diluted per common share basis, net income was $1.26 in 2018, as compared to $1.10 in 2017, an increase of $0.16, or 14.5%.
Net income available to common stockholders in 2018 was impacted by a severance payment made to our former CEO in October 2018. The total value of cash, stock compensation and professional fees incurred as a result of this severance was $28.3 million; however, the net amount, after incorporating accruals for CEO compensation previous to this severance, was $18.7 million, equivalent to $0.06 per share.
Net income and funds from operations available to common stockholders per share in 2017 were impacted by a loss of $42.4 million, or $0.15 per share, on extinguishment of debt upon the early redemption on all $550.0 million of our outstanding 6.75% notes due August 2019 during December 2017. Net income and funds from operations available to common stockholders for 2017 were also impacted by a $13.4 million non-cash redemption charge on the shares of Class F preferred stock that were redeemed in April 2017, which represented $0.05 on a diluted per common share basis. This charge was based on the excess of redemption value over the carrying value of the Class F preferred stock that represents the original issuance cost that was paid in 2012.
The calculation to determine net income available to common stockholders includes impairments and gains from the sale of properties, which can vary from period to period based on the timing and significantly impact net income available to common stockholders.
Funds from Operations Available to Common Stockholders (FFO)
In 2018, our FFO increased by $130.6 million, or 16.9%, to $903.3 million, as compared to $772.7 million in 2017. On a diluted per common share basis, FFO was $3.12 in 2018, as compared to $2.82 in 2017, an increase of $0.30, or 10.6%.
Adjusted Funds from Operations Available to Common Stockholders (AFFO)
In 2018, our AFFO increased by $86.0 million, or 10.3%, to $924.6 million, as compared to $838.6 million in 2017. On a diluted per common share basis, AFFO was $3.19 in 2018, as compared to $3.06 in 2017, an increase of $0.13, or 4.2%.
See our discussion of FFO and AFFO (which are not financial measures under generally accepted accounting principles, or GAAP), later in the section entitled “Management’s Discussion and Analysis of Financial Condition
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and Results of Operations,” in this annual report, which includes a reconciliation of net income available to common stockholders to FFO and AFFO.
DIVIDEND POLICY
Distributions are paid monthly to holders of shares of our common stock.
Distributions are paid monthly to the limited partners holding common units of Realty Income, L.P., each on a per unit basis that is generally equal to the amount paid per share to our common stockholders. Prior to the redemption of our common units of Tau Operating Partnership, L.P. in January 2019, distributions were paid monthly to the limited partners holding common units of Tau Operating Partnership, L.P., each on a per unit basis that was generally equal to the amount paid per share to our common stockholders.
In order to maintain our 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 taxable income (excluding net capital gains), and we are subject to income tax to the extent we distribute less than 100% of our taxable income (including net capital gains). In 2018, our cash distributions to common stockholders totaled $761.6 million, or approximately 133.5% of our estimated taxable income of $570.4 million. Our estimated taxable income reflects non-cash deductions for depreciation and amortization. Our estimated taxable income is presented to show our compliance with REIT dividend requirements and is not a measure of our liquidity or operating performance. We intend to continue to make distributions to our stockholders that are sufficient to meet this dividend requirement and that will reduce or eliminate our exposure to income taxes. Furthermore, we believe our funds from operations are sufficient to support our current level of cash distributions to our stockholders. Our cash distributions to common stockholders in 2018 totaled $761.6 million, representing 82.4% of our adjusted funds from operations available to common stockholders of $924.6 million. In comparison, our 2017 cash distributions to common stockholders totaled $689.3 million, representing 82.2% of our adjusted funds from operations available to common stockholders of $838.6 million.
Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, AFFO, cash flow from operations, financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended, or 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” is generally 20%. In general, dividends payable by REITs are not eligible for the reduced tax rate on qualified dividend income, except to the extent that certain holding requirements have been met with respect to the REIT’s stock and the REIT’s dividends are attributable to dividends received from certain taxable corporations (such as our taxable REIT subsidiaries) or 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). However, non-corporate stockholders, including individuals, generally may deduct up to 20% of dividends from a REIT, other than capital gain dividends and dividends treated as qualified dividend income, for taxable years beginning after December 31, 2017 and before January 1, 2026.
Distributions in excess of earnings and profits generally will first be treated as a non-taxable reduction in the stockholders’ basis in their stock, but not below zero. Distributions in excess of that basis generally will be taxable as a capital gain to stockholders who hold their shares as a capital asset. Approximately 22.9% of the distributions to our common stockholders, made or deemed to have been made in 2018, were classified as a return of capital for federal income tax purposes. We estimate that in 2019, between 15% and 25% of the distributions may be classified as a return of capital.
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BUSINESS PHILOSOPHY AND STRATEGY
We believe that owning an actively managed, diversified portfolio of primarily single-tenant commercial properties under long-term, net lease agreements produces consistent and predictable income. A net lease typically requires the tenant to be responsible for monthly rent and certain property operating expenses including property taxes, insurance, and maintenance. In addition, tenants of our properties typically pay rent increases based on: (1) increases in the consumer price index (typically subject to ceilings), (2) fixed increases, or (3) additional rent calculated as a percentage of the tenants’ gross sales above a specified level. We believe that a portfolio of properties under long-term, net lease agreements 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.
Diversification is also a key component of our investment philosophy. We believe that diversification of the portfolio by tenant, industry, geography, and, to a certain extent, property type leads to more consistent and predictable income for our stockholders by reducing vulnerability that can come with any single concentration. Our investment activities have led to a diversified property portfolio that, as of December 31, 2018, consisted of 5,797 properties located in 49 states and Puerto Rico, leased to 262 different commercial tenants doing business in 48 industries. Each of the 48 industries represented in our property portfolio accounted for no more than 12.4% of our rental revenue during either the quarter or year ended December 31, 2018.
Investment Strategy
When identifying new properties for investment, we generally focus on acquiring high-quality real estate that tenants consider important to the successful operation of their business. We generally seek to acquire real estate that has the following characteristics:
• | Properties that are freestanding, commercially-zoned with a single tenant; |
• | Properties that are in significant markets or strategic locations critical to generating revenue for our tenants (i.e. they need the property in which they operate in order to conduct their business); |
• | Properties that we deem to be profitable for the tenants and/or can generally be characterized as important to the successful operations of the company’s business; |
• | Properties that are located within attractive demographic areas relative to the business of our tenants, generally fungible, and have good visibility and easy access to major thoroughfares; |
• | Properties with real estate valuations that approximate replacement costs; |
• | Properties with rental or lease payments that approximate market rents; 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 future rent increases. |
We seek to invest in industries in which several well-organized tenants are capturing market share through the selection of prime real estate locations supported by superior service, quality control, economies of scale, consumer branding, and advertising. In addition, we frequently acquire large portfolios of single-tenant properties net leased to different tenants operating in a variety of industries. We have an internal team dedicated to sourcing such opportunities, often using our relationships with various tenants, owners/developers, brokers and advisers to uncover and secure transactions. We also undertake thorough research and analysis to identify what we consider to be appropriate property locations, tenants, and industries for investment. This research expertise is instrumental to uncovering net lease opportunities in markets where we believe we can add value.
In selecting potential investments, we look for tenants with the following attributes:
• | Tenants with reliable and sustainable cash flow; |
• | Tenants with revenue and cash flow from multiple sources; |
• | Tenants that are willing to sign a long-term lease (10 or more years); and |
• | Tenants that are large owners and users of real estate. |
From a retail perspective, our investment strategy is to target tenants that have a service, non-discretionary, and/or low-price-point component to their business. We believe these characteristics better position tenants to operate in a variety of economic conditions and to compete more effectively with internet retailers. As a result of the execution of this strategy, approximately 95% of our annualized retail rental revenue at December 31, 2018 is derived from tenants with a service, non-discretionary, and/or low price point component to their business. From a non-retail perspective, we target industrial properties leased to industry leaders that are primarily investment grade rated
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companies. We believe these characteristics enhance the stability of the rental revenue generated from these properties.
After applying this investment strategy, we pursue those transactions where we can achieve an attractive investment spread over our cost of capital and favorable risk-adjusted returns. We will continue to evaluate all investments consistent with our objective of owning net lease assets.
Underwriting Strategy
In order to be considered for acquisition, properties must meet stringent underwriting requirements. We have established a four-part analysis to examine each potential investment based on:
• | The aforementioned overall real estate characteristics, including demographics, replacement cost and comparative rental rates; |
• | Industry, tenant (including credit profile), and market conditions; |
• | Store profitability for retail locations if profitability data is available; and |
• | The importance of the real estate location to the operations of the tenants’ business. |
We believe the principal financial obligations for most of our tenants 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 or which are critical to the tenant’s ability to generate revenue, we believe the risk of default on a tenant’s lease obligation is less than the tenant’s unsecured general obligations. It has been our experience that tenants must retain their profitable and critical locations in order to survive. Therefore, in the event of reorganization, they are less likely to reject a lease of a profitable or critical location because this would terminate their right to use the property.
Thus, as the property owner, we believe that 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 real estate leases can be further mitigated by monitoring the performance of the tenants’ individual locations and considering whether to proactively sell locations that meet our criteria for disposition.
Prior to entering into any transaction, our research department conducts a review of a tenant’s credit quality. The information reviewed may include reports and filings, including any public credit ratings, financial statements, debt and equity analyst reports, and reviews of corporate credit spreads, stock prices, market capitalization, and other financial metrics. We conduct additional due diligence, including additional financial reviews of the tenant and a more comprehensive review of the business segment and industry in which the tenant operates. We continue to monitor our tenants’ credit quality on an ongoing basis by reviewing the available information previously discussed, and providing summaries of these findings to management. Approximately 51% of our annualized rental revenue comes from properties leased to investment grade rated companies or their subsidiaries. At December 31, 2018, our top 20 tenants represented approximately 54% of our annualized revenue and 12 of these tenants have investment grade credit ratings or are subsidiaries of investment grade companies.
Portfolio and Asset Management Strategy
In addition to pursuing new properties for investment, we seek to increase earnings and distributions to stockholders through active portfolio and asset management.
Generally, our portfolio and asset management efforts seek to achieve:
• | Rent increases at the expiration of existing leases, when market conditions permit; |
• | Optimum exposure to certain tenants, industries, and markets through re-leasing vacant properties and selectively selling properties; |
• | Maximum asset-level returns on properties that are re-leased or sold; |
• | Additional value creation from the existing portfolio by enhancing individual properties, pursuing alternative uses, and deriving ancillary revenue; and |
• | Investment opportunities in new asset classes for the portfolio. |
We continually monitor our portfolio for any changes that could affect the performance of our tenants, our tenants’ industries, and the real estate locations in which we have invested. We also regularly analyze our portfolio with a
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view towards optimizing its returns and enhancing its overall credit quality. Our active portfolio and asset management strategy pursues asset sales 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; and/or |
• | Strategically decrease tenant, industry, or geographic concentration. |
At December 31, 2018, we classified 17 properties with a carrying amount of $16.6 million as held for sale on our balance sheet. For 2019, we intend to continue our active disposition efforts to further enhance our real estate portfolio and anticipate $75 to $100 million in property sales. We plan to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during 2019 at our estimated values or be able to invest the property sale proceeds in new properties.
The active management of the portfolio is an essential component of our long-term strategy of maintaining high occupancy. Since 1970, our occupancy rate at the end of each year has never been below 96%. However, we cannot assure you that our future occupancy levels will continue to equal or exceed 96%.
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. 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 initially financed by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at all times and at terms that are acceptable to us.
Our primary cash obligations, for the current year and subsequent years, are included in the “Table of Obligations,” which is presented later in this section. We expect to fund our operating expenses and other short-term liquidity requirements, including property acquisitions and development costs, payment of principal and interest on our outstanding indebtedness, property improvements, re-leasing costs and cash distributions to common and preferred stockholders, primarily through cash provided by operating activities, property sales, borrowing on our credit facility and periodically through public securities offerings.
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, 2018, our total outstanding borrowings of senior unsecured notes and bonds, term loans, mortgages payable and credit facility borrowings were $6.5 billion, or approximately 25.4% of our total market capitalization of $25.7 billion.
We define our total market capitalization at December 31, 2018 as the sum of:
• | Shares of our common stock outstanding of 303,742,090, plus total common units outstanding of 690,819, multiplied by the last reported sales price of our common stock on the NYSE of $63.04 per share on December 31, 2018, or $19.2 billion; |
• | Outstanding borrowings of $252.0 million on our credit facility; |
• | Outstanding mortgages payable of $298.4 million, excluding net mortgage premiums of $4.4 million and deferred financing costs of $183,000; |
• | Outstanding borrowings of $570.0 million on our term loans, excluding deferred financing costs of $1.4 million; and |
• | Outstanding senior unsecured notes and bonds of $5.4 billion, excluding unamortized net original issuance premiums of $10.5 million and deferred financing costs of $33.7 million. |
In January 2019, we redeemed all of our outstanding 317,022 common units of Tau Operating Partnership, L.P., which reduced our total common units outstanding to 373,797 as of January 3, 2019.
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Impact of Real Estate and Credit Markets
In the commercial real estate market, property prices generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant price volatility, dislocations, and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly.
Universal Shelf Registration
In November 2018, we filed a shelf registration statement with the SEC, which is effective for a term of three years and will expire in November 2021. In accordance with 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 (1) common stock, (2) preferred stock, (3) debt securities, (4) depositary shares representing fractional interests in shares of preferred stock, (5) warrants to purchase debt securities, common stock, preferred stock, or depositary shares, and (6) 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 these 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.
Revolving Credit Facility
In October 2018, we entered into a new $3.25 billion unsecured credit facility to replace our previous $2.25 billion unsecured credit facility, of which $2.0 billion was due to expire in June 2019. This new credit facility includes a $3.0 billion unsecured revolving credit facility and a new $250.0 million unsecured term loan due March 2024. The new revolving credit facility, or our revolving credit facility, matures in March 2023 and includes two six-month extensions that can be exercised at our option. Our revolving credit facility also has a $1.0 billion expansion feature. Under our new revolving credit facility, our current investment grade credit ratings provide for financing at LIBOR plus 0.775% with a facility commitment fee of 0.125%, for all-in drawn pricing of 0.90% over LIBOR.
The borrowing rate under our revolving credit facility is subject to an interest rate floor and may change if our investment grade credit ratings change. We also have other interest rate options available to us under our credit facility. Our revolving credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.
At December 31, 2018, we had a borrowing capacity of $2.75 billion available on our revolving credit facility and an outstanding balance of $252.0 million. The weighted average interest rate on borrowings outstanding under our revolving credit facility, at December 31, 2018, was 3.2% per annum. We must comply with various financial and other covenants in our credit facility. At December 31, 2018, we were in compliance with these covenants. We expect to use our credit facility to acquire additional properties and for other general corporate purposes. Any additional borrowings will increase our exposure to interest rate risk.
We generally use our credit facility for the short-term financing of new property acquisitions. Thereafter, 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 the refinancing will enable us to issue equity or debt securities at acceptable terms.
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, 2018, we had cash and cash equivalents totaling $10.4 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 next twelve months. We intend, however, to use permanent or long-term capital to fund property acquisitions and to repay future borrowings under our credit facility.
Credit Agency Ratings
The borrowing interest rates under our credit facility are based upon our ratings assigned by credit rating agencies. As of December 31, 2018, we were assigned the following investment grade corporate credit ratings on our senior unsecured notes and bonds: Moody’s Investors Service has assigned a rating of A3 with a “stable” outlook,
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Standard & Poor’s Ratings Group has assigned a rating of A- with a “stable” outlook, and Fitch Ratings has assigned a rating of BBB+ with a “stable” outlook.
Based on our ratings as of December 31, 2018, the facility interest rate was LIBOR, plus 0.775% with a facility commitment fee of 0.125%, for all-in drawn pricing of 0.90% over LIBOR. Our credit facility provides that the interest rate can range between: (i) LIBOR, plus 1.45% if our credit rating is lower than BBB-/Baa3 or unrated and (ii) LIBOR, plus 0.75% if our credit rating is A/A2 or higher. In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which range from: (i) 0.30% for a rating lower than BBB-/Baa3 or unrated, and (ii) 0.10% for a credit rating of A/A2 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.
Term Loans
In October 2018, in conjunction with our revolving credit facility, we entered into a new $250.0 million senior unsecured term loan, which matures in March 2024. Borrowing under this term loan bears interest at the current one-month LIBOR plus 0.85%. In conjunction with this term loan, we also entered into an interest rate swap which effectively fixes our per annum interest on this term loan at 3.89%.
In December 2017, in conjunction with the acquisition of a portfolio of properties, we entered into a $125.9 million promissory note, which was paid in full at maturity in January 2018. Borrowings under this note bore interest at 1.52%.
In June 2015, in conjunction with entering into our previous credit facility, we entered into a $250.0 million senior unsecured term loan maturing on June 30, 2020. Borrowing under this term loan bears interest at the current one-month LIBOR, plus 0.90%. In conjunction with this term loan, we also entered into an interest rate swap which effectively fixes our per annum interest rate on this term loan at 2.62%.
In January 2013, in conjunction with our acquisition of American Realty Capital Trust, Inc., or ARCT, we entered into a $70.0 million senior unsecured term loan with an initial maturity date of January 2018. Borrowing under this term loan bore interest at the current one-month LIBOR plus 1.10%. In conjunction with this term loan, we also entered into an interest rate swap, which, until its termination in January 2018, effectively fixed our per annum interest rate on this term loan at 2.05%. In 2018, we entered into two separate six–month extensions of this loan, during which periods the interest was born at the current one–month LIBOR, plus 0.90%. In January 2019, we paid off the outstanding principal and interest on this term loan.
Mortgage Debt
As of December 31, 2018, we had $298.4 million of mortgages payable, all of which were assumed in connection with our property acquisitions. Additionally, at December 31, 2018, we had net premiums totaling $4.4 million on these mortgages and deferred financing costs of $183,000. We expect to pay off the mortgages payable as soon as prepayment penalties have declined to a level that would make it economically feasible to do so. During 2018, we made $21.9 million of principal payments, including the repayment of two mortgages in full for $17.0 million.
Notes Outstanding
As of December 31, 2018, we had $5.4 billion of senior unsecured note and bond obligations, excluding unamortized net original issuance premiums of $10.5 million and deferred financing costs of $33.7 million. All of our outstanding notes and bonds have fixed interest rates. Interest on all of our senior note and bond obligations is paid semiannually.
No Unconsolidated Investments
We have no unconsolidated investments, nor do we engage in trading activities involving energy or commodity contracts.
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Corporate Responsibility
Realty Income is committed to conducting our business according to the highest ethical standards. We are dedicated to providing an engaging, diverse, and safe work environment for our employees, operating our business in an environmentally conscious manner, and upholding our corporate responsibilities as a public company for the benefit of our shareholders. As The Monthly Dividend Company®, our mission is to provide our stockholders with monthly dividends that increase over time. How we manage and use the physical, financial and talent resources that enable us to achieve this mission, demonstrates our commitment to corporate responsibility.
Environmental Practices
Our focus on the environment is demonstrated by how we manage our day-to-day activities at our corporate headquarters. At our headquarters, we promote energy efficiency and encourage practices such as:
• | Powering down office equipment at the end of the day; |
• | Implementing file-sharing technology and automatic “duplex mode” to limit paper use; |
• | Adopting electronic approval systems; |
• | Encouraging employees to carpool to our headquarters; and |
• | Recycling paper waste. |
With respect to recycling and reuse practices, we encourage the use of recycled products and the recycling of materials used in our operations. Cell phones, wireless devices and office equipment are recycled or donated whenever possible. In 2018, we sent more than 28,500 pounds of paper to our offsite partner for recycling.
In addition, our headquarters was constructed according to the State of California energy efficiency standards (specifically following California Green Building Standards Code and Title 24 of the California Code of Regulations), with features such as an automatic lighting control system with light-harvesting technology, a building management system that monitors and controls energy use, an energy-efficient PVC roof and heating and cooling system, and drought-tolerant landscaping with recycled materials. We continue to evaluate our current operations, strive to improve our environmental performance, and implement sustainable business practices.
The properties in our portfolio are primarily net leased to our tenants who are responsible for maintaining the buildings and are in control of their energy usage and environmental sustainability practices. We work with our tenants to promote environmental responsibility at the properties we own, with some locations achieving LEED (Leadership in Energy and Environmental Design) certification.
Our Asset Management team has engaged with a renewable energy development company to identify assets that would maximize energy efficiency initiatives throughout our property portfolio. These initiatives include solar energy arrays, battery storage, and charging stations. In addition, we continue to explore regional opportunities with our tenants in order to qualify for city and county renewable energy or energy efficiency programs to conserve our world’s finite resources.
Realty Income also has an internal "Green Team" that encourages our employees to focus on environmentally-smart choices to further reduce our environmental impact as a company. The Green Team, which includes executive and officer-level employees, works to positively impact the environment through education and engagement within the company and local communities, focusing on waste, energy, and water management.
Company Culture and Employees
We put great effort into cultivating an inclusive company culture. We are one team, and together we are committed to a culture that provides an engaging work environment and encourages respect, collaboration, humility, transparency, and integrity. Regular open communication is central to how we work, and our employees take pride in our 50-year history of providing monthly dividends to our stockholders. We hire talented employees with diverse backgrounds and perspectives, and work to provide an environment where capable team members have fulfilling careers in the real estate industry.
Social Responsibility
We are committed to providing a positive and engaging work environment for our employees and taking an active role in the betterment of the communities in which our employees and shareholders live and work. Our employees are awarded compensation that is in line with those of our peers and competitors, including generous healthcare benefits (medical, dental, vision) for all employees and their families, participation in a 401(k) plan with a matching contribution from Realty Income, restricted stock awards based on company performance, competitive paid time-off
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benefits, a well-being program, continued education and development opportunities, up to 16 weeks of paid parental leave, and an infant-at-work program for new parents. We also have a long-standing commitment to being an equal opportunity employer and adhere to all Equal Employer Opportunity Policy guidelines.
We believe that giving back to our community is an extension of our mission to improve the lives of our shareholders, our employees, and their families. Realty Income and its employees have taken an active role in supporting communities through civic involvement with non-profit organizations and corporate donations. Our non-profit activities resulted in approximately 810 company-sponsored employee volunteer hours in 2018, principally through our partnership with San Diego Habitat for Humanity. We are proud of the efforts we have made to date and look forward to continuing to strengthen our impact as part of the successful operations of The Monthly Dividend Company®.
Additional information on Realty Income’s commitment to social responsibility may be found on our website.
Corporate Governance
We believe that nothing is more important than a company’s reputation for integrity and serving as a responsible fiduciary for its shareholders. We are committed to managing the company for the benefit of our stockholders and are focused on maintaining good corporate governance. Practices that illustrate this commitment include, but are not limited to:
• | Our Board of Directors is currently comprised of ten directors, nine of whom are independent, non-employee directors; |
• | In accordance with our continued focus on board refreshment, in July 2018, we added two new independent, non-employee directors; |
• | Our Board of Directors is elected on an annual basis with a majority vote standard; |
• | Our directors conduct annual self-evaluations and participate in orientation and continuing education programs; |
• | An Enterprise Risk Management evaluation is conducted annually to identify and assess company risk; |
• | Each committee within our Board of Directors is comprised entirely of independent directors; and |
• | We adhere to all other corporate governance principles outlined in our Corporate Governance Guidelines. These guidelines, as well as our bylaws, committee charters and other governance documents may be found on our website. |
Business Ethics
We are committed to conducting our business according to the highest ethical standards and upholding our corporate responsibilities as a public company operating for the benefit of our shareholders. Our Board of Directors has adopted a Code of Business Ethics that applies to our directors, officers, and other employees. The Code of Business Ethics includes our commitment to dealing fairly with all of our customers, service providers, suppliers, and competitors. We conduct an annual training with our employees regarding ethical behavior and require all employees to acknowledge the terms of, and abide by, our Code of Business Ethics, which is also available on our website. Our employees have access to members of our Board of Directors to report anonymously, if desired, any suspicion of misconduct by any member of our senior management or executive team. Anonymous reporting is always available through the company’s whistleblower hotline and reported to our Audit Committee quarterly.
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PROPERTY PORTFOLIO INFORMATION
At December 31, 2018, we owned a diversified portfolio:
• | Of 5,797 properties; |
• | With an occupancy rate of 98.6%, or 5,717 properties leased and 80 properties available for lease; |
• | Leased to 262 different commercial tenants doing business in 48 separate industries; |
• | Located in 49 states and Puerto Rico; |
• | With over 93.3 million square feet of leasable space; and |
• | With an average leasable space per property of approximately 16,110 square feet; approximately 11,260 square feet per retail property and 229,000 square feet per industrial property. |
At December 31, 2018, of our 5,797 properties, 5,717 were leased under net lease agreements. A net lease typically requires the tenant to be responsible for monthly rent and certain property operating expenses including property taxes, insurance, and maintenance. In addition, our tenants are typically subject to 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.
At December 31, 2018, our 262 commercial tenants, which we define as retailers with over 50 locations and non-retailers with over $500 million in annual revenues, represented approximately 95% of our annualized revenue. We had 326 additional tenants, representing approximately 5% of our annualized revenue at December 31, 2018, which brings our total tenant count to 588 tenants.
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Industry Diversification
The following table sets forth certain information regarding our property portfolio classified according to the business of the respective tenants, expressed as a percentage of our total rental revenue:
Percentage of Rental Revenue by Industry | |||||||||||||||||
For the Quarter Ended December 31, 2018 | For the Years Ended | ||||||||||||||||
Dec 31, 2018 | Dec 31, 2017 | Dec 31, 2016 | Dec 31, 2015 | Dec 31, 2014 | |||||||||||||
Aerospace | 0.8 | % | 0.8 | % | 0.9 | % | 1.0 | % | 1.1 | % | 1.2 | % | |||||
Apparel stores | 1.2 | % | 1.3 | % | 1.6 | % | 1.9 | % | 2.0 | % | 2.0 | % | |||||
Automotive collision services | 0.9 | % | 0.9 | % | 1.0 | % | 1.0 | % | 1.0 | % | 0.8 | % | |||||
Automotive parts | 1.7 | % | 1.7 | % | 1.3 | % | 1.3 | % | 1.4 | % | 1.3 | % | |||||
Automotive service | 2.2 | % | 2.2 | % | 2.2 | % | 1.9 | % | 1.9 | % | 1.8 | % | |||||
Automotive tire services | 2.3 | % | 2.4 | % | 2.6 | % | 2.7 | % | 2.9 | % | 3.2 | % | |||||
Beverages | 2.4 | % | 2.5 | % | 2.7 | % | 2.6 | % | 2.7 | % | 2.8 | % | |||||
Child care | 1.7 | % | 1.7 | % | 1.8 | % | 1.9 | % | 2.0 | % | 2.2 | % | |||||
Consumer appliances | 0.5 | % | 0.5 | % | 0.5 | % | 0.5 | % | 0.6 | % | 0.5 | % | |||||
Consumer electronics | 0.3 | % | 0.3 | % | 0.3 | % | 0.3 | % | 0.3 | % | 0.3 | % | |||||
Consumer goods | 0.7 | % | 0.7 | % | 0.8 | % | 0.9 | % | 0.9 | % | 0.9 | % | |||||
Convenience stores | 12.4 | % | 11.2 | % | 9.6 | % | 8.7 | % | 9.2 | % | 10.1 | % | |||||
Crafts and novelties | 0.7 | % | 0.7 | % | 0.6 | % | 0.6 | % | 0.6 | % | 0.6 | % | |||||
Diversified industrial | 0.8 | % | 0.8 | % | 0.9 | % | 0.9 | % | 0.8 | % | 0.5 | % | |||||
Dollar stores | 7.4 | % | 7.5 | % | 7.9 | % | 8.6 | % | 8.9 | % | 9.6 | % | |||||
Drug stores | 9.8 | % | 10.2 | % | 10.9 | % | 11.2 | % | 10.6 | % | 9.5 | % | |||||
Education | 0.3 | % | 0.3 | % | 0.3 | % | 0.3 | % | 0.3 | % | 0.4 | % | |||||
Electric utilities | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | |||||
Entertainment | 0.4 | % | 0.4 | % | 0.4 | % | 0.5 | % | 0.5 | % | 0.5 | % | |||||
Equipment services | 0.4 | % | 0.4 | % | 0.4 | % | 0.6 | % | 0.5 | % | 0.6 | % | |||||
Financial services | 2.3 | % | 2.3 | % | 2.4 | % | 1.8 | % | 1.7 | % | 1.8 | % | |||||
Food processing | 0.5 | % | 0.5 | % | 0.6 | % | 1.1 | % | 1.2 | % | 1.4 | % | |||||
General merchandise | 2.3 | % | 2.3 | % | 2.0 | % | 1.8 | % | 1.7 | % | 1.5 | % | |||||
Government services | 0.9 | % | 0.9 | % | 1.0 | % | 1.1 | % | 1.2 | % | 1.3 | % | |||||
Grocery stores | 4.9 | % | 5.0 | % | 4.4 | % | 3.1 | % | 3.0 | % | 3.0 | % | |||||
Health and beauty | 0.3 | % | 0.2 | % | * | * | * | * | |||||||||
Health and fitness | 7.2 | % | 7.4 | % | 7.5 | % | 8.1 | % | 7.7 | % | 7.0 | % | |||||
Health care | 1.5 | % | 1.5 | % | 1.4 | % | 1.5 | % | 1.7 | % | 1.8 | % | |||||
Home furnishings | 0.8 | % | 0.8 | % | 0.9 | % | 0.8 | % | 0.9 | % | 0.9 | % | |||||
Home improvement | 2.9 | % | 3.0 | % | 2.6 | % | 2.5 | % | 2.4 | % | 1.7 | % | |||||
Insurance | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | |||||
Jewelry | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | |||||
Machinery | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.2 | % | |||||
Motor vehicle dealerships | 1.7 | % | 1.9 | % | 2.1 | % | 1.9 | % | 1.6 | % | 1.6 | % | |||||
Office supplies | 0.2 | % | 0.2 | % | 0.2 | % | 0.3 | % | 0.3 | % | 0.4 | % | |||||
Other manufacturing | 0.7 | % | 0.7 | % | 0.8 | % | 0.8 | % | 0.7 | % | 0.7 | % | |||||
Packaging | 1.1 | % | 1.1 | % | 1.0 | % | 0.8 | % | 0.8 | % | 0.8 | % | |||||
Paper | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | 0.1 | % | |||||
Pet supplies and services | 0.5 | % | 0.5 | % | 0.6 | % | 0.6 | % | 0.7 | % | 0.7 | % | |||||
Restaurants - casual dining | 3.4 | % | 3.2 | % | 3.8 | % | 3.9 | % | 3.8 | % | 4.3 | % | |||||
Restaurants - quick service | 6.2 | % | 5.7 | % | 5.1 | % | 4.9 | % | 4.2 | % | 3.7 | % | |||||
Shoe stores | 0.5 | % | 0.5 | % | 0.6 | % | 0.7 | % | 0.7 | % | 0.9 | % | |||||
Sporting goods | 1.0 | % | 1.1 | % | 1.4 | % | 1.6 | % | 1.8 | % | 1.6 | % | |||||
Telecommunications | 0.6 | % | 0.6 | % | 0.6 | % | 0.6 | % | 0.7 | % | 0.7 | % | |||||
Theaters | 5.4 | % | 5.5 | % | 5.0 | % | 4.9 | % | 5.1 | % | 5.3 | % | |||||
Transportation services | 4.8 | % | 5.0 | % | 5.4 | % | 5.5 | % | 5.4 | % | 5.2 | % | |||||
Wholesale clubs | 2.8 | % | 3.0 | % | 3.3 | % | 3.6 | % | 3.8 | % | 4.1 | % | |||||
Other | 0.1 | % | 0.1 | % | 0.1 | % | 0.2 | % | 0.2 | % | 0.2 | % | |||||
Totals | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||||
* Less than 0.1%
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Property Type Composition
The following table sets forth certain property type information regarding our property portfolio as of December 31, 2018 (dollars in thousands):
Property Type | Number of Properties | Approximate Leasable Square Feet | Rental Revenue for the Quarter Ended December 31, 2018(1) | Percentage of Rental Revenue | |||||||||
Retail | 5,623 | 63,297,600 | $ | 268,258 | 81.7 | % | |||||||
Industrial | 117 | 26,793,100 | 39,922 | 12.1 | |||||||||
Office | 42 | 3,104,200 | 13,652 | 4.2 | |||||||||
Agriculture | 15 | 184,500 | 6,639 | 2.0 | |||||||||
Totals | 5,797 | 93,379,400 | $ | 328,471 | 100.0 | % | |||||||
(1) Includes rental revenue for all properties owned at December 31, 2018. Excludes revenue of $934 from sold properties.
Tenant Diversification
The following table sets forth the largest tenants in our property portfolio, expressed as a percentage of total rental revenue at December 31, 2018:
Tenant | Number of Leases | % of Rental Revenue | ||||
Walgreens | 219 | 6.3 | % | |||
7-Eleven | 398 | 5.5 | % | |||
FedEx | 42 | 4.8 | % | |||
Dollar General | 576 | 3.9 | % | |||
LA Fitness | 54 | 3.7 | % | |||
Dollar Tree / Family Dollar | 468 | 3.4 | % | |||
AMC Theatres | 32 | 3.3 | % | |||
Walmart / Sam's Club | 51 | 2.8 | % | |||
Circle K (Couche-Tard) | 297 | 2.3 | % | |||
BJ's Wholesale Clubs | 15 | 2.0 | % | |||
Treasury Wine Estates | 17 | 1.9 | % | |||
CVS Pharmacy | 85 | 1.9 | % | |||
Life Time Fitness | 11 | 1.9 | % | |||
Regal Cinemas | 24 | 1.7 | % | |||
GPM Investments / Fas Mart | 210 | 1.6 | % | |||
Super America (Marathon) | 132 | 1.6 | % | |||
TBC Corporation (Sumitomo) | 159 | 1.4 | % | |||
Kroger | 17 | 1.4 | % | |||
Rite Aid | 51 | 1.2 | % | |||
Home Depot | 15 | 1.2 | % | |||
Totals | 2,873 | 53.8 | % | |||
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Service Category Diversification for our Retail Properties
The following table sets forth certain information regarding the properties owned at December 31, 2018, classified according to the business types and the level of services they provide (dollars in thousands):
Retail Rental Revenue for the Quarter Ended December 31, 2018(1) | Percentage of Retail Rental Revenue | |||||||
Tenants Providing Services | ||||||||
Automotive collision services | $ | 2,936 | 1.1 | % | ||||
Automotive service | 7,153 | 2.7 | ||||||
Child care | 5,696 | 2.1 | ||||||
Education | 868 | 0.3 | ||||||
Entertainment | 1,292 | 0.5 | ||||||
Equipment services | 114 | * | ||||||
Financial services | 6,655 | 2.5 | ||||||
Health and fitness | 23,729 | 8.9 | ||||||
Health care | 2,009 | 0.8 | ||||||
Telecommunications | 66 | * | ||||||
Theaters | 17,714 | 6.6 | ||||||
Transportation services | 250 | 0.1 | ||||||
Other | 124 | * | ||||||
$ | 68,606 | 25.6 | % | |||||
Tenants Selling Goods and Services | ||||||||
Automotive parts (with installation) | 1,653 | 0.6 | ||||||
Automotive tire services | 7,470 | 2.8 | ||||||
Convenience stores | 40,711 | 15.2 | ||||||
Health and beauty | 14 | * | ||||||
Motor vehicle dealerships | 5,710 | 2.1 | ||||||
Pet supplies and services | 675 | 0.2 | ||||||
Restaurants - casual dining | 10,543 | 3.9 | ||||||
Restaurants - quick service | 20,317 | 7.6 | ||||||
$ | 87,093 | 32.4 | % | |||||
Tenants Selling Goods | ||||||||
Apparel stores | 3,960 | 1.5 | ||||||
Automotive parts | 3,497 | 1.3 | ||||||
Book stores | 113 | * | ||||||
Consumer electronics | 1,064 | 0.4 | ||||||
Crafts and novelties | 1,999 | 0.8 | ||||||
Dollar stores | 24,385 | 9.1 | ||||||
Drug stores | 30,860 | 11.5 | ||||||
General merchandise | 6,460 | 2.4 | ||||||
Grocery stores | 16,167 | 6.0 | ||||||
Home furnishings | 2,178 | 0.8 | ||||||
Home improvement | 8,351 | 3.1 | ||||||
Jewelry | 175 | 0.1 | ||||||
Office supplies | 615 | 0.2 | ||||||
Shoe stores | 185 | 0.1 | ||||||
Sporting goods | 3,205 | 1.2 | ||||||
Wholesale clubs | 9,345 | 3.5 | ||||||
$ | 112,559 | 42.0 | % | |||||
Totals | $ | 268,258 | 100.0 | % | ||||
* Less than 0.1%
(1) Includes rental revenue for all retail properties owned at December 31, 2018. Excludes revenue of $60,213 from non-retail properties and$934 from sold properties.
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Lease Expirations
The following table sets forth certain information regarding the timing of the lease term expirations in our portfolio (excluding rights to extend a lease at the option of the tenant) and their contribution to rental revenue for the quarter ended December 31, 2018 (dollars in thousands):
Total Portfolio(1) | ||||||||||||||||
Expiring | Approx. | % of | ||||||||||||||
Leases | Leasable | Rental | Rental | |||||||||||||
Year | Retail | Non-Retail | Sq. Feet | Revenue | Revenue | |||||||||||
2019 | 244 | 10 | 3,012,700 | $ | 11,279 | 3.4 | % | |||||||||
2020 | 224 | 13 | 4,192,100 | 12,848 | 3.9 | |||||||||||
2021 | 328 | 15 | 5,494,400 | 15,395 | 4.7 | |||||||||||
2022 | 396 | 22 | 10,023,900 | 21,563 | 6.6 | |||||||||||
2023 | 544 | 23 | 9,590,100 | 29,642 | 9.0 | |||||||||||
2024 | 284 | 13 | 5,194,300 | 15,863 | 4.8 | |||||||||||
2025 | 338 | 13 | 5,246,500 | 20,499 | 6.2 | |||||||||||
2026 | 313 | 4 | 4,631,100 | 15,664 | 4.8 | |||||||||||
2027 | 536 | 5 | 6,224,300 | 22,581 | 6.9 | |||||||||||
2028 | 336 | 13 | 8,825,300 | 21,835 | 6.6 | |||||||||||
2029 | 413 | 7 | 7,596,400 | 22,226 | 6.8 | |||||||||||
2030 | 164 | 14 | 3,512,900 | 16,909 | 5.2 | |||||||||||
2031 | 304 | 25 | 5,973,600 | 27,582 | 8.4 | |||||||||||
2032 | 92 | 4 | 3,113,500 | 11,987 | 3.7 | |||||||||||
2033 | 260 | — | 2,161,100 | 14,842 | 4.5 | |||||||||||
2034 - 2044 | 828 | 4 | 7,422,400 | 47,688 | 14.5 | |||||||||||
Totals | 5,604 | 185 | 92,214,600 | $ | 328,403 | 100.0 | % | |||||||||
* | Less than 0.1% |
(1) | The lease expirations for leases under construction are based on the estimated date of completion of those projects. Excludes revenue of $68 from 99 expired leases, and $934 from sold properties at December 31, 2018. Leases on our multi-tenant properties are counted separately in the table above. |
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Geographic Diversification
The following table sets forth certain state-by-state information regarding our property portfolio as of December 31, 2018 (dollars in thousands):
State | Number of Properties | Percent Leased | Approximate Leasable Square Feet | Rental Revenue for the Quarter Ended December 31, 2018(1) | Percentage of Rental Revenue | |||||||||||
Alabama | 169 | 98 | % | 1,589,700 | $ | 5,958 | 1.8 | % | ||||||||
Alaska | 3 | 100 | 274,600 | 523 | 0.2 | |||||||||||
Arizona | 117 | 100 | 1,821,000 | 6,848 | 2.1 | |||||||||||
Arkansas | 86 | 100 | 922,300 | 2,288 | 0.7 | |||||||||||
California | 193 | 100 | 6,031,800 | 28,977 | 8.8 | |||||||||||
Colorado | 95 | 97 | 1,530,600 | 5,300 | 1.6 | |||||||||||
Connecticut | 19 | 95 | 508,500 | 2,022 | 0.6 | |||||||||||
Delaware | 18 | 100 | 93,000 | 750 | 0.2 | |||||||||||
Florida | 398 | 98 | 4,196,800 | 18,672 | 5.7 | |||||||||||
Georgia | 268 | 99 | 4,299,800 | 13,397 | 4.1 | |||||||||||
Idaho | 12 | 100 | 87,000 | 418 | 0.1 | |||||||||||
Illinois | 265 | 99 | 5,933,500 | 19,674 | 6.0 | |||||||||||
Indiana | 189 | 98 | 2,220,400 | 9,087 | 2.8 | |||||||||||
Iowa | 40 | 95 | 3,034,800 | 4,403 | 1.3 | |||||||||||
Kansas | 110 | 96 | 1,931,800 | 5,042 | 1.5 | |||||||||||
Kentucky | 80 | 100 | 1,695,300 | 4,689 | 1.4 | |||||||||||
Louisiana | 115 | 97 | 1,588,000 | 5,144 | 1.6 | |||||||||||
Maine | 18 | 100 | 203,700 | 1,225 | 0.4 | |||||||||||
Maryland | 37 | 97 | 1,017,500 | 4,891 | 1.5 | |||||||||||
Massachusetts | 58 | 91 | 656,500 | 2,833 | 0.9 | |||||||||||
Michigan | 184 | 99 | 1,961,400 | 7,082 | 2.2 | |||||||||||
Minnesota | 164 | 100 | 2,134,500 | 10,374 | 3.2 | |||||||||||
Mississippi | 154 | 95 | 1,720,600 | 4,864 | 1.5 | |||||||||||
Missouri | 176 | 97 | 2,775,500 | 8,719 | 2.7 | |||||||||||
Montana | 11 | 100 | 87,000 | 498 | 0.2 | |||||||||||
Nebraska | 43 | 98 | 780,100 | 1,981 | 0.6 | |||||||||||
Nevada | 24 | 100 | 1,196,900 | 2,218 | 0.7 | |||||||||||
New Hampshire | 13 | 100 | 296,400 | 1,372 | 0.4 | |||||||||||
New Jersey | 73 | 97 | 998,400 | 5,731 | 1.7 | |||||||||||
New Mexico | 34 | 100 | 366,400 | 1,105 | 0.3 | |||||||||||
New York | 125 | 100 | 2,838,400 | 15,670 | 4.8 | |||||||||||
North Carolina | 186 | 99 | 2,812,200 | 8,861 | 2.7 | |||||||||||
North Dakota | 6 | 100 | 117,700 | 212 | 0.1 | |||||||||||
Ohio | 304 | 100 | 6,962,500 | 17,416 | 5.3 | |||||||||||
Oklahoma | 168 | 100 | 1,775,300 | 4,990 | 1.5 | |||||||||||
Oregon | 28 | 96 | 593,300 | 2,291 | 0.7 | |||||||||||
Pennsylvania | 223 | 99 | 2,295,500 | 10,766 | 3.3 | |||||||||||
Rhode Island | 3 | 100 | 158,000 | 814 | 0.2 | |||||||||||
South Carolina | 175 | 99 | 1,683,100 | 7,651 | 2.3 | |||||||||||
South Dakota | 15 | 100 | 195,200 | 472 | 0.1 | |||||||||||
Tennessee | 251 | 98 | 3,589,800 | 10,930 | 3.3 | |||||||||||
Texas | 712 | 99 | 10,614,100 | 37,695 | 11.5 | |||||||||||
Utah | 22 | 100 | 933,000 | 2,264 | 0.7 | |||||||||||
Vermont | 2 | 100 | 88,000 | 365 | 0.1 | |||||||||||
Virginia | 212 | 98 | 3,129,000 | 10,057 | 3.1 | |||||||||||
Washington | 47 | 98 | 755,700 | 2,987 | 0.9 | |||||||||||
West Virginia | 25 | 100 | 418,100 | 1,471 | 0.4 | |||||||||||
Wisconsin | 117 | 99 | 2,383,700 | 7,029 | 2.1 | |||||||||||
Wyoming | 6 | 100 | 54,700 | 296 | 0.1 | |||||||||||
Puerto Rico | 4 | 100 | 28,300 | 149 | * | |||||||||||
Totals\Average | 5,797 | 99 | % | 93,379,400 | $ | 328,471 | 100.0 | % | ||||||||
* Less than 0.1%
(1) Includes rental revenue for all properties owned at December 31, 2018. Excludes revenue of $934 from sold properties.
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, including the documents incorporated by reference, 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; and |
• | Future expenditures for development projects. |
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 or which may occur in the future; 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 Securities and Exchange Commission, or 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.
Item 1A: Risk Factors
This “Risk Factors” section contains references to our “capital stock” and to our “stockholders.” Unless expressly stated otherwise, the references to our “capital stock” represent our common stock and any class or series of our preferred stock, while the references to our “stockholders” represent holders of our common stock and any class or series of our preferred stock.
In order to grow we need to continue to acquire investment properties. The acquisition of investment properties may be subject to competitive pressures.
We face competition in the acquisition and operation of our properties. We expect competition from:
• | Businesses; |
• | Individuals; |
• | Fiduciary accounts and plans; and |
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• | Other entities engaged in real estate investment and financing. |
Some of these competitors are larger than we are and have greater financial resources. This competition may result in a higher cost for properties we wish to purchase.
Negative market conditions or adverse events affecting our existing or potential tenants, or the industries in which they operate, could have an adverse impact on our ability to attract new tenants, re-lease space, collect rent or renew leases, which could adversely affect our cash flow from operations and inhibit growth.
Cash flow from operations depends in part on our ability to lease space to tenants on economically favorable terms. We could be adversely affected by various facts and events over which we have limited or no control, such as:
• | Lack of demand in areas where our properties are located; |
• | Inability to retain existing tenants and attract new tenants; |
• | Oversupply of space and changes in market rental rates; |
• | Declines in our tenants’ creditworthiness and ability to pay rent, which may be affected by their operations, economic downturns and competition within their industries from other operators; |
• | Defaults by and bankruptcies of tenants, failure of tenants to pay rent on a timely basis, or failure of tenants to comply with their contractual obligations; |
• | Economic or physical decline of the areas where the properties are located; and |
• | Deterioration of physical condition of our properties. |
At any time, any tenant may experience a downturn in its business that may weaken its operating results or overall financial condition. As a result, a tenant may delay lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent, or declare bankruptcy. Any tenant bankruptcy or insolvency, leasing delay or failure to make rental payments when due could result in the termination of the tenant’s lease and material losses to us.
If tenants do not renew their leases as they expire, we may not be able to rent or sell the properties. Furthermore, leases that are renewed, and some new leases for properties that are re-leased, may have terms that are less economically favorable than expiring lease terms, or may require us to incur significant costs, such as renovations, tenant improvements, or lease transaction costs. Negative market conditions may cause us to sell vacant properties for less than their carrying value, which could result in impairments. Any of these events could adversely affect cash flow from operations and our ability to make distributions to stockholders and service indebtedness. A significant portion of the costs of owning property, such as real estate taxes, insurance, and maintenance, are not necessarily reduced when circumstances cause a decrease in rental revenue from the properties. In a weakened financial condition, tenants may not be able to pay these costs of ownership and we may be unable to recover these operating expenses from them.
Further, the occurrence of a tenant bankruptcy or insolvency could diminish the income we receive from the tenant’s lease or leases. In addition, a bankruptcy court might authorize the tenant to terminate its leases with us. If that happens, our claim against the bankrupt tenant for unpaid future rent would be subject to statutory limitations that most likely would result in rent payments that would be substantially less than the remaining rent we are owed under the leases or we may elect not to pursue claims against a tenant for terminated leases. In addition, any claim we have for unpaid past rent, if any, may not be paid in full, or at all. Moreover, in the case of a tenant’s leases that are not terminated as the result of its bankruptcy, we may be required or elect to reduce the rent payable under those leases or provide other concessions, reducing amounts we receive under those leases. As a result, tenant bankruptcies may have a material adverse effect on our results of operations. Any of these events could adversely affect our cash flow from operations and our ability to make distributions to stockholders and service our indebtedness.
As of December 31, 2018, 80 of our properties were available for lease or sale, of which 77 were single-tenant properties. At December 31, 2018, 69 of our properties under lease were unoccupied and available for sublease by the tenants, all of which were current with their rent and other obligations. During 2018, each of our tenants accounted for less than 10% of our rental revenue.
For 2018, our tenants in the “convenience store” industry accounted for approximately 11.2% of our rental revenue, while our tenants in the "drug store" industry accounted for approximately 10.2% of our rental revenue for the same period. A downturn in these industries could have a material adverse effect on our financial position, results of
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operations, our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions on our common stock, including the common stock offered hereby, and preferred stock.
Individually, each of the other industries in our property portfolio accounted for less than 10% of our rental revenue for 2018. Nevertheless, downturns in these industries could also adversely affect our tenants, which in turn could also have a material adverse effect on our financial position, results of operations and our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions on our common stock, and preferred stock.
In addition, some of our properties are leased to tenants that may have limited financial and other resources, and therefore, they are more likely to be adversely affected by a downturn in their respective businesses or in the regional, national, or international economy.
As a property owner, we may be subject to unknown environmental liabilities.
Investments in real property can create a potential for environmental liability. An owner of property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. We can face such liability regardless of:
• | Our knowledge of the contamination; |
• | The timing of the contamination; |
• | The cause of the contamination; or |
• | The party responsible for the contamination of the property. |
There may be environmental conditions associated with our properties of which we are unaware. In that regard, a number of our properties are leased to operators of convenience stores that sell petroleum-based fuels, as well as to operators of oil change and tune-up facilities and operators that use chemicals and other waste products. These facilities, and some other of our properties, use, or may have used in the past, underground lifts or underground tanks for the storage of petroleum-based or waste products, which could create a potential for the release of hazardous substances.
The presence of hazardous substances on a property may adversely affect our ability to lease or sell that property and we may incur substantial remediation costs or third party liability claims. Although our leases generally require our tenants to operate in compliance with all applicable federal, state, and local environmental laws, ordinances and regulations, and to indemnify us against any environmental liabilities arising from the tenants’ activities on the property, we could nevertheless be subject to liability, including strict liability, by virtue of our ownership interest. There also can be no assurance that our tenants could or would satisfy their indemnification obligations under their leases. The discovery of environmental liabilities attached to our properties could have an adverse effect on our results of operations, our financial condition, or our ability to make distributions to stockholders and to pay the principal of and interest on our debt securities and other indebtedness.
In addition, several of our properties were built during the period when asbestos was commonly used in building construction and we may acquire other buildings with asbestos in the future. Environmental laws govern the presence, maintenance, and removal of asbestos-containing materials, or ACMs, and require that owners or operators of buildings containing asbestos properly manage and maintain the asbestos, that they adequately inform or train those who may come into contact with asbestos and that they undertake special precautions, including removal or other abatement in the event that asbestos is disturbed during renovation or demolition of a building. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.
It is possible that our insurance could be insufficient to address any particular environmental situation and/or that, in the future, we could be unable to obtain insurance for environmental matters at a reasonable cost, or at all. Our tenants are generally responsible for, and indemnify us against, liabilities for environmental matters that arise during the lease terms as a result of tenants’ activities on the properties. For properties that have underground storage tanks, in addition to providing an indemnity in our favor, the tenants generally are required to meet applicable state financial assurance obligations, including maintaining certain minimum net worth requirements, obtaining environmental insurance, or relying upon the state trust funds where available in the states where these properties are located to reimburse responsible parties for costs of environmental remediation. However, it is possible that one or more of our tenants could fail to have sufficient funds to cover any such indemnification or to meet applicable
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state financial assurance obligations, and thus we may still be obligated to pay for any such environmental liabilities.
Compliance. We have not been notified by any governmental authority, and are not otherwise aware, of any material noncompliance, liability, or claim relating to hazardous substances, toxic substances, or petroleum products in connection with any of our properties. In addition, we believe we are in compliance in all material respects with all present federal, state, and local laws relating to ACMs. Nevertheless, if environmental contamination should exist, we could be subject to liability, including strict liability, by virtue of our ownership interest.
Insurance and Indemnity. In March 2018, we entered into a ten-year environmental insurance policy that expires in March 2028 and replaced our previous ten-year environmental insurance policy. The limits on our current policy are $10 million per occurrence and $60 million in the aggregate. The limits on the excess policy are $5 million per occurrence and $10 million in the aggregate. Therefore, the primary and excess ten-year policies together provide a total limit of $15 million per occurrence and $70 million in the aggregate.
It is possible that our insurance could be insufficient to address any particular environmental situation and that, in the future, we could be unable to obtain insurance for environmental matters at a reasonable cost, or at all. Our tenants are generally responsible for, and indemnify us against, liabilities for environmental matters that occur on our properties. For properties that have underground storage tanks, in addition to providing an indemnity in our favor, the tenants generally obtain environmental insurance or rely upon the state funds in the states where these properties are located to reimburse tenants for environmental remediation.
If we fail to qualify as a REIT, the amount of dividends we are able to pay would decrease, which could adversely affect the market price of our capital stock and could adversely affect the value of our debt securities.
Commencing with our taxable year ended December 31, 1994, we believe that we have been organized and have operated, and we intend to continue to operate, so as to qualify as a REIT under Sections 856 through 860 of the Code. However, we cannot assure you that we have been organized or have operated in a manner that has satisfied the requirements for qualification as a REIT, or that we will continue to be organized or operate in a manner that will allow us to continue to qualify as a REIT.
Qualification as a REIT involves the satisfaction of numerous requirements under highly technical and complex Code provisions, for which there are only limited judicial and administrative interpretations, as well as the determination of various factual matters and circumstances not entirely within our control.
For example, in order to qualify as a REIT, at least 95% of our gross income in each year must be derived from qualifying sources, and we must pay distributions to stockholders aggregating annually at least 90% of our taxable income (excluding net capital gains).
If we fail to satisfy all of the requirements for qualification as a REIT, we may be subject to certain penalty taxes or, in some circumstances, we may fail to qualify as a REIT. If we were to fail to qualify as a REIT in any taxable year:
• | We would be required to pay regular U.S. federal corporate income tax on our taxable income; |
• | We would not be allowed a deduction for amounts distributed to our stockholders in computing our taxable income; |
• | We could be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost; |
• | We would no longer be required to make distributions to stockholders; and |
• | This treatment would substantially reduce amounts available for investment or distribution to stockholders because of the additional tax liability for the years involved, which could have a material adverse effect on the market price of our capital stock and the value of our debt securities. |
Even if we qualify for and maintain our REIT status, we may be subject to certain federal, state, and local taxes on our income and property. For example, if we have net income from a prohibited transaction, that income will be subject to a 100% tax. In addition, our taxable REIT subsidiaries, including Crest, are subject to federal and state taxes at the applicable tax rates on their income and property. Any failure to comply with legal and regulatory tax obligations could adversely affect our ability to conduct business and could adversely affect the market price of our capital stock and the value of our debt securities.
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Legislative or other actions affecting REITs could have a negative effect on us or our investors.
The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the Internal Revenue Services, or the IRS, and the U.S. Department of the Treasury, or the Treasury. Changes to the tax laws, with or without retroactive application, could adversely affect us or our investors, including holders of our common stock or debt securities. We cannot predict how changes in the tax laws might affect us or our investors. New legislation, Treasury regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT, the federal income tax consequences of such qualification, or the federal income tax consequences of an investment in us. Also, the law relating to the tax treatment of other entities, or an investment in other entities, could change, making an investment in such other entities more attractive relative to an investment in a REIT.
The 2017 Tax Cuts and Jobs Act, or TCJA, has significantly changed the U.S. federal income taxation of U.S. businesses and their owners, including REITs and their stockholders. We are continuing to assess the potential impact of TCJA on us as related regulations are proposed and finalized. The changes made by TCJA that could affect us and our investors include:
• | Temporarily reducing individual U.S. federal income tax rates on ordinary income, including the reduction of the highest individual U.S. federal income tax rate from 39.6% to 37% for taxable years beginning after December 31, 2017 and before January 1, 2026; |
• | Permanently eliminating the progressive corporate tax rate structure, which previously imposed a maximum corporate tax rate of 35%, and replacing it with a flat corporate tax rate of 21%; |
• | Permitting a deduction for certain domestic qualified business income from pass-through income entities, including dividends received by our stockholders from us that are not designated by us as capital gain dividends or qualified dividend income, which will allow individuals, trusts, and estates to deduct up to 20% of such amounts for taxable years beginning after December 31, 2017 and before January 1, 2026; |
• | Reducing the highest rate of withholding with respect to our distributions to non-U.S. stockholders that are treated as attributable to gains from the sale or exchange of U.S. real property interests from 35% to 21%; |
• | Limiting our deduction for net operating losses arising in taxable years beginning after December 31, 2017 to 80% of REIT taxable income (prior to the application of the dividends paid deduction); |
• | Generally limiting the deduction for net business interest expense in excess of 30% of a business’s “adjusted taxable income,” except for taxpayers (including most equity REITs) that engage in certain real estate businesses and elect out of this rule (provided that such electing taxpayers must use an alternative depreciation system with longer depreciation periods); and |
• | Eliminating the corporate alternative minimum tax. |
Many of these changes were effective on January 1, 2018, without any transition periods or grandfathering for existing transactions. The legislation is still unclear in some respects and could be subject to potential amendments and technical corrections, as well as interpretations and implementing regulations by the Treasury and IRS, any of which could lessen or increase the impact of the legislation. In addition, state and local tax jurisdictions, which often use federal taxable income as a starting point for computing state and local tax liabilities, are continuing to evaluate the legislation to determine their respective levels of conformity to the new law. While some of the changes made by the tax legislation may adversely affect us in one or more reporting periods and prospectively, other changes may be beneficial on a going forward basis. We continue to work with our tax advisors and auditors to determine the full impact that the recent tax legislation as a whole will have on us.
Distribution requirements imposed by law limit our flexibility.
To maintain our status as a REIT for federal income tax purposes, we generally are required to distribute to our stockholders at least 90% of our taxable income, excluding net capital gains, each year. We also are subject to tax at regular corporate rates to the extent that we distribute less than 100% of our taxable income (including net capital gains) each year.
In addition, we are subject to a 4% nondeductible excise tax to the extent that we fail to distribute during any calendar year at least the sum of 85% of our ordinary income for that calendar year, 95% of our capital gain net income for the calendar year, and any amount of that income that was not distributed in prior years.
We intend to continue to make distributions to our stockholders to comply with the distribution requirements of the Code as well as to reduce our exposure to federal income taxes and the nondeductible excise tax. Differences in timing between the receipt of income and the payment of expenses to arrive at taxable income, along with the effect
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of required debt amortization payments, could require us to borrow funds to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT.
Future issuances of equity securities could dilute the interest of holders of our common stock.
Our future growth will depend, in large part, upon our ability to raise additional capital. If we were to raise additional capital through the issuance of equity securities, we could dilute the interests of holders of our common stock. The interests of our common stockholders could also be diluted by the issuance of shares of common stock pursuant to stock incentive plans. Likewise, our Board of Directors is authorized to cause us to issue preferred stock of any class or series (with dividend, voting and other rights as determined by our Board of Directors). Accordingly, our Board of Directors may authorize the issuance of preferred stock with voting, dividend and other similar rights that could dilute, or otherwise adversely affect, the interest of holders of our common stock.
We may acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in stockholder dilution and limit our ability to sell or refinance such assets.
We have in the past and may in the future acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for partnership units in an operating partnership, which could result in stockholder dilution through the issuance of operating partnership units that, under certain circumstances, may be exchanged for shares of our common stock. This acquisition structure may have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to restrictions on our ability to dispose of, or refinance the debt on, the acquired properties in order to protect the contributors’ ability to defer recognition of taxable gain. Similarly, we may be required to incur or maintain debt we would otherwise not incur so we can allocate the debt to the contributors to maintain their tax bases. These restrictions could limit our ability to sell or refinance an asset at a time, or on terms, that would be favorable absent such restrictions.
We are subject to risks associated with debt and capital stock financing.
We intend to incur additional indebtedness in the future, including the use of our unsecured revolving credit facility, which has a borrowing capacity of $3.0 billion. At December 31, 2018, we had $252.0 million of outstanding borrowings under our revolving credit facility, a total of $5.4 billion of outstanding unsecured senior debt securities (excluding unamortized net original issuance premiums of $10.5 million and deferred financing costs of $33.7 million), $570.0 million of borrowings outstanding under our senior unsecured term loans (excluding deferred financing costs of $1.4 million) and approximately $298.4 million of outstanding mortgage debt (excluding net unamortized premiums totaling $4.4 million and deferred financing costs of $183,000 on this mortgage debt). To the extent that new indebtedness is added to our current debt levels, the related risks that we now face would increase. As a result, we are and will be subject to risks associated with debt financing, including the risk that our cash flow could be insufficient to make required payments on our debt. We also face variable interest rate risk as the interest rates on our revolving credit facility, our term loans and some of our mortgage debt are variable and could therefore increase over time. We also face the risk that we may be unable to refinance or repay our debt as it comes due. Given past disruptions in the financial markets and the recent global financial crisis and related uncertainties, including the impact of the United Kingdom’s advisory referendum to withdraw from the European Union (referred to as Brexit), we also face the risk that one or more of the participants in our revolving credit facility may not be able to lend us money.
In addition, our revolving credit facility, our term loan facilities and mortgage loan documents contain provisions that could limit or, in certain cases, prohibit the payment of dividends and other distributions on our common stock and preferred stock. In particular, our revolving credit facility and our two $250.0 million term loan facilities, all of which are governed by the same credit agreement, provide that, if an event of default (as defined in the credit agreement) exists, neither we nor any of our subsidiaries (other than our wholly-owned subsidiaries) may pay any dividends or other distributions on (except distributions payable in shares of a given class of our stock to the stockholders of that class), or repurchase or redeem, among other things, any shares of our common stock or preferred stock, during any period of four consecutive fiscal quarters in an aggregate amount in excess of the greater of:
• | The sum of (a) 95% of our adjusted funds from operations (as defined in the credit agreement) for that period plus (b) the aggregate amount of cash distributions on our preferred stock for that period, and |
• | The minimum amount of cash distributions required to be made to our stockholders in order to maintain our status as a REIT for federal income tax purposes and to avoid the payment of any income or excise taxes that would otherwise be imposed under specified sections of the Code on income we do not distribute to our stockholders, |
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except that we may repurchase or redeem shares of our preferred stock with the net proceeds from the issuance of shares of our common stock or preferred stock. The credit agreement further provides that, in the event of a failure to pay principal, interest or any other amount payable thereunder when due or upon the occurrence of certain events of bankruptcy, insolvency or reorganization with respect to us or with respect to one or more of our subsidiaries that in the aggregate meet a significance test set forth in the credit agreement, we and our subsidiaries (other than our wholly-owned subsidiaries) may not pay any dividends or other distributions on (except for (a) distributions payable in shares of a given class of our stock to the stockholders of that class and (b) dividends and distributions described in the second bullet point above), or repurchase or redeem, among other things, any shares of our common stock or preferred stock. If any such event of default under the credit agreement were to occur, it would likely have a material adverse effect on the market price of our outstanding common and preferred stock and on the market value of our debt securities, could limit the amount of dividends or other distributions payable on our common stock and preferred stock or the amount of interest and principal we are able to pay on our indebtedness, or prevent us from paying those dividends, other distributions, interest or principal altogether, and may adversely affect our ability to qualify, or prevent us from qualifying, as a REIT.
Our indebtedness could also have other important consequences to holders of our common stock, preferred stock, and debt securities, including:
• | Increasing our vulnerability to general adverse economic and industry conditions; |
• | Limiting our ability to obtain additional financing to fund future working capital, acquisitions, capital expenditures and other general corporate requirements; |
• | Requiring the use of a substantial portion of our cash flow from operations for the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund working capital, acquisitions, capital expenditures, and general corporate requirements; |
• | Limiting our flexibility in planning for, or reacting to, changes in our business and our industry; and |
• | Putting us at a disadvantage compared to our competitors with less indebtedness. |
If we default under a credit facility, loan agreement or other debt instrument, the lenders will generally have the right to demand immediate repayment of the principal and interest on all of their loans and, in the case of secured indebtedness, to exercise their rights to seize and sell the collateral.
Our business operations may not generate the cash needed to make distributions on our capital stock or to service our indebtedness.
Our ability to make distributions on our common stock and preferred stock and payments on our indebtedness, and to fund planned acquisitions and capital expenditures will depend on our ability to generate cash in the future. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to make distributions on our common stock and preferred stock, to pay our indebtedness, or to fund our other liquidity needs.
The market value of our capital stock and debt securities could be substantially affected by various factors.
The market value of our capital stock and debt securities will depend on many factors, which may change from time to time and may be outside of our control, including:
• | Prevailing interest rates, increases in which may have an adverse effect on the market value of our capital stock and debt securities; |
• | The market for similar securities issued by other REITs; |
• | General economic, political and financial market conditions; |
• | The financial condition, performance and prospects of us, our tenants and our competitors; |
• | Changes in legal and regulatory taxation obligations; |
• | Litigation and regulatory proceedings; |
• | Changes in financial estimates or recommendations by securities analysts with respect to us, our competitors or our industry; |
• | Changes in our credit ratings; and |
• | Actual or anticipated variations in quarterly operating results of us and our competitors. |
In addition, over the last several years, prices of common stock and debt securities in the United States, or U.S., trading markets have been experiencing extreme price fluctuations, and the market values of our common stock and debt securities have also fluctuated significantly during this period. As a result of these and other factors,
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investors who purchase our capital stock and debt securities may experience a decrease, which could be substantial and rapid, in the market value of our capital stock and debt securities, including decreases unrelated to our operating performance or prospects.
Real estate ownership is subject to particular conditions that may have a negative impact on our revenue.
We are subject to all of the inherent risks associated with the ownership of real estate. In particular, we face the risk that rental revenue from our properties may be insufficient to cover all corporate operating expenses, debt service payments on indebtedness we incur, and distributions on our capital stock. Additional real estate ownership risks include:
• | Adverse changes in general or local economic conditions; |
• | Changes in supply of, or demand for, similar or competing properties; |
• | Changes in interest rates and operating expenses; |
• | Competition for tenants; |
• | Changes in market rental rates; |
• | Inability to lease properties upon termination of existing leases; |
• | Renewal of leases at lower rental rates; |
• | Inability to collect rents from tenants due to financial hardship, including bankruptcy; |
• | Changes in tax, real estate, zoning and environmental laws that may have an adverse impact upon the value of real estate; |
• | Uninsured property liability; |
• | Property damage or casualty losses; |
• | Unexpected expenditures for capital improvements, including requirements to bring properties into compliance with applicable federal, state and local laws; |
• | The need to periodically renovate and repair our properties; |
• | Development oriented activities; |
• | Physical or weather-related damage to properties; |
• | The potential risk of functional obsolescence of properties over time; |
• | Acts of terrorism and war; and |
• | Acts of God and other factors beyond the control of our management. |
Real estate property investments are illiquid; therefore, the company may not be able to dispose of properties when desired or on favorable terms.
Real estate investments are relatively illiquid. Our ability to quickly sell or exchange any of our properties in response to changes in economic and other conditions will be limited. No assurances can be given that we will recognize full value, at a price and at terms that are acceptable to us, for any property that we are required to sell for liquidity reasons. Our inability to respond rapidly to changes in the performance of our investments could adversely affect our financial condition and results of operations.
Our acquisition of additional properties may have a significant effect on our business, liquidity, financial position and/or results of operations.
We are engaged in the process of identifying, analyzing, underwriting, and negotiating possible acquisition transactions. We cannot provide any assurances that we will be successful in consummating future acquisitions on favorable terms or that we will realize the benefits that we anticipate from such acquisitions. Our inability to consummate one or more acquisitions on such terms, our failure to adequately underwrite and identify risks and obligations when acquiring properties, or our failure to realize the intended benefits from one or more acquisitions, could have a significant adverse effect on our business, liquidity, financial position and/or results of operations, including as a result of our incurrence of additional indebtedness and related interest expense and our assumption of unforeseen contingent liabilities in connection with completed acquisitions.
Furthermore, we have made and may continue to make selected acquisitions of properties that fall outside our historical focus on freestanding, single-tenant, net lease locations. We may be exposed to a variety of new risks by expanding into new property types and properties leased to tenants engaged in non-retail businesses, including risks resulting from our limited experience in managing, underwriting and assessing risks related to such properties or understanding the market dynamics applicable to such properties, tenants or lease structures, any of which could also have a significant adverse effect on our business, liquidity, financial position and/or results of operations.
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If we acquire properties outside of the United States, we would be subject to a variety of additional risks that may negatively impact our operations.
We may make selected acquisitions of properties outside of the United States, in which case we may be exposed to a variety of new risks such as:
• | The laws, rules and regulations applicable in such jurisdictions outside of the United States, including those related to property ownership by foreign entities; |
• | Fluctuations in exchange rates between foreign currencies and the U.S. dollar, and exchange controls; |
• | Limited experience with local business and cultural factors that differ from our usual standards and practices; |
• | Challenges in establishing effective controls and procedures to regulate operations in different regions and to monitor compliance with applicable regulations, such as applicable laws related to corrupt practices, employment, licensing, construction or environmental compliance; |
• | Unexpected changes in regulatory requirements, tax, tariffs, trade barriers and other laws within jurisdictions outside the United States or between the United States and such jurisdictions; |
• | Potentially adverse tax consequences with respect to our properties; |
• | The impact of regional or country-specific business cycles and economic instability, including deteriorations in political relations with the United States, instability in, or further withdrawals from, the European Union or other international trade alliances or agreements; and |
• | Political instability, uncertainty over property rights, civil unrest, drug trafficking, political activism or the continuation or escalation of terrorist or gang activities. |
If we are unable to adequately address these risks, they could have a significant adverse effect on our operations.
An uninsured loss or a loss that exceeds the policy limits on our properties could subject us to lost capital or revenue on those properties.
Under the terms and conditions of the leases currently in force on our properties, tenants generally are required to indemnify and hold us harmless from liabilities resulting from injury to persons, air, water, land or property, due to activities conducted on the properties, except for claims arising from the negligence or intentional misconduct of us or our agents. Additionally, tenants are generally required, at the tenant’s expense, to obtain and keep in full force during the term of the lease, liability and property damage insurance policies. The insurance policies our tenants are required to maintain for property damage are generally in amounts not less than the full replacement cost of the improvements less slab, foundations, supports and other customarily excluded improvements. Our tenants are generally required to maintain general liability coverage depending on the tenant and the industry in which the tenant operates.
In addition to the indemnities and required insurance policies identified above, many of our properties are also covered by flood and earthquake insurance policies (subject to substantial deductibles) obtained and paid for by the tenants as part of their risk management programs. Additionally, we have obtained blanket liability, flood and earthquake (subject to substantial deductibles) and property damage insurance policies to protect us and our properties against loss should the indemnities and insurance policies provided by the tenants fail to restore the properties to their condition prior to a loss. However, should a loss occur that is uninsured or in an amount exceeding the combined aggregate limits for the policies noted above, or in the event of a loss that is subject to a substantial deductible under an insurance policy, we could lose all or part of our capital invested in, and anticipated revenue from, one or more of the properties, which could have a material adverse effect on our
results of operations or financial condition and on our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions to our stockholders. We also face the risk that our insurance carriers may not be able to provide payment under any potential claims that might arise under the terms of our insurance policies, and we may not have the ability to purchase insurance policies we desire.
In addition, although we obtain title insurance policies of our properties to protect us and our properties against unknown title defects (such as claims of ownership, liens or other encumbrances), there may be certain title defects that our title insurance will not cover. If a material title defect related to any of our properties is not adequately covered by a title insurance policy, we could lose some or all of our capital invested in and our anticipated profits from such property, cause a financial misstatement or lead to reputational damage to the company.
Compliance with the Americans with Disabilities Act of 1990 and fire, safety, and other regulations may require us to make unintended expenditures that could adversely impact our results of operations.
Our properties are generally required to comply with the Americans with Disabilities Act of 1990, or the ADA. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities,” but generally
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requires that buildings be made accessible to people with disabilities. Compliance with the ADA requirements could require removal of access barriers and non-compliance could result in imposition of fines by the U.S. government or an award of damages to private litigants. The retailers to whom we lease properties are obligated by law to comply with the ADA provisions, and we believe that these retailers may be generally obligated to cover costs associated with compliance. If required changes involve greater expenditures than anticipated, or if the changes must be made on a more accelerated basis than anticipated, the ability of these retailers to cover costs could be adversely affected and we could be required to expend our own funds to comply with the provisions of the ADA, which could materially adversely affect our results of operations or financial condition and our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions to our stockholders. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties. We may be required to make substantial capital expenditures to comply with those requirements and these expenditures could have a material adverse effect on our results of operations or financial condition and our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions to our stockholders.
Litigation risks could affect our business.
From time to time, we are involved in legal proceedings, lawsuits, and other claims. An unfavorable resolution of litigation may have a material adverse effect on our business, results of operations and financial condition. Regardless of its outcome, litigation may result in substantial costs and expenses and significantly divert the attention of management.
Property taxes may increase without notice.
The real property taxes on our properties and any other properties that we develop or acquire in the future may increase as property tax rates change and as those properties are assessed or reassessed by tax authorities.
We depend on key personnel.
We depend on the efforts of our executive officers and key employees. The loss of the services of our executive officers and key employees could have a material adverse effect on our results of operations or financial condition and on our ability to pay the principal and interest on our debt securities and other indebtedness and to make distributions to our stockholders. It is possible that we will not be able to recruit additional personnel with equivalent experience in the net lease industry.
Natural disasters, terrorist attacks, other acts of violence or war, or other unexpected events may affect the value of our debt and equity securities, the markets in which we operate and our results of operations.
Natural disasters, terrorist attacks, other acts of violence or war, or other unexpected events may negatively affect our operations, the market price of our capital stock and the value of our debt securities. There can be no assurance that events like these will not occur or have a direct impact on our tenants, our business or the United States generally.
If events like these were to occur, they could materially interrupt our business operations, cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. They also could result in or prolong an economic recession in the U.S. or abroad. Any of these occurrences could have a significant adverse impact on our operating results and revenues and on the market price of our capital stock and on the value of our debt securities. It could also have an adverse effect on our ability to pay principal and interest on our debt securities or other indebtedness and to make distributions to our stockholders.
We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business.
We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information and to manage or support a variety of our business processes, including financial transactions and maintenance of records, which may include personal identifying information. Although we have taken steps to protect the security of the data maintained in our information systems, our security measures may not be able to prevent the systems’ improper functioning, or the theft of intellectual property, personal information, or personal property, such as in the event of cyber-attacks. Any failure to maintain proper function, security and availability of our information systems could interrupt our operations, result in theft of company assets, damage our reputation, subject us to liability claims and could adversely affect our business, financial condition and results of operations.
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In addition, we implemented a new enterprise resource planning system in 2018. We may experience difficulties with this system, which could potentially result in disruption to our normal accounting procedures and internal control over financial reporting, inaccuracies in the conversion of electronic data, difficulties integrating the systems and processes, additional costs to continue to refine the system’s functionality, and disruption of our financial reporting process.
Disruptions in the financial markets could affect our ability to obtain financing on reasonable terms and have other adverse effects on us and the market price of our common stock.
Over the last several years, the United States stock and credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which have caused market prices of many stocks and debt securities to fluctuate substantially and the spreads on prospective debt financings to widen considerably. In addition, recent global financial crises (such as concerns that certain European countries may be unable to pay their national debt) has had a similar effect. These circumstances have materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in certain cases have resulted in the unavailability of certain types of financing. Unrest in certain Middle Eastern countries and resultant fluctuation in petroleum prices have added to the uncertainty in the capital markets. Continued uncertainty in the stock and credit markets may negatively impact our ability to access additional financing at reasonable terms, which may negatively affect our ability to make acquisitions. A prolonged downturn in the stock or credit markets may cause us to seek alternative sources of potentially less attractive financing, and may require us to adjust our business plan accordingly. In addition, these factors may make it more difficult for us to sell properties or may adversely affect the price we receive for properties that we do sell, as prospective buyers may experience increased costs of financing or difficulties in obtaining financing. These events in the stock and credit markets may make it more difficult or costly for us to raise capital through the issuance of our common stock or preferred stock or debt securities. These disruptions in the financial markets also may have a material adverse effect on the market value of our common stock, preferred stock and debt securities, the income we receive from our properties and the lease rates we can charge for our properties, as well as other unknown adverse effects on us or the economy in general.
Inflation may adversely affect our financial condition and results of operations.
Although inflation has not materially impacted our results of operations in the recent past, increased inflation could have a more pronounced negative impact on any variable rate debt we incur in the future and on our results of operations. During times when inflation is greater than increases in rent, as provided for in our leases, rent increases may not keep up with the rate of inflation. Likewise, even though net leases reduce our exposure to rising property expenses due to inflation, substantial inflationary pressures and increased costs may have an adverse impact on our tenants if increases in their operating expenses exceed increases in revenue, which may adversely affect the tenants’ ability to pay rent.
Current volatility in market and economic conditions may impact the accuracy of the various estimates used in the preparation of our financial statements and footnotes to the financial statements.
Various estimates are used in the preparation of our financial statements, including estimates related to asset and liability valuations (or potential impairments), and various receivables. Often these estimates require the use of market data values that are currently difficult to assess, as well as estimates of future performance or receivables collectability that can also be difficult to accurately predict. Although management believes it has been prudent and used reasonable judgment in making these estimates, it is possible that actual results may differ from these estimates.
Inherent limitations of internal controls over financial statements, disclosure controls and safeguarding of assets may adversely impact our financial condition and results of operations.
Our internal controls over financial reporting, disclosure controls and procedures and our operating internal controls may not prevent or detect financial misstatements or loss of assets because of inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Effective internal controls can provide only reasonable assurance with respect to financial statement and disclosure accuracy and safeguarding of assets. Any failure of these internal controls could result in decreased investor confidence in the accuracy and completeness of our financial reports and disclosures, our REIT qualification being jeopardized, impairment in the company’s access to capital, civil litigation or investigations by the NYSE, the SEC or other regulatory authorities, which may adversely impact our financial condition and results of operations.
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Our business could be negatively affected as a result of actions of activist stockholders and shareholder advisory firms.
Campaigns by stockholders to effect changes at publicly traded companies are sometimes led by investors seeking to increase short-term stockholder value through actions such as financial restructuring, increased debt, special dividends, stock repurchases or sales of assets or the entire company. If we become engaged in a process or proxy contest with an activist stockholder in the future, our business could be adversely affected, as such activities could be costly and time-consuming, disrupt our operations and divert the attention of management and our employees from executing our business plan. Additionally, perceived uncertainties as to our future direction as a result of stockholder activism or actual or potential changes to the composition of our Board of Directors or management team may lead to the perception of a change in the direction of our business, instability or lack of continuity, which may be exploited by our competitors, cause concern to current or potential sellers of properties, tenants and financing sources, and make it more difficult to attract and retain qualified personnel. If potential or existing sellers of properties, tenants or financing sources choose to delay, defer or reduce transactions with us or transact with our competitors instead of us because of any such issues, then our results of operations could be adversely affected. Similarly, we may suffer damage to our reputation (for example, regarding our corporate governance or stockholder relations) or brand by way of actions taken or statements made by outside constituents, including activist investors and shareholder advisory firms, which could adversely affect the market price of our common stock and preferred stock and the value of our debt securities, including the notes, resulting in significant loss of value, which could impact our ability to access capital, increase our cost of capital, and decrease our ability to acquire properties on attractive terms.
Our charter contains restrictions upon ownership of our common stock.
Our charter contains restrictions on ownership and transfer of our common stock intended to, among other purposes, assist us in maintaining our status as a REIT for United States federal and/or state income tax purposes. For example, our charter restricts any person from acquiring actual or constructive ownership of more than 9.8% (in value or number of shares, whichever is more restrictive) of our outstanding common stock. These restrictions could have anti-takeover effects and could reduce the possibility that a third party will attempt to acquire control of us, which could adversely affect the market price of our common stock.
The value of certain of our investment in real property may be reduced as the result of the expiration or loss of local tax abatements, tax credit programs, or other governmental incentives.
Certain of our investments have the benefit of governmental tax incentives aimed at inducing retail users to relocate to incentivize development in areas and neighborhoods which have not historically seen robust commercial development. The Tax Cuts and Jobs Act provided for such communities to be designated as Qualified Opportunity Zones, which are eligible for such tax benefits. These incentives typically have specific sunset provisions and may be subject to governmental discretion in the eligibility or award of the applicable incentives. The expiration of these incentive programs or the inability of potential tenants or users to be eligible for or to obtain governmental approval of the incentives, or the inability to remain compliant with such programs, may have an adverse effect on the value of our investment, cash flow and net income, and may result in impairment charges.
Item 1B: Unresolved Staff comments
There are no unresolved staff comments.
Item 2: Properties
Information pertaining to our properties can be found under Item 1.
Item 3: Legal Proceedings
We are subject to certain claims and lawsuits in the ordinary course of business, the outcome of which cannot be determined at this time. In the opinion of management, any liability we might incur upon the resolution of these claims and lawsuits will not, in the aggregate, have a material adverse effect on our consolidated financial position or results of operations.
Item 4: Mine Safety Disclosures
None.
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PART II
Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
A. Our common stock is traded on the NYSE under the ticker symbol “O.” The following table shows the high and low sales prices per share for our common stock as reported by the NYSE, and distributions declared per share of common stock for the periods indicated.
Price Per Share of Common Stock | Distributions | |||||||||||
High | Low | Declared (1) | ||||||||||
2018 | ||||||||||||
First Quarter | $ | 57.07 | $ | 47.26 | $ | 0.6575 | ||||||
Second Quarter | 54.99 | 48.81 | 0.6590 | |||||||||
Third Quarter | 59.18 | 52.74 | 0.6605 | |||||||||
Fourth Quarter | 66.85 | 55.56 | 0.6620 | |||||||||
Total | $ | 2.6390 | ||||||||||
2017 | ||||||||||||
First Quarter | $ | 63.60 | $ | 56.92 | $ | 0.6320 | ||||||
Second Quarter | 62.31 | 52.86 | 0.6335 | |||||||||
Third Quarter | 60.02 | 53.35 | 0.6350 | |||||||||
Fourth Quarter | 58.22 | 53.02 | 0.6365 | |||||||||
Total | $ | 2.5370 | ||||||||||
(1)Common stock cash distributions are declared monthly by us based on financial results for the prior months. At December 31, 2018, a distribution of $0.221 per common share had been declared and was paid in January 2019.
B. There were 9,789 registered holders of record of our common stock as of December 31, 2018. We estimate that our total number of stockholders is over 525,000 when we include both registered and beneficial holders of our common stock.
C. During the fourth quarter of 2018, the following shares of stock were withheld for state and federal payroll taxes on the vesting of employee stock awards, as permitted under the 2012 Incentive Award Plan of Realty Income Corporation:
• | 66,246 shares of stock, at a weighted average price of $57.56, in October 2018; |
• | 124,460 shares of stock, at a weighted average price of $63.90, in November 2018; and |
• | 278 shares of stock, at a weighted average price of $64.27, in December 2018. |
Item 6: Selected Financial Data
(not covered by Report of Independent Registered Public Accounting Firm)
(dollars in thousands, except for per share data)
The following table sets forth our selected historical consolidated financial information for each of the five years in the period ended December 31, 2018. The statements of income and comprehensive income data, the statements of equity data, the statements of cash flows data and the other data for the years ended December 31, 2018, 2017 and 2016 and the balance sheet data as of December 31, 2018 and 2017 were derived from our audited consolidated financial statements included elsewhere in this Form 10-K. The statements of income and comprehensive income data, the statements of equity data, the statements of cash flows data and the other data for the years ended December 31, 2015 and 2014, and the balance sheet data as of December 31, 2016, 2015 and 2014 were derived from our audited consolidated financial statements that are not included in this Form 10-K.
The selected financial data presented below is not necessarily indicative of results of future operations and should be read in conjunction with our consolidated financial statements and the information included under the headings “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K.
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As of or for the years ended December 31, | 2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
Total assets (book value) | $ | 15,260,483 | $ | 14,058,166 | $ | 13,152,871 | $ | 11,845,379 | $ | 10,989,349 | ||||||||||
Cash and cash equivalents | 10,387 | 6,898 | 9,420 | 40,294 | 3,852 | |||||||||||||||
Total debt | 6,499,976 | 6,111,471 | 5,839,605 | 4,820,995 | 4,907,673 | |||||||||||||||
Total liabilities | 7,139,505 | 6,667,458 | 6,365,818 | 5,292,046 | 5,348,249 | |||||||||||||||
Total equity | 8,120,978 | 7,390,708 | 6,787,053 | 6,553,333 | 5,641,099 | |||||||||||||||
Net cash provided by operating activities | 940,742 | 875,850 | 799,863 | 693,567 | 617,768 | |||||||||||||||
Net change in cash, cash equivalents and restricted cash | 8,929 | (3,539 | ) | (34,652 | ) | 4,152 | 20,211 | |||||||||||||
Total revenue | 1,327,838 | 1,215,768 | 1,103,172 | 1,023,285 | 933,505 | |||||||||||||||
Net income | 364,598 | 319,318 | 316,477 | 284,855 | 271,940 | |||||||||||||||
Preferred stock dividends | — | (3,911 | ) | (27,080 | ) | (27,080 | ) | (37,062 | ) | |||||||||||
Excess of redemption value over carrying value of preferred shares redeemed | — | (13,373 | ) | — | — | (6,015 | ||||||||||||||