What is the source of the company's growth, and how is it financed?

Growth comes from acquiring freestanding, single-tenant retail properties and leasing them back under long-term net leases, often to middle-market chains. In 1997 the company bought 96 properties for about $139 million, financed with the $110 million 7.75% notes due 2007, the $150 million unsecured revolving credit facility (LIBOR + 0.85%, expiring December 2000), and equity offerings of 2.7 million shares in October 1997 and 751,174 shares in February 1998. Management targets an unleveraged initial return of about 10.4% on new acquisitions, though this is an estimate and actual returns could differ if tenants default.

What are the biggest risks to tenant rent collections?

Rental revenue is concentrated in child care (35.9% of 1997 rental revenue) and restaurants (19.8%), so industry downturns could hurt many tenants at once. The top three tenants are Children's World Learning Centers (20.4%), La Petite Academy (13.8%) and Golden Corral (10.2%). Levitz Furniture filed for Chapter 11 in September 1997 and occupies four properties representing about $2.5 million, or 3.3%, of annual base rent, with no assurance it will keep paying. Management says the company has historically collected over 98% of contractual rent on the 797 properties it has acquired since 1970.

Is Realty Income's REIT status and balance sheet a concern?

The company has elected REIT status and must distribute at least 95% of taxable income to avoid corporate-level tax; it states it intends to qualify, but it notes that the rules are complex and that qualification cannot be assured in any year. If REIT status were lost, distributions would be taxed as ordinary income and could be substantially reduced. On the balance sheet, total liabilities were $143.7 million against $577.0 million in total assets at year-end 1997, and debt was about 20.3% of equity market capitalization. Management believes cash, operating cash flow and borrowing capacity cover liquidity needs, except that external capital will be required to fund future acquisitions.

What was the 1997 operating performance compared with 1996?

Rental revenue rose to $67.6 million from $56.8 million, driven mainly by $10.5 million of added revenue from properties acquired in 1996 and 1997, plus a 1.4% same-store rent increase on 667 properties. Net income increased $2.55 million to $34.8 million, but G&A and interest expense rose, with interest expense climbing to $8.2 million from $2.4 million after the notes issuance. Net cash from operating activities was $52.7 million, up from $48.1 million. Overall, the results show the acquisition program adding income while the higher debt cost and depreciation absorbed part of the gain.

O 10-K FY1997 Annual Report — Revenue, Net Income, EPS

Q: How much does Realty Income pay in distributions, and is the dividend covered?

The monthly distribution was increased to $0.16 in December 1997 and to $0.1625 effective April 1998, an annualized $1.95 per share and roughly a 7.5% yield at the $26.00 share price on March 16, 1998. In 1997 the company declared $1.895 per share against diluted FFO of about $2.22 per share (FFO of $52.4 million over 23.6 million weighted diluted shares), and it intends to keep reducing the payout ratio as a percentage of FFO. The distributions are not guaranteed, however, and are at the discretion of the Board.

01—Abstract

Summary

Summary of the 10-K filed March 20, 1998. Cited figures are marked; the original filing is the authoritative source.

Realty Income Corporation (NYSE: O) reported a steady 1997 under its net-lease retail REIT model, with 826 properties across 43 states (6.3 million sq. ft.), more than 99%^a of single-tenant properties net leased, and an average remaining lease term of about 8.4 years.

Total revenue rose to $67.9 million^b from $57.0 million, net income reached $34.8 million ($1.48 per share, up from $1.40), and funds from operations (FFO) grew 9.7% to $52.4 million. The growth was driven by the acquisition of 96 properties in 1997 at a weighted average estimated unleveraged return of 10.4%, funded largely by a $110 million 7.75% notes offering, an October 1997 equity issuance of 2.7 million shares at $27.00, and the $150 million unsecured credit facility. For income investors, the key facts are the distribution trajectory and coverage.

The monthly distribution was raised to $0.16 in December 1997 and to $0.1625^c effective April 1998, an annualized $1.95 per share, or roughly a 7.5% yield at the $26.00 share price on March 16, 1998. Total 1997 distributions declared were $1.895 per share against diluted FFO of about $2.22 per share, and management intends to keep lowering the payout ratio as a share of FFO over time. Balance sheet metrics are conservative: total indebtedness was about 20.3% of equity market capitalization at year-end, the company holds investment-grade ratings (BBB / Baa3 / BBB-), and it had $138.0 million of credit facility capacity available as of March 16, 1998.

The main risks are tenant concentration and sector exposure. Child care (35.9%^d of 1997 rental revenue) and restaurants (19.8%) dominate the portfolio, and the three largest tenants (Children's World, La Petite Academy and Golden Corral) account for about 44% of rental revenue combined.

Levitz Furniture's Chapter 11 filing affects four properties representing about 3.3% of base rent. The company also serves mostly middle-market tenants with below-investment-grade credit, and it notes that it will need additional capital to fund acquisitions, which could mean further equity or debt issuance and dilution.

02—Key points

Key Highlights

Total revenue rose 19.2% to $67.9 million in 1997, and net income increased 7.9% to $34.8 million ($1.48 per diluted share vs. $1.40 in 1996).
FFO grew 9.7% to $52.4 million, supporting a monthly distribution increase to $0.1625 ($1.95 annualized, ~7.5% yield at $26.00) effective April 1998.
The portfolio expanded to 826 properties (+11.6%) in 43 states, with 96 acquisitions in 1997 totaling about $139 million at an estimated 10.4% unleveraged initial return and 14.4-year average initial lease terms.
Conservative capital structure: debt was about 20.3% of equity market capitalization at year-end 1997, the company has BBB/Baa3/BBB- ratings, and $138.0 million of credit facility capacity was available as of March 16, 1998.
Concentration risk is significant: child care represents 35.9% and restaurants 19.8% of 1997 rental revenue, and the top three tenants generate roughly 44% of rental revenue combined.
Tenant credit risk is elevated: Levitz Furniture (Chapter 11, four properties, ~3.3% of base rent) poses a near-term risk, and the portfolio is concentrated in middle-market, sub-investment-grade retailers.
Equity was issued at $27.00 in October 1997 and at about $25.30 in February 1998, funding acquisitions and raising dilution concerns for existing holders, with 25.7 million shares outstanding at year-end 1997 and 26.5 million by March 1998.

03—Questions

Frequently Asked Questions

How much does Realty Income pay in distributions, and is the dividend covered?
The monthly distribution was increased to $0.16 in December 1997 and to $0.1625 effective April 1998, an annualized $1.95 per share and roughly a 7.5% yield at the $26.00 share price on March 16, 1998. In 1997 the company declared $1.895 per share against diluted FFO of about $2.22 per share (FFO of $52.4 million over 23.6 million weighted diluted shares), and it intends to keep reducing the payout ratio as a percentage of FFO. The distributions are not guaranteed, however, and are at the discretion of the Board.
What is the source of the company's growth, and how is it financed?
Growth comes from acquiring freestanding, single-tenant retail properties and leasing them back under long-term net leases, often to middle-market chains. In 1997 the company bought 96 properties for about $139 million, financed with the $110 million 7.75% notes due 2007, the $150 million unsecured revolving credit facility (LIBOR + 0.85%, expiring December 2000), and equity offerings of 2.7 million shares in October 1997 and 751,174 shares in February 1998. Management targets an unleveraged initial return of about 10.4% on new acquisitions, though this is an estimate and actual returns could differ if tenants default.
What are the biggest risks to tenant rent collections?
Rental revenue is concentrated in child care (35.9% of 1997 rental revenue) and restaurants (19.8%), so industry downturns could hurt many tenants at once. The top three tenants are Children's World Learning Centers (20.4%), La Petite Academy (13.8%) and Golden Corral (10.2%). Levitz Furniture filed for Chapter 11 in September 1997 and occupies four properties representing about $2.5 million, or 3.3%, of annual base rent, with no assurance it will keep paying. Management says the company has historically collected over 98% of contractual rent on the 797 properties it has acquired since 1970.
Is Realty Income's REIT status and balance sheet a concern?
The company has elected REIT status and must distribute at least 95% of taxable income to avoid corporate-level tax; it states it intends to qualify, but it notes that the rules are complex and that qualification cannot be assured in any year. If REIT status were lost, distributions would be taxed as ordinary income and could be substantially reduced. On the balance sheet, total liabilities were $143.7 million against $577.0 million in total assets at year-end 1997, and debt was about 20.3% of equity market capitalization. Management believes cash, operating cash flow and borrowing capacity cover liquidity needs, except that external capital will be required to fund future acquisitions.
What was the 1997 operating performance compared with 1996?
Rental revenue rose to $67.6 million from $56.8 million, driven mainly by $10.5 million of added revenue from properties acquired in 1996 and 1997, plus a 1.4% same-store rent increase on 667 properties. Net income increased $2.55 million to $34.8 million, but G&A and interest expense rose, with interest expense climbing to $8.2 million from $2.4 million after the notes issuance. Net cash from operating activities was $52.7 million, up from $48.1 million. Overall, the results show the acquisition program adding income while the higher debt cost and depreciation absorbed part of the gain.

04—Continue

← View all 10-K filings