Welcome to the Realty Income second quarter 2011 earnings conference call. (Operator instructions) I'd like to inform everyone that this conference is being recorded today, Thursday, July 28, 2011 at 1:30 pm Pacific Center Time. I'd now like to turn the conference over to Mr. Tom Lewis, CEO of Realty Income.

Good afternoon, everyone, and thanks for joining us on the call to discuss our second quarter of this year. With me as usual is Gary Malino, our President and Chief Operating Officer; Paul Meurer, our Executive Vice President and Chief Financial Officer; John Case, our EVP and Chief Investment Officer; Mike Pfeiffer, our EVP and General Counsel. And during this conference call, we will make certain statements that may be considered to be forward-looking statements under Federal Securities Law. The company's actual future results may differ significantly from the matters discussed in the forward-looking statements. And we will disclose in greater detail on the company's Form 10-Q the factors that may cause such differences. And with that, as is our custom, we'll let Paul start with some discussion of the numbers.

Thanks, Tom. As usual, I'll just briefly walk through the financial statements and provide a few highlights of the financial results for the quarter, starting with the income statement. Total revenue increased 24.5% to $102.6 million this quarter versus $82.4 million during the second quarter of 2010. This reflects the significant amount of new acquisitions over the past year as well as positive same-store rent increases for the quarterly period of 1.8%. On the expense side, depreciation and amortization expense increased by $5.7 million in the comparative quarterly period, and of course depreciation expense increased as our property portfolio continues to grow. Interest expense increased by just over $4 million. This increase was due to the $250 million of senior notes due 2021 which we issued in June of last year and our recent issuance of $150 million of notes in the reopening of our 2035 bonds. One of related note, our coverage ratio has both improved since last quarter with interest coverage now at 3.6 times and fixed charge coverage now at 2.9 times. General and administrative or G&A expenses in the second quarter were $7.987 million. As we've mentioned over the past year, these comparative increases in G&A are due partly to recent hirings and our acquisition in research departments. Our G&A expense has increased as our acquisition activity has increased and we've invested in some new personnel for future growth. Furthermore and specific to this quarter, this quarter's G&A was also impacted by the expensing of $542,000 of acquisition due diligence cost. That compares to a similar number of our category of $40,000 of acquisition due diligence cost in the comparative quarter a year ago. Our current projection for G&A for the year for 2011 is approximately $29.5 million, which will represent only about 7% of total…

Let me start with the portfolio. Obviously the metrics for the second quarter for the portfolio were very good and operations continued to improve pretty much across the portfolio. At the end of the quarter, as you can see in the release, 15 largest tenants accounted for about 52% of revenue. That's down 180 basis points from last quarter and about 260 basis points for the year. So obviously additional sources of revenue have given us some added diversification. And the average cash flow coverage rent at the store level for the top 15 tenants remained very stable at about 2.35 times. So overall a very good metric. Occupancy in second quarter was 97.3% and 68 properties available for lease, and that's out of the 2,523 properties we own. That's up 50 basis points from the first quarter and about 110 basis points versus same period a year ago. For the quarter, we had only two new vacancies. That's obviously versus 10 in the first quarter and we leased or sold 15 properties during the quarter and I think added 10 to the portfolio. And that's the reason for the increase in occupancy, but obviously at 97.3% very healthy. My sense is we should probably look for the portfolio to operate at about this level going forward. I think with the normal amount of rollover and other activities in the portfolio, and ebb and flow a bit around this number, but as we really look at our internal projections for the balance of the year, it may go up a bit next quarter. But I think this is around where we would anticipate being at the end of the year and back to where we were a few years ago, before we went into the recession. And obviously at this…

(Operator Instructions) Our first question comes from the line of Joshua Barber with Stifel Nicolaus.

I guess from a high-level view, how would you guys think of growth versus portfolio sales going forward as the portfolio is getting now close to $4 billion? I guess there has to be some additional if you really want to make future accretive acquisitions. Do you guys think about either pairing back to portfolio on some of the lower-quality stuff, or do you think that the primary growth is going to come from acquisitions going forward?

I would hope over the long-term, given how we structured the leases, there is probably 1.5% to 2% internal growth from same-store rent increases given a kind of flat occupancy. And so you're right. Majority of the rest of growth really has to come externally. And as we get larger now and if you're looking at 5% FFO growth in the next year, you're probably looking at about $700 million of acquisitions. Unfortunately, even though while we've grown, it is a very large net lease market, of which we hold a very small share. So I think we can continue to grow. With that said, one of the things that I was really trying to focus on, it's likely not to have as much impact this year, but going into next year and the following is really doing what you said, which is we have a project underway to go through the portfolio and kind of look at each of the properties and rate them 1 through 2,500-plus relative to what we think the long-term risk is, return. And that's a project that's ongoing, and we're going to marry that also with the tenant review. And kind of taking a look, as we look forward five, 10 years, given we've had 30 years of declining interest rates and almost to zero, kind of how we view the tenants relative to their operations, but also if they had to go out and refinance their balance sheets, which most will, and the combination of those two will lead us probably in the next year and the year after to work on some portfolio sales. And while I don't think it will be massive, I think it will step up continuously what we're selling off. And that may be partially with fund acquisitions, but I still believe that new assets will be responsible for our growth primarily in the next three, four years.

You also touched before on the 1031 market before. Have you seen any additional demand coming from that market or it's still been sort of sleepy like it's been the last year or so?

As it was a few years ago, it's very sleepy, because obviously the one thing you have to have is a gain. You need a 1031. But as we've seen cap rates falling, prices rise, there is a little more activity in the 1031 market out there. And absent the volatility you are seeing, we are watching potentially in the financial markets today, it is a time where there probably would be some opportunities for sales coming there. That's fine for selling out of the portfolio relative to adding assets and starting Crest back up. Given the potential volatility, I am not quite sure I'd do it yet. But if things continue and reach the low, then there probably will be additional demand coming on from the 1031 market on one-off transactions.

Our next question comes from the line of Lindsay Schroll of Bank of America.

I am not sure what those three remaining Crest properties are, but I guess is there any thought that you'd dispose of those three assets and get rid of Crest all together?

I don't think we'd get rid of Crest all together. I think there may be a time of the future when we could use it again, although I don't know in how much volume. But to give you an idea, Crest at its peak when we had well over $100 million inventory, there was approximately two employees in Crest, and the person that was the professional there is still with us and is doing a lot of our good acquisition work. And the other person has really transferred aside. So Crest has no employees, and really the only expenses that we have there is a little bit of tax and bookkeeping. The three assets that we hold in there are assets that wrote down quite a bit. They were the three Hometown Buffet, and I think they're carrying value. We're more focused now out of leasing them and hope to have some progress there and then decide what to do with them. And then there is also a couple of other assets in Crest that are generating income. I mean these are mortgages taking back, taking back at a fairly low loan to value ratio from a couple of sales we did. So there is very little cost in Crest, but there is some revenue coming in there right now, and we may use them it again some day. So it's not a huge carrying cost.

What is really driving the higher level of opportunities that you're seeing?

I think M&A is back on the table, and we've started to see that heat up. And I also think that there are a number of investments banks that have been talking to their clients about taking advantage of what is a bit of a resurgent market relative to net lease properties. The flow has just continued to pick up. It kind of flattened out in the first quarter. But as we sit here today, I know the flow we're seeing from investment banks, directly from retailers and then the private equity firms has increased quite a bit. So that's basically it. But the volumes have increased and there is a lot out there. And I think I used a line on the last call that Odds are good, but the goods are odd. Given kind of animal spirit reemerging back into the marketplace, some of these are structured at prices and cap rates that don't make sense for us, and there are a lot of players out there. But I think some of them are getting end up in our sweet spot and we'd be able to do some more, but it is very active.

Our next question comes from the line of Michael Bilerman with Citi.

Can you guys talk a little bit about the general health of the retail environment? You had a good uptick in occupancy this quarter. Has anything changed from the leasing discussions recently that led to that, or is it just sort of a gradual improvement?

First, in lease rollover, we had some pretty good results. I think we had 86 properties to do at the start of the year. 40 of them are done and had pretty good results in there. And so there wasn't really incoming on from that. And there is not a lot of tenant activity in terms of getting anything back. And people during the second quarter, first quarter felt better about leasing space to smaller tenants and growing their businesses. And I don't want to sound like it's a great retail environment, but I think over the last 30 days or so, people are a little more cautious. But I hear in the third quarter, I think the activity is going to be pretty good.

Do you have an internal estimate as to when you think the mortgages will be paid off?

The other thing is I'm also speaking most of what we have the smaller box-type space. I'm not sure if that's true for the larger box. So I'll just take that caveat.

We'll give all the details in the Q, but just so you know, it's four different mortgages on three different properties aggregating about $58.6 million. And we will be paying those off somewhere between 2013 and 2015. That's the earliest very economically-feasible prepayment date.

And I think when we first announced our transaction, we thought we might have $90 million, $92 million in mortgages, but we were able to work on that and get it down to about a little under $60 million.

Our next question comes from the line of Todd Lukasik with Morningstar.

You talked a little bit about the retail environment. It sounds like it's still pretty healthy. I think in the last couple of quarters, there've been no tenants on the credit watch list. Is that still the case?

Yes, there is nobody on the credit watch list, which we think if anything is imminent. Particularly over the last three to four months, if you look at those that really work with kind of low income, those are the people that continue to suffer. We paint a picture generally, but most of our businesses came back really well, but there are a few guys there still working very hard, but nothing that we see is imminent.

You mentioned the cash flow coverage of rent, Tom. Do you have the range for the top 15 tenants?

Yes, I do. It's about the same as last quarter, 1.5% to 3.5%.

And with regards to the direct transaction cost, should we think about those as costs for already agreed to acquisitions or costs related to potential future acquisitions or a combination of the two?

I'd say it's primarily associated with acquisitions that either closed or in the process of closing. You need kind of diligence costs on unique property types as well as unique work you need to do on in-placed leases, if you will, things of that nature. And you have a large portfolio.

And then my last question just with regard to dividends, coverage is obviously improving. If the Board thinks about a dividend increase in the third quarter, can you just give us some idea around what type of metrics they will be looking at to set a possible dividend increase?

I think we have been steadily increasing it in the last few years, small amounts on a quarterly basis. That's particularly as revenue and FFO flattened out during the recession. And so this is going to be a bit of a catch-up going on getting the payout ratio back down in the 80s. I think by the end of the year, we will have done that. And so my sense is, although this is going to be a subject of our Board meeting, that it wouldn't be a bad idea to have just a full increases this year. But in next year, probably dividend increases would be much closer to matching up FFO growth.

Our next question comes from the line of Tayo Okusanya with Jefferies & Company. Tayo Okusanya - Jefferies & Company: Recently, you guys have been doing more deals with higher credit tenants, got much lower cap rates. But when we think about just the overall competitive environment, as you mentioned, cap rates keep going down, how should we be thinking about your appetite if you're doing deals at pretty tough cap rates? Should we be kind of thinking about you guys are going down or you guys still would be in very competitive, but maybe levering up the balance sheet (inaudible) and end up with a decent spread on those deals?

Even though rates in the last couple of years have fallen, the spreads have been the widest they have ever been since we've been in business. Again, working on credit curve, we are really looking around 8 cap rates on what we're doing. And an 8 cap rate in this cost to capital environment is a pretty good rate. Relative to levering up, I'm not sure that we want to take balance sheet metrics much further out than they are. And like you saw us two quarters or so ago, to the extent we would do it, we'd probably want to do it in very long-term paper. With rates near zero, I think the odds in the next five to 10 years for interest rates to be a little higher or decent, I'm not sure you want to add on to your balance sheet intermediate and short-term financing. You're going to refinance at higher rates. So I think it will be a combination from equity, maybe a little preferred, maybe a little debt, and then on an accelerated basis, but not the majority from outside recycling as we move into the next couple of years or so. Tayo Okusanya - Jefferies & Company: Are there any retail categories that you guys would be more interested in increasing exposure to or decreasing exposure to going forward?

In the retail area, we continue to like the convenience stores. We're probably pretty heavy there, but we can do some more. The casual dining restaurant is not an area that we'd want to go to, but quick service is a nice solid business if we could get the right tenant. And then movie theaters, we like theaters quite a bit. That's always of interest to us and still under 10%. And then kind of outside of that, in the other areas that newly went into, the transportation, FedEx type tenants are some that if we can be additive there and get a cap rate that makes sense, we wouldn't mind doing it. But it's pretty broad-based. It really has more to do with the particular transaction, cash flow coverage into our credit and the prices and cap rate that we can get rather than saying, "Hey, this is the industry we want to go after." Tayo Okusanya - Jefferies & Company: You've had the Diageo deal under your belt for a bit now. Just how that's going relative to your initial thoughts?

Absolutely great. They are a great tenant, obviously a very, very good credit, and their business continues to move forward. And we have Diageo on the lease for a very long time. I think we added on Hewitt as the number one, another one of their wineries such as Sterling and BV and both are doing well. As a leader of the wine sector, strongly recommended, 2007 Georges De Latour. 90 points.

Our next question comes from the line of Wes Golladay with RBC Capital Markets.

Can you comment on what type of tenants have been active in leasing your Vegan properties?

It's pretty broad-based. A lot of this was smaller, some of the childcare and restaurant that we added over the years. So it's been a combination of local tenants, primarily or small three, four, five, six-unit chains. And that's why you've kind of more sales than leases, but pretty broad-based. We've been out there really working hard beating the bushes. One of the advantages of having smaller units is you have the opportunity to work with some smaller organizations. And then it's a question if you're more comfortable keeping them in the portfolio and selling them. But it really is a lot of two, three, four-unit people that look at the current opportunity and see an opportunity to expand. I really give credit to our people in portfolio management. They have been very active and very successful this year.

Our next question comes from the line of RJ Milligan with Raymond James.

Tom, just curious if we're seeing any change in terms of the mix of where the capital is coming from, looking for the triple net assets and maybe if some of the recent economic data points have changed that mix.

The private REIT space, which is getting a lot of pressure today, there has been a couple of people there that have been expanding, and that just seems to be the asset class they've moved to mix. So there is a fair amount coming from that end of it as well as the public companies being active. And then there is also some kind of real estate private equity that's out. Even some of the mortgage people that are unable to get the yields they want in their business have been opening up some shops to do this. So it just happened three, four, or five times since we have been public, and there is just a lot of people looking moving into this space right now as they see falling cap rates in another areas, trying to get some yield. So it's pretty broad-based and it's very active, but we think we'll get our appropriate share of the business.

So there is still pretty strong demand from the smaller owners, the more local guys?

There is a demand for buying triple-net leases. The 1031 market has picked up a bit. But it's a lot of larger transaction stuff. As we all know, a lot of money on the streets flushing around and some of it's looking to net lease given where the yields are today.

Our next question comes from the line of Todd Stender with Wells Fargo Securities.

Building of the ECM portfolio, do you find yourself in more conversations for deals and the FedEx-type acquisition opportunities or it really still too early to see any flow from that yet?

I think it's too early to see flow on a current quarter, but we're in a lot of discussions there, and we're kind of adding to our efforts in that area, because we think it'd be very good place to go. If one of your views is interest rates could be higher in the future, we look back on some of the lower rated tenants and some of their success may have come from the low interest rate environment over a prolonged period of time, so moving up the credit curve over the next five to 10 years is not a bad place to be. So we are putting more effort there. And it's some nice discussions with some very large corporations just about how they view the world, and we hope going into the next year that that will be additive. The initial moves we had here with some industrial and distribution and manufacturing was really a function of the two transactions, Diageo and then secondarily the ECM. But now we're trying to get granular with those people. But as is it when you go into a new line here, it's going to take a year or two or three. We'll have better clarity of exactly what's going be, but we're active.

There are no further questions at this time. This concludes the question-and-answer session for the Realty Income conference call. Mr. Lewis, please continue.

As always, thank you very much for the attention. We appreciate it and we look forward to talking to you again at one of the industry meetings or in the next 90 days when we do this again. Thanks so much.

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation. Please disconnect your lines.