Fitch Affirms Realty Income's IDR at 'BBB+'; Outlook Stable
NEW YORK -- September 5, 2013
Fitch Ratings has affirmed the credit ratings of Realty Income Corporation
(NYSE: O) as follows:
--Issuer Default Rating (IDR) at 'BBB+';
--$1 billion unsecured revolving credit facility at 'BBB+';
--$3.2 billion of senior unsecured notes at 'BBB+';
--$609.4 million of preferred stock at 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The affirmation of Realty Income's IDR at 'BBB+' is supported by the
geographic diversity of the company's predominantly net leased retail property
portfolio, limited tenant concentration and moderate tenant credit risk. Fixed
charge coverage is appropriate for the 'BBB+' rating, and Realty Income's
management team has been and remains cognizant of maintaining consistent
credit metrics despite fluctuations attributable to mergers and acquisitions.
Liquidity and access to capital are strong for the rating. Offsetting these
credit strengths is leverage that is at the high end of the range that is
appropriate for the 'BBB+' rating. In addition, the company's recent track
record of investing outside of net lease retail is somewhat limited within the
context of Realty Income's long history.
DIVERSE NET LEASE PORTFOLIO
As of June 30, 2013, Realty Income's portfolio consisted of 3,681 properties
across 49 U.S. states and Puerto Rico, protecting bondholders from possible
regional supply-and-demand imbalances. The most significant growth driver
year-to-date was the American Realty Capital Trust, Inc. (ARCT) acquisition
that closed in January 2013, totaling 501 properties for $3.2 billion.
Fitch views the portfolio's tenant industry diversification favorably. The
portfolio includes 46 tenant industries, and top segments based on 2Q'13
revenues were convenience stores (11.4%), casual dining and quick service
restaurants (9.9%), and drug stores (6.9%). Industry expansion is consistent
with Realty Income's strategic plan to be less concentrated in net lease
retail and more focused on improving tenant credit quality.
IMPROVING TENANT CREDIT
The company has 194 tenants and its top 15 tenants comprised 43.5% of 2Q'13
rent, which is somewhat concentrated. The top three tenants at June 30, 2013
were FedEx at 5.3% of rent, L.A. Fitness at 4.5% and Walgreens at 4.1%.
Acquisition activity year-to-date including the ARCT acquisition has focused
on properties leased to investment-grade rated tenants, thereby improving the
overall tenant credit quality. The company has materially reduced the
percentage of annualized rental revenue derived from properties leased to
speculative-grade companies since 2010.
The company's weighted average lease duration is long at 11 years, signaling
durability in the cash flow that supports the ratings, absent tenant
bankruptcies. Cash flow coverage of rent has improved in recent years and was
in excess of 2.5x for the top 15 tenants in 2Q'13.
SOLID FIXED-CHARGE COVERAGE
Fixed charge coverage is solid for the rating at 2.9x in 2Q'13 pro forma for
the July 2013 offering of $750 million 4.65% senior unsecured notes due 2023
(3.3x actual in 2Q'13), compared with 2.6x in 2012 and 2.8x in 2011. EBITDA
growth from acquisitions as well as contractual rent increases and occupancy
gains in the same-store portfolio, partially offset by increased fixed charges
associated with debt incurred to fund a portion of those acquisitions, drove
the increase. Fitch defines fixed charge coverage as recurring operating
EBITDA less straight-line rent adjustments less recurring capital expenditures
divided by total interest incurred and preferred dividends.
Fitch's base case projection is predicated on contractual base rent increases
and additional acquisitions, which should result in coverage sustaining around
3.0x over the next 12 to 24 months, which remains consistent with the 'BBB+'
rating. In a stress case not anticipated by Fitch in which tenant bankruptcies
similar to the Friendly's and Buffets bankruptcies in 2011-2012 reduce annual
rent by approximately 5%, fixed charge coverage would remain above 2.5x and
remain appropriate for a 'BBB+' rating.
FORWARD-LOOKING STRATEGIC PLANNING
Realty Income has a long track record of growth since its formation in 1969,
having increased the portfolio to 3,681 properties across 46 tenant industries
in 2Q'13 from 630 properties across five industries in 1994. The original
initiatives of generating monthly income from retail properties leased on a
long-term triple-net basis (1969 to 1994) evolved towards being attuned to
portfolio diversity as well as focusing on cash flow coverage and underwriting
(1997 to 2007). Following the recession, the company has concentrated on
improving tenant credit and pursued new industries while re-underwriting and
ranking the portfolio.
Realty Income's strategy centers on owning real estate net leased to stronger
credit tenants, with a preference for services over goods. The company owns
both discretionary and non-discretionary retail as well as non-retail.
However, its experience owning non-retail such as distribution (11.7% of 2Q'13
revenue), office (5.3%), agriculture (2.8%), manufacturing (2.3%) and
industrial (0.2%) properties is somewhat limited.
MANAGEMENT CHANGE ANNOUNCEMENT
On Sept. 3, 2013, Realty Income announced that its Board of Directors
appointed John P. Case to the position of Chief Executive Officer of the
company. Case succeeds Tom A. Lewis, who decided to retire as the company's
CEO. Case has been with Realty Income as Chief Investment Officer since April
2010 and was also named President in March 2013. Fitch does not expect the
company's strategy to change materially following this announcement given
Case's involvement with the company to date.
STRONG LIQUIDITY AND ACCESS TO CAPITAL
Liquidity coverage pro forma for the July 2013 bond offering is strong at 3.0x
for the period from July 1, 2013 to Dec. 31, 2015. Fitch defines liquidity
coverage as sources of liquidity (unrestricted cash, availability under the
unsecured revolving credit facility pro forma for the bond offering, and
projected retained cash flows from operating activities after dividends and
distributions) divided by uses of liquidity (debt maturities and projected
recurring capital expenditures). Longer-term, debt maturities are manageable
with 0.6% maturing in 2013 followed by 1.6% in 2014 and 6.7% in 2015 pro
Contingent liquidity is adequate for the rating with unencumbered asset
coverage of net unsecured debt of 2.4x at June 30, 2013 pro forma (assuming a
stressed 8% capitalization rate). The company intends to further unencumber
the portfolio when prepayment penalties on secured debt assumed as part of the
ARCT become less onerous. In addition, the covenants under the company's
revolving credit facility agreement and bond indenture do not restrict Realty
Income's financial flexibility.
Fitch anticipates that the company's adjusted funds from operations (AFFO)
payout ratio will remain in the mid-to-high 80% range (86.2% in 2012, although
this ratio increased to 92.3% in 2Q'13 as a result of the dividend increase
associated with the ARCT acquisition). Recent AFFO payout levels indicate the
company's ability to generate some internal liquidity despite its emphasis on
predictable and growing monthly dividends.
ELEVATED LEVERAGE FOR THE RATING
Net debt to recurring operating EBITDA was 5.9x at 2Q'13 compared with 6.6x in
2012 and 5.4x in 2011. Leverage was skewed upward in 2012 due to the
incurrence of debt prior to the close of the ARCT transaction. Under Fitch's
base case leverage is forecast to approach the 5.5x to 6.0x range in
2014-2015, which would remain appropriate for the rating. In the stress case
tenant bankruptcy scenario not anticipated by Fitch, leverage could sustain
above 6.0x, which would be weak for the rating.
PREFERRED STOCK NOTCHING
The two-notch differential between Realty Income's IDR and preferred stock
rating is consistent with Fitch's criteria for corporate entities with an IDR
of 'BBB+'. Based on Fitch research titled 'Treatment and Notching of Hybrids
in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's web
site at 'www.fitchratings.com', these preferred securities are deeply
subordinated and have loss absorption elements that would likely result in
poor recoveries in the event of a corporate default.
The following factors may result in positive momentum in the ratings and/or
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro
forma fixed charge coverage was 2.9x);
--Fitch's expectation of leverage sustaining below 4.0x (pro forma leverage
--Fitch's expectation of unencumbered assets-to-unsecured debt sustaining
above 3.0x (pro forma unencumbered coverage was 2.4x).
The following factors may result in negative momentum in the ratings and/or
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.0x;
--Tenant bankruptcies resulting in a weakening of the company's credit
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Corporate Rating Methodology (Aug. 5, 2013);
--Criteria for Rating U.S. Equity REITs and REOCs (Feb. 26, 2013);
--Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis (Dec. 13, 2012);
--Recovery Ratings and Notching Criteria for Equity REITs (Nov. 12, 2012).
Applicable Criteria and Related Research:
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Recovery Ratings and Notching Criteria for Equity REITs
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
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Sean Pattap, +1 212-908-0642
Fitch Ratings, Inc.
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Britton Costa, +1 212-908-0524
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