Fitch Rates Realty Income's $350MM 3.875% Sr. Unsecured Notes Due 2024
'BBB+'; Outlook Stable
NEW YORK -- June 19, 2014
Fitch Ratings has assigned a 'BBB+' credit rating to the $350 million
aggregate principal amount 3.875% coupon senior unsecured notes due 2024
issued by Realty Income Corporation (NYSE: O, Realty Income). The notes were
priced at 99.956% of par to yield 3.88% to maturity, or 125 basis points over
the benchmark treasury rate.
Net proceeds from the offering of $347.6 million are expected to be used to
repay a portion of borrowings outstanding under the company's unsecured credit
facility and for other general corporate purposes and working capital, which
may include acquisitions.
In addition to the 2024 notes, Fitch currently rates Realty Income as follows:
--Issuer Default Rating (IDR) 'BBB+';
--$1.5 billion unsecured revolving credit facility 'BBB+';
--$3.2 billion of senior unsecured notes 'BBB+';
--$609.4 million of preferred stock 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Realty Income's IDR of '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. Leverage has been elevated for the 'BBB+'
rating, though declined following the company's April 2014 $528.5 million
equity issuance. In addition, the company's recent focus on investing outside
of net lease retail has less of a track record within the context of Realty
Income's long history.
Diverse Net Lease Portfolio
As of March 31, 2014, Realty Income's portfolio consisted of 4,208 properties
across 49 U.S. states and Puerto Rico, protecting bondholders from possible
regional supply-and-demand imbalances. The most significant portfolio
transaction over the past two years was the acquisition of American Realty
Capital Trust, Inc. (ARCT) that closed in January 2013, totaling 501
properties for $3.2 billion.
Fitch views the portfolio's tenant industry diversification favorably. The
portfolio includes 47 tenant industries, and top segments based on 1Q'14
revenues were convenience stores (10.3%), drug stores (9.5%), dollar stores
(9.1%), casual dining and quick service restaurants (8.5%) and health and
fitness (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 211 tenants and its top 15 tenants comprised 46.4% of 1Q'14
rent, which is somewhat concentrated. The top three tenants at March 31, 2014
were Walgreens at 5.4%, FedEx at 5.2% of rent, and L.A. Fitness at 5%. The
company has materially reduced the percentage of annualized rental revenue
derived from properties leased to speculative-grade companies since 2010 and,
somewhat relatedly, property-level cash flow coverage has also improved in
recent years. In addition, the company's weighted average lease duration is
long at 10.8 years, signaling durability in the cash flow that supports the
ratings, absent tenant bankruptcies.
Solid Fixed-Charge Coverage
Fixed charge coverage is solid for the rating at 3.1x in 1Q'14 pro forma for
the April 2014 equity offering, recent acquisitions and proceeds from the
senior unsecured notes due 2024 (also 3.1x actual for the TTM ended March 31,
2014) 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
(1.5% same-store rent growth) and additional acquisitions (assumed to be $1.2
billion in 2014), 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 4,208 properties across 47 tenant industries
in 1Q'14 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 industrial and distribution
(10.7% of 1Q'14 revenue), office (6.5%), manufacturing (2.5%) and agriculture
(2.4%) properties is somewhat limited.
Strong Liquidity and Access to Capital
Liquidity coverage pro forma is strong at 5.0x for the period April 1, 2014 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 equity and bond offerings, 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 1.1% maturing during the
remainder of 2014 followed by 6.1% in 2014 and 13.2% in 2016 pro forma.
Contingent liquidity is adequate for the rating with unencumbered asset
coverage of net unsecured debt of 2.8x at March 31, 2014 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.
Fitch anticipates that the company's adjusted funds from operations (AFFO)
payout ratio will remain in the mid-to-high 80% range (85.5% in 1Q2014 2012,
although this ratio increased to 88.4% in 2013 as a result of the dividend
increase associated with the ARCT acquisition). Recent AFFO payout levels
indicate the company's ability to generate a modest amount of internal
Decline in Recently Elevated Leverage
Net debt to recurring operating EBITDA was 6.1x at 1Q'14 but improves to 5.5x
pro forma compared with 6.6x in 2012 and 5.3x 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 remain around
5.5x in 2014-2015, which would remain appropriate for the rating. In a stress
case (principally a material 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 is 3.1x);
--Fitch's expectation of leverage sustaining below 4.0x (pro forma leverage is
--Fitch's expectation of unencumbered assets-to-unsecured debt sustaining
above 3.0x pro forma coverage is 2.8x).
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' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs (Sector Credit Factors) (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Recovery Ratings and Notching Criteria for Equity REITs
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Fitch Ratings, Inc.
Sean Pattap, +1-212-908-0642
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
Britton Costa, +1-212-908-0524
Michael Weaver, +1-312-368-3156
Sandro Scenga, +1-212-908-0278
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