Realty Income - Earnings Call - Q1 2012
April 26, 2012
Transcript
Speaker 4
Welcome to the Realty Income First Quarter 2012 Earnings Conference Call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for your questions. If you have a question, please press the star followed by the one on your touch-tone phone. If you'd like to withdraw your question, press the star followed by the two. If you're using speaker equipment today, it will be necessary to lift your hands up before making your selection. Today's conference is being recorded, April 26, 2012. I would now like to turn the conference over to Tom Lewis, CEO of Realty Income. Please go ahead.
Speaker 2
All right. Good afternoon, everybody, and thank you, Alicia. Welcome to our call to talk about the first quarter. In the room with me today is Gary Molino, our President, Chief Operating Officer, Paul Meurer, our Executive Vice President, Chief Financial Officer, John Case, our Executive Vice President, Chief Investment Officer, Mike Pfeiffer, our General Counsel, and he is also an Executive Vice President, and Tere Miller, who is our Vice President, Corporate Communications. As always, during this call, we will make certain statements that may be considered to be forward-looking statements under Federal Securities Law, and the company's actual future results may differ significantly from the matters discussed in any forward-looking statements, and we'll disclose in greater detail on the company's Form 10-Q the factors that may cause such differences. With that, we'll open it up, as we usually do, going over the numbers. Paul, if you'll handle that.
Speaker 5
Thank you, Tom. As usual, I will comment briefly on our financial statements, provide a few highlights of the results for the quarter, and start with the income statement. Total revenue increased 17.9% for the quarter. Our revenue for the quarter was approximately $115 million for about a $460 million annualized run rate. This obviously reflects the significant amount of new acquisitions over the past year. Other income was only $255,000 for the quarter. On the expense side, depreciation and amortization expense increased by about $8.6 million in the comparative quarterly period. Obviously, as depreciation expense increases and our property portfolio continues to grow, interest expense increased by just over $3.8 million, and this increase was due primarily to the June 2011 issuance of $150 million of notes in the reopening of our 2035 bonds, as well as credit facility borrowings during the quarter.
On a related note, our coverage ratios both remain strong, with interest coverage of 3.5 times and fixed charge coverage of 2.7 times. General administrative or G&A expenses in the first quarter were $9.2 million. Our G&A expense has increased a bit as our acquisition activity has increased, and we invested this past year in new personnel for future growth. G&A also includes the expensing of additional due diligence costs on the acquisition side, which totaled $242,000 during the quarter. Our current projection for G&A for all of 2012 is approximately $34 million, which will represent only about 7% to 7.25% of total revenues projected for the year. Property expenses were $2.5 million for the quarter. These expenses are primarily associated with the taxes, maintenance, and insurance expenses, which we are responsible for on properties available for lease.
Our current estimate for property expenses for all of 2012 is about $9.4 million. Income taxes consist of income taxes paid to various states by the company, and they were $405,000 during the quarter. Income from discontinued operations for the quarter totaled $851,000. This income is associated with our property sales activity during the quarter. We did sell five properties during the quarter. A reminder again that we do not include property sales gains in our FFO or AFFO. Preferred stock cash dividends totaled $9.5 million for the quarter, and this increase reflects our issuance of the 6.58% Class F preferred stock this year. Excessive redemption value over carrying value of preferred shares redeemed refers to the $3.7 million non-cash redemption charge stemming from the repayment of our outstanding 7.38% preferred D stock with some of the proceeds from our preferred F offering this year.
Replacement of this preferred D stock in our capital structure saves us about $1 million cash annually, obviously due to the lower coupon of the new preferred F stock that we just issued. Net income available to common stockholders was $26.1 million for the quarter. Funds from operations or FFO per share was $0.46 for the quarter. Although excluding the $3.7 million preferred stock redemption charge, our FFO for the quarter would have been $0.49 for a 2.1% increase over the $0.48 earned in the first quarter of last year. Adjusted funds from operations or AFFO or the actual cash we have available for distribution of dividends was higher at $0.50 per share for the quarter, an increase of 2% over $0.49 AFFO earned in the first quarter of last year.
As we've always mentioned, our AFFO will continue to be higher than our FFO, and we believe this differential between our FFO and a higher AFFO will actually continue to increase slightly. Our capital expenditures are fairly low. We have minimal straight-line rent adjustments in our portfolio, and we do believe that over time we will continue to have some FAS 141 non-cash reductions to FFO when we purchase large portfolios that have some in-place leases. In addition, in 2012, of course, we have the $3.7 million non-cash preferred redemption charge, which affects our FFO but not in the calculation of our AFFO. Our 2012 AFFO earnings projection is $2.08 to $2.13 per share, an increase of 3.5% to 6% over our 2011 AFFO per share of $2.01. We increased our cash monthly dividend again this quarter.
We have increased the dividend 58 consecutive quarters and 65 times overall since we went public over 17 and a half years ago. Our AFFO dividend payout ratio for the quarter was 87%. Briefly turning to the balance sheet for a moment, we believe we've continued to maintain our conservative and very safe capital structure. We were very pleased to raise $409 million with our 6.58% Class F preferred stock offerings this year, including the 1.4 million share reopening add-on offering that we did earlier this month in April. As I mentioned, the proceeds were used to redeem our higher coupon Class B preferred stock and also to repay borrowings on our acquisition credit facility. Our balance sheet continues to be well-positioned to support our acquisition growth. Our current debt-to-total market capitalization is now only 24%, and our preferred stock outstandings still represent only 8% of our capital structure.
Our $425 million credit facility had just $43 million of borrowing at quarter end, and of course, some of that was paid off with the Class F preferred stock add-on offering earlier this month in April. We have no debt maturities until 2013. In summary, we currently have excellent liquidity, and we believe our overall balance sheet remains very healthy and safe. Let me turn this call back over to Tom, who will give you a little bit more background on the results.
Speaker 2
Thanks, Paul, and I'll kind of run through the various areas of the business. Let me start with the portfolio. The portfolio continued to generate very consistent revenue throughout the first quarter, and at the end of the quarter, our 15 largest tenants accounted for about 49.4% of our revenue. That's down 440 basis points from the same period a year ago and 40 basis points from the fourth quarter. The acquisition efforts and movement in the portfolio continue to reduce concentrations. Relative to the health of the portfolio, the average cash flow coverage at the store level for those top 15 remains very high and very stable from previous quarters at about 2.4 times. Overall, the operations of the tenants in those properties are doing pretty well. We ended the first quarter at occupancy of 96.6%, with 90 properties available for lease out of the 2,631.
That's down about 10 basis points from the fourth quarter and down about 20 basis points for the same period a year ago. During the quarter, we had 16 new vacancies in the portfolio. Eight came from buffets and Friendlies leases that were rejected during the reorganizations, and the balance from the normal operations of the portfolio, which is lease rollover. We also leased or sold 13 vacant properties during the quarter, and that basically gives you the reason for the movement in the assets. I mentioned last quarter that we thought that during the first quarter, we could see another 30 basis points or so of occupancy decline. Obviously, we were able to do better than that, and we think throughout the year, absent anything material changing, that the portfolio occupancy will remain very high. Our best guess will be around 97% at the end of the second quarter.
Third quarter, maybe high 96, 97, and then a little over 97% in the fourth quarter. That's kind of how things are looking stable and up a bit. The formula for how we do occupancy is basically take the vacant number of properties, 90, divided by the occupied or total number, 2,631, and that gets us to the 3.4% vacancy and 96.6% occupancy. As I mentioned last quarter, we also run it a couple of other ways. One is to take the vacant square footage and divide it by the total square footage, and that gives you a different number. That number today is vacant square footage, is about 790,000 square feet. If you divide that by our total of 27,377,000 square feet, that gives you 2.9% vacancy and about 97.1% occupancy.
The third way we run it is to take the previous rent on vacant properties and divide that by the sum of that number and the rent on the occupied properties. If you run that today, the vacant properties' former contractual rent in the first quarter was about $2.87 million. If you combine that with the rent on all the occupied properties, which is $114.6 million, you'll get $117.47 million. Divide that by the $2.87 million, and essentially you get to, on a dollar basis, about 2.4% vacancy or 97.6% occupancy. If you look at the three ways: number of properties, 96.6%; square footage, 97.1%; by dollars, 97.6%. Each quarter, I probably will not go through the definitions in the future, but we'll mention what they are utilizing each method. In each case, I think it still represents a very good occupancy.
Same-store rents on the core portfolio increased 1.1% during the first quarter. While fairly small, that is a bit unusual and is really a function of the impact kind of coming to fruition in the first quarter of the buffets and Friendlies reorganizations. Excluding those, same-store rent would have increased 1.1% during the quarter, but that's a bit like saying, "Gee, hey, except for the bad stuff, the good stuff looked like this." We believe that those numbers should turn positive over the next couple of quarters. If we had to make a guess right now, same-store rents over the course of the year should be flat to slightly up. If you look where really that came from, there were only three industries that had declining same-store rents. One was bookstores. We only have one bookstore, home furnishings, and then casual dining restaurants, and that includes the buffets and Friendlies.
The total decrease was about $2,057,000, of which $2 million came from the buffets and Friendlies. Four industries had flat same-store rents: business services, equipment services, shoe stores, and transportation. There were 24 industries that saw same-store rent increases, with the majority coming from sporting goods, motor vehicle dealerships, health and fitness, theaters, quick service restaurants, and childcare. The 24 industries together that had increases was about $1.1 million, and that gets you to the net decline of about $990,000. From a diversification standpoint, the portfolio continues to be well-diversified. We had 2,631 properties at the end of the quarter, and that's down three from the previous quarter, 38 different industries, 137 different tenants in 49 states. We anticipate, as we've said, materially adding to that in the second quarter through acquisitions. Industry exposure continues to be well-diversified and decline.
Our largest industry, convenience stores, you can see in the releases at 17%. That's down about 20 basis points from last quarter. Restaurants, if you combine both casual dining and QSR, quick service restaurants, are down about 180 basis points from last quarter. For QSR, it's actually up a bit, and casual dining is where most of that drop came from, some of it from reduced rent on the buffets and Friendly's, which is really not the way we want to reduce the concentration. It's really theaters, you know, to 9.7%. That's down 10 basis points. Health and fitness up 10 at 7%. Very quickly, the only other area over 5% is beverages, which was unchanged. We continue to try and diversify out by industry. On a tenant basis, the largest you can see there is AMC at 5.3%. Diageo is also over 5% just slightly.
All of the rest of the tenants under 5%, again with the 15 largest at about 49.4%. You can see when you get to the 15th largest tenant, you're down to 2.2% of revenue. When you get to number 20, by the way, it's down to 1.5% and down from there. Fairly well diversified by tenant and then lastly by geography. The average remaining lease length on the portfolio remains healthy at about 11.1 years. If we look forward to the balance of the year on the portfolio, we feel pretty good about things for the year, and we think we should have a good year in operations. Friendly's releases on the 19 properties that we got back are ahead of schedule.
In our model, we had assumed that the first releases would occur next year in January in the model, and we leased three of those in the first quarter, have contracts out for two more, and LOIs, letter of intents, on five. We think 10 of the 19 should get done here relatively quickly, and then we'll follow on the other ones. With buffets, we got seven back in the first quarter. One has been leased. We have LOIs on three more. Running a bit ahead of schedule there. We had assumed or had mentioned an assumption that tenants equal to about 5% of rent might have some issues going forward. We've said that in the last couple of calls. Yeah. I'm sorry, Paul?
Speaker 5
Not 2% to 3% of rent, not 5%.
Speaker 2
Excuse me, 2 to 3% of rent. Basically, our concerns there have abated quite a bit, as in talking to the tenants, they've seen their businesses improve. A bit more positive there relative to how we view the portfolio going forward this year. I would also say that leasing and sales activity is brisk. In the Portfolio Management department, it's a pretty good environment right now. Overall, we think the portfolio should be pretty stable going forward. There are no new tenant issues that have emerged over the last quarter. A little bit more positive tone relative to the portfolio. Let me move on to property acquisitions. First quarter was obviously quiet, but should get very busy. I'll let John Case, our Chief Investment Officer, comment on acquisitions.
Speaker 3
Thanks, Tom. We remain quite active on the acquisitions front. We continue to see a high volume of acquisition opportunities. While we only invested $10.7 million in the first quarter, we expect to see a very active closing calendar over the next two to three months. Our quarterly closing activity is typically driven by the timing of our larger portfolio transactions, of which there were none in the first quarter of this year. As we stated in our earnings release subsequent to the end of the first quarter, we have acquired or placed under contract to acquire $514 million in acquisitions, which we expect to close during the second quarter. A few larger portfolio transactions are driving the bulk of this activity. These acquisitions are comprised of 250 properties leased to four tenants and four different industries, all of which are industries we're currently invested in.
Virtually all of the acquisitions are retail properties and about 36% for investment-grade tenants. We will provide more color on these acquisitions once they close. Year to date, we've seen a broad range of investment possibilities. We've sourced approximately $6 billion in acquisition opportunities so far this year. This is everything that has come in the door that our acquisitions team has reviewed. This activity is comprised of 1,300 properties leased to 115 tenants and 33 industries. The majority of what we are seeing continue to be retail and distribution properties. About half of the properties we're analyzing are leased to investment-grade tenants. While we are no longer evaluating the majority of these acquisitions, we continue to pursue a number of these investments. Given our level of activity to date this year, we are raising our acquisition estimates for 2012 to $650 million from our previously announced $500 million.
We currently believe our initial cap rates should average from 7.5% to 7.75% for the year. Our initial lease terms should continue to average 15 years or longer. While the acquisition market is active, it is also competitive. Investment yields remain under pressure. Our investment spreads continue to hold up very well, though. Our anticipated acquisition cap rates reflect about a 175 basis point spread over our year-to-date average nominal cost of equity. This is taking our average price year to date and adjusting it for the forward FFO yield, and we're calculating the forward FFO yield on that and grossing it up for our equity issuance cost. This spread compares favorably to our long-term average of 110 basis points, and it's just a shade above our 2011 average spread of 170 basis points. At our current share price, our expected investment spreads are in excess of 200 basis points.
Tom?
Speaker 2
Thanks. Obviously, spreads remain very, very wide, even on slightly lower cap rates. We're pleased with what we plan in the second quarter with the $514 million that we'll have coming in the door during the quarter. John mentioned it's 250 properties, so it's a lot of retail properties leased to four tenants in all industries that we're in already. The vast majority of it is retail. The other thing is it's very typical of what we bought over the years. It has fairly high cash flow coverages that would be in line with the balance of our larger tenants, and about a third of it is investment grade. I think normal right up the middle for us in terms of what we acquire.
Normally, we would not have announced it until they close, which is what we typically do, but we needed to disclose that we did have those acquisitions coming in because we were doing the additional preferred offering. Those transactions, some of them are part of larger transactions that tenants are undertaking, and those will transpire over the next couple of months. We'll comment further on those after we get them done, and the tenants are able to complete the overall transactions, and then we're freed up from confidentiality agreements and able to talk a little more about them. We believe that all of them should close in the second quarter. There could be a little leakage into the third quarter, but obviously very, very positive. John mentioned we're using $650 million in acquisitions in our numbers for now.
Transaction flow is excellent, so we could exceed that, but it really is, as we've said for a long time, lumpy quarter to quarter and highly dependent on the larger transactions closing in a competitive environment. It's really instructive to look now where in the first quarter you're looking at $10 million and the second quarter $514 million. It's a very good example of how it can be lumpy quarter to quarter and hard to take what you do one quarter and then annualize that.
We think the acquisitions will continue to play a big role in our ability to grow the revenue and the AFFO, which will drive dividend increases, but also in really adjusting the makeup of the portfolio where we want to move up the credit curve relative to tenant quality and then be selective in terms of retail in what sectors we want to be in and also outside. If you look at the last couple of years as we've been trying to do this movement, as of the end of the second quarter, that would take us for kind of 2010, 2011, and 2012 to date about $2.2 billion of property that we've acquired. About $1.4 billion of that has been in retail, $800 million in other areas outside of retail that we think will do well for us.
Of the $2.2 billion, just under $800 million with investment-grade tenants or their subsidiaries, and a decent amount of the balance of the acquisitions pretty close to investment grade. That's a trend we would like to continue, but given the volumes we're looking at now and kind of where it's coming from, the best guess this year is we'll be a little heavier in retail than we have in the last two years and more to what we have traditionally done. That's just really a matter of the transaction flow that's coming across. We'll see how that goes as the year goes on. Relative to funding those acquisitions, as I mentioned last quarter, we're all living in a very low interest rate environment, and it's easy to get lulled into the assumption that it will always be that way.
We want to make sure on the capital that we're raising that we're not really creating any near-term maturities and that if interest rates go up in the future, we will have appropriately match-funded long-term leases and long-term capital. That's what we've been trying to do. In the last couple of years, we've done a little over $1 billion of equity, obviously, with no maturities, $150 million debt offering last year that matures in 2035, and then the $400 million of preferred we've done recently. About $1.5 billion of capital where we're making sure not to create any near-term maturities. Going forward today and looking at what we might do, long-term debt obviously looks very attractive, but it'd be nothing with a short maturity. Obviously, the equity is trading very well and is attractive.
Over the next couple of months, we'll watch the markets, look at what's going on, and try and make an appropriate decision relative to what type of permanent capital we'll use with these acquisitions. Paul mentioned the balance sheet and plenty of dry powder to continue to grow. We feel that the capital markets are obviously open and available and at very good pricing. Let me go on to earnings and guidance. The acquisitions and high occupancy obviously have had an impact on the numbers here and will benefit us the balance of the year. We increased the guidance for 2012 a penny on both ends on FFO of $2.02 to $2.06, and then on AFFO of $2.08 to $2.13, which is about 3.5% to 6% AFFO growth.
As we continue to raise the monthly dividend a bit each quarter, it has been our custom every year in August at our Board meeting to sit down and see if a fifth dividend increase is warranted each year. We are now seeing the AFFO payout ratio, which Paul, you said 97% to 87% quarter.
Speaker 4
87%. Excuse me. That should drop further as the year goes on and we see FFO grow. I would anticipate that the board will meet and consider a fifth and larger increase this year, which obviously would be positive for shareholders. With that, I think what we'll do, Alicia, is open it up for questions.
Speaker 0
Thank you. Ladies and gentlemen, we will now begin the question and answer session. As a reminder, if you have a question, please press the star followed by the one on your touch-tone phone. If you need to withdraw your question, press the star followed by the two. If you're using speaker equipment today, it will be necessary to lift your hands up before making your selection. Our first question comes from the line of Joshua Barber with Stifel Nicolaus. Please go ahead.
Speaker 2
Hi. Good afternoon.
Speaker 5
Good afternoon, Josh.
Speaker 2
Tom, I'm wondering if you guys could give a little bit more comments about your two to three-year outlook on the sales process. I know you noted that sales have been kind of slow in the first quarter, but sort of a question within a question. A, what do you expect from the sales process over the next couple of years? B, is there some right size of the enterprise that you'd like Realty Income to get over the next few years, just given that you guys have gotten bigger and that probably necessitates larger deals to continue growing?
Speaker 5
Yeah. I'll start with the last part of that. I think we'll continue to get bigger, notwithstanding sales, because the acquisitions will outstrip them. Fortunately, we have been able to do more acquisitions as the market's been. There's been a lot of product on the market, and we've been very active. With good spreads and a cost to capital, it's really a nice window here to jump through. Size over time is certainly an issue down the road. Relative to sales, I talked at length, so I won't do it again in the last two, about kind of re-rating the whole portfolio and starting to sell off some things that we don't want to hold over the long term. We targeted initially 106 properties out of the portfolio. They're fairly small. It was about $114 million in asset size.
We really just stacked that, really an additional department to do that in January and started the process. Obviously, these aren't like selling securities where you can push a button. They do take some time. I think that initial $114 million will take the balance of this year and probably into the first quarter of next year. What we'll do is we'll probably just have another 100, 150 right behind that that we try and do over a year. If I could target a run rate once we get up and operating here, it'll be $100 million, give or take $25 million, $50 million on each side. That should be something that should continue, I would think, for the next three, four years based on how we've analyzed the portfolio.
If you look at the 106 that we targeted, and again, really just staffed it in January, there's 49 of those right now where we're out talking to brokers in the communities where those properties are and going through due diligence, getting a broker opinion of value, and coming to some agreement with the person we'll use. We have another 24 that are listed on the market right now and available. There are 13 that we had on the market that have letter of intents, and then two under contract, and we closed one. There's another 17 or so that we need to initiate. I think we're off to a good start, but it'll take a couple of quarters to get going.
We should start seeing sales ramp up a little bit in the second quarter, and then in the third and fourth, I would hope that it becomes very, very active. We're off and running there. The final guess would be $100 million, give or take, that we're selling each year.
Speaker 2
That's very helpful. One last question. Have you seen the high-yield market, which has been, as you know, very strong this year? Has that been impacting tenant decisions on whether to go with the triple net financing, or have you seen, it sounds like the deal flow this year has been pretty good. Has the high-yield market been impacting that either positively or negatively?
Speaker 5
You know, the high-yield market is on fire, and that does give an alternative to tenants, but they've also realized that net lease is permanent financing and we're at very low interest rates. I think some people have sat down, really thought their way through it and said, "If we have these properties on the books, let's go out and get some very long-term financing," which I think is smart for them to do. John, you want to comment?
Speaker 3
I can think of just a couple of transactions involving private equity firms where they opted to pursue more high-yield financing than sale-leaseback financing over the last three to four months. It hasn't really been a significant impact on our business, but we're seeing a little of it given the strength of that market right now.
Speaker 2
Right. Plus, on the triple net side, you don't get retraded at the last moment.
Speaker 5
Yeah. We try very hard to make that point when we're doing a transaction.
Speaker 2
Thanks very much. Good luck.
Speaker 5
You bet.
Speaker 0
Thank you. Our next question comes from the line of Paula Poskin with Baird. Please go ahead.
Speaker 1
Thank you. Good afternoon, everyone.
Speaker 2
Hey, Paula.
Speaker 1
Tom, you described the transaction flow as excellent. Does that reflect just the velocity of opportunities that you're seeing, or does that reflect the suitability of the opportunity set relative to your acquisition criteria?
Speaker 5
Yeah, I think it is excellent. John mentioned that in committee here and down in acquisitions this year, about $6 billion had come in the door. For the whole year last year, if I recall, it was about $13 billion. We'll use last year's numbers. Of the $13 billion, about $8 billion get seriously analyzed, and then about $3 billion goes into committee. We actually had a very high hit rate last year of those where we bought $1 billion. Looking at $6 billion and closing about $500 million, the numbers in terms of are pretty, pretty high. The suitability is also very high. A good part of it, I forget the percentage again, is investment grade that we're looking at.
Speaker 3
Yeah. About half of what we're seeing is investment grade, and of what we're invested in or projected to invest in, it's about a third, about 36%.
Speaker 5
It is also across a lot of different industries. That tells us, you know, sometimes there's something going on in convenience stores or restaurants where those industries don't have capital or there's a lot of M&A, and that's really what causes people to come into the market. Today, it's pretty broad-based across industries, which tells us it's people saying, "Hey, this is a good time while interest rates are low to go out and do something." I think they're right. Conversely, it is for us too, given where spreads are and we can get long-term financing.
Speaker 1
What are some of the industries that you'd like to be in that you're not currently?
Speaker 5
In retail, we're kind of got it fully funded. There you just kind of say anything in there that is non-discretionary to middle upper income, we love. In retail, if it's going to be to kind of lower income, it better be value, club stores, dollar stores, or along those lines. Outside, it's really kind of the Fortune 1000 that we're trying to troll in a little bit and look into those industries that tend not to be as capital intensive and tend to benefit from some of the trends going on. Conversely, in retail, like in the internet retailing and transportation, we're looking in that area, and we've done some business with FedEx and looking at some others. It's kind of up the credit curve outside of retail and, you know, non-heavy equipment type businesses, service business, but really Fortune 1000 type companies.
Speaker 1
That's really helpful. Finally, one last question. What do you think the spread is in the cap rates between what you're buying and selling at?
Speaker 5
That's a very interesting question. We had targeted for our modeling, you know, selling at a 10% cap rate, and we had probably bought those assets at 8%. Today they're yielding us, happening to yield us 8.83%, those we wanted to sell. The sales, we only have one sale, but then through looking at the LOIs and the others, it's down closer where the cap rate spread is pretty tight. I think in the four or five to date, it's about 9%. I think we're going to have a better range of cap rates, and some are lower than what we're holding at. We're going to do pretty good. If you look today, it's hard to really say, "Here's what we're buying.
Here's what we're selling." We're selling generally those tenants who we think might be challenged in the future or in industries that we'd like to move away from, and we're buying going up the credit curve. There should be a spread there if there's any type of credit spreads that go on in the net lease business.
Speaker 1
I'm sorry, Lad. One last question. This is really big picture. As you sort of think about long term, really long term, about the trends of, you know, consumer spending patterns and whatnot, is there anything kind of emerging to you of where you definitely want to be or don't want to be? I'll sort of use a metaphor of, you know, this next generation coming out where I'd be, you know, long sushi and short garden hoses.
Speaker 5
Right. Yeah, very much so. We do have some very, very strong feelings about that. It's a function that we think, A, retail will be tougher, and then second, interest rates will be something that comes in as a problem in the future. It's interesting. We kind of thought the recession was coming. We were doing a big picture dive relative to where we were. Where we kind of missed it for a couple of years, and the last couple, it's really come up front for us, is dividing the consumer up to upper income, middle income, and lower income, and then looking at discretionary versus non-discretionary items. In the upper income, you can do both discretionary and non-discretionary. We'll do very well. They've got money. When you get into middle income, it's a little bit of a shrinking group.
You want to stay with non-discretionary things they have to buy. When you're looking at discretionary, be careful. In the lower income, it's really tough going forward. Credit's tough. It's a lot of people out of work, and it's not improving rapidly. We think for discretionary spending, it's going to be a huge problem. We don't want anything that we view as discretionary spending to the lower income consumer. We made some significant investments in restaurants in 2007 and 2008, and I wish we would have looked at what we thought was going to happen with the economy and tied it to the consumer a couple of years earlier because a lot of that was casual dining incomes right down to the low-end consumer on discretionary spending. That's really kind of where we don't want to be.
In retail, we want to make sure it's primarily the middle income, upper income consumer. We can play in both discretionary and non-discretionary. If you did that, and I'll give you examples. If it's consumer discretionary to the middle and upper income, health and fitness, theaters, pet supplies, that looks pretty good. You have to watch where you're buying from a demographic standpoint. If it's consumer non-discretionary kind of to the middle, gee, auto collision, auto service, tire, convenience stores, drug stores, those look fairly attractive to us. For all demographics, those retailers that have good value propositions as kind of wholesale clubs, dollar stores, discount, volume retailers. To couple it, given where we think interest rates might go in the future, by trying to go a bit up the credit curve.
Speaker 1
That's very helpful. Thank you very much.
Speaker 0
Thank you. Our next question comes from the line of Todd Spender with Wells Fargo Securities. Please go ahead.
Speaker 6
Hi. Thanks, guys. Tom, just circling back to your comments on the disposition. Are the real opportunities here to sell properties on a one-off basis? I know it might be a little more time-consuming, but you've got that 1031 exchange buyer who might not be as price-sensitive, and they have an urgency to close. Any color on if these are going to be portfolios, grouped, or maybe just the one-offs?
Speaker 5
We'll do a few in pieces, but I think we've come to the conclusion the best buyer for these, they're good locations, is to a buyer in the community where the property exists. These tend to be on the main drag. People know them as they go by, and they're comfortable with their community, and they're comfortable with that location in their community. Best sold by, I think, the local broker in there. Since they're fairly small asset size, they fit kind of that type of buyer. With that said, along the way, we're getting a few calls where somebody says, "Gee, I'd like to do four or five." What we learned in CREST over a number of years is you get people who will come in, try and tie up four or five, and then try and work the transaction and throw one out here and one in there.
We've just been better off, unless you're really going to discount them and do a big volume block, you'll get maximum value kind of one-off. That's the system we're trying to build as we do these sales.
Speaker 6
That's helpful. You know, just a couple with that. Any geographic pockets that concern you, maybe some macro issues related to the housing market not coming back that are skewing you to sell more in any parts of the country?
Speaker 5
You know, that's a great question. I have to say a soft no. There are some areas that are a little less attractive. We did a really interesting study. When we went through and studied all of the tenants last year in the industries and rerated them, and it took a year, we undertook the same project with properties and started assigning real estate characteristics to them relative to income, population, demographics, and really going through the portfolio. When it was done, we weighted and rated the properties from real estate characteristics that we then could marry to the credit statistics of the tenant. We thought it'd be interesting to backtest those real estate characteristics. We basically took the last couple, three bankruptcies the company has had, we took those properties and rated, and the correlation to whether we got the properties back or they were successful was almost zero.
The correlation was almost always cash flow coverage, and then there was a weighting for consumer discretionary to the low-income consumer. We're more focused in that area because when we backtested it, it was stunning to me that you're looking at traffic flows and attractive demographics and all these other things, and all that really mattered was the cash flow coverage.
Speaker 6
That's helpful. Thanks, Tom. Last question. With the new acquisition you announced, the pending one that's going to close in the second quarter, is there any secured debt that comes along with that?
Speaker 5
No, there's none on this one.
Speaker 6
Okay, thanks, guys.
Speaker 0
Thank you. Our next question comes from the line of Rich Moore with RBC Capital Markets. Please go ahead.
Speaker 6
Yeah. Hello, guys. Good afternoon. Staying with that last question for a second, your acquisition facility, I assume, is at about zero, I think. Paul, you're basically saying, and as you add these acquisitions this quarter, that's going to pretty much max you out. Is that about right?
Speaker 5
Yeah. Obviously, options include utilizing the accordion on the credit facility, which has $200 million that can be added to the $425 million, or accessing permanent capital, which, whether it be common, preferred, or bonds, are all very available at the moment and very well priced. I'll also add to that that we have a fabulous group of banks that we have a great relationship with and have been told over time, and that's the truth, that it's an environment where you pick up the phone if you need something. We don't have a concern in that area.
Speaker 6
Okay. Tom, your confidence level, I take it, is high that you'll close on these. You could, if say you were going to do equity, you could do that really at any point, right?
Speaker 5
You could, but we have found that the best idea is to match those things up. While we think there's a very, very high chance of these closing, given where we are on them, we generally like to make sure they're going to close and close them before we go out and raise a lot of money.
Speaker 6
Okay. That sounds pretty intelligent. When you look at Friendlies and buffets, is there any more impact in the second quarter, and what do you think happens beyond 2Q?
Speaker 5
I think the impact lags throughout the year. I think same-store rents will be a little soft in the second quarter and get a little better in the third and fourth. I think the leasing happens over time. Obviously, since we're comping off last year's number of pre-bankruptcy on both of these and some of the concessions we made on a comp basis, those will show up this year. In terms of handling it, I'd say it gets done in the first three quarters. I think most of it could do. I know our portfolio management group is listening and now knows what we need to do. That'll pretty much end, and we'll move forward from there. As I mentioned earlier, there's nothing that's jumped up we see as of right now in the portfolio above me on those.
Speaker 6
Okay. Good. Thanks. One more thing. It looked like you added two stores in the quarter, and it looked like you added one retail chain. I was curious, two things. One, what the retail chain was and why you would add one store of one new retail chain.
Speaker 5
You know, the retail chain increase was due to a release of a property.
Speaker 6
Oh, okay. I got you.
Speaker 5
As part of the acquisition effort, because we agree relative to the acquisition front, for the most part, you're not going to see that sort of situation. Rich, I was just going to say, I don't know.
Speaker 6
Yeah, exactly. Okay, good. Very good. Thank you, guys.
Speaker 0
Thank you. Ladies and gentlemen, this concludes the question and answer portion of the Realty Income conference call. I will now turn the call over to Tom Lewis for closing remarks.
Speaker 5
Thank you. As always, we appreciate everybody's time and look forward to talking to you again at any upcoming Mayread or other meetings. Other than that, we'll talk to you in about 90 days. Thank you. Alicia, thank you for your help.
Speaker 0
Ladies and gentlemen, if you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4531-986, followed by the pound sign. Thank you for your participation. You may now disconnect.