Edgar Filing: REALTY INCOME CORP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

Commission File Number 1-13374

REALTY INCOME CORPORATION

(Exact name of registrant as specified in its charter)

Maryland		33-0580106
(State or Other Jurisdiction of		(IRS Employer
Incorporation or Organization)		Identification Number)

220 West Crest Street, Escondido, California 92025

(Address of Principal Executive Offices)

Registrant’s telephone number, including area code: (760)741-2111

Securities registered pursuant to Section 12 (b) of the Act:

		Name of Each Exchange
Title of Each Class		On Which Registered

Common Stock, $1.00 Par Value		New York Stock Exchange
Class D Preferred Stock, $1.00 Par Value		New York Stock Exchange
Class E Preferred Stock, $1.00 Par Value		New York Stock Exchange
8.25% Monthly Income Senior Notes, due 2008		New York Stock Exchange

Securities registered pursuant to Section 12 (g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2).

Large accelerated filer x Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

At June 30, 2006, the aggregate market value of the Registrant’s shares of common stock, $1.00 par value, held by non-affiliates of the Registrant was $1.9 billion, at the New York Stock Exchange (“NYSE”) closing price of $21.90.

At February 13, 2007, the number of shares of common stock outstanding was 101,005,867, the number of Class D preferred shares outstanding was 5,100,000, the number of Class E preferred shares outstanding was 8,800,000 and the number of Monthly Income Senior Notes, due 2008, outstanding was 4,000,000.

Documents incorporated by reference: Part III, Item 10, 11, 12, 13 and Part IV, Item 14 incorporate by reference certain specific portions of the definitive proxy statement for Realty Income Corporation’s Annual Meeting to be held on May 15, 2007, to be filed pursuant to Regulation 14A. Only those portions of the proxy statement which are specifically incorporated by reference herein shall constitute a part of this Annual Report.

Forward-Looking Statements

This annual report on Form 10-K, including documents incorporated by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. When used in this annual report, the words “estimated”, “anticipated”, “expect”, “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are subject to risks, uncertainties, and assumptions about Realty Income Corporation, including, among other things:

• Our anticipated growth strategies;

• Our intention to acquire additional properties and the timing of these acquisitions;

• Our intention to sell properties and the timing of these property sales;

• Our intention to re-lease vacant properties;

• Anticipated trends in our business, including trends in the market for long-term net-leases of freestanding, single-tenant retail properties;

• Future expenditures for development projects; and

• Profitability of our subsidiary, Crest Net Lease, Inc. (“Crest”).

Future events and actual results, financial and otherwise, may differ materially from the results discussed in the forward-looking statements. In particular, some of the factors that could cause actual results to differ materially are:

• Our continued qualification as a real estate investment trust;

• General business and economic conditions;

• Competition;

• Fluctuating interest rates;

• Access to debt and equity capital markets;

• Other risks inherent in the real estate business including tenant defaults, potential liability relating to
environmental matters, illiquidity of real estate investments and potential damages from natural disasters;

• Impairments in the value of our real estate assets;

• Changes in the tax laws of the United States of America;

• The outcome of any legal proceedings to which we are a party; and

• Acts of terrorism and war.

Additional factors that may cause risks and uncertainties include those discussed in the sections entitled “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report.

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date that this annual report was filed with the Securities and Exchange Commission, or SEC. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated events. In light of these risks and uncertainties, the forward-looking events discussed in this annual report might not occur.

REALTY INCOME CORPORATION

Index to Form 10-K

PART I

Item 1:	Business
	The Company	4
	Recent Developments	5
	Distribution Policy	8
	Business Philosophy and Strategy	9
	Properties	13
Item 1A:	Risk Factors	18
Item 1B:	Unresolved Staff Comments	24
Item 2:	Properties	24
Item 3:	Legal Proceedings	24
Item 4:	Submission of Matters to a Vote of Security Holders	24

PART II

Item 5:	Market for the Registrant’s Common Equity and Related Stockholder Matters	25
Item 6:	Selected Financial Data	26
Item 7:	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	General	27
	Liquidity and Capital Resources	27
	Results of Operations	32
	Funds from Operations (FFO) Available to Common Stockholders	39
	Impact of Inflation	40
	Impact of Accounting Pronouncements	40
Item 7A:	Quantitative and Qualitative Disclosures About Market Risk	41
Item 8:	Financial Statements and Supplementary Data	42
Item 9:	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	65
Item 9A:	Controls and Procedures	65
Item 9B:	Other Information	66

PART III

Item 10:	Directors and Executive Officers of the Registrant	66
Item 11:	Executive Compensation	66
Item 12:	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	66
Item 13:	Certain Relationships and Related Transactions	66
Item 14:	Principal Accountant Fees and Services	66

PART IV

Item 15:	Exhibits and Financial Statement Schedules	67

SIGNATURES		71

PART I

Item 1: Business

THE COMPANY

Realty Income Corporation, The Monthly Dividend Company®, is a Maryland corporation organized to operate as an equity real estate investment trust, or REIT. Our primary business objective is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations, or FFO per share. The monthly distributions are supported by the cash flow from our portfolio of retail properties leased to regional and national retail chains. We have in-house acquisition, leasing, legal, retail and real estate research, portfolio management and capital markets expertise. Over the past 38 years, Realty Income and its predecessors have been acquiring and owning freestanding retail properties that generate rental revenue under long-term lease agreements (primarily 15- to 20-years).

In addition, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties. Our portfolio management focus includes:

• Contractual rent increases on existing leases;

• Rent increases at the termination of existing leases when market conditions permit; and

• Active management of our property portfolio, including re-leasing vacant properties and selectively selling properties.

In acquiring additional properties, we adhere to a focused strategy of primarily acquiring properties that are:

• Freestanding, single-tenant, retail locations;

• Leased to regional and national retail chains; and

• Leased under long-term, net-lease agreements.

At December 31, 2006, we owned a diversified portfolio:

• Of 1,955 retail properties;

• With an occupancy rate of 98.7%, or 1,929 properties occupied of the 1,955 properties in the portfolio;

• Leased to 103 different retail chains doing business in 29 separate retail industries;

• Located in 48 states;

• With over 16.7 million square feet of leasable space; and

• With an average leasable retail space per property of 8,600 square feet.

Of the 1,955 properties in the portfolio, 1,948, or 99.6%, are single-tenant, retail properties and the remaining seven are multi-tenant, distribution and office properties. At December 31, 2006, 1,923, or 98.7%, of the 1,948 single-tenant properties were leased with a weighted average remaining lease term (excluding extension options) of approximately 12.9 years.

In addition, at December 31, 2006, our wholly-owned taxable REIT subsidiary, Crest Net Lease, Inc. (“Crest”), had invested $137.5 million in 60 properties, which are classified as held for sale. Crest was created to buy and sell properties, primarily to individual investors, many of whom are involved in tax-deferred exchanges under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Tax Code”).

We typically acquire retail store properties under long-term leases with retail chain store operators. These transactions generally provide capital to owners of retail real estate and retail chains for expansion or other corporate purposes. Our acquisition and investment activities are concentrated in well-defined target markets and generally focus on retail chains providing goods and services that satisfy basic consumer needs.

Our net-lease agreements generally:

• Are for initial terms of 15 to 20 years;

• Require the tenant to pay minimum monthly rents and property operating expenses (taxes, insurance and maintenance); and

Realty Income commenced operations as a REIT on August 15, 1994 through the merger of 25 public and private real estate limited partnerships with and into the Company. Each of the partnerships was formed between 1970 and 1989 for the purpose of acquiring and managing long-term, net-leased properties.

The eight senior officers of Realty Income owned 1.3% of our outstanding common stock with a market value of $37.4 million at February 13, 2007. The directors and eight senior officers of Realty Income, as a group, owned 2.5% of our outstanding common stock with a market value of $72.6 million at February 13, 2007.

Realty Income’s common stock is listed on The New York Stock Exchange (“NYSE”) under the ticker symbol “O.” Our central index key number is 726728 and cusip number is 756109-104.

Realty Income’s Class D cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprD” and its cusip number is 756109-609.

Realty Income’s Class E cumulative redeemable preferred stock is listed on the NYSE under the ticker symbol “OprE” and its cusip number is 756109-708.

Realty Income’s 8.25% Monthly Income Senior Notes, due 2008 are listed on the NYSE under the ticker symbol “OUI.” The cusip number of these notes is 756109-203.

In February 2007, we had 70 permanent employees as compared to February 2006 when we had 69 permanent employees and four temporary employees.

We maintain an Internet website at www.realtyincome.com. On our website we make available, free of charge, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8 K, and amendments to those reports, as soon as reasonably practicable after we electronically file these reports with the SEC. None of the information on our website is deemed to be part of this report.

RECENT DEVELOPMENTS

Acquisitions during 2006

During 2006, Realty Income and Crest invested $769.9 million, in aggregate, in 378 new properties and properties under development. These 378 properties are located in 30 states and are 100% leased with an initial average lease term of 17.1 years. As described below, Realty Income acquired 322 properties and Crest acquired 56 properties.

Included in the $769.9 million is $656.7 million invested by Realty Income in 322 new properties and properties under development, with an initial weighted average contractual lease rate of 8.6%. These 322 properties are located in 30 states, are 100% leased with an initial average lease term of 16.7 years and will contain over 3.3 million leasable square feet. The 322 new properties acquired by Realty Income are net-leased to 16 different retail chains in the following 11 industries: automotive collision services, automotive tire services, convenience store, drug store, general merchandise, health and fitness, home improvement, motor vehicle dealership, private education, restaurant, and theater. Also included in the $769.9 million is $113.2 million invested by Crest in 56 new retail properties.

At December 31, 2006, Realty Income had invested $15.9 million in four properties that were leased and being developed by the tenant (with development costs funded by Realty Income). Rent on these properties is scheduled to begin at various times during 2007. At December 31, 2006, we had outstanding commitments to pay estimated unfunded development costs totaling approximately $16.4 million.

The initial weighted average contractual lease rate is computed as estimated contractual net operating income (in a net-leased property this is equal to the base rent or, in the case of properties under development, the estimated base rent under the lease) for the first year of each lease, divided by the estimated total costs. Since it is possible that a tenant could default on the payment of contractual rent, we cannot assure you that the actual return on the funds invested will remain at the percentages listed above.

Acquisition of $349 million of Buffets/Ryan’s Restaurants on November 1, 2006

The 2006 acquisition amounts include Realty Income and Crest’s aggregate investment of $349 million to acquire 144 Buffets/Ryan’s restaurant properties. The properties are leased under 20-year, triple-net lease agreements. These properties were acquired subsequent to a merger between Buffets, Inc. and Ryan’s Restaurant Group.

Of the 144 restaurant properties, 116 were acquired by Realty Income and 28 were acquired by Crest. The restaurants have, on average, approximately 10,300 leasable square feet and are situated on an average lot size of approximately 2.86 acres. The properties are existing locations that, on average, have been operating for 11 years.

Investments in Existing Properties

In 2006, we capitalized costs of $964,000 on existing properties in our portfolio, consisting of $761,000 for re-leasing costs and $203,000 for building improvements.

Net Income Available to Common Stockholders

Net income available to common stockholders was $99.4 million in 2006 versus $89.7 million in 2005, an increase of $9.7 million. On a diluted per common share basis, net income was $1.11 per share in 2006 and $1.12 per share in 2005.

The calculation to determine net income available to common stockholders includes gains from the sale of properties. The amount of gains varies from period to period based on the timing of property sales and can significantly impact net income available to common stockholders.

The gain recognized from the sales of investment properties during 2006 was $3.0 million as compared to $6.6 million for 2005.

Funds from Operations (FFO)

In 2006, our FFO increased by $26.2 million, or 20.2%, to $155.8 million versus $129.6 million in 2005. On a diluted per common share basis, FFO was $1.73 in 2006 compared to $1.62 for 2005, an increase of $0.11, or 6.8%.

See our discussion of FFO in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report, which includes a reconciliation of net income available to common stockholders to FFO.

Issuances of Common Stock

In October and November 2006, we issued an aggregate of 6.9 million shares of common stock at a price of $26.40 per share. The net proceeds of approximately $173.2 million were used to fund a portion of the purchase price of the Buffets/Ryan’s properties and for other general corporate purposes.

In September 2006, we issued 4.715 million shares of common stock at a price of $24.32 per share. The net proceeds of approximately $109 million from this offering were used to fund new property acquisitions, repay borrowings under our credit facility and for other general corporate purposes.

In March 2006, we issued 5.2 million shares of common stock at a price of $24.39 per share. The net proceeds of approximately $120.5 million were used to fund new property acquisitions and for other general corporate purposes.

Issuance of Preferred Stock

In December 2006, we issued 8.8 million shares of 6-3/4% Monthly Income Class E cumulative redeemable preferred stock, with a liquidation value of $25 per share. The net proceeds of $214 million from this issuance were used to repay borrowings under our credit facility and for other general corporate purposes. Beginning December 7, 2011, the Class E preferred shares are redeemable at our option for $25 per share. Dividends of $0.140625 per share are paid monthly in arrears on the Class E preferred stock.

Credit Ratings Upgrades

In February 2006, Moody’s Investors Service, Inc. affirmed our senior unsecured debt rating of Baa2 and our preferred stock rating of Baa3 and raised the outlook to “positive” from “stable.”

In December 2006, Standard & Poor’s Ratings Group affirmed our senior unsecured debt rating of BBB and our preferred stock rating of BBB- and raised the outlook to “positive” from “stable.”

Redemption of 2007 Notes

In September 2006, we redeemed all of our outstanding $110 million, 7-3/4%, unsecured notes due May 2007 (the “2007 Notes”). The 2007 Notes were redeemed at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest of $3.2 million and a make-whole payment of $1.6 million. We recorded a loss on extinguishment of debt totaling $1.6 million related to the make-whole payment associated with the 2007 Notes. For 2006, the make-whole payment represented approximately $0.017 per share.

Issuance of 10-Year Senior Unsecured Notes

In September 2006, we issued $275 million in aggregate principal amount of 5.95% senior unsecured notes due 2016 (the “2016 Notes”). The price to the investor for the 2016 Notes was 99.74% of the principal amount for an effective yield of 5.985%. The net proceeds of approximately $271.9 million from this offering were used to redeem the 2007 Notes and for other general corporate purposes. Interest on the 2016 Notes is paid semiannually.

Crest Property Sales

During 2006, Crest sold 13 properties from its inventory for an aggregate of $22.4 million, which resulted in a gain of $2.2 million. Crest’s gains are included in “income from discontinued operations, real estate acquired for resale by Crest.”

Crest Property Inventory

Crest’s property inventory at December 31, 2006 and December 31, 2005 totaled $137.5 million and $45.7 million, respectively, and is included in “real estate held for sale, net”, on our consolidated balance sheets.

Increases in Monthly Distributions to Common Stockholders

We continue our 37-year policy of paying distributions monthly to our common stockholders. Monthly distributions per share were increased in April 2006 by $0.000625 to $0.116875, in July 2006 by $0.000625 to $0.1175, in September 2006 by $0.00775 to $0.12525, in October 2006 by $0.000625 to $0.125875 and in January 2007 by $0.000625 to $0.1265. The increase in January 2007 was our 37th consecutive quarterly increase and the 42nd increase in the amount of our dividend since our listing on the New York Stock Exchange, or NYSE, in 1994. In 2006, we paid the following monthly cash distributions per share: three in the amount of $0.11625, three in the amount of $0.116875, two in the amount of $0.1175, one in the amount of $0.12525 and three in the amount of $0.125875, totaling $1.43725. In December 2006, January 2007 and February 2007, we declared distributions of $0.1265 per share, which were paid on January 16, 2007 and February 15, 2007 and will be paid on March 15, 2007, respectively.

The monthly distribution of $0.1265 per share represents a current annualized distribution of $1.518 per share, and an annualized distribution yield of approximately 5.2% based on the last reported sale price of our common stock on the NYSE of $29.09 on February 13, 2007. Although we expect to continue our policy of paying monthly distributions, we cannot guarantee that we will maintain the current level of distributions, that we will continue our pattern of increasing distributions per share, or what the actual distribution yield will be in any future period.

DISTRIBUTION POLICY

Distributions are paid monthly to our common stockholders and Class D and Class E preferred stockholders if, and when declared by our Board of Directors.

In order to maintain our tax status as a REIT for federal income tax purposes, we generally are required to distribute dividends to our stockholders aggregating annually at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and by excluding net capital gains) and we are subject to income tax to the extent we distribute less than 100% of our REIT taxable income (including net capital gains). In 2006, our cash distributions totaled $139.1 million, or approximately 113.3% of our estimated REIT taxable income of $122.8 million. Our estimated REIT taxable income reflects non-cash deductions for depreciation and amortization. We intend to continue to make distributions to our stockholders that are sufficient to meet this distribution requirement and that will reduce our exposure to income taxes. Our 2006 cash distributions to common stockholders totaled $129.7 million, representing 83.2% of our funds from operations available to common stockholders of $155.8 million.

The Class D preferred stockholders receive cumulative distributions at a rate of 7.375% per annum on the $25 per share liquidation preference (equivalent to $1.84375 per annum per share). The Class E preferred stockholders receive cumulative distributions at a rate of 6.75% per annum on the $25 per share liquidation preference (equivalent to $1.6875 per annum per share).

Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, cash flow from operations, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Tax Code, our debt service requirements and any other factors the Board of Directors may deem relevant. In addition, our credit facility contains financial covenants that could limit the amount of distributions payable by us in the event of a deterioration in our results of operations or financial condition, and which prohibit the payment of distributions on the common or preferred stock in the event that we fail to pay when due (subject to any applicable grace period) any principal or interest on borrowings under our credit facility.

Distributions of our current and accumulated earnings and profits for federal income tax purposes, generally will be taxable to stockholders as ordinary income, except to the extent that we recognize capital gains and declare a capital gains dividend or that such amounts constitute “qualified dividend income” subject to a reduced tax rate. The maximum tax rate of non-corporate taxpayers for “qualified dividend income” has generally been reduced to 15% (for taxable years beginning after December 31, 2002). In general, dividends payable by REITs are not eligible for the reduced tax rate on corporate dividends, except to the extent the REIT’s dividends are attributable to dividends received from taxable corporations (such as our taxable REIT subsidiary, Crest), to income that was subject to tax at the corporate or REIT level (for example, if we distribute taxable income that we retained and paid tax on in the prior taxable year) or, as discussed above, dividends properly designated by us as “capital gain dividends.” Distributions in excess of earnings and profits generally will be treated as a non-taxable reduction in the stockholders’ basis in the stock. Distributions above that basis, generally, will be taxable as a capital gain. Approximately 9.9% of the distributions to our common stockholders, made or deemed to have been made in 2006, were classified as a return of capital for federal income tax purposes. We are unable to predict the portion of future distributions that may be classified as a return of capital.

BUSINESS PHILOSOPHY AND STRATEGY

Investment Philosophy

We believe that owning an actively managed, diversified portfolio of retail properties under long-term, net leases produces consistent and predictable income. Net leases typically require the tenant to be responsible for minimum monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants are typically responsible for future rent increases based on increases in the consumer price index, fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level. We believe that a portfolio of properties under long-term leases, coupled with the tenant’s responsibility for property expenses, generally produces a more predictable income stream than many other types of real estate portfolios, while continuing to offer the potential for growth in rental income.

Investment Strategy

In identifying new properties for acquisition, our focus is generally on providing capital to retail chain owners and operators by acquiring, then leasing back, retail store locations. We categorize retail tenants as: 1) venture market, 2) middle market, and 3) upper market. Venture companies typically offer a new retail concept in one geographic region of the country and operate between five and 50 retail locations. Middle market retail chains typically have 50 to 500 retail locations, operations in more than one geographic region, have been successful through one or more economic cycles, and have a proven, replicable concept. The upper market retail chains typically consist of companies with 500 or more locations, operating nationally, in a proven, mature retail concept. Upper market retail chains generally have strong operating histories and access to several sources of capital.

Realty Income primarily focuses on acquiring properties leased to middle market retail chains that we believe are attractive for investment because:

• They generally have overcome many of the operational and managerial obstacles that can adversely affect venture retailers;

• They typically require capital to fund expansion but have more limited financing options;

• They generally have provided us with attractive risk-adjusted returns over time since their financial strength has, in many cases, tended to improve as their businesses have matured;

• Their relatively large size allows them to spread corporate expenses across a greater number of stores; and

• Middle market retailers typically have the critical mass to survive if a number of locations are closed due to underperformance.

We also focus on, and have selectively made investments in, properties of upper market retail chains. We believe upper market retail chains can be attractive for investment because:

• They typically are of a higher credit quality;

• They usually are larger public and private retailers with more commonly recognized brand names;

• They utilize a larger building ranging in size from 10,000 to 50,000 square feet; and

• They are able to grow because access to capital facilitates larger transaction sizes.

While our investment strategy focuses primarily on acquiring properties leased to middle and upper market retail chains, we also selectively seek investment opportunities with venture market retail chains. Periodically, venture market opportunities arise where we feel that the real estate used by the tenant is high quality and can be purchased at favorable prices. To meet our stringent investment standards, however, venture retail companies must have a well-defined retailing concept and strong financial prospects. These opportunities are examined on a case by case basis and we are highly selective in making investments in this area.

Historically, our investment focus has been on retail industries that have a service component because we believe the lease revenue from these types of businesses is more stable. Because of this investment focus, for the quarter ended December 31, 2006, approximately 80.9% of our rental revenue was derived from retailers with a service component in their business. Furthermore, we believe these service-oriented businesses would be

difficult to duplicate over the Internet and that our properties continue to perform well relative to competition from Internet businesses.

Credit Strategy

We generally provide sale-leaseback financing to less than investment grade retail chains. We typically acquire and lease back properties to regional and national retail chains and believe that within this market we can achieve an attractive risk-adjusted return on the financing we provide to retailers. Since 1970, our overall weighted average occupancy rate at the end of each year has been 98.6%, and the occupancy rate at the end of each year has never been below 97.5%.

We believe the principal financial obligations of most retailers typically include their bank and other debt, payment obligations to suppliers and real estate lease obligations. Because we typically own the land and building in which a tenant conducts its retail business, we believe the risk of default on a retailers’ lease obligations is less than the retailers’ unsecured general obligations. It has been our experience that since retailers must retain their profitable retail locations in order to survive, in the event of reorganization they are less likely to reject a lease for a profitable location because this would terminate their right to use the property. Thus, as the property owner, we believe we will fare better than unsecured creditors of the same retailer in the event of reorganization. If a property is rejected by the tenant during reorganization, we own the property and can either lease it to a new tenant or sell the property. In addition, we believe that the risk of default on the real estate leases can be further mitigated by monitoring the performance of the retailers’ individual unit locations and considering whether to sell locations that are weaker performers.

In order to qualify for inclusion in our portfolio, new property acquisitions must meet stringent investment and credit requirements. The properties must generate attractive current yields and the tenant must meet our credit profile. We have established a three-part analysis that examines each potential investment based on:

• Industry, company, market conditions and credit profile;

• Location profitability, if profitability data is available; and

• Overall real estate characteristics, including value and comparative rental rates.

The typical profile of companies whose properties have been approved for acquisition are those with 50 or more retail locations. Generally the properties:

• Are located in highly visible areas,

• Have easy access to major thoroughfares; and

• Have attractive demographics.

Acquisition Strategy

We seek to invest in industries in which several, well-organized, regional and national chains are capturing market share through service, quality control, economies of scale, advertising and the selection of prime retail locations. We execute our acquisition strategy by acting as a source of capital to regional and national retail chain store owners and operators, doing business in a variety of industries, by acquiring and leasing back retail store locations. We undertake thorough research and analysis to identify appropriate industries, tenants and property locations for investment. Our research expertise is instrumental to uncovering net-lease opportunities in markets where our real estate financing program adds value. In selecting real estate for potential investment, we generally seek to acquire properties that have the following characteristics:

• Freestanding, commercially-zoned property with a single tenant;

• Properties that are important retail locations for regional and national retail chains;

• Properties that are located within attractive demographic areas relative to the business of their tenants, with high visibility and easy access to major thoroughfares; and

• Properties that can be purchased with the simultaneous execution or assumption of long-term, net-lease agreements, offering both current income and the potential for rent increases.

Portfolio Management Strategy

The active management of the property portfolio is an essential component of our long-term strategy. We continually monitor our portfolio for any changes that could affect the performance of the industries, tenants and

locations in which we have invested. The portfolio is regularly analyzed with a view toward optimizing its returns and enhancing its credit quality. Our executives review industry research, tenant research, property due diligence and significant portfolio management activities. This monitoring typically includes regular review and analysis of:

• The performance of various retail industries; and

• The operation, management, business planning and financial condition of the tenants.

We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment of the sales proceeds will generate higher returns, enhance the credit quality of our real estate portfolio, or extend our average remaining lease term. At December 31, 2006, we classified real estate with a carrying amount of $138 million as held for sale, which includes $137.5 million in properties owned by Crest. Additionally, we anticipate selling investment properties from our portfolio that have not yet been specifically identified from which we anticipate receiving between $10 million and $35 million in proceeds during the next 12 months. We intend to invest these proceeds into new property acquisitions. However, we cannot guarantee that we will sell properties during the next 12 months.

Universal Shelf Registration

In April 2006, we filed a shelf registration statement with the SEC, which is effective for a term of three years. In accordance with the SEC rules, the amount of securities to be issued pursuant to this shelf registration statement was not specified when it was filed. The securities covered by this registration statement include common stock, preferred stock, debt securities, or any combination of such securities. Realty Income may periodically offer one or more of these securities in amounts, prices and on terms to be announced when and if the securities are offered. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of any offering. As such, there is no specific limit to the dollar amount of new securities that can be issued under this new shelf registration before it expires in April 2009. The common stock issued in September 2006, October 2006 and November 2006, the 2016 Notes issued in September 2006 and the Class E preferred stock issued in December 2006 were issued pursuant to our universal shelf registration statement.

Conservative Capital Structure

We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and fixed charge coverage ratios. At February 13, 2007, our total outstanding credit facility borrowings and outstanding notes were $920 million or approximately 21.9% of our total market capitalization of $4.21 billion. We calculate our total market capitalization at February 13, 2007 as the sum of:

• Shares of our common stock outstanding of 101,000,536 multiplied by the last reported sales price of our common stock on the NYSE of $29.09 per share, or $2.94 billion;

• Aggregate liquidation value of the Class D preferred stock of $127.5 million;

• Aggregate liquidation value of the Class E preferred stock of $220 million; and

• Outstanding notes of $920 million.

Historically, we have met our long-term capital needs through the issuance of common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that the majority of our future securities issuances should be in the form of common stock, however, we may issue additional preferred stock or debt securities from time to time. We may issue common stock when we believe that our share price is at a level that allows for the proceeds of any offering to be accretively invested into additional properties. In addition, we may issue common stock to permanently finance properties that were financed by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at terms that are acceptable to us.

We have a $300 million revolving, unsecured credit facility that expires in October 2008. Realty Income’s current investment grade credit ratings provide for financing under the credit facility at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 65 basis points with a facility fee of 15 basis points, for all-in drawn pricing of 80 basis points over LIBOR. At February 13, 2007, we had borrowing capacity of $300 million available on our credit facility and no outstanding balance.

The credit facility is expected to be used to acquire additional retail properties and for other corporate purposes. Any additional borrowings will increase our exposure to interest rate risk. We have the right to request an increase in the borrowing capacity of the credit facility by up to $100 million, to a total borrowing capacity of $400 million. Any increase in the borrowing capacity is subject to approval by the lending banks of our credit facility.

We use our credit facility for the short-term financing of new property acquisitions. When outstanding borrowings under the credit facility reach a certain level (generally in the range of $100 million to $200 million) and capital is available on acceptable terms, we generally seek to refinance those borrowings with the net proceeds of long-term or permanent financing, which may include the issuance of common stock, preferred stock, convertible preferred stock, debt securities or convertible debt securities. We cannot assure you, however, that we will be able to obtain any such refinancing or that market conditions prevailing at the time of refinancing will enable us to issue equity or debt securities upon acceptable terms.

We are currently assigned investment grade corporate credit ratings, on our senior unsecured notes, from Fitch Ratings, Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Group. Currently, Fitch Ratings has assigned a rating of BBB+, Moody’s has assigned a rating of Baa2 and Standard & Poor’s has assigned a rating of BBB to our senior notes. Moody’s and Standard & Poor’s ratings have “positive” outlooks and Fitch has a “stable” outlook.

We have also been assigned investment grade credit ratings from the same rating agencies on our preferred stock. Fitch Ratings has assigned a rating of BBB, Moody’s has assigned a rating of Baa3 and Standard & Poor’s has assigned a rating of BBB- to our preferred stock. Moody’s and Standard & Poor’s ratings have “positive” outlooks and Fitch has a “stable” outlook.

The credit ratings assigned to us could change based upon, among other things, our results of operations and financial condition. These ratings are subject to ongoing evaluation by credit rating agencies and we cannot assure you that any such rating will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. Moreover, a rating is not a recommendation to buy, sell or hold our debt securities, preferred stock or common stock.

We have no mortgage debt on any of our properties.

No Off-Balance Sheet Arrangements or Unconsolidated Investments

Realty Income and its subsidiaries have no unconsolidated or off-balance sheet investments in “variable interest entities” or off-balance sheet financing, nor do we engage in trading activities involving energy or commodity contracts or other derivative instruments.

As we have no joint ventures, off-balance sheet entities, or mandatory redeemable preferred stock, our financial position and results of operations are currently not affected by Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities and Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.

Competitive Strategy

We believe that to successfully pursue our investment philosophy and strategy, we must seek to maintain the following competitive advantages:

• Size and Type of Investment Properties: We believe smaller ($500,000 to $10,000,000) net-leased retail properties represent an attractive investment opportunity in today’s real estate environment. Due to the complexities of acquiring and managing a large portfolio of relatively small assets, we believe these types of properties have not experienced significant institutional ownership interest or the corresponding yield reduction experienced by larger income-producing properties. We believe the less intensive day-to-day property management required by net-lease agreements, coupled with the active management of a large portfolio of smaller properties, is an effective investment strategy. The tenants of our freestanding retail properties generally provide goods and services that satisfy basic consumer needs. In order to grow and

expand, they generally need capital. Since the acquisition of real estate is typically the single largest capital expenditure of many of these retailers, our method of purchasing the property and then leasing it back, under a net-lease arrangement, allows the retail chain to free up capital.

• Investment in New Retail Industries: Though we specialize in single-tenant properties, we will seek to further diversify our portfolio among a variety of retail industries. We believe diversification will allow us to invest in retail industries that currently are growing and have characteristics we find attractive. These characteristics include, but are not limited to, retail industries that are dominated by local store operators where regional and national chain store operators can increase market share and dominance by consolidating local operators and streamlining their operations, as well as capitalizing on major demographic shifts in a population base.

• Diversification: Diversification of the portfolio by retail industry type, tenant, and geographic location is key to our objective of providing predictable investment results for our stockholders, therefore further diversification of our portfolio is a continuing objective. At December 31, 2006, our retail property portfolio consisted of 1,955 properties located in 48 states, leased to 103 retail chains doing business in 29 industry segments. Each of the 29 industry segments, represented in our property portfolio, individually accounted for no more than 17.8% of our rental revenue for the quarter ended December 31, 2006.

• Management Specialization: We believe that our management’s specialization in single-tenant retail properties, operated under net-lease agreements, is important to meeting our objectives. We plan to maintain this specialization and will seek to employ and train high-quality professionals in this specialized area of real estate ownership, finance and management.

• Technology: We intend to stay at the forefront of technology in our efforts to efficiently and economically carry out our operations. We maintain sophisticated information systems that allow us to analyze our portfolio’s performance and actively manage our investments. We believe that technology and information-based systems will play an increasingly important role in our competitiveness as an investment manager and source of capital to a variety of industries and tenants.

PROPERTIES

At December 31, 2006, we owned a diversified portfolio:

• Of 1,955 retail properties;

• With an occupancy rate of 98.7%, or 1,929 properties occupied of the 1,955 properties in the portfolio;

• Leased to 103 different retail chains doing business in 29 separate retail industries;

• Located in 48 states;

• With over 16.7 million square feet of leasable space; and

• With an average leasable retail space per property of approximately 8,600 square feet.

In addition to our real estate portfolio at December 31, 2006, our subsidiary, Crest had invested $137.5 million in 60 properties located in 15 states. These properties are classified as held for sale.

At December 31, 2006, 1,923, or 98.4%, of our 1,955 retail properties were leased under net-lease agreements. Net leases typically require the tenant to be responsible for minimum monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants are typically responsible for future rent increases based on increases in the consumer price index, fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level.

Our net-leased retail properties primarily are leased to regional and national retail chain store operators. Most buildings are single-story structures with adequate parking on site to accommodate peak retail traffic periods. The properties tend to be on major thoroughfares with relatively high traffic counts, adequate access and proximity to a sufficient population base to constitute a suitable market or trade area for the retailer’s business.

Industry Diversification

The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest) classified according to the business of the respective tenants, expressed as a percentage of our total rental revenue:

	Percentage of Rental Revenue (1)
	For the Quarter Ended		For the Years Ended
Industries	Dec. 31, 2006		Dec 31, 2006		Dec 31, 2005		Dec 31, 2004		Dec 31, 2003		Dec 31, 2002		Dec 31, 2001
Apparel stores	2.3	%	1.7	%	1.6	%	1.8	%	2.1	%	2.3	%	2.4	%
Automotive collision services	1.2		1.3		1.3		1.0		0.3		—		—
Automotive parts	2.7		2.8		3.4		3.8		4.5		4.9		5.7
Automotive service	5.4		6.9		7.6		7.7		8.3		7.0		5.7
Automotive tire services	6.2		6.1		7.2		7.8		3.1		2.7		2.6
Book stores	0.2		0.2		0.3		0.3		0.4		0.4		0.4
Business services	*		0.1		0.1		0.1		0.1		0.1		0.1
Child care	8.9		10.3		12.7		14.4		17.8		20.8		23.9
Consumer electronics	1.0		1.1		1.3		2.1		3.0		3.3		4.0
Convenience stores	14.1		16.1		18.7		19.2		13.3		9.1		8.4
Crafts and novelties	0.3		0.4		0.4		0.5		0.6		0.4		0.4
Drug stores	2.8		2.9		2.8		0.1		0.2		0.2		0.2
Entertainment	1.4		1.6		2.1		2.3		2.6		2.3		1.8
Equipment rental services	0.2		0.2		0.4		0.3		0.2		—		—
Financial services	0.1		0.1		0.1		0.1		—		—		—
General merchandise	0.8		0.6		0.5		0.4		0.5		0.5		0.6
Grocery stores	0.8		0.7		0.7		0.8		0.4		0.5		0.6
Health and fitness	4.1		4.3		3.7		4.0		3.8		3.8		3.6
Home furnishings	2.8		3.1		3.7		4.1		4.9		5.4		6.0
Home improvement	4.2		3.4		1.1		1.0		1.1		1.2		1.3
Motor vehicle dealerships	3.4		3.4		2.6		0.6		—		—		—
Office supplies	1.2		1.3		1.5		1.6		1.9		2.1		2.2
Pet supplies and services	0.9		1.1		1.3		1.4		1.7		1.7		1.6
Private education	0.8		0.8		0.8		1.1		1.2		1.3		1.5
Restaurants	17.8		11.9		9.4		9.7		11.8		13.5		12.2
Shoe stores	—		—		0.3		0.3		0.9		0.8		0.7
Sporting goods	2.6		2.9		3.4		3.4		3.8		4.1		0.9
Theaters	9.4		9.6		5.2		3.5		4.1		3.9		4.3
Travel plazas	0.3		0.3		0.3		0.4		0.3		—		—
Video rental	1.8		2.1		2.5		2.8		3.3		3.3		3.7
Other	2.3		2.7		3.0		3.4		3.8		4.4		5.2
Totals	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

* Less than 0.1%

(1) Includes rental revenue for all properties owned by Realty Income at the end of each period presented, including revenue from properties reclassified to discontinued operations.

Service Category Diversification

The following table sets forth certain information regarding the properties owned by Realty Income (excluding properties owned by Crest) at December 31, 2006, classified according to the retail business types and the level of services they provide (dollars in thousands):

		Rental Revenue
		for the Quarter		Percentage of
	Number of	Ended		Rental
Industry	Properties	Dec. 31, 2006 (1)		Revenue
Tenants Providing Services
Automotive collision services	13	$	825	1.2	%
Automotive service	219	3,689		5.4
Child care	268	6,063		8.9
Entertainment	8	970		1.4
Equipment rental services	2	150		0.2
Financial services	4	84		0.1
Health and fitness	16	2,760		4.1
Private education	6	574		0.8
Theaters	31	6,409		9.4
Other	10	1,531		2.3
	577	23,055		33.8
Tenants Selling Goods and Services
Automotive parts (with installation)	30	583		0.9
Automotive tire services	149	4,229		6.2
Business services	1	32		*
Convenience stores	393	9,611		14.1
Home improvement	1	1,154		1.7
Motor vehicle dealerships	21	2,348		3.4
Pet supplies and services	9	595		0.9
Restaurants	471	12,158		17.8
Travel plazas	1	170		0.3
Video rental	34	1,235		1.8
	1,110	32,115		47.1
Tenants Selling Goods
Apparel stores	6	1,567		2.3
Automotive parts	73	1,214		1.8
Book stores	2	159		0.2
Consumer electronics	21	678		1.0
Crafts and novelties	4	212		0.3
Drug stores	34	1,943		2.8
General merchandise	25	518		0.8
Grocery stores	7	557		0.8
Home furnishings	40	1,905		2.8
Home improvement	31	1,684		2.5
Office supplies	10	788		1.2
Pet supplies	2	37		*
Sporting goods	13	1,769		2.6
	268	13,031		19.1
Totals	1,955	$	68,201	100.0	%

* Less than 0.1%

(1) Includes rental revenue for all properties owned by Realty Income at December 31, 2006, including revenue from properties reclassified to discontinued operations of $8.

Lease Expirations

The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest) regarding the timing of the initial lease term expirations (excluding extension options) on our 1,923 net leased, single-tenant retail properties as of December 31, 2006 (dollars in thousands):

	Total Portfolio					Initial Expirations (3)					Subsequent Expirations (4)
Year	Total Number of Leases Expiring (1)	Rental Revenue for the Quarter Ended 12/31/06 (2)		% of Total Rental Revenue		Number of Leases Expiring	Rental Revenue for the Quarter Ended 12/31/06		% of Total Rental Revenue		Number of Leases Expiring	Rental Revenue for the Quarter Ended 12/31/06		% of Total Rental Revenue
2007	139	$	2,624	4.0	%	92	$	1,795	2.7	%	47	$	829	1.3	%
2008	117	2,568		3.9		63	1,551		2.4		54	1,017		1.5
2009	107	2,330		3.5		33	789		1.2		74	1,541		2.3
2010	74	2,680		4.1		36	2,011		3.1		38	669		1.0
2011	81	3,175		4.8		46	1,672		2.5		35	1,503		2.3
2012	47	1,407		2.1		43	1,354		2.0		4	53		0.1
2013	75	3,411		5.1		67	3,196		4.8		8	215		0.3
2014	48	1,996		3.0		36	1,755		2.6		12	241		0.4
2015	90	1,968		3.0		65	1,409		2.2		25	559		0.8
2016	112	1,823		2.8		111	1,796		2.7		1	27		0.1
2017	23	1,638		2.5		19	1,570		2.4		4	68		0.1
2018	23	1,068		1.6		23	1,068		1.6		—	—		—
2019	94	4,651		7.0		93	4,457		6.7		1	194		0.3
2020	82	3,200		4.8		80	3,167		4.8		2	33		*
2021	145	5,977		9.0		144	5,240		7.9		1	737		1.1
2022	97	2,597		3.9		95	2,597		3.9		2	—		—
2023	233	6,453		9.7		232	6,427		9.7		1	26		*
2024	59	1,851		2.8		59	1,851		2.8		—	—		—
2025	68	6,317		9.5		64	6,254		9.4		4	63		0.1
2026	182	6,810		10.3		180	6,771		10.2		2	39		0.1
2027	12	440		0.7		12	440		0.7		—	—		—
2028	5	95		0.1		5	95		0.1		—	—		—
2030	2	240		0.4		2	240		0.4		—	—		—
2033	3	357		0.5		3	357		0.5		—	—		—
2034	2	230		0.4		2	230		0.4		—	—		—
2037	2	325		0.5		2	325		0.5		—	—		—
2043	1	13		*		—	—		—		1	13		*

Totals	1,923	$	66,244	100.0	%	1,607	$	58,417	88.2	%	316	$	7,827	11.8	%

*Less than 0.1%

(1) Excludes six multi-tenant properties and 26 vacant unleased properties, one of which is a multi-tenant property. The lease expirations for properties under construction are based on the estimated date of completion of those properties.

(2) Includes rental revenue of $8 from properties reclassified to discontinued operations and excludes revenue of $1,957 from six multi-tenant properties and from 26 vacant unleased properties at December 31, 2006.

(3) Represents leases to the initial tenant of the property that are expiring for the first time.

(4) Represents lease expirations on properties in the portfolio, which have previously been renewed, extended or re-tenanted.

State Diversification

The following table sets forth certain state-by-state information regarding Realty Income’s property portfolio (excluding properties owned by Crest) as of December 31, 2006 (dollars in thousands):

					Rental Revenue
				Approximate	For the Quarter		Percentage of
	Number of	Percent		Leasable	Ended Dec 31,		Rental
State	Properties	Leased		Square Feet	2006 (1)		Revenue
Alabama	61	98	%	422,900	$	1,255	1.8	%
Alaska	2	100		128,500	271		0.4
Arizona	71	100		344,500	1,989		2.9
Arkansas	15	100		94,500	1,041		1.5
California	61	98		1,101,900	3,929		5.8
Colorado	47	96		418,200	1,776		2.6
Connecticut	16	100		245,600	1,019		1.5
Delaware	15	100		27,700	316		0.5
Florida	151	99		1,374,600	5,509		8.1
Georgia	127	99		910,700	3,430		5.0
Idaho	14	100		91,900	369		0.5
Illinois	62	100		769,200	3,501		5.1
Indiana	46	96		471,500	1,878		2.8
Iowa	19	100		138,600	391		0.6
Kansas	29	90		562,200	947		1.4
Kentucky	22	95		111,500	600		0.9
Louisiana	32	100		186,600	757		1.1
Maryland	25	100		230,000	1,197		1.8
Massachusetts	37	100		203,100	999		1.5
Michigan	20	100		158,300	573		0.8
Minnesota	21	100		359,200	1,278		1.9
Mississippi	70	96		353,800	1,317		1.9
Missouri	61	98		634,800	1,919		2.8
Montana	2	100		30,000	77		0.1
Nebraska	17	100		190,100	608		0.9
Nevada	15	100		191,000	849		1.3
New Hampshire	10	100		95,400	383		0.6
New Jersey	25	100		194,500	1,440		2.1
New Mexico	7	100		53,300	159		0.2
New York	28	96		419,400	2,022		3.0
North Carolina	60	100		433,000	1,874		2.8
North Dakota	5	100		31,900	68		0.1
Ohio	109	100		704,900	2,671		3.9
Oklahoma	24	100		133,300	552		0.8
Oregon	19	100		294,800	842		1.2
Pennsylvania	84	100		521,500	2,449		3.6
Rhode Island	1	100		3,500	29		*
South Carolina	59	100		250,700	1,531		2.3
South Dakota	7	100		18,300	76		0.1
Tennessee	126	100		607,800	2,816		4.1
Texas	202	98		2,274,700	9,480		13.9
Utah	6	83		35,100	96		0.1
Vermont	1	100		2,500	22		*
Virginia	67	100		485,900	2,497		3.7
Washington	37	100		243,900	751		1.1
West Virginia	2	50		23,200	30		*
Wisconsin	17	94		157,400	600		0.9
Wyoming	1	100		4,200	18		*
Totals/Average	1,955	99	%	16,740,100	$	68,201	100.0	%

* Less than 0.1%

(1) Includes rental revenue for all properties owned by Realty Income at December 31, 2006, including revenue from properties reclassified to discontinued operations of $8.

Description of Leasing Structure

At December 31, 2006, 1,923 single tenant and certain other retail properties or 98.4% of our 1,955 properties were net leased. In most cases, the leases:

• Are for initial terms of 15 to 20 years;

• Require the tenants to pay minimum monthly rents and property operating expenses (taxes, insurance and maintenance); and

• Provide for future rent increases based on increases in the consumer price index, fixed increases, or to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level. Where leases provide for rent increases based on increases in the consumer price index, generally these increases become part of the new permanent base rent. Where leases provide for percentage rent, this additional rent is typically payable only if the tenants’ gross sales, for a given period (usually one year), exceed a specified level and is then typically calculated as a percentage of only the amount of gross sales in excess of that level.

Matters Pertaining to Certain Properties and Tenants

Of the 26 properties available for lease or sale at December 31, 2006, all are single-tenant properties except one. At December 31, 2006, 16 of our properties under lease were unoccupied and available for sublease by the tenants, all of which were current with their rent and other obligations. During 2006, each of our tenants accounted for less than 10% of our rental revenue.

Certain Properties Under Development

Of the 322 properties Realty Income acquired in 2006, all were occupied at December 31, 2006, except for four properties that were leased and being developed. In the case of development properties, we either enter into an agreement with a retail chain where the retailer retains a contractor to construct the building and we fund the costs of that development, or we fund a developer who constructs the building. In either case, there is an executed lease with a retail tenant at the time of the land purchase (with a fixed rent commencement date) and there is a requirement to complete the construction in a timely basis and within a specific budget, typically within eight months after we purchase the land. The tenant or developer generally is required to pay construction cost overruns to the extent that they exceed the construction budget by more than a predetermined amount. We also enter into a lease with the tenant at the time we purchase the land, which generally requires the tenant to begin paying base rent when the store opens for business. The base rent is calculated by multiplying a predetermined capitalization rate by our total investment in the property including the land cost for the property, construction costs and capitalized interest. In 2006, Realty Income acquired 15 development properties. Crest did not acquire any development property in 2006. Both Realty Income and Crest will continue to pursue development opportunities under similar arrangements in the future.

Item 1A: Risk Factors

As used under this caption “Risk Factors,” references to our capital stock include our common stock and any class or series of our preferred stock and references to our stockholders include holders of our common stock or any class or series of our preferred stock, in each case unless otherwise expressly stated or the context otherwise requires.

In order to grow we need to continue to acquire investment properties which may be subject to competitive pressures.

We face competition in the acquisition, operation and sale of property. We expect competition from:

• Businesses;

• Individuals;

• Fiduciary accounts and plans; and

• Other entities engaged in real estate investment and financing.

Some of these competitors are larger than we are and have greater financial resources. This competition may result in a higher cost for properties we wish to purchase.

Our tenants’ creditworthiness and ability to pay rent may be affected by competition within their industries from other operators.

The tenants leasing our properties can face significant competition from other operators. This competition may adversely impact:

• That portion, if any, of the rental stream to be paid to us based on a tenant’s revenues; and

• The tenants’ results of operations or financial condition.

As a property owner, we may be subject to unknown environmental liabilities.

Investments in real property can create a potential for environmental liability. An owner of property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. We can face such liability regardless of:

• Our knowledge of the contamination;

• The timing of the contamination;

• The cause of the contamination; or

• The party responsible for the contamination of the property.

There may be environmental problems of which we are unaware associated with our properties. In that regard, a number of our properties are leased to operators of convenience stores that sell petroleum-based fuels, as well as to operators of oil change and tune-up facilities. These facilities, and some other of our properties, use, or may have used in the past, underground lifts or underground tanks for the storage of petroleum-based or waste products, which could create a potential for release of hazardous substances.

The presence of hazardous substances on a property may adversely affect our ability to sell that property and we may incur substantial remediation costs. Although our leases generally require our tenants to operate in compliance with all applicable federal, state and local environmental laws, ordinances and regulations, and to indemnify us against any environmental liabilities arising from the tenants’ activities on the property, we could nevertheless be subject to strict liability by virtue of our ownership interest. There also can be no assurance that our tenants could or would satisfy their indemnification obligations under their leases. The discovery of environmental liabilities attached to our properties could have an adverse effect on our results of operations, our financial condition or our ability to make distributions to stockholders and to pay the principal of and interest on our debt securities and other indebtedness.

In addition, several of our properties were built during the period when asbestos was commonly used in building construction and other buildings with asbestos may be acquired by the Company in the future. Environmental laws govern the presence, maintenance and removal of asbestos-containing materials, or ACMs, and require that owners or operators of buildings containing asbestos properly manage and maintain the asbestos, that they adequately inform or train those who may come into contact with asbestos and that they undertake special precautions, including removal or other abatement in the event that asbestos is disturbed during renovation or demolition of a building. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.

Compliance. We have not been notified by any governmental authority, and are not otherwise aware, of any material noncompliance, liability or claim relating to hazardous substances, toxic substances, or petroleum products in connection with any of our present properties. Nevertheless, if environmental contamination should exist, we could be subject to strict liability by virtue of our ownership interest. In addition, we believe we are in compliance in all material respects with all present federal, state and local laws relating to ACMs.

Insurance and Indemnity. In June 2005, we entered into a seven-year environmental insurance policy on our property portfolio which replaced the previous five-year environmental insurance policy. The limits on our current policy are $10 million per occurrence, and $50 million in the aggregate, subject to a $40,000 self insurance retention, per occurrence, for properties with underground storage tanks and a $100,000 self insurance retention, per occurrence, for all other properties. It is possible that our insurance could be insufficient to address any particular environmental situation and that, in the future, we could be unable to obtain insurance for environmental matters at a reasonable cost, or at all.

Our tenants are generally responsible for and indemnify us against liabilities for environmental matters that occur on our properties. For properties that have underground storage tanks, in addition to providing an indemnity in our favor, the tenants generally obtain environmental insurance or rely upon the state funds in the states where these properties are located.

If we fail to qualify as a real estate investment trust, the amount of dividends we are able to pay would decrease, which could adversely affect the market price of our capital stock and could adversely affect the value of our debt securities.

Commencing with our taxable year ended December 31, 1994, we believe that we have been organized and have operated, and we intend to continue to operate, so as to qualify as a “REIT” under Sections 856 through 860 of the Code. However, we cannot assure you that we have been organized or have operated in a manner that has satisfied the requirements for qualification as a REIT, or that we will continue to be organized or operate in a manner that will allow us to continue to qualify as a REIT.

Qualification as a REIT involves the satisfaction of numerous requirements under highly technical and complex Code provisions, for which there are only limited judicial and administrative interpretations, and the determination of various factual matters and circumstances not entirely within our control.

For example, in order to qualify as a REIT, at least 95% of our gross income in each year must be derived from qualifying sources, and we must pay distributions to stockholders aggregating annually at least 90% of our REIT taxable income (as defined in the Code and determined without regard to the dividends paid deduction and by excluding net capital gains).

In the future, it is possible that legislation, new regulations, administrative interpretations or court decisions will change the tax laws with respect to qualification as a REIT, or the federal income tax consequences of such qualification.

If we fail to satisfy all of the requirements for qualifications as a REIT, we may be subject to certain penalty taxes or, in some circumstances, we may fail to qualify as a REIT. If we were to fail to qualify as a REIT in any taxable year:

• We would be required to pay federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates;

• We would not be allowed a deduction in computing our taxable income for amounts distributed to our stockholders;

• We could be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost;

• We would no longer be required to make distributions to stockholders; and

• This treatment would substantially reduce amounts available for investment or distribution to stockholders because of the additional tax liability for the years involved, which could have a material adverse effect on the market price of our capital stock and the value of our debt securities.

Even if we qualify for and maintain our REIT status, we may be subject to certain federal, state and local taxes on our income and property. For example, if we have net income from a prohibited transaction, that income will be subject to a 100% tax. Our subsidiary Crest is subject to federal and state taxes at the applicable tax rates on its income and property.

Distributions requirements imposed by law limit our flexibility.

To maintain our status as a REIT for federal income tax purposes, we generally are required to distribute to our stockholders at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and by excluding net capital gains each year. We also are subject to tax at regular corporate rates to the extent that we distribute less than 100% of our REIT taxable income (including net capital gains) each year.

In addition, we are subject to a 4% nondeductible excise tax to the extent that we fail to distribute during any calendar year at least the sum of 85% of our ordinary income for that calendar year, 95% of our capital gain net income for the calendar year, and any amount of that income that was not distributed in prior years.

We intend to continue to make distributions to our stockholders to comply with the distribution requirements of the Code as well as to reduce our exposure to federal income taxes and the nondeductible excise tax. Differences in timing between the receipt of income and the payment of expenses to arrive at taxable income, along with the effect of required debt amortization payments, could require us to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT.

Future issuances of equity securities could dilute the interest of holders of our common stock.

Our future growth will depend, in large part, upon our ability to raise additional capital. If we were to raise additional capital through the issuance of equity securities, we could dilute the interests of holders of our common stock. The interests of our common stockholders could also be diluted by the issuance of shares of common stock upon the exercise of outstanding options or pursuant to stock incentive plans. Likewise, our Board of Directors is authorized to cause us to issue preferred stock of any class or series (with dividend, voting and other rights as determined by the Board of Directors). Accordingly, the Board of Directors may authorize the issuance of preferred stock with voting, dividend and other similar rights that could dilute, or otherwise adversely affect, the interests of holders of our common stock.

We are subject to risks associated with debt and capital stock financing.

We intend to incur additional indebtedness in the future, including borrowings under our $300 million acquisition credit facility. At February 13, 2007, we had no borrowings outstanding under our $300 million acquisition credit facility and a total of $920 million aggregate principal amount of outstanding unsecured senior debt securities. To the extent that new indebtedness is added to our current debt levels, the related risks that we now face would increase. As a result, we are and will be subject to risks associated with debt financing, including the risk that our cash flow could be insufficient to meet required payments on our debt. We also face variable interest rate risk as the interest rate on our $300 million credit facility is variable and could therefore increase over time. We also face the risk that we may be unable to refinance or repay our debt as it comes due. In addition, our $300 million credit facility contains financial covenants that could limit the amount of distributions payable by us on our common stock and preferred stock in the event of deterioration in our results of operations or financial condition, and our $300 million credit facility provides that, in the event of a failure to pay principal of or interest on borrowings there under when due (subject to any applicable grace period), we and our subsidiaries may not pay any dividends on our capital stock, including our outstanding common and preferred stock. If this were to occur, it would likely have an adverse effect on the market price of our outstanding common and preferred stock and on the value of our debt securities.

Our indebtedness could also have other important consequences to holders of our common and preferred stock, including:

• Increasing our vulnerability to general adverse economic and industry conditions;

• Limiting our ability to obtain additional financing to fund future working capital, capital expenditures and other general corporate requirements;

• Requiring the use of a substantial portion of our cash flow from operations for the payment of principal, and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund working capital, capital expenditures and general corporate requirements;

• Limiting our flexibility in planning for, or reacting to, changes in our business and our industry; and

• Putting us at a disadvantage compared to our competitors with less indebtedness.

Our business operations may not generate the cash needed to make distributions on our capital stock or to service our indebtedness.

Our ability to make distributions on our common stock and preferred stock and payments on our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to make distributions on our common stock and preferred stock, to pay our indebtedness or to fund our other liquidity needs.

The market value of our capital stock and debt securities could be substantially affected by various factors.

The market value of our capital stock and debt securities will depend on many factors, which may change from time to time, including:

• Prevailing interest rates, increases in which may have an adverse effect on the market value of our capital stock and our debt securities;

• The market for similar securities issued by REITs;

• General economic and financial market conditions;

• The financial condition, performance and prospects of us and our competitors;

• Changes in financial estimates or recommendations by securities analysts with respect to us, our competitors or our industry;

• Changes in our credit ratings; and

• Actual or anticipated variations in quarterly operating results.

As a result of these and other factors, investors who purchase our capital stock and debt securities may experience a decrease, which could be substantial, in the market value of our capital stock and debt securities, including decreases unrelated to our operating performance or prospects.

Real estate ownership is subject to particular economic conditions that may have a negative impact on our revenue.

We are subject to all of the general risks associated with the ownership of real estate. In particular, we face the risk that rental revenue from our properties may be insufficient to cover all corporate operating expenses, debt service payments on indebtedness we incur and distributions on our stock. Additional real estate ownership risks include:

• Adverse changes in general or local economic conditions;

• Changes in supply of, or demand for, similar or competing properties;

• Changes in interest rates and operating expenses;

• Competition for tenants;

• Changes in market rental rates;

• Inability to lease properties upon termination of existing leases;

• Renewal of leases at lower rental rates;

• Inability to collect rents from tenants due to financial hardship, including bankruptcy;

• Changes in tax, real estate, zoning and environmental laws that may have an adverse impact upon the value of real estate;

• Uninsured property liability;

• Property damage or casualty losses;

• Unexpected expenditures for capital improvements or to bring properties into compliance with applicable federal, state and local laws;

• Acts of terrorism and war; and

• Acts of God and other factors beyond the control of our management.

An uninsured loss or a loss that exceeds the policy limits on our properties could subject us to lost capital or revenue on those properties.

Under the terms and conditions of the leases currently in force on our properties, tenants generally are required to indemnify and hold us harmless from liabilities resulting from injury to persons, air, water, land or property, due to activities conducted on the properties, except for claims arising from the negligence or intentional misconduct of us or our agents. Additionally, tenants are generally required, at the tenant’s expense, to obtain and keep in full force during the term of the lease, liability and property damage insurance policies. The insurance policies our tenants are required to maintain for property damage are generally in amounts not less than the full replacement cost of the improvements less slab, foundations, supports and other customarily excluded improvements. Our tenants are generally required to maintain general liability coverage varying between $1,000,000 and $10,000,000 depending on the tenant and the industry in which it operates.

In addition to the indemnities and required insurance policies identified above, many of our properties are also covered by flood and earthquake insurance policies (subject to substantial deductibles) obtained and paid for by

the tenants as part of their risk management programs. Additionally, we have obtained blanket liability, flood and earthquake (subject to substantial deductibles) and property damage insurance policies to protect us and our properties against loss should the indemnities and insurance policies provided by the tenants fail to restore the properties to their condition prior to a loss. However, should a loss occur that is uninsured or in an amount exceeding the combined aggregate limits for the policies noted above, or in the event of a loss that is subject to a substantial deductible under an insurance policy, we could lose all or part of our capital invested in, and anticipated revenue from, one or more of the properties, which could have a material adverse effect on our results of operations or financial condition and on our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions to our stockholders.

Compliance with the Americans With Disabilities Act of 1990 and fire, safety, and other regulations may require us to make unintended expenditures that could adversely impact our results of operation.

Our properties are generally required to comply with the Americans with Disabilities Act of 1990, or the ADA. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities,” but generally requires that buildings be made accessible to people with disabilities. Compliance with the ADA requirements could require removal of access barriers and non-compliance could result in imposition of fines by the U.S. government or an award of damages to private litigants. The retailers to whom we lease properties are obligated by law to comply with the ADA provisions, and we believe that these retailers may be obligated to cover costs associated with compliance. If required changes involve greater expenditures than anticipated, or if the changes must be made on a more accelerated basis than anticipated, the ability of these retailers to cover costs could be adversely affected and we could be required to expend our own funds to comply with the provisions of the ADA, which could materially adversely affect our results of operations or financial condition and our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions to our stockholders. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties. We may be required to make substantial capital expenditures to comply with those requirements and these expenditures could materially adversely affect our results of operations or financial condition and our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions to our stockholders.

Property taxes may increase without notice.

The real property taxes on our properties and any other properties that we develop or acquire in the future may increase as property tax rates change and as those properties are assessed or reassessed by tax authorities.

Matters pertaining to certain properties and tenants.

Twenty-six of our properties were available for lease or sale at December 31, 2006, of which all but one were single-tenant properties. As of February 13, 2007, transactions to lease or sell four of the 26 properties available for lease at December 31, 2006 were underway or completed. At December 31, 2006, 16 of our properties under lease were unoccupied and available for sublease by the tenants, all of which were current with their rent and other obligations.

For 2006, our tenants in the convenience store, restaurant and child care industries accounted for approximately 16.1%, 11.9% and 10.3%, respectively, of our rental revenue. A downturn in any of these industries, whether nationwide or limited to specific sectors of the United States, could adversely affect tenants in these industries, which in turn could have a material adverse affect on our financial position, results of operations and our ability to pay the principal of and interest on our debt securities and other indebtedness and to make distributions on our common stock and preferred stock. Individually, each of the other industries in our property portfolio accounted for less than 10% of our rental revenue for 2006.

In addition, a substantial number of our properties are leased to middle-market retail chains that generally have more limited financial and other resources than certain upper-market retail chains, and therefore they are more likely to be adversely affected by a downturn in their respective businesses or in the regional or national economy.

We depend on key personnel.

We depend on the efforts of our executive officers and key employees. The loss of the services of our executive officers and key employees could have a material adverse effect on our results of operations or financial condition and on our ability to pay the principal and interest on our debt securities and other indebtedness and to make distributions to our stockholders. It is possible that we will not be able to recruit additional personnel with equivalent experience in the retail, net-lease industry.

Terrorist attacks and other acts of violence or war may affect the value of our debt and equity securities, the markets in which we operate and our results of operations.

Terrorist attacks may negatively affect our operations and your investment. There can be no assurance that there will not be further terrorist attacks against the United States or United States businesses. These attacks, or armed conflicts, may directly impact our physical facilities or the businesses of our tenants.

Such events could cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. They also could result in or prolong an economic recession in the U.S. or abroad. Any of these occurrences could have a significant adverse impact on our operating results and revenues and on the market price of our capital stock and on the value of our debt securities. It could also have an adverse effect on our ability to pay principal and interest on our debt securities or other indebtedness and to make distributions to our stockholders.

Item 1B: Unresolved Staff comments

There are no unresolved staff comments.

Item 2: Properties

Information pertaining to our properties can be found under Item 1.

Item 3: Legal Proceedings

We are subject to certain claims and lawsuits in the ordinary course of business, the outcome of which cannot be determined at this time. In the opinion of management, any liability we might incur upon the resolution of these claims and lawsuits will not, in the aggregate, have a material adverse effect on our consolidated financial position or results of operations.

Item 4: Submission of Matters to a Vote of Security Holders

No matters were submitted to stockholders during the fourth quarter of the fiscal year.

PART II

Item 5: Market For Registrant’s Common Equity And Related Stockholder Matters

A. Our common stock is traded on the NYSE under the ticker symbol “O.” The following table shows the high and low sales prices per share for our common stock as reported by the NYSE, and distributions declared per share of common stock for the periods indicated.

	Price Per Share
	of Common Stock				Distributions
	High		Low		Declared(1)
2006
First quarter	$	24.93	$	21.57	$	0.349375
Second quarter	24.06		21.25		0.351250
Third quarter	25.10		21.65		0.368625
Fourth quarter	28.43		24.40		0.378250

Total					$	1.447500

2005
First quarter	$	25.61	$	22.00	$	0.330625
Second quarter	25.69		22.50		0.332500
Third quarter	25.65		22.00		0.341875
Fourth quarter	23.97		21.08		0.347500

Total					$	1.352500

(1) Common stock cash distributions currently are declared monthly by us based on financial results for the prior months. At December 31, 2006, a distribution of $0.1265 per common share had been declared and was paid in January 2007.

There were 9,737 registered holders of record of our common stock as of January 31, 2007. We estimate that our total number of shareholders is approximately 78,000 when we include both registered and beneficial holders of our common stock.

Item 6: Selected Financial Data

(not covered by Report of Independent Registered Public Accounting Firm)

As of or for the years ended December 31, (dollars in thousands, except for per share data)	2006			2005			2004			2003			2002
Total assets (book value)	$	2,546,508		$	1,920,988		$	1,442,315		$	1,360,257		$	1,080,230
Cash and cash equivalents	10,573			65,704			2,141			4,837			8,921
Lines of credit and notes payable	920,000			891,700			503,600			506,400			339,700
Total liabilities	970,516			931,774			528,580			532,491			357,775
Total stockholders’ equity	1,575,992			989,214			913,735			827,766			722,455
Net cash provided by operating activities	86,945			109,557			178,337			73,957			124,807
Net change in cash and cash equivalents	(55,131		)	63,563			(2,696		)	(4,084		)	6,454
Total revenue	240,100			196,020			173,062			142,656			127,337
Income from continuing operations	106,065			88,749			81,642			70,947			63,800
Income from discontinued operations	4,716			10,370			21,755			15,488			14,867
Net income	110,781			99,119			103,397			86,435			78,667
Preferred stock cash dividends	(11,362		)	(9,403		)	(9,455		)	(9,713		)	(9,713		)
Excess of redemption value over carrying value of preferred shares redeemed	—			—			(3,774		)	—			—
Net income available to common stockholders	99,419			89,716			90,168			76,722			68,954
Cash distributions paid to common stockholders	129,667			108,575			97,420			83,842			78,042
Ratio of earnings to fixed charges (1)	2.9 times			3.2 times			3.9 times			4.1 times			4.3 times
Ratio of earnings to combined fixed charges and preferred stock cash dividends (1)	2.4 times			2.6 times			3.1 times			3.0 times			3.0 times
Basic net income per common share	1.11			1.12			1.15			1.08			1.02
Diluted net income per common share	1.11			1.12			1.15			1.08			1.01
Cash distributions paid per common share	1.43725			1.34625			1.24125			1.18125			1.15125
Cash distributions declared per common share	1.44750			1.35250			1.25125			1.18375			1.15375
Basic weighted average number of common shares outstanding	89,766,714			79,950,255			78,518,296			71,128,282			67,867,498
Diluted weighted average number of common shares outstanding	89,917,554			80,208,593			78,598,788			71,222,628			67,976,314

(1)

Ratio of Earnings to Fixed Charges is calculated by dividing earnings by fixed charges. For this purpose, earnings consist of net income before interest expense, including the amortization of debt issuance costs and interest classified to discontinued operations. Fixed charges are comprised of interest costs (including capitalized interest), the amortization of debt issuance costs and interest classified to discontinued operations. In computing the ratio of earnings to combined fixed charges and preferred stock cash dividends, preferred stock cash dividends consist of dividends on our Class B preferred stock, Class C preferred stock and our outstanding Class D and Class E preferred stock. We redeemed our Class B preferred stock in June 2004 and our Class C preferred stock in July 2004. We issued 4,000,000 shares of our 7-3/8% Class D preferred stock in May 2004, 1,100,000 shares of our 7-3/8% Class D preferred stock in October 2004, and 8,800,000 shares of our 6.75% Class E preferred stock in December 2006.

Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

Realty Income Corporation, The Monthly Dividend Company^®, is a Maryland corporation organized to operate as an equity real estate investment trust, or REIT. Our primary business objective is to generate dependable monthly cash distributions from a consistent and predictable level of funds from operations, or FFO per share. The monthly distributions are supported by the cash flow from our portfolio of retail properties leased to regional and national retail chains. We have in-house acquisition, leasing, legal, retail research, real estate research, portfolio management and capital markets expertise. Over the past 38 years, Realty Income and its predecessors have been acquiring and owning freestanding retail properties that generate rental revenue under long-term lease agreements (primarily 15- to 20-years).

In addition, we seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties. At December 31, 2006, we owned a diversified portfolio:

• Of 1,955 retail properties;

• With an occupancy rate of 98.7%, or 1,929 properties occupied of the 1,955 properties in the portfolio;

• Leased to 103 different retail chains doing business in 29 separate retail industries;

• Located in 48 states;

• With over 16.7 million square feet of leasable space; and

• With an average leasable retail space per property of approximately 8,600 square feet.

LIQUIDITY AND CAPITAL RESOURCES

Cash Reserves

Realty Income is organized to operate as an equity REIT that acquires and leases properties and distributes to stockholders, in the form of monthly cash distributions, a substantial portion of its net cash flow generated from leases on its retail properties. We intend to retain an appropriate amount of cash as working capital. At December 31, 2006, we had cash and cash equivalents totaling $10.6 million.

We believe that our cash and cash equivalents on hand, cash provided from operating activities and borrowing capacity is sufficient to meet our liquidity needs for the foreseeable future. We intend, however, to use additional sources of capital to fund property acquisitions and to repay our credit facility.

$300 Million Acquisition Credit Facility

Mortgage Debt

We have no mortgage debt on any of our properties.

Universal Shelf Registration

The common stock issued in September 2006, October 2006 and November 2006, the 2016 Notes issued in September 2006 and the Class E preferred stock issued in December 2006 were issued pursuant to our universal shelf registration statement.

Issuances of Common Stock

Issuance of Preferred Stock

In December 2006, we issued 8.8 million shares of 6-³/₄% Class E cumulative redeemable preferred stock, with a liquidation value of $25 per share. The net proceeds of $214 million from this issuance were used to repay borrowings under our credit facility and for other general corporate purposes.

Redemption of 2007 Notes

In September 2006, we redeemed all of our outstanding $110 million, 7-³/₄%, unsecured notes due May 2007 (the “2007 Notes”). The 2007 Notes were redeemed at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest of $3.2 million and a make-whole payment of $1.6 million. We recorded a loss on extinguishment of debt totaling $1.6 million related to the make-whole payment associated with the 2007 Notes. For 2006, the make-whole payment represented approximately $0.017 per share.

Issuance of 10-Year Senior Unsecured Notes

Conservative Capital Structure

We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and fixed charge coverage ratios. At February 13, 2007, our total outstanding credit facility borrowings and outstanding notes were $920 million or approximately 21.9% of our total market capitalization of $4.21 billion. We define our total market capitalization at February 13, 2007 as the sum of:

• Shares of our common stock outstanding of 101,000,536 multiplied by the last reported sales price of our common stock on the NYSE of $29.09 per share, or $2.94 billion;

• Aggregate liquidation value of the Class D preferred stock of $127.5 million;

• Aggregate liquidation value of the Class E preferred stock of $220 million; and

• Outstanding notes of $920 million.

Historically, we have met our long-term capital needs through the issuance of common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that the majority of our future securities issuances should be in the form of common stock; however, we may issue additional preferred stock or debt securities from time to time. We may issue common stock when we believe that our share price is at a level that allows for the proceeds of any offering to be accretively invested into additional properties. In addition, we may issue common stock to permanently finance properties that were financed by our credit facility or debt securities. However, we cannot assure you that we will have access to the capital markets at terms that are acceptable to us.

Credit Agency Ratings

We are currently assigned investment grade corporate credit ratings on our senior unsecured notes from Fitch Ratings, Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Group. Currently, Fitch Ratings has assigned a rating of BBB+, Moody’s has assigned a rating of Baa2 and Standard & Poor’s has assigned a rating of BBB to our senior notes. Moody’s and Standard & Poor’s ratings have “positive” outlooks and Fitch has a “stable” outlook.

Notes Outstanding

Senior note obligations consist of the following (dollars in thousands), sorted by maturity date:

	At December 31,
	2006
8-¹/₄% senior notes, issued in October 1998 and due in 2008	$	100,000
8% senior unsecured notes, issued in January 1999 and due in 2009	20,000
5-³/₈% senior unsecured notes, issued in March 2003 and due in 2013	100,000
5-¹/₂% senior unsecured notes, issued in November 2003 and due in 2015	150,000
5.95% senior unsecured notes, issued in September 2006 and due in 2016	275,000
5-³/₈% senior unsecured notes, issued in September 2005 and due in 2017	175,000
5-⁷/₈% senior unsecured bonds, issued in March 2005 and due in 2035	100,000
	$	920,000

Interest on all of the senior note obligations is paid semiannually, with the exception of the interest on the 8-¹/₄ % senior notes issued in October 1998, which is paid monthly. All of these notes contain various covenants, including: (i) a limitation on incurrence of any debt which would cause our debt to total adjusted assets ratio to exceed 60%; (ii) a limitation on incurrence of any secured debt which would cause our secured debt to total adjusted assets ratio to exceed 40%; (iii) a limitation on incurrence of any debt which would cause our debt service coverage ratio to be less than 1.5 times; and (iv) the maintenance at all times of total unencumbered assets not less than 150% of our outstanding unsecured debt. We have been in compliance with these covenants since each of the notes were issued.

The following is a summary of the key financial covenants to our senior unsecured notes. The actual amounts are as of December 31, 2006.

Note Covenants	Required	Actual
Limitation on Incurrence of Total Debt	< 60%	31.6	%
Limitation on Incurrence of Secured Debt	< 40%	0.0	%
Debt Service Coverage	> 1.5 x	4.0	x
Maintenance of Total Unencumbered Assets	> 150% of Unsecured Debt	316	%

All of our outstanding notes and bonds have fixed interest rates. Our credit facility interest rate is variable.

The following table summarizes the maturity of each of our obligations as of December 31, 2006 (dollars in millions):

Table of Obligations

Year of Maturity	Credit Facility (1)		Notes		Interest (2)		Other (3)		Totals
2007	$	—	$	—	$	55.1	$	17.2	$	72.3
2008	—		100.0		54.1		—		154.1
2009	—		20.0		45.3		—		65.3
2010	—		—		45.3		—		45.3
2011	—		—		45.3		—		45.3
Thereafter	—		800.0		305.5		—		1,105.5
Totals	$	—	$	920.0	$	550.6	$	17.2	$	1,487.8

(1) There was no outstanding credit facility balance on December 31, 2006 or February 13, 2007.

(2) Interest on credit facility and notes has been calculated based on outstanding balances as of December 31, 2006 through their respective maturity dates.

(3) Other consists of $16.4 million of estimated unfunded costs on properties under development and $806,000 of contingent payments for tenant improvements and leasing costs.

Our credit facility and note obligations are unsecured. Accordingly, we have not pledged any assets as collateral for these obligations.

Preferred Stock Outstanding

In May and October 2004, we issued an aggregate of 5.1 million shares of 7-³/₈ % Class D cumulative redeemable preferred stock. Beginning May 27, 2009, shares of Class D preferred stock are redeemable at our option for $25.00 per share, plus any accrued and unpaid dividends. Dividends on shares of Class D preferred stock are paid monthly in arrears.

In December 2006, we issued 8.8 million shares of 6-³/₄% Class E cumulative redeemable preferred stock. Beginning December 7, 2011, shares of Class E preferred stock are redeemable at our option for $25 per share, plus any accrued and unpaid dividends. Dividends on shares of Class E preferred stock are paid monthly in arrears.

No Off-Balance Sheet Arrangements or Unconsolidated Investment

As we have no joint ventures, off-balance sheet entities, or mandatory redeemable preferred stock, our financial position or results of operations are currently not affected by Financial Accounting Standard Board Interpretation No. 46R, Consolidation of Variable Interest Entities and Statement of Financial Accounting Standard No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.

Acquisitions During 2006

Included in the $769.9 million is $656.7 million invested by Realty Income in 322 new properties and properties under development, with an initial weighted average contractual lease rate of 8.6%. These 322 properties are located in 30 states, are 100% leased with an initial average lease term of 16.7 years and will contain over 3.3 million leasable square feet. The 322 new properties acquired by Realty Income are net-leased to 16 different retail chains in the following 11 industries: automotive collision services, automotive tire services, convenience store, drug store, general merchandise, health and fitness, home improvement, motor vehicle dealership, private education, restaurant and theater. Also included in the $769.9 million is $113.2 million invested by Crest in 56 new retail properties.

At December 31, 2006, Realty Income had invested $15.9 million in four properties that were leased and under contract for development by the tenant (with development costs funded by Realty Income). Rent on these properties is scheduled to begin at various times during 2007. At December 31, 2006, we had outstanding commitments to pay estimated unfunded development costs totaling $16.4 million.

Acquisition of $349 million of Buffets/Ryan’s Restaurants on November 1, 2006

Of the 144 restaurant properties, 116 were acquired by Realty Income and 28 were acquired by Crest. The restaurants have, on average, approximately 10,300 leasable square feet and are situated on an average lot size of approximately 2.86 acres. In general, the properties are existing locations that, on average, have been operating for 11 years.

Investments in Existing Properties

In 2006, we capitalized costs of $964,000 on existing properties in our portfolio, consisting of $761,000 for re-leasing costs and $203,000 for building improvements.

Sales of Investment Properties

During 2006, we sold or exchanged 13 properties for $10.7 million, which resulted in a gain of $3.0 million. This gain is included in discontinued operations. The 13 properties sold or exchanged consisted of one automotive parts store, one automotive service facility, one child care facility, two convenience stores, and eight restaurants. The net proceeds from the sale of these properties were used to repay outstanding indebtedness on our credit facility and to invest in new properties.

Crest Property Sales

During 2006, Crest, our wholly-owned subsidiary, sold 13 properties from its inventory for an aggregate of $22.4 million, which resulted in a gain of $2.2 million. Crest’s gains are included in “income from discontinued operations, real estate acquired for resale by Crest.”

Crest Property Inventory

Crest’s property inventory at December 31, 2006 and 2005 totaled $137.5 million and $45.7 million, respectively, and is included in “real estate held for sale, net”, on our consolidated balance sheets.

The financial statements of Crest are consolidated into Realty Income’s financial statements. All material intercompany transactions have been eliminated in consolidation.

Increases in Monthly Cash Distributions to Common Stockholders

We continue our 37-year policy of paying distributions monthly to our common stockholders. Monthly distributions per share were increased in April 2006 by $0.000625 to $0.116875, in July 2006 by $0.000625 to $0.1175, in September 2006 by $0.00775 to $0.12525, in October 2006 by $0.000625 to $0.125875 and in January 2007 by $0.000625 to $0.1265. The increase in January 2007 was our 37th consecutive quarterly increase and the 42nd increase in the amount of our dividend since our listing on the NYSE in 1994. In 2006, we paid the following monthly cash distributions per share: three in the amount of $0.11625, three in the amount of $0.116875, two in the amount of $0.1175, one in the amount of $0.12525, and three in the amount of $0.125875 totaling $1.43725. In December 2006, January 2007 and February 2007, we declared distributions of $0.1265 per share, which were paid on January 16, 2007 and February 15, 2007 and will be paid on March 15, 2007, respectively.

RESULTS OF OPERATIONS

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Our consolidated financial statements are the basis for our discussion and analysis of financial condition and results of operations. Preparing our consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. We believe that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions.

In order to prepare our consolidated financial statements according to the rules and guidelines set forth by GAAP, many subjective judgments must be made with regard to critical accounting polices. One of these judgments is our estimate for useful lives in determining depreciation expense for our properties. Depreciation of buildings and improvements is generally computed using the straight–line method over an estimated useful life

of 25 years. If we use a shorter or longer estimated useful life it could have a material impact on our results of operations. We believe that 25 years is an appropriate estimate of useful life. No depreciation has been recorded on Crest’s properties because they are held for sale.

Another significant judgment must be made as to if, and when, impairment losses should be taken on our properties when events or a change in circumstances indicate that the carrying amount of the asset may not be recoverable. Generally, a provision is made for impairment loss if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value. Impairment losses are measured as the amount by which the current book value of the asset exceeds the fair value of the asset. If a property is held for sale, it is carried at the lower of carrying cost or estimated fair value, less cost to sell. The carrying value of our real estate is the largest component of our consolidated balance sheet. If events should occur that require us to reduce the carrying value of our real estate by recording provisions for impairment losses, it could have a material impact on our results of operations.

The following is a comparison of our results of operations for the years ended December 31, 2006, 2005 and 2004.

Rental Revenue

Rental revenue was $238.1 million for 2006 versus $195.7 million for 2005, an increase of $42.4 million, or 21.7%. Rental revenue was $172 million in 2004. The increase in rental revenue in 2006 compared to 2005 is primarily attributable to:

• The 322 retail properties acquired by Realty Income in 2006, which generated $15.7 million of rent in 2006;

• The 135 retail properties acquired by Realty Income in 2005, which generated $33.5 million of rent in 2006 compared to $12.1 million in 2005, an increase of $21.4 million;

• Same store rents generated on 1,421 properties leased during the entire years of 2006 and 2005 increased by $1.3 million, or 0.7%, to $175.3 million from $174.0 million.

• An increase in straight-line rent and other non-cash adjustments to rent of $155,000 in 2006 as compared to 2005; and

• An increase of $4.0 million relating to the aggregate of (i) development properties acquired before 2005 that started paying rent in 2005, (ii) properties that were vacant during part of 2006 or 2005 and (iii) lease termination settlements. These items totaled $9.7 million in aggregate in 2006 compared to $5.7 million in 2005.

Of the 1,955 properties in the portfolio at December 31, 2006, 1,948, or 99.6%, are single-tenant properties and the remaining seven are multi-tenant properties. Of the 1,948 single-tenant properties, 1,923, or 98.7%, were net leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 12.9 years at December 31, 2006. Of our 1,923 leased single-tenant properties, 1,713, or 89.1%, were under leases that provide for increases in rents through:

• Primarily base rent increases tied to a consumer price index;

• Fixed increases;

• To a lesser degree, overage rent based on a percentage of the tenants’ gross sales; or

• A combination of two or more of the above rent provisions.

Percentage rent, which is included in rental revenue, was $1.1 million in 2006, $1.2 million in 2005 and $1.3 million in 2004. Percentage rent in 2006 was less than 1% of rental revenue and we anticipate percentage rent to be less than 1% of rental revenue in 2007.

Our portfolio of retail real estate, leased primarily to regional and national chains under net leases, continues to perform well and provide dependable lease revenue supporting the payment of monthly dividends to our stockholders. At December 31, 2006, our portfolio of 1,955 retail properties was 98.7% leased with 26 properties available for lease, one of which is a multi-tenant property.

As of February 13, 2007, transactions to lease or sell four of the 26 properties available for lease at December 31, 2006 were underway or completed. We anticipate these transactions will be completed during the next several

months, although we cannot guarantee that all of these properties can be leased or sold within this period. It has been our experience that approximately 1% to 3% of our property portfolio will be unleased at any given time; however, we cannot assure you that the number of properties available for lease will not exceed these levels.

Interest Expense

Interest expense was $10.4 million higher in 2006 than in 2005. Interest expense increased in 2006 primarily due to higher average outstanding balances, which was partially offset by slightly lower interest rates related to our average outstanding borrowings. We issued $275 million of 10-year notes in September 2006, $175 million of 12-year notes in September 2005 and $100 million of 30-year bonds in March 2005, which contributed to the increase in average outstanding balances and slightly lower average interest rates on our debt.

The following is a summary of the components of our interest expense (dollars in thousands):

	2006			2005			2004
Interest on our credit facility and notes	$	54,068		$	40,968		$	32,442
Interest included in discontinued operations from real estate acquired for resale by Crest	(3,708		)	(1,139		)	(674		)
Amortization of settlements on treasury lock agreements	717			756			756
Credit facility commitment fees	456			498			508
Amortization of credit facility origination costs and deferred bond financing costs	2,014			1,752			1,631
Interest capitalized	(2,184		)	(1,886		)	(531		)

Interest expense	$	51,363		$	40,949		$	34,132

Credit facilities and notes outstanding		2006			2005			2004
Average outstanding balances (dollars in thousands)		$	881,669