Edgar Filing: REALTY INCOME CORP

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2014, or

o Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

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 Incorporation or Organization)		(IRS Employer Identification Number)

600 La Terraza Boulevard, Escondido, California 92025-3873

(Address of Principal Executive Offices)

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

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company 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

There were 222,686,209 shares of common stock outstanding as of October 23, 2014.

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REALTY INCOME CORPORATION

Form 10-Q

September 30, 2014

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PART I.		FINANCIAL INFORMATION		Page

	Item 1:		Financial Statements

			Consolidated Balance Sheets	3
			Consolidated Statements of Income	4
			Consolidated Statements of Cash Flows	5
			Notes to Consolidated Financial Statements	6

	Item 2:		Management’s Discussion and Analysis of Financial Condition and Results of Operations

			Forward-Looking Statements	22
			The Company	23
			Recent Developments	26
			Liquidity and Capital Resources	30
			Results of Operations	36
			Funds from Operations Available to Common Stockholders (FFO)	42
			Adjusted Funds from Operations Available to Common Stockholders (AFFO)	44
			Property Portfolio Information	45
			Impact of Inflation	52
			Impact of Recent Accounting Pronouncements	52
			Other Information	52

	Item 3:		Quantitative and Qualitative Disclosures About Market Risk	53

	Item 4:		Controls and Procedures	54

PART II.		OTHER INFORMATION

	Item 1A:		Risk Factors	55

	Item 2:		Unregistered Sales of Equity Securities and Use of Proceeds	55

	Item 6:		Exhibits	56

SIGNATURE				59

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

September 30, 2014 and December 31, 2013

(dollars in thousands, except per share data)

	2014			2013
ASSETS	(unaudited)
Real estate, at cost:
Land	$	3,008,036		$	2,791,147
Buildings and improvements	7,995,808			7,108,328
Total real estate, at cost	11,003,844			9,899,475
Less accumulated depreciation and amortization	(1,317,760		)	(1,114,888		)
Net real estate held for investment	9,686,084			8,784,587
Real estate held for sale, net	15,757			12,022
Net real estate	9,701,841			8,796,609
Cash and cash equivalents	16,936			10,257
Accounts receivable, net	47,852			39,323
Acquired lease intangible assets, net	1,059,879			935,459
Goodwill	15,535			15,660
Other assets, net	97,797			127,133
Total assets	$	10,939,840		$	9,924,441

LIABILITIES AND EQUITY
Distributions payable	$	43,289		$	41,452
Accounts payable and accrued expenses	78,271			102,511
Acquired lease intangible liabilities, net	201,245			148,250
Other liabilities	44,410			44,030
Preferred shares subject to mandatory redemption	220,000			-
Line of credit payable	45,000			128,000
Term loan	70,000			70,000
Mortgages payable, net	862,212			783,360
Notes payable, net	3,785,027			3,185,480
Total liabilities	5,349,454			4,503,083

Commitments and contingencies

Stockholders’ equity:
Preferred stock and paid in capital, par value $0.01 per share, 69,900,000 shares authorized, 16,350,000 shares issued and outstanding as of September 30, 2014 and 25,150,000 shares issued and outstanding as of December 31, 2013	395,377			609,363
Common stock and paid in capital, par value $0.01 per share, 370,100,000 shares authorized, 222,670,846 shares issued and outstanding as of September 30, 2014 and 207,485,073 shares issued and outstanding at December 31, 2013	6,361,400			5,767,878
Distributions in excess of net income	(1,194,987		)	(991,794		)
Total stockholders’ equity	5,561,790			5,385,447
Noncontrolling interests	28,596			35,911
Total equity	5,590,386			5,421,358
Total liabilities and equity	$	10,939,840		$	9,924,441

The accompanying notes to consolidated financial statements are an integral part of these statements.

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REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

For the three and nine months ended September 30, 2014 and 2013

(dollars in thousands, except per share data) (unaudited)

	Three months ended						Nine months ended
	September 30,						September 30,
	2014			2013			2014			2013
REVENUE
Rental	$	226,832		$	195,332		$	662,822		$	543,219
Tenant reimbursements	8,275			5,107			20,872			15,619
Other	606			1,642			2,238			5,207
Total revenue	235,713			202,081			685,932			564,045

EXPENSES
Depreciation and amortization	95,260			80,822			278,124			221,476
Interest	52,814			49,836			157,246			130,667
General and administrative	11,025			16,640			35,499			40,356
Property (including reimbursable)	12,770			8,466			33,474			25,792
Income taxes	697			569			2,358			1,770
Provisions for impairment	495			-			2,676			290
Merger-related costs	-			240			-			12,875
Total expenses	173,061			156,573			509,377			433,226

Gain on sales of real estate	10,975			-			14,211			-

Income from continuing operations	73,627			45,508			190,766			130,819

Income from discontinued operations	-			6,399			3,097			50,831

Net income	73,627			51,907			193,863			181,650

Net income attributable to noncontrolling interests	(344		)	(336		)	(1,016		)	(422		)

Net income attributable to the Company	73,283			51,571			192,847			181,228
Preferred stock dividends	(9,327		)	(10,482		)	(30,292		)	(31,447		)
Excess of redemption value over carrying value of preferred shares subject to redemption	(6,015		)	-			(6,015		)	-
Net income available to common stockholders	$	57,941		$	41,089		$	156,540		$	149,781

Amounts available to common stockholders per common share:
Income from continuing operations, basic and diluted	$	0.26		$	0.18		$	0.71		$	0.53
Net income, basic and diluted	$	0.26		$	0.21		$	0.72		$	0.80

Weighted average common shares outstanding:
Basic	222,061,661			195,768,298			216,804,815			187,805,222
Diluted	222,236,071			196,619,866			217,147,035			188,399,848

The accompanying notes to consolidated financial statements are an integral part of these statements.

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REALTY INCOME CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended September 30, 2014 and 2013

(dollars in thousands) (unaudited)

	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	193,863		$	181,650
Adjustments to net income:
Depreciation and amortization	278,124			221,476
Income from discontinued operations	(3,097		)	(50,831		)
Amortization of share-based compensation	7,653			14,235
Non-cash rental adjustments	(5,390		)	(3,862		)
Amortization of net premiums on mortgages payable	(10,843		)	(6,959		)
Amortization of deferred financing costs	8,027			6,682
Gain on sales of real estate	(14,211		)	-
Provisions for impairment on real estate	2,676			290
Cash provided by discontinued operations:
Real estate	490			4,809
Proceeds from sale of real estate	820			-
Change in assets and liabilities, other than from the impact of our acquisition of American Realty Capital Trust, Inc., or ARCT
Accounts receivable and other assets	12,420			1,481
Accounts payable, accrued expenses and other liabilities	(30,451		)	(23,304		)
Net cash provided by operating activities	440,081			345,667
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in real estate, net of cash acquired	(1,076,391		)	(1,286,384		)
Improvements to real estate, including leasing costs	(4,538		)	(5,902		)
Proceeds from sales of real estate:
Continuing operations	46,644			8
Discontinued operations	6,918			98,768
Collection (issuance) of loans receivable	350			(10,551		)
Restricted escrow deposits for Section 1031 tax-deferred exchanges and pending acquisitions	(27,340		)	(7,344		)
Net cash used in investing activities	(1,054,357		)	(1,211,405		)
CASH FLOWS FROM FINANCING ACTIVITIES
Cash distributions to common stockholders	(356,735		)	(298,544		)
Cash dividends to preferred stockholders	(31,447		)	(31,447		)
Borrowings on line of credit	1,359,121			2,096,300
Payments on line of credit	(1,442,121		)	(1,785,900		)
Proceeds from notes and bonds payable issued	598,594			750,000
Principal payment on notes payable	-			(100,000		)
Principal payments on mortgages payable	(77,619		)	(16,207		)
Proceeds from term loan	-			70,000
Repayment of ARCT line of credit	-			(317,207		)
Repayment of ARCT term loan	-			(235,000		)
Proceeds from common stock offerings, net	528,615			755,085
Distributions to noncontrolling interests	(1,390		)	(751		)
Debt issuance costs	(5,609		)	(9,150		)
Proceeds from dividend reinvestment and stock purchase plan, net	56,580			3,827
Other items, including shares withheld upon vesting	(7,034		)	(10,556		)
Net cash provided by financing activities	620,955			870,450
Net increase in cash and cash equivalents	6,679			4,712
Cash and cash equivalents, beginning of period	10,257			5,248
Cash and cash equivalents, end of period	$	16,936		$	9,960

For supplemental disclosures, see note 18.

The accompanying notes to consolidated financial statements are an integral part of these statements.

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REALTY INCOME CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(unaudited)

1. Management Statement

The consolidated financial statements of Realty Income Corporation (“Realty Income”, the “Company”, “we”, “our” or “us”) were prepared from our books and records without audit and include all adjustments (consisting of only normal recurring accruals) necessary to present a fair statement of results for the interim periods presented. Readers of this quarterly report should refer to our audited consolidated financial statements for the year ended December 31, 2013, which are included in our 2013 Annual Report on Form 10-K, as certain disclosures that would substantially duplicate those contained in the audited financial statements have not been included in this report.

At September 30, 2014, we owned 4,284 properties, located in 49 states and Puerto Rico, containing over 69.8 million leasable square feet.

2. Summary of Significant Accounting Policies and Procedures and Recent Accounting Pronouncements

A. The accompanying consolidated financial statements include the accounts of Realty Income and other entities for which we make operating and financial decisions (i.e., control), after elimination of all material intercompany balances and transactions. We consolidate entities that we control and record a noncontrolling interest for the portion that we do not own. Noncontrolling interest that was created or assumed as part of a business combination was recognized at fair value as of the date of the transaction (see note 11). We have no unconsolidated investments.

B. We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. We believe we have qualified and continue to qualify as a REIT. Under the REIT operating structure, we are permitted to deduct dividends paid to our stockholders in determining our taxable income. Assuming our dividends equal or exceed our net income, we generally will not be required to pay federal corporate income taxes on such income. Accordingly, no provision has been made for federal income taxes in the accompanying consolidated financial statements, except for federal income taxes of our taxable REIT subsidiaries. The income taxes recorded on our consolidated statements of income represent amounts paid by Realty Income for city and state income and franchise taxes.

C. We recognize an allowance for doubtful accounts relating to accounts receivable for amounts deemed uncollectible. We consider tenant specific issues, such as financial stability and ability to pay rent, when determining collectability of accounts receivable and appropriate allowances to record. The allowance for doubtful accounts was $346,000 at September 30, 2014 and $498,000 at December 31, 2013.

D. We assign a portion of goodwill to our applicable property sales, which results in a reduction of the carrying amount of our goodwill. In order to allocate goodwill to the carrying amount of properties that we sell, we utilize a relative fair value approach based on the original methodology for assigning goodwill. As we sell properties, our goodwill will likely continue to gradually decrease over time. During our tests for impairment of goodwill during the second quarters of 2014 and 2013, we determined that the estimated fair values of our reporting units exceeded their carrying values. We did not have an impairment on our existing goodwill in 2014 and 2013.

E. In April 2014, the Financial Accounting Standards Board, or FASB, issued ASU 2014-08, which amends Topic 205, Presentation of Financial Statements, and Topic 360, Property, Plant, and Equipment. The amendments in this ASU changed the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have, or will have, a major effect on an entity’s operations and financial results. ASU 2014-08 is effective, on a prospective basis, for all disposals or classifications as held for sale of components of an entity that occur within interim and annual periods beginning after December 15, 2014. Early adoption is permitted, but only for disposals or classifications as held for sale that have not been reported in financial statements previously issued. We chose to early adopt ASU 2014-08 beginning with the three-month period ended March 31, 2014. Starting with the first quarter of 2014, the results of operations for all qualifying disposals and properties classified as held for sale that were not previously reported in discontinued operations in our 2013 Annual Report on Form 10-K will be presented within income from continuing operations on our consolidated statements of income.

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Prior to the date of adoption of Accounting Standards Update 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, or ASU 2014-08, we reported, in discontinued operations, the results of operations of properties that had either been disposed of or classified as held for sale in financial statements issued. See footnote 2.E. below for a description of our early adoption of this recent accounting pronouncement and the impact on our presentation of discontinued operations on our consolidated statements of income.

Certain of the 2013 balances have been revised on our consolidated financial statements as follows:

- We previously reported certain operating activities of our wholly owned taxable REIT subsidiary, Crest Net Lease, Inc., or Crest, as discontinued operations. We have revised the 2013 amounts to report those activities in continuing operations. Subsequent to the revision, results of operations for Crest properties that were disposed of or classified as held for sale as of December 31, 2013, continue to be reported in discontinued operations.

3. Supplemental Detail for Certain Components of Consolidated Balance Sheets

A. Acquired lease intangible assets, net, consist of the following	September 30,			December 31,
(dollars in thousands) at:	2014			2013
Acquired in-place leases	$	994,407		$	843,616
Accumulated amortization of acquired in-place leases	(156,522		)	(95,084		)
Acquired above-market leases	257,251			207,641
Accumulated amortization of acquired above-market leases	(35,257		)	(20,714		)
	$	1,059,879		$	935,459

	September 30,		December 31,
B. Other assets, net, consist of the following (dollars in thousands) at:	2014		2013
Restricted escrow deposits	$	27,340	$	10,158
Deferred financing costs, net	24,381		21,323
Notes receivable issued in connection with property sales	18,440		19,078
Prepaid expenses	12,592		11,674
Impounds related to mortgages payable	5,511		5,555
Credit facility origination costs, net	4,940		7,146
Corporate assets, net	1,559		1,259
Loans receivable	-		48,844
Other items	3,034		2,096
	$	97,797	$	127,133

C. Distributions payable consist of the following declared	September 30,		December 31,
distributions (dollars in thousands) at:	2014		2013
Common stock distributions	$	40,796	$	37,797
Preferred stock dividends		2,339		3,494
Noncontrolling interests distributions		154		161
	$	43,289	$	41,452

D. Accounts payable and accrued expenses consist of the	September 30,		December 31,
following (dollars in thousands) at:	2014		2013
Notes payable - interest payable	$	30,264	$	55,616
Accrued costs on properties under development	18,889		14,058
Mortgages payable - interest payable	3,035		2,790
Other items	26,083		30,047
	$	78,271	$	102,511

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E. Acquired lease intangible liabilities, net, consist of the	September 30,			December 31,
following (dollars in thousands) at:	2014			2013
Acquired below-market leases	$	220,329		$	158,703
Accumulated amortization of acquired below-market leases	(19,084		)	(10,453		)
	$	201,245		$	148,250

F. Other liabilities consist of the following	September 30,		December 31,
(dollars in thousands) at:	2014		2013
Rent received in advance	$	31,718	$	31,144
Preferred units issued upon acquisition of ARCT	6,750		6,750
Security deposits	5,942		6,136
	$	44,410	$	44,030

4. Investments in Real Estate

We acquire land, buildings and improvements necessary for the successful operations of commercial tenants.

A. Acquisitions during the First Nine Months of 2014 and 2013

During the first nine months of 2014, we invested $1.24 billion in 439 new properties and properties under development or expansion with an initial weighted average contractual lease rate of 7.1%. The 439 new properties and properties under development or expansion, are located in 42 states, will contain over 8.5 million leasable square feet and are 100% leased with a weighted average lease term of 12.6 years. The tenants occupying the new properties operate in 27 industries and the property types consist of 85.6% retail, 7.2% office, 5.8% industrial and distribution, and 1.4% manufacturing, based on rental revenue. None of our investments during the first nine months of 2014 caused any one tenant to be 10% or more of our total assets at September 30, 2014.

The $1.24 billion invested during the first nine months of 2014 was allocated as follows: $240.1 million to land, $861.9 million to buildings and improvements, $202.0 million to intangible assets related to leases, $901,000 to other assets, net, and $60.5 million to intangible liabilities related to leases and other assumed liabilities. We also recorded net mortgage premiums of $604,000 associated with the $166.7 million of mortgages acquired during the first nine months of 2014. There was no contingent consideration associated with these acquisitions.

The properties acquired during the first nine months of 2014 contributed total revenues of $47.3 million and income from continuing operations of $19.2 million.

The purchase price allocations for $159.8 million invested by us in the third quarter of 2014 is based on a preliminary measurement of fair value that is subject to change. The allocations for these properties represent our current best estimate of fair value and we expect to finalize the valuations and complete the purchase price allocations in 2014. In the first nine months of 2014, we finalized the purchase price allocations for $120.8 million invested in the fourth quarter of 2013 and $789.8 million invested in the first two quarters of 2014. There were no material changes to our consolidated balance sheets or income statements as a result of these purchase price allocation adjustments.

In comparison, during the first nine months of 2013, Realty Income invested $1.37 billion in 407 properties and properties under development or expansion (in addition to our acquisition of American Realty Capital Trust, Inc. or ARCT, which is discussed below), with an initial weighted average contractual lease rate of 7.0%. These 407 properties are located in 40 states, contain over 8.0 million leasable square feet and are 100% leased with a weighted average lease term of 14.1 years. The tenants occupying the new properties operate in 21 industries and the property types consist of 84.1% retail, 10.4% office, 3.1% industrial and distribution, and 2.4% manufacturing, based on rental revenue. These investments are in addition to the $3.2 billion acquisition of ARCT, which added 515 properties to our real estate portfolio during the first quarter of 2013.

The 515 properties added to our real estate portfolio as a result of the ARCT acquisition are located in 44 states and Puerto Rico, contain over 16.0 million leasable square feet, and are 100% leased with a weighted average lease term of 12.2 years. The 69 tenants occupying the 515 properties acquired operate in 28 industries and the property types consist of 54.0% retail, 32.6% industrial and distribution, and 13.4% office, based on rental revenue. We recorded ARCT merger-related transaction costs of $12.9 million in the first nine months of 2013.

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These merger related transaction costs included, but were not limited to, advisor fees, legal fees, accounting fees, printing fees and transfer taxes.

Our combined total investment in real estate assets, including the ARCT acquisition, during the first nine months of 2013 was $4.5 billion.

The $4.5 billion invested during the first nine months of 2013 was allocated as follows: $769.4 million to land, $3.10 billion to buildings and improvements, $765.3 million to intangible assets related to leases, $13.5 million to other assets, net, and $115.0 million to intangible liabilities related to leases and other assumed liabilities. We also recorded mortgage premiums of $28.4 million associated with the mortgages acquired. There was no contingent consideration associated with these acquisitions.

The estimated initial weighted average contractual lease rate for a property is generally computed as estimated contractual net operating income, which, in the case of a net leased property, is equal to the aggregate base rent under the lease for the first full year of each lease, divided by the total cost of the property. Since it is possible that a tenant could default on the payment of contractual rent, we cannot provide assurance that the actual return on the funds invested will remain at the percentages listed above.

In the case of a property under development or expansion, the contractual lease rate is generally fixed such that rent varies based on the actual total investment in order to provide a fixed rate of return. When the lease does not provide for a fixed rate of return on a property under development or expansion, the estimated initial weighted average contractual lease rate is computed as follows: estimated net operating income (determined by the lease) for the first full year of each lease, divided by our projected total investment in the property, including land, construction and capitalized interest costs. Of the $1.24 billion we invested during the first nine months of 2014, $69.0 million was invested in 32 properties under development or expansion with an estimated initial weighted average contractual lease rate of 8.5%. Of the $4.5 billion we invested in the first nine months of 2013, $28.8 million was invested in 19 properties under development or expansion with an estimated initial weighted average contractual lease rate of 8.5%

B. Acquisition Transaction Costs

Acquisition transaction costs (excluding ARCT merger-related costs) of $589,000 and $1.7 million were recorded to general and administrative expense on our consolidated statement of income for the first nine months of 2014 and 2013, respectively.

C. Investments in Existing Properties

During the first nine months of 2014, we capitalized costs of $4.5 million on existing properties in our portfolio, consisting of $655,000 for re-leasing costs and $3.9 million for building and tenant improvements. In comparison, during the first nine months of 2013, we capitalized costs of $5.9 million on existing properties in our portfolio, consisting of $1.1 million for re-leasing costs and $4.8 million for building and tenant improvements.

D. Properties with Existing In-place Leases

Of the $1.24 billion we invested in the first nine months of 2014, approximately $949.6 million was used to acquire 180 properties with existing in-place leases. In comparison, of the $4.5 billion invested during the first nine months of 2013, approximately $4.3 billion was used to acquire 756 properties with existing in-place leases. The value of the in-place and above-market leases is recorded to acquired lease intangible assets, net on our consolidated balance sheets, and the value of the below-market leases is recorded to acquired lease intangible liabilities, net on our consolidated balance sheets. The values recorded to all of these intangible values, for properties acquired during the third quarter of 2014, are based on a preliminary measurement of fair value that is subject to change.

The value of the in-place leases is amortized as depreciation and amortization expense. The amounts amortized to expense for the first nine months of 2014 and 2013 were $62.1 million and $46.4 million, respectively.

The value of the above-market and below-market leases is amortized as an adjustment to rental revenue on our consolidated statements of income. All of these amounts are amortized over the term of the respective leases. The amounts amortized as a net decrease to rental revenue for capitalized above-market and below-market leases for the first nine months of 2014 and 2013 were $6.4 million and $6.2 million, respectively. If a lease was terminated prior to its stated expiration, all unamortized amounts relating to that lease would be recorded to revenue or expense as appropriate.

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The following table presents the impact during the next five years and thereafter related to the net increase (decrease) to rental revenue from the amortization of the acquired above-market and below-market lease intangibles and the increase to amortization expense from the amortization of the in-place lease intangibles for properties held for investment at September 30, 2014 (in thousands):

	Net increase			Increase to
	(decrease) to			amortization
	rental revenue			expense
2014	$	(2,066	)	$	21,543
2015	(8,271		)	84,970
2016	(8,283		)	84,598
2017	(8,227		)	83,399
2018	(7,968		)	80,955
Thereafter	14,066			481,502
Totals	$	(20,749	)	$	836,967

5. Credit Facility

We have a $1.5 billion unsecured acquisition credit facility with an initial term that expires in May 2016 and includes, at our election, a one-year extension option. Under this credit facility, our current investment grade credit ratings provide for financing at the London Interbank Offered Rate, commonly referred to as LIBOR, plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The borrowing rate is not subject to an interest rate floor or ceiling. We also have other interest rate options available to us under this credit facility. Our credit facility is unsecured and, accordingly, we have not pledged any assets as collateral for this obligation.

At September 30, 2014, credit facility origination costs of $4.9 million are included in other assets, net, on our consolidated balance sheets. These costs are being amortized over the remaining term of our current $1.5 billion credit facility.

At September 30, 2014, we had a borrowing capacity of $1.46 billion available on our credit facility (subject to customary conditions to borrowing) and an outstanding balance of $45.0 million, as compared to an outstanding balance of $128.0 million at December 31, 2013.

The weighted average interest rate on outstanding borrowings under our credit facility was 1.2% during the first nine months of 2014 and 1.3% during the first nine months of 2013. At September 30, 2014, the effective interest rate was 1.2%. Our current credit facility is subject to various leverage and interest coverage ratio limitations, and at September 30, 2014, we remain in compliance with these covenants.

6. Mortgages Payable

During the first nine months of 2014, we made $77.6 million in principal payments, including the repayment of five mortgages in full for $72.0 million. Additionally, during the first nine months of 2014, we assumed mortgages totaling $166.7 million, excluding net premiums. The mortgages are secured by the properties on which the debt was placed. $152.0 million of mortgages assumed during the first nine months of 2014 are considered non-recourse with limited customary exceptions for items such as solvency, bankruptcy, misrepresentation, fraud, misapplication of payments, environmental liabilities, failure to pay taxes, insurance premiums, liens on the property, violations of the single purpose entity requirements, and uninsured losses. The remaining $14.7 million, representing two mortgages, has partial recourse to Realty Income in the aggregate amount of $3.2 million; the remaining balance of $11.5 million is non-recourse and includes the same customary exceptions described in the preceding sentence. We expect to pay off the mortgages as soon as prepayment penalties make it economically feasible to do so.

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During the first nine months of 2014, aggregate net premiums totaling $604,000 were recorded upon assumption of the mortgages for above-market interest rates, as compared to net premiums totaling $28.4 million recorded in the first nine months of 2013. Amortization of these net premiums is recorded as a reduction to interest expense over the remaining term of the respective mortgages, using a method that approximates the effective-interest method.

These mortgages contain customary covenants, such as limiting our ability to further mortgage each applicable property or to discontinue insurance coverage, without the prior consent of the lender. At September 30, 2014, we remain in compliance with these covenants.

We did not incur any deferred financing costs on our mortgages payable assumed in the first nine months of 2014 and incurred $211,000 in the first nine months of 2013. The balance of our deferred financing costs, which are classified as part of other assets, net, on our consolidated balance sheets, was $937,000 at September 30, 2014, and $1.2 million at December 31, 2013, which is being amortized over the remaining term of each mortgage.

The following is a summary of all our mortgages payable as of September 30, 2014 and December 31, 2013, respectively (dollars in thousands):

Weighted

Average

Stated

Effective

Remaining

Unamortized

Mortgage

Number of

Interest

Years Until

Principal

Premium

Payable

As Of

Properties(1)

Rate(2)

Rate(3)

Maturity

Balance

Balance, net

Balance

9/30/14

243

5.0%

4.0%

4.0

$ 843,600

$ 18,612

$ 862,212

12/31/13

227

5.3%

3.9%

4.3

$ 754,508

$ 28,852

$ 783,360

(1) At September 30, 2014, there were 58 mortgages on the 243 properties, while at December 31, 2013, there were 47 mortgages on the 227 properties. The mortgages require monthly payments, with principal payments due at maturity. The mortgages are at fixed interest rates, except for five mortgages on 14 properties totaling $74.4 million at September 30, 2014, including net unamortized discounts. At December 31, 2013, two mortgages totaling $31.1 million, including net unamortized discounts, were at variable interest rates. All of these variable rate mortgages were acquired with arrangements which limit our exposure to interest rate risk.

(2) Stated interest rates ranged from 2.0% to 6.9% at September 30, 2014, while stated interest rates ranged from 2.5% to 6.9% at December 31, 2013.

(3) Effective interest rates range from 2.2% to 9.1% at September 30, 2014, while effective interest rates ranged from 2.4% to 9.2% at December 31, 2013.

The following table summarizes the maturity of mortgages payable, excluding net premiums of $18.6 million, as of September 30, 2014 (dollars in millions):

Year of
Maturity
2014	$	7.6
2015	119.7
2016	248.4
2017	142.5
2018	15.1
Thereafter	310.3
Totals	$	843.6

7. Term Loan

In January 2013, in conjunction with our acquisition of ARCT, we entered into a $70 million senior unsecured term loan maturing January 21, 2018. Borrowing under the term loan bears interest at the current one month LIBOR, plus 1.2%. In conjunction with this term loan, we also acquired an interest rate swap which essentially fixes our per annum interest rate on the term loan at 2.15%. As a result of entering into our term loan, we incurred deferred financing costs of $303,000 in 2013, which are being amortized over the remaining term of the term loan. The net balance of these deferred financing costs was $202,000 at September 30, 2014, and $248,000 at December 31, 2013, which are included in other assets, net on our consolidated balance sheets.

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8. Notes Payable

A. General

Our senior unsecured notes and bonds consist of the following, sorted by maturity date (dollars in millions):

	September 30,			December 31,
	2014			2013
5.5% notes, issued in November 2003 and due in November 2015	$	150		$	150
5.95% notes, issued in September 2006 and due in September 2016	275			275
5.375% notes, issued in September 2005 and due in September 2017	175			175
2.0% notes, issued in October 2012 and due in January 2018	350			350
6.75% notes, issued in September 2007 and due in August 2019	550			550
5.75% notes, issued in June 2010 and due in January 2021	250			250
3.25% notes, issued in October 2012 and due in October 2022	450			450
4.65% notes, issued in July 2013 and due in August 2023	750			750
3.875% notes, issued in June 2014 and due in July 2024	350			-
4.125% notes, issued in September 2014 and due in October 2026	250			-
5.875% bonds, $100 issued in March 2005 and $150 issued in
June 2011, both due in March 2035	250			250
Total principal amount	3,800			3,200
Unamortized original issuance discounts	(15		)	(15		)
	$	3,785		$	3,185

The following table summarizes the maturity of our notes and bonds payable as of September 30, 2014, excluding unamortized original issuance discounts (dollars in millions):

	Notes and
Year of Maturity	Bonds
2014	$	-
2015	150
2016	275
2017	175
2018	350
Thereafter	2,850
Totals	$		3,800

As of September 30, 2014, the weighted average interest rate on our notes and bonds payable was 4.8% and the weighted average remaining years until maturity was 7.5 years.

B. Note Issuance

In September 2014, we issued $250 million of 4.125% senior unsecured notes due October 2026, or the 2026 Notes. The price to the investors for the 2026 Notes was 99.499% of the principal amount for an effective yield of 4.178% per annum. A portion of the total net proceeds of approximately $246.3 million from these offerings were used to repay all outstanding borrowings under our acquisition credit facility, and the remaining proceeds were used for other general corporate purposes and working capital, including additional property acquisitions. Interest is paid semiannually on the 2026 Notes. In October 2014, we utilized our acquisition credit facility to redeem our 6.75% Monthly Income Class E Preferred Stock.

In June 2014, we issued $350 million of 3.875% senior unsecured notes due July 2024, or the 2024 Notes. The price to the investors for the 2024 Notes was 99.956% of the principal amount for an effective yield of 3.88% per annum. The total net proceeds of approximately $346.7 million from these offerings were used to repay a portion of the outstanding borrowings under our acquisition credit facility. Interest is paid semiannually on the 2024 Notes.

In July 2013, we issued $750 million of 4.65% senior unsecured notes due August 2023, or the 2023 Notes. The price to the investors for the 2023 Notes was 99.775% of the principal amount for an effective yield of 4.678% per annum. The total net proceeds of approximately $741.4 million from these offerings were used to repay all outstanding borrowings under our acquisition credit facility, and the remaining proceeds were used for other general corporate purposes and working capital, including additional property acquisitions. Interest is paid semiannually on the 2023 Notes.

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C. Note Repayment

In March 2013, we repaid $100 million of outstanding 5.375% notes, plus accrued and unpaid interest, using proceeds from our March 2013 common stock offering and our credit facility.

9. Redemption of Preferred Stock

In September 2014, we issued an irrevocable notice of redemption for all 8.8 million shares of our 6.75% Monthly Income Class E Preferred Stock for $25 per share, plus accrued dividends. The redemption occurred in October 2014. The issuance of the redemption notice prior to the end of the quarter required us to reclassify $220.0 million of preferred stock from stockholders’ equity to liabilities on our consolidated balance sheet at September 30, 2014. These shares subject to mandatory redemption are now presented at fair value. We incurred a charge of $6.0 million, representing the Class E preferred stock original issuance costs that we paid in 2006.

10. Issuance of Common Stock

In April 2014, we issued 13,800,000 shares of common stock, including 1,800,000 shares purchased by the underwriters upon the exercise of their option to purchase additional shares. After underwriting discounts and other offering costs of $22.8 million, the net proceeds of $528.6 million were used to repay borrowings under our acquisition credit facility.

In March 2013, we issued 17,250,000 shares of common stock, including 2,250,000 shares purchased by the underwriters upon the exercise of their option to purchase additional shares. After underwriting discounts and other offering costs of $36.7 million, the net proceeds of $755.1 million were used to redeem our 5.375% notes in March 2013 and repay borrowings under our acquisition credit facility, which were used to fund property acquisitions, including our acquisition of ARCT.

In connection with our January 2013 acquisition of ARCT, we issued a total of 45,573,144 shares of our common stock to ARCT shareholders and we received 208,709 shares of our common stock that were previously held by ARCT. The total value of the 45,573,144 common shares was approximately $2 billion.

11. Noncontrolling Interests

In January 2013, we completed our acquisition of ARCT. Equity issued as consideration for this transaction included common and preferred partnership units issued by Tau Operating Partnership, L.P., or Tau Operating Partnership, the consolidated subsidiary which owns properties acquired through the ARCT acquisition. Realty Income and its subsidiaries hold a 99.3% interest in Tau Operating Partnership, and consolidate the entity.

In June 2013, we completed the acquisition of a portfolio of properties by issuing common partnership units in a newly formed entity, Realty Income, L.P. The units were issued as consideration for the acquisition. At September 30, 2014, the remaining units represent a 2.2% ownership in Realty Income, L.P. Realty Income holds the remaining 97.8% interests in this entity, and consolidates the entity.

A. Neither of the common partnership units has voting rights. Both common partnership units are entitled to monthly distributions equal to the amount paid to common stockholders of Realty Income, and are redeemable in cash or Realty Income common stock, at our option, and at a conversion ratio of one to one, subject to certain exceptions. Noncontrolling interests with redemption provisions that permit the issuer to settle in either cash or common stock, at the option of the issuer, were evaluated to determine whether temporary or permanent equity classification on the balance sheet was appropriate. We evaluated this guidance and determined that the units meet the requirements to qualify for presentation as permanent equity.

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The following table represents the change in the carrying value of all noncontrolling interests through September 30, 2014 (dollars in thousands):

	Tau Operating			Realty Income, L.P.
	Partnership units(1)			units(2)			Total
Carrying value at December 31, 2013	$	13,489		$	22,422		$	35,911
Reallocation of equity	-			(6,647		)	(6,647		)
Redemptions	-			(294		)	(294		)
Distributions	(521		)	(869		)	(1,390		)
Allocation of net income	218			798			1,016
Carrying value at September 30, 2014	$	13,186		$	15,410		$	28,596

	Tau Operating			Realty Income, L.P.
	Partnership units(1)			units(2)			Total
Fair value of units issued during 2013	$	13,962		$	22,601		$	36,563
Distributions	(691		)	(680		)	(1,371		)
Allocation of net income	218			501			719
Carrying value at December 31, 2013	$	13,489		$	22,422		$	35,911

(1) 317,022 Tau Operating Partnership units were issued on January 22, 2013 and remain outstanding as of September 30, 2014.

(2) 534,546 Realty Income, L.P. units were issued on June 27, 2013, and 524,546 units remain outstanding as of September 30, 2014.

During the first nine months of 2014 we recorded an equity reclassification adjustment of $6.6 million between noncontrolling interests and additional paid in capital to adjust the carrying value of the Realty Income, L.P. noncontrolling interests to be in-line with their equity ownership interest in the entity.

B. The Tau Operating Partnership preferred units were recorded at fair value as of the date of acquisition. Since they are redeemable at a fixed price on a determinable date, we have classified them in other liabilities on our consolidated balance sheets. Payments on these preferred units are made monthly at a rate of 2% per annum and are included in interest expense. As of September 30, 2014, the preferred units have a carrying value of $6.75 million.

12. Fair Value of Financial Assets and Liabilities

Fair value is defined as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The disclosure for assets and liabilities measured at fair value requires allocation to a three-level valuation hierarchy. This valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Categorization within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

We believe that the carrying values reflected on our consolidated balance sheets reasonably approximate the fair values for cash and cash equivalents, accounts receivable, escrow deposits, loans receivable, line of credit payable, term loan and all other liabilities, due to their short-term nature or interest rates and terms that are consistent with market, except for our notes receivable issued in connection with property sales, mortgages payable (which includes net mortgage premiums) and our senior notes and bonds payable, which are disclosed below (dollars in millions):

	Carrying value per		Estimated fair
At September 30, 2014	balance sheet		value
Notes receivable issued in connection with property sales	$	18.4	$	20.3
Mortgages payable assumed in connection with acquisitions	862.2		869.2
Notes and bonds payable, net of unamortized original issuance discounts	3,785.0		4,044.0

	Carrying value per		Estimated fair
At December 31, 2013	balance sheet		value
Notes receivable issued in connection with property sales	$	19.1	$	21.1
Mortgages payable assumed in connection with acquisitions	783.4		780.0
Notes and bonds payable, net of unamortized original issuance discounts	3,185.5		3,340.7

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The estimated fair values of our notes receivable issued in connection with property sales and our mortgages payable have been calculated by discounting the future cash flows using an interest rate based upon the relevant Treasury yield curve, plus an applicable credit-adjusted spread. Because this methodology includes unobservable inputs that reflect our own internal assumptions and calculations, the measurement of estimated fair values, related to our notes receivable and mortgages payable, is categorized as level three on the three-level valuation hierarchy.

The estimated fair values of our senior notes and bonds payable are based upon indicative market prices and recent trading activity of our senior notes and bonds payable. Because this methodology includes inputs that are less observable by the public and are not necessarily reflected in active markets, the measurement of the estimated fair values, related to our senior notes and bonds payable, is categorized as level two on the three-level valuation hierarchy.

13. Gain on Sales of Real Estate

During the third quarter of 2014, we sold 11 properties for $33.8 million, which resulted in a gain of $11.0 million. During the first nine months of 2014, we sold 28 properties for $53.6 million, which resulted in a gain of $16.8 million. Only the results of operations specifically related to the properties classified as held for sale at December 31, 2013 and sold during the first nine months of 2014 have been reclassified as discontinued operations.

In comparison, during the third quarter of 2013, Realty Income sold 19 properties for $22.4 million, which resulted in a gain of $6.2 million. During the first nine months of 2013, we sold 53 properties for $106.1 million which resulted in a gain of $50.5 million. The results of operations for the dispositions during 2013 have been reclassified as discontinued operations.

During the first nine months of 2014, Crest sold one property for $820,000, which resulted in no gain. The results of operations for this property have been reclassified as discontinued operations. During the first nine months of 2013, Crest did not sell any properties.

14. Impairments

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. A provision is made for impairment if estimated future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value of the property. Key factors that we estimate in this analysis include projected rental rates, estimated holding periods, capital expenditures and property sales capitalization rates. If a property is classified as held for sale, it is carried at the lower of carrying cost or estimated fair value, less estimated cost to sell, and depreciation of the property ceases.

During the third quarter of 2014 we recorded total provisions for impairment of $495,000 on one sold property and three properties classified as held for sale in the following industries: two in the home improvement industry, one in the convenience stores industry, and one in the restaurant-casual dining industry. For the first nine months of 2014, we recorded total provisions for impairment of $2.7 million on six sold properties and three properties classified as held for sale in the following industries: one in the consumer electronics industry, one in the home furnishings industry, one in the convenience stores industry, two in the home improvement industry, and four in the restaurant-casual dining industry. These properties were not previously classified as held for sale in financial statements issued prior to the date of adoption of ASU 2014-08; accordingly, these provisions for impairment are included in income from continuing operations on our consolidated statements of income for the three and nine months ended September 30, 2014.

In comparison, for the third quarter of 2013, we recorded total provisions for impairment of $76,000 on one sold property in the restaurants-casual dining industry. For the first nine months of 2013, we recorded total provisions for impairment of $3.0 million on eight sold properties and one property classified as held for sale in the following industries: one in the automotive parts industry, two in the automotive service industry, two in the child care industry, one in the grocery store industry, one in the pet supplies and services industry, and two in the restaurant-casual dining industry. Except for a provision for impairment of $290,000 that was recorded in income from continuing operations for one property not previously classified as held for sale as of December 31, 2013, the remaining provisions for impairment are included in income from discontinued operations on our consolidated statement of income for the three and nine months ended September 30, 2013.

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15. Discontinued Operations

Operations from 11 properties were classified as held for sale at September 30, 2014. We do not depreciate properties that are classified as held for sale. The results of operations for ten of these properties that have not previously been classified as held for sale are included in income from continuing operations, and the results of operations of the one remaining property that was classified as held for sale as of December 31, 2013 have been reclassified to discontinued operations on our consolidated statement of income for the three and nine months ended September 30, 2014.

No debt was assumed by buyers of our properties, or repaid as a result of our property sales, and we do not allocate interest expense to discontinued operations related to real estate held for investment.

The following is a summary of income from discontinued operations on our consolidated statements of income (dollars in thousands):

	Three months ended						Nine months ended
	September 30,						September 30,
Income from discontinued operations	2014			2013			2014			2013
Gain on sales of real estate	$	-		$	6,163		$	2,607		$	50,467
Rental revenue	15			906			111			5,016
Tenant reimbursements	-			34			-			133
Other revenue	-			7			13			414
Depreciation and amortization	-			(426		)	-			(1,536		)
Property expenses (including reimbursable)	(15		)	(174		)	(132		)	(812		)
Provisions for impairment	-			(76		)	-			(2,738		)
Crest’s income (loss) from discontinued operations	-			(35		)	498			(113		)
Income from discontinued operations	$	-		$	6,399		$	3,097		$	50,831
Per common share, basic and diluted	$	0.00		$	0.03		$	0.01		$	0.27

16. Distributions Paid and Payable

A. Common Stock

We pay monthly distributions to our common stockholders. The following is a summary of the monthly distributions paid per common share for the first nine months of 2014 and 2013:

Month	2014		2013
January	$	0.1821667	$	0.1517500
February	0.1821667		0.1809167
March	0.1821667		0.1809167
April	0.1824792		0.1812292
May	0.1824792		0.1812292
June	0.1824792		0.1812292
July	0.1827917		0.1815417
August	0.1827917		0.1815417
September	0.1827917		0.1815417

Total	$	1.6423128	$	1.6018961

At September 30, 2014, a distribution of $0.1831042 per common share was payable and was paid in October 2014.

B. Class E Preferred Stock

In 2006, we issued 8.8 million shares of our 6.75% Monthly Income Class E Cumulative Redeemable Preferred Stock, or Class E preferred stock, at a price of $25.00 per share. Since December 7, 2011, the shares of Class E preferred stock were redeemable, at our option, for $25.00 per share. During each of the first nine

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months of 2014 and 2013, we paid nine monthly dividends to holders of our Class E preferred stock totaling $1.265625 per share, or $11.1 million, and at September 30, 2014, a monthly dividend of $0.140625 per share was payable and was paid in October 2014. As discussed in note 9, during October 2014 we redeemed all 8.8 million shares of our Class E preferred stock for $25 per share, plus accrued dividends. Dividends that accrued subsequent to the September 2014 notice of redemption date for the Class E preferred stock were recorded to interest expense.

C. Class F Preferred Stock

In February 2012, we issued 14.95 million shares of 6.625% Monthly Income Class F Cumulative Redeemable Preferred Stock, or Class F preferred stock, at a price of $25.00 per share. In April 2012, we issued an additional 1.4 million shares of our Class F preferred stock at a price of $25.2863 per share. Beginning February 15, 2017, the shares of Class F preferred stock will be redeemable, at our option, for $25.00 per share, plus any accrued and unpaid dividends. During each of the first nine months of 2014 and 2013, we paid nine monthly dividends to holders of our Class F preferred stock totaling $1.242189 per share, or $20.3 million, and at September 30, 2014, a monthly dividend of $0.138021 per share was payable and was paid in October 2014.

We are current in our obligations to pay dividends on our Class F preferred stock.

17. Net Income Per Common Share

Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income per common share is computed by dividing net income available to common stockholders for the period by the weighted average number of common shares that would have been outstanding assuming the issuance of common shares for all potentially dilutive securities outstanding during the reporting period.

The following is a reconciliation of the denominator of the basic net income per common share computation to the denominator of the diluted net income per common share computation. The numerator has been adjusted for income allocated to convertible common units determined to be dilutive.

	Three months ended		Nine months ended
	September 30,		September 30,
	2014	2013	2014	2013
Weighted average shares used for the basic net income
per share computation	222,061,661	195,768,298	216,804,815	187,805,222
Incremental shares from share-based compensation	174,410	-	25,198	114,018
Weighted average partnership common units convertible
to common shares that were dilutive	-	851,568	317,022	480,608
Weighted average shares used for diluted net
income per share computation	222,236,071	196,619,866	217,147,035	188,399,848
Unvested shares from share-based compensation that
were anti-dilutive	45,654	60,259	58,654	59,749
Weighted average partnership common units convertible
to common shares that were anti-dilutive	841,568	-	529,381	-

18. Supplemental Disclosures of Cash Flow Information

Cash paid for interest was $183.1 million in the first nine months of 2014 and $142.4 million in the first nine months of 2013.

Interest capitalized to properties under development was $383,000 in the first nine months of 2014 and $579,000 in the first nine months of 2013.

Cash paid for income taxes was $3.5 million in the first nine months of 2014 and $1.5 million in the first nine months of 2013.

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The following non-cash investing and financing activities are included in the accompanying consolidated financial statements:

A. See note 14 for a discussion of impairments recorded by Realty Income for the first nine months of 2014 and 2013.

B. See note 9 for a discussion of the $6.0 million excess of redemption value over carrying value of preferred shares subject to redemption charge recorded by Realty Income during the third quarter and first nine months of 2014.

C. During the first nine months of 2014, we assumed mortgages payable to third-party lenders of $166.7 million, recorded $604,000 of net premiums, and recorded $901,000 of interest rate swap value to other assets, net, related to property acquisitions. During the first nine months of 2013, we assumed mortgages payable (excluding the mortgages payable discussed in items D and E) of $81.3 million to third-party lenders and recorded $6.1 million of net premiums related to property acquisitions.

D. During the first nine months of 2013, the following components were acquired in connection with our acquisition of ARCT: (1) real estate investments and related intangible assets of $3.2 billion, (2) other assets of $19.5 million, (3) lines of credit payable of $317.2 million, (4) a term loan for $235.0 million, (5) mortgages payable of $539.0 million, (6) intangible liabilities of $79.7 million, (7) other liabilities of $29.0 million, and (8) noncontrolling interests of $14.0 million.

E. During the first nine months of 2013, we acquired $55.9 million of real estate through the assumption of a $32.4 million mortgage payable, the issuance of 534,546 units by Realty Income, L.P. and cash of $1.0 million.

F. During the first nine months of 2014, we applied $48.9 million of loans receivable to the purchase price of five properties acquired during the period.

G. During the first nine months of 2013, we acquired real estate for $7.4 million via exchanges of our properties.

H. Accrued costs on properties under development resulted in an increase in buildings and improvements and accounts payable of $4.8 million at September 30, 2014, and $3.0 million at September 30, 2013.

19. Segment Information

We evaluate performance and make resource allocation decisions on an industry by industry basis. For financial reporting purposes, we have grouped our tenants into 48 activity segments. All of the properties are incorporated into one of the applicable segments. Because almost all of our leases require the tenant to pay operating expenses, rental revenue is the only component of segment profit and loss we measure.

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The following tables set forth certain information regarding the properties owned by us, classified according to the business of the respective tenants, as of September 30, 2014 (dollars in thousands):

	September 30,		December 31,
Assets, as of:	2014		2013
Segment net real estate:
Apparel	$	185,946	$	114,126
Automotive service	112,522		116,190
Automotive tire services	256,741		258,403
Beverages	303,070		306,278
Child care	55,190		56,599
Convenience stores	761,463		766,472
Dollar stores	1,171,645		824,274
Drug stores	1,029,922		943,401
Financial services	264,045		252,987
Food processing	134,436		138,000
Grocery stores	333,903		280,047
Health and fitness	556,846		493,981
Health care	228,374		228,491
Home improvement	213,226		121,575
Restaurants-casual dining	459,391		475,480
Restaurants-quick service	297,659		312,474
Theaters	379,498		367,830
Transportation services	661,504		623,541
Wholesale club	468,820		455,875
29 other non-reportable segments	1,827,640		1,660,585
Total segment net real estate	9,701,841		8,796,609

Intangible assets:
Apparel	54,371		37,553
Automotive service	2,994		3,248
Automotive tire services	15,288		15,770
Beverages	2,861		3,055
Convenience stores	17,909		13,342
Dollar stores	59,875		50,209
Drug stores	194,160		180,506
Financial services	40,799		40,112
Food processing	23,516		25,297
Grocery stores	42,887		22,073
Health and fitness	69,275		53,703
Health care	36,284		38,465
Home improvement	39,262		18,039
Restaurants-casual dining	10,963		11,906
Restaurants-quick service	16,905		17,936
Theaters	22,794		23,600
Transportation services	104,178		107,296
Wholesale club	40,580		33,221
Other non-reportable segments	264,978		240,128

Goodwill:
Automotive service	451		454
Automotive tire services	865		865
Child care	5,127		5,141
Convenience stores	2,030		2,031
Restaurants-casual dining	2,299		2,328
Restaurants-quick service	1,086		1,131
Other non-reportable segments	3,677		3,710
Other corporate assets	162,585		176,713
Total assets	$	10,939,840	$	9,924,441

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		Three months ended			Nine months ended
		September 30,			September 30,
Revenue		2014	2013		2014		2013
Segment rental revenue:
Apparel	$	4,922	$	3,626	$	12,999	$	10,579
Automotive service		4,025	3,900		12,427		11,561
Automotive tire services		6,973	6,866		21,111		20,106
Beverages		6,321	6,246		18,827		18,603
Child care		4,990	5,095		14,974		15,613
Convenience stores		22,592	21,727		67,221		62,178
Dollar stores		21,810	12,185		62,880		31,959
Drug stores		21,269	17,767		62,673		40,690
Financial services		4,248	3,916		12,572		11,026
Food processing		3,004	2,815		9,014		8,299
Grocery stores		7,163	5,553		19,763		16,365
Health and fitness		15,800	11,843		46,114		33,005
Health care		4,017	3,824		12,022		10,645
Home improvement		4,796	2,899		10,650		8,364
Restaurants-casual dining		9,591	9,755		28,996		28,568
Restaurants-quick service		7,933	8,026		24,530		23,639
Theaters		11,899	11,538		34,975		34,584
Transportation services		11,598	10,427		34,383		29,505
Wholesale club		9,250	8,655		27,247		20,696
29 other non-reportable segments		44,631	38,669		129,444		107,234
Total rental revenue		226,832	195,332		662,822		543,219
Tenant reimbursements		8,275	5,107		20,872		15,619
Other revenue		606	1,642		2,238		5,207
Total revenue	$	235,713	$	202,081	$	685,932	$	564,045

20. Common Stock Incentive Plan

In 2012, our Board of Directors adopted and stockholders approved the Realty Income Corporation 2012 Incentive Award Plan, or the 2012 Plan, to enable us to motivate, attract and retain the services of directors, employees and consultants considered essential to our long-term success. The 2012 Plan offers our directors, employees and consultants an opportunity to own stock in Realty Income or rights that will reflect our growth, development and financial success. Under the terms of the 2012 Plan, the aggregate number of shares of our common stock subject to options, restricted stock, stock appreciation rights, restricted stock units and other awards, will be no more than 3,985,734 shares. The 2012 Plan has a term of 10 years from the date it was adopted by the Board of Directors.

The amount of share-based compensation costs recognized in general and administrative expense on our consolidated statements of income was $2.2 million during the third quarter of 2014, $6.7 million during the third quarter of 2013, $7.7 million during the first nine months of 2014 and $14.2 million during the first nine months of 2013.

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A. Restricted Stock

The following table summarizes our common stock grant activity under the 2012 Plan. Our common stock grants vest over periods ranging from immediately to five years.

	For the nine months ended			For the year ended
	September 30, 2014			December 31, 2013
			Weighted			Weighted
	Number of		average	Number of		average
	shares		price(1)	shares		price(1)
Outstanding nonvested
shares, beginning of year	722,263		$23.37	895,550		$19.94
Shares granted	251,693		$39.68	484,060		$41.13
Shares vested	(321,408	)	$36.48	(654,650	)	$30.91
Shares forfeited	(17,394	)	$39.07	(2,697	)	$37.30
Outstanding nonvested
shares, end of each period	635,154		$29.83	722,263		$23.37

(1) Grant date fair value.

During the first nine months of 2014, we issued 251,693 shares of common stock under the 2012 Plan. These shares vest over the following service periods: 30,829 vested immediately, 8,000 vest over a service period of two years, 4,000 vest over a service period of three years, 30,535 vest over a service period of four years, and 178,329 vest over a service period of five years. Additionally, during 2013, 51,454 shares of performance-based common stock was granted, of which 12,864 shares vested at the end of 2013 based on the achievement of certain 2013 performance metrics, and of which 12,864 may vest at the end of 2014, 2015 and 2016, if certain performance metrics are reached.

As of September 30, 2014, the remaining unamortized share-based compensation expense related to restricted stock totaled $18.9 million, which is being amortized on a straight-line basis over the service period of each applicable award.

Due to a historically low turnover rate, we do not estimate a forfeiture rate for our nonvested shares. Accordingly, unexpected forfeitures will lower share-based compensation expense during the applicable period. Under the terms of our 2012 Plan, we pay non-refundable dividends to the holders of our nonvested shares. Applicable accounting guidance requires that the dividends paid to holders of these nonvested shares be charged as compensation expense to the extent that they relate to nonvested shares that do not or are not expected to vest. However, since we do not estimate forfeitures given our historical trends, we did not record any compensation expense related to dividends paid in the first nine months of 2014 or 2013.

B. Performance Shares

During the first nine months of 2014, we granted performance share awards, as well as dividend equivalent rights. Eighty percent (80%) of the total award value is market-based and subject to two Total Shareholder Return (“TSR”) market measures: 60% relative to the MSCI US REIT Index and 20% relative to the NAREIT Freestanding Index. The remaining 20% is performance-based, and will vest based on our debt-to-EBITDA ratio achieved during the performance period. The number of performance shares that vest based on the achievement of the performance goals will vest 50% on January 1, 2017 and 50% on January 1, 2018, subject to continued employment.

During the first nine months of 2014, 71,705 performance shares, with an estimated fair value of $3.0 million and an average grant date fair value of $41.46, were granted to our executive officers. The performance period for these awards began on January 1, 2014 and will end on December 31, 2016. The fair value of the market-based awards was estimated on the date of grant using a Monte Carlo Simulation model.

As of September 30, 2014, the remaining unamortized share-based compensation expense related to the performance shares totaled $2.6 million. The portion related to the market-based awards is being amortized on a straight-line basis over the service period, and the portion related to the performance-based awards is being amortized on a tranche-by-tranche basis over the service period.

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21. Dividend Reinvestment and Stock Purchase Plan

We have a Dividend Reinvestment and Stock Purchase Plan, or the DRSPP, to provide our common stockholders, as well as new investors, with a convenient and economical method of purchasing our common stock and reinvesting their distributions. The DRSPP also allows our current stockholders to buy additional shares of common stock by reinvesting all or a portion of their distributions. The DRSPP authorizes up to 6,000,000 common shares to be issued. During the first nine months of 2014, we issued 1,290,872 shares and raised approximately $56.6 million under the DRSPP. During the first nine months of 2013, we issued 89,975 shares and raised approximately $3.9 million under the DRSPP. From the inception of the DRSPP, in April 2011, through September 30, 2014, we have issued 2,855,214 shares and raised approximately $116.7 million.

In 2013, we revised our DRSPP to pay for a majority of the plan-related fees, which were previously paid by investors, and to institute a waiver approval process, allowing larger investors or institutions, per a formal approval process, to purchase shares at a small discount, if approved by us. In June 2014, we issued 1,135,897 shares and raised $50.0 million under the waiver approval process.

22. Commitments and Contingencies

In the ordinary course of business, we are party to various legal actions which we believe are routine in nature and incidental to the operation of our business. We believe that the outcome of the proceedings will not have a material adverse effect upon our consolidated financial position or results of operations.

At September 30, 2014, we have contingent payments of $3.3 million for tenant improvements and leasing costs. In addition, as of September 30, 2014, we had committed $23.0 million under construction contracts, which is expected to be paid in the next twelve months.

23. Subsequent Events

In October 2014, we declared the following dividends, which will be paid in November 2014:

- $0.1831042 per share to our common stockholders; and

- $0.138021 per share to our Class F preferred stockholders.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including the documents incorporated by reference, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended. When used in this quarterly report, the words “estimated”, “anticipated”, “expect”, “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Forward-looking statements include discussions of strategy, plans, or intentions of management. 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 properties; and

· Future expenditures for development projects.

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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;

· Continued volatility and uncertainty in the credit markets and broader financial 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 or which may occur in the future; 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 our Annual Report on Form 10-K, for the fiscal year ended December 31, 2013.

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date that this quarterly report was filed with the Securities and Exchange Commission, or SEC. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. 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 quarterly report or to reflect the occurrence of unanticipated events. In light of these risks and uncertainties, the forward-looking events discussed in this quarterly report might not occur.

THE COMPANY

Realty Income, The Monthly Dividend Company®, is a publicly traded real estate company with the primary business objective of generating dependable monthly cash dividends from a consistent and predictable level of cash flow from operations. Our monthly dividends are supported by the cash flow from our portfolio of properties leased to commercial tenants. We have in-house acquisition, portfolio management, asset management, credit research, real estate research, legal, finance and accounting, and capital markets expertise. Over the past 45 years, Realty Income has been acquiring and managing freestanding commercial properties that generate rental revenue under long-term net lease agreements.

Realty Income (NYSE: O) was founded in 1969, and in 1994 was listed on the New York Stock Exchange, or NYSE. We elected to be taxed as a real estate investment trust, or REIT, requiring us to distribute dividends to our stockholders aggregating at least 90% of our taxable income (excluding net capital gains).

We seek to increase earnings and distributions to stockholders, through both active portfolio management and the acquisition of additional properties.

Generally, our portfolio management efforts seek to achieve:

· Contractual rent increases on existing leases;

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

· The active management of our property portfolio, including re-leasing vacant properties, and selectively selling properties, thereby mitigating our exposure to certain tenants and markets.

At September 30, 2014, we owned a diversified portfolio:

· Of 4,284 properties;

· With an occupancy rate of 98.3%, or 4,210 properties leased and 74 properties available for lease;

· Leased to 231 different commercial tenants doing business in 47 separate industries;

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· Located in 49 states and Puerto Rico;

· With over 69.8 million square feet of leasable space; and

· With an average leasable space per property of approximately 16,300 square feet, including approximately 11,250 square feet per retail property.

Of the 4,284 properties in the portfolio, 4,262, or 99.5%, are single-tenant properties, and the remaining 22 are multi-tenant properties. At September 30, 2014, of the 4,262 single-tenant properties, 4,189 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 10.4 years.

Investment Philosophy

We believe that owning an actively managed, diversified portfolio of commercial properties under long-term, net leases produces consistent and predictable income. Net leases typically require the tenant to be responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants of our properties typically pay rent increases based on: 1) increases in the consumer price index (typically subject to ceilings), 2) additional rent calculated as a percentage of the tenants’ gross sales above a specified level, or 3) fixed increases. We believe that a portfolio of properties under long-term leases 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.

We estimate that approximately 46% of our annualized rental revenue comes from properties leased to investment grade companies or their subsidiaries. At September 30, 2014, our top 20 tenants represent approximately 54% of our annualized revenue and eight of these tenants have investment grade credit ratings.

Investment Strategy

When identifying new properties for acquisition, we generally focus on providing capital to owners and operators of commercial tenants by acquiring the real estate they consider important to the successful operation of their business.

We primarily focus on acquiring properties with many of the following attributes:

· Tenants with reliable and sustainable cash flow;

· Tenants with revenue and cash flow from multiple sources;

· Tenants that are willing to sign a long-term lease (10 or more years);

· Tenants that are large owners and users of real estate;

· Real estate that is critical to the tenant’s ability to generate revenue (i.e. they need the property in which they operate in order to conduct their business);

· Real estate with property valuations that approximate replacement cost;

· Properties with rental or lease payments that approximate market rents; and

· Property transactions where we can achieve an attractive spread over our cost of capital.

From a retail perspective, our investment strategy is to target tenants with a service, non-discretionary, and/or low price point component to their business. We believe these characteristics better position tenants to operate in a variety of economic conditions and to compete more effectively with internet retailers. As a result of the execution of this strategy, over 90% of our retail rental revenue for the third quarter of 2014 was derived from tenants with a service, non-discretionary, and/or low price point component to their business. We believe rental revenue generated from businesses with these characteristics is generally more durable and stable.

Diversification is also a key objective of our investment strategy. We believe that diversification of the portfolio by tenant, industry, geographic location, and, to a certain extent, property type leads to more predictable investment results for our shareholders by reducing vulnerability that can come with any single concentration. Our investment efforts have led to a diversified property portfolio that, as of September 30, 2014, consisted of 4,284 properties located in 49 states and Puerto Rico, leased to 231 different commercial tenants doing business in 47 industry segments. Each of the 47 industry segments represented in our property portfolio individually accounted for no more than 10% of our rental revenue for the quarter ended September 30, 2014.

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We typically acquire and lease properties to tenants in transactions where we can achieve an attractive risk-adjusted return. Since 1970, our occupancy rate at the end of each year has never been below 96%.

Credit Strategy

We believe the principal financial obligations for most of our tenants 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 business or which are critical to the tenant’s ability to generate revenue, we believe the risk of default on a tenant’s lease obligations is less than the tenant’s unsecured general obligations. It has been our experience that since tenants must retain their profitable and critical locations in order to survive, and in the event of reorganization, they are less likely to reject a lease for a profitable or critical 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 tenant 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 real estate leases can be further mitigated by monitoring the performance of the tenants’ individual locations and considering whether to sell locations that are weaker performers.

In order to be considered for acquisition, properties must meet stringent investment and credit requirements. The properties must generate attractive current yields and the tenant must meet our credit criteria. We have established a four-part analysis that examines each potential investment based on:

· Industry, company, market conditions and credit profile;

· Store profitability for retail locations, if profitability data is available;

· Overall real estate characteristics, including property value and comparative rental rates; and

· The importance of the real estate location to the operations of the company’s business.

Prior to entering into any transaction, our investment professionals, assisted by our research department, conduct a review of a tenant’s credit quality. The information reviewed may include reports and filings, including any public credit ratings, financial statements, debt and equity analyst reports, and reviews of corporate credit spreads, stock prices, market capitalization and other financial metrics. We conduct additional due diligence, including additional financial reviews of the tenant and a more comprehensive review of the business segment and industry in which the tenant operates. We continue to monitor our tenants’ credit quality on an ongoing basis by reviewing the available information previously discussed, and providing summaries of these findings to management.

Acquisition Strategy

We seek to invest in industries in which several, well-organized, regional and national commercial tenants are capturing market share through service, quality control, economies of scale, strong consumer brands, advertising, and the selection of prime locations. Our acquisition strategy is to act as a source of capital to regional and national commercial tenants by acquiring and leasing back their real estate locations. In addition, we frequently acquire large portfolios of properties net leased to multiple tenants in a variety of industries. We have an internal team dedicated to sourcing such opportunities, often using our relationships with various tenants, owners/developers and advisers to uncover and secure transactions. We also undertake thorough research and analysis to identify what we consider to be appropriate industries, tenants and property locations for investment. This research expertise is instrumental to uncovering net lease opportunities in markets where our real estate financing program adds value. In selecting potential investments, we generally seek to acquire real estate that has the following characteristics:

· Properties that are freestanding, commercially-zoned with a single tenant;

· Properties that are in significant markets or strategic locations critical to generating revenue for regional and national commercial tenants;

· Properties that we deem to be profitable for the tenants and/or can generally be characterized as important to the operations of the company’s business;

· Properties that are located within attractive demographic areas, relative to the business of our 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.

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Asset 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. We also regularly analyze our portfolio with a view toward optimizing its returns and enhancing our credit quality.

We regularly review and analyze:

· The performance of the various industries of our tenants;

· The operation, management, business planning and financial condition of our tenants; and

· The quality of the underlying real estate locations.

We have an active asset management program that incorporates the sale of assets when we believe the reinvestment of the sale proceeds will:

· Generate higher returns;

· Enhance the credit quality of our real estate portfolio;

· Extend our average remaining lease term; or

· Decrease tenant or industry concentration.

At September 30, 2014, we classified real estate with a carrying amount of $15.8 million as held for sale on our balance sheet. For the remainder of 2014, we intend to continue our active disposition efforts to further enhance our real estate portfolio and anticipate approximately $100 million in property sales for all of 2014. We intend to invest these proceeds into new property acquisitions, if there are attractive opportunities available. However, we cannot guarantee that we will sell properties during the next 12 months at our estimated values or be able to invest the property sale proceeds in new properties.

Impact of Real Estate and Credit Markets

In the commercial real estate market, property prices generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy accordingly.

RECENT DEVELOPMENTS

Increases in Monthly Dividends to Common Stockholders

We have continued our 45-year policy of paying monthly dividends. We increased the dividend four times during 2014.

	Month	Dividend	Increase
2014 Dividend increases	Paid	per share	per share
1st increase	Jan 2014	$ 0.1821667	$ 0.0003125
2nd increase	Apr 2014	0.1824792	0.0003125
3rd increase	Jul 2014	0.1827917	0.0003125
4th increase	Oct 2014	0.1831042	0.0003125

The dividends paid per share totaled $1.6423128 in the first nine months of 2014 as compared to $1.6018961 in the first nine months of 2013, an increase of $0.0404167, or 2.5%.

The increase in October was our 68th consecutive quarterly increase and the 77th increase in the amount of the dividend since our listing on the NYSE in 1994. In September 2014 and October 2014, we declared dividends of $0.1831042 per share, which were paid in October 2014 and will be paid in November 2014, respectively.

The monthly dividend of $0.1831042 per share represents a current annualized dividend of $2.1972504 per share, and an annualized dividend yield of approximately 5.4% based on the last reported sale price of our common stock on the NYSE of $40.79 on September 30, 2014. Although we expect to continue our policy of paying monthly dividends, we cannot guarantee that we will maintain our current level of dividends, that we will continue our pattern of increasing dividends per share, or what our actual dividend yield will be in any future period.

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Acquisitions during the Third Quarter of 2014

During the third quarter of 2014, we invested $182.1 million in 49 new properties and properties under development or expansion, with an estimated initial weighted average contractual lease rate of 7.4%. The 49 new properties and properties under development or expansion are located in 26 states, will contain over 1.9 million leasable square feet and are 100% leased, with a weighted average lease term of 11.2 years. The tenants occupying the new properties operate in 15 industries and the property types consist of 96.0% retail, and 4.0% industrial and distribution, based on rental revenue.

Acquisitions during the First Nine Months of 2014

During the first nine months of 2014, we invested $1.24 billion in 439 new properties and properties under development or expansion with an initial weighted average contractual lease rate of 7.1%. The 439 new properties and properties under development or expansion, are located in 42 states, will contain over 8.5 million leasable square feet and are 100% leased, with a weighted average lease term of 12.6 years. The tenants occupying the new properties operate in 27 industries and the property types consist of 85.6% retail, 7.2% office, 5.8% industrial and distribution, and 1.4% manufacturing, based on rental revenue. None of our investments during the first nine months of 2014 caused any one tenant to be 10% or more of our total assets at September 30, 2014.

In the case of a property under development or expansion, the contractual lease rate is generally fixed such that rent varies based on the actual total investment in order to provide a fixed rate of return. When the lease does not provide for a fixed rate of return on a property under development or expansion, the estimated initial weighted average contractual lease rate is computed as follows: estimated net operating income (determined by the lease) for the first full year of each lease, divided by our projected total investment in the property, including land, construction and capitalized interest costs. Of the $1.24 billion we invested during the first nine months of 2014, $69.0 million was invested in 32 properties under development or expansion with an estimated initial weighted average contractual lease rate of 8.5%. We may continue to pursue development or expansion opportunities under similar arrangements in the future.

Portfolio Discussion

Leasing Results

At September 30, 2014, we had 74 properties available for lease out of 4,284 properties in our portfolio, which represents a 98.3% occupancy rate. Since December 31, 2013, when we reported 70 properties available for lease and a 98.2% occupancy rate, we:

· Had 166 lease expirations;

· Re-leased 153 properties; and

· Sold nine vacant properties.

Of the 153 properties re-leased during the first nine months of 2014, 138 properties were re-leased to either existing or new tenants without vacancy, and 15 were re-leased to new tenants after a period of vacancy. The annual rent on these leases was $28.7 million, as compared to the previous rent on these same properties of $28.8 million.

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At September 30, 2014, our average annualized rental revenue was approximately $13.12 per square foot on the 4,210 leased properties in our portfolio. At September 30, 2014, we classified eleven properties with a carrying amount of $15.8 million as held for sale on our balance sheet.

Investments in Existing Properties

In the third quarter of 2014, we capitalized costs of $1.8 million on existing properties in our portfolio, consisting of $188,000 for re-leasing costs and $1.6 million for building and tenant improvements. In the third quarter of 2013, we capitalized costs of $2.6 million on existing properties in our portfolio, consisting of $369,000 for re-leasing costs and $2.2 million for building and tenant improvements.

In the first nine months of 2014, we capitalized costs of $4.5 million on existing properties in our portfolio, consisting of $655,000 for re-leasing costs and $3.9 million for building and tenant improvements. In the first nine months of 2013, we capitalized costs of $5.9 million on existing properties in our portfolio, consisting of $1.1 million for re-leasing costs and $4.8 million for building and tenant improvements.

As part of our re-leasing costs, we typically pay leasing commissions and sometimes provide tenant rent concessions. Leasing commissions are paid based on the commercial real estate industry standard and any rent concessions provided are minimal. We do not consider the collective impact of the leasing commissions or tenant rent concessions to be material to our financial position or results of operations.

The majority of our building and tenant improvements relate to roof repairs, HVAC improvements, and parking lot resurfacing and replacements. It is not customary for us to offer significant tenant improvements on our properties as tenant incentives. The amounts of our capital expenditures can vary significantly, depending on the rental market, tenant credit worthiness, and the willingness of tenants to pay higher rents over the terms of the leases.

Note Issuance

Redemption of Preferred Stock

In September 2014, we issued an irrevocable notice of redemption for all 8.8 million shares of our 6.75% Monthly Income Class E Preferred Stock for $25 per share, plus accrued dividends. The redemption occurred in October 2014. The issuance of the redemption notice prior to the end of the quarter required us to reclassify $220.0 million of preferred stock from stockholders’ equity to liabilities on our consolidated balance sheet at September 30, 2014. These shares subject to mandatory redemption are now presented at fair value. We incurred a non-cash charge of $6.0 million. This charge is for the excess of redemption value over the carrying value and represents the Class E preferred stock original issuance cost that was paid in 2006.

Issuance of Common Stock

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Modifications to Compensation Program

During April 2014, the Compensation Committee of the Board of Directors made modifications to the existing compensation program. The modified compensation program now consists of distinct short-term and long-term incentive plans based on separate metrics. The redesigned short-term incentive plan includes a mix of cash and equity awards. Under the long-term incentive plan, an individual’s award is granted in performance-vesting equity awards, which vest based strictly on achieving future performance goals. With respect to the performance based restricted shares, the award is based on objective performance metrics and determined primarily by relative stockholder return metrics with a smaller component based on balance sheet metrics. As part of this new program, the Compensation Committee of the Board of Directors granted performance-vesting shares with an approximate grant date fair value of $3.0 million to our executive officers during April 2014.

Net Income Available to Common Stockholders

Net income available to common stockholders was $57.9 million in the third quarter of 2014, compared to $41.1 million in the third quarter of 2013, an increase of $16.8 million. On a diluted per common share basis, net income was $0.26 in the third quarter of 2014 and $0.21 in the third quarter of 2013.

Net income available to common stockholders was $156.5 million in the first nine months of 2014, compared to $149.8 million in the first nine months of 2013, a increase of $6.7 million. On a diluted per common share basis, net income available to common stockholders was $0.72 in the first nine months of 2014, as compared to $0.80 in the first nine months of 2013, a decrease of $0.08, or 10.0%. Net income available to common stockholders in the third quarter and the first nine months of 2014 includes a non-cash redemption charge of $6.0 million on the Class E preferred shares that were redeemed in October 2014, which represents $0.03 on a diluted per common share basis. This charge is for the excess of redemption value over the carrying value and represents the Class E preferred stock original issuance cost that was paid in 2006. Net income available to common stockholders in the first nine months of 2013 was impacted by an unusually large gain on property sales, which represents $0.18 on a diluted per common share basis. Additionally, net income available to common stockholders in the first nine months of 2013 includes $12.9 million of merger-related costs, for the acquisition of American Realty Capital Trust, Inc., ARCT, which represents $0.07 on a diluted per common share basis, and $3.7 million for accelerated vesting of restricted shares that occurred in July 2013 from ten-year vesting to five years, which represents $0.02 on a diluted per common share basis.

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.

Gains from the sale of properties during the third quarter of 2014 were $11.0 million, as compared to $6.2 million during the third quarter of 2013. Gains from the sale of properties during the first nine months of 2014 were $16.8 million, as compared to $50.5 million during the first nine months of 2013.

Funds from Operations Available to Common Stockholders (FFO)

In the third quarter of 2014, our FFO increased by $26.2 million, or 22.6%, to $142.3 million, compared to $116.1 million in the third quarter of 2013. On a diluted per common share basis, FFO was $0.64 in the third quarter of 2014 and $0.59 in the third quarter of 2013, an increase of 8.5%.

In the first nine months of 2014, our FFO increased by $81.8 million, or 24.2% to $419.2 million, compared to $337.4 million in the first nine months of 2013. On a diluted per common share basis, FFO was $1.93 in the first nine months of 2014, compared to $1.79 in the first nine months of 2013, an increase of $0.14, or 7.8%. FFO in the third quarter and first nine months of 2014 includes a non-cash redemption charge of $6.0 million on the Class E preferred shares that were redeemed in October 2014, which represents $0.03 on a diluted per common share basis. This charge is for the excess of redemption value over the carrying value and represents the Class E preferred stock original issuance cost that was paid in 2006. FFO for the first nine months of 2013, was normalized to exclude $12.9 million of merger-related costs for the acquisition of ARCT, which represents $0.07 on a diluted per common share basis. FFO for the first nine months of 2013 includes $3.7 million for accelerated vesting of restricted shares that occurred in July 2013 from ten-year vesting to five years, which represents $0.02 on a diluted per common share basis. All references to FFO for the first nine months of 2013 reflect the adjustments for merger-related costs for the acquisition of ARCT.

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Adjusted Funds from Operations Available to Common Stockholders (AFFO)

In the third quarter of 2014, our AFFO increased by $24.5 million, or 20.8%, to $142.4 million, compared to $117.9 million in the third quarter of 2013. On a diluted common share basis, AFFO was $0.64 in the third quarter of 2014 and $0.60 in the third quarter of 2013, an increase of 6.7%.

In the first nine months of 2014, our AFFO increased by $78.9 million, or 23.4%, to $416.3 million versus $337.4 million in the first nine months of 2013. On a diluted per common share basis, AFFO was $1.92 in the first nine months of 2014, compared to $1.79 in the first nine months of 2013, an increase of $0.13, or 7.3%.

See our discussion of FFO and AFFO (which are not financial measures under U.S. generally accepted accounting principles, or GAAP), later in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which includes a reconciliation of net income available to common stockholders to FFO and AFFO.

LIQUIDITY AND CAPITAL RESOURCES

Capital Philosophy

Historically, we have met our long-term capital needs by issuing common stock, preferred stock and long-term unsecured notes and bonds. Over the long term, we believe that common stock should be the majority of our capital structure. However, we may issue additional preferred stock or debt securities. 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 times and at terms that are acceptable to us.

Our primary cash obligations, for the current year and subsequent years, are included in the “Table of Obligations,” which is presented later in this section. We expect to fund our operating expenses and other short-term liquidity requirements, including property acquisitions and development costs, payment of principal and interest on our outstanding indebtedness, property improvements, re-leasing costs and cash distributions to common and preferred stockholders, primarily through cash provided by operating activities, borrowing on our $1.5 billion credit facility, and occasionally through public securities offerings.

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 September 30, 2014, our total outstanding borrowings of senior unsecured notes and bonds, term loan, mortgages payable and credit facility borrowings, as well as our mandatorily redeemable preferred shares of $220.0 million, totaled $4.98 billion, or approximately 34.3% of our total market capitalization of $14.50 billion.

We define our total market capitalization at September 30, 2014 as the sum of:

· Shares of our common stock outstanding of 222,670,846, plus total common units of 841,568, multiplied by the closing sales price of our common stock on the NYSE of $40.79 per share on September 30, 2014, or $9.12 billion;

· Aggregate liquidation value (par value of $25 per share) of the Class E preferred stock of $220.0 million currently classified as a liability on our consolidated balance sheet as of September 30, 2014.

· Aggregate liquidation value (par value of $25 per share) of the Class F preferred stock of $408.8 million;

· Outstanding borrowings of $45.0 million on our credit facility;

· Outstanding mortgages payable of $843.6 million, excluding net mortgage premiums of $18.6 million;

· Outstanding borrowings of $70.0 million on our term loan; and

· Outstanding senior unsecured notes and bonds of $3.8 billion, excluding unamortized original issuance discounts of $15.0 million.

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Universal Shelf Registration

In February 2013, we filed a shelf registration statement with the SEC, which is effective for a term of three years and will expire in February 2016. This replaces our prior shelf registration statement. In accordance with SEC rules, the amount of securities to be issued pursuant to this shelf registration statement was not specified when it was filed and there is no specific dollar limit. The securities covered by this registration statement include (1) common stock, (2) preferred stock, (3) debt securities, (4) depositary shares representing fractional interests in shares of preferred stock, (5) warrants to purchase debt securities, common stock, preferred stock or depositary shares, and (6) any combination of these securities. We 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.

Mortgage Debt

As of September 30, 2014, we had $843.6 million of mortgages payable, all of which were assumed in connection with our property acquisitions. Additionally, at September 30, 2014, we had net premiums totaling $18.6 million on these mortgages. We expect to pay off the mortgages payable as soon as prepayment penalties have declined to a level that will make it economically feasible to do so. During the first nine months of 2014, we made $77.6 million in principal payments, which includes the repayment of five mortgages in full for $72.0 million.

Term Loan

In January 2013, in conjunction with our acquisition of ARCT, we entered into a $70 million senior unsecured term loan maturing in January 2018. Borrowing under the term loan bears interest at LIBOR, plus 1.20%. In conjunction with this term loan, we also acquired an interest rate swap which essentially fixes our per annum interest rate on the term loan at 2.15%.

$1.5 Billion Acquisition Credit Facility

At September 30, 2014, we had a borrowing capacity of $1.46 billion available on our credit facility and an outstanding balance of $45.0 million. The interest rate on borrowings outstanding under our credit facility, at September 30, 2014, was 1.2% per annum. We must comply with various financial and other covenants in our credit facility. At September 30, 2014, we remain in compliance with these covenants. We expect to use our credit facility to acquire additional properties and for other corporate purposes. Any additional borrowings will increase our exposure to interest rate risk. We regularly review our credit facility and may seek to extend or replace our credit facility, to the extent we deem appropriate.

We generally use our credit facility for the short-term financing of new property acquisitions. Thereafter, when 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 or 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 the refinancing will enable us to issue equity or debt securities upon acceptable terms.

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Notes Outstanding

Our senior unsecured note and bond obligations consist of the following as of September 30, 2014, sorted by maturity date (dollars in millions):

5.5% notes, issued in November 2003 and due in November 2015	$	150
5.95% notes, issued in September 2006 and due in September 2016	275
5.375% notes, issued in September 2005 and due in September 2017	175
2.0% notes, issued in October 2012 and due in January 2018	350
6.75% notes, issued in September 2007 and due in August 2019	550
5.75% notes, issued in June 2010 and due in January 2021	250
3.25% notes, issued in October 2012 and due in October 2022	450
4.65% notes, issued in July 2013 and due in August 2023	750
3.875% notes, issued in June 2014 and due in July 2024	350
4.125% notes, issued in September 2014 and due in October 2026	250
5.875% bonds, $100 issued in March 2005 and $150 issued in
June 2011, both due in March 2035	250
Total principal amount	$	3,800
Unamortized original issuance discounts	(15		)
	$	3,785

All of our outstanding notes and bonds have fixed interest rates and contain various covenants, which we remain in compliance with at September 30, 2014. Additionally, interest on all of our senior note and bond obligations is paid semiannually.

The following is a summary of the key financial covenants for our senior unsecured notes, as defined and calculated per the terms of our senior notes and bonds. These calculations, which are not based on U.S. GAAP measurements, are presented to investors to show our ability to incur additional debt under the terms of our senior notes and bonds only and are not measures of our liquidity or performance. The actual amounts as of September 30, 2014 are:

Note Covenants	Required	Actual

Limitation on incurrence of total debt	< 60% of adjusted assets	44.8	%
Limitation on incurrence of secured debt	< 40% of adjusted assets	7.7	%
Debt service coverage (trailing 12 months)(1)	> 1.5 x	3.7	x
Maintenance of total unencumbered assets	> 150% of unsecured debt	230.1	%

(1) This covenant is calculated on a pro forma basis for the preceding four-quarter period on the assumption that: (i) the incurrence of any Debt (as defined in the covenants) incurred by us since the first day of such four-quarter period and the application of the proceeds therefrom (including to refinance other Debt since the first day of such four-quarter period), (ii) the repayment or retirement of any of our Debt since the first day of such four-quarter period, and (iii) any acquisition or disposition by us of any asset or group since the first day of such four-quarters had in each case occurred on October 1, 2013, and subject to certain additional adjustments. Such pro forma ratio has been prepared on the basis required by that debt service covenant, reflects various estimates and assumptions and is subject to other uncertainties, and therefore does not purport to reflect what our actual debt service coverage ratio would have been had transactions referred to in clauses (i), (ii) and (iii) of the preceding sentence occurred as of October 1, 2013, nor does it purport to reflect our debt service coverage ratio for any future period. The following is our calculation of debt service coverage at September 30, 2014 (in thousands, for trailing twelve months):

Net income attributable to the Company	$	257,182
Plus: interest expense	199,906
Plus: provision for taxes	1,889
Plus: depreciation and amortization	363,454
Plus: provisions for impairment	2,677
Plus: pro forma adjustments	43,529
Less: gain on sales of real estate	(31,093		)
Income available for debt service, as defined	$	837,544
Total pro forma debt service charge	$	226,865
Debt service coverage ratio	3.7

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Fixed Charge Coverage Ratio

Fixed charge coverage ratio is calculated in exactly the same manner as the debt service coverage ratio, except that preferred stock dividends are also added to the denominator. Similar to debt service coverage ratio, we consider fixed charge coverage ratio to be an appropriate supplemental measure of a company’s ability to make its interest and preferred stock dividend payments. Our calculations of both debt service and fixed charge coverage ratios may be different from the calculations used by other companies and, therefore, comparability may be limited. The presentation of debt service and fixed charge coverage ratios should not be considered as alternatives to any U.S. generally accepted accounting principles, or GAAP, operating performance measures. Below is our calculation of fixed charges at September 30, 2014 (in thousands, for trailing twelve months):

Income available for debt service, as defined	$	837,544
Pro forma debt service charge plus preferred stock dividends	$	253,945
Fixed charge coverage ratio	3.3

Cash Reserves

We are 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 our net cash flow generated from leases on our properties. We intend to retain an appropriate amount of cash as working capital. At September 30, 2014, we had cash and cash equivalents totaling $16.9 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 next twelve months. We intend, however, to use permanent or long-term capital to fund property acquisitions and to repay future borrowings under our credit facility.

Credit Agency Ratings

The borrowing interest rates under our credit facility are based upon our ratings assigned by credit rating agencies. We are currently assigned the following investment grade corporate credit ratings on our senior unsecured notes and bonds: Fitch Ratings has assigned a rating of BBB+ with a “stable” outlook, Moody’s Investors Service has assigned a rating of Baa1 with a “stable” outlook, and Standard & Poor’s Ratings Group has assigned a rating of BBB+ with a “stable” outlook to our senior notes.

Based on our current ratings, the current facility interest rate is LIBOR plus 1.075% with a facility commitment fee of 0.175%, for all-in drawn pricing of 1.25% over LIBOR. The credit facility provides that the interest rate can range between: (i) LIBOR plus 1.85% if our credit rating is lower than BBB-/Baa3 and (ii) LIBOR plus 1.00% if our credit rating is A-/A3 or higher. In addition, our credit facility provides for a facility commitment fee based on our credit ratings, which range from (i) 0.45% for a rating lower than BBB-/Baa3, and (ii) 0.15% for a credit rating of A-/A3 or higher.

We also issue senior debt securities from time to time and our credit ratings can impact the interest rates charged in those transactions. If our credit ratings or ratings outlook change, our cost to obtain debt financing could increase or decrease.

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 our ratings 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.

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Table of Obligations

The following table summarizes the maturity of each of our obligations as of September 30, 2014 (dollars in millions):

															Ground			Ground
															Leases			Leases
				Notes											Paid by			Paid by
Year of	Credit			and			Term		Mortgages						Realty			Our
Maturity	Facility		(1)	Bonds		(2)	Loan		Payable		(3)	Interest		(4)	Income		(5)	Tenants		(6)	Other		(7)	Totals
2014	$	-		$	-		$	-	$	7.6		$	56.0		$	0.3		$	3.2		$	221.6		$	288.7
2015		-			150.0			-		119.7			221.1			1.0			12.7			26.3			530.8
2016		-			275.0			-		248.4			196.3			1.0			12.7			-			733.4
2017		45.0			175.0			-		142.5			173.8			1.0			12.8			-			550.1
2018		-			350.0			70.0		15.1			155.4			1.0			12.8			-			604.3
Thereafter		-			2,850.0			-		310.3			707.8			9.4			144.6			-			4,022.1
Totals	$	45.0		$	3,800.0		$	70.0	$	843.6		$	1,510.4		$	13.7		$	198.8		$	247.9