Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Realty Income Third Quarter 2013 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, there will be an opportunity to ask questions, and instructions will be given at that time. Should anyone require assistance on the call today, please press the star followed by the zero, and as a reminder, this call is being recorded today, October 31st, 2013. I would now like to turn the call over to Terry Miller, Vice President of Investor Relations for Realty Income. Please go ahead.
Thank you, Craig, thank you all for joining us today for Realty Income's third quarter operating results conference call. Discussing our third quarter results will be John Case, Chief Executive Officer, Paul Meurer, Executive Vice President, Chief Financial Officer, and Treasurer, Sumit Roy, Executive Vice President and Chief Investment Officer. Also joining us on the call are Gary Malino, President and Chief Operating Officer, and Mike Pfeiffer, our Executive Vice President and General Counsel. During this conference call, we will make certain statements that may be considered to be forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the company's Form 10-Q. I will now turn the call over to Mr. Case.
Thanks, Terry. Good afternoon, everyone, welcome to our call. We're pleased with the company's operating performance for the third quarter, with solid results coming from our areas of the business. Paul's going to start and review the financial numbers. I'm going to hand it over to Paul. Paul?
Thanks, John. As usual, I'm going to comment on our financial statements and provide a few highlights of our financial results for the quarter, starting with the income statement. Total revenue increased 70% for the quarter. Our current revenue on an annualized basis is approximately $805 million. This increase reflects positive same-store rents of 1.3%. More significantly, it obviously reflects our growth in new acquisitions over the past year. On the expense side, depreciation and amortization expense increased significantly to almost $81 million in the quarter, as depreciation expense has obviously increased with our portfolio growth. Interest expense increased in the quarter to $49.7 million. This increase was primarily due to the $800 million of bonds that were issued last October and the $750 million bond issuance in July, as well as some credit facility borrowings during the quarter.
On a related note, our coverage ratios both remain strong, with interest coverage at 3.5 times and fixed charge coverage at 2.9 times. General and administrative expenses, or G&A, in the third quarter was approximately $16.6 million. Our G&A expense has naturally increased this past year as our acquisition activity has increased, and we did add some new personnel to manage a larger portfolio. Our employee base has grown from 92 employees a year ago to 114 employees at quarter end. The other unique factor, though, in our third quarter G&A was a $3.7 million non-cash expense related to the acceleration in July of our older tenure stock grants to 5-year vesting. Overall, our total G&A year-to-date as a percentage of total revenues was still only 7.3%, compared to historically, our G&A had a run rate of about 7.5%-8% of revenues.
Our current projection for G&A for 2014 is about $50 million, or less than 6% of revenues. Property expenses were approximately $5.9 million for the quarter. Our property expense estimate for all of 2013 is about $18 million, and our projection for 2014 is $20 million. Income taxes consist of income taxes paid to various states by the company, and they were $671,000 for the quarter. Merger-related costs. This line item refers to the cost associated with the ARCT acquisition earlier in the year. During the quarter, we expensed $240,000 of such remaining costs. Income from discontinued operations for the quarter totaled $6.6 million. This income is associated with our property sales activity during the quarter. We sold 19 properties during the quarter for $22.4 million, with a gain on sales of $6.2 million.
A reminder that we do not include property sales gains in our FFO or in our AFFO. Preferred stock cash dividends totaled approximately $10.5 million for the quarter, and net income available to common stockholders was about $41 million for the quarter. Turning to FFO and AFFO, reminder that our normalized FFO simply adds back the ARCT merger-related costs to FFO. Normalized funds from operations, or FFO per share, was $0.59 for the quarter, a 13.5% increase versus a year ago. It would have been $0.61, but it was reduced $0.02 by the non-cash expense for the accelerated stock vesting I already mentioned. Adjusted funds from operations, or AFFO, or the actual cash we have available for distribution as dividends, was $0.60 for the quarter, a 15.4% increase versus a year ago. We again increased our cash monthly dividend this quarter.
We've increased the dividend 64 consecutive quarters and 73 times overall since we went public over 19 years ago. Dividends paid per common share increased 23% this quarter versus the same quarterly period a year ago, and our current monthly dividend now equates to a current annualized amount of just over $2.18 per share. Our AFFO dividend payout ratio is currently about 89%. Briefly turning to the balance sheet. We've continued to maintain a conservative and very safe capital structure. As you know, in July, we raised $750 million of new capital with a 10-year bond offering. Earlier this month, we did a $397 million common equity offering. Just this week, we closed on the accordion expansion of our acquisition credit facility for a new capacity of $1.5 billion. We currently have about $100 million of borrowings on that line.
We do want to take a moment to say thank you to the investor banks and commercial lending partners who've helped us access this capital over the past several months. We're grateful to the bond and equity investors who continue to support us with their capital as we continue to grow as a company. We did not assume any in-place mortgages during the quarter, so our outstanding mortgage debt has decreased to approximately $780 million. As for debt maturities, we have $11 million of mortgages coming due in Q4 this year, $64 million of mortgages due in 2014, and $125 million of mortgages in 2015. Our next bond maturity is only $150 million due in November of 2015. Our overall current total debt to total market cap is 30%, and our preferred stock outstanding is only 4.5% of our capital structure.
Our debt to EBITDA today is currently only 5.8 times. In summary, revenue growth this quarter was significant, and our expenses remained moderate, so our earnings growth was very positive. Our overall balance sheet remains very healthy and safe, and we do continue to enjoy excellent access to the public capital markets to fund our continued growth. Now let me turn the call back over to John, who will give you more background on these results.
Thanks, Paul. I'll begin with an overview of the portfolio, which continues to generate consistent cash flow. Our tenants are doing well, and based on what we're seeing now, we do not anticipate any issues in the foreseeable future. We ended the third quarter with 98.1% occupancy based on the number of properties, with 73 properties available for lease out of 3,866 properties. Our occupancy is up from 97% one year ago. Occupancy based on square footage is 98.9%, and economic occupancy is 99%. Our occupancy remains stable and strong, and we expect our occupancy at the end of the year to be in these areas. We're comfortable with where they are. Same-store rents increased 1.3% during the quarter and year to date versus the same period last year.
We're pleased with this level of growth and think it will continue over the next few quarters and perhaps be even a touch higher. At the end of the third quarter, our 15 largest tenants accounted for 44.4% of our revenue. That's down 2.4% from the same period one year ago. However, it's up about 1% from last quarter. As you know, this number will ebb and flow from quarter to quarter, but generally speaking, our acquisitions efforts will continue to diversify our rental revenues. We've continued to make progress on this over time. If you look back to 2008, the top 15 accounted for 54.3% of revenue. Again, today it's 44.4%. We continue to diversify our overall portfolio, again, with 3,866 properties leased to 200 commercial enterprises in 47 different industries across 49 states, plus Puerto Rico. We remain well-diversified by industry.
No industry accounts for more than 11.2% of our revenue. Convenience stores are our largest industry at 11.2%, and that's down 5.1% from a year ago. Drug stores are now at 9.3%, up 5.8% from a year ago. Restaurants, if you combine both the casual dining segment and the quick service segment, are now at 9.2% of our revenues, down 4% from a year ago. As you may recall, in early 2008, restaurants were approximately 24% of our revenues. Dollar stores are now at 6.3%, up 3.3% from a year ago. Health and fitness is at 6.1% of revenues, virtually unchanged from a year ago. Theaters are at 5.9%, down 3.6% from a year ago. Finally, transportation services are 5.3%, up 2.8% from a year ago. All other industry categories are below 4.5% of revenue. So we're in good shape keeping our revenues diversified by industry.
Looking at individual tenants, our largest tenant remains FedEx at 5.1% of revenues. Walgreens and Family Dollar are our second and third largest tenants at 5% and 4.9% of revenue respectively. Walgreens is up by about 1% from last quarter, and Family Dollar is up by about 1.5% from last quarter. LA Fitness is now at 4.2%, which is down 30 basis points from last quarter. All other tenants are at or below 3.1% of overall revenues. When you go down to our 15th largest tenant, which is Walmart and Sam's Club, it represents only 1.6% of revenue. If you move another five spots and go to our 20th largest tenant, it represents just 1.3% of revenue. So we're still very well-diversified by tenant. The credit quality of the portfolio continues to improve with about 40% of our revenue generated from investment-grade tenants.
This is up about 1.5% from the last quarter and 19% from quarter end 2012. In terms of our top 15 tenants, about 26% of that rent is generated from eight investment-grade tenants. As recently as 2010, there was only one investment-grade tenant in our top 15, and that tenant generated just over 5% of revenue. So we remain comfortable having a significant portion of our rental revenues coming from high-credit tenants. In terms of lease length, the average remaining lease term is just under 11 years, at 10.9 years. Relative to property dispositions, we continue selling select properties to further strengthen the portfolio. During the quarter, we sold 19 properties for $22.4 million, which brings us to 53 properties sold for the year for $106.1 million. The sales this quarter were primarily in the restaurant, child daycare, and convenience store industries.
For the year, we're looking at approximately $125 million in property dispositions. Moving on to property acquisitions. During our third quarter, we completed approximately $503 million in property-level investments at a yield of 7.1%. This gets us to $1.37 billion for the first nine months of the year, excluding the $3.2 billion acquisition of ARCT that closed in January of this year. So we're raising our acquisitions guidance for 2013 to approximately $1.5 billion from the previously at least $1.25 billion. We're quite pleased with the continued momentum we're seeing on the acquisitions front. Now I'd like to hand it over to Sumit Roy, our recently appointed Chief Investment Officer, who's headed acquisitions for about a year now, to discuss acquisitions. Sumit?
Thank you, John. We remained active on the acquisitions front. During the third quarter, we made $502.7 million in property-level investments in 219 properties at an average initial cash yield of 7.1%, with a weighted average lease term of 14.7 years. 72% of the revenue generated by these acquisitions is from investment-grade tenants. These assets are leased to 20 different tenants in 15 different industries. Four of the tenants are new to our portfolio, and most significant industries represented were discount store, drug stores, and health and fitness. The properties are located in 33 states. 81% of the investments are comprised of our traditional retail properties. We were successful in accelerating the closing on a number of transactions in the third quarter and were pleased with the activity this quarter.
Through third quarter 2013, as John mentioned, we've invested $1.37 billion in 407 properties at an average initial cap rate of 7% and lease term of 14.1 years. 65% of total rents are generated by investment-grade tenants. These assets are leased to 35 different tenants in 21 different industries. The properties are located in 40 states. 84% of the investments are comprised of our traditional retail properties, including ARCT. Year to date, we have invested approximately $4.5 billion in total investments. Regarding our outlook, given our current pipeline for the remaining quarter, and as John has mentioned, we now think 2013 acquisitions will pencil in at approximately $1.5 billion for the year, versus our last guidance of at least $1.25 billion. The $1.5 billion in forecasted acquisitions is in addition to the $3.2 billion in acquisitions of ARCT during the first quarter.
On transaction flow, we continue the theme of seeing a record amount of transaction flow this year. We sourced $37 billion in acquisition opportunities through the third quarter, $17 billion of which was sourced in the third quarter alone. To put it in perspective, the $17 billion sourced in the third quarter is equal to the volume sourced in all of 2012, which was a record year of sourcing for us. The volume of opportunities were primarily driven by large portfolios and entity-level transactions as compared to one-off transactions. We have remained very selective in our acquisitions and are pursuing only those that match what we are trying to do strategically with the portfolio. We continue to analyze a number of these sourced opportunities but have ceased to pursue a majority of these transactions that came in the third quarter.
In a large portfolio, unless the vast majority of the properties fit our investment strategy, we will elect to pass. Overall, we are pleased with the acquisitions volume, and a lot of it has been smaller, organic, relationship-driven property transactions that offer superior risk-adjusted returns and fit where we are trying to go with the portfolio. As to pricing, cap rates have stabilized at the levels where they were at the end of the second quarter. Still a lot of capital pursuing transactions. Investment-grade property cap rates range from 6.25%-7.25%. Non-investment-grade properties are trading from 7.25%-8.25% cap rates. Looking at spreads, third quarter investment spreads remained healthy. We invested $502.7 million at a 7.1 cap rate. As we have frequently discussed, we look at our investment spreads relative to our nominal cost of equity.
That has averaged 111 basis points over the last 20 years, with most of that leased to non-investment-grade tenants. With over 72% of acquisitions investment grade, our cap rate of 7.1 represents a spread of approximately 110 basis points to our current nominal cost of equity. We like the ability to continue to upgrade the tenant credit quality and yet remain close to our historical average spreads. In conclusion, we continue to see an exceptional level of volume in the sector and have been pleased with our $1.37 billion in acquisitions to date. Including (ARCT), we have closed $4.5 billion in acquisitions. John?
Thanks, Sumit. Obviously, we're pleased with the acquisitions we closed this quarter and our level of activity. We expect acquisitions to remain active for us for the foreseeable future. Acquisitions also continues to be the primary driver of our revenue, earnings and dividend growth. We're pleased with our earnings in the third quarter. Our growth in normalized FFO per share is 13.5% versus the third quarter of 2012, and our growth in AFFO per share is 15.4% versus the third quarter of 2012. As Paul mentioned, our balance sheet and access to capital remain strong. We have plenty of flexibility to pursue acquisitions. Just last week, we completed our second-largest equity offering in the history of the company by raising $378 million in net proceeds. We used the proceeds to repay borrowings under our credit facility to permanently and accretively finance third-quarter acquisitions activity.
Additionally, you may have seen two days ago, we announced the expansion of our credit facility from $1 billion to $1.5 billion by exercising the in-place $500 million accordion feature that Paul spoke to a few minutes ago. Given the level of acquisitions activity we have been experiencing, we like the additional flexibility the $1.5 billion capacity gives us. We currently have $1.4 billion in available credit capacity on our facility. Relative to the earnings guidance for this year, we've tightened our range for FFO and raised and tightened our range for AFFO. We now expect normalized FFO per share to be $2.38-$2.42 for the year, which represents 18%-20% FFO per share growth. We also adjusted our AFFO per share to $2.38-$2.42, which represents 16%-17% AFFO per share growth.
AFFO continues to be a primary focus of ours as it best represents the recurring cash flow from which we pay dividends. We've also established earnings guidance for 2014, with normalized FFO estimated to be $2.53-$2.58 per share, which represents 5%-8% FFO per share growth over the 2013 estimated range. AFFO is estimated to be $2.53-$2.58 per share as well, which represents again 5%-8% AFFO per share growth. Regarding dividends, we remain optimistic that our activities will continue to support our ability to increase the dividend. Last month, we announced the 73rd dividend increase since the company went public in 1994. This brings the annualized dividend amount to just over $2.18 per share. Our dividends paid year-to-date have increased just under 22% over the same period last year.
Our payout ratio is currently at about 89% of our AFFO, which is a level we are comfortable with. Finally, I'd be remiss if I did not note that this is our company's first earnings call since our former CEO, Tom Lewis, announced his retirement. I want to take a moment to thank Tom for leading the company as CEO for over 16 years and helping produce outstanding results for our shareholders. Tom, if you're listening out there, thanks. With that, I'd like to open it up for questions. Craig?
Thank you very much. Ladies and gentlemen, at this time we will begin the question and answer session. If you do have a question today, please press the star followed by the one on your push button telephone. You may also decline from the polling process at any time by pressing the star followed by the two. As a reminder, if you are on speakerphone, you'll need to lift the handset first before making your selection. Once again, if you do have a question, please press star one at this time. Our first question does come from the line of Daniel Donlan with Ladenburg Thalmann. Please go ahead.
Thank you, and good afternoon.
Hey, Dan.
Hey, Dan.
Hello. A couple questions here on the office that you guys acquired in the quarter. Could you maybe tell us if that was kind of above that 7.1 cash cap rate range, or is it above it, or where did those come in, if possible?
On the office activity for the quarter, which represented about 18% of the quarterly volume. We're not at liberty to discuss the exact economics there. It was a situation where we invested in the office facilities of one of our largest retail clients with an investment-grade rating. They brought the opportunity to us, and it was an attractive opportunity on an economic basis, with the added benefit of enhancing our overall relationship with that tenant. We're not at liberty to discuss the economics related to the transaction, though.
Sure. Understood. Just as far as if the third quarter activity was concerned, how much was sourced directly from tenants or retailers versus marketed transactions?
Yeah. I'd say around 30% to 40% was directly sourced from relationships with tenants and other retailers, and the rest was sourced either from private developers or private owners or through marketed transactions through the advisory and brokerage community.
Okay. Appreciate the color there. Then just two questions for Paul. Paul, it looks like your stock comp as a percentage of G&A is kind of moving towards this 30% number. I think previously it'd be kind of in the low to mid 20% range. Should we expect that level of stock comp as a percentage of overall G&A going forward?
No, I think this year you're seeing two events. One was the July acceleration relative to the old 10-year vesting converting to the 5-year, which is how our stock vests now for all outstanding old tenure grants. Then the other is the process of our transition at the executive suite level and as it relates to what I would describe as a slight anomaly in the level of stock issuance this year versus a run rate going forward.
Okay. I guess given that your AFFO is equal to your FFO, are you going to see then, since you're probably going to have less stock comp next year, are you going to see maybe a drop-off then in CapEx versus what you recognized this year?
That's part of it. The other thing you're seeing in the AFFO calculation is a little bit more amortization related to above-market leases in our FAS 141 work, if you will. There's offsetting factors there that historically we didn't have in the portfolio, whether it be assumed mortgages or assumed existing leases and the accounting related to them that creates differentials between FFO and AFFO. In the past, all we had was adding back amortization of financing costs and stock comp offset by straight line rent and CapEx. As for CapEx, specifically to answer your question, we see a similar run rate for next year. Call it an $8 million projected number as it relates to 2013 as a whole and 2014 as a whole.
Okay. Thank you very much.
Our next question does come from the line of Juan Sanabria with Bank of America.
Good afternoon, guys. I was just wondering for 2014, kind of what you're penciling in for acquisitions. I don't think you touched on that in the prepared remarks, and as well as on same-store NOI growth or rent growth.
Sure. Juan, we are expecting approximately $1 billion in acquisitions at roughly the yields we're seeing today in the market. That's what we've budgeted for 2014. With regard to same-store rents, we think they'll continue around 1.3% or be perhaps a bit higher. Those are the numbers we're using in our estimates for 2014.
Okay, great. In the acquisition pipelines you look at, are you guys looking at all or interested in going forward and looking at potential public transactions-
Well-
in terms of publicly traded companies?
We look at really everything that comes across our desk. I'd say this, as the largest player in the sector and one of the more active players in the sector with a long, successful history, we believe we see most major opportunities, whether it be at the property level, property portfolio level, or entity level. We'll consider all of that. It will need to meet our investment strategies. We've been, as Sumit mentioned, quite selective this year relative to the transactions we sourced, and a lot of that is just remaining true to what we want to accomplish with the portfolio. We've passed on a number of opportunities, obviously, based on the sourced transactions and what we've done here today.
Just one other quick question. With regards to the payout ratio, it seems like CapEx is going to be fairly stable. As we think of the portfolio longer term with a greater % of office and industrial versus your historical retail focus, how should we think of CapEx as leases mature and kind of thinking about your payout ratio needing to retain presumably some CapEx to re-lease the space?
Yeah, that's a good question. We're comfortable with it at 89%, as I said, but we would expect it to move into probably the mid-80s over time. That's primarily to accommodate a little bit more on the CapEx side associated with the non-retail properties.
Thank you very much.
Our next question does come from the line of Emmanuel Korchman with Citi.
Hey, thanks for taking the questions, guys.
Hey, Manny.
Just maybe with the CEO transition, could you discuss any potential changes in strategy, or should we just expect status quo going forward?
Yeah. I don't see any major changes in strategy. We're going to remain careful and selective in our underwriting approach. We'll maintain our conservative balance sheet philosophy, and our focus will be on the income generation from which we pay dividends that we intend to increase over time. The core team remains in place, as you well know. Tom will continue as vice chairman of the board, and he's also serving as an executive advisor, so we see a fair amount of him. One thing I am looking at are our internal systems and staffing and making sure we're adequately structured for the anticipated growth we'll have in the future on those fronts. We could see a few changes on that front or some additions, I should say. Overall, the successful philosophy we've implemented here over the last cycle will continue.
Maybe we can go back to that point that you had made on G&A earlier, and that's you're building up sort of staffing to deal with the larger portfolio. I think you take that and you contrast it to what you guys did when you bought ARCT, where you didn't bring any staff on board. Can you help me kind of connect the dots and why didn't you bring any ARCT people on board if you were going to effectively hire, and how do we think about scalability going forward? I think the triple net model has always worked as one where you need to kind of limited heads to make the model work and how do we think about that?
Well, our staffing has grown less than our overall portfolio has grown, the business remains scalable. A lot of the staffing we've added and we're considering adding is related to what we anticipate will be additional growth in the future. We were able to take on the ARCT acquisition without bringing in any of their people and do it primarily in-house. Historically, our G&A has run probably between 7.5%-8% of revenues. It's going to be just over 7%, I think, for this year. We would expect that number to decline closer to 6% of revenues next year. You can see the impact of the scalability.
Thanks, guys.
Thank you.
Our next question does come from the line of Jonathan Pong with Robert W. Baird.
Hey, good afternoon, guys.
Hey.
Just wanted to dig in a little bit on the office asset topic and maybe just what you guys think about your exposure going forward. You're at about 6% today. Are you think about doing just more of these strategic types of deals, or could you see that percentage moving higher because you see attractive risk-reward on a valuation basis for those assets?
Yeah. Well, with regard to office, typically when we acquire office, it's part of a broader portfolio of properties that we like that happens to have an office component. There are a couple of exceptions to that. One is, if we find a facility that is associated with the retail operations of one of our major tenants and they asked us to take a look at that, we'll pursue that on a one-off basis. Our real emphasis continues to be on retail as demonstrated by the completed acquisitions to date as well as industrial and distribution, leased investment-grade tenants with tenants that have generally Fortune 1000 characteristics and good revenue bases and are in industries that we're comfortable with and locations that are strategic to their business.
On the office front, that was a heavy quarter for us on the office side, I really wouldn't expect those sort of percentages going forward. With regard to office, those are our views, Jonathan.
Great, thanks. Maybe on the implied guidance for fourth quarter acquisition activity. Does seem a little conservative at about $130 million. Are you seeing a slowdown in attractive opportunities for the one-off deals? I hear what you're saying on the M&A side, are you seeing people pulling back a bit on sourcing for the one-off ones?
Well, as you know, our acquisitions have always been lumpy. That's the word we've used to describe them. In the first quarter of this year, they were $128 million at the property level, $738 million in the second quarter, which was a record quarter, another heavy quarter, $502 million. 75% of these acquisitions really come in in the form of portfolios. If you miss a portfolio or two, or win a portfolio or two, it can really swing your numbers. If they slip a date or move up a couple of weeks into the new quarter, they can really make the quarters quite lumpy. It's never been a smooth acquisition process for us. We have pretty good visibility with just a couple of months remaining in the year, so we feel comfortable with the approximately $1.5 billion in guidance we've given you.
Great. Thanks for the color.
Okay. Thank you.
Our next question does come from the line of Wes Golladay with RBC Capital Markets.
Hey, good afternoon, guys, congratulations, John. I wondered if you could touch upon the disposition side of the equation. I think you guys had done an extensive analysis in the past of all the properties you wanted to sell. Just want to get some color on where you guys are in the process of that, and how big is the bucket?
Yeah. With regard to dispositions, we're going to end out the year having sold about $125 million, which is a pretty good number for us in terms of size. Last year, that was closer to $50 million. Next year, we're anticipating in excess of $75 million-$100 million. Most of what we're selling is kind of coming out of what is our kind of bottom bucket, which is sort of a watch list. As we've grown the company through acquisitions and made dispositions, we've brought the watch list down, or the black, as we call it, group of companies from 23% in July of 2011 to 9% today. That doesn't mean we want to sell everything that's in that 9% category. That just means those are properties that we're watching. Maybe we have industry concerns or credit concerns or specific real estate concerns.
Generally, the dispositions will come out of that pool. We'll remain active on that front, but as you know, our ability to transact in very large quantities there is offset by what we acquire in order to minimize the dilution from the activities. We normally budget on the property dispositions 8% sales cap rates. I'll say that that's a bit conservative. This year, we've run around the mid-7s in terms of sales cap rates, so we're pleased with that. We'll continue to budget for conservativism right around an 8% for the disposition cap rates.
Okay, thanks for the color.
Sure.
Our next question does come from the line of Ross Nussbaum with UBS.
Hey, Ross.
Hi, guys. Good afternoon. I missed last quarter's call, so I would be remiss if I just didn't give a big shout-out to Tom. I had the pleasure of working with him for most of his 16 years at the company. I always said I thought he was one of the most underappreciated CEOs in the business. That means, John, you've got some big shoes to fill.
I'm aware of that. Thanks.
Now with that, I can give you a hard time. Can we talk a little bit, and I might have missed this, did you give the underlying assumption behind that 5%-8% FFO growth next year? What's the acquisition volume that's behind that?
Yeah. It's approximately $1 billion at cap rates consistent or in the area of where we're seeing them today, so the low 7s.
Got it. Okay. Can we talk a little more about your portfolio strategy? If I think about the last couple of decades at Realty Income, I think about the ARCT transaction that took place, that was, in my mind, the first big departure in terms of buying a large group of assets at a premium to what was then the NAV. As you look at acquisitions going forward, can you talk a little bit about how do you balance what the underlying market real estate value is versus how accretive that portfolio might be to your bottom line? Because as I'm sure you know, the math works out that you could pay all day long 10 and 20% premiums to what an asset or a portfolio is worth and still make it accretive.
Right. We're out there, I think we're as active as anyone in the sector in terms of investing and purchasing property. It's important to us to do transactions that are accretive, it's also very important for us to be protected relative to replacement costs and relative to market rents. We look at all of that. In terms of asset values, we see transactions that we like where we don't win those due to pricing. We try to be quite cognizant of that. ARCT was a transaction that accomplished a lot for us on the strategic side. As you know, we financed it two-thirds equity, one-third debt, and locked in the spreads there. It was at a cap rate that was below what we were achieving at the time on our organic property-level acquisitions. It was in the high fives.
We looked at that transaction differently than we do some of our property-level organic acquisitions.
That's sort of where I'm going, as you might expect, we've received quite a few phone calls over the last week or two from folks wondering if you would be interested in going in and topping ARCT's deal with Cole, basically on the same premise that, hey, you've paid big premium to NAV before, you can still make the deal accretive. Can we maybe just nip that one in the bud to start with? Is Cole on the table for you or not?
We don't comment on pending merger and acquisition activity. I will say this with regard to the activity that's occurred in the sector, I think it's positive. We've seen a lot of private-to-public consolidation, public-to-public consolidation in the sector, which I think attracts more interest into the sector. Being the largest company with the longest operating track record, I think that interest in the sector with new investors and a new awareness can only help us. I can't speak specifically on any pending acquisition opportunities.
Let me see if I can tackle it this way strategically. Clearly, the ARCT deal was a bit of a game-changer for you strategically. Is the portfolio at where you'd like it to be from that perspective, or do you feel like you need another, quote-unquote, game-changing transaction to ultimately meet your strategic goals?
ARCT was a very strong strategic fit for us. When we pursue entity-level acquisitions, we look for a number of checks. The transaction needs to be immediately accretive, as ARCT was on a leverage-neutral basis. It needs to generally improve our overall diversification and our portfolio credit quality. Ideally, it would improve occupancy and lengthen our average remaining lease terms and reduce concentrations in our portfolio. We see few of those opportunities, ARCT was one of those.
Great. Thanks, John. Appreciate it.
Thanks, Ross.
Our next question does come from the line of Todd Lukasik with Morningstar.
Hey, good afternoon, guys. Thanks for taking my questions.
Hey, Todd. Yep.
Just to follow along the same line of questioning there with regards to the large entity deals. The ones that you've seen come across the desk recently, have they been relatively quick no's or have they been interesting enough where you've spent a lot of time looking at them and the final details just didn't work out?
Yeah. We thoroughly analyze everything that comes through the door with our acquisitions team and the broader team here and make decisions, either prior to investment committee or within the investment committee in terms of what we do on all acquisitions. Seldom do we dismiss things quickly, but it does happen.
Okay. Just on the acquisitions guidance for 2014. Of the roughly $1 billion, would you expect more of that to be in the investment-grade area or the non-investment grade area? What's the spread that you're seeing between those initial yields today?
Yeah. I would think that it would be consistent with the percentages we've seen this year, maybe a little bit lower. In terms of spreads, Sumit touched on those. The cap rates seem to have stabilized and adjusted to the change in capital costs that occurred really in May. Cap rates seem to be holding steady at where they are today. In terms of spreads, our spreads are actually better relative to our weighted average cost of capital on our acquisitions this quarter than where they have been historically. We're running at about 165 basis points spread relative to our weighted average cost of capital currently. Over the life of the company, that's been about 145 basis points.
Our spreads to debt have gotten better, while our, as Sumit mentioned, our spreads to our nominal cost of equity have come down a little bit to the average levels during the life of the company. I think those spreads, I don't know where our capital will be priced next year, but we're anticipating those spreads to hold for now.
Okay. Maybe a couple questions for you, too, Paul. If you could just first comment on what was in the other revenue line this quarter and accounting for that increase. Secondly, I don't know if there are any major takeaways from the increase with the revolver, but I'm wondering if one of them is that you guys keep a balance on there accumulating a little longer and go to market with larger capital transactions like we've seen recently.
Yeah. The other income line is one that I typically don't comment on because it's not a line that we want people to underwrite from a run rate perspective. It typically includes ongoing property-level type issues like easements or eminent domain takings, where you receive a payment. Those are usually very positive cash flow transactions, by the way, but they flow into that line. As well as interest income that we might have, cash on hand, rents come in early. You raise money that sits for a week before you invest it, things of that nature. It kind of flows into that line. It's not one that we try to project out to have people underwrite in their projections or earnings for us.
There's always going to be something there, and that's what fell into that line as is the norm. In terms of the credit line, we're real pleased with our existing bank group of 15 lenders all saying yes and participating in the increase there and the exercise of our accordion. What it does do is give us more flexibility, as John referenced on the acquisition front, gives us more flexibility. The ability for Sumit to proceed with LOIs that have no financing contingency in them because we have a large line to draw upon, so that it makes your offer naturally stronger when you have the ability to do that.
Yes, on the permanent capital financing front, gives us more flexibility and patience to wait for the appropriate market windows, whether that be for equity or bonds or preferred, but to be able to carry a little bit of balance and wait for good market window in order to raise the permanent capital. Kind of gives us flexibility on the front end with acquisitions, but also in the capital markets front as well.
Okay, great. Thanks a lot, guys.
Thank you.
Our next question does come from the line of Todd Stender with Wells Fargo.
Hi, thanks guys. Would you say, is your visibility better on deal flow as we sit here today? If you look back this time last year, your original guidance for 2013 was $550 million, and now you're saying you could do $1 billion next year. Is that just a reflection that you're a bigger company at this point, or is there anything to kind of look at just the pace of deal flow?
Well, we're seeing activity based on our sourcing numbers that are very high. We continue to work some of that. We do have some visibility over the next few quarters. Todd, it remains very difficult to predict and project, but we felt it would be more appropriate to come out with a number of approximately $1 billion next year. Part of that is guided based upon our view of what's happening today and may spill over into the early part of next year.
Okay. Thanks, John. You also indicated it was the office property acquisition that you highlighted, or a previous caller highlighted, leased back to your second-largest retail tenant. That did not close yet, did I get that right?
No, it's closed.
It's closed.
You can't disclose any color on that?
No, we can't. Subject to a confidentiality agreement we've signed with the tenant.
Will that unlock at some point to get more information, or what kind of window is that?
It's as long as we own the building.
Okay. Just switching gears, Paul, your operating expenses, I think you indicated that you can kind of look at maybe a $20 million number for next year. What is in that number? What kind of property operating expenses would Realty Income be responsible for?
Yeah. Historically, as you know, the property expense line was going to be related to taxes, maintenance, insurance, utilities on vacant properties. It was a catchall line for the 50 to 100 properties in any given point in time that we were carrying until we re-leased them or sold them, or we were responsible for those expenses. That was a different number. That was a number that was more in the $12 million-$14 million type range, I'd call it. That is still in that number and part of that. The reason it's increased a bit from a run rate, obviously, still a pretty manageable number, is that we have had a portion of our portfolio grow into more of a double net structure. Some assets that we've bought do have leases that give us some responsibilities as landlord. That's primarily roof and structure.
Those costs are not an order of magnitude that are concerning. They're ones that we budget for, and they could range from $0.05 a square foot to $0.30 a square foot, if you will, in terms of what we're budgeting for those. That's what has increased that run rate. It started to hit $15 million area beginning of the year, now we're looking at more of a $20 million run rate into next year as we look at our existing portfolio.
Thanks for that. Would you purchase new acquisitions in the double net lease, or that's just going to be legacy assets?
Well, I think we'd be open-minded.
Yeah, we'd be open-minded. It depends on what the property is and the overall return in economics. In the industrial sector, they often refer to triple net lease in a manner a bit different than we do in the retail sector. It's triple net in that the tenant is responsible for maintenance, insurance, and taxes, but there may be some structural components that the landlord is responsible for, and that's the primary difference, and that's what Paul was alluding to. Having those responsibilities would not preclude us from pursuing the right assets there, Todd.
Okay. Thanks, guys.
Thanks, Todd.
Thank you.
This concludes the question and answer portion of Realty Income's conference call. I will now turn the call over to John Case for concluding remarks.
Okay, thanks Craig, thanks everyone for joining us today. We appreciate your time, and we look forward to seeing many of you at Nareit and speaking to you again at the beginning of the year for the fourth quarter call. Everybody have a great Halloween. Take care.
Thank you.
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