UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-K

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

For the Fiscal Year Ended December 31, 20042005

Commission File Number 1-13374

REALTY INCOME CORPORATION

(Exact name of registrant as specified in its charter)

220 West Crest Street, Escondido, California  92025

(Address of principal executive offices)

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

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

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

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  ý   No  o

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý   No  o

At June 30, 2004, the aggregate market value of the Registrant’s shares of common stock, $1.00 par value, held by non-affiliates of the Registrant was $1.6 billion, at the New York Stock Exchange (“NYSE”) closing price of $20.87, adjusted for a 2-for-1 stock split.

REALTY INCOME CORPORATION

(Exact name of registrant as specified in its charter)

220 West Crest Street, Escondido, California  92025

(Address of principal executive offices)

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

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

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

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

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

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  ý  No  o

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

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

Large accelerated filer ý  Accelerated filer o  Non-accelerated filer o

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

REALTY INCOME CORPORATION

Index to Form 10-K

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•                  Provide for future rent increases (typically subject to ceilings) based on increases in the consumer price index, fixed increases, or to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level.

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

The six senior officers of Realty Income owned 1.3% of our outstanding common stock with a market value of $24.7$25.1 million at February 15, 2005.10, 2006. The directors and six senior officers of Realty Income, as a group, owned 2.6%2.7% of our outstanding common stock with a market value of $51.9$51.6 million at February 15, 2005.10, 2006.

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

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

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

Realty IncomeAt February 10, 2006, we had 69 permanent employees and four temporary employees as ofcompared to February 15, 2005 when we had 64 permanent employees and six of whom are part-time, plus one contract consultant..temporary employees.  The temporary employees have been working on a record retention project that is expected to conclude during 2006.

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

RECENT DEVELOPMENTS

Two-for-one Common Stock SplitCredit Facility

On December 31, 2004, afterIn June 2005, Realty Income entered into a new $300 million acquisition credit facility to replace our existing $250 million acquisition credit facility that expired in October 2005. Under the New York Stock Exchange closed, we completed a 2-for-1 stock split.  At that time we issued, to our common stockholders, one share of common stock for each common share outstanding.  The total number of shares paid as a stock dividend to our common stockholders was 39,650,815.  All common share amounts and per common share amounts have been adjusted to reflect the common stock split.

One Billion Dollars of Dividends Paid

With the paymentterms of the Januarynew credit facility, which commenced in October 2005, dividend, Realty Income and its predecessors have paid $1 billionthe borrowing rate was reduced to LIBOR (London Interbank Offered Rate) plus 65 basis points with a facility fee of 15 basis points, for all-in drawn pricing of 80 basis points over LIBOR, based on our current credit ratings.  The new credit facility offers us other interest rate options as well. The term of the new facility expires in common stock dividends. In addition, since October 1994 when the Company began trading on the New York Stock Exchange, shareholders have enjoyed regular increases2008, unless extended as provided in the amount of the dividend. The annualized dividend amount has grown from $0.90 per share in 1994 to $1.32 per share as of December 31, 2004, an increase of 46.7%.  The December 31, 2004 annualized dividend amount increased by 10% as compared to the December 31, 2003 annualized dividend amount.agreement.

Common Stock Issuance

In March 2004,September 2005, we issued 3.24.1 million shares of common stock.  The net proceeds of $67.9$92.7 million were used to fund new property acquisitions and for other general corporate purposes.

Credit Ratings Upgrade

In September 2005, our credit ratings were upgraded by Fitch Ratings.  Our senior unsecured debt rating was raised to BBB+ from thisBBB and our preferred stock rating was raised to BBB from BBB- with a stable outlook.

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

Issuance of 12-Year Senior Unsecured Notes

In September 2005, Realty Income issued $175 million in aggregate principal amount of 12-year, 5-³/₈% senior unsecured notes due 2017.  The price to the public for the notes was 99.974% of the principal

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amount for an effective yield of 5.378%.  The net proceeds from the offering were used to repay a portion ofborrowings under the borrowings on our $250 millionCompany’s unsecured acquisition credit facility, including amounts that were borrowed to fund the acquisition of 112 convenience store properties in March 2004.for property acquisitions and for other general corporate purposes.  Our outstanding notes and bonds are rated BBB+ by Fitch Ratings, Baa2 by Moody’s Investors Service and BBB by Standard & Poor’s Ratings Group.

Class D Preferred Stock Issuance of 30-Year Senior Unsecured Bonds

In May 2004, weMarch 2005, Realty Income issued 4.0$100 million sharesin aggregate principal amount of 7.375% Monthly Income Cumulative Redeemable Class D preferred stock with a liquidation value30-year, 5-⁷/₈% senior unsecured bonds due 2035.  The price to the investor for the bonds was 98.296% of $25 per share.the principal amount for an effective yield of 5.998%.  The issuance price was $25 per share and the net proceeds of approximately $96.4 millionfrom the offering were used to redeem our outstanding Class B and C preferred stock, repay borrowings under our $250 million unsecured acquisition credit facility and for other general corporate purposes.

In October 2004, we issued an additional 1.1 million shares of 7.375% Class D preferred stock for $25.4311 per share.  The net proceeds of $27.4 million were used to repay borrowings on our $250 million unsecured credit facility, which had been used for recent acquisitions of new retail properties.

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Class B Preferred Stock RedemptionAcquisitions During 2005

In June 2004, we redeemed all of the 2,745,700 outstanding shares of our Class B preferred stock for $68.6 million.  Each share was redeemed at a liquidation value of $25.00, plus accrued and unpaid dividends at the time of the redemption.

In addition, when our Class B preferred stock was redeemed, we incurred a non-cash charge of $2.4 million representing the Class B preferred stock original issuance costs that were paid in 1999 and recorded as a reduction to net income available to common stockholders in June 2004.

Class C Preferred Stock Redemption

On July 30, 2004 we redeemed all of the 1,380,000 outstanding shares of our Class C preferred stock for $34.5 million.  Each share was redeemed at a liquidation value of $25.00, plus accrued and unpaid dividends at the time of the redemption.

In addition, when our Class C preferred stock was redeemed, we incurred a non-cash charge of $1.4 million representing the Class C preferred stock original issuance costs that were paid in 1999 and recorded as a reduction to net income available to common stockholders in July 2004.

Realty Income and Crest Net Aggregate Acquisitions

During 2005, Realty Income and Crest Net invested $215.3in aggregate $486.6 million in aggregate in 194156 new properties and properties under development in 2004.development. These 194156 properties are located in 1930 states and are 100% leased with an initial average lease term of 17.515.8 years.  As described below, Realty Income acquired 135 properties and Crest Net acquired 21 properties.

In February 2005, weIncluded in the $486.6 million is $430.7 million invested $67.3 million in a portfolio of 24 properties leased to Rite Aid Corporation.  We acquired existing stores that are net-leased to Rite Aid with an average remaining lease term of 14.2 years.by Realty Income plans to hold approximately $58 million in its core portfolio as long-term investments and approximately $9 million was acquired by Crest Net lease.

Realty Income Acquisitions

Realty Income invested $193.8 million during 2004 in 172135 new properties and properties under development with an initial weighted average contractual lease rate of 9.5%8.4%. These 172135 properties are located in 1828 states, and are 100% leased with an initial average lease term of 17.515.6 years and will contain over 913,0001.7 million leasable square feet.  The 135 new properties acquired by Realty Income are net-leased to 13 different retail chains in the convenience store, drug store, financial services, health and fitness, motor vehicle dealership, restaurant and theater industries.

Included in the $486.4 million is $55.9 million invested by Crest Net in 21 new retail properties and properties under development.

Of the $193.8$430.7 million Realty Income invested in real estate during 2004, $11.12005, $43.9 million was invested in 10 properties under development that were acquired before 2004. Estimated unfunded development costs on Realty Income and Crest Net properties under development at December 31, 2004 totaled $13.0 million. At December 31, 2004, five new properties acquired during 2004 were leased and under contract for development by the tenant at December 31, 2005 (with development costs funded by Realty Income or Crest Net) with rentIncome).  Rent on these properties is scheduled to begin at various times during 2005.2006.  At December 31, 2005, we also had committed to pay estimated unfunded development costs totaling $42.2 million.

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

The 172 new properties acquired by Realty Income are net-leased to 12 different retail chains in seven industries: automotive collision service, automotive service, convenience store, health and fitness, motor vehicle dealerships, restaurant, and sporting goods.

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Crest Net Acquisitions

Crest Net invested $21.5 million during 2004 in 22 new retail properties and properties under development.

Investments in Existing Properties

In 2004,2005, we capitalized costs of $1.1$1.6 million on existing properties in our portfolio, consisting of $323,000$570,000 for re-leasing costs and $789,000$1.0 million for building improvements.

Net Income Available to Common Stockholders

Net income available to common stockholders was $89.7 million in 2005 versus $90.2 million in 2004, versus $76.7 million in 2003, an increasea decrease of $13.5 million.$452,000. On a diluted per common share basis, net income was $1.12 per share in 2005 as compared to $1.15 per share in 2004 as compared to $1.08 per share in 2003.  During 2004, net income available to common stockholders included one-time, non-cash charges totaling $3.8 million, or approximately, $0.05 per share.  These non-cash charges represent the Class B and Class C preferred stock original issuance costs that were paid in 1999 and recorded as a reduction in net income available to common stockholders in 2004 when the preferred stock was redeemed.2004.

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

The gain recognized from the sales of investment properties during 20042005 was $12.7$6.6 million as compared to $7.2$12.7 million during 2003.2004.

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Funds from Operations (FFO)

In 2004,2005, our FFO increased by $14.8$11.4 million, or 14.3%9.6%, to $129.6 million versus $118.2 million versus $103.4 million in 2003.2004.  On a diluted per common share basis, FFO was $1.50$1.62 in 20042005 compared to $1.45$1.50 for 2003,2004, an increase of $0.05,$0.12, or 3.4%8.0%.  Included in FFO per diluted common share for 2004 was $0.08 per share in non-cash charges for property impairments and origination costs on redeemed preferred stock. For 2004, non-cash charges for property impairments of $2.4 million equated to $0.03 in FFO per diluted common share and non-cash charges for origination costs on redeemed preferred stock of $3.8 million equated to $0.05 in FFO per diluted common share.

FFO for 2003 has been adjusted to reflect additional impairments on the sale of certain properties.  These additional impairments relate to properties where a contract for the sale of a property and the closing of the sale transaction occurred during the same quarterly period. As these transactions were contracted for and closed during the same quarter, losses on the sales were booked and reflected in the Company’s financial statements, but no impairments were booked on these properties in the Company’s calculation of FFO.  The Company now believes that such impairments on property sales should be deducted from the calculation of FFO.  FFO for 2003 was reduced by $672,000 or $0.01 per share.  The losses from these transactions were previously included in the Company’s calculation of net income and, as such, have no impact on the Company’s previously reported consolidated statements of income or consolidated balance sheets for these periods.

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

Crest Net Property Sales

During 20042005, Crest Net sold 5112 properties from its inventory for $75.0$23.5 million, which resulted in a gain of $10.3$3.3 million.

Crest Net’s Property Inventory

Crest Net’s property inventory at December 31, 20042005 and December 31, 20032004 totaled $10.1$45.7 million and $53.3$10.1 million, respectively, and is included in real“real estate held for sale, net,net”, on our consolidated balance sheets.

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

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Sales of Investment Properties by Realty Income

During 2004, we sold or exchanged 43 properties and a portion of land from four properties for an aggregate of $35.4 million, which resulted in gains on sales, of $12.7 million on 38 properties and impairments of $1.7 million on five properties. The 43 properties sold consisted of 16 child care facilities, 13 restaurants, 10 convenience stores, three consumer electronics stores and one automotive service location. Of this gain on sales, $12.5 million is included in discontinued operations and $185,000 is included in other revenue. The net proceeds from the sale of these properties were used to repay outstanding indebtedness on our credit facility and to invest in new properties.

Increases in Monthly Cash Distributions to Common Stockholders

We continue our 35-year36-year policy of paying distributions monthly.  Monthly distributions per share were increased in April 2005 by $0.000625 in April 2004 to $0.100625,$0.110625, in July 20042005 by $0.000625 to $0.10125,$0.11125, in September 2005 by $0.00375 to $0.115, in October 20042005 by $0.000625 to $0.109375$0.115625 and in January 20052006 by .000625 to $0.11. The monthly distributions were also increased by $0.0075 per share in September 2004 to $0.10875.$0.11625.  The increase in January 20052006 was our 29^th 33rd consecutive quarterly increase and the 32^nd 37th increase in the amount of our cash dividend since our listing on the NYSE in 1994. In 2004,2005, we paid the following monthly cash distributions per share;share: three in the amount of $0.10,$0.11, three in the amount of $0.100625,$0.110625, two in the amount of $0.10125,$0.11125, one in the amount of $0.10875$0.115, and three in the amount of $0.109375,$0.115625 totaling $1.24125 per share.$1.34625. In December 2004,2005, January 20052006 and February 2005,2006, we declared distributions of $0.11$0.11625 per share, which were paid on January 18, 2005, on17, 2006, February 15, 20052006 and will be paid on March 15, 2005,2006, respectively.

The monthly distribution of $0.11$0.11625 per share represents a current annualized distribution of $1.32$1.395 per share, and an annualized distribution yield of approximately 5.3%6.1% based on the last reported sale price of our common stock on the NYSE of $24.84$22.78 on February 15, 2005.10, 2006. Although we expect to continue our policy of paying monthly distributions, we cannot guarantee that we will maintain the current level of distributions that we will continue our pattern of increasing distributions per share, or what the actual distribution yield will be in any future period.

DISTRIBUTION POLICY

Distributions are paid monthly to our common stockholders and Class D preferred stockholders on a monthly basis if, as and when declared by our Board of Directors. The Class D preferred stockholders receive cumulative distributions at a rate of 7.375% per annum on the $25 per share liquidation preference (equivalent to $1.84375 per annum per share).

In order to maintain our tax status as a REIT for federal income tax purposes, we generally are required to distribute dividends to our stockholders aggregating annually at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and by excluding net capital gains) and we are subject to income tax to the extent we distribute less than 100% of our REIT taxable income (including net capital gains). In 2004,2005, our cash distributions totaled $106.5$118.0 million, or approximately 107.8%113.2% of our estimated REIT taxable income of $98.8$104.2 million. Our estimated REIT taxable income reflects non-cash deductions for depreciation and amortization. We intend to continue to make distributions to our stockholders that are sufficient to meet this distribution requirement and that will reduce our exposure to income taxes. Our 20042005 cash distributions to common stockholders totaled $97.4$108.6 million, representing 82.4%83.8% of our funds from operations available to common stockholders of $118.2$129.6 million.

Future distributions will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, FFO, cash flow from operations, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code, of 1986, as amended, our debt service requirements and any other factors the Board of Directors may deem relevant. In addition, our credit facility contains financial covenants that

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could limit the amount of distributions payable by us in the event of a deterioration in our results of operations or financial condition, and which prohibit the payment of distributions on the common or preferred stock in the event that we fail to pay when due (subject to any applicable grace period) any principal or interest on borrowings under our credit facility.

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Distributions of our current and accumulated earnings and profits for federal income tax purposes, generally will be taxable to stockholders as ordinary income, except to the extent that we recognize capital gains and declare a capital gains dividend or that such amounts constitute “qualified dividend income” subject to a reduced rate of tax. The maximum tax rate of non-corporate taxpayers for “qualified dividend income” has generally been reduced to 15% (for taxable years beginning after December 31, 2002). In general, dividends payable by REITs are not eligible for the reduced tax rate on corporate dividends, except to the extent the REIT’s dividends are attributable to dividends received from taxable corporations (such as our taxable REIT subsidiary, Crest Net), to income that was subject to tax at the corporate or REIT level (for example, if we distribute taxable income that we retained and paid tax on in the prior taxable year) or, as discussed above, dividends properly designated by us as “capital gain dividends.” Distributions in excess of earnings and profits generally will be treated as a non-taxable reduction in the stockholders’ basis in the stock. Distributions above that basis, generally, will be taxable as a capital gain. Approximately 4.7%10.1% of the distributions, made or deemed to have been made in 2004,2005, to our common stockholders were classified as a return of capital for federal income tax purposes. We are unable to predict the portion of future distributions that may be classified as a return of capital.

BUSINESS PHILOSOPHY AND STRATEGY

Investment Philosophy

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

Investment Strategy

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

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

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

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

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

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

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

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

•                  They typically are of a higher credit quality;

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

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

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

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

Historically, our investment focus has been on retail industries that have a service component because we believe the lease revenue from these types of businesses is more stable. Because of this investment focus, for the quarter ended December 31, 2004,2005, approximately 81.6%81.2% of our rental revenue rent was derived from retailers with a service component in their business. Furthermore, we believe these service-oriented businesses would be difficult to duplicate over the Internet and that our properties continue to perform well relative to competition from Internet businesses.

Credit Strategy

We generally provide sale-leaseback financing to less than investment grade retail chains.  From 1970 through December 31, 2004, we have acquiredWe typically acquire and leasedlease back properties to regional and national retail chains 1,678 properties (including 177 properties that have been sold) and have collected approximately 98% of the original contractual rent obligations on those properties. We believe that within this market we can achieve an attractive risk-adjusted return on the financing we provide to retailers.  Since 1970, our overall weighted average occupancy rate at the end of each year has been 98.5%, and the occupancy rate at the end of each year has never been below 97.5%.

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

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

•                  Industry, company, market conditions and credit profile;

•                  Location profitability, if profitability data is available; and

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

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

•                  Are located in highly visible areas,

•                  Have easy access to major thoroughfares; and

•                  Have attractive demographics.

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Acquisition Strategy

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

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

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

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

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

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Portfolio Management Strategy

The active management of the property portfolio is an essential component of our long-term strategy. We continually monitor our portfolio for changes that could affect the performance of the industries, tenants and locations in which we have invested. The portfolio is regularly analyzed with a view toward optimizing its returns and enhancing its credit quality. Our executives review industry research, tenant research, property due diligence and significant portfolio management activities. This monitoring typically includes regular review and analysis of:

•                  The performance of various retail industries; and

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

We have an active portfolio management program that incorporates the sale of assets when we believe the reinvestment of the sales proceeds will generate higher returns, enhance the credit quality of our real estate portfolio, or extend our average remaining lease term. At December 31, 2004,2005, we classified real estate with a carrying amount of $17.2$47.1 million as held for sale, which includes $10.1$45.5 million in properties owned by Crest Net.  In addition, $219,000 invested by Crest Net in real estate is included in other assets and was classified as intangible assets in accordance with Financial Accounting Standards Board Statement No. 141, Business Combinations.  Additionally, we anticipate selling investment properties from our portfolio that have not yet been specifically identified. Weidentified from which we anticipate we will receivereceiving between $15 million and $35 million in proceeds from the sale of investment properties during the next 12 months and wemonths.  We intend to invest these proceeds into new property acquisitions. However, we cannot guarantee that we will sell properties during the next 12 months.

Conservative Capital Structure

We believe that our stockholders are best served by a conservative capital structure. Therefore, we seek to maintain a conservative debt level on our balance sheet and solid interest and fixed charge coverage ratios. At February 15, 2005,10, 2006, our total outstanding credit facility borrowings and outstanding notes were $571.0$886.6 million or approximately 21.3%30.3% of our total market capitalization of $2.68$2.92 billion. We definecalculate our total market capitalization at February 15, 200510, 2006 as the sum of:

•                  Shares of our common stock outstanding of 79,581,37383,880,873 multiplied by the last reported sales price of our common stock on the NYSE of $24.84$22.78 per share, or $1.98$1.91 billion;

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

•                  Outstanding borrowings of $91.0$131.6 million on our credit facility; and

•                  Outstanding notes of $480.0$755.0 million.

Historically, we have met our long-term capital needs through the issuance of common stock, preferred stock and long-term unsecured notes.notes and bonds. Over the long term, we believe that the majority of our future securities issuances should be in the form of common stock, however, we may issue additional preferred stock or debt securities from time to time. We may issue common stock when we believe that our share price is at a level that allows for the proceeds of any offering to be accretively invested into additional properties.properties on an accretive basis. In addition, we may issue common stock to permanently finance properties that were financed by our credit facility

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or debt securities. However, we cannot assure you that we will have access to the capital markets at terms that are acceptable to us.

We have a $250$300 million revolving, unsecured credit facility that expires in October 2005.2008. At February 15, 2005,10, 2006, the outstanding balance on the acquisition credit facility was $91.0$131.6 million, with an effective interest rate of approximately 3.5%5.2%. A commitment fee of 0.2%0.15% per annum accrues on the total $250$300 million credit commitment of the credit facility. The credit facility has been, and is expected to be, used to acquire additional retail properties leased to regional and national retail chains under long-term, net-lease agreements. The credit facility has also been used to provide capital to subsidiaries for the purpose of funding the acquisition of properties.  We regularly evaluate our credit facility and may seek to extend, renew or replace our credit facility, to the extent we deem appropriate.

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We use our credit facility for the short-term financing of new property acquisitions. When outstanding borrowings under the credit facility reach a certain level (generally in the range of $100 million to $150$200 million) and capital is available on acceptable terms, we generally seek to refinance those borrowings with the net proceeds of long-term or permanent financing, which may include the issuance of common stock, preferred stock, convertible preferred stock, debt securities or convertible debt securities. We cannot assure you, however, that we will be able to obtain any such refinancing or that market conditions prevailing at the time of refinancing will enable us to issue equity or debt securities upon acceptable terms.

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

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

The credit ratings assigned to us could change based upon, among other things, our results of operations and financial condition.

We have no mortgage debt on any of our properties.

No Off-Balance Sheet Arrangements or Unconsolidated Investments

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

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

Competitive Strategy

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

•                  Size and Type of Investment Properties:  We believe smaller ($500,000 to $10,000,000) net-leased retail properties represent an attractive investment opportunity in today’s real estate environment. Due to the complexities of acquiring and managing a large portfolio of relatively small assets, we believe these types of properties have not experienced significant institutional ownership interest or the corresponding yield reduction experienced by larger income-producing properties. We believe the less intensive day-to-day

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property management required by net-lease agreements, coupled with the active management of a large portfolio of smaller properties, is an effective investment strategy. The tenants of our freestanding retail properties generally provide goods and services that satisfy basic consumer needs. In order to grow and expand, they generally need capital. Since the acquisition of real estate is typically the single largest capital expenditure of many of these retailers, our method of purchasing the property and then leasing it back, under a net-lease arrangement, allows the retail chain to free up capital.

•                  Investment in New Retail Industries:  Though we specialize in single-tenant properties, we will seek to further diversify our portfolio among a variety of retail industries. We believe diversification will allow us to invest in retail industries that currently are growing and have characteristics we find attractive. These characteristics include, but are not limited to, retail industries that are dominated by local store operators where regional and national chain store operators can increase market share and dominance by consolidating local operators and streamlining their operations, as well as capitalizing on major demographic shifts in a population base. During 2004, we added two new industries, financial services and motor vehicle dealerships, to our portfolio.

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•                  Diversification:  Diversification of the portfolio by retail industry type, tenant, and geographic location is key to our objective of providing predictable investment results for our stockholders, therefore further diversification of our portfolio is a continuing objective. At December 31, 2004,2005, our retail property portfolio consisted of 1,5331,646 properties located in 48 states, leased to 93101 retail chains doing business in 3029 industry segments. Each of the 3029 industry segments, represented in our property portfolio, individually accounted for no more than 19.6%17.8% of our rental revenue for the quarter ended December 31, 2004.2005.

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

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

PROPERTIES

At December 31, 2004,2005, we owned a diversified portfolio:

•                  Of 1,5331,646 retail properties;

•                  With an occupancy rate of 97.9%98.5%, or 1,5011,621 properties occupied of the 1,5331,646 properties in the portfolio;

•                  Leased to 93101 different retail chains doing business in 3029 separate retail industries;

•                  Located in 48 states;

•                  With over 11.913.4 million square feet of leasable space; and

•                  With an average leasable retail space of 7,8008,200 square feet.

In addition to our real estate portfolio at December 31, 2004,2005, our subsidiary, Crest Net had invested $10.1$45.7 million in a portfolio of eight retail17 properties located in fivenine states. These properties are classified as held for sale on our consolidated balance sheets.sale.

At December 31, 2004, 1,497,2005, 1,617, or 97.7%98.2%, of our 1,5331,646 retail properties were owned under net-lease agreements. Net leases typically require the tenant to be responsible for minimum monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants are typically responsible for future rent increases (generally subject to ceilings) based on increases in the consumer price index, fixed increases or , to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level.

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

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

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

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The following table sets forth certain information regarding the properties owned by Realty Income (excluding properties owned by Crest Net) at December 31, 2005, classified according to the retail business types and the level of services they provide (dollars in thousands):

(1)Includes rental revenue for all properties owned by Realty Income at December 31, 2005, including revenue from properties reclassified to discontinued operations of $59.

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The following table sets forth certain information regarding Realty Income’s property portfolio (excluding properties owned by Crest Net) regarding the timing of the initial lease term expirations (excluding extension options) on our 1,617 net leased, single-tenant and certain other retail properties as of December 31, 2005 (dollars in thousands):

* Less than 0.1%

(1)Excludes four multi-tenant properties and 25 vacant unleased properties, one of which is a multi-tenant property.  The lease expirations for properties under construction are based on the estimated date of completion of those properties.

(2)Includes rental revenue of $59 from properties reclassified to discontinued operations and excludes revenue of $1,852 from four multi-tenant properties and from 25 vacant and unleased properties at December 31, 2005.

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

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

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The following table sets forth certain state-by-state information regarding Realty Income’s property portfolio (excluding properties owned by Crest Net) as of December 31, 2005 (dollars in thousands):