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| NNN > SEC Filings for NNN > Form 10-K on 26-Feb-2009 | All Recent SEC Filings |
26-Feb-2009
Annual Report
The term "NNN" or the "Company" refers to National Retail Properties, Inc. and all of its consolidated subsidiaries. NNN has elected to treat certain subsidiaries as taxable real estate investment trust ("REIT") subsidiaries. These subsidiaries and their majority owned and controlled subsidiaries are collectively referred to as the "TRS."
Overview
NNN's operations are divided into two primary business segments: (i) investment assets, including real estate assets and mortgages and notes receivable (including structured finance investments) (collectively, "Investment Assets"), and (ii) inventory real estate assets ("Inventory Assets"). NNN acquires, owns, invests in, manages and develops properties that are leased primarily to retail tenants under long-term net leases ("Investment Properties" or "Investment Portfolio"). The Inventory Assets are operated through the TRS. The TRS, directly and indirectly, through investment interests, primarily owns real estate generally for the purpose of selling the real estate ("Inventory Properties" or "Inventory Portfolio"). The TRS typically owns two types of properties, property for development ("Development Properties" or "Development Portfolio") and improved properties ("Exchange Properties" or "Exchange Portfolio").
As of December 31, 2008, NNN owned 1,005 Investment Properties, with an aggregate leasable area of 11,251,000 square feet, located in 44 states. Approximately 97 percent of total properties in NNN's Investment Portfolio were leased at December 31, 2008. In addition, as of December 31, 2008, NNN's Investment Assets included $60,472,000 in mortgages and notes receivable (including accrued interest receivable and structured finance investments) and $22,000,000 of commercial mortgage residual interests. As of December 31, 2008, the TRS owned 19 Development Properties (11 completed, one under construction and seven land parcels) and 13 Exchange Properties.
NNN's management team focuses on certain key indicators to evaluate the financial condition and operating performance of NNN. The key indicators for NNN include items such as: the composition of NNN's Investment Portfolio and structured finance investments (such as tenant, geographic and line of trade diversification), the occupancy rate of NNN's Investment Portfolio, certain financial performance ratios and profitability measures, and industry trends and performance compared to that of NNN.
NNN continues to maintain its diversification by tenant, geography and line of trade. NNN's largest lines of trade concentration are the convenience store and restaurant sectors. These sectors represent a large part of the freestanding retail property marketplace which NNN believes represents an area of attractive investment opportunity. However, any financial hardship within these sectors could have a growing adverse effect on the financial condition and operating performance of NNN. NNN has some geographic concentration in the south and southeast which NNN believes are generally areas of above average population growth.
NNN formed a joint venture with an institutional investor in September 2007, in which NNN owns a 15 percent equity interest. The joint venture owns real estate assets leased to convenience store operators.
During the years ended December 31, 2008, 2007 and 2006, occupancy of the Investment Portfolio has averaged approximately 97 to 98 percent. The Investment Portfolio's average remaining lease term of 13 years has remained fairly constant over the past three years which, coupled with its net lease structure, provide enhanced probability of maintaining occupancy and operating earnings.
The poor current economic environment has made it more difficult and more expensive to obtain debt and equity capital, which will likely reduce the pace of investments in new acquisitions or developments as well as the volume of dispositions. Additionally, the poor economic and retail environment will result in more retailers filing for bankruptcy, which may have an adverse impact on NNN's occupancy.
Critical Accounting Policies and Estimates
The preparation of NNN's consolidated financial statements in conformance with accounting principles generally accepted in the United States of America requires management to make estimates and judgments on assumptions that affect the reported amounts of assets, liabilities, revenues and expenses as well as other disclosures in the financial statements. On an ongoing basis, management evaluates its estimates and judgments; however, actual results may differ from these estimates and assumptions, which in turn could have a material impact on NNN's financial statements. A summary of NNN's accounting policies and procedures are included in Note 1 of NNN's consolidated financial statements. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of NNN's consolidated financial statements.
Real Estate - Investment Portfolio. NNN records the acquisition of real estate at cost, including acquisition and closing costs. The cost of properties developed by NNN includes direct and indirect costs of construction, property taxes, interest and other miscellaneous costs incurred during the development period until the project is substantially complete and available for occupancy.
Purchase Accounting for Acquisition of Real Estate Subject to a Lease. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" ("SFAS 141"), the fair value of the real estate acquired with in-place leases is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, value of in-place leases, and value of tenant relationships, based in each case on their relative fair values.
Real estate is generally leased to tenants on a net lease basis, whereby the tenant is responsible for operating expenses relating to the property, generally including property taxes, insurance, maintenance and repairs. The leases are accounted for using either the operating or the direct financing method. Such methods are described below:
Operating method - Leases accounted for using the operating method are recorded at the cost of the real estate. Revenue is recognized as rentals are earned and expenses (including depreciation) are charged to operations as incurred. Buildings are depreciated on the straight-line method over their estimated useful lives. Leasehold interests are amortized on the straight-line method over the terms of their respective leases. When scheduled rental revenue varies during the lease term, income is recognized on a straight-line basis so as to produce a constant periodic rent over the term of the lease. Accrued rental income is the aggregate difference between the scheduled rents which vary during the lease term and the income recognized on a straight-line basis.
Direct financing method - Leases accounted for using the direct financing method are recorded at their net investment (which at the inception of the lease generally represents the cost of the property). Unearned income is deferred and amortized into income over the lease terms so as to produce a constant periodic rate of return on NNN's net investment in the leases.
Real Estate - Inventory Portfolio. The TRS acquires and/or develops and owns properties for the purpose of resale. The properties that are classified as held for sale at any given time may consist of properties that have been acquired in the marketplace with the intent to sell and properties that have been, or are currently being, constructed by the TRS. The TRS records the acquisition of the real estate at cost, including the acquisition and closing costs. The cost of the real estate developed by the TRS also includes direct and indirect costs of construction, interest and other miscellaneous costs incurred during the development period until the project is substantially complete and available for occupancy. Real estate held for sale is not depreciated.
Impairment - Real Estate. Management periodically assesses its real estate for possible impairment whenever events or changes in certain circumstances indicate that the carrying value of the asset may not be recoverable through operations. Management determines whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the residual value of the real estate, with the carrying cost of the individual asset. If an impairment is indicated, a loss will be recorded for the amount by which the carrying value of the asset exceeds its fair value.
Commercial Mortgage Residual Interest at Fair Value. Commercial mortgage residual interests, classified as available for sale, are reported at their market values with unrealized gains and losses reported as other comprehensive income in stockholders' equity. The commercial mortgage residual interests were acquired in connection with the acquisition of 78.9 percent equity interest of Orange Avenue Mortgage Investments, Inc. ("OAMI"). NNN recognizes the excess of all cash flows attributable to the commercial mortgage residual interests estimated at the acquisition/transaction date over the initial investment (the accretable yield) as interest income over the life of the beneficial interest using the effective yield method. Losses are considered other than temporary valuation impairments if and when there has been a change in the timing or amount of estimated cash flows, exclusive of changes in interest rates, that leads to a loss in value. Certain of the commercial mortgage residual interests were pledged as security for a note payable which was repaid in February 2008.
Revenue Recognition. Rental revenues for non-development real estate assets are recognized when earned in accordance with SFAS 13, "Accounting for Leases," based on the terms of the lease at the time of acquisition of the leased asset. Rental revenues for properties under construction commence upon completion of construction of the leased asset and delivery of the leased asset to the tenant.
Recent Accounting Pronouncements. Financial Accounting Standards Board ("FASB") Staff Position No. APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1") will become effective January 1, 2009, and is required to be applied retrospectively to all presented periods, as applicable. NNN estimates that the adoption of FSP APB 14-1 will result in the recognition of additional non-cash interest expense of approximately $5.5 and $2.6 million for the years ended December 31, 2008 and 2007, respectively, and $6.0 million for the year ending December 31, 2009.
Use of Estimates. Additional critical accounting policies of NNN include management's estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses and the disclosure
of contingent assets and liabilities to prepare the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Additional critical accounting policies include management's estimates of the useful lives used in calculating depreciation expense relating to real estate assets, the recoverability of the carrying value of long-lived assets, including the commercial mortgage residual interests, the collectibility of receivables from tenants, including accrued rental income, and capitalized overhead relating to development projects. Actual results could differ from those estimates.
Results of Operations
Property Analysis - Investment Portfolio
General. The following table summarizes NNN's Investment Portfolio as of
December 31:
2008 2007 2006
Investment Properties Owned:
Number 1,005 908 710
Total gross leasable area (square feet) 11,251,000 10,610,000 9,341,000
Investment Properties Leased:
Number 972 892 697
Total gross leasable area (square feet) 10,728,000 10,355,000 9,173,000
Percent of total gross leasable area - leased 97% 98% 98%
Weighted average remaining lease term (years) 13 13 12
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The following table summarizes the lease expirations, assuming none of the tenants exercise renewal options, of NNN's Investment Portfolio for each of the next 10 years and then thereafter in the aggregate as of December 31, 2008:
% %
of Annual Gross of Annual Gross
Base # of Leasable Base # of Leasable
Rent(1) Properties Area(2) Rent(1) Properties Area(2)
2009 1.0% 20 386,000 2015 2.5% 19 463,000
2010 2.8% 40 405,000 2016 1.9% 15 287,000
2011 2.0% 20 333,000 2017 4.4% 26 751,000
2012 3.5% 34 525,000 2018 2.9% 24 418,000
2013 4.5% 38 842,000 Thereafter 70.3% 700 5,795,000
2014 4.2% 36 523,000
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(1) Based on the annualized base rent for all leases in place as of December 31, 2008.
(2) Approximate square feet.
The following table summarizes the diversification of NNN's Investment Portfolio based on the top 10 lines of trade:
% of Annual Base Rent(1)
Top 10 Lines of Trade 2008 2007 2006
1. Convenience Stores 25.7% 23.9% 16.3%
2. Automotive Service 8.9% 5.2% 0.2%
3. Restaurant - Full Service 8.7% 10.3% 12.1%
4. Theaters 6.1% 4.2% -
5. Automotive Parts 5.1% 4.9% 1.6%
6. Drug Stores 4.0% 5.0% 8.3%
7. Books 4.0% 4.4% 5.7%
8. Restaurants - Limited Service 3.3% 3.7% 4.7%
9. Sporting Goods 3.3% 3.9% 7.3%
10. Consumer Electronics 3.2% 4.3% 5.6%
Other 27.7% 30.2% 38.2%
100.0% 100.0% 100.0%
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(1) Based on annualized base rent for all leases in place as of December 31 of the respective year.
The following table shows the top 10 states in which NNN's Investment Properties are located in as of December 31, 2008:
% of
Annual
# of Base
State Properties Rent(1)
1. Texas 211 19.9%
2. Florida 84 9.8%
3. Illinois 39 6.6%
4. North Carolina 62 6.1%
5. California 26 5.2%
6. Georgia 57 5.1%
7. Pennsylvania 80 4.2%
8. Indiana 37 4.2%
9. Ohio 31 3.1%
10. Tennessee 30 3.1%
Other 348 32.7%
1,005 100.0%
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(1) Based on annualized base rent for all leases in place as of December 31, 2008.
Property Acquisitions. The following table summarizes the Investment Properties acquired for each of the years ended December 31 (dollars in thousands):
2008 2007 2006
Acquisitions:
Number of Investment Properties 109 235 213
Gross leasable area (square feet) 868,000 2,205,000 1,130,000
Total dollars invested(1) $ 355,107 $ 696,682 $ 371,898
(1) Includes dollars invested on projects under construction for each respective year.
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Property Dispositions. The following table summarizes the Investment Properties sold by NNN for each of the years ended December 31 (dollars in thousands):
2008 2007 2006
Number of properties 19 37 30
Gross leasable area (square feet) 290,000 997,000 1,015,000
Net sales proceeds $ 59,796 $ 146,041 $ 319,361
Net gain $ 9,980 $ 56,625 $ 91,332
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Property Analysis - Inventory Portfolio
General. The following summarizes the number of properties held for sale in the
Inventory Portfolio as of December 31:
2008 2007 2006
Development Portfolio:
Completed Inventory Properties 11 8 11
Properties under construction 1 9 5
Land parcels 7 6 13
19 23 29
Exchange Portfolio:
Inventory Properties 13 33 68
Total Inventory Properties 32 56 97
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Property Acquisitions. The following table summarizes the property acquisitions and dollars invested in the Inventory Portfolio for each of the years ended December 31 (dollars in thousands):
2008 2007 2006
Development Portfolio:
Number of properties acquired 3 3 16
Dollars invested(1) $ 9,545 $ 64,694 $ 82,524
Exchange Portfolio:
Number of properties acquired 4 23 77
Dollars invested $ 19,994 $ 105,152 $ 118,553
Total dollars invested $ 29,539 $ 169,846 $ 201,077
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(1) Includes dollars invested on projects under construction for each respective year.
Property Dispositions. The following table summarizes the number of Inventory Properties sold and the corresponding gain recognized from the disposition of real estate held for sale included in earnings from continuing and discontinued operations for each of the years ended December 31 (dollars in thousands):
2008 2007 2006
# of # of # of
Properties Gain Properties Gain Properties Gain
Development(1) 6 $ 4,751 13 $ 5,125 9 $ 5,774
Exchange 19 4,607 58 5,888 55 3,892
25 $ 9,358 71 $ 11,013 64 $ 9,666
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(1) Net of minority interest.
Revenue from Continuing Operations Analysis
General. During the year ended December 31, 2008, NNN's rental income increased primarily due to the acquisition of Investment Properties (See "Results of Operations - Property Analysis - Investment Portfolio - Property Acquisitions"). NNN anticipates any significant increase in rental income will continue to come primarily from additional property acquisitions.
The following summarizes NNN's revenues from continuing operations (dollars in thousands):
2008 2007
Versus Versus
Percent of Total 2007 2006
Percent Percent
Increase Increase
2008 2007 2006 2008 2007 2006 (Decrease) (Decrease)
Rental Income(1) $ 210,402 $ 165,471 $ 119,327 92.9% 91.5% 88.0% 27.2% 38.7%
Real estate expense
reimbursement from tenants 7,126 5,688 4,569 3.2% 3.1% 3.4% 25.3% 24.5%
Interest and other income
from real estate
transactions 4,352 4,834 4,436 1.9% 2.7% 3.3% (10.0)% 9.0%
Interest income on
commercial mortgage
residual interests 4,636 4,882 7,268 2.0% 2.7% 5.3% (5.0)% (32.8)%
Total revenues from
continuing operations $ 226,516 $ 180,875 $ 135,600 100.0% 100.0% 100.0% 25.2% 33.4%
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(1) Includes rental income from operating leases, earned income from direct financing leases and percentage rent from continuing operations ("Rental Income").
Revenue from Operations by Source of Income. NNN has identified two primary operating segments, and thus, sources of revenue: (i) earnings from NNN's Investment Assets, and (ii) earnings from NNN's Inventory Assets. NNN revenues from continuing operations come primarily from Investment Assets. The following table summarizes the revenues from continuing operations for each of the years ended December 31 (dollars in thousands):
2008 2007
Versus Versus
Percent of Total 2007 2006
Percent Percent
Increase Increase
2008 2007 2006 2008 2007 2006 (Decrease) (Decrease)
Investment Assets $ 213,059 $ 164,698 $ 119,146 94.1% 91.1% 87.9% 29.4% 38.2%
Inventory Assets 13,457 16,177 16,454 5.9% 8.9% 12.1% (16.8)% (1.7)%
Total revenues $ 226,516 $ 180,875 $ 135,600 100.0% 100.0% 100.0% 25.2% 33.4%
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Comparison of Year Ended December 31, 2008 to Year Ended December 31, 2007.
Rental Income. Rental Income increased for the year ended December 31, 2008, as compared to the same period in 2007, primarily from the addition of 109 Investment Properties with an aggregate gross leasable area of 868,000 square feet. In addition, the increase in Rental Income is also attributable to a full year of Rental Income from the 235 Investment Properties with an aggregate gross leasable area of 2,205,000 square feet which were acquired during the year ended December 31, 2007. The Investment Portfolio occupancy rate remained relatively stable during each of the years ended December 31, 2008 and 2007 with an average of approximately 97 percent and 98 percent, respectively.
Real Estate Expense Reimbursements from Tenants. Real estate expense reimbursements from tenants remained fairly consistent as a percentage of total revenues from continuing operations. The increase for the year ended December 31, 2008, as compared to 2007, was attributable to a full year of reimbursements from certain tenants acquired in 2007 and the reimbursements from newly acquired properties in 2008.
Interest and Other Income from Real Estate Transactions. Interest and other income from real estate transactions decreased for the year ended December 31, . . .
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