REALTY INCOME CORP, 424B5, 1997-05-02

REALTY INCOME CORP
424B5, 1997-05-02
REAL ESTATE INVESTMENT TRUSTS

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<PAGE>
PROSPECTUS SUPPLEMENT

(TO PROSPECTUS DATED APRIL 18, 1997)

$110,000,000
abcd

7 3/4% NOTES DUE 2007
----------------

Realty Income Corporation, a Delaware corporation (the "Company"), will
issue the 7 3/4% Notes due 2007 (the "Notes") offered hereby (the "Offering") in
an aggregate principal amount of $110,000,000. Interest on the Notes is payable
semiannually on each May 6 and November 6, commencing November 6, 1997. The
Notes will mature on May 6, 2007 and are redeemable at any time at the option of
the Company, in whole or in part, at a redemption price equal to the sum of (i)
the principal amount of the Notes being redeemed plus accrued interest to the
redemption date and (ii) the Make-Whole Amount (as defined in "Description of
the Notes--Optional Redemption"), if any. The Notes are not subject to any
mandatory sinking fund.

The Notes will be represented by a single fully registered note in
book-entry form (the "Global Note") registered in the name of The Depository
Trust Company ("DTC") or its nominee. Currently, there is no market for the
Notes. In addition, the Company does not intend to list the Notes on any
securities exchange. Beneficial interests in the Global Note will be shown on,
and transfers thereof will be effected only through, records maintained by DTC
(with respect to beneficial interests of participants) or by participants or
persons that hold interests through participants (with respect to beneficial
interests of beneficial owners). Owners of beneficial interests in the Global
Note will be entitled to physical delivery of Notes in certificated form equal
in principal amount to their respective beneficial interests only under the
limited circumstances described under "Description of the Notes--Book Entry
System." Settlement for the Notes and all payments of principal, premium, if
any, and interest in respect of the Global Note will be made in immediately
available funds. The Notes will trade in DTC's Same-Day Funds Settlement System
until maturity or until the Notes are issued in definitive form, and secondary
market trading activity in the Notes will therefore settle in immediately
available funds. See "Description of the Notes--Same-Day Settlement and
Payment."
--------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS
SUPPLEMENT OR THE PROSPECTUS TO WHICH IT RELATES. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT(2) COMPANY(3)
<S> <C> <C> <C>
Per Note........................................... 99.929% .7% 99.229%
Total.............................................. $109,921,900 $770,000 $109,151,900
</TABLE>

(1) Plus accrued interest, if any, from May 6, 1997.

(2) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."

(3) Before deducting expenses payable by the Company estimated at $180,000.
--------------------------

The Notes are offered by the several Underwriters, subject to prior sale,
when, as and if issued by the Company and delivered to and accepted by them,
subject to approval of certain legal matters by counsel for the Underwriters and
subject to certain other conditions. The Underwriters reserve the right to
withdraw, cancel or modify such offer and to reject orders in whole or in part.
It is expected that delivery of the Notes offered hereby will be made in
book-entry form through the facilities of DTC in New York, New York on or about
May 6, 1997.

--------------------------

MERRILL LYNCH & CO.

DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION

J.P. MORGAN & CO.

SALOMON BROTHERS INC

--------------------------

The date of this Prospectus Supplement is May 1, 1997.
<PAGE>
Certain persons participating in this offering may engage in transactions
that stabilize, maintain or otherwise affect the price of the Notes. Such
transactions may include stabilizing and the purchase of Notes to cover
syndicate short positions. For a description of these activities, see
"Underwriting."

INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE

The document listed below has been filed by the Company under the Securities
and Exchange Act of 1934, as amended (the "Exchange Act"), with the Securities
and Exchange Commission (the "Commission") and is incorporated herein by
reference:

The Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1996.

All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 and
15(d) of the Exchange Act subsequent to the date of this Prospectus Supplement
and prior to the termination of the offering of the Notes shall be deemed to be
incorporated by reference in this Prospectus Supplement and to be part hereof
from the date of filing such documents.

Any statement contained herein or in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus Supplement to the extent that a statement
contained herein (or in the accompanying Prospectus) or in any other
subsequently filed document that also is or is deemed to be incorporated by
reference herein modifies or supersedes such statement. Any such statement so
modified or superseded shall not be deemed, except as so modified or superseded,
to constitute a part of this Prospectus Supplement.

Copies of all documents that are incorporated herein by reference (not
including the exhibits to such documents, unless such exhibits are specifically
incorporated by reference into the information that this Prospectus Supplement
incorporates) will be provided without charge to each person, including any
beneficial owner, to whom this Prospectus Supplement is delivered, upon written
or oral request. Requests should be directed to the Corporate Secretary of the
Company, 220 West Crest Street, Escondido, California 92025 (telephone number:
(760) 741-2111).

S-2
<PAGE>
PROSPECTUS SUPPLEMENT SUMMARY

THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN, OR INCORPORATED BY REFERENCE INTO, THIS PROSPECTUS SUPPLEMENT OR
THE ACCOMPANYING PROSPECTUS. UNLESS THE CONTEXT OTHERWISE REQUIRES, AS USED
HEREIN THE TERMS "COMPANY" AND "REALTY INCOME" REFER TO REALTY INCOME
CORPORATION AND ITS SUBSIDIARIES ON A CONSOLIDATED BASIS FOR PERIODS FROM AND
AFTER AUGUST 15, 1994 (THE DATE OF THE CONSOLIDATION REFERRED TO UNDER "BUSINESS
AND PROPERTIES") AND TO THE COMPANY'S PREDECESSOR PARTNERSHIPS FOR PERIODS PRIOR
TO AUGUST 15, 1994. UNLESS OTHERWISE INDICATED, INFORMATION REGARDING THE
COMPANY'S PROPERTIES IS AS OF APRIL 1, 1997.

THE COMPANY

Realty Income Corporation ("Realty Income" or the "Company") is a fully
integrated, self-administered and self-managed real estate investment trust
("REIT") which management believes is the nation's largest publicly-traded owner
of freestanding, single-tenant, retail properties diversified geographically and
by industry and operated under net lease agreements. As of April 1, 1997, the
Company owned a diversified portfolio of 747 properties located in 42 states
with over 5.4 million square feet of leasable space. Over 99% of the Company's
properties were leased as of April 1, 1997.

Realty Income adheres to a focused strategy of acquiring freestanding,
single-tenant, retail properties leased to national and regional retail chains
under long-term, net lease agreements. The Company typically acquires, and then
leases back, retail store locations from retail chain store operators, providing
capital to the operators for continued expansion and other purposes. The
Company's net lease agreements generally are for initial terms of 10 to 20
years, require the tenant to pay a minimum monthly rent and property operating
expenses (taxes, insurance and maintenance), and provide for future rent
increases (typically subject to ceilings) based on increases in the consumer
price index or additional rent calculated as a percentage of the tenant's gross
sales above a specified level.

Since 1970 and through December 31, 1996, Realty Income has acquired and
leased back to national and regional retail chains over 700 properties
(including 25 properties that have been sold) and has collected in excess of 98%
of the original contractual rent obligations on those properties. Realty Income
believes that the long-term ownership of an actively managed, diversified
portfolio of retail properties leased under long-term, net lease agreements can
produce consistent, predictable income and the potential for long-term capital
appreciation. Management believes that long-term leases, coupled with tenants
assuming responsibility for property expenses under the net lease structure,
generally produce a more predictable income stream than many other types of real
estate portfolios. As of April 1, 1997, the Company's single-tenant properties
were leased pursuant to leases with an average remaining term (excluding
extension options) of approximately 8.4 years.

The Company is a fully integrated real estate company with in-house
acquisition, leasing, legal, financial underwriting, portfolio management and
capital markets expertise. The seven senior officers of the Company, who have
each managed the Company's properties and operations for between six and 27
years, owned approximately 3.9% of the Company's outstanding common stock as of
April 15, 1997. Realty Income had 36 employees as of April 15, 1997.

S-3
<PAGE>
THE OFFERING

All capitalized terms used herein and not defined herein have the meanings
provided in "Description of the Notes." For a more complete description of the
terms of the Notes specified in the following summary, see "Description of the
Notes" in this Prospectus Supplement and "Description of Debt Securities" in the
accompanying Prospectus.

Securities
Offered........... $110,000,000 aggregate principal amount of 7 3/4% Notes
due 2007 (the "Notes").

Maturity............ The Notes will mature on May 6, 2007.

Interest Payment
Dates............. Semiannually on May 6 and November 6, commencing Novem-
ber 6, 1997.

Ranking............. The Notes will be direct, senior unsecured obligations
of the Company and will rank equally with all other
senior unsecured indebtedness of the Company from time
to time outstanding. The Notes will be effectively
subordinated to all indebtedness and other liabilities
of the Company's subsidiaries, and will also be
effectively subordinated to any senior secured
indebtedness of the Company to the extent of the
collateral pledged as security therefor. As of March 31,
1997, such subsidiary indebtedness (not including
guarantees of borrowings under the Credit Facility
(defined below)) and other liabilities (primarily rents
received in advance) aggregated approximately $331,000
and the Company (excluding its subsidiaries) had
unsecured senior indebtedness aggregating approximately
$94.7 million (approximately $6.5 million (excluding the
Notes) on a pro forma basis after giving effect to this
Offering and the application of net proceeds therefrom)
and senior secured indebtedness aggregating
approximately $869,000.

Use of Proceeds..... To pay down amounts drawn under the Company's revolving
acquisition credit facility (the "Credit Facility") and
for other general corporate purposes. See "Use of
Proceeds."

Limitations on
Incurrence of
Debt.............. The Notes contain various covenants, including the
following:

(1) The Company will not, and will not permit any
Subsidiary to, incur any Debt if, after giving effect
thereto, the aggregate principal amount of all
outstanding Debt of the Company and its Subsidiaries on
a consolidated basis is greater than 60% of the sum of
(i) the Company's Total Assets as of the end of the
fiscal quarter covered by the Company's most recent
report on Form 10-K or 10-Q, as the case may be, prior
to the incurrence of such additional Debt and (ii) the
increase in Total Assets from the end of such quarter
including, without limitation, any increase in Total
Assets caused by the application of the proceeds of such
additional Debt (such increase together with the
Company's Total Assets is referred to as "Adjusted Total
Assets").

S-4
<PAGE>

<TABLE>
<S> <C>
(2) The Company will not, and will not permit any
Subsidiary to, incur any Secured Debt if, after giving
effect thereto, the aggregate principal amount of all
outstanding Secured Debt of the Company and its
Subsidiaries on a consolidated basis is greater than 40%
of the Company's Adjusted Total Assets.

(3) The Company will not, and will not permit any
Subsidiary to, incur any Debt if the ratio of
Consolidated Income Available for Debt Service to Annual
Debt Service Charge for the four consecutive fiscal
quarters most recently ended prior to the date on which
such additional Debt is to be incurred would be less
than 1.5 to 1.0, calculated on a pro forma basis after
giving effect to the incurrence of such additional Debt
and the application of the proceeds therefrom.

(4) The Company will maintain Total Unencumbered Assets
of not less than 150% of the aggregate outstanding
principal amount of Unsecured Debt of the Company and
its Subsidiaries on a consolidated basis.

Optional
Redemption........ The Notes are redeemable at any time at the option of
the Company, in whole or in part, at a redemption price
equal to the sum of (i) the principal amount of the
Notes being redeemed plus accrued interest to the
redemption date and (ii) the Make-Whole Amount, if any.
See "Description of the Notes-- Optional Redemption."
</TABLE>

THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS, INCLUDING THE
DOCUMENTS INCORPORATED AND DEEMED TO BE INCORPORATED HEREIN AND THEREIN BY
REFERENCE, CONTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A
OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION
21E OF THE EXCHANGE ACT. FORWARD-LOOKING STATEMENTS ARE INHERENTLY SUBJECT TO
RISK AND UNCERTAINTIES, MANY OF WHICH CANNOT BE PREDICTED WITH ACCURACY AND SOME
OF WHICH MIGHT NOT EVEN BE ANTICIPATED. FUTURE EVENTS AND ACTUAL RESULTS,
FINANCIAL AND OTHERWISE, MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE
FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE,
BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULT OF OPERATIONS" AND "BUSINESS AND
PROPERTIES--MATTERS PERTAINING TO CERTAIN PROPERTIES AND TENANTS" IN THIS
PROSPECTUS SUPPLEMENT AND IN THE SECTION ENTITLED "BUSINESS--OTHER ITEMS" IN THE
COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
(THE "ANNUAL REPORT") INCLUDING THE SUBHEADINGS ENTITLED "--COMPETITION FOR
ACQUISITION OF REAL ESTATE," "--ENVIRONMENTAL MATTERS", "TAXATION OF THE
COMPANY," "--EFFECT OF DISTRIBUTION REQUIREMENTS," "--REAL ESTATE OWNERSHIP
RISKS," AND "--DEPENDENCE ON KEY PERSONNEL."

S-5
<PAGE>
RECENT DEVELOPMENTS

AMENDMENT OF CREDIT FACILITY. On March 7, 1997, the Company amended its
$130 million unsecured acquisition credit facility (the "Credit Facility") to
provide for lower pricing levels that are tied to the investment grade ratings
given by certain credit rating agencies to the Company's senior unsecured debt
and to remove leverage-induced increases on the interest rate charged on both
unused credit balances and on the amount borrowed. See "Use of Proceeds."

INVESTMENT GRADE CREDIT RATING. The Company received an investment grade
corporate senior debt credit rating from Duff & Phelps Credit Rating Company,
Moody's Investors Service, Inc., and Standard & Poor's Rating Group in December
1996. Duff & Phelps assigned a rating of BBB, Moody's assigned a rating of Baa3,
and Standard & Poor's assigned a rating of BBB-. These ratings are subject to
change based upon, among other things, the Company's results of operations and
financial condition.

ACQUISITION OF 62 NET LEASED, RETAIL PROPERTIES. During 1996, the Company
increased the size of its portfolio through a strategic program of acquisitions.
The Company acquired 62 additional properties (the "New Properties"), and
selectively sold seven properties, increasing the number of properties in its
portfolio by 8.0% from 685 properties to 740 properties during 1996. Of the New
Properties, 60 were occupied as of April 1, 1997 and the remaining two were
pre-leased and under construction pursuant to contracts under which the tenants
have agreed to develop the properties (with development costs funded by the
Company) and to begin paying rent when the premises open for business. The New
Properties were acquired for an aggregate cost of approximately $57.5 million
(excluding the estimated unfunded development costs totaling $1.8 million on
properties under construction) at March 31, 1997. The New Properties are located
in 22 states, will contain approximately 603,900 leasable square feet and are
100% leased under net leases, with an average initial lease term of 11.7 years.
The weighted average annual unleveraged return on the cost of the New Properties
(including the estimated unfunded development cost of properties under
construction) is estimated to be 10.6%, computed as estimated contractual net
operating income (which in the case of a net leased property is equal to the
base rent or, in the case of properties under construction, the estimated base
rent under the lease) for the first year of each lease, divided by total
acquisition and estimated development costs. Since it is possible that a tenant
could default on the payment of contractual rent, no assurance can be given that
the actual return on the cost of the New Properties will not differ from the
foregoing percentage.

During the first quarter of 1997, the Company acquired 11 retail properties
in six states for $15.9 million (excluding the estimated unfunded development
costs totaling $1.6 million on five such properties under construction) and
selectively sold four properties, increasing the number of properties in its
portfolio to 747 properties. The 11 properties acquired will contain
approximately 236,200 leasable square feet and are 100% leased under net leases,
with an average initial lease term of 14.0 years. The weighted average annual
unleveraged return on the cost of the 11 properties (including the estimated
unfunded development costs of the five properties under development) is
estimated to be 10.2%, computed as estimated contractual net operating income
(calculated as described in the preceding paragraph) for the first year of each
lease, divided by total acquisition and estimated development costs. However, as
described in the preceding paragraph, no assurance can be given that the actual
return on the cost of these 11 properties will not differ from the foregoing
percentage. During the first quarter of 1997, the Company also invested $2.0
million in nine development properties acquired in 1996.

REINCORPORATION OF THE COMPANY IN MARYLAND. The Company has submitted a
proposal to its stockholders to reincorporate the Company in the State of
Maryland. Assuming approval by the stockholders at the upcoming annual meeting,
the Company expects to effect the reincorporation in May 1997.

S-6
<PAGE>
USE OF PROCEEDS

The net proceeds to the Company from the sale of the Notes offered hereby
are estimated to be approximately $109 million (after deducting the discount to
the Underwriters and other estimated expenses of this Offering payable by the
Company). The Company intends to use the net proceeds to pay down outstanding
indebtedness under the Credit Facility, which had an outstanding balance at
April 15, 1997 of $93.7 million, and for other general corporate purposes. The
Credit Facility is a three year, revolving, unsecured acquisition credit
facility with a borrowing capacity of $130 million. Borrowings under the Credit
Facility currently bear interest at a spread of 1.25% over the London Interbank
Offered Rate ("LIBOR"). The Credit Facility also offers the Company other
interest rate options. The maturity date on the Credit Facility is November 27,
1999 and the effective interest rate was 6.85% at December 31, 1996. Pending
application for such purposes, such net proceeds may be invested in short-term
investments.

CAPITALIZATION

The following table sets forth the historical capitalization of the Company
as of December 31, 1996 and as adjusted to give effect to the issuance and sale
of the Notes offered hereby and the use of the estimated net proceeds therefrom
to repay borrowings under the Credit Facility as described in "Use of Proceeds."

<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
------------------------
HISTORICAL AS ADJUSTED
----------- -----------
<S> <C> <C>
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
DEBT
Credit Facility(1)................................................ $ 70,000 $ --
Notes due 2007.................................................... -- 110,000
----------- -----------
Total debt...................................................... 70,000 110,000

STOCKHOLDERS' EQUITY
Preferred stock, par value $1.00 per share, 5,000,000 shares
authorized, no shares issued or outstanding..................... -- --
Common stock, $1.00 par value per share; 40,000,000 shares
authorized; 22,979,537 issued and outstanding................... 22,980 22,980
Capital in excess of par value...................................... 516,004 516,004
Accumulated distributions in excess of net income................... (164,743) (164,743)
----------- -----------
Total stockholders' equity...................................... 374,241 374,241
----------- -----------
Total capitalization............................................ $ 444,241 $ 484,241
----------- -----------
----------- -----------
</TABLE>

- ------------------------

(1) The amount drawn on the Credit Facility was $93.7 million at April 15, 1997
and is expected to be approximately $93.7 million on the closing date of the
Offering.

S-7
<PAGE>
BUSINESS AND PROPERTIES

OVERVIEW

The Company is a fully integrated, self-administered and self-managed REIT
which management believes is the nation's largest publicly-traded owner of
freestanding, single-tenant, retail properties diversified geographically and by
industry and operated under net lease agreements. As of April 1, 1997, the
Company owned a diversified portfolio of 747 properties located in 42 states
with over 5.4 million square feet of leasable space. Approximately 99% of the
Company's properties were leased as of April 1, 1997. Unless otherwise
indicated, information regarding the Company's properties is as of April 1,
1997.

The Company was formed on September 9, 1993 in the State of Delaware. Realty
Income commenced operations as a REIT on August 15, 1994 through the merger of
25 public and private real estate limited partnerships (the "Partnerships") with
and into the Company (the "Consolidation"). Each of the partnerships was formed
between 1970 and 1989 for the purpose of acquiring and managing long-term, net
leased properties.

BUSINESS OBJECTIVES AND STRATEGY

GENERAL. The Company's primary business objective is to generate a
consistent and predictable level of FFO per share and distributions to
stockholders. Additionally, the Company generally will seek to increase FFO per
share and distributions to stockholders through active portfolio management and
the acquisition of additional properties. The Company also seeks to lower the
ratio of distributions to stockholders as a percentage of FFO in order to allow
internal cash flow to be used to fund additional acquisitions and for other
corporate purposes. The Company's portfolio management focus includes (i)
contractual rent increases on existing leases; (ii) rental increases at the
termination of existing leases when market conditions permit; and (iii) the
active management of the Company's property portfolio, including selective sales
of properties. The Company generally pursues the acquisition of additional
properties under long-term, net lease agreements with initial contractual base
rent which, at the time of acquisition and as a percentage of acquisition cost,
is in excess of the Company's estimated cost of capital.

INVESTMENT PHILOSOPHY. Realty Income believes that the long-term ownership
of an actively managed, diversified portfolio of retail properties under
long-term, net lease agreements can produce consistent, predictable income and
the potential for long-term capital appreciation. Under a net lease agreement,
the

S-8
<PAGE>
tenant agrees to pay a minimum monthly rent and property expenses (taxes,
maintenance, and insurance) plus, typically, future rent increases (typically
subject to ceilings) based on increases in the consumer price index or
additional rent calculated as a percentage of the tenant's gross sales above a
specified level. The Company believes that long-term leases, coupled with the
tenants assuming responsibility for property expenses, generally produce a more
predictable income stream than many other types of real estate portfolios, while
continuing to offer the opportunity for capital appreciation.

INVESTMENT STRATEGY. In identifying new properties for acquisition, Realty
Income focuses on providing expansion capital to middle market retail chains by
acquiring, then leasing back, their retail store locations. The Company
classifies retail tenants into three categories: venture, middle market, and
upper market. Venture companies are those which typically offer a new retail
concept in one geographic region of the country and operate between five and 50
retail outlets. In general, these retail chains are thinly capitalized and are
in the process of solving distribution, marketing, concept, geographic
adaptation, and other problems associated with a new, growing company. Middle
market retail chains are those which typically have 50 to 500 retail outlets,
operations in more than one geographic region, success through one or more
economic cycles, a proven, replicable concept, and an objective of further
expansion. The upper market retail chains typically consist of companies with
500 or more stores which operate nationally in a mature retail concept. They
generally have strong operating histories and access to several sources of
capital.

Realty Income focuses on acquiring properties leased to emerging, middle
market retail chains which the Company believes are more attractive for
investment because: (i) they generally have overcome many of the operational and
managerial obstacles that tend to adversely affect venture retailers; (ii) they
typically require capital to fund expansion but have more limited financing
options compared to upper market retailers; (iii) historically, they generally
have provided attractive risk-adjusted returns to the Company over time, since
their financial strength has in many cases tended to improve as their businesses
have matured; (iv) their relatively large size compared to venture retailers
allows them to spread corporate expenses among a greater number of stores; and
(v) compared to venture retailers, middle market retailers typically have the
critical mass to survive if a number of locations have to be closed due to
underperformance.

CREDIT STRATEGY. Realty Income provides sale leaseback financing primarily
to less than investment grade retail chains. Since 1970 and through December 31,
1996, Realty Income has acquired and leased back to national and regional retail
chains over 700 properties (including 25 properties that have been sold) and has
collected in excess of 98% of the original contractual rent obligations on those
properties. The Company believes that it is within this market that it can
receive a better risk adjusted return on the financing that it provides to
retailers.

Realty Income believes that the primary financial obligations of middle
market retailers typically include their bank and other debt, payment
obligations to suppliers and real estate lease obligations. Because the Company
owns the land and buildings on which the tenant conducts its retail business,
the Company believes that the risk of default on the retailers' lease
obligations is less than the retailers' unsecured general obligations. It has
been the Company's experience that since retailers must retain their profitable
retail locations in order to survive, in the event of a Chapter 11
reorganization they are less likely to reject a lease for a profitable location,
which would terminate their right to use the property. Thus, as the property
owner, the Company believes it will fare better than unsecured creditors of the
same retailer in the event of a Chapter 11 reorganization. In addition, Realty
Income believes 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 selling those units that are weaker performers.

In order to qualify for inclusion in the Company's portfolio, new
acquisitions must meet stringent investment and credit requirements. The
properties must generate attractive current yields, and the tenant must meet the
Company's credit standards and have a proven market concept. The Company has

S-9
<PAGE>
established a three part analysis that examines each potential investment based
on: 1) industry, company, market conditions and credit profile; 2) location
profitability, if available; and 3) overall real estate characteristics, value,
and comparative rental rates. Companies that have been approved for acquisitions
are generally those with fifty or more retail stores which are located in highly
visible areas, with easy access to major thoroughfares, attractive demographics,
and acquisition costs at or below appraised value.

ACQUISITION STRATEGY. Realty Income seeks to invest in industries that are
dominated by independent local operators and in which several well organized
regional and national chains are capturing market share through service, quality
control, economies of scale, mass media advertising, and selection of prime
retail locations. The Company executes its acquisition strategy by acting as a
source of capital to regional and national retail chain stores in a variety of
industries by acquiring, then leasing back, their retail store locations.
Relying on executives from its acquisitions, credit underwriting, portfolio
management, finance, accounting, operations, capital markets, and legal
departments, the Company undertakes thorough research and analysis in
identifying appropriate industries, tenants, and property locations for
investment. In selecting real estate for potential investment, the Company
generally will seek to acquire properties that have the following
characteristics:

- Freestanding, commercially zoned property with a single tenant;

- Properties that are important retail locations for national and regional
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;

- Properties that can be purchased with the simultaneous execution or
assumption of long-term, net lease agreements, providing the opportunity
for both current income and future rent increases (typically subject to
ceilings) based on increases in the consumer price index or through the
payment of additional rent calculated as a percentage of the tenant's
gross sales above a specified level; and

- Properties that can be acquired at or below their appraised value at
prices generally ranging from $300,000 to $10 million.

PORTFOLIO MANAGEMENT STRATEGY. The active management of the property
portfolio is an essential component of the Company's long-term strategy. The
Company continually monitors its portfolio for changes that could affect the
performance of the industries, tenants, and locations in which it has invested.
Realty Income's Executive Committee meets at least monthly to review industry
and tenant research, due diligence, property operations and portfolio
management. This monitoring typically includes ongoing review and analysis of:
(i) the performance of various tenant industries; (ii) the operation,
management, business planning, and financial condition of the tenants; (iii) the
health of the individual markets in which the Company owns properties, from both
an economic and real estate standpoint; and (iv) the physical maintenance of the
Company's individual properties. The portfolio is analyzed on an ongoing basis
with a view towards optimizing performance and returns.

While the Company generally intends to hold its net lease properties for
long-term investment, the Company actively manages its portfolio of net lease
properties. The Company intends to pursue a strategy of identifying properties
that may be sold at attractive prices, particularly where the Company believes
reinvestment of the sales proceeds can generate a higher cash flow to the
Company than the property being sold. While the Company intends to pursue such a
strategy, it will only do so within the constraints of the income tax rules
regarding REIT status.

CAPITAL STRATEGY. The Company utilizes its $130 million, unsecured
acquisition Credit Facility as a vehicle for the short-term financing of the
acquisition of new properties. When outstanding borrowings under the Credit
Facility reach a certain level (generally in the range of $75 to $100 million),
the Company intends to refinance those borrowings with the net proceeds of
long-term or permanent financing, which

S-10
<PAGE>
may include the issuance of common stock, preferred stock or convertible
preferred stock, debt securities or convertible debt securities. However, there
can be no assurance that the Company will be able to effect any such refinancing
or that market conditions prevailing at the time of refinancing will enable the
Company to issue equity or debt securities upon acceptable terms. The Company
believes that it is best served by a conservative capital structure, with a
majority of its capital consisting of equity. On a pro forma basis assuming
issuance of the Notes and application of the estimated net proceeds therefrom
occurring on March 31, 1997, the Company's total indebtedness would have been
approximately 18% of its total market capitalization (defined as shares of the
Company's common stock outstanding multiplied by the last reported sales price
of the Common Stock on March 31, 1997 of $23.00 per share plus total
indebtedness).

The Company received an investment grade corporate credit rating from Duff &
Phelps Credit Rating Company, Moody's Investors Service, Inc., and Standard &
Poor's Rating Group in December 1996. Duff & Phelps assigned a rating of BBB,
Moody's assigned a rating of Baa3, and Standard & Poor's assigned a rating of
BBB-. These ratings are subject to change based upon, among other things, the
Company's results of operations and financial condition.

In December 1996, the Company entered into a treasury interest rate lock
agreement to hedge against the possibility of rising interest rates. Under the
interest rate lock agreement, the Company receives or makes a payment based on
the differential between a specified interest rate, 6.537%, and the actual
10-year treasury interest rate on a notional principal of $90 million. Based on
the 10-year treasury interest rate at March 31, 1997, the Company had an
unrecognized gain on the agreement of approximately $2,310,000. The Company is
using the treasury interest rate lock agreement to offset its interest rate risk
on $90 million of the $110 million of the Notes offered hereby.

COMPETITIVE STRATEGY. The Company believes that, to utilize its investment
philosophy and strategy most successfully, it must seek to maintain the
following competitive advantages:

(i) SIZE AND TYPE OF INVESTMENT PROPERTIES: The Company believes that
smaller ($300,000 to $10,000,000) retail net leased 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, the Company believes that these types of properties have not
experienced significant institutional participation or the corresponding
yield reduction experienced by larger income producing properties. The
Company believes the less intensive day to day property management required
by net lease agreements, coupled with the active management of a large
portfolio of smaller properties by the Company, is an effective investment
strategy.

In 1969, Realty Income identified a market niche and systematically
built a portfolio around this niche. Twenty-seven years later, the Company
believes that it is the nation's largest publicly-traded owner of
free-standing, single-tenant, retail properties diversified geographically
and by industry and operated under net lease agreements, with over 5.4
million square feet of leasable space.

The tenants of Realty Income's freestanding retail properties include
convenience stores, consumer electronics stores, child care centers,
restaurants, and other retailers providing goods and services which satisfy
basic human 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 such retailers, Realty Income's method of purchasing the
property and then leasing it back under a net lease arrangement allows the
retail chain to free up capital.

(ii) INVESTMENT IN NEW INDUSTRIES: While specializing in single tenant
properties, the Company will seek to further diversify its portfolio among a
variety of industries. The Company believes that diversification will allow
it to invest in industries that are currently growing and have
characteristics the Company finds attractive. These characteristics include,
but are not limited to, industries dominated by local operators where
national and regional chain operators can gain market share and dominance
through more efficient operations, as well as industries taking advantage of
major

S-11
<PAGE>
demographic shifts in the population base. For example, in the early 1970s,
Realty Income targeted the fast food industry to take advantage of the
country's increasing desire to dine away from home, and in the early 1980s,
it targeted the child day care industry, responding to the need for
professional child care as more women entered the work force.

(iii) DIVERSIFICATION: Diversification of the portfolio by industry
type, tenant and geographic location is key to the Company's objective of
providing predictable investment results for its stockholders. As the
Company expands it will seek to further diversify its portfolio. During 1996
and 1995, the Company added the consumer electronics and convenience store
industries, respectively, to the portfolio.

(iv) MANAGEMENT SPECIALIZATION: The Company believes that its
management's specialization in single tenant properties operated under net
lease agreements is important to meeting its objectives. The Company plans
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.

(v) TECHNOLOGY: The Company intends to stay at the forefront of
technology in its efforts to efficiently and economically carry out its
operations. The Company maintains a sophisticated information system that
allows it to analyze its portfolio's performance and actively manage its
investments. The Company believes that technology and information based
systems will play an increasingly important role in its competitiveness as
an investment manager and source of capital to a variety of industries and
tenants.

PROPERTIES

As of April 1, 1997, the Company owned a diversified portfolio of 747
properties in 42 states containing over 5.4 million square feet of leasable
space. The portfolio consisted of 159 after-market automotive retail locations
(80 automotive parts stores and 79 automotive service locations), one book
store, 318 child care centers, 36 consumer electronics stores, 42 convenience
stores, seven home furnishings stores, one office supply store, 171 restaurant
facilities and 12 other properties. Of the 747 properties, 684 or 91% were
leased to national or regional retail chain operators; 42 or 6% were leased to
franchisees of retail chain operators; 16 or 2% were leased to other tenant
types; and five or less than 1% were available for lease. At April 1, 1997, over
98% of the properties were under net lease agreements. Net leases typically
require the tenant to be responsible for property operating costs including
property taxes, insurance and expenses of maintaining the property.

The Company's net leased retail properties are retail locations leased to
national and regional retail chain store operators. At April 1, 1997, the
properties averaged approximately 7,300 square feet of leasable retail space on
approximately 43,500 square feet of land. Generally, buildings are single-story
properties 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, egress and proximity to a sufficient
population base to constitute a sufficient market or trade area for the
retailer's business.

The following table sets forth certain geographic diversification
information regarding Realty Income's portfolio at April 1, 1997:

<TABLE>
<CAPTION>
PERCENT OF
APPROXIMATE TOTAL
NUMBER OF PERCENT LEASABLE ANNUALIZED ANNUALIZED
STATE PROPERTIES LEASED SQUARE FEET BASE RENT(1) BASE RENT
- ------------------------------- ------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Alabama........................ 6 100% 42,300 $ 319,000 0.5%
Arizona........................ 26 100 178,400 2,362,000 3.8
California..................... 53 98 1,001,900 10,593,000 17.1
Colorado....................... 42 98 233,500 2,984,000 4.8
Connecticut.................... 4 100 17,200 240,000 0.4
</TABLE>

S-12
<PAGE>
<TABLE>
<CAPTION>
PERCENT OF
APPROXIMATE TOTAL
NUMBER OF PERCENT LEASABLE ANNUALIZED ANNUALIZED
STATE PROPERTIES LEASED SQUARE FEET BASE RENT(1) BASE RENT
- ------------------------------- ------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Florida........................ 49 100 461,900 4,264,000 6.9
Georgia........................ 37 100 187,600 2,448,000 3.9
Idaho.......................... 11 100 52,000 656,000 1.1
Illinois....................... 25 100 182,600 2,081,000 3.4
Indiana........................ 23 100 122,800 1,438,000 2.3
Iowa........................... 8 100 51,700 456,000 0.7
Kansas......................... 15 100 129,000 1,441,000 2.3
Kentucky....................... 11 100 33,300 835,000 1.3
Louisiana...................... 2 100 10,700 126,000 0.2
Maryland....................... 6 100 34,900 505,000 0.8
Massachusetts.................. 4 100 20,900 440,000 0.7
Michigan....................... 5 100 26,900 353,000 0.6
Minnesota...................... 17 100 118,400 1,713,000 2.7
Mississippi.................... 11 100 106,600 792,000 1.3
Missouri....................... 27 100 163,600 1,842,000 2.9
Montana........................ 1 100 5,400 71,000 0.1
Nebraska....................... 8 100 47,100 509,000 0.8
Nevada......................... 5 100 29,100 353,000 0.6
New Hampshire.................. 1 100 6,400 122,000 0.2
New Jersey..................... 2 100 22,700 346,000 0.6
New Mexico..................... 3 100 12,000 103,000 0.2
New York....................... 5 100 38,300 539,000 0.9
North Carolina................. 20 100 82,200 1,337,000 2.1
Ohio........................... 48 100 210,500 3,426,000 5.5
Oklahoma....................... 9 100 60,200 543,000 0.9
Oregon......................... 18 100 98,500 1,133,000 1.8
Pennsylvania................... 4 100 28,300 420,000 0.7
South Carolina................. 20 95 85,000 1,152,000 1.9
South Dakota................... 1 100 6,100 79,000 0.1
Tennessee...................... 10 100 78,900 963,000 1.6
Texas.......................... 127 99 980,900 9,073,000 14.6
Utah........................... 7 100 45,400 591,000 1.0
Virginia....................... 16 100 79,000 1,256,000 2.0
Washington..................... 42 98 249,700 2,959,000 4.8
West Virginia.................. 2 100 16,800 147,000 0.2
Wisconsin...................... 11 100 60,500 738,000 1.2
Wyoming........................ 5 100 26,900 324,000 0.5
--- --- ------------ ------------- -----
Total/Average.................. 747 99% 5,446,100 $ 62,072,000 100.0%
--- --- ------------ ------------- -----
--- --- ------------ ------------- -----
</TABLE>

- ------------------------

(1) Annualized base rent is calculated by multiplying the monthly contractual
base rent as of April 1, 1997 for each of the properties by 12, except that,
for the properties under construction, estimated contractual base rent for
the first month of the respective leases is used instead of base rent as of
April 1, 1997. The estimated contractual base rent for the properties under
construction is based upon the estimated acquisition costs of the
properties. Annualized base rent does not include percentage rents (i.e.,
additional rent calculated as a percentage of the tenant's gross sales above
a specified level), if any, that may be payable under leases covering
certain of the properties.

S-13
<PAGE>
The following table sets forth certain information regarding the Company's
properties, classified according to the business of the respective tenants:

<TABLE>
<CAPTION>
APPROXIMATE REALTY INCOME APPROXIMATE
TOTAL OWNED LEASABLE ANNUALIZED
TENANT INDUSTRY SEGMENT LOCATIONS(1) LOCATIONS SQUARE FEET BASE RENT(2)
- ------------------------------------ ---------------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
AFTER-MARKET AUTOMOTIVE
CSK Auto, Inc. (formerly Northern Parts 580 79 409,200 $ 4,192,000
Automotive).......................
Discount Tire....................... Service 310 18 103,200 1,177,000
Econo Lube N' Tune.................. Service 210 18 49,400 1,257,000
Jiffy Lube.......................... Service 1,400 29 68,700 1,851,000
Q Lube.............................. Service 490 4 7,600 183,000
R&S Strauss......................... Service 110 2 31,200 431,000
Speedy Muffler King................. Service 1,080 7 40,900 531,000
Other............................... Parts/Service -- 2 6,500 90,000
--- ------------ ------------
TOTAL AFTER-MARKET AUTOMOTIVE..... 159 716,700 9,712,000

BOOK STORES
Barnes & Noble...................... Book Stores 1,010 1 30,000 450,000
--- ------------ ------------
TOTAL BOOK STORES................. 1 30,000 450,000

CHILD CARE
Children's World Learning Centers... Child Care 530 134 964,000 13,612,000
Kinder-Care Learning Centers........ Child Care 1,150 13 79,800 1,087,000
La Petite Academy................... Child Care 790 170 972,700 8,853,000
Other............................... Child Care -- 1 4,200 --
--- ------------ ------------
TOTAL CHILD CARE.................. 318 2,020,700 23,552,000

CONSUMER ELECTRONICS
Best Buy............................ Consumer Electronics 270 2 104,800 1,321,000
Rex Stores.......................... Consumer Electronics 230 34 408,300 2,694,000
--- ------------ ------------
TOTAL CONSUMER ELECTRONICS........ 36 513,100 4,015,000

CONVENIENCE STORES
7-ELEVEN............................ Convenience 20,240 3 9,700 235,000
Dairy Mart.......................... Convenience 1,020 22 66,500 1,513,000
East Coast Oil...................... Convenience 40 2 6,400 219,000
The Pantry, Inc..................... Convenience 400 14 34,400 1,333,000
Other............................... Convenience -- 1 2,100 31,000
--- ------------ ------------
TOTAL CONVENIENCE STORES.......... 42 119,100 3,331,000

HOME FURNISHINGS
Levitz.............................. Home Furnishings 130 4 376,400 2,496,000
Aaron Rents......................... Home Furnishings 290 3 161,600 464,000
--- ------------ ------------
TOTAL HOME FURNISHINGS............ 7 538,000 2,960,000

OFFICE SUPPLIES
Office Max.......................... Office Supplies 560 1 28,700 431,000
--- ------------ ------------
TOTAL OFFICE SUPPLIES............. 1 28,700 431,000
</TABLE>

S-14
<PAGE>
<TABLE>
<CAPTION>
APPROXIMATE REALTY INCOME APPROXIMATE
TOTAL OWNED LEASABLE ANNUALIZED
TENANT INDUSTRY SEGMENT LOCATIONS(1) LOCATIONS SQUARE FEET BASE RENT(2)
- ------------------------------------ ---------------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
RESTAURANTS
Don Pablo's......................... Dinner House 70 7 60,700 $ 604,000
Carvers............................. Dinner House 90 3 26,600 495,000
Other............................... Dinner House -- 13 108,300 1,015,000
Golden Corral....................... Family 460 87 512,500 6,747,000
Sizzler............................. Family 630 7 37,600 841,000
Other............................... Family -- 4 23,400 151,000
Hardees............................. Fast Food 3,100 3 10,300 144,000
Taco Bell........................... Fast Food 4,890 24 54,100 1,502,000
Whataburger......................... Fast Food 520 9 23,000 616,000
Other............................... Fast Food -- 14 39,800 747,000
--- ------------ ------------
TOTAL RESTAURANTS............... 171 896,300 12,862,000

TOTAL OTHER..................... Miscellaneous 12 583,500 4,759,000
--- ------------ ------------

TOTAL........................... 747 5,446,100 $ 62,072,000
--- ------------ ------------
--- ------------ ------------
</TABLE>

- --------------------------

(1) Approximate total number of retail locations in operation (including both
owned and franchised locations), based on information provided to the
Company by the respective tenants.

(2) Annualized base rent is calculated by multiplying the monthly contractual
base rent as of April 1, 1997 for each of the properties by 12, except that,
for the properties under construction, estimated contractual base rent for
the first month of the respective leases is used instead of base rent as of
April 1, 1997. The estimated contractual base rent for the properties under
construction is based upon the estimated acquisition costs of the
properties. Annualized base rent does not include percentage rents (i.e.,
additional rent calculated as a percentage of the tenant's gross sales above
a specified level), if any, that may be payable under leases covering
certain of the properties.

Of the 747 properties in the portfolio, 740 are single-tenant properties
with the remaining properties being multi-tenant properties. As of April 1,
1997, 735 or 99% of the single-tenant properties were net leased with an average
remaining lease term (excluding extension options) of approximately 8.4 years.
The

S-15
<PAGE>
following table sets forth certain information regarding the timing of initial
lease term expirations (excluding extension options) on the Company's 735 net
leased, single tenant retail properties:

<TABLE>
<CAPTION>
PERCENT OF
NUMBER OF TOTAL
LEASES ANNUALIZED ANNUALIZED
YEAR EXPIRING BASE RENT(2) BASE RENT
- ------------------------------------------------------ -------------- ------------- -------------
<S> <C> <C> <C>
1997.................................................. 25 $ 1,068,000 1.8%
1998.................................................. 4 168,000 0.3
1999.................................................. 20 900,000 1.5
2000.................................................. 27 1,335,000 2.3
2001.................................................. 49 3,796,000 6.5
2002.................................................. 74 5,878,000 10.1
2003.................................................. 68 5,163,000 8.9
2004.................................................. 110 8,896,000 15.3
2005.................................................. 86 6,044,000 10.4
2006.................................................. 29 2,446,000 4.2
2007.................................................. 82 4,949,000 8.5
2008.................................................. 39 3,174,000 5.5
2009.................................................. 12 896,000 1.5
2010.................................................. 34 2,729,000 4.7
2011.................................................. 31 3,541,000 6.1
2012.................................................. 8 714,000 1.2
2014.................................................. 2 265,000 0.5
2015.................................................. 25 4,789,000 8.2
2016.................................................. 7 1,351,000 2.3
2017.................................................. 2 83,000 0.1
2018.................................................. 1 39,000 0.1
--- ------------- -----
Total............................................... 735(1) $ 58,224,000 100.0%
--- ------------- -----
--- ------------- -----
</TABLE>

- ------------------------

(1) The table does not include seven multi-tenant properties and five vacant,
unleased properties owned by the Company. The lease expirations for
properties under construction are based on the estimated date of completion
of such properties.

DESCRIPTION OF LEASING STRUCTURE. At April 1, 1997, over 98% of the
Company's properties were leased pursuant to net leases. In most cases, the
leases are for initial terms of from 10 to 20 years and the tenant has an option
to extend the initial term. The leases generally provide for a minimum base rent
plus future increases (typically subject to ceilings) based on increases in the
consumer price index or additional rent based upon the tenant's gross sales
above a specified level (i.e., percentage rent). Where leases provide for rent
increases based on increases in the consumer price index, typically such
increases permanently become part of the base rent. Where leases provide for
percentage rent, this additional rent is typically payable only if the tenant's
gross sales for a given period (usually one year) exceed a specified level, and
then is typically calculated as a percentage of only the amount of gross sales
in excess of such level. In

S-16
<PAGE>
general, the leases require the tenant to pay property taxes, insurance, and
expenses of maintaining the property.

MATTERS PERTAINING TO CERTAIN PROPERTIES AND TENANTS

As of April 1, 1997, the Company's four largest tenants were Children's
World Learning Centers, La Petite Academy, Golden Corral and CSK Auto, Inc. (CSK
was formerly called Northern Automotive), which accounted for approximately
23.7%, 16.5%, 12.4% and 8.4%, respectively, of the Company's rental revenue for
the year ended December 31, 1996. The financial position and results of
operations of the Company and its ability to make distributions to stockholders
and debt service payments may be materially adversely affected by financial
difficulties experienced by any such major tenants or other tenants, including,
but not limited to, a bankruptcy, insolvency or general downturn in the business
of such tenants.

For the year ended December 31, 1996, approximately 42.0%, 24.3% and 15.3%
of the Company's rental revenues were attributable to tenants in the child care,
restaurant and after-market automotive industries, respectively. A downturn in
any of these industries generally, whether nationwide or limited to specific
sectors of the United States, could adversely affect tenants in those
industries, which in turn could materially adversely affect the financial
position and results of operations of the Company and its ability to make
distributions to stockholders and debt service payments. In that regard, a
substantial number of the Company's properties are leased to middle market
retail chains, which generally have more limited financial and other resources
than certain upper market retail chains and therefore are more likely to be
adversely affected by a downturn in their respective businesses or in the
national or regional economy generally.

Five of the Company's properties were vacant as of April 1, 1997 and
available for lease. Four of the vacant properties were previously leased to
restaurant operators and one was formerly leased to a child care operator.

As of April 1, 1997, 20 of the Company's properties which were under lease
were vacant and available for sublease by the tenant. These 20 properties (11
restaurants, four after-market automotive stores, three child care, one other
store and one medical building) were available for sublease and had tenants who
were current with their rent and other lease obligations.

As of April 1, 1997, 19 of the Company's properties had been sublet to
tenants in different industries than the original tenant. All of these tenants
were current with their rent and other lease obligations.

DEVELOPMENT OF CERTAIN PROPERTIES

Of the 62 New Properties acquired by the Company in 1996, 60 were occupied
as of April 1, 1997 and the remaining two were pre-leased and under construction
pursuant to contracts under which the tenants have agreed to develop the
properties (with development costs funded by the Company) and to begin paying
rent when the premises opens for business. In the case of development
properties, the Company typically enters into an agreement with a tenant
pursuant to which the tenant retains a contractor to construct the improvements
on the property and the Company funds the costs of such development. The tenant
is contractually obligated to complete the construction on a timely basis,
generally within eight months after the Company purchases the land and to pay
construction cost overruns to the extent they exceed the construction budget by
more than a predetermined amount. The Company typically also enters into a lease
with the tenant at the time the Company purchases the land, which generally
requires that the tenant begin paying base rent, calculated as a percentage of
the Company's acquisition cost for the property, including construction costs
and capitalized interest, when the premises opens for business. During 1996, the
Company acquired 18 development properties, 16 of which have been completed, are
operating and paying rent. Completion of the remaining two development
properties is anticipated in May 1997. The Company will continue to seek to
acquire land for development under similar arrangements.

S-17
<PAGE>
Of the 11 properties acquired during the first quarter of 1997, six were
occupied as of April 1, 1997 and the remaining five were pre-leased and under
construction pursuant to contracts under which the tenants have agreed to
develop the properties (with development costs funded by the Company) and to
begin paying rent when the premises open for business.

S-18
<PAGE>
SELECTED FINANCIAL INFORMATION

The following table sets forth selected financial data for the Company and
the Predecessor (as defined below), as the case may be, for each of the five
years in the period ended December 31, 1996, and has been derived from financial
statements which have been audited by the Company's independent auditors, KPMG
Peat Marwick LLP. The following financial information should be read in
conjunction with the consolidated financial statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996, which is
incorporated by reference herein and in the accompanying Prospectus, and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included herein. The following table also includes certain property
data.
<TABLE>
<CAPTION>
COMPANY PREDECESSOR(2)
------------------------------------- ------------------------
AS OF OR FOR THE YEAR ENDED DECEMBER AS OF OR FOR THE YEAR
31, ENDED DECEMBER 31,
------------------------------------- ------------------------
1996 1995 1994(1) 1993 1992
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<CAPTION>
<S> <C> <C> <C> <C> <C>
OPERATING DATA
Revenue:
Rental revenue............................... $ 56,777 $ 51,185 $ 47,905 $ 48,584 $ 48,694
Interest and other income.................... 180 370 958 434 340
----------- ----------- ----------- ----------- -----------
Total revenue.............................. 56,957 51,555 48,863 49,018 49,034
----------- ----------- ----------- ----------- -----------
Expenses:
Depreciation and amortization................ 16,422 14,849 13,790 14,689 14,811
General and administrative expenses and
advisor fees............................... 5,181 6,875 7,187 5,886 5,416
Property..................................... 1,640 1,607 2,095 1,768 1,867
Interest..................................... 2,367 2,642 396 5 --
Provision for impairment losses.............. 579 -- 135 935 --
Consolidation costs.......................... -- -- 11,201 -- --
----------- ----------- ----------- ----------- -----------
Total expenses............................. 26,189 25,973 34,804 23,283 22,094
----------- ----------- ----------- ----------- -----------
Income from operations......................... 30,768 25,582 14,059 25,735 26,940
Net gain on sales of properties................ 1,455 18 1,165 3,583 1,113
----------- ----------- ----------- ----------- -----------
Net income..................................... $ 32,223 $ 25,600 $ 15,224 $ 29,318 $ 28,053
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Net income per share(3)........................ $ 1.40 $ 1.27 $ 0.78 $ -- $ --
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Weighted average common shares
outstanding(3)............................... 22,977,837 20,230,963 19,502,091 -- --
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
BALANCE SHEET DATA
Properties, before accumulated depreciation.... $ 564,540 $ 515,426 $ 450,703 $ 451,738 $ 476,822
Total assets (book value)...................... 454,097 417,639 352,768 384,474 395,671
Total liabilities.............................. 79,856 36,218 17,352 2,570 2,150
Stockholders' equity........................... 374,241 381,421 335,416 381,904 393,418
OTHER DATA
FFO(4)......................................... 47,718 40,414 39,185 41,359 41,751
Capital expenditures........................... 37 296 222 94 13
RATIOS
Debt as a percentage of Total Assets(5)........ 12.8% 4.0% 3.0% 0.3% 0.3%
Secured Debt as a percentage of Total
Assets(5)(6)................................. 0.2% 0.2% -- -- --
Debt Service Coverage Ratio(7)................. 27x 20x 87x 9,706x --
Ratio of earnings to fixed charges(8).......... 14x 10x 39x 5,865x --
PORTFOLIO DATA (AT END OF PERIOD)
Number of properties........................... 740 685 630 631 634
Net rentable square feet....................... 5,226,700 4,673,700 4,064,800 4,052,800 4,468,200
</TABLE>

- --------------------------

(1) Realty Income commenced operations as a REIT on August 15, 1994 through the
merger of the Partnerships with and into the Company (the "Consolidation").
The Consolidation was accounted for as a reorganization of

S-19
<PAGE>
affiliated entities under common control in a manner similar to a
pooling-of-interests. Under this method, the assets and liabilities of the
Partnerships were carried over at their historical book values and their
operations have been recorded on a combined historical cost basis. The
pooling-of-interests method of accounting also requires the reporting of the
results of operations as though the entities had been combined as of the
beginning of the earliest period presented. Accordingly, the results of
operations for the year ended December 31, 1994 comprise those of the
separate Partnerships combined from January 1, 1994 through August 15, 1994
and those of the Company from August 16, 1994 through December 31, 1994.
Costs incurred to effect the Consolidation and integrate the continuing
operations of the separate Partnerships were expenses of the Company in
1994, the year in which the Consolidation was consummated.

(2) Prior to the Consolidation, the Company had no significant operations.
Therefore, the combined operations for the periods prior to the
Consolidation represent the operations of the Partnerships (the
"Predecessor").

(3) Due to the change in the capital structure caused by the Consolidation as
described in note (1) above, share and per share information would not be
meaningful for 1993 and 1992 and therefore has not been included.

(4) FFO is calculated by adding (i) net income before net gain on sale of
properties, (ii) depreciation and amortization, (iii) provision for
impairment losses and (iv) one-time Consolidation costs. Management
considers FFO to be an appropriate measure of the performance of an equity
REIT. FFO is used by financial analysts in evaluating REITs and can be one
measure of a REIT's ability to make cash distributions. Presentation of this
information will provide the reader with an additional measure to compare
the performance of different REITs; however, FFO is not comparable to "funds
from operations" reported by other REITs that do not define funds from
operations in accordance with the National Association of Real Estate
Investment Trusts ("NAREIT") definition. FFO is not necessarily indicative
of cash flow available to fund cash needs and should not be considered as an
alternative to net income as an indication of the Company's performance or
to cash flow from operating, investing and financing activities as a measure
of liquidity or ability to make cash distributions or pay debt service.

In March 1995, NAREIT issued a clarification of its definition of FFO. The
clarification provides that amortization of deferred financing costs should
no longer be added back to net income in arriving at FFO. Since the Company
includes amortization of deferred financing costs in interest expense, it
was not added back in computing the Company's FFO. The Company's FFO
presented herein therefore conforms with this clarification.

(5) For a definition of the terms "Debt," "Secured Debt" and "Total Assets," see
"Description of the Notes-- Additional Covenants of the Company."

(6) For 1996 and 1995, the Company's sole Secured Debt was a capitalized lease.
For 1992, 1993 and 1994, the Company did not have any Secured Debt.

(7) The Debt Service Coverage Ratio is defined as Consolidated Income Available
for Debt Service divided by the Annual Debt Service Charge. See "Description
of the Notes--Additional Covenants of the Company."

(8) Ratio of earnings to fixed charges is calculated by dividing earnings by
fixed charges. For this purpose, earnings consist of net income before
extraordinary items plus fixed charges (excluding interest costs
capitalized). Fixed charges are comprised of interest expense (including
interest costs capitalized) and the amortization of debt issuance costs. On
a pro forma basis, assuming that the Notes were issued and the proceeds
therefrom were applied to repay indebtedness of the Company on January 1,
1996, the ratio of earnings to fixed charges for the year ended December 31,
1996 would have been 4x.

S-20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

GENERAL

The Company was organized to operate as an equity REIT. The Company's
primary business objective is to generate a consistent and predictable level of
FFO per share and distributions to stockholders. Additionally, the Company
generally will seek to increase FFO per share and distributions to stockholders
through active portfolio management and the acquisition of additional
properties. The Company also seeks to lower the ratio of distributions to
stockholders as a percentage of FFO in order to allow internal cash flow to be
used to fund additional acquisitions and for other corporate purposes. The
Company's portfolio management focus includes: (i) contractual rent increases on
existing leases; (ii) rental increases at the termination of existing leases
when market conditions permit; and (iii) the active management of the Company's
property portfolio, including selective sales of properties. The Company
generally pursues the acquisition of additional properties under long-term, net
lease agreements with initial contractual base rent which, at the time of
acquisition and as a percentage of acquisition cost, is in excess of the
Company's estimated cost of capital.

The Company's common stock is listed on the NYSE under the symbol "O" and
commenced trading on October 18, 1994.

Realty Income was organized in the State of Delaware on September 9, 1993 to
facilitate the merger, which was effective on August 15, 1994, of 10 private and
15 public real estate limited partnerships (the "Partnerships") with and into
Realty Income.

Investors in the Partnerships who elected to invest in the equity of the
Company received a total of 19,503,080 shares of common stock. Certain investors
elected to receive Variable Rate Senior Notes due 2001 totaling $12.6 million.
These notes were redeemed, at par, by the Company on March 29, 1996.

The Consolidation was accounted for as a reorganization of affiliated
entities in a manner similar to a pooling-of-interests. Under this method, the
assets and liabilities of the Partnerships were carried over at their historical
book values and operations were recorded on a combined historical cost basis.
The pooling-of-interests method of accounting also requires the reporting of the
results of operations as though the entities had been combined as of the
beginning of the earliest period presented. Accordingly, the results of
operations for the year ended December 31, 1994 comprise those of the separate
entities combined from the beginning of the period through August 15, 1994 (the
date of the Consolidation) and those of the Company from August 16, 1994 through
December 31, 1994.

Prior to August 17, 1995, the Company's day-to-day affairs were managed by
R.I.C. Advisor, Inc. ("R.I.C. Advisor") which provided advice and assistance
regarding acquisitions of properties by the Company and performed the day-to-day
management of the Company's properties and business. On August 17, 1995, R.I.C.
Advisor was merged with and into Realty Income (the "Merger") and the advisory
agreement between Realty Income and R.I.C. Advisor was terminated. Realty Income
issued 990,704 shares of common stock as consideration for the outstanding
common stock of R.I.C. Advisor.

In July 1996, the Company expanded its board of directors to seven members.
The new directors are Richard J. VanDerhoff, President and Chief Operating
Officer of the Company, and Willard H. Smith Jr, formerly a Managing Director,
Equity Capital Markets Division, of Merrill Lynch & Co. from 1983 until his
retirement in August 1995.

In October 1996, the Company changed transfer agents from Chase Mellon
Shareholder Services to The Bank of New York.

S-21
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES

CASH RESERVES

Realty Income was organized for the purpose of operating as an equity REIT
which acquires and leases properties and distributes to stockholders, in the
form of monthly cash distributions, a substantial portion of its net cash flow
generated from lease revenue. The Company intends to retain an appropriate
amount of cash as working capital reserves. At December 31, 1996, the Company
had cash and cash equivalents totaling $1.6 million.

Management believes that the Company's cash and cash equivalents on hand,
cash provided from operating activities and borrowing capacity are sufficient to
meet its liquidity needs other than the repayment of debt for the foreseeable
future, except that (as described below) the Company will require additional
sources of capital to fund property acquisitions.

CAPITAL FUNDING

Realty Income has a $130 million three-year, revolving, unsecured Credit
Facility that expires in November 1999. The credit facility currently bears
interest at 1.25% over the London Interbank Offered Rate ("LIBOR") and offers
the Company other interest rate options. As of April 15, 1997, $36.3 million of
borrowing capacity was available to the Company under the Credit Facility. At
that time, the outstanding balance was $93.7 million. On March 29, 1996, this
credit facility was used to redeem the Variable Rate Senior Notes due 2001 at
par, and has been and is expected to be used to acquire additional retail
properties leased to national and regional retail chains under long term lease
agreements. Any additional borrowings will increase the Company's exposure to
interest rate risk.

Realty Income will seek to meet its long-term capital needs for the
acquisition of properties through the issuance of public or private debt or
equity. In August 1995, the Company filed a universal shelf registration
statement with the Commission covering up to $200 million in value of common
stock, preferred stock or debt securities. After giving effect to the Offering,
approximately $159.8 million of securities will have been issued under this
registration statement.

In the fourth quarter of 1995, the Company issued 2,540,000 shares of common
stock at a price of $19.625 per share under the shelf registration. The net
proceeds were primarily used to repay borrowings under the Credit Facility.
These borrowings were used to acquire properties in 1995.

During the fourth quarter of 1996, the Company received investment grade
corporate credit ratings for senior unsecured debt from Duff & Phelps Credit
Rating Company, Moody's Investors Services, Inc. and Standard and Poor's Rating
Group, of BBB, Baa3, and BBB-, respectively. These ratings are subject to change
based upon, among other things, the Company's results of operations and
financial condition.

PROPERTY ACQUISITIONS

During 1996, Realty Income purchased 62 New Properties in 22 states for
approximately $57.5 million (excluding the estimated unfunded development costs
of $1.8 million on properties under development) at March 31, 1997. These 62
properties will contain approximately 603,900 leasable square feet and are 100%
leased under net leases, with an average initial lease term of 11.7 years. The
weighted average annual unleveraged return on the cost of the 62 New Properties
(including the estimated unfunded development

S-22
<PAGE>
costs of properties under construction) is estimated to be 10.6%, computed as
estimated contractual net operating income (which in the case of a net leased
property is equal to the base rent or, in the case of properties under
construction, the estimated base rent under the lease) for the first year of
each lease divided by the total acquisition and estimated development costs.
Since it is possible that a tenant could default on the payment of contractual
rent, no assurance can be given that the actual return on the cost of the 62 New
Properties acquired in 1996 will not differ from the foregoing percentage.

Of the 62 New Properties acquired in 1996, 60 were occupied as of April 1,
1997 and the remaining two were pre-leased and under construction pursuant to
contracts under which the tenants have agreed to develop the properties (with
development costs funded by the Company) and to begin paying rent when the
premises open for business. All of the New Properties, including the properties
under development, are leased with initial terms of 7.8 to 20 years.

During 1996, the Company purchased a property which was adjacent to an
existing tenant for $102,000 and leased the property to that tenant. The Company
also invested $37,000 in existing properties, received equipment and other
assets valued at $58,000 as settlements for amounts receivable, and purchased
the outstanding Class A units in R.I.C. Trade Center, Ltd., Silverton Business
Center, Ltd. and Empire Business Center, Ltd. for an aggregate of $150,000.
After this purchase, Realty Income owned 100% of these partnerships, which were
then dissolved. These partnerships owned three mixed-use light industrial
business parks in San Diego, CA.

During the first quarter of 1997, the Company acquired 11 retail properties
in six states for $15.9 million (excluding the estimated unfunded development
costs totaling $1.6 million on five such properties under construction) and
selectively sold four properties, increasing the number of properties in its
portfolio to 747 properties. The 11 properties acquired will contain
approximately 236,200 leasable square feet and are 100% leased under net leases,
with an average initial lease term of 14.0 years. The weighted average annual
unleveraged return on the cost of the 11 properties (including the estimated
unfunded development costs of the five properties under development) is
estimated to be 10.2%, computed as estimated contractual net operating income
(calculated as described above) for the first year of each lease, divided by
total acquisition and estimated development costs. However, as described above,
no assurance can be given that the actual return on the cost of these 11
properties will not differ from the foregoing percentage. During the first
quarter of 1997, the Company also invested $2.0 million in nine development
properties acquired in 1996.

1996 ACQUISITION ACTIVITY

<TABLE>
<CAPTION>
INITIAL APPROXIMATE
LEASE TERM LEASABLE
TENANT INDUSTRY LOCATION (YEARS) SQUARE FEET
- ------------------------------- ---------------------- ---------------------------------- ----------- ------------
<S> <C> <C> <C> <C>
1ST QUARTER
Carver's....................... Restaurant Glendale, AZ 19.8 8,100
Econo Lube N' Tune............. Auto Service Chula Vista, CA 15.0 2,800
Broomfield, CO 15.0 2,800
Dallas, TX 15.0 2,700
Lewisville, TX 15.0 2,600
2ND QUARTER
Dairy Mart..................... Convenience Store Mt Washington, KY(1) 20.0 2,800
Tipp City, OH(1) 15.0 3,800
Econo Lube N' Tune............. Auto Service Arvada, CO 15.0 2,800
Jiffy Lube..................... Auto Service Centerville, OH 20.0 2,400
3RD QUARTER
Best Buy....................... Consumer Electronics Thousand Oaks, CA 20.0 59,200
Dairy Mart..................... Convenience Store Streetsboro, OH(1) 15.0 3,800
Wadsworth, OH(1) 15.0 2,700
Econo Lube N' Tune............. Auto Service Arvada, CO(1) 15.0 2,500
Virginia Beach, VA 15.0 2,800
</TABLE>

S-23
<PAGE>
<TABLE>
<CAPTION>
INITIAL APPROXIMATE
LEASE TERM LEASABLE
TENANT INDUSTRY LOCATION (YEARS) SQUARE FEET
- ------------------------------- ---------------------- ---------------------------------- ----------- ------------
<S> <C> <C> <C> <C>
Bremerton, WA 15.0 2,800
Jiffy Lube..................... Auto Service Beavercreek, OH(1) 20.0 2,300
Huber Heights, OH(1) 20.0 2,300
Speedy Brake & Muffler......... Auto Service Hartford, CT 15.0 10,000
Indianapolis, IN 15.0 5,300
Milwaukee, WI 15.0 5,300
4TH QUARTER
Best Buy....................... Consumer Electronics Topeka, KS 20.0 45,600
East Coast Oil................. Convenience Store Stafford, VA 15.0 2,800
Warrenton, VA 15.0 3,600
Econo Lube N' Tune............. Auto Service Thornton, CO 15.0 2,800
Olathe, KS(1) 15.0 2,800
Independence, MO 15.0 2,800
Richmond, VA 15.0 2,900
Jiffy Lube..................... Auto Service Hamilton, OH(1) 20.0 2,300
Rex Stores..................... Consumer Electronics Oxford, AL 7.8 10,000
Tuscaloosa, AL 7.8 12,000
Bradenton, FL 7.8 6,300
Mary Esther, FL 7.8 8,200
Melbourne, FL 7.8 8,000
Merritt Island, FL 7.8 10,000
Ocala, FL 7.8 10,000
Pensacola, FL 7.8 64,600
Tallahassee, FL 7.8 10,600
Titusville, FL 7.8 12,000
Venice, FL 7.8 8,200
Rome, GA 7.8 10,000
Council Bluffs, IA 7.8 9,000
Des Moines, IA 7.8 10,000
Peoria, IL 7.8 8,800
Rockford, IL 7.8 10,100
Springfield, IL 7.8 10,300
Anderson, IN 7.8 15,600
Muncie, IN 7.8 12,500
Richmond, IN 7.8 6,500
Columbus, MS 7.8 10,000
Greenville, MS 7.8 9,100
Gulfport, MS 7.8 12,000
Hattiesburg, MS 7.8 12,000
Jackson, MS 7.8 15,100
Meridian, MS 7.8 9,000
Tupelo, MS 7.8 12,000
Vicksburg, MS 7.8 10,000
Lakewood, NY 7.8 14,100
Defiance, OH 7.8 7,200
Kettering, OH 7.8 10,600
Bristol, TN 7.8 12,400
Clarksville, TN 7.8 10,100
Vienna, WV 7.8 12,200
--- ------------
Average/Total.......................................... 11.7 603,900
--- ------------
--- ------------
</TABLE>

- --------------------------
(1) The Company acquired these properties as undeveloped land and is funding
construction and other costs relating to the development of the properties
by the tenants. The tenants have entered into leases with the Company
covering these properties and are contractually obligated to complete
construction on a timely basis and to pay construction cost overruns to the
extent they exceed the construction budget by more than a predetermined
percentage. As of December 31, 1996, the total acquisition and estimated
construction costs for the properties under development was $8.7 million, of
which $3.8 million had not been funded. As of April 1, 1997, tenants of
seven of these properties had assumed occupancy and begun paying rent
because development of such properties was substantially completed.

S-24
<PAGE>
DISTRIBUTIONS

Cash distributions paid for the years ended December 31, 1996, 1995 and 1994
were $48.1 million, $36.7 million and $44.7 million, respectively. The 1996 and
1994 cash distributions include a special distribution of $5.3 million and $5.8
million, respectively.

For the year ended December 31, 1996, the Company paid 11 monthly
distributions of $0.155 per share and increased the monthly distributions to
$0.1575 per share in December 1996. The regular distributions paid during 1996
totaled $1.8625 per share. In addition, the Company paid a special distribution
of $0.23 per share in January 1996. Total distributions paid in 1996 were
$2.0925 per share. For tax purposes, a portion of the special distribution, in
the amount of approximately $0.144 per share, was taxable as ordinary income in
1995 and the remaining $0.086 per share was included in each stockholders 1996
Form 1099. In December 1996, and January and February 1997, the Company declared
distributions of $0.1575 per share which were paid on January 15, 1997, February
17, 1997 and March 17, 1997, respectively.

For the year ended December 31, 1995, the Company paid monthly distributions
of $0.15 per share from January through July and increased its monthly
distributions to $0.155 per share in August. Monthly distributions of $0.155 per
share were paid in August through December 1995. The distributions paid for 1995
totaled $1.825 per share.

The 1994 distributions were made up of eight partnership and four corporate
monthly distributions in the aggregate amount of $38.9 million and the final
partnership distribution of $5.8 million. The 1994 final partnership
distributions were substantially comprised of proceeds from the sales of
properties sold during 1993.

From August 15, 1994, the date of the Consolidation, through December 31,
1994, the Company paid four monthly distributions of $0.15 per share, totaling
$0.60 per share. Prior to the Consolidation on August 15, 1994, the Company did
not have equivalent shares outstanding so no comparative per share information
is presented.

OTHER INFORMATION

As a result of the Merger on August 17, 1995, the Company assumed a defined
benefit pension plan (the "Plan") covering substantially all of its employees.
The board of directors of R.I.C. Advisor froze the Plan effective May 31, 1995.
For each Plan participant, the accrued benefit earned under the Plan as of May
31, 1995 was frozen. The Plan was terminated on January 2, 1996. As part of the
Plan's termination, the Company met its obligation to the Plan of $2.3 million
in February 1997.

In December 1996, the Company obtained a five year environmental insurance
policy on the property portfolio. Based upon the 740 properties in the portfolio
at December 31, 1996, the cost of the insurance will be approximately $80,000
per year. The limit of the policy is $10.0 million for each loss and $20.0
million in the aggregate, with a $100,000 deductible. There is a sublimit on
properties with underground storage tanks of $1.0 million per occurrence and
$5.0 million in the aggregate, with a deductible of $25,000.

FUNDS FROM OPERATIONS

FFO for 1996 was $47.7 million versus $40.4 million during 1995 and $39.2
million during 1994. Realty Income defines FFO as net income before net gain on
sales of properties and the one-time expenses of the 1994 Consolidation, plus
provision for impairment losses, plus depreciation and amortization. In
accordance with the recommendations of the National Association of Real Estate
Investment Trusts ("NAREIT"), amortization of deferred financing costs are not
added back to net income to calculate FFO. Amortization of financing costs are
included in interest expense in the consolidated statements of income.

S-25
<PAGE>
Management considers FFO to be an appropriate measure of the performance of
an equity REIT. FFO is used by financial analysts in evaluating REITs and can be
one measure of a REIT's ability to make cash distribution payments. Presentation
of this information provides the reader with an additional measure to compare
the performance of different REITs, although it should be noted that not all
REITs calculate FFO the same way so comparisons with such REITs may not be
meaningful.

FFO is not necessarily indicative of cash flow available to fund cash needs
and should not be considered as an alternative to net income as an indication of
the Company's performance or to cash flow from operating, investing, and
financing activities as a measure of liquidity or ability to make cash
distributions or to pay debt service.

Below is reconciliation of net income to FFO (dollars in thousands):

<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Net Income................................................... $ 32,223 $ 25,600 $ 15,224
Plus Depreciation and Amortization........................... 16,422 14,849 13,790
Plus Provision for Impairment Losses......................... 579 -- 135
Plus Consolidation Costs..................................... -- -- 11,201
Less Depreciation of Furniture, Fixtures and Equipment....... (51) (17) --
Less Net Gain on Sales of Properties......................... (1,455) (18) (1,165)
--------- --------- ---------
Total FFO.................................................... $ 47,718 $ 40,414 $ 39,185
--------- --------- ---------
--------- --------- ---------
</TABLE>

For 1996, 1995 and 1994, FFO exceeded cash distributions, excluding the
non-recurring special distributions of $5.3 million in 1996 (pertaining to the
Merger) and $5.8 million in 1994 (final distribution for the predecessor
Partnerships), by $4.9 million, $3.7 million and $369,000, respectively.

RESULTS OF OPERATIONS

Prior to the Consolidation on August 15, 1994, the capital structure of the
Partnerships consisted of limited partner interests with no long term debt. In
the Consolidation, limited partners exchanged their partnership units for shares
of common stock or debt securities of the Company. The general partners did not
receive any shares of common stock or debt securities of the Company for their
general partner interests. Due to these changes in capital structure, which were
caused by the Consolidation, and additional expenses associated with the
operations of a publicly traded REIT, the results of operations for the year
ended December 31, 1994 are not necessarily comparable to 1996 and 1995.

COMPARISON OF 1996 TO 1995

Rental revenue was $56.8 million for 1996 versus $51.2 million for 1995, an
increase of $5.6 million. The increase in rental revenue was primarily due to
the acquisition of 124 properties from December 1994 through December 1996.
These properties generated revenue in 1996 and 1995 of $8.8 million and $3.8
million, respectively, an increase of $5.0 million. During 1997, the contractual
lease payments (not including any percentage rents or estimated rent from
properties under development) on these 124 properties are approximately $13.6
million.

At December 31, 1996, 723 or 98.8% of the Company's leases, on the 732
single-tenant properties, provide for increases in rents through (i) base rent
increases tied to a consumer price index with adjustment ceilings or (ii)
overage rent based on a percentage of the tenants' gross sales. Some leases
contain both types of clauses. Rental revenue generated on the 619 properties
owned for all of both 1995 and 1996 increased by $871,000 or 1.9%, to $48.0
million from $47.1 million. Percentage rent, which is included in rental
revenue, was $1.7 million for 1996 as compared to $1.6 million in 1995.

S-26
<PAGE>
The following table represents Realty Income's rental revenue by industry
for the years ended December 31, 1996 and 1995:

<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
---------------------------- ----------------------------
RENTAL PERCENTAGE OF RENTAL PERCENTAGE OF
INDUSTRY REVENUE TOTAL REVENUE TOTAL
- --------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Automotive Parts....................... $ 4,814,000 8.5% $ 4,724,000 9.2%
Automotive Service..................... 3,859,000 6.8% 3,007,000 5.9%
Child Care............................. 23,854,000 42.0% 23,358,000 45.6%
Consumer Electronics................... 507,000 0.9% -- --
Convenience Stores..................... 2,647,000 4.7% 1,254,000 2.4%
Home Furnishings....................... 2,496,000 4.4% 1,471,000 2.9%
Restaurant............................. 13,836,000 24.3% 12,632,000 24.7%
Other.................................. 4,764,000 8.4% 4,739,000 9.3%
------------- ----- ------------- -----
Total.................................. $ 56,777,000 100.0% $ 51,185,000 100.0%
------------- ----- ------------- -----
------------- ----- ------------- -----
</TABLE>

Unleased properties are a factor in determining gross revenue generated and
property costs incurred by the Company. At December 31, 1996, the Company had
nine properties that were not under lease as compared to four properties at
December 31, 1995. The remaining 731 properties were under lease agreements with
third party tenants as of December 31, 1996.

The significant portion of the remaining revenue earned during 1996 and 1995
was attributable to interest earned on cash invested in two funds which hold
short-term investments in United States government agency securities and
treasury securities. Interest revenue was $109,000 for 1996 as compared to
$276,000 during 1995. The decrease in interest revenue was due to lower average
cash balances held during 1996, which reflects the Company's desire to maintain
an appropriate amount of cash as working capital reserves and invest excess
available cash in properties.

Depreciation and amortization was $16.4 million in 1996 versus $14.8 million
in 1995. The $1.6 million increase was primarily due to the depreciation of
properties acquired during 1995 and 1996 and amortization of goodwill recorded
in connection with the Merger of R.I.C. Advisor.

Total advisor fees and general and administrative expenses decreased by $1.7
million to $5.2 million in 1996 versus $6.9 million in 1995. General and
administrative expenses were $5.2 million in 1996 versus $3.2 million in 1995
and advisor fees of $3.7 million in 1995. The $2.0 million increase in general
and administrative expenses was due primarily to the Merger of R.I.C. Advisor.
Subsequent to the Merger, the Company commenced paying for management,
accounting systems, office facilities and professional and support personnel
expenses (i.e., costs of being self-administered). Prior to August 17, 1995,
such costs were the responsibility of R.I.C. Advisor.

During the third quarter of 1996, the Company initiated a 401(k) plan. Costs
of $65,000 associated with the plan are included in general and administrative
expenses.

Property expenses were $1.6 million in 1996 and 1995. Property expenses are
broken down into costs associated with multi-tenant non-net lease properties,
unleased single-tenant properties and general portfolio expenses. Expenses
related to the multi-tenant and unleased single-tenant properties include, but
are not limited to, property taxes, maintenance, insurance, utilities, site
checks, bad debt expense and legal fees. General portfolio costs include, but
are not limited to, insurance, legal, site checks and title search fees.

Property expenses of $1.0 million were incurred on ten multi-tenant
properties during 1996, eight of which were owned at the end of 1996. Property
expenses of $1.0 million were incurred on eleven multi-tenant properties in
1995, ten of which were owned at the end of 1995. During 1996 two multi-tenant

S-27
<PAGE>
properties were sold and in 1995 one multi-tenant property was sold. Expenses
incurred in 1996 on ten unleased single-tenant properties totaled $250,000 as
compared to $161,000 in 1995 on seven unleased single-tenant properties. At
December 31, 1996, nine properties were available for lease, one of which was a
multi-tenant property. At December 31, 1995, four single-tenant properties were
available for lease. The $89,000 increase is due to property taxes, maintenance
and utilities on the additional vacant properties. General portfolio expenses in
1996 and 1995 totaled $337,000 and $441,000, respectively. The decrease in
general portfolio costs is primarily due to a decrease in insurance costs.

Interest expense is made up of four components which include: (i) interest
on outstanding loans and notes; (ii) commitment fees on the undrawn portion of
the Credit Facility; (iii) amortization of the Credit Facility origination
costs; which are offset by: (iv) interest capitalized on properties under
development. Interest capitalized on properties under development is included in
the cost of the completed property and amortized over the estimated useful life
of the property.

Interest expense decreased by $275,000 to $2.4 million in 1996 as compared
to $2.6 million for 1995. Interest incurred on loans and notes in 1996 and 1995
was $2.1 million and $2.4 million, respectively. Interest incurred was $266,000
lower in 1996 than in 1995 due to a decrease in the average outstanding balance
and lower interest rates on the Credit Facility and the notes that were redeemed
by the Company on March 29, 1996 (the "Redeemed Notes"). During 1996, the
average outstanding balance and interest rate were $30.7 million and 6.96% as
compared to $31.3 million and 7.68% during the comparable period in 1995.
Included in the interest incurred in 1996 and 1995 was capitalized interest
totaling $150,000 and $217,000, respectively. Commitment fees in 1996 were
$156,000 as compared to $127,000 in 1995. In 1996 and 1995, a commitment fee of
0.15% per annum was incurred on the undrawn portion of the Credit Facility.
Commitment fees increased in 1996 because the borrowing capacity was increased
to $130 million from $100 million in December 1995. Amortization of the Credit
Facility origination fees was $224,000 in 1996 as compared to $329,000 in 1995.
The amortized Credit Facility origination fees decreased in 1996 as compared to
1995, because in December 1995 the term of the Credit Facility was extended one
year, which extended the period of time over which unamortized fees are
amortized.

The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. In 1996, a $579,000 charge was taken to reduce the net carrying
value on four properties because they became held for sale. No charge was
recorded for an impairment loss in 1995.

The Company anticipates property sales will occur in the normal course of
business. During 1996, the Company recorded a gain of $1.5 million on the sale
of two multi-tenant properties, five restaurant properties and the granting of
an easement on another property. During 1995, the Company recorded a net gain of
$18,000 on the sale of two child care properties and a multi-tenant property.
During 1996 and 1995, cash proceeds generated from these sales were $4.4 million
and $617,000, respectively.

For 1996, the Company recorded net income of $32.2 million versus $25.6
million in 1995. The $6.6 million increase in net income is primarily due to an
increase in rental revenue from 124 properties acquired from December 1994
through December 1996 of $5.0 million, an increase in the net gain on sales of
properties of $1.4 million and a net decrease in advisor fees and general and
administrative expenses of $1.7 million, offset by an increase in depreciation
and amortization expense of $1.6 million.

COMPARISON OF 1995 TO 1994

Rental revenue was $51.2 million for 1995 versus $47.9 million for 1994, an
increase of $3.3 million. The increase in rental revenue was primarily due to
the acquisition of 62 properties from December 1994 through December 1995. These
properties generated revenue of $3.8 million in 1995. This increase in rental
revenue was offset in part by a decline in revenue from properties owned during
both 1995 and 1994 that was primarily attributable to a decline in percentage
rents. Percentage rent was $1.6 million for 1995 as compared to $2.6 million in
1994.

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<PAGE>
The following table represents Realty Income's rental revenue by industry
for the years ended December 31, 1995 and 1994:

<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
---------------------------- ----------------------------
RENTAL PERCENTAGE OF RENTAL PERCENTAGE OF
INDUSTRY REVENUE TOTAL REVENUE TOTAL
- --------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Automotive Parts....................... $ 4,724,000 9.2% $ 4,977,000 10.4%
Automotive Service..................... 3,007,000 5.9% 2,705,000 5.7%
Child Care............................. 23,358,000 45.6% 23,522,000 49.1%
Convenience Stores..................... 1,254,000 2.4% -- --
Home Furnishings....................... 1,471,000 2.9% -- --
Restaurant............................. 12,632,000 24.7% 12,047,000 25.1%
Other.................................. 4,739,000 9.3% 4,654,000 9.7%
------------- ----- ------------- -----
Total.................................. $ 51,185,000 100.0% $ 47,905,000 100.0%
------------- ----- ------------- -----
------------- ----- ------------- -----
</TABLE>

Unleased properties are a factor in determining gross revenue generated and
property costs incurred by the Company. At December 31, 1995 and 1994, the
Company had four properties that were not under lease, while the remaining 681
and 626 properties, respectively, were under lease agreements with third party
tenants.

The significant portion of the remaining revenue earned during 1995 and 1994
was attributable to interest earned on cash invested in two funds which hold
short-term investments in United States government agency securities or direct
purchases of short-term United States government agency securities. Interest
revenue was $276,000 for 1995 as compared to $862,000 during 1994. The decrease
in interest revenue was due to a reduction of cash held, which was primarily
invested in properties.

Depreciation and amortization was $14.8 million in 1995 versus $13.8 million
in 1994. The $1.0 million increase was primarily due to the depreciation of 62
properties acquired from December 1994 through December 31, 1995 and
amortization of goodwill recorded in connection with the Merger of R.I.C.
Advisor.

Total advisor fees and general and administrative expenses decreased by
$312,000 to $6.9 million in 1995 versus $7.2 million in 1994. General and
administrative expenses were $3.2 million in 1995 versus $1.8 million in 1994.
R.I.C. Advisor fees were $3.7 million in 1995 versus $5.4 million in 1994. The
$1.4 million increase in general and administrative expenses and $1.7 million
decrease in advisor fees was due to the Merger of R.I.C. Advisor. Subsequent to
the Merger, the Company commenced paying for management, accounting systems,
office facilities, and professional and support personnel expenses (i.e., costs
of being self-administered). Such costs were the responsibility of R.I.C.
Advisor through August 17, 1995.

The advisor fees for 1995 were calculated in accordance with the terms of
the advisory agreement which became effective August 15, 1994 and was terminated
on August 17, 1995. Prior to August 16, 1994, advisor fees were calculated in
accordance with the terms of the partnership agreements of the Partnerships.

Administrative expense in 1994 included approximately $500,000 of one-time
expenses primarily associated with the distribution of stock certificates,
shareholder informational material and final partnership K-1's to shareholders
after the Consolidation had occurred. Other administrative expenses increased in
1995 compared to 1994 due to additional expenses associated with the operation
of a publicly traded REIT including, but not limited to, transfer agent fees,
NYSE fees, board of directors fees and property acquisition expenses.

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<PAGE>
Property expenses decreased to $1.6 million in 1995 as compared to $2.1
million in 1994. The $488,000 decrease was primarily due to a decrease in
property taxes, maintenance and utilities.

Interest expense for 1995 was $2.6 million as compared to $396,000 for 1994.
Of the $2.2 million increase, $1.4 million was for interest paid on the Credit
Facility in 1995 and $665,000 for interest paid on the Redeemed Notes. Interest
incurred on loans and notes in 1995 and 1994 was $2.4 million and $354,000,
respectively. Interest incurred was higher in 1995 due to borrowings on the
Credit Facility and the Redeemed Notes issued as part of the Consolidation.
During 1995, the average outstanding balances and interest rates on the Credit
Facility and the Redeemed Notes were $31.3 million and 7.68%. Included in the
interest incurred in 1995 was capitalized interest totaling $217,000. No
interest was capitalized in 1994. Commitment fees in 1995 were $127,000 as
compared to $13,000 in 1994. In 1995 and 1994, a commitment fee of 0.15% per
annum was incurred on the undrawn portion of the Credit Facility. Amortization
of the Credit Facility origination fees was $329,000 in 1995 as compared to
$29,000 in 1994. Commitment fees and amortization of Credit Facility origination
fees increased in 1995 because the Credit Facility was not entered into until
November 1994.

The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. In 1994, a $135,000 charge was taken to reduce the net carrying
value on one property because it became held for sale. No charge was recorded
for an impairment loss in 1995.

In 1994, the Company expensed Consolidation costs aggregating $11.2 million
which were nonrecurring costs incurred to effect the Consolidation. In a manner
similar to the pooling-of-interests method of accounting, the Consolidation
costs were charged to expense upon the consummation of the Consolidation. Such
costs included, but were not limited to, fees paid to underwriters, appraisers,
attorneys, and accountants, as well as costs associated with obtaining a
fairness opinion, soliciting the limited partners, and registering and listing
the common stock and the Redeemed Notes on the NYSE.

During 1995, the Company recorded a net gain of $18,000 on the sale of two
child care properties and a multi-tenant property. During 1994, the Company
recorded a gain of $1.2 million on the sale of five restaurant properties.
During 1995 and 1994 cash proceeds generated from these sales were $617,000 and
$3.8 million, respectively.

For 1995, the Company recorded net income of $25.6 million versus $15.2
million in 1994. The net income in 1994 was negatively impacted by one time
Consolidation costs of $11.2 million. Net income for 1994, excluding the
Consolidation costs, was $26.4 million.

IMPACT OF INFLATION

Tenant leases generally provide for increases in rent as a result of
increases in the tenant's sales volumes or increases (typically subject to
ceilings) in the consumer price index. Management expects that inflation will
cause these lease provisions to result in increases in rent over time. However,
inflation and increased costs may have an adverse impact on the tenants if
increases in the tenant's operating expenses exceed increases in revenue. At
December 31, 1996, approximately 98% of the properties are leased to tenants
under net leases in which the tenant is responsible for substantially all
property costs and expenses. These features in the leases reduce the Company's
exposure to rising expenses due to inflation.

S-30
<PAGE>
MANAGEMENT OF THE COMPANY

The following table sets forth the executive officers and members of the
Board of Directors of Realty Income:

<TABLE>
<CAPTION>
NAME TITLE AGE
- ------------------------------- ------------------------------------------------------ ---
<S> <C> <C>
William E. Clark............... Chairman of the Board and Chief Executive Officer;
Director 59

Richard J. VanDerhoff.......... President and Chief Operating Officer; Director 43

Thomas A. Lewis................ Vice Chairman of the Board and Vice President Capital
Markets; Director 44

John W. Wolfe.................. Vice President, Portfolio Acquisitions 48

Gary M. Malino................. Vice President, Chief Financial Officer and Treasurer 39

Michael R. Pfeiffer............ Vice President, General Counsel and Secretary 36

Richard G. Collins............. Vice President, Portfolio Management 49

Donald R. Cameron.............. Director 57

Roger P. Kuppinger............. Director 56

Michael D. McKee............... Director 51

Willard H. Smith Jr............ Director 60
</TABLE>

Set forth below is a summary of the business experience of the above-listed
persons.

WILLIAM E. CLARK has been the Chairman of the Board of Directors and Chief
Executive Officer and a Director of the Company since September 1993 and has
been involved as a principal in commercial real estate acquisition, development,
management and sales for over 30 years. His involvement includes land
acquisition, tenant lease negotiations, construction and sales of prime
commercial properties for regional and national fast-food restaurant, automotive
and retail chain store operations throughout the United States. He had been a
director and an officer of R.I.C. Advisor since 1969 until it was merged with
the Company on August 17, 1995 (the "Merger").

RICHARD J. VANDERHOFF has been President and Chief Operating Officer of
Realty Income since November 1994 and a Director of the Company since July 1996
and had been with R.I.C. Advisor from 1987 until the Merger. From August 1994 to
November 1994, he served as general counsel of the Company. Prior to 1987, he
was employed as Vice President, General Counsel and Secretary of FNCO
Corporation, an owner and operator of community newspaper companies located
throughout the midwest United States (1984-1987) and was in private law practice
specializing in real property and business law (1980-1984). He graduated from
Jacksonville University, B.S., and the University of San Diego School of Law,
J.D.

THOMAS A. LEWIS has been the Vice Chairman of the Board of Directors, Vice
President, Capital Markets and a Director of the Company since September 1993
and had been with R.I.C. Advisor from 1987 until the Merger. Prior to joining
R.I.C. Advisor, he served in various capacities, including Senior Vice President
with Johnstown Capital, a real estate management and syndication company
(1982-1987), and Investment Specialist with Sutro & Co., a member of the New
York Stock Exchange (1979-1982), and was employed by the Procter & Gamble
Company (1974-1979). He graduated from Chaminade University of Hawaii, B.A., and
holds NASD General Securities (Series 7) and Registered Principal (Series 24)
licenses.

JOHN H. WOLFE has been Vice President, Portfolio Acquisitions of the Company
since August 1995 and had been with R.I.C. Advisor from 1983 until the Merger.
He has announced his retirement from the

S-31
<PAGE>
Company, to be effective in June 1997. Prior to joining R.I.C. Advisor, he was
the Director of Development for Black Angus Restaurants (1978-1983) and owned
and operated a real estate investment company (1975-1978). He graduated from San
Diego State University, B.S.

GARY M. MALINO has been Chief Financial Officer of the Company since August
1994 and the Vice President, Chief Financial Officer and Treasurer of the
Company since August 1995 and had been with R.I.C. Advisor from 1985 until the
Merger. Prior to joining R.I.C. Advisor in 1985, he was a Certified Public
Accountant with Kendall & Forman, an accountancy corporation (1981-1985) and
Assistant Controller with McMillin Development Company, a real estate
development company (1979-1981). He graduated from San Diego State University,
B.S.

MICHAEL R. PFEIFFER has been Vice President, General Counsel and Secretary
of the Company since August 1995 and had been with R.I.C. Advisor from 1990
until the Merger. Prior to joining R.I.C. Advisor he was in private practice
specializing in real estate transactional law (1987-1990), and was employed as
Associate Counsel with First American Title Insurance Company (1986-1987). He
graduated from the University of Rhode Island, B.S., and the University of San
Diego School of Law, J.D. He is a licensed attorney and member of the State Bar
of California and the State Bar of Florida.

RICHARD G. COLLINS has been Vice President, Portfolio Management of the
Company since August 1995 and had been with R.I.C. Advisor from 1990 until the
Merger. The Company plans to appoint him Vice President, Portfolio Acquisitions
in connection with Mr. Wolfe's retirement from this position. Prior to joining
R.I.C. Advisor, he was involved as a principal in the acquisition and sale of
land and commercial real estate and a general partner for land and commercial
real estate partnerships (1979-1990) and a leasing and sales specialist in the
Office Properties Division for Grubb & Ellis Commercial Real Estate Services
(1974-1979). He graduated from San Diego State University, B.S.

DONALD R. CAMERON has been a Director of the Company since August 1994 and
is a co-founder and President of Cameron, Murphy & Spangler, Inc., a securities
broker-dealer firm located in Pasadena, California. He graduated from the
University of Glasgow, Scotland, B.Sc. Prior to founding Cameron, Murphy &
Spangler in 1975, he worked at the securities brokerage firm of Glore Forgan
Staats, Inc. and its successors (1969-1975). He is currently a director of Ayr
United Football and Athletic Club, Ltd. Mr. Cameron is chairman of the
Compensation Committee and is a member of the Audit Committee, the Special
Committee and the Corporate Governance Committee.

ROGER P. KUPPINGER has been a Director of the Company since August 1994 and
is a self-employed investment banker and financial advisor and is an active
investor in both private and public companies. Prior to March 1994, he was a
Managing Director at the investment banking firm Sutro & Co. Inc. He graduated
from Northwestern University, B.S. and M.B.A., and from LaSalle University in
Chicago, LL.B. Prior to joining Sutro in 1969, he worked at First Interstate
Bank, formerly named United California Bank (1964-1969). He has served on over
ten boards of directors for both public and private companies, and currently
serves on the board of directors of BRE Properties, Inc. Mr. Kuppinger is
chairman of the Audit Committee and is a member of the Compensation Committee,
the Special Committee and the Corporate Governance Committee.

MICHAEL D. MCKEE has been a Director of the Company since August 1994 and
has been Executive Vice President of The Irvine Company since March 1994 and has
served as Chief Financial Officer of The Irvine Company since January 1997.
Prior thereto, he was a partner in the law firm of Latham & Watkins. He
graduated from Azusa Pacific University, B.A., University of Southern
California, M.A., and University of California at Los Angeles, J.D. His business
and legal experience includes numerous acquisition and disposition transactions,
as well as a variety of public and private offerings of equity and debt
securities. He is currently a member of the board of directors of Health Care
Property Investors, Inc., Circus Circus Enterprises, Inc. and Irvine Apartment
Communities, Inc. Mr. McKee is chairman of the Special Committee and is a member
of the Compensation Committee, the Audit Committee and the Corporate Governance
Committee.

S-32
<PAGE>
WILLARD H. SMITH JR has been a Director of the Company since July 1996 and
was the Managing Director, Equity Capital Markets Division, of Merrill Lynch &
Co. from 1983 until his recent retirement. Prior to joining Merrill Lynch in
1979, he was employed by F. Eberstadt & Co. (1971-1979). Mr. Smith also serves
on the board of directors of four investment companies: Cohen & Steers Realty
Shares; Cohen & Steers Realty Income Fund; Cohen & Steers Total Return Realty
Fund; and Cohen & Steers Special Equity Fund, Inc. Additionally, he is a member
of the board of directors of Essex Property Trust and Highwoods Property Trust,
two NYSE listed real estate investment trusts, and Willis Lease Finance
Corporation, a Nasdaq listed company. Mr. Smith is chairman of the Corporate
Governance Committee and is a member of the Audit Committee, the Special
Committee and the Compensation Committee.

DESCRIPTION OF THE NOTES

The following description of the particular terms of the Notes offered
hereby supplements and, to the extent inconsistent therewith, replaces the
description of the general terms and provisions of the Debt Securities set forth
in the accompanying Prospectus. The following statements relating to the Notes
and the Indenture (as defined below) are summaries of provisions contained
therein and do not purport to be complete. Such statements are qualified by
reference to the provisions of the Notes and the Indenture, including the
definitions therein of certain terms. Unless otherwise expressly stated or the
context otherwise requires, all references to the "Company" appearing under this
caption "Description of the Notes" and under the caption "Description of Debt
Securities" in the accompanying Prospectus shall mean Realty Income Corporation
excluding its consolidated subsidiaries. Other capitalized terms used herein but
not otherwise defined shall have the meanings given to them in the accompanying
Prospectus.

The Notes constitute Debt Securities (which are more fully described in the
accompanying Prospectus), to be issued pursuant to an indenture (the
"Indenture") between the Company and The Bank of New York, as trustee (the
"Trustee"). The terms of the Notes include those provisions contained in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "TIA"). The Notes are subject to all such
terms, and investors are referred to the Indenture and the TIA for a statement
thereof.

GENERAL

The Notes will be a separate series of Debt Securities under the Indenture,
limited in aggregate principal amount to $110 million. Such series may not be
reopened for the issuance of additional Debt Securities of such series. The
Notes will be direct, senior unsecured obligations of the Company and will rank
equally with all other senior unsecured indebtedness of the Company from time to
time outstanding. The Notes will be effectively subordinated to all indebtedness
and other liabilities (including guarantees) of the Company's subsidiaries and
will also be effectively subordinated to any senior secured indebtedness of the
Company to the extent of any collateral pledged as security therefor. As of
March 31, 1997, such subsidiary indebtedness (not including guarantees of
borrowings under the Credit Facility) and other liabilities (primarily rents
received in advance) aggregated approximately $331,000 and the Company
(excluding its subsidiaries) had unsecured senior indebtedness aggregating
approximately $94.7 million (approximately $6.5 million (excluding the Notes) on
a pro forma basis after giving effect to this Offering and the application of
the net proceeds therefrom) and senior secured indebtedness aggregating
approximately $869,000. See "Use of Proceeds" and "Capitalization." Subject to
certain limitations set forth in the Indenture and as described below under
"--Additional Covenants of the Company," the Indenture will permit the Company
and its subsidiaries to incur additional secured and unsecured indebtedness.

The Notes will be issued only in fully registered form without coupons, in
denominations of $1,000 and integral multiples thereof. The Notes will be
evidenced by a global Note (the "Global Note") in book-entry form, except under
the limited circumstances described below under "--Book Entry System." Notices
or demands to or upon the Company in respect of the Notes and the Indenture may
be served and, in the event that Notes are issued in definitive certificated
form, Notes may be surrendered for payment,

S-33
<PAGE>
registration of transfer or exchange, at the office or agency of the Company
maintained for such purpose in the Borough of Manhattan, The City of New York,
which shall initially be the corporate trust office of the Trustee, which on the
date of this Prospectus Supplement is located at Attention: Corporate Trust
Administration, 101 Barclay Street, 21st Floor, New York, New York 10286.

Reference is made to the section titled "Description of Debt
Securities--Certain Covenants" in the accompanying Prospectus and "--Additional
Covenants of the Company" below for a description of certain covenants
applicable to the Notes. Compliance with such covenants generally may not be
waived unless the holders of a majority in principal amount of the outstanding
Notes consent to such waiver. In addition, the defeasance and covenant
defeasance provisions of the Indenture described under "Description of Debt
Securities--Discharge, Defeasance and Covenant Defeasance" in the accompanying
Prospectus will apply to the Notes; such covenant defeasance will be applicable
with respect to the covenants described in the accompanying Prospectus under
"Description of Debt Securities--Certain Covenants" (except the covenant
requiring the Company to preserve and keep in full force and effect its
corporate existence) and the covenants described below under "--Additional
Covenants of the Company".

Except as described under "Description of Debt Securities--Merger,
Consolidation or Sale of Assets" in the accompanying Prospectus or "--Additional
Covenants of the Company" below, the Indenture does not contain any provisions
that would afford holders of the Notes protection in the event of (i) a highly
leveraged or similar transaction involving the Company, (ii) a change of control
or the management of the Company, or (iii) a reorganization, restructuring,
merger or similar transaction involving the Company that may adversely affect
the holders of the Notes. In addition, subject to the limitations set forth
under "Description of Debt Securities--Merger, Consolidation or Sale of Assets"
in the accompanying Prospectus, the Company may, in the future, enter into
certain transactions such as the sale of all or substantially all of its assets
or the merger or consolidation of the Company with another entity that would
increase the amount of the Company's indebtedness or substantially reduce or
eliminate the Company's assets, which may have an adverse affect on the
Company's ability to service its indebtedness, including the Notes.

The Company has no present intention of engaging in a highly leveraged or
similar transaction involving the Company. In addition, certain restrictions on
ownership and transfers of the Company's capital stock designed to preserve its
status as a REIT may act to prevent or hinder any such transaction or change of
control.

INTEREST AND MATURITY

The Notes will mature on May 6, 2007 (the "Maturity Date"). The Notes are
not subject to any sinking fund provisions. The Notes are subject to redemption
at the Company's option and are not subject to repayment or repurchase by the
Company at the option of the Holders (as defined below). See
"--Optional Redemption."

The Notes will bear interest at the rate per annum set forth on the cover
page of this Prospectus Supplement from the date of issuance or from the
immediately preceding Interest Payment Date (as defined below) to which interest
has been paid, payable semi-annually in arrears on each May 6 and November 6
(the "Interest Payment Dates"), commencing November 6, 1997, to the persons (the
"Holders") in whose names the Notes are registered in the security register
applicable to the Notes at the close of business on the April 21 or October 22
(the "Regular Record Dates"), as the case may be, immediately prior to such
Interest Payment Dates regardless of whether such Regular Record Date is a
Business Day. Interest on the Notes will be computed on the basis of a 360-day
year of twelve 30-day months.

If any Interest Payment Date, the Maturity Date, any date fixed for
redemption or any other day on which the principal of, premium, if any, or
interest on a Note becomes due and payable falls on a day that is not a Business
Day, the required payment shall be made on the next Business Day as if it were
made on

S-34
<PAGE>
the date such payment was due and no interest shall accrue on the amount so
payable for the period from and after such Interest Payment Date, Maturity Date,
redemption date or other date, as the case may be.

ADDITIONAL COVENANTS OF THE COMPANY

Reference is made to the section titled "Description of Debt Securities" in
the accompanying Prospectus for a description of certain covenants applicable to
the Notes. In addition to the foregoing, the following covenants of the Company
will apply to the Notes for the benefit of the Holders of the Notes:

LIMITATION ON INCURRENCE OF TOTAL DEBT. The Company will not, and will not
permit any Subsidiary to, incur any Debt, other than Intercompany Debt if,
immediately after giving effect to the incurrence of such additional Debt and
the application of the proceeds therefrom on a pro forma basis, the aggregate
principal amount of all outstanding Debt of the Company and its Subsidiaries on
a consolidated basis determined in accordance with GAAP is greater than 60% of
the sum of (i) the Company's Total Assets as of the end of the latest fiscal
quarter covered in the Company's Annual Report on Form 10-K or Quarterly Report
on Form 10-Q, as the case may be, most recently filed with the Commission (or,
if such filing is not required under the Exchange Act, with the Trustee) prior
to the incurrence of such additional Debt and (ii) the increase, if any, in
Total Assets from the end of such quarter including, without limitation, any
increase in Total Assets caused by the application of the proceeds of such
additional Debt (such increase together with the Company's Total Assets is
referred to as the "Adjusted Total Assets").

LIMITATION ON INCURRENCE OF SECURED DEBT. The Company will not, and will
not permit any Subsidiary to, incur any Secured Debt other than Intercompany
Debt if, immediately after giving effect to the incurrence of such additional
Secured Debt and the application of the proceeds therefrom on a pro forma basis,
the aggregate principal amount of all outstanding Secured Debt of the Company
and its Subsidiaries on a consolidated basis determined in accordance with GAAP
is greater than 40% of the Company's Adjusted Total Assets.

DEBT SERVICE COVERAGE. The Company will not, and will not permit any
Subsidiary to, incur any Debt, other than Intercompany Debt, if the ratio of
Consolidated Income Available for Debt Service to the Annual Debt Service Charge
for the period consisting of the four consecutive fiscal quarters most recently
ended prior to the date on which such additional Debt is to be incurred is less
than 1.5 to 1.0, on a pro forma basis after giving effect to the incurrence of
such Debt and the application of the proceeds therefrom, and calculated on the
assumption that (i) such Debt and any other Debt incurred by the Company or any
of its Subsidiaries since the first day of such four-quarter period and the
application of the proceeds therefrom (including to refinance other Debt since
the first day of such four-quarter period) had occurred on the first day of such
period, (ii) the repayment or retirement of any other Debt of the Company or any
of its Subsidiaries since the first day of such four-quarter period had occurred
on the first day of such period (except that, in making such computation, the
amount of Debt under any revolving credit facility, line of credit or similar
facility shall be computed based upon the average daily balance of such Debt
during such period), and (iii) in the case of any acquisition or disposition by
the Company or any Subsidiary of any asset or group of assets since the first
day of such four-quarter period, including, without limitation, by merger, stock
purchase or sale, or asset purchase or sale, such acquisition or disposition had
occurred on the first day of such period with the appropriate adjustments with
respect to such acquisition or disposition being included in such pro forma
calculation. If the Debt giving rise to the need to make the foregoing
calculation or any other Debt incurred after the first day of the relevant
four-quarter period bears interest at a floating rate then, for purposes of
calculating the Annual Debt Service Charge, the interest rate on such Debt shall
be computed on a pro forma basis as if the average interest rate which would
have been in effect during the entire such four-quarter period had been the
applicable rate for the entire such period.

S-35
<PAGE>
MAINTENANCE OF TOTAL UNENCUMBERED ASSETS. The Company will maintain at all
times Total Unencumbered Assets of not less than 150% of the aggregate
outstanding principal amount of the Unsecured Debt of the Company and its
Subsidiaries, computed on a consolidated basis in accordance with GAAP.

As used herein:

"ANNUAL DEBT SERVICE CHARGE" as of any date means the amount which is
expensed in any 12-month period for interest on Debt of the Company and its
Subsidiaries.

"CONSOLIDATED INCOME AVAILABLE FOR DEBT SERVICE" for any period means
Consolidated Net Income plus, without duplication, amounts which have been
deducted in determining Consolidated Net Income during such period for (i)
Consolidated Interest Expense, (ii) provision for taxes of the Company and its
Subsidiaries based on income, (iii) amortization (other than amortization of
debt discount) and depreciation, (iv) provisions for losses from sales or joint
ventures, (v) provision for impairment losses, (vi) increases in deferred taxes
and other non-cash charges, (vii) charges resulting from a change in accounting
principles, and (viii) charges for early extinguishment of debt, and less,
without duplication, amounts which have been added in determining Consolidated
Net Income during such period for (a) provisions for gains from sales or joint
ventures, and (b) decreases in deferred taxes and other non-cash items.

"CONSOLIDATED INTEREST EXPENSE" for any period, and without duplication,
means all interest (including the interest component of rentals on capitalized
leases, letter of credit fees, commitment fees and other like financial charges)
and all amortization of debt discount on all Debt (including, without
limitation, payment-in-kind, zero coupon and other like securities) but
excluding legal fees, title insurance charges, other out-of-pocket fees and
expenses incurred in connection with the issuance of Debt and the amortization
of any such debt issuance costs that are capitalized, all determined for the
Company and its Subsidiaries on a consolidated basis in accordance with GAAP.

"CONSOLIDATED NET INCOME" for any period means the amount of consolidated
net income (or loss) of the Company and its Subsidiaries for such period
determined on a consolidated basis in accordance with GAAP.

"DEBT" means any indebtedness of the Company or any Subsidiary, whether or
not contingent, in respect of (i) money borrowed or evidenced by bonds, notes,
debentures or similar instruments, (ii) indebtedness secured by any mortgage,
pledge, lien, charge, encumbrance, trust deed, deed of trust, deed to secure
debt, security agreement or any security interest existing on property owned by
the Company or any Subsidiary, (iii) letters of credit or amounts representing
the balance deferred and unpaid of the purchase price of any property except any
such balance that constitutes an accrued expense or trade payable or (iv) any
lease of property by the Company or any Subsidiary as lessee that is reflected
on the Company's consolidated balance sheet as a capitalized lease in accordance
with GAAP, in the case of items of indebtedness under (i) through (iii) above to
the extent that any such items (other than letters of credit) would appear as
liabilities on the Company's consolidated balance sheet in accordance with GAAP,
and also includes, to the extent not otherwise included, any obligation of the
Company or any Subsidiary to be liable for, or to pay, as obligor, guarantor or
otherwise (other than for purposes of collection in the ordinary course of
business), indebtedness of another person (other than the Company or any
Subsidiary) of the type referred to in (i), (ii), (iii) or (iv) above (it being
understood that Debt shall be deemed to be incurred by the Company or any
Subsidiary whenever the Company or such Subsidiary shall create, assume,
guarantee or otherwise become liable in respect thereof).

"EXECUTIVE GROUP" means, collectively, those individuals holding the offices
of Chairman, President, Chief Executive Officer, Chief Operating Officer, or any
Vice President of the Company.

"GAAP" means generally accepted accounting principles, as in effect from
time to time, as used in the United States applied on a consistent basis.

S-36
<PAGE>
"INTERCOMPANY DEBT" means indebtedness owed by the Company or any Subsidiary
solely to the Company or any Subsidiary.

"SECURED DEBT" means Debt secured by any mortgage, lien, charge,
encumbrance, trust deed, deed of trust, deed to secure debt, security agreement,
pledge, conditional sale or other title retention agreement, capitalized lease,
or other security interest or agreement granting or conveying security title to
or a security interest in real property or other tangible assets.

"SUBSIDIARY" means (i) any corporation, partnership, joint venture, limited
liability company or other entity the majority of the shares, if any, of the
non-voting capital stock or other equivalent ownership interests of which
(except directors' qualifying shares) are at the time directly or indirectly
owned by the Company, and the majority of the shares of the voting capital stock
or other equivalent ownership interests of which (except for directors'
qualifying shares) are at the time directly or indirectly owned by the Company,
any other Subsidiary or Subsidiaries, and/or one or more individuals of the
Executive Group (or, in the event of death or disability of any of such
individuals, his/her respective legal representative(s), or such individuals'
successors in office as an officer of the Company), and (ii) any other entity
the accounts of which are consolidated with the accounts of the Company. The
foregoing definition of "Subsidiary" shall only be applicable with respect to
the covenants and other definition set forth herein under "-- Additional
Covenants of the Company" and, insofar as the provisions described in the
accompanying Prospectus under "Description of Debt Securities--Merger,
Consolidation or Sale of Assets" apply to the Notes, the foregoing definition of
Subsidiary shall be applicable instead of the definition of "Subsidiary" set
forth in the accompanying Prospectus.

"TOTAL ASSETS" as of any date means the sum of (i) Undepreciated Real Estate
Assets and (ii) all other assets of the Company and its Subsidiaries determined
on a consolidated basis in accordance with GAAP (but excluding accounts
receivable and intangibles).

"TOTAL UNENCUMBERED ASSETS" as of any date means Total Assets minus the
value of any properties of the Company and its Subsidiaries that are encumbered
by any mortgage, charge, pledge, lien, security interest, trust deed, deed of
trust, deed to secure debt, security agreement, or other encumbrance of any kind
(other than those relating to Intercompany Debt), including the value of any
stock of any Subsidiary that is so encumbered determined on a consolidated basis
in accordance with GAAP. For purposes of this definition, the value of each
property shall be equal to the purchase price or cost of each such property and
the value of any stock subject to any encumbrance shall be determined by
reference to the value of the properties owned by the issuer of such stock as
aforesaid.

"UNDEPRECIATED REAL ESTATE ASSETS" as of any date means the amount of real
estate assets of the Company and its Subsidiaries on such date, before
depreciation and amortization, determined on a consolidated basis in accordance
with GAAP.

"UNSECURED DEBT" means Debt of the Company or any Subsidiary that is not
Secured Debt.

OPTIONAL REDEMPTION

The Notes may be redeemed at any time at the option of the Company, in whole
or from time to time in part, at a redemption price equal to the sum of (i) the
principal amount of the Notes being redeemed plus accrued interest thereon to
the redemption date and (ii) the Make-Whole Amount (as defined below), if any,
with respect to such Notes (the "Redemption Price"); provided that installments
of interest on Notes which are payable on Interest Payment Dates falling on or
prior to the relevant redemption dates shall be payable to the Holders of such
Notes (or one or more predecessor Notes) registered as such at the close of
business on the relevant Regular Record Dates.

If notice has been given as provided in the Indenture and funds for the
redemption of any Notes called for redemption shall have been made available on
the redemption date referred to in such notice,

S-37
<PAGE>
such Notes will cease to bear interest on the date fixed for such redemption
specified in such notice and the only right of the Holders of the Notes will be
to receive payment of the Redemption Price.

Notice of any optional redemption of any Notes will be given to Holders at
their addresses, as shown in the security register for the Notes, not more than
60 nor less than 30 days prior to the date fixed for redemption. The notice of
redemption will specify, among other items, the Redemption Price and the
principal amount of the Notes held by such Holder to be redeemed.

If less than all the Notes are to be redeemed at the option of the Company,
the Company will notify the Trustee at least 45 days prior to giving notice of
redemption (or such shorter notice period as is satisfactory to the Trustee) of
the aggregate principal amount of Notes to be redeemed and their redemption
date. The Trustee shall select, in such manner as it shall deem fair and
appropriate, Notes to be redeemed in whole or in part.

As used herein:

"MAKE-WHOLE AMOUNT" means, in connection with any optional redemption of any
Notes, the excess, if any, of (i) the aggregate present value as of the date of
such redemption of each dollar of principal being redeemed and the amount of
interest (exclusive of interest accrued to the date of redemption) that would
have been payable in respect of each such dollar if such redemption had not been
made, determined by discounting, on a semi-annual basis, such principal and
interest at the Reinvestment Rate (determined on the third Business Day
preceding the date such notice of redemption is given) from the respective dates
on which such principal and interest would have been payable if such redemption
had not been made to the date of redemption over (ii) the aggregate principal
amount of the Notes being redeemed. For purposes of the Indenture, all
references to "premium, if any" on the Notes shall be deemed to refer to the
Make-Whole Amount, if any.

"REINVESTMENT RATE" means .25% plus the arithmetic mean of the yields under
the heading "Week Ending" published in the most recent Statistical Release under
the caption "Treasury Constant Maturities" for the maturity (rounded to the
nearest month) corresponding to the remaining life to maturity of the Notes, as
of the payment date of the principal being redeemed. If no maturity exactly
corresponds to such maturity, yields for the two published maturities most
closely corresponding to such maturity shall be calculated pursuant to the
immediately preceding sentence and the Reinvestment Rate shall be interpolated
or extrapolated from such yields on a straight-line basis, rounding in each of
such relevant periods to the nearest month. For the purposes of calculating the
Reinvestment Rate, the most recent Statistical Release published prior to the
date of determination of the Make-Whole Amount shall be used.

"STATISTICAL RELEASE" means the statistical release designated "H.15(519)"
or any successor publication which is published weekly by the Federal Reserve
System and which reports yields on actively traded U.S. government securities
adjusted to constant maturities, or, if such statistical release is not
published at the time of any determination under the Indenture, then such other
reasonably comparable index which shall be designated by the Company.

BOOK-ENTRY SYSTEM

The following are summaries of certain rules and operating procedures of DTC
that affect the payment of principal, premium, if any, and interest and
transfers of interests in the Global Note. Upon issuance, the Notes will only be
issued in the form of a Global Note which will be deposited with, or on behalf
of, DTC and registered in the name of Cede & Co., as nominee of DTC. Unless and
until it is exchanged in whole or in part for Notes in definitive form under the
limited circumstances described below, a Global Note may not be transferred
except as a whole (i) by DTC to a nominee of DTC, (ii) by a nominee of DTC to
DTC or another nominee of DTC or (iii) by DTC or any such nominee to a successor
of DTC or a nominee of such successor.

S-38
<PAGE>
Ownership of beneficial interests in a Global Note will be limited to
persons that have accounts with DTC for such Global Note ("participants") or
persons that may hold interests through participants. Upon the issuance of a
Global Note, DTC will credit, on its book-entry registration and transfer
system, the participants' accounts with the respective principal amounts of the
Notes represented by such Global Note beneficially owned by such participants.
Ownership of beneficial interests in the Global Note will be shown on, and the
transfer of such ownership interests will be effected only through, records
maintained by DTC (with respect to interests of participants) and on the records
of participants (with respect to interests of persons holding through
participants). The laws of some states may require that certain purchasers of
securities take physical delivery of such securities in definitive form. Such
laws may limit or impair the ability to own, transfer or pledge beneficial
interests in the Global Note.

So long as DTC or its nominee is the registered owner of a Global Note, DTC
or its nominee, as the case may be, will be considered the sole owner or Holder
of the Notes represented by such Global Note for all purposes under the
Indenture. Except as set forth below, owners of beneficial interests in a Global
Note will not be entitled to have Notes represented by such Global Note
registered in their names, will not receive or be entitled to receive physical
delivery of such Notes in certificated form and will not be considered the
registered owners or Holders thereof under the Indenture. Accordingly, each
person owning a beneficial interest in a Global Note must rely on the procedures
of DTC and, if such person is not a participant, on the procedures of the
participant through which such person owns its interest, to exercise any rights
of a Holder under the Indenture. The Company understands that under existing
industry practices, if the Company requests any action of Holders or if an owner
of a beneficial interest in a Global Note desires to give or take any action
that a Holder is entitled to give or take under the Indenture, DTC would
authorize the participants holding the relevant beneficial interests to give or
take such action, and such participants would authorize beneficial owners owning
through such participants to give or take such action or would otherwise act
upon the instructions of beneficial owners holding through them.

Principal, premium, if any, and interest payments on interests represented
by a Global Note will be made to DTC or its nominee, as the case may be, as the
registered owner of such Global Note. None of the Company, the Trustee or any
other agent of the Company or agent of the Trustee will have any responsibility
or liability for any aspect of the records relating to or payments made on
account of beneficial ownership of interests in the Global Notes or for
maintaining, supervising or reviewing any records relating to such beneficial
ownership interests. The Company expects that DTC, upon receipt of any payment
of principal, premium, if any, or interest in respect of a Global Note, will
immediately credit participants' accounts with payments in amounts proportionate
to their respective beneficial interests in such Global Note as shown on the
records of DTC. The Company also expects that payments by participants to owners
of beneficial interests in the Global Note held through such participants will
be governed by standing customer instructions and customary practice, as is now
the case with securities held for the accounts of customers in bearer form or
registered in "street name," and will be the responsibility of such
participants.

The Indenture will provide that if (i) DTC notifies the Company that it is
unwilling or unable to continue as depositary or if DTC ceases to be a clearing
agency registered as such under the Exchange Act at any time when the depositary
is required to be so registered in order to act as depositary for the Notes and
a successor depositary is not appointed within 90 days after the Company
receives such notice or learns of such ineligibility, (ii) the Company
determines that the Notes shall no longer be represented by a Global Note and
executes and delivers to the Trustee an officers' certificate to such effect or
(iii) an Event of Default with respect to the Notes shall have occurred and be
continuing and beneficial owners representing a majority in aggregate principal
amount of the outstanding Notes advise DTC to cease acting as depositary for the
Notes, the Company will issue the Notes in definitive form in exchange for
interests in the Global Note. Any Notes issued in definitive form in exchange
for interests in the Global Note will be registered in such name or names, and
will be issued in denominations of $1,000 and such integral multiples thereof,
as DTC shall instruct the Trustee. It is expected that such instructions will be
based upon

S-39
<PAGE>
directions received by DTC from participants with respect to ownership of
beneficial interests in the Global Note.

DTC is a limited-purpose trust company organized under the Banking Law of
the State of New York, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code, and a
"clearing agency" registered pursuant to the provisions of Section 17A of the
Exchange Act. DTC was created to hold securities of its participants and to
facilitate the clearance and settlement of transactions among its participants
in such securities through electronic book-entry changes in accounts of the
participants, thereby eliminating the need for physical movement of securities
certificates. DTC's participants include securities brokers and dealers, banks,
trust companies, clearing corporations and certain other organizations, some of
which (and/or their representatives) own DTC. Access to the DTC book-entry
system is also available to others, such as banks, brokers and dealers and trust
companies that clear through or maintain a custodial relationship with a
participant, either directly or indirectly.

SAME-DAY SETTLEMENT AND PAYMENT

Settlement for the Notes will be made by the Underwriters in immediately
available funds. All payments of principal, premium, if any, and interest in
respect of the Notes will be made by the Company by wire transfer of immediately
available funds to an account maintained in the United States; provided that, in
the event that Notes are issued in definitive certificated form, the Holders
thereof shall have given appropriate wire transfer instructions to the Company.

Secondary trading in long-term notes and debentures of corporate issuers is
generally settled in clearing house or next-day funds. In contrast, the Notes
will trade in DTC's Same-Day Funds Settlement System until maturity or until the
Notes are issued in certificated form, and secondary market trading activity in
the Notes will therefore be required by DTC to settle in immediately available
funds. The Company expects that secondary trading in the certificated
securities, if any, will also be settled in immediately available funds. No
assurance can be given as to the effect, if any, of settlement in immediately
available funds on trading activity in the Notes.

UNDERWRITING

Subject to the terms and conditions contained in the purchase agreement (the
"Purchase Agreement"), the Company has agreed to sell to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), Donaldson, Lufkin & Jenrette
Securities Corporation, J.P. Morgan Securities Inc. and Salomon Brothers Inc
(the "Underwriters"), and the Underwriters have severally agreed to purchase the
respective principal amount of Notes set forth opposite their names below. In
the Purchase Agreement, the several Underwriters have agreed, subject to the
terms and conditions set forth therein, to purchase all of the Notes offered
hereby if any such Notes are purchased. In the event of a default by an
Underwriter, the Purchase Agreement provides that, in certain circumstances, the
purchase commitments of the non-defaulting Underwriters may be increased or the
Purchase Agreement may be terminated.

<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT OF
UNDERWRITER NOTES
- ------------------------------------------------------------------------------ --------------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated........................................................ $ 27,500,000
Donaldson, Lufkin & Jenrette Securities Corporation........................... 27,500,000
J.P. Morgan Securities Inc.................................................... 27,500,000
Salomon Brothers Inc.......................................................... 27,500,000
--------------
Total............................................................... $ 110,000,000
--------------
--------------
</TABLE>

S-40
<PAGE>
The Underwriters have advised the Company that they propose initially to
offer the Notes to the public at the public offering price set forth on the
cover page of this Prospectus Supplement, and to certain dealers at such price
less a concession not in excess of .45% of the principal amount thereof. The
Underwriters may allow, and such dealers may reallow, a discount not in excess
of .25% of the principal amount to certain other dealers. After the initial
public offering, the public offering price, concession and discount may be
changed.

The Notes constitute a new issue of securities with no established trading
market. The Company does not intend to apply for listing of the Notes on a
national securities exchange. The Company has been advised by the Underwriters
that the Underwriters intend to make a market in the Notes, but the Underwriters
are not obligated to do so and may discontinue market-making at any time without
notice. No assurance can be given as to whether or not a trading market for the
Notes will develop or as to the liquidity of any trading market for the Notes
which may develop.

Until the distribution of the Notes is completed, rules of the Securities
and Exchange Commission may limit the ability of the Underwriters to bid for and
purchase the Notes. As an exception to these rules, the Underwriters are
permitted to engage in certain transactions that stabilize the price of the
Notes. Such transactions consist of bids or purchases for the purpose of
pegging, fixing or maintaining the price of the Notes.

If the Underwriters create a short position in the Notes in connection with
this offering, I.E., they sell more Notes than are set forth on the cover page
of this Prospectus Supplement, the Underwriters may reduce that short position
by purchasing Notes in the open market.

In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases.

Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Notes. In addition, neither the
Company nor any of the Underwriters makes any representation that the
Underwriters will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.

The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act or to contribute to
payments the Underwriters may be required to make in respect thereof.

LEGAL MATTERS

The validity of the Notes to be issued in connection with the Offering will
be passed upon for the Company by Latham & Watkins, Costa Mesa, California.
Brown & Wood LLP, San Francisco, California will act as counsel for the
Underwriters.

S-41
<PAGE>
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NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS SUPPLEMENT AND
THE PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER.
NEITHER THIS PROSPECTUS SUPPLEMENT NOR THE ACCOMPANYING PROSPECTUS CONSTITUTES
AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY
JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE
DELIVERY OF THIS PROSPECTUS SUPPLEMENT NOR THE ACCOMPANYING PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THE INFORMATION CONTAINED HEREIN OR THEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT
TO THE DATE HEREOF.
------------------------

TABLE OF CONTENTS

PROSPECTUS SUPPLEMENT

<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Incorporation of Certain Documents By
Reference.................................... S-2
Prospectus Supplement Summary.................. S-3
Recent Developments............................ S-6
Use of Proceeds................................ S-7
Capitalization................................. S-7
Business and Properties........................ S-8
Selected Financial Information................. S-19
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... S-21
Management of the Company...................... S-31
Description of the Notes....................... S-33
Underwriting................................... S-40
Legal Matters.................................. S-41
PROSPECTUS
Available Information.......................... 2
Incorporation of Certain Documents by
Reference.................................... 2
The Company.................................... 3
Use of Proceeds................................ 3
Ratios of Earnings to Fixed Charges............ 3
Description of Debt Securities................. 4
Description of Common Stock.................... 14
Description of Preferred Stock................. 15
Restrictions on Ownership and Transfers of
Capital Stock................................ 21
Certain Federal Income Tax Considerations...... 22
Plan of Distribution........................... 28
Experts........................................ 29
Legal Matters.................................. 29
</TABLE>

$110,000,000

abcd

7 3/4% NOTES DUE 2007

---------------------

PROSPECTUS SUPPLEMENT

---------------------

MERRILL LYNCH & CO.

DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION

J.P. MORGAN & CO.

SALOMON BROTHERS INC

MAY 1, 1997

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