Leases

3 Months Ended

Mar. 31, 2012

Leases [Abstract]

LEASES

2. LEASES

We lease or sublet our properties primarily to distributors and retailers engaged in the sale of gasoline and other motor fuel products, convenience store products and automotive repair services who are responsible for the operations conducted at these properties. Our tenants are generally responsible for the payment of all taxes, maintenance, repairs, insurance and other operating expenses related to these properties. In those instances where we determine that the best use for a property is no longer as a retail motor fuel outlet, we will seek an alternative tenant or buyer for the property. We lease or sublease approximately 20 of our properties for uses such as fast food restaurants, automobile sales and other retail purposes. Our 1,145 properties are located in 21 states across the United States with concentrations in the Northeast and Mid-Atlantic regions.

As of March 31, 2012, Getty Petroleum Marketing Inc. (“Marketing”) was in possession of 793 properties comprising a unitary premises pursuant to a master lease (the “Master Lease”). Following a pattern of late and nonpayment of rent, on November 28, 2011, we sent Marketing a notice terminating the Master Lease on its terms effective December 12, 2011. On December 5, 2011, Marketing filed for protection under Chapter 11 of the Federal Bankruptcy Code. Pursuant to an Order issued by the U.S. Bankruptcy Court, Southern District of New York (the “Bankruptcy Court”), effective April 30, 2012 Marketing rejected the Master Lease under United States Bankruptcy Code (the “Bankruptcy Code”) and surrendered full possession of the properties subject to the Master Lease to us. In addition to the $8,802,000 bad debt reserve we provided in the fourth quarter of 2011, during the quarter ended March 31, 2012, we provided bad debt reserves included in general and administrative expenses of $10,016,000 related to uncollected rent and real estate taxes due from Marketing for the period from January 1, 2012 through March 31, 2012. We have provided bad debt reserves for all outstanding receivables due from Marketing as of March 31, 2012 which remain unpaid as of the date of this Quarterly Report on Form 10-Q. (See note 9 for additional information regarding the portion of our historical financial results that are attributable to Marketing. See note 3 for additional information regarding Marketing and the Master Lease.)

We estimate that Marketing made annual real estate tax payments to us and directly to municipalities for properties leased under the Master Lease aggregating approximately $12,000,000. As a result of Marketing’s bankruptcy filing, beginning in the first quarter of 2012, we began paying past due real estate taxes for 2011 and 2012, which taxes Marketing historically paid directly. Real estate taxes that we pay and are due from Marketing are included in revenues from rental properties and in rental property expense in our consolidated statement of operations. Revenues from rental properties and rental property expense included $3,026,000 for the quarter ended March 31, 2012 and $160,000 for the quarter ended March 31, 2011 for real estate taxes paid by us which were due from Marketing. Marketing also made additional direct payments for other operating expenses related to these properties, including environmental remediation costs other than those liabilities that were retained by us. Costs paid directly by Marketing under the terms of the Master Lease are not reflected in revenues from rental properties or rental property expense in our consolidated financial statements. We expect to continue to incur costs associated with the bankruptcy proceedings with Marketing and subsequent to Marketing’s bankruptcy filing and we anticipate paying directly other property operating expenses historically paid by Marketing under the terms of the Master Lease.

Revenues from rental properties included in continuing operations for the quarters ended March 31, 2012 and 2011 were $31,214,000 and $24,945,000, respectively, of which $17,951,000 and $15,135,000, respectively, were contractually due or received from Marketing under the Master Lease and $12,629,000 and $9,595,000, respectively, were contractually due or received from other tenants. Revenues from rental properties and rental property expenses included $4,447,000 for the quarter ended March 31, 2012 and $919,000 for the quarter ended March 31, 2011 for real estate taxes paid by us which were reimbursable by tenants (which includes amounts related to the Master Lease discussed in the preceding paragraph). In accordance with GAAP, we recognize rental revenue in amounts which vary from the amount of rent contractually due or received during the periods presented. As a result, revenues from rental properties include non-cash adjustments recorded for deferred rental revenue due to the recognition of rental income on a straight-line (or average) basis over the current lease term, net amortization of above-market and below-market leases and recognition of rental income recorded under direct financing leases using the effective interest method which produces a constant periodic rate of return on the net investments in the leased properties (the “Revenue Recognition Adjustments”). Revenue Recognition Adjustments included in continuing operations increased rental revenue by $634,000 for the quarter ended March 31, 2012 and $215,000 for the quarter ended March 31, 2011.

We provide reserves for a portion of the recorded deferred rent receivable if circumstances indicate that a property may be disposed of before the end of the current lease term or if it is not reasonable to assume that a tenant will make all of its contractual lease payments during the current lease term. Our assessments and assumptions regarding the recoverability of the deferred rent receivable are reviewed on an ongoing basis and such assessments and assumptions are subject to change. As of March 31, 2012 and December 31, 2011, the gross deferred rent receivable attributable to the Master Lease of $24,574,000 and $25,630,000, respectively, was fully reserved. As a result of the developments described above, we previously concluded that it was probable that we would not receive from Marketing the entire amount of the contractual lease payments owed to us under the Master Lease. Accordingly, during the third and fourth quarters of 2011, we recorded non-cash allowances for deferred rental revenue aggregating $19,758,000 fully reserving for the deferred rent receivable relating to the Master Lease. These non-cash allowances reduced our net earnings for the year ended December 31, 2011, but did not impact our cash flow from operating activities.

Under the Master Lease, Marketing remains responsible to pay for the retirement and decommissioning or removal of USTs at the end of their useful life or earlier if circumstances warrant and all environmental liabilities discovered during the term of the Master Lease, including: (i) remediation of environmental contamination Marketing caused and compliance with various environmental laws and regulations as the operator of our properties, and (ii) known and unknown environmental liabilities allocated to Marketing under the terms of the Master Lease and various other agreements with us relating to Marketing’s business and the properties it leases from us (collectively the “Marketing Environmental Liabilities” or “Environmental Expenditures”). Despite such contractual responsibility, given Marketing’s bankruptcy, we have, as noted below, accrued for the Marketing Environmental Liabilities in the fourth quarter of 2011 and do not expect to be reimbursed for such Environmental Expenditures unless we ultimately recover a portion of our claims as a result of the Lukoil Complaint defined below. In connection with our repositioning of the properties previously subject to the Master Lease, we anticipate that, as between us and any new tenant or transferee of a property or group of properties, we will in almost all cases retain some or all of the environmental liabilities (including the Marketing Environmental Liabilities) that exist with respect to that property or group of properties prior to the date of re-letting or sale, to the extent there is no third party responsible therefor.

In the fourth quarter of 2011, since we no longer believed that Marketing would be able to meet its environmental remediation obligations including its obligations to remove underground storage tanks, we accrued $47,874,000 as the aggregate Marketing Environmental Liabilities which we are contingently liable for. The actual amount of the Marketing Environmental Liabilities may be significantly higher and we can provide no assurance as to the accuracy of our estimates. As a result of Marketing’s bankruptcy filing, we anticipate that we will commence paying for these Environmental Expenditures, which Marketing historically paid directly, beginning in the second quarter of 2012.

The components of the $92,471,000 net investment in direct financing leases as of March 31, 2012, are minimum lease payments receivable of $212,012,000 plus unguaranteed estimated residual value of $11,991,000 less unearned income of $131,532,000.