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Developers Diversified Realty Corp. (NYSE:DDR)

Q3 2008 Earnings Call

October 24, 2008 10:00 am ET

Executives

Michelle Dawson – Vice President Investor Relations

Scott Wolstein – Chairman and CEO

Dan Hurwitz – President and COO

Bill Schafer – Executive Vice President and CFO

David Oakes – Executive Vice President of Finance and CIO

Francine Glandt

Analysts

Christine McElroy - Banc of America

Steve Sakwa – Merrill Lynch

Lou Taylor - Deutsche Bank

Michael Bilerman - Citigroup

Nick Vedder - Green Street Advisors

Jay Habermann - Goldman Sachs

Carol Campbell - Hilliard Lyons

Michael Mueller – JP Morgan

Jeff Donnelly – Wachovia Securities

David Harris – Royal Capital

Jeff Spector – UBS

Craig Schmidt - Merrill Lynch

[Anar Ismelo] – GEM Realty

[Quentin Valeli]– Citigroup

Operator

(Operator Instructions) Welcome to the Third Quarter 2008 Developers Diversified Realty Earnings Conference Call. I would now like to turn the call over to your host for today’s call Ms. Michelle Dawson, Vice President of Investor Relations.

Michelle Dawson

On today's call, you'll hear from Scott Wolstein, Dan Hurwitz, Bill Schafer and David Oakes. Before we begin, I'd like to alert you that certain of our statements today may be forward looking. Although we believe that such statements are based upon reasonable assumptions, you should understand those statements are subject to risks and uncertainties and actual results may differ materially from the forward looking statements.

Additional information about such factors and uncertainties that could cause actual results to differ may be found in the press release issued yesterday and filed with the SEC on Form 8-K, and in our Form 10-K for the year ended December 31, 2007 and filed with the SEC. In addition, we will be discussing non-GAAP financial measures on today’s call including FFO. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in our press release dated October 23, 2008.

This release and our quarterly financial supplement are available on our website at www.DDR.com. Lastly, I’d like to request that callers observe a two question limit during the Q&A portion of our call in order to give everyone a chance to participate. If you have additional questions, please rejoin the queue.

At this time I'll turn the call over to Scott Wolstein.

Scott Wolstein

I am pleased to announce this quarter’s financial results of $0.83 per share which compares to last years third quarter results of $0.80 per share. Before I begin I would like to reiterate the statements I expressed in the press release that we issued earlier this week. My own experiences over the past several weeks have illuminated the risks associated with leverage in capital constrained environment.

In my day to day activities as Chairman and CEO I am committed to fostering a more conservative approach across all business lines and throughout or national and international pursuits. The absolute top priority on my agenda and that of each of us on this call is to ensure that we are positioned to comfortably navigate this challenging environment and emerge from it even stronger. We will take proactive steps to reduce our leverage utilizing any and all necessary financial measures to protect our long term financial strength.

Throughout today’s call you will hear how we are adjusting our strategy and proactively adapting to the current environment. That being said, as we review our third quarter results we continue to see the stability of our product type becoming increasingly evident which contributed to the consistency of our core operations.

For example retail sales results reflect consumers continued shift to value oriented retailers and as a result our centers and our largest tenants have been and should continue to be the relative winners in the retail marketplace. We can see this trend reflected in our leasing volumes which set an all time company record in terms of the number of new leases executed in a quarter and in our leasing spreads which are comparable to historic averages of roughly 10% growth on an overall blended basis.

Moreover the same store long term leases and renewal options that dampen our internal growth in bull markets now serve as important down size protection in a bear market. As evidenced by our recent press release we continue to close on asset sales and are actively addressing upcoming debt maturities. In response to unprecedented events that have taken place in the capital markets we have adapted our strategies and continue to do so in order to mitigate risk and focus on our core operating results.

While you will hear much detail on those results later in the call I would like to focus on the big picture. Our priority continues to be enhancing liquidity, protecting the quality of our balance sheet and maximizing our access to a broad set of capital sources. Potential new investment opportunities will be pursued but only with significant equity and debt financing in place and only where carefully underwritten expected returns sufficiently exceed our current cost of capital.

I want to reiterate our focus on selling assets to third parties and into joint ventures. If we look across our maturities in 2009, 2010 and beyond and taking severe disproportionate approach as many of you have done in recent weeks we know that these asset sales represent one of the least expensive sources of capital available. Probably only surpassed by our internally generated retained cash flow. We had flows and are continuing to progress on numerous individual or small portfolio asset sales that should generate over $200 million for 2008.

In addition, as we announced this morning we have signed a letter of intent for the sale of approximately $900 million of assets into an 80/20 joint venture with an institutional partner that we know that will generate several hundred million of net proceeds. I will let David Oakes give you details later as well as the progress update on a number of smaller asset sales.

Second, we continue to work very hard to conserve capital and to make all capital allocation decisions more prudently than ever. To that end we continue to scrutinize any and all capital expenditures on our development pipeline. We will mitigate risk by phasing projects and carrying land which we already own until leased and financed. We will not pursue any projects that do not meet our pre-leasing thresholds or whatever percentage is necessary to secure third party construction financing or our return thresholds which stand in excess of 10% return on costs.

Fortunately our asset class does not require a significant amount of regular leasing or maintenance capital expenditures. We could operate our portfolio in a highly cash efficient manner and still generate consistent cash flows. Our free cash flow after all expenses and interest and including CapEx and preferred dividends exceed $300 million per year.

Before we discuss capital markets I will briefly review our third quarter results. With respect to international development we have suspended all spending in Russia until we have greater clarity on the economic and business environment in that country and until debt financing is available on commercially reasonable terms.

In Brazil we are finishing our project in Manaus which is almost fully leased and expected to come online at April. We are not commencing any new development projects at this time. We continue to believe in these development projects in Brazil and their returns but we are carefully rationing capital for the near term. With respect to our operating portfolio in Brazil we continue to generate extraordinary NOI growth we are pursuing capital recycling opportunities and are in discussions with several large institutional investors regarding joint venture investments.

We have seen many very difficult cycles before and we know that the best strategy is to focus and commit to the basic blocking and tackling of running a high quality retail real estate portfolio which generates the vast majority of our revenue, drives value creation and generates more capital available for distribution.

At this point I will turn the call over to Bill Shafer for his comments on the quarter.

Bill Shafer

Before we discuss capital markets I will briefly review our third quarter results. Our FFO for the quarter continues to reflect consistent results driven by our core portfolio performance. We earned FFO of $0.83 per share which compares to $0.80 per share in the prior year, an increase of 3.75%. Although our operating margin dropped somewhat reflecting higher vacancy and bad debt levels same store operating results were positive for this quarter.

In light of all the volatility in the economy and the financial markets I was pleased with our portfolio results which reflected a $0.03 increase over the prior year results. I would also like to discuss a few specific items that were included in our numbers but had no net impact on the overall results.

First, during the quarter we recognized $16 million tax benefit similar to the valuation reserve that was released in the first quarter 2007 the majority of this amount related to the release of additional valuation reserves associated with deferred tax assets that were established over prior years that were acquired from JDN. These valuation reserves were established due to the uncertainty the deferred tax assets would be utilizable.

Based upon the increase in fee and miscellaneous other non-real estate related income opportunities and the recent transfer of various management contracts from the re into the TRS which will result in future taxable income. It was necessary to eliminate the reserve based on the current facts and circumstances which now indicate that a reserve is no longer necessary.

Second, we recognized approximately $3.5 million of mark to market hedging losses which were generated by our additional equity ownership in MDT Joint Venture. These mark to market losses offset the mark to market income of over $3 million of those recognized in last quarter. There was no cash impact to our operations however as a result of these accounting related adjustment there was also approximately $1 million of transactional related charges incurred relating to our joint venture in Brazil. Both of these charges reduced our equity and net income from joint ventures.

Third, we recognized $5.8 million accounting loss on the sale of our 55% consolidated joint venture interest in an office building in Massachusetts that was formerly occupied by Cisco. Our partner triggered the buy sell provisions and we determined that selling our interest in the building was much more economically and strategically attractive then buying their interest despite the negative FFO implications for the quarter.

Finally, as is common in our business we are involved in certain litigation matters. In one case the jury came back with a verdict in favor of the plaintiff. Although we disagree with the jury’s decision and are appealing the verdict we have increased our reserves relating to this matter. This accrual significantly contributed to the increase in our other expense line item of $6.6 million over last years third quarter amount. We do not believe there are any other potential material legal rulings that will impact our operations. Again, the net impact of these four items on our quarterly results was essentially zero.

Turning to capital markets, as we disclosed in our recent press releases our financing activities on behalf of DDR and our joint venture partners aggregated $525 million during the third quarter. Aggregate financings total $1.2 billion for the year, $1.1 billion of which represented new capital. Although the credit environment has become much more difficult in the last few weeks we continue to pursue opportunities with the largest US banks, select life insurance companies, certain local banks and some international lenders.

Across the board approval process has slowed while pricing and loan to value ratios remained dependent upon the specific deal terms but in general spreads are higher and loan to values are lower. The financial crisis is not unique to DDR or the RE industry in general for that matter. Various governments throughout the world have announced numerous initiatives that are intended to strengthen and solidify the world’s financial systems and restore confidence in the global economy. This process however will take some time.

Although the ultimate impact to the national and global economy is uncertain today we believe it should become much clearer over the next several months as opposed to years. Accordingly we have always focused on the company’s long term growth and the primary focus on the current environment and navigating through the upcoming year and through 2010 as well.

Early in the year I provided you a capital plan for upcoming quarters. I would like to give you an update on that plan having put 2008 largely behind us. I will outline our cash needs followed by our funding strategy.

Excluding loans for which we have options to extend we have approximately $400 million of consolidated debt maturing in 2009. We have approximately $350 million of joint venture debt maturing in 2009 of which our share is approximately $60 million. Of the aggregate $750 million to be refinanced in 2009 approximately $275 million of indebtedness is unsecured and less than $15 million of mortgage debt has recourse to DDR.

Of the $400 million consolidated 2009 maturities we expect to repay approximately $50 million using a combination of equity raised from expected sales, retained capital, additional secured financings and our line of credit. These obligations are comprised primarily of mortgages originated several years ago and assumed in various acquisitions. The loans are small, well amortizing and thereby have low leverage of approximately 50% loan to value.

We expect to refinance roughly $70 million of mortgage debt on two assets. These loans were originated in 1999 and are also well amortized and have an estimated loan to value ratio of approximately 44%. The most significant maturity relates to the $275 million of unsecured notes maturing at the end of January 2009.

Although this maturity has been address to retain capital line of credit availability, additional sources of capital potentially include proceeds from sales initiatives mentioned earlier in which David will discuss in more detail, proceeds from new secured financing along with other initiatives currently underway.

As Scott mentioned our strategy includes looking ahead not just to 2009 but to the following years as well. Over the years we have been very careful to balance the amount and timing of our debt maturities. Notably we have no major maturities between February 2009 and April 2010 providing us with adequate time to ensure that the larger maturities including our credit facilities, which occur in 2010 through 2012, are addressed well in advance.

The weighted average interest rate on the consolidated debt expires without extension options in 2010, is approximately 5% using current LIBOR rates. This includes $500 million of unsecured senior notes and $428 million of secured debt. The estimated loan to value ratio on the consolidated secured debt maturing in 2010 is approximately 40%.

Even in dislocated markets this low loan to value should allow a very high likelihood that refinancing even at increased proceed levels will be achievable. Potential sources however clearly also include capital recycling and retained capital which has consistently been a cornerstone of our financing strategy.

With respect to capital expenditures we consider this type of spending to be completely discretionary. Within our development and re-development portfolios we have dramatically reduced expected spending and as Scott described are able to do so by phasing construction until sufficient pre-leasing is reached and financing is in place.

Funding for these expenditures will be provided by capital recycling and asset sale activities including potential joint venture and sale of certain developments. Operating cash flow and existing perspective construction loans a market we continue to tap for new financing. Moreover we have significant unencumbered asset pool of approximately $5.5 billion which continues to be available for potential financing, and we have the ability to replace over $500 million of unsecured debt with secured debt and still satisfy our covenants.

Furthermore one of the great benefits of our asset class is the relatively low level of capital necessary to lease and maintain the portfolio. We expect we will need approximately $26 million or $0.38 per square foot during 2009 for leasing and maintenance CapEx including our proportionate share of joint ventures which is line with actual amounts expended in previous years.

As David will discuss in more detail we will continue to increase our flexibility as the result of pending joint ventures, third party asset sales and financing activities that are already under way. We will be extremely diligent to improve our balance sheet and this objective is at the top of each of our priority lists today.

These are difficult times but once this period of macro volatility is behind us we will emerge a stronger company as a result of our ability to act quickly and opportunistically as we have done in other challenging cycles. Moreover, we have the support of our large lenders and equity partners to get us through this period of market uncertainty.

I’ll turn the call over to Dan now.

Dan Hurwitz

Considering the enormous disruption occurring in the capital markets and the internal operating disruption that can result we are pleased with the portfolios performance this quarter and the focus of our employees.

As Scott mentioned leasing activity this quarter established a new record for aggregate new square feet leased. We signed new leases with Kohl’s, Publix, Buy Buy Baby, Fresh Market, Bells Outlet and HH Gregg. Not only did we produce 1.84 million square feet of lease space but the highest production region was our Southern region which produced 182 leases and 940,000 square feet. Given our exposure to Georgia and Florida it is important to note the outstanding deal velocity in that market compared to the negative headlines at each market, particularly Florida continues to generate today.

These results reflect certain changes in our leasing strategy some of which have been in place for several months already. Our top priority is to maintain occupancy. We’re staying in front of tenants by conducting full portfolio reviews and traveling to their headquarters in record numbers. We’re renewing tenants early and currently have 67% of our 2009 renewals either complete or in documentation.

We continue to accelerate the time it takes for leases to be processed by our attorneys and revisiting deals that had previously been declined. Simply put, it takes more hustle and creativity to close deals and our leasing team continues to deliver. Moreover it is important to note that our capital contribution to these leasing transactions is minimal by nature of the community center business compared to other property types. We typically re-lease space on an as is basis with minimal costs associated with new leases and essentially no capital expenditures on lease renewals.

We also see clear trends across the broad retail industry and in an environment such as this there is a flight to value. Consumers become increasingly price sensitive, becoming discretionary spending in favor of necessities, groceries and discounted apparel and general merchandise. Retailers that can offer this price leadership and value proposition are outperforming those that cannot. We see that manifest itself every month in sales and margin results. The market share shift to tenants that offer value and convenience is accelerating dramatically.

Moreover while retail bankruptcies and store closing are frequently in the news today the reality is that most of our tenants are very healthy with larger more diversified operations and much stronger balance sheets than in the past. Credit quality matters now more than ever.

With respect to those handful of tenants that have recently announced bankruptcies I’d like to bring you up to speed with recent announcements. With respect to Mervyn’s we have eight locations aggregating 600,000 square feet and $3.7 million in pro-rata annual rental revenues which were on the initial closing list.

Mervyn’s however has not rejected any leases and as a requirement of the bankruptcy law is required to remain current in their rental payments. Mervyn’s announced last week that it intends to liquidate. They have not yet announced the definitive auction date for all its real estate and as a member of the creditors committee we are monitoring the proceedings very closely.

We are currently receiving positive tenant interest for many of these boxes and are prepared to respond quickly to opportunities to release or sell if we were able to recapture some stores after the auction process. In the event that a competing retailer, adjacent property owner or another interested party acquires a Mervyn’s lease that buyer of the lease would assume all terms and obligations of that lease and we would not incur any costs or experience any interruption in rental payments.

As discussed in the press release we issued earlier in the week our original underwriting on this investment was based on the value of the underlying real estate reflecting the possibility that Mervyn’s would default or declare bankruptcy. We were the first buyer to acquire locations from Mervyn’s and as such focused our interest on those assets we believe represented the best long term real estate value.

In addition, the acquisition was intentionally structured to protect our interest by providing a $25 million purchase price adjustment secured by a letter of credit provided by the seller. In addition, we have an $8 million letter of credit provided by Mervyn’s as security deposits on specific leases. All of our Mervyn’s locations currently contribute less than $10 million per year or approximately $0.08 per share after the debt service secured by these assets.

Based on the current level of tenant interest in these locations and the funds available to us to cover the cost of re-tenanting the space we do not expect our results to be materially impacted as a result of the Mervyn’s bankruptcy.

It is worthwhile to note that these Mervyn’s are the exclusive collateral for $259 million of mortgage financing which is non-recourse to DDR and MDT and matures in October, 2010. We own the Mervyn’s assets in a 50% consolidated joint venture with Macquarie DDR Trust in which we both invested roughly $75 million of equity in 2005 and we have received approximately $25 million in net cash flow after debt service since we acquired the portfolio three years ago.

Linens ‘n Things has announced that they are liquidating. The real estate will be sold at auction which we expect to be held in early 2009. We currently expect to have 10 closed locations that represent 325,000 square feet and $2.3 million in pro-rata revenues. We have another 28 leases, which, depending on the outcome of that auction could be assigned or rejected. These leases aggregate 940,000 square feet and $4.7 million in pro-rata rents.

In anticipation of a worst case scenario we been actively marketing our Linen boxes under the assumption that we receive all of them back and to date we have received positive feedback on many from potential tenants.

Steve and Barry’s which filed in July has been purchased and will emerge from bankruptcy. Of our 10 locations three leases were assumed and assigned. The two locations that were rejected and the other five locations that are holding going out of business sales aggregate 380,000 square feet and $1.9 million of pro-rata annual revenue or approximately $5.00 in annualized base revenue per square foot.

Similarly Goody’s which filed in June emerged from bankruptcy earlier this week with new equity and debt capital in place. We had 16 leases rejected and expect to receive one more in early 2009. These rejections represent 550,000 square feet and $1.8 million in pro-rata revenues. Our remaining 21 leases will continue to operate without interruption.

As a result of the new bankruptcy laws we are seeing important differences in the manner in which retailers proceed through the bankruptcy process compared to previous years. Retailers must now be much more prepared prior to filing bankruptcy because the window of time they are allowed to come up with a plan of reorganization or liquidation has been shortened dramatically. While it used to be common practice to lengthen the delay decisions on leases we are seeing tenants make decisions much quicker thereby giving us better visibility then we have had in the past.

We have also significantly adjusted our leasing strategy to meet our challenging environment. In response to recent tenant bankruptcies and likely space recapture we have created a dedicated division within our leasing department to focus on marketing and re-tenanting of those boxes. As part of this initiative we have a Vice President of Leasing and staff members actively monitoring and involved in the day to day events of the bankruptcy.

This process increases our ability to pursue package deals or portfolio transactions. We are dedicating considerable resources and putting significant focus on the re-tenanting process to ensure that it is smooth and is profitable as possible.

We are already evaluating a number of potential transactions with retailers who are obviously viewing this opportunity as their means to enter new markets and win market share. Tenants that are actively making new deals that could potentially backfill these boxes include Bed Bath and Beyond and their Christmas Tree Shops and Buy Buy Baby concepts, TJMaxx, Marshall’s, AJ Wright, Kohl’s, JC Penney, Ross Dress for Less, Joanne’s, Dicks, Sports Authority, PetSmart, Petco, HH Gregg, Staples, Fresh Market, Best Buy and several others.

We expect more bankruptcies to occur and our positioning ourselves appropriately. That being said we do expect a short term hit to our portfolio leased rate because of down time regarding the re-leasing efforts of the bankrupt tenants previously discussed. Occupancy should trough mid way through 2009 and then start to regain ground during the second half of the year.

Turning to development, we have significantly reduced our anticipated spending for the remainder of 2008 and through 2009. One of the important benefits of our asset class is that we have the ability to phase development projects over time until comfortable leasing levels can be achieved. To further ensure judicious capital spending earlier this year we put new more stringent investment criteria in place. The new underwriting criteria include a higher cash on cost project return threshold, a longer lease up period and a higher stabilized occupancy rate.

It is also important to note that among our development joint ventures we, as the development director have the control over capital expenditures.

With respect to our international developments we will host the grand opening for our project in Manaus, Brazil where over 90% of the space has been leased in April 2009. Funding for this development has been provided by a combination of retained capital from the operating portfolio in Brazil and our Real based revolver.

In light of the volatility of the Russian markets and the current unavailability of local debt however we will suspend development there until we see a debt market emerge that can finance our investments more efficiently. Our joint venture currently owns two sites there aggregating 69 acres. Operationally this past quarter was very rewarding considering the environment in which we operate.

We have every expectation that 2009 will be equally as challenging. We are responding in a conservative manner by concentrating on our core operations and limiting development spending. More importantly this realistic approach has been carefully reflected in our 2009 budget.

On that note I’d like to turn the call over to David.

David Oakes

There have been two major themes you’ve been hearing about throughout the call. First that we have been and continue to evaluate all sources of funds to ensure that we are liquid and well capitalized in the near term and the long term and prepared for threats and opportunities that may arise. We have sold assets in the past and we will continue to do so with these transactions represent one of our least expensive forms of capital and can have a very positive impact on our portfolio operations and performance.

Second, we continue to be very prudent and selective in evaluating all expenditures on a risk adjusted basis. We are viewing investments through a very different prism then used in the past. While this is an opportunistic time for many investments our focus is only on pursuing those in a fashion that does not cause any stress to our balance sheet.

I would like to give you a brief update on how we have implemented those strategies, an idea of what we expect to occur over the next few months. As described in last weeks press release we closed on $73 million of asset sales during the third quarter bringing the total to over $100 million of asset sales year to date.

Pricing on these asset sales reflect reasonable comp rates given the current environment with an average cap rate below 6% for the third quarter. Pricing on these asset sales reflected some vacancy but generally reflected cap rates of roughly 7% for smaller assets in non-core locations on a fully leased basis.

The sale of our Massachusetts office building is a good case study on how asset dispositions may incur short term costs but are economically appropriate under a long term scenario. We had acquired this asset as part of our acquisition of American Industrial Properties and held our 55% interest in a consolidated joint venture with an insurance company. The in place cap rate on the sale was 3.4% and reflected the properties 70% occupancy rate.

This asset sale made sense in terms of our overall business strategy and generated $20 million of liquidity in addition to the amount of capital that would have been required to re-tenant the currently vacant space. These aspects of the sale significantly outweighed the near term cost of the $0.05 loss that included in FFO due to this sale.

Other dispositions completed during the third quarter include the sale of Brownfield Jersey City asset which was fully occupied by two tenants with long term relatively flat leases; a private individual with local financing purchased this asset at a cap rate in the upper sixes. Also during the quarter we sold four single tenant assets leased to PetSmart and Joanne’s at cap rates in the low to mid 7%.

Although these sales may reflect negotiations that began in a strong economic climate transactions continue to move forward and investors continue to have an interest in quality real estate with predictable cash flows at fair pricing. As evidence of this continued activity last week we put $23 million of assets under contract. This week we put another $35 million of assets under contract and signed LOIs on an additional $27 million of asset sales.

Plus, as Scott mentioned we find a term sheet with an institutional investor that we have worked with before on approximately $900 million of asset sales at a cap rate near 8%. The transaction is expected to generate over $270 million of net proceeds to DDR, more than $170 million of which will be available immediately upon closing which is expected in mid December. These proceeds in turn will be used to de-leverage our balance sheet. We will provide further details on this transaction once the sale is closed.

We are also having advanced discussions with other large institutional capital sources regarding potential joint ventures. In addition, we are in the process of offering a portfolio of stores to the largest and best capitalized retailers in our portfolio. The potential sale of these relatively flat cash flow streams could generate in excess of $200 million of net cash proceeds.

Currently we have a total of $71 million of asset sales under contract with a weighted average cap rate around 8% and another $92 million subject to LOI with weighted average cap rate in the low 8%. Perspective buyers range from local individuals to larger more regional private investors to large Re’s. We continue to receive bids on assets we have listed and will push forward to close those sales.

We are working to tee up additional sales for 2009 closings including a mix of quality assets likely to be placed in joint ventures as well as non-core assets and single tenant assets with flat but highly predictable cash flows. We feel it’s a good opportunity to monetize our investments in these assets and reduce leverage or recycle the capital in the new investments. Similar to Dan’s comments with respect our leasing team our transaction team is working harder, faster, and more creatively to find buyers and close deals.

We are also moving forward on the formation of an institutional venture to invest in distressed development projects and other high value add opportunities. We are currently in advanced stages of documentation with select lead institutional investors with a collective objective of executing a first closing before year end. Give the pipeline a very attractive opportunity that we are tracking today. Thereafter we expect that subsequent closing with additional institutional investors during the first half of 2009.

We would use this venture to selectively acquire projects that have become available as a result of the considerable market dislocation. This is an opportunistic time for many investments but we continue to be very prudent in choosing investments with the highest risk adjusted returns. We see a significant number of projects with some level of distress and increasingly projects offer considerably below another investors cost basis in an effort to avoid personal bankruptcy.

We are underwriting those using a very conservative assumptions which quickly eliminate the vast majority of those projects. That being said there are some very compelling opportunities that are becoming available at highly favorable terms and pricing.

At this point I’d like to turn the call back to Scott for his concluding remarks.

Scott Wolstein

In our remarks today you’ve heard how we are making proactive adjustments to our operations and long term strategies and how our balance sheet strength is our top priority. We intend to generate capital from expected asset sales including sales to JV’s, retain capital and existing and perspective financing to fund our debt maturities and to the extent we deem appropriate any further capital expenditures.

With respect to the remainder of 2008 the primary uncertainties are the timing, volume and pricing of merchant built sales. Due to the significant volatility in the market we may not hit our previously announced targets. Obviously current pricing for larger, high quality assets is not fully reflecting those positive attributes so we may well choose not to sell all of our potential merchant built assets this year. Our goal is to generate proceeds that can be profitably reinvested not just to look at booking near term merchant building gains to achieve earnings targets.

The risks associated with the recognition of these gains in fact have largely clouded our story which as you’ve heard this morning is quite simple and consistent. To improve the transparency of our business and to encourage investors to focus on our recurring, reliable, operating revenue we have made two important changes.

First, at the rest of several analysts we added disclosure to our quarterly supplement which lists all developments and re-developments that comprise assets that could be sold to generate merchant build gain recognition. Second, with respect to the remainder of this year and beyond based upon extensive feedback from numerous investors and analysts we will be providing guidance based only on operating FFO exclusive of gains, losses and other items relating to the sale of assets.

We believe this change in guidance and reporting will prove the transparency of our business, highlight the visibility and consistency of our earnings and return the focus of our business to where the vast majority of our cash flows are earned. That being said, excluding these gains and losses we expect 2008 FFO to be in a range of $3.22 to $3.28 per share. Even at the low end of this guidance at the current share price we traded 2.6 times FFO. This multiple reflects more than a 60% discount to our peers and to the industry.

While this guidance is a more appropriate reflection of our core operations we still do believe that there may be significant transactional income that would be added to this number that may be recognized before the end of the year.

With respect to 2009 guidance, however, given the extreme uncertainty in the markets there are too many significant variables that are too fluid for us to provide the same levels of formal guidance that we have traditionally provided on our third quarter conference call. That being said, our best estimation at this time based upon our outlook regarding leasing, development and financing activity is that 2009 FFO should be approximately $3.00 per share.

This expectation includes net de-leveraging of more than $500,000, increases in interest rates and also includes a non-cash impact of the change in accounting treatment for the convertible securities which amount to approximately $0.12 per share. As referenced above this figure excludes any gains and losses from asset sales.

Based upon these expectations management has recommended and the Board of Directors has approved a 2009 dividend policy that will maximize our free cash flow while still adhering to payout requirements. This policy amounts to an annual 2009 dividend per share of approximately $1.50 to be paid quarterly.

To further enhance our liquidity and to apply this updated mindset regarding payout policy we will omit our fourth quarter 2008 dividend. This will generate more than $80 million of additional capital to further increase our liquidity. As a result our 2008 common share dividends will aggregate $2.07 per share. In total the change to our 2008 and 2009 dividend policy should result in additional free cash flow of at least $230 million which will be applied primarily to reduce leverage.

In summary, we have a great company and an outstanding portfolio. We are hopeful that the dramatic improvement in our balance sheet and the significant change in our policy as to earnings guidance will eliminate distractions and enable investors to focus on the exceptional company we are and the quality of our operating cash flow.

At this point I will return the line to the operator and receive your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Christine McElroy - Banc of America.

Christine McElroy - Banc of America

Can you provide some more color on what types of assets were included in the sale announced today? Would you say they’re a good representation of your overall portfolio or are these more non-core assets?

Dan Hurwitz

The 13 assets as a whole represent a pretty broad spectrum of our assets by geography and even product type. I would say they are reasonably representative of the portfolio as a whole. It’s not the best but wouldn’t consider them non-core, they’re good shopping centers.

Scott Wolstein

The best way to look at that is if we put assets in the JV those assets that we want to continue to be invested in and in this particular joint venture we have a promote structure that enables us to benefit from value creation in those assets over time. When we’re dealing with non-core assets we typically don’t keep them in joint ventures because we consider our joint venture partners just like our shareholders and we don’t want to put any assets that we wouldn’t want to own ourselves. You can always assume that when we announce a joint venture those are closer to core than non-core.

Christine McElroy - Banc of America

You mentioned that assets sales are your least expensive option for raising capital today. Can you walk through how you think about the cost of raising other types of equity capital as you look to de-lever next year?

Dan Hurwitz

I think we specifically said the retained cash flow now with the revised dividend policy that we generate is the lowest cost of capital and the most certain capital in this environment, asset sales then behind that based on where other alternatives are today. As we look at an extremely depressed stock price that implies a cap rate that is well above where we continue to execute on asset sales it seems clear that generating equity from asset sales is the more attractive option.

Christine McElroy - Banc of America

Where you are getting the $500 million is basically the asset sales and the dividend cuts?

Dan Hurwitz

That is accurate.

Operator

Your next question comes from Steve Sakwa – Merrill Lynch.

Steve Sakwa – Merrill Lynch

When you’re talking to these institutions about these JVs I guess how are their return expectations change, what are they looking for, what kind of hurdles do they want to hit in these kinds of arrangements?

David Oakes

It depends on the institution whether they’re a leveraged investor or an un-leveraged investor. Typically the leveraged investors that are willing to tolerate a little more risk are looking for a current cash flow of roughly 12% leveraged. Something north of that in IRR over a long term hold.

Dan Hurwitz

As part of managing the gap in expectations today we are finding a number of investors with an interest in down side protection or minimizing the risk there and I think our assets in the long term cash flows serve that very well versus some of the investors a few years ago looking for the extreme up side. For us especially in a joint venture with promoted structure we still believe we can capture that up side and our assets naturally deliver the stability that many of the investors that are still in the market are looking for today.

Steve Sakwa – Merrill Lynch

I just want to make sure I understand when you were talking about this whole de-leveraging process, put into perspective how much exact capital would you like to raise or how much debt are you looking to effectively pay down over the course of the next 15 months?

Scott Wolstein

That $500 million target that David mentioned it’s a good ball park of what we would like to achieve in 2009 as far as de-leveraging. I think what is equally important is that we have a clear visibility on addressing all our debt maturities far in advance. So it isn’t purely a matter of de-leveraging but it’s also a matter of terming out a lot of our debt and finding other sources of capital that are more reliable long term. Basically terming out our debt maturities.

Steve Sakwa – Merrill Lynch

Between the dividend cut and the large joint venture that you just raised that effectively is the $500 million.

Scott Wolstein

I was talking about $500 million before the dividend cut. In terms of transactions.

Operator

Your next question comes from Lou Taylor - Deutsche Bank.

Lou Taylor - Deutsche Bank

Can you talk a little bit about the rationale in the dividend cut in terms of maybe other options you thought about maybe just to dividend suspensions for a couple of quarters or maybe taking some of the money and actually buying your stock a little bit as well. Can you just go through the thought process there?

Scott Wolstein

The dividend cut is a source of capital whether we use some of that capital to repurchase our securities whether they are debt or equity is a completely different decision. I wouldn’t rule that out. We just felt that based on where these shares were trading and where the investors seem to be concerned about our company’s balance sheet and liquidity it was really inappropriate to maintain the dividends at such a high level and we thought that the capital could be better deployed in doing some of the things you’re suggesting.

We have debt securities outstanding trading is huge discounts and we have abilities to take this retained capital and go out and buy back that debt and eliminate any risk going forward and on a very highly accretive basis. The interesting aspect of a de-leveraging strategy today isn’t just to de-lever but it’s also to de-lever and take advantage of investment opportunities that give us historic yields on our investment and at the same time give us an opportunity to increase the quality of the balance sheet. I think we would be remiss if we didn’t take advantage of that opportunity.

Lou Taylor - Deutsche Bank

In terms of the large JV you announced this morning. What’s the status of that is it just at the LOI stage or you at a signed contract stage. Where is it in the process?

David Oakes

We have actually a letter of intent that agrees on all the economic turns and the partner has been engaged in due diligence for a few months now. We expect to be under contract shortly and we expect the transaction to close in mid December.

Operator

Your next question comes from Michael Bilerman – Citigroup.

Michael Bilerman - Citigroup

Sticking with the joint venture here for a second, can you just with comp structure you have $890 million total assets, how much debt is going along side that, how much seller financing would you be providing to the venture and then understand the proceeds that you’re taking out and timing, the $260 million and then total but only $170 million up front.

David Oakes

Basically the transaction is structured with overall leverage of about 70% well into the value addressed in the transaction. Approximately 50% loan to value is in the form of third party financing and approximately 20% is in seller financed mezzanine paper. The reason there’s a difference between the immediate proceeds and the ultimate proceeds on the transaction to us is because half of the assets are already have financing in place and the other half of the assets are unencumbered and we’re in negotiation with lenders on a loan secured by those assets and we’ve basically structured the transaction with the terms we anticipate that loan to provide.

Michael Bilerman - Citigroup

So there’s about $220 million of existing debt that’s going with it you’re going to go out and get another $220 million.

David Oakes

More than that but at this point our historic policy has been that we haven’t announced the transaction until we were further along. At this point we thought a signed LOI on a deal of this size in a market like this was a material event to provide some details on but would not look to provide complete details on this transaction until we’re closer to closing.

Michael Bilerman - Citigroup

How do you think about the $180 million of seller financing and what sort of terms is that being provided, what sort of rate is that being provided?

Scott Wolstein

We’re not going to get into those details on this call. I’m not sure we ever will get into that level of detail because we’re in negotiations with other institutions on similar joint ventures and we don’t want them to use the terms of this joint venture against us in other negotiations.

Michael Bilerman - Citigroup

If you’re providing capital to a joint venture I would assume that’s going to be an important piece of your capital raising strategy but also it will impact how your numbers are going to be.

Scott Wolstein

Yes but the capital that we announced is net of that. That’s all net new capital. Net of any seller financing that we’re providing.

Michael Bilerman - Citigroup

It’s 70% levered with your seller financing that only leaves $260 million total why is there a difference and that’s for total you only have 80% of that. I’m just trying to understand.

Scott Wolstein

We have 100% of the proceeds from the joint venture. We’re selling the assets to the joint venture. We continue to own 20% on a go forward basis. I don’t understand your point.

Michael Bilerman - Citigroup

Can you talk a little bit more have you thought about it from a metric standpoint in terms of de-leveraging where you say okay today I’m at this leverage ratio and this fixed charge I want to get to ‘x’ and ‘y’ by the end of next year and ‘a’ and ‘b’ by the year after.

David Oakes

Yes, we look at it both from a covenant standpoint as well as from the standpoint of where we would calculate our leverage today based on our metrics. The top priorities as we look at this strategy are one, in a market where the investor feedback we’ve gotten is an extreme concern about the liquidity situation of every real estate company to at minimum make sure that we have addressed our maturities over the next several years with a clear plan and with as much of that plan as possible being events that are completely under our control as opposed to dependent on a third party.

Along with that strategy to lower our leverage by any metrics whether it’s ours or the banks by several 100 basis points. Say lowering a leverage metric by two to five percentage points.

Michael Bilerman - Citigroup

What are your stock holdings today and any other margin that you may have, where does it stand?

Scott Wolstein

I have 500,000 and change in remaining shares in the company. They are placed as collateral to a line of credit that’s not a traditional margin law.

Operator

Your next question comes from Nick Vedder - Green Street Advisors.

Nick Vedder - Green Street Advisors

In your prepared remarks you mentioned that you have roughly $500 million of secured debt that you could place on encumbered assets. Is that as of 3Q or is that including some of these potential asset sales?

Dan Hurwitz

That is as of September 30th. Sales reflected in the third quarter what we closed would be reflected in those metrics what is post-September closing is not.

Nick Vedder - Green Street Advisors

In terms of your total and your debt covenant and your line of credit with respect to your total debt over your total assets you’re boxed in at 60%. Where do you stand as of 3Q?

David Oakes

Actually we have the ability to go to 65% too for a few quarters there. We are under the 60% threshold as of September 30.

Nick Vedder - Green Street Advisors

How much room do you have to increase debt under that covenant, are you close to the 60% or you have some more wiggle room in there?

David Oakes

The transaction we announced today and with the dividend policy we’ve announced we’re having significant push under there. Several hundred million dollars.

Nick Vedder - Green Street Advisors

With respect to the asset sale that you have under contract can you provide some comment in terms of the characteristics of those properties and are they core, non-core, are they unencumbered properties or is there assumable debt. Just trying to get a feel for what those properties are like?

Scott Wolstein

Are you talking about the assets sales versus the JV?

Nick Vedder - Green Street Advisors

Yes.

Scott Wolstein

It’s a broad array of properties that are all considered non-core. There’s one large package of single tenants, CVS Drugstores, for instance pretty flat leases. There are properties that have fairly low occupancy where buyers are paying for the pro-forma income where we don’t share the buyer’s optimism as to the future of those assets. None of those assets would be considered assets that we would want to maintain in the core portfolio.

Operator

Your next question comes from Jay Habermann - Goldman Sachs.

Jay Habermann - Goldman Sachs

You mentioned occupancy troughing sometime mid next year. Can you give us a sense of where you anticipate occupancy going over this time and you mentioned more bankruptcies, any more specifics there?

Dan Hurwitz

As far as occupancy is concerned for our 2009 budget we see it across the board dropping between 150 and perhaps 200 basis points from where we are today. Over the course of the third and fourth quarters we see ourselves battling our way back up to maybe a little better than we actually are today. A lot of that is really going to depend on what happens with the final disposition of these bankrupt tenants because we are assuming that we have all the Linens ‘n Things back in vacant.

We’re assuming we have all the Mervyn’s stores back in vacant and it is unlikely that some of those stores will not be purchased in auction. Exactly how many is pretty hard to predict based on the bids that have been received to date and the negotiations that are ongoing. But 150 to 200 basis points seems to be where we’re headed. By the end of next year we should be back a little above where we are today.

Jay Habermann - Goldman Sachs

You mentioned in the release as well there’s been pretty strong interest for the Mervyn’s spaces. Can you give us a sense of perhaps how much of that space there’s been interest already indicated for on the part of retailers?

Dan Hurwitz

Right now probably a little less than half of the Mervyn’s spaces have I would consider very, very strong interest where actual economics discussions have commenced. The other half it may take a different type of occupant. We may have to split the boxes, for example, as opposed to someone taking the entire box. We know that there are currently transactions being discussed amongst the debtor and tenants directly. We’re going to have to see. We’re very comfortable that the downside on approximately half of the Mervyn’s boxes should be able to minimize that.

As far as your second question which was future bankruptcies, it’s a very difficult question to answer. There are tenants quite frankly that are operating out there today not in bankruptcy that many people thought would already be in bankruptcy. Certainly it’s no secret that we have a large exposure to Circuit City and Circuit City has had its share of issues. There are others out there as well.

It remains to be seen what happens with the vendor community because what’s happening with these retailers as we’ve gotten very involved with the Goody’s process, the Linens’ process the Mervyn’s process is that it’s the vendor community that’s putting these tenants out of business it’s not the landlords and it’s actually not even the banks it’s the vendor community.

If the vendor gives up on the retailer then it sort of lights out for that retailer. The tenants that continue to receive vendor support will be able to limp their way through and the tenants that don’t won’t make it. It’s going to be very interesting to see. Right now it seems like the vendor community is not incentivised to put anyone out of business. That’s what we’re seeing because if you go into some stores that are really undercapitalized today they still have a lot of inventory and a lot of merchandise.

Vendor support is still there for some. The ones that have disappeared though and particularly in the Linens ‘n Things situation if you shop their stores you could tell that the vendor community had quit on that retailer very early in the process.

Scott Wolstein

One other thing that I think all of you should keep in mind as you look into the Christmas season and so forth. A lot of people try to equate the health of retailers to their sales volumes and this is going to be a year where retailers are going to be looking for margin and not looking for high volume. Retailers are not going to go out on a limb this year and buy a lot of inventory, put on the shelves and hoping that the customer shows up.

Even though you may see some drops in same store sales over the holiday season that doesn’t necessarily mean that retailers are not achieving their plans and in many cases it may actually enhance their profitability and the quality of their credit. It’s going to be an interesting season. Often time’s people watch CNBC and they just look at the sales number. On tenant in our portfolio for instance that’s a good example of that is Old Navy. We’ve seen their sales drop dramatically across the portfolio but they’re doing better on their margins then they were doing before at higher volume.

Jay Habermann - Goldman Sachs

You talked about de-leveraging and obviously given the weakness in the stock price of late it certainly puts more emphasis on probably selling more assets here in the near term. Given that 2010 seems to be the number that everyone’s focusing on these days can you respond to that in terms of again the $5.5 billion of unencumbered assets? You’re talking about selling some boxes back to some big retailers.

Scott Wolstein

Yes, we are in discussions with Wal-Mart, Target, Lowe’s and others to sell them back flat leases in the portfolio that improves our growth rate. It also enables us to access capital at a fairly good price.

Jay Habermann - Goldman Sachs

Is that sub 8%?

Scott Wolstein

I would expect they would come in at sub 8%. You basically have to look at what their cost of capital is for the various retailers. Obviously Wal-Mart has the lowest cost of capital of that group. That can generate upwards of $200 million in proceeds to the company. It’s a highly efficient transaction and we can deploy that very accretively to investments. We will be aggressively applying these proceeds to repay some of those maturities in advance. We will be in the market trying to buy those bonds at a discount. As I said before it’s truly an historical opportunity.

We have converts out there trading right now at yield to maturity north of 20%. The ability to sell a box to Wal-Mart at anything south of an eight cap and take that money and put it to work at a 20% yield to maturity is a pretty remarkable opportunity which we are going to aggressively pursue.

Operator

Your next question comes from Carol Campbell - Hilliard Lyons.

Carol Campbell - Hilliard Lyons

Have you all taken care of refinancing any of your 2009 maturities at this point?

Scott Wolstein

I think we addressed that in the script. The only major maturity is at the end of January. That will be refinanced from retained capital and our credit line availability.

Operator

Your next question comes from Michael Mueller – JP Morgan.

Michael Mueller – JP Morgan

I think you may have touched on this at various points, you talked about assets you would want to hold and then you talked about assets you wouldn’t want to hold. Can you about where you see the cap rates for where institutions would pay for the stuff that you would want to hold, core stuff versus the non-core which looks like its trading at around 8%?

Scott Wolstein

Eight cap is kind of a ballpark. There will be deals that get done a little south of that, a little north of that but that’s the ballpark.

Michael Mueller – JP Morgan

That’s the ballpark pretty much for everything.

Scott Wolstein

For the institutional quality stuff today. The irony is that non-institutional quality stuff, the non-core stuff it actually trades at cap rates typically lower on income in place because the buyers are buying pro-forma income. From a standpoint of taking income off of our income statement and putting it to work in new capital a lot of those transactions are actually getting done a ridiculously low cap rates.

For instance the office building in Boston that we’re selling is like a 3.4% cap rate because there’s a fair amount of vacancy. We’re only taking a small amount of income off of the income statement and generating a lot of capital that we can put to work immediately at much higher returns.

Michael Mueller – JP Morgan

I think you were talking about assets under contract, assets under letter of intent. Outside of the joint venture that you close in December can you just quantify what do you think will hit in the balance of ’08 in terms of asset sales? Really just a magnitude of, like a ballpark range for what you think could be the asset sale number in 2009?

David Oakes

The assets we mentioned either under contracts or subject to letter of intent we would expect the great majority of that to close during 2008 so looking at the next really six weeks for the closing there that’s where due diligence has been done in many cases and in other cases its just extremely simple assets based upon they’re single tenant, highly stable, cash flow.

At this point the outlook for 2009 asset sales includes the transactions with large well capitalized retailers that Scott mentioned where they could be repurchasing some boxes where they currently have long term flat leases with us. It also includes roughly $100 million of additional non-core sales. We’ve been, as Scott mentioned, continuing to find buyers for these assets somewhat because the individual assets are smaller, somewhat because you’ve got individuals that simply have a more bullish outlook on an individual local property than we might.

The target on that number and the expectation for non-core sales is $100 million for 2009 and then the other less tangible initiatives we mentioned in terms of discussions regarding other joint ventures are not included in those figures but could easily amount to several hundred million dollars.

Michael Mueller – JP Morgan

The retailer related transactions that was a couple hundred million dollars.

David Oakes

It could be as much as $200 million is what we outlined based on the packages that are out there. A safe range would probably be $100 to $200 million.

Operator

Your next question comes from Jeff Donnelly – Wachovia Securities.

Jeff Donnelly – Wachovia Securities

Are you able to bracket for us the prospects for realized gains and losses on asset sales across the organization in 2008 and 2009 maybe like a sensitivity different cap rates?

Scott Wolstein

Maybe you didn’t hear the statement about not providing guidance on gains from asset sales. We’re not going to do that. As we do our formal guidance later in the quarter we’ll probably have to look at that more closely because it may affect the dividends during the year.

Jeff Donnelly – Wachovia Securities

The reason I was asking is that I’m wondering do you think there’s a greater chance if you recognize losses instead of gains on these. I just curious what your basis is in your assets.

Scott Wolstein

I don’t believe that’s going to happen.

Jeff Donnelly – Wachovia Securities

Concerning your 2009 guidance what are you anticipating for things such as bad debt, expense recapture efficiency and maybe even rent concessions through existing tenants. We’re facing a difficult holiday season on top of this already tough environment. I think people want to know you’ve baked in a fair degree of conservatism to arrive at your $3.00 guidance.

David Oakes

With regard to bad it’s relatively consistent. I think for a big chunk of the expense that we’ve been recognizing this year probably is taken into account the tenants that are the lesser quality. We’ve already recorded I would say significant bad debt expense this year. When you look at the credit quality of our asset base on a moving forward basis we expect really bad debt per se to be a little bit lower. They have indicated there’s going to be some actual occupancy, our occupancy right now is a little bit lower and that will be increasing throughout the year.

Dan Hurwitz

In regard to rent concessions we’ve had a surprisingly low amount of rent concessions in the actual core portfolio which is one of the reasons why it’s holding up so well and performing well. Interestingly though we have had a number of tenants try to re-trade us on development projects that have not yet commenced. As a result, since that spending as we’ve talked about completely discretionary if the tenants want to re-trade a deal that reduces the return below the level that we’ve prior approved we just won’t build the project.

What that’s going to do it’s going to make it very difficult for the tenants to hit their open to buy for the given year. It actually will give us more pricing power going forward. We are under no pressure to build projects unless they hit our threshold returns and most of the re-trading that we’re seeing is on those projects where tenants feel that they have the leverage in the current environment. Of course the response to that leverage is not to build the project.

Jeff Donnelly – Wachovia Securities

Where are those development thresholds going in this environment?

Scott Wolstein

For us they’re going up because we’re requiring them to go up or we’re not building the projects. Overall for some of the projects that are in the process they have cracked down. We have projects in the low 9% that are coming out of the ground, some in the high 8%.

David Oakes

The exciting opportunity in the development business is going to be in taking on projects that are already in tough shape with private developers who are capital constrained and unable to deliver in working with banks to capture those projects and use the banks capital to get them finished. I expect returns on those projects to be frankly well north of our 10% threshold.

One of the reasons that catch rate of some other companies who are dismantling their development operations we’re keeping ours in tact because we think our competency is going to be a very rare resource that banks are going to really want to tap into in the coming year or two because they’re going to be forced by regulators to take back a lot of projects that are in process that have already been titled, already leased but just can’t get financed.

They’re going to turn to people like us to work it out for them and to get those projects finished. We’re pretty excited about that opportunity and that’s why we’ve created this value fund with institutional capital to take advantage of that.

Dan Hurwitz

I think another important part of it is sometimes we just talk about these headline return numbers but I assure you there’s also been extreme focus from the senior most members of our development department up to the senior members of management to make sure that the underwriting of these developments is extremely cautious and extremely realistic reflecting the current market environment whether that’s a timing issue on lease ups, whether its more clearly quantifying risk in an environment that clearly has more risk.

It’s not only the headline number going up its that we are much more carefully underwriting this and believe we’ve got an exceptional development team that can do that even in an environment with this many challenges and an exceptional leasing team that can do that in terms of their relationship and knowledge of what retailers will actually pay to be on a sight.

Operator

Your next question comes from David Harris – Royal Capital.

David Harris – Royal Capital

Does this feel worse than the early 90’s in an operational sense the capital markets?

Scott Wolstein

I would say that was pretty bad but yes I think this is worse.

David Harris – Royal Capital

It’s worse now or you expect it to get worse?

Scott Wolstein

No, I think it’s worse now. I think that it was difficult to get a loan in 1991 on a real estate project. One of the problems with that question is we’re a very different company today then we were then. We have access to the very few loans that are out there where we may not have back before we became a public company and had the size and scale that we have today. Back in the early 90’s there were certain aspects of the capital markets that were closed. It wasn’t all of them. The dislocation in the corporate bond market today is really unbelievable, and much worse then that was back then I believe.

There was a lack of liquidity back then because there was really occasion by the tax reform act of ’86 and the S&L crisis and taking that liquidity for the syndication market out of the real estate industry. This particular liquidity crisis goes well beyond the real estate industry and it goes throughout the entire economy. That really wasn’t the issue back in the early 90’s.

David Harris – Royal Capital

Can you comment as comparisons between now and back in the early 90’s on the operational side, the property side? I think most of us have a fair handle as to how terrible it is on the capital markets.

Scott Wolstein

Operationally maybe Dan could speak to that even better than I can. Other than these few tenant bankruptcies operations side right now is pretty good. We’re not feeling a lot of distress out there. We just went through our portfolio reviews, went through virtually all of our properties with our leasing agents and I was frankly amazed at the level of activity that’s out there and the level of interest from retailers and boxes.

The problem with the retail business is that it’s highly competitive and there are times where retailers take market share from each other and people come and go. We’re just in one of those places because of the lack of capital in the system where we’ve got some of the weaker retailers are disappearing and being replaced by others. When I look at that operationally it’s really more an issue of down time until you put a stronger retailer in the box I really don’t think we’re looking at a severe dislocation in the retail market particularly at the value retail level where you’re dealing with everyday necessities.

Dan Hurwitz

The biggest difference operationally from the tenant community is that today our tenants are better capitalized, they’re stronger, they have more market share and they have most importantly in this environment much better control over their inventory. Tenants are able to gauge their inventory needs to a point of profitability much better today then they did in the early 90’s which is where we had significant fall out.

That being said there are far fewer tenants today then there were in the 90’s. It’s nice that our tenant community is healthy because we need them. In the early 90’s you in some cases had three, four and even five players in every category but today because of consolidation we’re really down to two. The options on re-leasing space and operating in this environment the tenant roster is shorter, much shorter than it was in the early 90’s but at the same time the tenants are healthier.

David Harris – Royal Capital

On the operational guidance that you’ve given I’m right in thinking that would exclude any transactional income that might have been generated through the joint ventures?

Bill Shafer

Yes.

Operator

Your next question comes from Jeff Spector – UBS.

Jeff Spector – UBS

I just want to make sure the new guidance is this a permanent change?

Scott Wolstein

Yes.

Jeff Spector – UBS

A quick question on the credit markets, obviously they’re still frozen. We’re hearing that a lot of banks have stopped lending even in the past week because companies continue to draw down their lines of credit. Can you just talk about some of the conversations you had this week, even just in the past couple days?

Scott Wolstein

I’m going to let Francine Glandt answer that because she talks to these banks almost every minute.

Francine Glandt

We are talking to banks daily and actually we’re in the market right now with some financings and have received quotes. Last week we received a few and we’ve got some this week as well. There are still key relationships that are lending to us. I will say the loan to values are lower. What would be quoted as a 60% loan to value in our eyes is probably a low 50% to mid 50% when you factor in the calculations and cap rates and various reserves that the lenders use.

The hold levels are lower; a bank typically would have held $50 to $60 million in some cases they’re now asking for $25 to $30 million. The pricing of course as Bill mentioned is a bit higher. They do take longer to close but they are doable. I would say one benefit that we have is that we can take financings and break them up into smaller portfolios. We can put properties individually into loans of $30 or $35 million as opposed to having to put together a consortium of banks for $200 million. That is an advantage in this market where smaller does tend to finance better.

Bill Schafer

There’s one other think that I’d like to mention which hasn’t been talked about much by anybody. Necessity is the mother of invention and there are a number of people out raising funds right now to go out and fill the void that’s left behind by the banks in providing debt. I had dinner last night with somebody that runs one of those funds who’s just raised $3 billion in institutional capital and there are several of these out in the marketplace.

While it may be pretty tough right now for a lot of people there is going to be lenders out there that are non-traditional that are going to start to fill that void. They may even provide capital to people like us to go out and buy some of our debt in the marketplace. There is some good news on the horizon too it’s not all bleak.

Jeff Spector – UBS

Can you mention what cap rate the banks are talking about over the last week in their quotes?

Francine Glandt

The typical cap rate that I’m seeing these days is in the 7% to 7.5%. Of course it depends on the deal that you’re shopping but that’s what I’ve seen.

Jeff Spector – UBS

On the leasing front can you talk a little bit more about the progress you’ve made in ’09 I believe you said you’re about 67% is that in contract stage?

Dan Hurwitz

That is correct. That’s either executed or in contract. That’s on renewals. As we look at our ’09 budget we’ve made the conscious decision to advance discussions with tenants on renewals because we want to have obviously clear visibility on what those tenants intend to do. Historically we have not done that that is a change in policy for us because we like the idea of tenants missing their renewals because we get to mark that lease to market which is usually substantially higher than the actual renewal price.

We’ve been actively out there, we have a staff of specialists that just handle renewals because there was something that we are extremely focused on and we’re very comfortable with where we are. At the time of the weekly volume of transactions as you can see from our numbers is so high, much higher than we thought it would be the 67% number is probably by the end of this week by today will be closer to 70% for ’09.

Jeff Spector – UBS

Can you let us know what type of spread you’re seeing?

Dan Hurwitz

It’s very consistent with what we’ve seen with the past. A spread when we do a new lease is down a little. We had some quarters in the mid to high 20% and on new leases we’re seeing in the mid to high teens for the most part. On renewals we’re seeing in the 8% to 10% range and the blend is really in that sort of 10% to 12% range. One of the things that could skew that number though that we’re very sensitive to is what happens with the vacant boxes.

There will be boxes no question that we do deals with tenants at a lower rent than Linen ‘n Things was paying or Mervyn’s was paying. That could have a negative impact on that number. Absent those extreme situations we’re trading a little lower in the new leases and we’re trading within our norms on the renewals.

Jeff Spector – UBS

I don’t know if you can answer this but clearly one of the pressures the vendors are, one of the pressure points is from the factors do you have any color on what’s happening on that side of the equation?

Dan Hurwitz

It’s not pretty. There’s no question about it. The factors are scrutinizing the retailers in a way that they’ve never done before. Terms for retailers are continuing to shrink for the most part. That is adding to some of the stress that is on members of the retail community. Some of the vendors are making up for that.

There are certain vendors out there that fear the day when there’s only one retailer that is actually a distribution channel for them. They are keeping other retailers afloat themselves where they’re actually almost factoring themselves. The pressure currently in the vendor community and the factor community is as extreme as you would imagine in a market like this.

Operator

Your next question comes from Michael Bilerman – Citigroup.

Michael Bilerman - Citigroup

Can you expand on the litigation and the legal verdict in the $6 million of costs and what that sort of related to and what the status is?

Scott Wolstein

We had a tenant in one of our shopping centers who claimed a loss of business by an improper operation of a valet parking service, sued us for loss of business over a period of years won a jury verdict that we are appealing.

Michael Bilerman - Citigroup

The $6 million is the reserve that you’ve taken for that?

Scott Wolstein

No, the $6 million is not the full reserve and we have been advised by council not to—It’s not the full amount of the judgment its.

Dan Hurwitz

The judgment was $10.8 million the reserve was $6 million.

Scott Wolstein

That does not indicate the full reserve we had for that particular item.

Bill Schafer

By the way we also have the opportunity to pursue a cross claim against the city because the reason the valet service wasn’t what the tenant had hoped for was because the city didn’t allow us to provide it. It’s a very complicated situation but that’s about what we’re looking at in terms of the numbers.

Dan Hurwitz

Just to further clarify on that matter. The increase in the other expense line item was about $6.6 million. It includes probably a normal recurring abandoned project stuff but it also includes the litigation related costs in addition to potential reserves associated with ultimate settlement.

Michael Bilerman - Citigroup

The list of assets that are eligible for merchant build is very helpful to have so I appreciate you putting that in. I’m not trying to ask for more but what would be helpful is just to have the un-depreciated book value of those assets so that we can understand what the totality from a development cost is of those assets to be able to understand what could occur.

David Oakes

We should be able to provide that, it’s available in our public filings and we can certainly include that.

Operator

Your next question comes from Jay Habermann - Goldman Sachs.

Jay Habermann - Goldman Sachs

The senior debt based on the credit facilities can you just remind us if you have the ability to extend the unsecured credit as well as the secured?

Scott Wolstein

Yes, we do have the ability to extend each of those for one year term.

Jay Habermann - Goldman Sachs

Have you already begun that process?

Scott Wolstein

They don’t mature until several years out.

Operator

Your next question comes from Craig Schmidt - Merrill Lynch.

Craig Schmidt - Merrill Lynch

I’m just wondering given the real estate business as a lagging indicator at what point to you think your operating metrics will be the worse during the 2009 is it going to be right after holiday or later in the year?

Dan Hurwitz

It’s usually right after holiday. What happens is we’ll know and retailers will know right after holiday, when I say right after holiday, holiday today includes January. We’re really talking about February. The retailer’s cash position is the best obviously in the first quarter and we’ll know at that point in time if they have the resources necessary to get to the fourth quarter to reenergize and replenish that cash supply.

If you look at the cash position of most retailers, June/July is the low because they’re placing orders for the holiday and their sales are always the lowest. If they don’t get enough cash reserves generated out of the first and second quarter we’ll know that and we’ll start to see some fall out. If we get through midway point of the year and we’ve seen that this year as well. Most retailers survive through the holiday because there’s really no benefit for them to close before they have the opportunity to benefit from holiday sales.

Craig Schmidt - Merrill Lynch

Is there a potential for negative same store sales during ’09 in any of the quarters?

Dan Hurwitz

Yes, I think there is real potential for negative NOI for same store sales depending on what happens with these bankruptcies and I think you’ll start to see that in first and second quarter if it’s going to happen.

Operator

Your next question comes from [Anar Ismelo] – GEM Realty.

[Anar Ismelo] – GEM Realty

You mentioned non-recourse on your mortgages. What is your ability to really walk away from those properties not that you have to but if you were without triggering anything under the credit facility?

Dan Hurwitz

We have the contractual right under the terms of the mortgage to deliver the properties not anything that we’ve done or take lightly in any way nor is it our expectation that it is something that we will do. You pay a certain price for non-recourse financing for that level of flexibility in those situations but I reiterate again that is not anything that we have plans or historically have done.

[Anar Ismelo] – GEM Realty

I was trying to understand if the credit facility limits the amount of walking away you can do from the assets?

Dan Hurwitz

We would expect that if that were the case which again we do not at all expect that there would be a negotiation to be had with the unsecured creditors where at that point they would have to view what’s in their best interests and we would deal with that if we came to it. Again, we don’t expect to get there.

[Anar Ismelo] – GEM Realty

Do you still have an option to expand your credit facility to $1.4 billion?

Scott Wolstein

Yes.

[Anar Ismelo] – GEM Realty

Are there any conditions satisfied before you expand it?

David Oakes

The conditions are, there’s not any obligation for any existing lender to increase their commitment levels. It’s just a matter of going out and finding the additional commitments to take it up to that level.

Operator

Your next question comes from Jeff Donnelly – Wachovia Securities.

Jeff Donnelly – Wachovia Securities

I was curious maybe more big picture about how we should be thinking about the evolution of big box tenant leasing demand obviously we’ve seen announcements and actions taken around closings this year I think conventional wisdom is we should see more of that closing going into 2009. How long do you think it takes before we move from what I’ll call a net closing market to maybe a net absorbing market? Is it late ’09 that we begin to see retailers look to find leases for openings in 2010 or does it come sooner than that.

Dan Hurwitz

It really depends on the retailer you’re talking about. Most of the retailers that we’re dealing with forgetting the ones that are in bankruptcy aren’t net closing at all. In fact they’re net opening. There are certain stores out there that we have a sense that are net closing but they’re the vast minority. In fact what people sometimes don’t realize but you do pick up when you talk to the retailers directly is that even though they’re new store count is down its more down because of the absence of supply as opposed to the absence of demand.

Most of our tenants are adjusting their new store openings to the lack of development activity and the lack of product and going back into the inner core. I think in general it will take us probably 18 to 24 months to absorb the boxes that are going to hit the market or have already hit the market due to bankruptcy. Overall if you look at the big box retailers the health and the growth profiles are quite strong and the demand for space obviously still exists as you can see from the leasing results.

Jeff Donnelly – Wachovia Securities

Related to that are there regions around the country where you’re seeing a disproportionate impact on those closings you mentioned. Conversely are retailers the ones you mentioned to the extent they do have limited opportunities to open stores are there regions that they’re avoiding, is it Florida markets such as that?

Dan Hurwitz

We’ve said many times that retailers really are a very local business. While Florida certainly has a bad name as does of course Phoenix or Vegas there are opportunities to do leasing in those markets and that’s why even we were surprised by the volume of deals that we did in Florida over the last quarter. I think in general though if you talk to most retailers they do have their hot markets that they are looking to go in to. Most would say that given an opportunity that makes sense from their global perspective they would do it in any market.

We’re seeing New England for example is extremely hot right now as is Washington D.C. which has been hot for about 10 years now from a retail perspective. If we were going to take a look at a market though that has the bulk of the closings in our portfolio its going to be the Southern California market and the Phoenix area where you’re going to have a whole slew of Mervyn’s and you’re going to have a whole slew of Linens ‘n Things.

Scott Wolstein

In terms of the portfolio reviews that we recently completed, the only region that had negative growth budgeted for 2009 was the Southeast. We had pretty good numbers in the other regions frankly in our portfolio.

Dan Hurwitz

That actually includes Puerto Rico which as many people have read recently has come under some pressure economically as well no different then we are here yet our same store sales continue to grow in Puerto Rico and our NOI continues to grow there as well.

Operator

Your last question comes from [Quentin Valeli]– Citigroup.

[Quentin Valeli] - Citigroup

I know you’ve had $140 million of asset sales under negotiation in the MDT joint venture I’m just wondering if you can give us an update on those sales?

Dan Hurwitz

Yes, we continue to work on sales not only for our own consolidated balance sheet as well as for our important partners. That includes MDT we’ve made considerable progress on one transaction that we expect to have more news on in the very near term and continue to advance on assets listed and make progress on other asset sales on the behalf of Macquarie DDR Trust.

Operator

At this time we thank you for participating in today’s conference you all may disconnect and enjoy the rest of your day.

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Source: Developers Diversified Realty Corp. Q3 2008 Earnings Call Transcript
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