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Federal Realty Investment Trust (NYSE:FRT)

Q3 2008 Earnings Call

October 30, 2008 11:00 am ET

Executives

Gina Birdsall - IR

Don Wood - President and CEO

Andy Blocher - SVP, CFO and Treasurer

Jeff Berkes - EVP and CIO

Chris Weilminster - SVP of Leasing

Analyst

Christie McElroy - Banc of America

Paul Morgan - FBR

Jeff Donnelly - Wachovia

Rich Moore - RBC Capital Markets

Michael Mueller - JPMorgan

Nick Vedder - Green Street Advisors

Nathan Isbee - Stifel Nicolaus

Craig Schmidt - Merrill Lynch

Jeff Spector - UBS

Philip Martin - Cantor Fitzgerald

Operator

Good morning ladies and gentlemen, and welcome to the third quarter 2008 Federal Realty Investment Trust earnings conference call. All participates will be able to listen-only until the question-and-answer session of the call. This conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to introduce the conference leader, Ms. Gina Birdsall, Investor Relations Coordinator. Ma'am, you may begin.

Gina Birdsall

Thank you. Good morning. I'd like to thank everyone for joining us today for Federal Realty's third quarter 20008 earnings call.

Joining me on the call today are Don Wood, Andy Blocher, and Jeff Berkes. These and other members of our management team are available to take your questions at the conclusion of our prepared remarks.

Our third quarter 2008 supplemental disclosure package and our 10-Q provide a significant amount of valuable information with respect to the Trust's operating and financial performance. Those documents are currently available on our website.

Certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information, as well as statements referring to expected or anticipated events or results. Although Federal Realty believes the expectations reflected in such forward-looking statements are based on reasonable assumptions, Federal Realty's future operations and its actual performance may differ materially from the information contained in our forward-looking statements, and we can give no assurance that these expectations will be attained.

Risks inherent in these assumptions include, but are not limited to future economic conditions, including interest rates, real estate conditions, and the risk in the cost of construction. The earnings release and supplemental reporting package that we issued yesterday, our Annual Report filed on Form 10-K, and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial condition and results of operations.

I'll now turn the call over to Don, to begin our discussion of third quarter results. Don?

Don Wood

Thanks Gina, and good morning everyone. I want to start my prepared remarks today, right upfront with some facts and observations that I think aren't all up at a time, when virtually all types of organized lending markets are in absolute mess; when volatility in the broad equity market has taken on new meaning; when consumers have broadly cut back on their spending habits; when all of this uncertainty has caused widespread gridlock on the expansion plans of most retailers.

At a time when all of this is happening concurrently, Federal Realty reported FFO of $0.98 a share in the third quarter, nearly 7% above last year's quarter. We completed 68 leases for over 350,000 square feet of comparable space at 23% more rent than the previous tenant was paying.

Physical occupancy levels were slightly lower than last year, actually increased from where they were at the end of the second quarter. We remain optimistic that we will hit our previous guidance levels at least at the low end for the 2008 total year. Yes, I am still excluding two lawsuit settlements from that guidance that may or may not hit in the fourth quarter.

Now I don't start out with such a strong statement to suggest to you that Federal is immune from this unprecedented time in our country's history, or suggest that we'll always be able to get on this call and have strong operational results. There is no doubt that we foresee a tough leasing environment in 2009, and almost certainly we'll have rising vacancy.

Now if you go back and review our conference call comments from past quarters and in fact past years, I think you will find a reassuring consistency in the primary message we deliver. That is, that we have worked very hard to reduce our exposure to every significant risk in our business, from investment only in the highest quality real estate to a manageable redevelopment pipeline, to very low relative leverage levels with low lauded maturities. I think that our relative performance in difficult times like this is indicative of that conservative strategy.

Now Andy's remarks will largely be focused on our capital structure and future plans, so I'll leave amplification on capital to him in a few minutes. First though, let me touch on a few operational points and start with leasing.

Our strong results in the quarter were really a pleasant surprise in a true testament for the quality at a real estate. As I said, comparable lease rollovers were 23%, which equates to $25.03 a foot for the first year of rent on deal signed in the quarter, compared with $20.28 for the final year's rent under the previous lease.

As is often the case with this portfolio, a few expiring older leases in the quarter in some of our strongest markets really drove the results. New deals and renewals at Third Street Promenade and Santa Monica, Bethesda Row in Maryland, and Fresh Meadows in Queens, New York; and at Ellisburg present on Cherry Hill, New Jersey were the largest contributors.

As been the case over a year long, we showed positive leasing spreads in every major market that we did deals in during the quarter. Now, in terms of replicating that performance over the next few quarters, we'll have to wait and see but it will certainly be tougher.

Leasing activity has clearly slowed, and we expect to see more tenant failures and rent relief request, particularly after the holiday season. Very few of the retailers were speaking where they are bullish about fourth quarter sales.

Announced liquidation of lands and things alone which affects two great locations with us as DC region will create 73,000 feet of short-term vacancy if those leases are not purchased in a $2.1 million annual income hold.

In the longer term, getting those spaces back will be value additive to the both Mid-Pike and Friendship Center, the two centers where they reside. As you know, we have a very stable portfolio for properties and I would expect us to continue to outperform compared with our public and private competition as this economic cycle tests its lower limits.

This result do however, reflect a changing environment as can be seem in our same-store growth, which slowed the 2.8% on an operational basis without the impact of the redevelopment and 4.8% including redevelopments in the quarter, due primarily, the higher bad debt expense that reflects our concern about overall retailers health. That number actually looks worse if you computed off the face of the P&L, as the prior year included a $1.2 million benefit from an expiring land option that would pay to us.

Any way you look at it though, we're clearly running our business from all sides; leasing, cost in overhead and capital, and preparation for long difficult environment. We're re-examining the way we conduct every facet of our operations, and we've reduced our overhead run rate by roughly 20% going into next year.

We've done that in a couple of ways. First, through the re-negotiations with our vendors. Secondly, with the title rope on investment initiatives. Regrettably, thirdly, through staff reductions in most areas of the organization. We strongly believe that one of the key requirements of operating a business to times like these is more nimble decision making on fundamental real estate issues, and we therefore try to remove layers than impede that process. I think those actions though have us well set up to handle whatever 2009 throws at us.

I don't have much to add about our redevelopment initiatives this quarter as there is a little change from the second quarter where my remarks still apply. No deteriorations of any significance in the timing or in the returns that we expect.

The one item of note relates the residential lease up for our latest development in the Bethesda and that's Arlington East, where we continue to lease up the residential portion and are now over 90% lease there.

On the acquisition front, we closed on a previously announced Courtyard Shops in Wellington, Florida in August for $38 million. Wellington is a 127,000 square foot Publix-anchored center and represents a second acquisition itself for Florida following Del Mar Village which question acquired last March.

Given the current state of the capital markets, you should expect to see us become even more selective with the deployment of capital, until we have greater visibility on the cost and terms of new long-term capital.

Finally, it is a good time to remind you that Federal Realty has increased its common dividend every year for 41 years through all kinds of economies and interest rate environments. We wouldn't expect that to change in 2009.

Let me stop there and turn it over to our new CFO, Andy Blocher to talk about capital markets and the future. Andy?

Andy Blocher

Thanks, Don and good morning everybody. I just want to spend a couple of minutes talking about our current balance sheet and 2009 debut maturities before providing a little bit of an overview on 2009 expectations, and turning the call over to your questions.

Three specific transactions impacted the Trust balance sheet in the third quarter. First, in July, we are able to extend the maturity of our $200 million unsecured term loan to November 6, 2009. You may recall, the rate on the term loan is LIBOR plus 57.5 basis points, which is a very attractive piece of capital in the current market.

Second, on August 15th, the holders of $20.8 million of our 748 notes due in 2026, they exercised their onetime put option for these notes to us. We utilized availability on a credit facility or facilitate the redemptions. The put option for all other debt redemptions has now expired.

The third is the deal that we're really excited about because it takes advantage of some of the foresight we have been talking about in the last few years. In late September, we completed a 1031 exchange transaction where we swapped our fee interest in four land parcels, three of which were at White Marsh that we talked about as trade bait when we talked about the deal last year.

We control the land under two parcels at the Bethesda Row, including our related space of mix-use development there, Arlington East. While we had the right to acquire the land under Bethesda in 2013, we are able to get at the land sooner due to our strong relationship with the owner, and our ownership of these ground leases desirable for trade purposes. As a result, we have better operational and ownership flexibility at our latest addition to one of our most valuable assets.

In addition, we are able to generate $28 million to cash on the balance sheet in an extremely tax efficient manner and increased earnings. This is really a smart deal for Federal Reality all around.

With respect to the balance sheet, Federal Reality has no material debt maturities until fourth quarter 2009, a year from now.

We have the previously mentioned $200 million term loan maturing on November 6, '09, and $175 million in 3.25% notes maturing December 1, '09. We would expect to refinance the term loan at a rate above the current rate, but also to refinance in 3.25 notes at a rate below the current rate. The absolute refinancing rate isn't something we have certainty around right now.

There are several things to make me more confident in our ability to access capital at reasonable rates, first is our low absolute level of leverage. Even with the significant decrease in equity values, Federal Realty continues to carry very well leverage, both on a market capitalization basis where we are at roughly 35% at today's stock price, but even more importantly, on a book value basis where leverage is under 45%.

A low book leverage is truly a positive when you consider the low book basis in many of our assets. Remember, we've been a public company since 1962 and have owned many of our properties since the great 1960s, and the early 1970s. The potential positive spread between book value and appraised value, really can be a positive with respect to certain non-covenants in the event we decide to refinance unsecured debt with secured debt.

Second is our large unencumbered pool of assets. Since we've historically been an unsecured borrower, over 80% of our asset base is currently unencumbered. This large unencumbered asset base increases our flexibility with respect to financing options, potentially allowing us to borrow on a secured basis inside seize conservatively a $0.5 billion or more, while maintaining our unsecured borrowing flexibility for when that market option returns.

Third, our coverage ratio has remained very strong and more than double our bond covenant requirements. Finally, the trust possesses high quality assets and management two attributes that we believe will become increasingly important when liquidity does return.

With volatility and uncertainties, the themes of the day with respect to the capital markets, our expectations are for shorter potential issuance windows and on certain absolute pricing levels in the near term.

As a result, we've already begun on doing the prep work to assure that we have accessed all market alternative: secured, unsecured from banks like company's pension funds et cetera, and be certain that we are prepared to execute windows. Windows reopened hopefully in early '09.

In conclusion, I wanted to provide some broad thoughts with respect to '09 earnings expectations. As we discussed, retailer help in cost of capital remained significant uncertainties. While we continue to believe their high quality assets and desirable interlocations well performed other alternatives, specific performance remains uncertain.

That said, I'd be surprised if we're able to produce our historic 7% to 10% growth in '09. I also have a tough time coming up with scenarios where '09 FFO per share isn't somewhat better than what we report for '08.

Now, maybe many of you may not find this wide range of expectations valuable at this time. Both in the operating and financing environment, we are in several standard deviations from a mean. Expectations are specific '09 performance as we talk in October '08 is not realistically achievable.

Kim, we're now available to take questions.

Question-and-Answer Session

Operator

Thank you. At this time, we'd like to begin the question-and-answer session of the conference. (Operator Instructions). And the first question comes from the line of J. Habermann with Goldman Sachs. Please proceed.

Unidentified Analyst

Yeah, guys this is (inaudible) here with [Jay] as well. We've been hearing a lot of chat of later retailers struggling to maintain comp store sales in the current environment. Are there any specific retailers that stand out in your portfolios have been benefited from this, maybe here Bed Bath and beyond benefiting from Linens liquidation sales? And also have they been more aggressive with the expansion plans to gain market share as the results?

Don Wood

Well, let me start it out and let me turn it over to Chris Weilminster who is our Head of Leasing, who is here also. First of all, the kind of change that's occurring out there is very recent in terms of a real trouble on the horizon. And so, we don't really have hard sales numbers, if any, from this month yet, for example, or even last month. So this is anecdotal.

But one other things that is really interesting including the example that you laid out is, when you have Linens and they are doing GOB sales and will probably doing this through Christmas, they are putting price pressure on Bed Baths. So it's kind of hard for Bed Bath to charge normal retail prices when you can go to Linens and gets the Bath offers whatever the GOB sales is.

So, I am not sure it help Bed Bath's profitability. I shouldn't be talking about them, then, we'll see. But logically, you've got that issue that creates some kind of a dislocation in the marketplace for a period of time.

I think that's a pretty common theme when you have competitors going out in all different segments and the consumer being able to buy a similar product even if its not same product, but something similar at significantly different prices. So I am not sure that's going to help all that much this holiday season, I don't know. Chris anything else that…

Chris Weilminster

I think Don you hit the big broader point what we're seeing in a couple of different areas. You talk about the home goods area, Bed Bath certainly will not benefit from the GOB sales of Linens. And what's interesting that's going on right now is usually, historically, when you look at bankruptcies they happened after the holidays because most retailers want to sell through their merchandise in the prime selling season. But what's happening now is, you have retailers going bankrupt prior to the holidays, which will put stress on the healthy retailers like Bed Bath.

Don Wood

And most of that is really capital markets.

Chris Weilminster

And think about Mervyns. I mean, Mervyns right now is also doing store closers. What that will do to Kohl's and some of the other [softgrade] operators, and the same thing's happening with Best Buy and Circuit City. So, hopefully, that gives enough insight.

Unidentified Analyst

Sure, yeah. And then just one more question. Switching gears to acquisition, what are your current thoughts on the acquisition environment going forward? And what sort of IRRs are you targeting? And then, do you feel that the spread in those requirements for a high quality A versus B, C type asset has widened more today versus, say, three or six months ago?

Don Wood

Oh gosh, it's so early to tell. Things haven't settled. We got to figure out where the world settles, but Jeff what do you think?

Jeff Berkes

Yeah, I think on start to the tailend of your question first, I definitely think going forward, you're going to see a widening of returns between primary markets and secondary and tertiary markets, and centers that are well-located and well-leased versus those that aren't. One other thing that happened in '06 and '07 when everybody was so exuberant and debt was so available and so cheap, that Gap narrowed, and when the opposite occurs, the Gap is going to widen out. And that's historically been the case.

In terms of how people are pricing deals and what's going on right now, I can tell you that there are a couple of big trades in our target markets that were priced over this summer. One actually closed over this summer, one didn't close until early October. Institutional quality assets, one in South Florida, one in Northern California that traded in that 7.5 to 8 on LIBOR to IRR range.

And as we move through the summer, some of the other deals that came to market that have either been dropped or haven't been done yet, and IRR drifted up into the low eights. And since that time, there really hasn't been a lot of stuff brought to market and priced.

Obviously, there are some deals on the market right now, but I would hesitate to really draw any conclusions from those because their assets are needed to be sold for whatever reason, and generally don't have good going forward NOI growth prospects, in fact, maybe they are negative.

So if you are looking at some of the stuff that's being talked about right now, I don't really think that's a good indication of where we're headed. But clearly, we're in the mid eights, and heading on 10-year unlevered IRR basis, and won't really know where it shakes out until the dead markets come back.

Unidentified Analyst

Okay. Thanks so much for that.

Operator

And the next question is from the line of Christie McElroy with Banc of America. Please proceed.

Christie McElroy - Banc of America

Hey, good morning guys. Don, just following up on your comments about being more selective in the use of capital. As you started thinking about projects to be slated for 2010 completion of those that are currently listed in the future potential pipeline, would you expect to slow your pace of new developments pending in this environment? I know you've been targeting around $100 million a year. Are you underwriting projects differently in the current market?

Don Wood

Well, yeah. I'd have to say we are, Christie. And you know this is all driven by trying to figure out what's the long-term cost of capital is going to be. The last thing in quarter we want to be doing is kind of using old metrics to evaluate moving forward.

I can tell you though, there are a bunch of projects that we are either in the middle of that we will not slowdown one bit. In fact, whether you are talking about Assembly Square or whether you are looking at the early planning stages of Mid-Pike and Bala Cynwyd, we're very confident we're going to be able to create significant value and we want to be out there in the marketplace with those products when they are ready, which will be a couple of years from now.

Turning this [pick or drop] completely now is not something we want to do, because we just can't turn it on very quickly, it obviously, is a long-term business. So, having said that to the extent new projects are being revaluated now, it's harder to figure out whether they make or not. So we know what longer term cost of capital is going to be. So, there is absolutely truth in your basic assumption but don't take that too far to suggest that you won't see the continuation of stuff that we've got already moving.

Christie McElroy - Banc of America

So the leasing on those projects that you referred to, that is still kind of going on plan?

Don Wood

Yeah. Well, I guess we really have to talk about the specific projects. A lot of the stuff that is under construction today had leasing basically done in it, and we're in very good shape. The long-term stuff like in Assembly Square or like Mid-Pike, it's just too early to have started the leasing and that will happen in the year and a half to two years from now. So we'll see what kind of environment we're in then, but it's too early to pull back on those.

The only exception I have for that is the construction that we have added Santana Row, which as you know is not a big project. It's a $40 million project where we're looking at that construction to be done late in 2009. And that's office over retail, that's stuff we couldn't release. So there is some exposure there in terms of 2010, but again, it's a very small part of our business.

Christie McElroy - Banc of America

Okay. And then Andy, regarding the $200 million term note that matures next November, it looks like the swap six buyer next week. Do you plan to put new shops in place? What are your options there? And how would your debt cost change?

Andy Blocher

Yeah. The swap rate that we got on those were in the 27, someone would say. LIBOR, I saw it reset down earlier today. We're certainly getting closer, I feel a lot better than about that than I did in two weeks ago. But we really do want to maintain as much flexibility as we can. My view right now would be to leave that floating for the near-term.

Christie McElroy - Banc of America

Okay. And you don't have another extension option on the term loan correct?

Andy Blocher

That's correct.

Christie McElroy - Banc of America

Okay, great. Thanks guys.

Operator

And the next question comes from the line of Paul Morgan with FBR. Please proceed.

Paul Morgan - FBR

Good morning. On the G&A drop, how much of that should I consider to be a good going forward number? What do you think our run rate for '09 will be?

Andy Blocher

Hey, Paul its Andy.

Paul Morgan - FBR

Hi.

Andy Blocher

For '09 you're probably looking at $5 million to $5.5 million a quarter.

Paul Morgan - FBR

Okay, great. And then, I think Don you mentioned something about rent relief and there have been a number of retailers making comments that they are having a lot more success these days with getting rent relief on in-place leases. And I was just wondering, what you are seeing? What type of tenant is? Are you more inclined to [grain] at these big box retailers that are on the verge of these mom and pops? And what your philosophy is there?

Don Wood

Philosophically I can tell you, it is very much a tenant-by-tenant negotiation or discussion. In preparation for a question like this, I was really trying to figure out whether we can make any kind of broad assessment that if this type of tenant or that type of tenant or whatever, and we're really can't. This is pretty broad; I mean this is affecting most different categories of retailers now, generally, in the United States. And so when we're talking about rent-relief discussions or even new leases and what the rent is going to be and what the terms are going to be, it's very much specific property related.

I can tell you that, I mean, maybe this is obvious, but by having the better properties, one other things we are proactively doing is trying to find tenants who are in the secondary, maybe the second-best shopping center or the third-best shopping center in a market and trying to incite them to come to the best shopping center in the market, if that's what we have. And then, that's a very specific leasing goal.

We're trying to create demand, such that we have more leverage in those leasing negotiations. But we'll have better luck on the best properties. We'll have less luck on the not-as-good properties. And so, it really, Paul, is a very, very, like everything, real estate specific, and tenant specific negotiations.

Paul Morgan - FBR

Thanks. And then Andy, you threw out there in your scenarios; it's not easy for you to come up with numbers that gets you to below your growth rate for this year. I would assume that a lot of those scenarios would entail slower internal growth at least. I mean, what are the drivers that might offset lower occupancy next year to get you to the same rough growth number?

Don Wood

Yeah, I want to jump in on that. Paul, you heard him wrong. He didn't say that he can't see us growing at 7% next year, which is our growth rate or so this year. He said, he can't see us below this year's number. So, our guidance…

Paul Morgan - FBR

You mean, just absolute FFO number?

Don Wood

Absolute FFO number.

Paul Morgan - FBR

Okay.

Don Wood

So, there's two giant unknowns here, right? One is basically the occupancy number. How many bankruptcies and what that does to physical space which goes dark for that period. We certainly are anticipating higher vacancy next year. And we're trying to model in some kind of number, but the range is big.

So for perspective, I can tell you that and this would never happen in one year but depending on our prolonged, Federal's been here a long time and we went back we looked at data going back into the 80s. And the lowest occupancy this portfolio has ever had was in the 91% range or so, and that was in 1990-1991. Even at that time and Chris can tell you because he was here, he's a million years old. There was still leasing being done and so that's where it got to.

Now, next year we are certainly not going to be down there, but we are going to see some bankruptcies and we're going to see some vacancies that comes out of that. How much that is makes it hard to estimate? And the second thing is on the refinancing of debt that comes due next year and it doesn't come due till October or December, but we're certainly not going to wait till October and December to refinance. And so, what the cost of that money is going to be when we do? Well, on average certainly be higher.

And so the combination of those two things makes it pretty clear that it will be very difficult for us to grow 7%, 8%, 9%, 10% over this year. But also, when you make some reasonable assumptions, pretty clear, that we'll hit this year's number or higher, where in that range is what makes us so tough to talk about. And that's when Andy was saying in his remarks.

Paul Morgan - FBR

Okay. So the flat FFO scenario would be pretty bearish in terms of what you would have to expect for bankruptcies over the course of the year.

Don Wood

Yes. It would.

Paul Morgan - FBR

Okay. Thanks.

Operator

And the next question comes from the line of Jeff Donnelly with Wachovia. Please proceed.

Jeff Donnelly - Wachovia

Good morning, guys. A few questions for you on the leasing front. Don, some of your competitors have more of like I call the centralized leasing model because they predominantly deal with national retailers, whereas others have more numerous regional [on site] offices with the focus on I guess local or regional banks. In your opinion, is there a structure here for the leasing world that should benefit disproportionally given the leasing environment that lies ahead?

Don Wood

Well, Jeff. It's a good question. We are a centralized organization modules, certainly in terms of our anchor deals in an absolute way. While Chris Weilminster is here with us run leasing for the company. His specialty is the big deals and he is the anchor guy. And I think Chris would certainly agree that having the purview to be able to do what needs to be done across jurisdictions is really important right now.

And in fact, these are all negotiations and it's all about leverage and it's all about satisfying what that retailer needs at the same time doing what's right for the trust, that balance I think is better if you can look over the entire portfolio. Dividing concur strategy is certainly one that if I'm a retailer I'd be deploying if I were dealing with somebody in one market and somebody else in another market and somebody in the third.

So we're happy to be centralized in terms of the anchor deals. But at same time, you've got to be local on the shop stuff and you better be in touch with what's going on in that specific marketplace and you better be clear on the help of that local retailer, and on what that local retailer needs to do to get through. Or if they are not going to get through, they are moving out and they move it through. So I think the combination Jeff, centralized anchor and local small shop has to be at least in my view, the best way to position a difficult environment.

Jeff Donnelly - Wachovia

It's helpful. I guess related to that, has there been any change, even subsequent to quarter end in the shop tenant defaulted delinquency rates?

Don Wood

I don't think so in terms of shop tenant delinquency rate, there has certainly been a lot more October consternation, which maybe a [apparel] to higher delinquency rates coming forward. I suspect certainly, if the ability for shop folks to find financing is not better than it is today, then it will have to be harder. And there has to be higher delinquency rates.

On the other hand, to the extent money opens up a bit, I think that impact will be significantly less. But you've definitely heard, October clearly has become far more pessimistic from almost every view of shop, regional, big box and land lords. So it's pretty pervasive.

Jeff Donnelly - Wachovia

This might be two open ended of a question, but I guess, if and when stress materializes and the tenant comes and even says that I have issues, do you have a preference for this point? How you resolve that situation? I mean, is it free rent? Is it going to present the sales agreements, somebody on your tenants or you try to shorten term?

Don Wood

I don't mean to, in any way suggest that hasn't started, that's been around big piece of the year, certainly those type of questions. And I got to go back to the way I answered the first question, that really is a tenant-by-tenant, location-by-location analysis. We don't want to put a broad brush on this is how we handle those situations, and if you knew our collections group which is very seasoned and it's been here a long time, in dealing with these situations.

If you knew them, you would know that they very much take it, especially on a shop side, very personally. And try to understand what needs to happen to get that tenant through, particularly if that tenant has been around for a long time, and has shown its ability to be able to be successful. The tougher ones are on the brand new deals.

So if there has been a lot of development in a bunch of companies, it would be interesting to me because a lot of new shop tenants where they haven't been able to prove themselves yet, and are opening up at a very difficult time in the environment. Those are tough calls to make. Those are calls that, do you want to help them limp along or do you not?

I know I almost answered every question, but it really depends on the specific real estate, what it does, and that's kind of where we are. You use whatever tools are in, whatever arrows are in your quiver.

Jeff Donnelly - Wachovia

And just a last question, Don just to clarify something. I know you are saying about being more judicious with your capital, I guess going forward. But does that mean that you will or won't remain an acquirer in Florida in the near-term if that's put on hold?

Don Wood

In the near-term in Florida, it's not that it's put on hold because you need to stay in the market; you need to understand what's going on. But you know what IRR we need on an asset that we seek today? I don't know. What do you think Jeff?

Jeff Berkes

Yeah, I think what Don is saying Jeff is, it's difficult to know whether or not you're getting a good deal on this environment until we have some clarity on that, which really comes back to, long-term what's the cost to capital? Sure, we're out there digging around like we always are, but it's really difficult to pull the trigger.

Don Wood

I can tell you, long-term there is no change. We want to be in Florida, we want this to shake out quickly. I don't know if it will but we want this to shake out as judiciously as we can, and then we want to be there.

Jeff Berkes

Again just a little bit more color. We view there is an opportunity and when that opportunity really starts and how long it lasts, remains to be seen. But, this is going to be an opportunity for us.

Jeff Donnelly - Wachovia

Last question, I guess, maybe for Jeff and Andy. Give us more color on the land and building area in the Bethesda, I guess, that overall land slop. And specifically, how you guys looked at the deal from a return on invested capital standpoint?

Andy Blocher

Yeah, I can give you the numbers for the deal, Jeff. Effectively, what we did is, we traded ground leases that we acquired when we bought the White Marsh portfolio, and when we bought the Eastern Development portfolio up in New England for the fee interest under some of the improvements in Bethesda. And what we bought, I believe was around 15 acres or so, with the land under the giant food store and then going across Arlington Road, land underneath New Arlington East building and some of the other improvements over there.

And what we sold or traded out was a land lease to loans, home improvement stores up in North Dartmouth which was part of the Eastern deal. A land lease to lows, up in White Marsh, land underneath an office building that was leased to John Hopkins Health Systems, and then a bank pad. And we basically bought on a cash basis at about an eight, seven cap and we sold on a cash basis, sold about a six cap on a Gap basis. So I think that spread widens 20 or 30 basis points.

We assume $24.5 million of debt and a weighted average interest rate of 5.3%. And we got back in security deposit. So borrowing $28 million of the cash including the security deposit, nice pump to earnings, got some flat assets out of our portfolio that, again, if you remember both of those transactions, one of the reasons we've agreed to buy those assets from the sellers is we thought that they were coming handy when opportunities like this arose and opportunities arose and we took advantage of it.

It was a real win for us and really a win for the other side of the transactions as well because it gave him a lot more visibility on delinquent time that could differ their capital gain stock. So, great deal all around.

Jeff Donnelly - Wachovia

Great, thanks guys.

Operator

And the next question comes from the line of Rich Moore with RBC Capital Markets. Please proceed.

Rich Moore - RBC Capital Markets

Hi. Good morning, guys, and Andy, I want to congratulate you on your new position and welcome to the credit nightmare. In that vein, I know you guys, you have a lot of unsecured debt, but it sounds like you are talking to some on the potential for some mortgage type debt. Can you give us a thought on what those conversations are like at this point and how they might for change perhaps over the last couple of months?

Andy Blocher

Yeah, Rich, let me give you a little bit on kind of what we're hearing on secured debt from a bank perspective and Jeff will follow-up with his discussions with insurance company. From the bank perspective, the market is still very much locked and there are deals that have been announced for either unsecured or secured term loan or credit facilities out there. A lot of these deals were deals that have been agreed to months ago that are just kind of closing now.

The types of spreads that we are talking about with the banks are in the, lets say, 200 to 300 range over a LIBOR, but the ability to actually get that done today is probably not real. It's more of theoretical spread than anything else.

At the end of the day, where we have the confident is the ability for us to contribute high quality assets. We have a very limited bank debt within Federal Realty already and very little leverage. We think that its just people who are thinking about credit, partners all that kind of stuff. We think that it's likely that we'll be able to check all those boxes appropriately when that market return.

Rich Moore - RBC Capital Markets

Okay. Do you see any before Jeff jumps in. Do you see any loosening in terms of the discussions, I mean are they more amenable than they were before or not really?

Andy Blocher

Yeah, I would say that they are. I think that they are maybe not today. But looking forward, they think that the beginning of '09 is likely to see kind of crack in the ice. And lot of our focus now is just being prepared. So when that window opens, we're able to hit those windows because those windows have been short.

Rich Moore - RBC Capital Markets

Okay. And then on the insurance side, what were you thinking there?

Jeff Berkes

Rich, I think over the summer and let me just be clear about something before I directly answer your question. What Andy said is correct. We're talking to people, but we're not out efficiently in the market trying to do a deal. We're working hard internally on running through the assets, making sure everything should shape from an underwriting standpoint. That kind of thing getting prepared, but not yet go in the market.

So, Andy talked to the banks, so I quite frequently, I talk to the Life Company lenders somewhat less frequently, but we're not out in the market trying to do a deal yet, because we don't think it makes sense to do that right now.

Spread wise, I think for kind of 50% to 60% of loan-to-value money, the Life company is up until. The Lehman meltdown were kind of 225 to 275 over, depending whether you're doing a five-year deal or a 10-year deal, probably at the wide end of that range for five-year and the narrow end of that range for 10-year.

I think that's widened out now, the 300, 350, and maybe more. You have a lot of insurance companies that aren't even quoting deals right now until the market settles down. So, that's kind of the range, where it shakes out, we won't know for a while.

But I think what Andy says is right, the beginning of next quarter where everybody has their allocations and a little bit more visibility on how all the new banking capital is going to work through the system. This is the time to start talking. And we're getting prepared to do that talking now.

Don Wood

And Rich, just to clarify, I mean, we have not made a firm decision that we are going secured. We absolutely still have that unsecured option out there. It's just a matter of, do we have the flexibility of going either way.

Rich Moore - RBC Capital Markets

Okay. All right. Very good, guys. Thanks. And then, one more thing maybe for you Don. You were talking about the possibility and I realize it's a Board decision of raising the dividend as you do each year. And I am wondering, is this a year where you might not want to do that and conserve capital or even, I assume you guys are well above your taxable net income threshold, maybe even cut the dividend, so you have extra cash available?

Don Wood

No, I don't think so, Rich. I think when you look at the taxable income that we do generate, when you look at what our expectations are going to be, even if they are and as robust as they had been, and frankly, they may still come out that way. It's just uncertain at this point.

The incremental capital that we are talking about in terms of raising dividend is just small. And so, to kind of lead this to save a few million dollars, to lose a great asset of the company, and that is the demonstration of that dividend record. When you have increasing earnings and when you do have a very strong balance sheet, I don't think it would be prudent to cut that dividend. I don't think it would be prudent to leave alone.

Rich Moore - RBC Capital Markets

Okay, very good. Thank you, guys.

Don Wood

Thanks.

Operator

And the next question comes form the line of Michael Mueller with JPMorgan. Please proceed.

Michael Mueller - JPMorgan

Hi, Don. I know you're laid out of scenario where you talked about occupancy heading down next year, and there are a lot of unknowns based on bankruptcies. But, based on what you know right now in terms of store closings etcetera, where do you think the occupancy could dip to, based on just what's known today?

Don Wood

You know Michael, I'd take another 80 basis points or something like that. I mean, I'd say 50 to 100, something like that as we kind of model out and lay through what we see, a bit conservative, that may be what you should look at. It comes down to things like this, we've got, take Lenin. Lenin is a great example. We've got two of them, 73,000 square feet. One of them is at Mid-Pike.

Mid-Pike is being looked at very hard for redevelopment. So we had very little term left on that lease. That lease isn't going to be assumed, it's just going to go dark. And while we'll try to lease it up on a temporary basis, we're not going to have a lot of options in terms of not having that dark, that's probably going to be dark. When you look at the other one in Friendship Center, I can't tell you the number of calls we're getting to assume that lease, or if not assume it then negotiate with us in terms of what new tenants who want to be there.

Depending upon how things just like that happened, and where we'll be with Circuit City, we've got two Circuit Cities. One, that's under construction right now, I doubt they will perform on. And a second, that is in a good operating store. When you talk about boxes like that and whether they are assumed or whether they are not, or what specifically happens to those stores, there is different lot of variability.

And so that's kind of the issue I was raising, but if you're going to make an estimate, make an estimate of 80 basis points or so, lower than where we are.

Michael Mueller - JPMorgan

Okay. But Wood, you were talking about Circuit City etcetera. I mean that's not in the 50 to 100, that could be the incremental above what you know?

Don Wood

I've got an overall cushion; I don't know who it is.

Michael Mueller - JPMorgan

Okay.

Don Wood

Don't which Circuit City or who it's going to be. All I know is, it's a good time to keep in mind that no one tenant makes up more than 2.5% of our current income stream. It's a good time to keep that in mind.

Michael Mueller - JPMorgan

Sure. And when you are looking at the leasing spreads, north of 20% again this quarter, and you highlighted a bunch of leases from older centers that really drove the numbers up. When you dig into the '09 roles, is it also peppered with a lot of the older leases as well that can keep the spreads up even if the general trend is for a little bit contraction?

Don Wood

Yeah. It is I think almost, not necessarily every quarter but in every year you are certainly going to see good times and bad, some very good renewed deals where an old tenant paying a little bit of money gets replaced by new tenant paying a lot of money, even if that lot of money is not what it would have been in the best time. So there is still going to be those deals that happened.

Overall though, we do 300 and some odd deals a year, and the general trend is certainly going to be for most of those deals to be at lower spreads, I would think. And so, while I can't tell you any particular quarter which may look great or not so great, I can tell you over the year I think it will be hard for us to 23% next year.

Michael Mueller - JPMorgan

Okay.

Don Wood

But I certainly would still expect it to be positive.

Michael Mueller - JPMorgan

Great. Thank you.

Operator

And the next question comes from the line of Jim Sullivan with Green Street Advisors. Please proceed.

Nick Vedder - Green Street Advisors

Hi, it's Nick Vedder here. I had a quick question with regards to capital allocation. Given your strong balance sheet in the world where federal stock is trading at an implied 7.50% cap rate. How do you think about acquisitions versus buying back your stock?

Don Wood

Look, both of those questions right now are so tied up in how the business gets financed. Going forward, it's hard to separate those two things. Using debt capacity to buyback stock at what I agree with you is just, I don't think its prudent management since we truly don't know what the cost of that new money is going to be long-term, and we really don't know. And I'm very, very interested is, what opportunities are going to avail themselves over the next 18 to 24 months which is hard to believe that we shouldn't be able to really play very strongly in terms of what happens out there. But where that settles out is just really hard Nick to estimate right now with the credit markets as locked up as they are.

So we do absolutely look at the best investments out there, including our own stock, no question about it. For an ongoing business, we plan to be around for a long time. And as we do that, we want to make sure that if there are, distressed is maybe the right word, distressed real estate our there or distressed owners not distressed real estate because we're really going to buy the best real estate. But distressed owners that we can take advantage of, I would rather do that then buyback stock. To the extent the returns looks similar.

Nick Vedder - Green Street Advisors

Great. Thank you. Andy, you made some comments earlier with respect to leverage ratio both on a margin cap basis as well as the book value of assets. Where do you think that leverage ratio stands as a percent of your market value of your assets?

Andy Blocher

Well, I think that based on the comments that Don said, if we're looking at 35% debt-to-total market cap, and our assumption that we view the stock as not necessarily trading reflective of where we view the assets that make that up, obviously somewhat inside of there. I don't have a specific number.

Nick Vedder - Green Street Advisors

Okay, thank you.

Operator

And the next question comes from the line of Nathan Isbee with Stifel Nicolaus. Please proceed.

Nathan Isbee - Stifel Nicolaus

Hi, good morning. Gap made a bit of a splash too, if you are talking about closing 15% of the stores. What are you hearing from Gap regarding your 11 stores?

Don Wood

Chris?

Chris Weilminster

We've really looked at our rent-to-sales ratios with the Gap and feel very comfortable that the majority of our stores are in pretty good position with regard to that ratio and they will be stores that the Gap wants to keep. The Gap has approached us on a handful of the Old Navies that we have about trying to downsize. We are productively working with Gap. We are trying to see whether we can manage that.

But overall, I think the Gap used the real estate or the locations they have within our real estate as productive stores that they would long-term want to keep.

Nathan Isbee - Stifel Nicolaus

Okay. How are your stores comping against the overall Gap numbers?

Chris Weilminster

I mean they are down. The Gap stores our numbers when you look at the sales.

Don Wood

The overall, our stores versus all Gaps.

Nathan Isbee - Stifel Nicolaus

Correct.

Chris Weilminster

Yeah.

Don Wood

I believe we only have one Gap stores. As the Gap itself, the Old Navy stores were down a bit, I think were probably right in line with what we are seeing as far as our comp store decreases.

Nathan Isbee - Stifel Nicolaus

Okay. And are there any near term lease expression in the Gap portfolio?

Don Wood

We've got two of the Old Navy leases that are coming up, they tend to do shorter terms and while our negotiations with them right now, they have got options that they are making decision going.

Nathan Isbee - Stifel Nicolaus

Okay. Thank you.

Don Wood

Thanks, [Nat].

Operator

And the next question comes from the line of Craig Schmidt with Merrill Lynch. Please proceed.

Craig Schmidt - Merrill Lynch

Thank you. You probably commented on most of these points, but there were three data points that I was wondering just how concerned to be. The first the 90 basis points within leased, it sounds like you think that maybe echoed in occupancy in the coming year to the 10% increase on renewals on the cash basis and then three of the $23 to $24 TI prescript for the new leasing. I guess on the last two points I'm just wondering what is it that makes the renewals a little tougher in this environment and why is there TI increasing at this point a new lease?

Don Wood

Craig, it really comes down to the specific deal. I think when we're looking at renewals far away most renewals that we have, don't have a lot money that's going to the tenant. In some of those numbers you do see landlord numbers in there. In other words, to the extent we got to put new [HBAC] and to the extent the spaces is old and has to be redone. There are often times when that number will be in the TI number that you're looking at. It just depends on who is paying it frankly.

There's not a trend there that we're seeing in terms of that. So I think that's really much more in terms of the specific deals. In terms of the percentage lease turning into occupancy, I think that's right. I think as I say, the guidance I gave earlier in the call about reduced physical occupancy obviously translate through lease occupancy too. So I think that's the trend, going into the next 12 months that you are going to see continue. But I don't see it on the TI side, okay, at this point.

Craig Schmidt - Merrill Lynch

That's good. And then, I mean the 10% relative to what has been high teens to 20s on the renewals in the past is on a good run rate for the few quarters or do you think…

Don Wood

Tough question man. That really depends on the quarter. As I say, even when its renewals or new stuff, when you look at Federal, there is always a very often in any year, a couple of deals that make that number go higher, make that number go lower. I don't know how they'll give you guidance really as to what that rollover should be on renewals.

Other than to say, there is a general pressure to make that number lower. Now, to the extent that winds up being some of our better centers, maybe 10, maybe higher as it goes through there. But, I don't know, I guess I'd probably use just -- that 10 is probably not a bad number to guess going forward.

Craig Schmidt - Merrill Lynch

Okay; listen, thanks a lot.

Don Wood

Okay.

Operator

And the next question comes from the line of [David Spector] with UBS. Please proceed.

Jeff Spector - UBS

Good morning, it's [Jeff Spector]. Just quick question on the tenant front, are you more concerned about the Mom and Pop's, the National Retailers or the Big Box.

Don Wood

It's all of the above and none of the above in terms of more or less concerned. I mean look, we're dealing today with Linens and things, right. I suspect we'll be dealing tomorrow with that one or two Circuit City location. We'll be dealing with Boxes because they are national and everybody knows about them and its hits on every radar screen to some extent.

That same thing applies to shops and it applies to regional. But you got to get down to the productivity of the particular real estate and they are just not leased in the 19 million square feet that we own. There is not a trend that I can tell you that applies more to any of those categories. It applies more to specific shopping centers than other shopping centers.

I mean if you're going to look at some of the weaker shopping centers within Federal's portfolio, I can tell you that that applies almost all away through. Just as it applies less including the big boxes like I just mentioned on our better centers like Friendship has, so it really does come down to accessing the market, the submarkets and the real estate. And if you can cut it that way rather than cut it box regional small shop you'll get a more accurate answer.

Jeff Spector - UBS

Okay. And then the mom and pops, I mean who is replacing a mom and pop as they are leasing their store. Are there new people, new mom and pops opening up today or--?

Don Wood

Some but not less. And frankly, there is two things that are really causing that to be a lot less. You know the ability to get financing for the store is certainly quiet a bit, but the much bigger piece of it is mindset. Just don't feel like taking that chance right now. And that I am hopeful as the bank market opens up a little bit and as this election gets behind us, that makes that psyche change, coupled with lower gas prices, could be a good thing.

Jeff Spector - UBS

Okay. And then just two statistics. What was your occupancy back in '80, '81? Do you happen to have that? I think you said, in 1991 that was the lowest?

Don Wood

Yeah. I can't tell you '80, '81. I can tell you through most of the period that we looked at, it was in the 93%, 94%, 95% range.

Jeff Spector - UBS

Okay. And then last question. Andy, can you quantify the unencumbered pool -- like maybe unencumbered NOI?

Andy Blocher

I don't have the unencumbered NOI in front of me. I can follow up with you online, I mean offline. Just from a book perspective, like I said it's 80%.

Jeff Spector - UBS

Great. Thanks guys.

Operator

And the next question comes from the line of Philip Martin with Cantor Fitzgerald. Please proceed.

Philip Martin - Cantor Fitzgerald

Good morning. Don, just following up on one of your earlier comments this morning, certainly tenants, even the stronger ones are expected to be having a more difficult time in this environment. But knowing the tenants and markets as well as Federal does, how much opportunity is there or isn't there in identifying tenants at competing centers, and enticing them to move to a Federal center?

Don Wood

We think it's -- I'm sorry, go ahead Philip.

Philip Martin - Cantor Fitzgerald LP

No, I just have to think on top of a weaker economy, I have to think that tenants may just be suffering somewhat unnecessarily from a poor location. Is there anyway to entice or provide these tenants with some anecdotal evidence in terms of possible increases?

Don Wood

Absolutely.

Philip Martin - Cantor Fitzgerald LP

I have to think it's an opportunity for Federal?

Don Wood

It is a huge opportunity for Federal. It's the point I was trying to make before that, it's a key part of our leasing strategy to basically, proactively, Rockville Pike is good example. There are tenants trying to get on the Pike for a long time, okay? Congressional is a good example of the best property in my view, and obviously that's from a sales productivity perspective. Only the best property is on the Pike.

There hasn't been the opportunity to get in here. There will be opportunities to get in here. And we're not just putting up for lease sign on the front of the property, we're proactively going out and seeing who we want to be in you, and how to get them in. And so this time, and the next year and two will be a very good time to be able to upgrade the merchandizing. And you know what we show them?

We show them the overall tenant sales and we told you in the past that overall tenant sales at Federal centers are far in excess of national averages, and I think they are higher than all of our competitors also on an average. And so that's a very enticing thing and it's a key part of exploiting the better real estate over times like this. That doesn't mean that we won't have vacancy for a period of time and therefore loss [in a way] we will.

But as we come out of this period at time, we have to be in a better position by the very nature of the real estate that you're talking about. We have to be able to come out here and grow faster than we would have otherwise. This is just an acceleration of that vacancy.

Philip Martin - Cantor Fitzgerald LP

Okay. Thank you.

Operator

And at this time ma'am, there are no further questions. You may continue.

Gina Birdsall

Thanks everybody. Thanks for calling and we'll talk to you next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Have a good day.

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Source: Federal Realty Investment Trust Q3 2008 Earnings Call Transcript
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