Inland Real Estate Corporation Q3 2008 (Qtr End 9/30/08) Earnings Call Transcript

| About: Inland Real (IRC)

Inland Real Estate Corporation (NYSE:IRC)

Q3 2008 Earnings Call

November 5, 2008 3:00 pm ET


Dawn Benchelt – Investor Relations Director

Mark E. Zalatoris – President & Chief Executive Officer

Brett A. Brown – Chief Financial Officer, Vice President & Treasurer

D. Scott Carr – President of Inland Commercial Property Management, Inc.


Paul E. Adornato – BMO Capital Markets Corp.

Jeffrey J. Donnelly – Wachovia Securities, LLC

[Steven Everett – Malty Financial]

[Charles Donner – ISI Securities]


Welcome to the Inland Real Estate Corporation 2008 third quarter earnings conference call and webcast. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator Instructions) Please note this conference is being recorded. Now I’d like to turn the conference over to Dawn Benchelt.

Dawn Benchelt

Thank you for joining us for Inland Real Estate Corporation’s third quarter 2008 earnings conference call. The third quarter earnings release and supplemental financial information package have been filed with the SEC today, November 5, 2008 and posted to our website We are hosting a live webcast of today’s call which is also accessible on our website.

Before we begin, please note that today’s discussion contains forward-looking statements which are management’s intentions, beliefs, expectations, representations, plans or predictions of the future. There are numerous risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. For a more complete discussion of these risks and uncertainties, please refer to the documents filed by the company with the SEC, specifically our annual report on Form 10K for the year ended December 31, 2007.

Participating on today’s call will be Mark Zalatoris, Inland’s President and Chief Executive Officer, Chief Financial Officer Brett Brown, and Scott Carr, President of Property Management. Now I’ll turn the call over to Mark.

Mark E. Zalatoris

Since our last call, stock markets around the world have taken dramatic swings. The credit markets have seized further and economic trends have continued to weaken. With the presidential election now behind us, we will follow with interest the actions of the new Administration and Congress take to right the economy, strengthening our financial system, and get the country back on track again.

Like most companies, our results have been affected by the economic downturn and significant volatility in the equity and credit markets. That being said, our portfolio which is largely focused on value and necessity retail continues to perform relatively well throughout a difficult market environment.

In my comments today I will highlight our results and provide an update on our joint venture activities, Scott will follow with a detailed discussion of our portfolio performance, and Bret will then provide a review of our financial results.

For the third quarter we reported funds from operations or FFO of $0.36 per share, an increase of nearly 3% over the $0.35 per share reported in the third quarter of 2007. We delivered the moderate increase in FFO despite a non-cash charge of approximately $1.2 million or $0.02 per share related to the other-than-temporary decline in value of certain investment securities.

Same-store net operating income was essentially level with the third quarter of 2007. For the nine-month period same-store NOI increased 100 basis points primarily due to increased lease termination income recorded last quarter to leasing gains we have achieved and a decrease in non-reimbursable tenant expenses.

I’m pleased to report that leasing activity was strong for the quarter. For the total portfolio we signed a total of 92 leases comprising more than 733,000 aggregate square feet of gross leasable area. This is an increase of almost 94% compared to square footage leased in the same period one year ago. Of this amount new leases were signed for a total of approximately 152,000 square feet, a quarter-over-quarter increase of over 280%.

The leasing gains we have achieved have helped to blunt the impact of loss of income related to the Wickes Furniture and Linens N Things chain failures. Regarding these big box vacancies, the good news is that we continue to have success with our re-tenanting efforts due to the strength of our asset locations. Scott will provide more detail on our leasing activities a little later in the call.

We also delivered solid rental rate increases on both new and renewal leases for the total portfolio. Average base rents increased over 10% on 20 new leases and more than 8% on 71 renewal leases over the expiring rates. Strong leasing results reported this quarter demonstrate the fundamental affect that our well-located properties remain in demand with retailers and consumers. Our concentration of assets within our core markets of Chicago and the Twin Cities enables us to offer a variety of locations in these regions to healthy retailers looking to gain market share.

We believe that our leasing successes are further strengthening our portfolio and will provide income benefits well into the future.

Of course in this credit constrained market place portfolio stability must be matched with a strong balance sheet. To that end, in early September we closed a two-year $140 million term loan with very attractive terms. We used the proceeds to retire all remaining 2008 maturities and also to pay down our three-year $155 million revolving line of credit that we had renewed back in April. We expect our line of credit combined with cash flows from operations to provide more than adequate resources to address future secured debt maturities including the limited amount of mortgage debt due to mature in 2009.

To sum up our current financial position, our balance sheets in order and our debt maturities are well managed.

Our business strategy has remained the same throughout all market cycles, a consistent focus on necessity and value based retail in Midwest markets with diverse economies and sound demographics. The assets in our core portfolio cater to the everyday needs of consumers rather than their discretionary or luxury wishes. Our retailers provide groceries, dry cleaning, prescriptions, quick serve meals, and discount apparel and goods. Our asset type although not immune to economic headwinds tends to perform relatively better through economic downturns.

This focus on value and everyday retail within stable markets is supported by an experienced management team, limited development exposure and a strong balance sheet. We believe these fundamentals position us to operate successfully through the current economic environment as well as an improved market place down the road.

I’d now like to provide a brief review of asset transactions and joint venture initiatives.

Turning to the IREX joint venture. This venture has provided a valuable acquisition and management fee income stream that should continue to grow over time as the venture acquires additional assets. Although we reported lower fee income from the venture for this quarter, year-to-date IREX joint venture fee income has in fact increased over 15% compared to the same nine-month period last year.

During the quarter we completed the syndicated sales of the Greenfield Commons Shopping Center and the three office properties acquired in sale-leaseback transactions with AT&T. With the sale of these assets to 1031 exchange investors, all properties that we acquired through the IREX joint venture in 2007 have been sold. Through these sales the capital we invested to acquire the assets has been fully recovered and recycled into new IREX joint venture acquisitions.

Last quarter we contributed Fox Run Square to the IREX joint venture. This is a 143,000 square foot grocery anchor shopping center in Naperville, Illinois. We expected that this necessity focused center would sell out quickly due to its tenant composition and prime location. As anticipated the property’s already fully subscribed with closings expected to be completed by the end of the year.

Last quarter we announced that in July the company contributed approximately $60.8 million of cash to the IREX joint venture to purchase four office buildings and sale-leaseback transactions from Bank of America for an aggregate purchase price of $152.6 million including $90 million of secured debt. The properties comprise a total of approximately 840,000 square feet of space and are 100% leased by Bank of America.

Taking a look at our current IREX joint venture inventory, the portfolio of properties to be sold consist of the Bank of America buildings and an 18,000 square foot office building in Merrillville, Indiana that is 100% leased to the University of Phoenix. We believe these properties will be attractive to 1031 exchange investors because of their high quality tenants and the long-term leases which are structured with annual increases.

For 2008 we anticipated sourcing $100 million in new acquisitions for the IREX joint venture and with the recent acquisitions of the University of Phoenix property and the four Bank of America office buildings, we have exceeded our annual IREX acquisition goal by over 80%.

That being said, in light of the turmoil in the credit and financial markets, we believe we may take a little longer to completely sell out the current inventory of the IREX joint venture properties and this timing issue has impacted our IREX fee income expectations for 2008. Some syndicated sales previously anticipated for 2008 may now occur in 2009. However we do expect to eventually record the fee income from IREX JV syndication sales in the first half of 2009. Brett will provide more detail on our current expectations for 2008 fee income in his comments.

In the interim the fully occupied properties held in our joint venture are providing a valuable income stream to the company. The income generated by these assets more than covers the cost of capital used to acquire them. Future acquisitions for the IREX JV will depend on the timing of pending syndications and the acquisition markets.

Moving to our development joint ventures. Given current market conditions we have not initiated any new development projects at this time. Instead we are systematically working through our existing project pipeline with an eye to holding development costs to a minimum. Although the lease-up period is lengthy in certain developments due to the economic slowdown, we are making progress with these projects.

A couple of highlights include: At North Aurora Towne Center in Illinois, the Best Buy build-to-suit was completed during the quarter and turned over to that retailer which opened for business on October 3. In addition we sold for $5.3 million a 20,000 square foot free-standing La-Z-Boy furniture store that opened in the first quarter to a third party investor.

Construction has been completed at our Orchard Crossing development in Fort Wayne, Indiana and we have active tenants in all but one building. As we reported last quarter, in July we sold for $1.2 million a total of 1.2 acres of land to Arby’s for a 3,500 square foot fast food restaurant.

Leasing activity has been very strong at this value-oriented center. To date we’ve signed leases for approximately 60% of the gross leasable area. Gordman’s, a discount fashion and home goods retailer, opened a new 50,000 square foot store in September. A 6,500 square foot Famous Footwear store opened October 24. Leases have also been executed with fashion retailers Maurices and rue21 as well as quick serve restaurant Kidoba, all of which are expected to open in the fourth quarter of this year.

In addition we’ve negotiated a lease with another national fashion retailer and have received a letter of intent from a national discount retailer. These prospective tenants are not included in the 60% figure I just quoted. Now that most of the anchors and junior anchors have been signed, we expect to fill the remaining small shop space at the center relatively quickly.

Our Savannah Crossing development in Aurora, Illinois is on track as well. The Wal-Mart anchor and other in-place retailers are generating a high level of consumer traffic to the center. During the quarter a Walgreens pharmacy store was completed and opened for business on October 24. The Walgreens store as well as the multi-tenant out-lot buildings are currently being marketed for sale. We have three pads left to sell at this location and have a letter of intent from a quick serve restaurant for one of these.

Moving to dispositions, during the quarter we sold for approximately $7.4 million an 86,000 square foot neighborhood shopping center in Madison, Wisconsin. Proceeds from that sale were used to pay down debt and for general corporate purposes.

With that I will turn the call over to Scott for additional details on our portfolio operations.

D. Scott Carr

No doubt these are challenging times for retailers and shopping center owners alike. The consumer pullback, credit crunch and lack of vendor support have pushed some well-known retailers out of business and we expect that other retailers may have to close stores as well. In response we continually refine our approach and redirect our resources to maximize results in this difficult leasing environment.

We have placed an increased focus on our existing tenant base to maintain occupancies. We’re carefully monitoring the health of our current tenants and working with them to maximize their chances of success and to manage our risk. Our efforts include downsizing of tenant spaces, relocating tenants and restructuring rents to help them better manage their occupancy costs. This strategy limits our exposure while creating new retail opportunities for other tenants. Our concentration of properties in core markets provides a broader opportunity to work with our existing retailers to relocate them to a less expensive yet equally viable location.

Regarding new leases we are seeing that even healthy retailers have curtailed their expansion plans and are much more deliberate with their leasing decisions. The period of time from receiving an indication of interest for a location to obtaining a signed lease has lengthened considerably. This has become the new reality, not only for development sites but also in lease negotiations for new stores in prime locations. We are doing everything in our power to speed up the leasing process including implementing a one-day turnaround policy for lease production.

The good news is that although the process may be taking a little longer, we are still signing deals with market-leading retailers who want to open new stores or who are capitalizing on opportunities to improve their locations and market share by relocating to our centers.

As Mark said, our leasing activities are driven by the strength of our locations. A case in point is the success we have had to date with our efforts to re-tenant the former Wickes furniture stores. In the first quarter we executed a replacement lease with Sports Authority for the former Wickes store in Minnesota. The new store opened for business in October and that space is once again on line and generating income for the company.

During the third quarter we signed a lease with Nordstrom Rack for the former Wickes store at Orland Park Place in Orland Park, Illinois. Orland Park is one of the top five trade areas in the Chicago market and our center is the dominant power center in the region. The new Nordstrom Rack store is expected to open in the first half of 2009.

I am pleased to announce that last week we signed a lease with Bye Bye Baby for our former Wickes store at Woodfield Plaza in Schaumberg, Illinois. Bye Bye Baby, a Bed Bath & Beyond concept, is making their initial market rollout in Chicago. As arguably the leading submarket within the Chicagoland MSA, Schaumberg is a priority location for new market entrants and Bye Bye Baby’s choice of Woodfield Plaza for their second store in the Chicago market is further proof of the strength of our locations.

Regarding the remaining two Wickes locations, lease negotiations are in process with a national discount retailer for one of these spaces and a letter of intent is in process for the remaining location.

Linens N Things recently announced that that chain will liquidate and we have a total of three Linens N Things stores in our consolidated portfolio with an annual base rental exposure of $1.5 million. Leases were rejected for two of our Linens N Things stores in early August and we expect to receive the remaining store back by year’s end. These spaces are in great locations within strong regional shopping hubs. We are confident that we will be able to re-tenant these spaces and enhance the value of these centers but we are also realistic in our expectations that this process may take a bit longer in today’s environment.

Our leasing successes are not limited to remediation of recent big-box bankruptcies. The opportunistic repositioning of assets is central to our asset management strategy and we have recently completed two such transactions.

During the second quarter we terminated the lease with the vacant Roundy’s grocery store and simultaneously executed a lease with a replacement tenant. In doing so we filled a long-term vacancy, upgraded the tenancy of the center and recorded approximately $1.1 million of lease termination income in the second quarter.

During the third quarter we executed a similar transaction for an unoccupied Cub Foods at a center held in our joint venture with New York State Teachers Retirement System. The grocery store was closed after SuperValu’s acquisition of the Cub Foods chain to resolve anti-trust concerns leaving this densely populated upper middle class community without a large discount grocer. In August we terminated the Cub Foods lease and simultaneously executed a lease with discount grocer Food for Less, a division of Kroger, which is expected to open in the first quarter of 2009.

In conjunction with this transaction we recorded an increase in equity and earnings of unconsolidated joint ventures of approximately $2.5 million. The lease termination fees will more than fund the cost of repositioning these assets and result in substantial value enhancement at these properties.

Turning to the performance of our same-store portfolio, which includes a total of 125 properties that were owned and operated for the same three- and six-month period in 2008 and 2007. Same-store net operating income for the quarter was $30.6 million essentially level with the same-store NOI for the third quarter of 2007. The quarter-over-quarter comparison demonstrates that the leasing gains we have achieved including the re-tenanting of the vacant Roundy’s have helped to mitigate the impact of the loss of income from the Wickes furniture and Linens N Things bankruptcies.

For the nine months ended September 30, 2008 same-store NOI increased 1% to $92.1 million from the same period last year. The increase was due to increased lease termination fee income primarily from the Roundy’s re-tenanting, ongoing leasing gains and a decrease in non-reimbursable related expenses. These items were partially offset by the loss of income from big-box vacancies.

We continue to project that same-store NOI will be flat to slightly down for the full year 2008. However we are consistently recording increases in same-store rental income despite the impact of the big-box chain failures. We expect to build on these gains over time as we remediate the remaining vacancies.

Turning to occupancy for the total portfolio, which includes consolidated and unconsolidated properties owned in our joint ventures, leased occupancy was 94.8%. Financial occupancy for the total portfolio was 94%. Leased occupancy declined 110 basis points and financial occupancy declined 170 basis points over the same period in 2007 primarily reflecting the Wickes and Linens N Things vacancies. However on a sequential basis, total portfolio leased occupancy increased 120 basis points and financial occupancy increased 40 basis points. These increases reflect our success in re-tenanting the former Wickes stores.

Leased occupancy for our wholly owned or consolidated portfolio was 94.6% consistent with the third quarter of 2007 and an increase of 100 basis points from the prior quarter. Same-store financial occupancy was 94.1%, a decrease of 150 basis points from third quarter 2007 but an increase of 100 basis points over the second quarter.

Mark earlier highlighted our leasing gains for the total portfolio and I’d like to focus on our consolidated portfolio, which is comprised of the properties that we own 100%. In the third quarter we signed a total of 74 leases for the consolidated portfolio aggregating over 439,000 square feet of GLA. To break out leasing detail, 17 new leases were signed with an average rental rate of $20.47 per square foot, an increase of 15.4% over average expiring rents. Fifty-seven renewal leases were signed with an average rental rate of $11.21 per square foot, an increase of 9.85 over expiring rents.

We believe these solid leasing volumes and rental rate spreads demonstrate the value of our premier infill locations and defensive property types. Our assets are consistently delivering stable cash flows that generate solid long-term returns for our investors.

Now I’ll turn it over to Brett for a view of our financial performance.

Brett A. Brown

For the third quarter 2008 FFO was $23.8 million, an increase of 4.2% compared to the third quarter of 2007. FFO per share for the quarter was $0.36, an increase of 2.9% compared to $0.35 per share in the prior year quarter. Third quarter FFO increased quarter-over-quarter primarily from increased income from 2008 acquisitions and increased equity in earnings of unconsolidated joint ventures which includes gains from land sales as well as income from the unconsolidated properties, specifically the large lease termination fee received in conjunction with the new replacement lease that Scott mentioned.

These increases were partially offset by a noncash charge of $1.2 million or $0.02 per share to record the decline in value of certain investment securities that were determined to be other-than-temporary. Lower fee income from the IREX joint venture compared to the third quarter of ’07 also impacted FFO for the quarter and as we have said in the past, fee income from the IREX joint venture varies quarter-to-quarter depending on the timing of sales to 1031 exchange investors.

In the nine months ended September 30, 2008 FFO increased approximately 1% to $70.5 million. FFO per share for the nine-month period was $1.07 equal to the comparable period last year. The increase in FFO for the nine-month period is primarily due to increased income from ’08 acquisitions, a deferred partnership gain of $3.2 million recognized last quarter, an increase in gains on sales of investment securities, and an increase in earnings recorded through our unconsolidated joint ventures.

These earnings were partially offset by a $700,000 impairment recorded to adjust the book value of a property that was subsequently sold and by aggregate noncash charges of approximately $3.7 million or $0.06 per share related to the other-than-temporary impairment of certain investment securities.

Net income for the quarter was $9.7 million a decrease of 3.8% compared to the third quarter of 2007. On a per share basis net income was $0.15 equal to the year ago quarter. Net income for the nine-month period was $30.1 million, a decrease of 7.3% compared to the same period last year and net income per share year-to-date was $0.46 a decrease of 8% compared to $0.50 per share for the nine months ended September 30, 2007. The decrease of net income for the quarter and year-to-date is due to the same items that impacted FFO in the comparable periods plus greater depreciation expense from acquisition closed during the year.

Turning to revenue, total revenues for the quarter increased 3.7% to $48.6 million from the third quarter of 2007. The revenue increase for the quarter is primarily due to increased rental income from leasing gains and the Bank of America acquisitions partially offset by lower fee income from the IREX joint venture. For the nine months ended September 30, 2008 total revenue was $145.8 million, an increase of 4.5% for the comparable prior year period. The increase for the nine-month period was also due to increased rental income and increase fee income from joint ventures compared to the prior year period.

I would like to note that income from the Bank of America properties acquired for the IREX joint venture as well as other properties that we buy for the venture moved from the revenue lines to a net basis in equity and earnings of unconsolidated joint ventures once the first sale to a 1031 exchange investor is completed.

As Mark mentioned earlier, fee income from unconsolidated joint ventures decreased quarter-over-quarter due to more sales to 1031 exchange investors completed in the prior year quarter than in the third quarter of ’08. However for the nine-month period fee income from the IREX JV increased 15%. Total fee income from unconsolidated joint ventures which includes both the IREX and [Meister’s] joint venture increased almost 26% to $4.1 million from the comparable period in 2007.

Moving to the balance sheet, displacement in the credit markets has brought balance sheet strength to the top of investors’ checklists. The company’s access to capital and ability to address near-term debt maturities are of critical importance in this environment. Given that reality, we would like to remind you of the actions we have taken this year to further solidify our financial position.

In April we renewed for three years our $155 million revolving line of credit with a lending group of five banks. We utilized funds available through our line of credit primarily as a source of opportunity capital for our IREX and development joint ventures. Borrowings under the line bear interest currently at a variable rate equal to either 150 basis points over LIBOR or 25 basis points over the prime rate in effect at the time of the borrowing. It’s at the company’s option to choose either rate.

We expect to realize additional pricing benefits after we achieve an unencumbered asset value to unsecured ratio of 1.5 times by the end of the year. As of September 30 our line of credit had an outstanding balance of $50 million.

As Mark said, in early September we closed a two-year $140 million term loan. We used net proceeds of borrowings under the term loan to retire remaining 2008 debt maturities and pay down our line of credit. Borrowings under the term loan bear interest at a variable rate equal to 200 basis points over LIBOR in effect at time of borrowing. The term loan also provides us a choice of an alternate rate equal to 50 basis points over the prime rate.

Having the option with both of these instruments to utilize a prime based rate or LIBOR did help us save over 100 basis points in rate despite the volatile market recently.

In 2009 we have five mortgage loans totaling $48.5 million due to mature. We expect to address those maturities with funds from our line of credit and cash flows from operations. Our development partners are currently in the process of extending the relevant construction loans set to mature within the next 12 months.

Our consolidated debt at quarter end was $900 million with an average rate of 4.85%. 72.5% of that debt was fixed at an average rate of 5.0% and 27.5% of the debt was floating with an average rate of 4.5%.

Our EBITDA or earnings before interest, taxes and depreciation to interest expense coverage ratio for the nine-month period was 2.8 times and our FFO payout ratio was 69%.

In summary, we believe we are in a very solid financial position with no obligations to fund and no significant obligations due until 2010.

Finally with respect to guidance, we now expect FFO per common share to be in the range of $1.43 to $1.45 for fiscal 2008. This lower guidance range reflects the impact of aggregate noncash charges of $3.7 million related to the other-than-temporary decline in the value of certain investment securities recorded during the nine-month period ended September 30, 2008. The new guidance also incorporates lower expectations of fee income from unconsolidated joint ventures due to the timing of sales to 1031 exchange investors and it reflects current economic and credit market conditions which have deteriorated since our second quarter earnings call.

In addition we may be required to record additional noncash impairment charges in subsequent quarters to adjust the cost basis of certain investment securities which may be deemed to be other-than-temporarily impaired.

With that I’ll turn it back over to Mark.

Mark E. Zalatoris

Looking ahead we expect the economy and overall business environment to remain challenging well into 2009. Within this difficult environment we are maintaining a consistent focus on real estate assets that cater to the everyday needs of consumers and we have located these assets in stable Midwestern communities with proven demographics. Because of these factors our portfolio has stayed c consistently in demand with retailers and consumers throughout market cycles. We’ve also put into place selected joint venture initiatives to enhance long-term performance and shareholder value.

Finally, our balance sheet is healthy and we have an experienced management team in place. Going forward we are confident that we can continue to provide a stable and secure long-term investment opportunity.

With that we’d like to open up the call for your questions.

Question-and-Answer Session


Our first question comes from Paul E. Adornato – BMO Capital Markets Corp.

Paul E. Adornato – BMO Capital Markets Corp.

Everyone is talking about the lack of transactions out there and anything that’s related to transaction income is kind of at risk these days. I was wondering if you could talk about the IREX JV and how the 1031 market seems to be performing in real time?

Mark E. Zalatoris

The 1031 market probably has slowed down a bit as all transactions have slowed down a bit. The 1031 investors are reliant upon buyers for their assets and financing to be available for their buyers so there has been a little bit of a slowdown that has been experienced in the overall market.

That being said, our partner Inland Real Estate Exchange Corporation has really full expectations of achieving the same level of sales for this year as they did last year and in many ways the reason is they’re taking market share away from their competitors who have fallen by the wayside. So the smaller universe of transactions that is occurring is being more directed to IREX than to anywhere else.

They’re also experiencing an unusual phenomenon in that they’re getting all-cash buyers coming in. So it’s not even 1031 exchange investors but buyers that want to put their cash into real estate assets, hard assets rather than into equity markets believe it or not.

We do expect a temporary slowdown and when the credit markets start loosening up as we’re experiencing this in the last week or so we’ve seen rates come down substantially, the LIBOR rate come down to more of a traditional level, etc. and some financing transactions getting done. We think there’ll be more sales of the properties that will create the demand for 1031 investments. We also think that given the new Administration that’s coming in, there’s a greater likelihood of an increase in capital gains taxes which should spur on some more sales activity.

Paul E. Adornato – BMO Capital Markets Corp.

A related question is that given the increase in the cost of capital, I was wondering if you could talk a little bit about the allocation of precious capital to the IREX JV versus alternative uses vis-à-vis your own balance sheet?

Mark E. Zalatoris

The IREX JV if you look at it on a true return basis due to the revolving nature of the investment provides us with I think our overall best return on our capital. We put it out into a property, the property that we buy gives us a good current return that covers our cost of the capital be it our line of credit or the secured financing that’s put on the property before it’s sold so it’s accretive to us, and then we receive our capital back and we can revolve it into a new property.

Obviously when we receive our capital back it comes with the fee income, the transaction fee income as well as the long-term recurring management fee income. So if you more or less did an internal rate of return on that type of investments, it’s one of the if not the highest returns on the capital.

That being said, I think that we do have a decent amount invested in the current properties, the B of A properties in particular, and we’d like to see more of those sales come back before we invest additional properties for the venture. We try to keep it on a measured pace.

Paul E. Adornato – BMO Capital Markets Corp.

Scott, you talked a little bit about working with tenants in order to help them reduce or manage their occupancy costs perhaps moving them around a little bit or otherwise helping them in this difficult environment. It seems like in the past when tenants in trouble would have approached you, you would have said no to renegotiating terms of the lease. Is this a change in policy?

D. Scott Carr

It’s more, and it’s always been, on an asset-by-asset basis, a tenant-by-tenant negotiation. I would say the requests for this are increasing and our instance of saying no is perhaps decreasing but we’re still evaluating each one on an individual basis. That means really pushing to get information on how they’re performing, what their plans are to try to help themselves before we help them, and in some instances at certain properties the answer is still no because we can do better.

It’s just in today’s environment especially in the small shop and apparel sectors the new tenant transaction volume has slowed and it’s just prudent to work with those that we have in place because it’s always a less expensive and better return to keep our existing tenants.

Paul E. Adornato – BMO Capital Markets Corp.

Is there a danger in setting a bad precedent or is the horse already out of the barn so to speak?

D. Scott Carr

I don’t think it’s necessarily a precedent that would continue absent the current environment. I think as things improve, performance improves so our policies would change with that. We have to adjust to the times and that’s exactly what we’re doing. One of the things we always build into these scenarios is a right to recapture space. So if we do give someone a reduction, we have the right to take the space back should we find a better opportunity. We keep working that angle simultaneously.


(Operator Instructions) Our next question comes from Jeffrey J. Donnelly – Wachovia Securities, LLC.

Jeffrey J. Donnelly – Wachovia Securities, LLC

I might be asking Paul’s question on IREX on a slightly different angle, but I keep reading similarly that [TIC] capital fund raising is down substantially. I think the last I’d seen it was probably down 50% the first half of the year in the industry. Has IREX been able to continue to raise capital? I would think it’s only gotten more difficult. Specifically, do you think you’re on pace to raise capital that’s sufficient to address the B of A assets that you’re sitting on?

Mark E. Zalatoris

As I mentioned in my comments, they are on pace to raise the same amount of capital as last year which probably for them is a little bit of a disappointment. But in the overall scheme of things given the general market like you said; if it’s down that much; I’m not sure it’s down that much; but it’s a big victory in a sense that they’ve been able to maintain that pace.

That being said, we gave them a whole big chunk of property with those four buildings. They put them out just recently on the street in two separate offerings and are proceeding to take subscriptions now. They had told us as realists it’s going to take a little bit longer than we originally hoped for but given the structure of those deals where you’ve got one of the big five survivors in the banking industry that’s signed a sales leaseback with long-term leases that have annual escalations that the demand is going to be there and they will fill out those sales.

That being said, unfortunately it’s not going to happen 100% this year but in many ways that’s okay because we acquired more than our $100 million goal for them this year anyway. We did $180 million so we front-end loaded 2009 by doing so and those sales when they come in 2009 will represent a good chunk of 2009 business that we would otherwise have to look for in new properties.

Jeffrey J. Donnelly – Wachovia Securities, LLC

I’m not insinuating that the IREX entity has issues but you’ve seen other [TIC] firms if you will in the market, they’re probably capitalized much differently, effectively go under or have problems.

Mark E. Zalatoris

There’s no question because those other firms have nowhere near the length of experience and the depth of relationships that Inland does with lenders, having been in business over 40 years, having structured over 500 partnerships, going on four separate real estate investment trust offerings with all kinds of different debt and equity offerings. That’s what makes IREX such a strong entity to compete with and that’s why they are taking that market share. They are the goal standard. They’re going to be the ultimate winner in this whole thing.

Jeffrey J. Donnelly – Wachovia Securities, LLC

My question though is you see that stress in the market and then IREX is telling you some of these assets are going to take longer to sell. Does that lead you guys to think that maybe after you sell through the B of A assets that maybe you don’t recharge the portfolio for a while and just step back from it or do you keep plowing ahead? I guess I’m wondering if those are early signs that it’s just becoming more and more difficult to keep executing.

Mark E. Zalatoris

I think our comfort zone would be to provide properties at a lower dollar amount, more of a manageable amount that gives us more flexibility within our balance sheet constraints. We stretched to do this four-property package because we know ultimately we felt comfortable that it would be syndicated and it would result in good fee income for us and the fact that the pricing and leases were structured so well that it’s a good accretive cash flow to us in the interim period.

But that wasn’t our goal originally. Our goal was to try and do a series of $20 million to $40 million deals. It’s a little easier to digest than to digest a 16-foot hotdog versus a regular hotdog. That’s I think how I look at it. A size perspective.

Jeffrey J. Donnelly – Wachovia Securities, LLC

I’m curious though, do you think you might return a little bit more towards the retail side of things with the assets that you put in that JV away from the office side? Maybe this sis the same way of asking that same question. If the interest from a [TIC] buyers market is to find probably household names with good long-term leases and obviously you want to make as much profit as you can, do you think you go after things like maybe retail bank locations which I would imagine with the bank business back on its heels, is that sort of a good arbitrage if you will?

Mark E. Zalatoris

There’s no question. Take a look at the property that we just contributed prior to this; that Fox Run Shopping Center that’s a dominix anchored grocery center. Our primary goal is to find those kinds of assets but we analyze each deal based on the economics and based on what our partner believes is ultimately a desirable syndicatable product.

If it’s not a retail asset, then we step back and look at it a little more diligently as to, is it something we could be comfortable living within our portfolio or not? Does it have growth in it? If these leases for example had no escalations in them, I’m not sure we would have taken the same level of interest in the acquisition given a risk if it didn’t syndicate we’d be stuck with a big bunch of flat leases, which is not the case.

Our first priority is always to look for multi-tenant retail without question.

Jeffrey J. Donnelly – Wachovia Securities, LLC

This next question I’m not sure if it’s for Scott or for Brett or for both. I’m not really looking so much for guidance if you will in the future per se but I’m just curious on the leasing front, where do you think occupancy generally speaking goes from here? Do you think that the inevitable trough is down 100 basis points from where folks are today? Is it down 200 basis points? When do you think we hit that bottom?

D. Scott Carr

So much is dependent on the rest of this year and the shakeout we see in 2009 based on retailer performance. In our portfolio we’re still remaining pretty resilient. We’ve seen our local market here in Chicago drop to a little under 91% in occupancy and we’re a little over 94%. So we’re maintaining our historical spread. I think there could be another 1% to 1.5% drop as things go forward into ’09 just anticipating more failure.

Jeffrey J. Donnelly – Wachovia Securities, LLC

I’m curious actually Scott now as you talk to retailers about leasing space, particularly for some of the bigger boxes you guys have had recently come available, do you get the sense from some of those retailers that they are gearing up for another round of store closings post holiday season, whether that’s voluntary or otherwise? I’m just curious what sort of the body language or what you’re hearing from them?

D. Scott Carr

There are certain ones. I think the general consensus that we hear from just about every retailer meeting we have outside of the people we’re doing business with, we just keep hearing “hunkered down.” Everyone is hunkered down into next year to see what happens. I think it’s inevitable there will be more store closings and whether or not it’s caused by chain failures or just underperforming stores within a particular chain, those that are susceptible to it are definitely going to face it in the coming year.


Our next question comes from [Steven Everett – Malty Financial].

[Steven Everett – Malty Financial]

My question’s going to be relatively straightforward compared to the last couple questioners. Given the increase in income from FFO, what’s your outlook for the current dividend?

Mark E. Zalatoris

The current dividend is at $0.98 a share and our payout ratio is roughly 68% or so. Given the times we’re in right now, I’m not an advocate of raising the dividend. There’s no current consideration to cutting our dividend. As a matter of fact, we have very little room to cut our dividend and still meet the REIT rules which are a payout of 90% of your taxable income.

We will continue to pay our dividend on a monthly basis. Our dividend payout does get reviewed at least annually by our Board of Directors and our long-term history is that on average we’ve raised it once a year. We are living through unprecedented times and it certainly would be prudent for us to conserve our capital given these times and given the tightening of the credit markets and the unwillingness of lenders just to make loans available as easily as they were in the past.

[Steven Everett – Malty Financial]

So kind of a short way of putting this is that for the next couple or three quarters you’re going to conserve capital that might possibly be used to increase the dividend to determine how bad this downturn is?

Mark E. Zalatoris

I would say that’s accurate, at least without question through the remainder of this year and then we’ll re-examine the dividend policy at some point in the first half of next year.


Our next question comes from Paul E. Adornato – BMO Capital Markets Corp..

Paul E. Adornato – BMO Capital Markets Corp.

Brett, you mentioned at the end of your comments that additional impairments may be required. I was wondering if you could characterize the composition of the investment portfolio. Is it REIT common stocks, preferred stocks, debt? Could you give us a little bit of color there?

Brett A. Brown

The majority of the investments are preferred stocks. We do have a number of common as well and very limited debt securities. The write-down in the second quarter was a combination of both preferred and common. In the third quarter it was just common and that was due to the fact the SEC came out with a letter to the FASB indicating the correct or their interpretation of FAS 115 with perpetual preferred securities with debt-like characteristics are not subject to other-than-temporary impairment. So that’s why the write-down was much smaller. Had it been all on the preferred as well, it would have been a larger number.

Paul E. Adornato – BMO Capital Markets Corp.

The decision date; everything is priced as of September 30 so if the common stocks have performed worse since then -

Brett A. Brown

That’s exactly the caveat I wanted to put out there. Exactly.


Our next question comes from [Charles Donner – ISI Securities].

[Charles Donner – ISI Securities]

What’s your feeling of how bad the recession could get? It’s encouraging to hear the occupancy rate’s 94%. Do you see that going down; a rough idea of what you’re anticipating and any type of duration on that occupancy rate? Paul asked the other question on the dividends. It sounds like you’re anticipating that to stay. You don’t have any plans to cut that in the near future?

Mark E. Zalatoris

If we could answer those questions, we’d probably go to work for our new President-Elect. Answering the dividend question once again, there is no current intention to cut our dividend, that’s for sure. Like I said we’ll examine our dividend policy next year and typically when I say that it means we look to see whether it makes sense to raise it at all. That of course depends on how the economy’s doing and how the credit markets are doing and how our own portfolio is performing.

[Charles Donner – ISI Securities]

How do you see it? It seems like in hard times there would be some excellent purchasing opportunities out there. Is that what you’re finding?

Mark E. Zalatoris

I think there’s going to be some great opportunities. There’s starting to be a little more at least anecdotal evidence of opportunities coming out there which really means that there are perhaps sellers that are in distress or sellers that have debt maturities and can’t get replacement financing and now are bringing properties to market. I think that’s going to accelerate to a much greater degree in 2009 and we’d certainly like to take a look at all those opportunities and have capital available for that at that time period. Again, the dividend policy somewhat reflects the business plan to make capital available when needed for taking advantage of those things.

[Charles Donner – ISI Securities]

Of course your farsighted plan of having like you were saying the grocery store dominated neighborhood facilities should pay off in exactly this kind of situation. Where things are hard, those should be able to remain in business and should continue to draw customers. How much do you think of a pullback, how far back in the occupancy rate could you go before you think you’d have to start considering a cut in the dividend? Down to 80%? 85%? 75%?

Mark E. Zalatoris

It’d have to be fairly dramatic. We have quite a bit of room in our payout ratio before our income would have to drop but we rely on the cash flow that’s dividended out to fund growth in our business and to fund capital improvements and to fund investment opportunities. So it’s not just a matter of having a cushion for reduced occupancy just to maintain our dividend. It’s also to fund the ongoing concerns of the business and growth opportunities.

I couldn’t give you an exact number. We could run a number of scenarios but I’m pretty confident that with our portfolio and the constitution of the necessity based tenants that we’re not going to see an occupancy reduction to the point where our dividend is threatened.

[Charles Donner – ISI Securities]

I think you’re situated well in Chicago mainly and Minneapolis and out in Nebraska, is that the other concentrated area?

Mark E. Zalatoris

We have one property in Omaha but it’s really Chicago and Minneapolis for the main portfolio.

[Charles Donner – ISI Securities]

I think compared to here in Detroit that Chicago’s doing much better. Is that how you’re feeling? And how about Minneapolis?

Mark E. Zalatoris

Without question. Chicago and Minneapolis we believe are the two strongest markets in the upper Midwest where we operate. Diverse economies, well educated labor force, high incomes and high densities. It’s a very good situation. That being said, everyone has some degree of pain in this recession we’re in.

[Charles Donner – ISI Securities]

I feel very optimistic going ahead for IRC with the situation and a little surprised to see the big cutback in the share prices shown on the market. Even today it pulled back a fair amount but I just was wondering if you felt the same way I did or really optimistic. It sounds like you do or if there’s something that I was missing and needed to be concerned about.

Mark E. Zalatoris

We’re optimistic in the future. We’re going to be around. As far as the share price goes, I think if you look at the total return statistics for us for IRC as compared to the peer group, we’ve held up very well. This is just a general reflection of the economy and the market place right now. It’s just something we can’t control.


We show no further questions at this time. I would like to turn the conference back over to Mr. Zalatoris for any closing remarks.

Mark E. Zalatoris

Before we sign off I’d like to take this opportunity to comment on yesterday’s historic election. As Jeff Donnelly said, I was not present at Grant Park last evening but I would like to congratulate President-Elect Obama, Vice President-Elect Biden and all the wining members of Congress. They have a formidable challenge ahead of them and we hope they will succeed in stabilizing our economy in short order.

My hope for our country is that our President-Elect will surround himself with advisors and staff members that will provide him with the same type of talent and dedication that I have enjoyed here at Inland. I’m truly blessed to be counseled by a deeply experienced Board of Directors who have always considered the best interest of our investors first and am equally fortunate to work every day with an outstanding staff that is second to none.

Wall Street votes every day. A company’s share price reflects public opinion and expectations in an immediate and often brutally efficient manner. We are gratified at the market’s opinion of Inland Real Estate Corporation has been positive on a relative basis when measured by our year-to-date total return metrics compared to that of the overall market and our peer group. We realize that we need to earn that vote each and every day and promise to make every effort to produce the results that will.

Thank you for your time today and we look forward to speaking with you all next quarter.


The conference has now concluded. We thank you for attending today’s presentation. You may now disconnect.

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