Acadia Realty Trust Q3 2008 Earnings Call Transcript

Nov.10.08 | About: Acadia Realty (AKR)

Acadia Realty Trust (NYSE:AKR)

Q3 2008 Earnings Call Transcript

October 30, 2008, 12:00 pm ET


Kenneth Bernstein – President and CEO

Jonathan Grisham – SVP and Chief Accounting Officer

Michael Nelson – CFO and SVP


Christine McElroy – Banc of America

Michael Bilerman – Citigroup

Michael Mueller – JP Morgan

Richard Moore – RBC Capital Markets


Good day, ladies and gentlemen, and welcome to the third quarter 2008 Acadia Realty Trust earning conference call. My name is Latrese. I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator instructions)

Today's presentation by management contains forward-looking statements within the meaning of the Securities and Exchange Act of 1934. These forward-looking statements represent the company's present expectations or beliefs concerning future events. The company cautions that such statements are necessarily based on certain assumptions, which are subject to risks and uncertainties, which could cause actual results to differ materially from those indicated today.

These risk factors include changes in general economy conditions, recent geo-political events, increased compensation, work stoppages and slow downs, exchange rate fluctuations, variations in the mixed of products sold, fluctuations in effective tax rate resulting from shift and sources of income, and the ability to successfully integrate and operate acquired businesses. Further information on these risk factors is included in the company's filing with the Securities and Exchange Commission.

And at this time, I would like to hand the presentation over to your host for today's call, Mr. Ken Bernstein, President and Chief Executive Officer of Acadia Realty Trust. Please proceed, sir.

Kenneth Bernstein

Thank you. Good afternoon. Thank you for joining our third quarter call. Before we discuss our quarterly results, I'd like to comment briefly on the current market conditions, the impact on our sector and how we have positioned Acadia so that we're able to respond to the current and anticipated environment.

While many of us have over the past few years been preparing for some level of correction, even perhaps, wishing for it so as to enable more attractive entry points for new investments, it would have been hard to imagine a meltdown in the capital markets as severe and as widespread as we're now experiencing. Not only does this caution us to be careful about what we wish for in the future, but even those of us who are well-positioned need to make sure that we're not exposed to risks that until recently, were not front center on our radar screen.

The credit crisis is now over a year old and has spilled over into full blown economic crisis and while our industry is clearly being impacted both in terms of operating fundamentals, debt availability and asset values, we're still in the early stages of trying to determine what the ultimate impact will be both in terms of the recessionary impact on rents and the impact of the credit crisis on cost of debt and ultimately asset values.

While we don't think that we are in any way uniquely qualified to forecast precisely how this crisis is going to play out, it's worth discussing what we're seeing right now and how we have positioned ourselves to address the current environment. As a general overview, the key themes that we'll address today during the call are first, operating fundamentals, second, balance sheet exposure and assets to capital, third, our development pipeline, and finally, the status of new investment opportunities.

First, in terms of fundamentals, whether looking at our third quarter operating results or our current collections data, we're not yet seeing a material softening in our fundamentals commensurate with the newspaper headlines. We expect that several factors are at work here.

First of all, our core portfolio consists primarily high-barrier-to-entry assets in supply constrained markets. Over the past several years we've aggressively called our portfolio by selling off the bottom half of it and rotating into high-barrier-to-entry, supply constrained properties in strong markets. Today, the vast majority of our properties are well located and anchored by either necessity based grocery and drug tenants or value oriented discounters.

Even in a softening economy, these types of tenants, especially the super markets and discounters, often experience positive same-store results and gain market share. Even for those tenants who are slowing their expansion or shrinking elsewhere in the country, because of the tight supply of real estate in our markets, they seem to retain their locations more often than not.

That being said, for many retailers, this has been one of the most difficult years in a long time, and we doubt that 2009 will be any easier for those tenants. We remain very caution as to retailer performance in general and don't expect any portfolios to be immune to what could be a longer-term and severe consumer slow down.

Finally, as relates to fundamentals, we need to recognize that to some extent, we're looking at lagging indicators. While our experience tells us that higher quality locations tend to out perform both in terms of operating performance as well as value retention, only time will tell just how resilient any one's portfolio will be.

The second component, balance sheet and access to capital. It's clear that debt is very scarce and expensive right now, especially for larger transactions. Balance sheet metric, strong access to debt and equity and limited debt maturity are going to continue to be of increased importance.

As Mike will walk through, we have no on balance sheet debt maturities for over three year and as I will discuss later in the call we have limited exposure with respect to our fund level development transactions as well.

In short, while no one wants to contemplate a multi-year continuation of capital illiquidity. If need be, we have enough capital to internally fund both our existing equity requirements, and our future equity growth initiatives for the next several years. Most importantly, our discretionary investment fund has plenty of dry powder to take advantage of the opportunities as they emerge.

Third, in terms of our existing development pipeline, while all development pipelines are coming under some level of pressure, New York City still remains a highly supply constrained market with strong tenant demand. Even though New York City is at the center of the credit crisis, our properties are generally in the dense outer burroughs, which are significantly under represented by the national retailers.

Most of our anchor tenants for these urban developments are necessity and discounter tenants such as our recently executed last month with BJ's Wholesale Club in Pelham Manor. Tenants like BJ's tend to outperform their more discretionary peers in a slowing economy and seem to be gaining market share in New York City. But even non-necessity based market leading tenants such as T.J. Max and BestBuy continue to look at market share in New York.

For example, BestBuy will open next month at our Fordham Road redevelopment in the Bronx. The Bronx has a population of 1.3 million people and our Fordham Road location will be the first BestBuy store to open in the Bronx. They have a second store at the related company's Bronx development that's slated to open next year, but these two stores are still significantly fewer stores for such a large population and contrast very favorably with other markets of similar size and it's not just the Bronx. BestBuy, T.J. MaX, BJ's and many other strong tenants are equally under represented in the outer burroughs as well.

We recognize that this strength is counter balanced to some extent by the fact that there are several tenants on a national level that are clearly struggling. And we don't believe that New York will in any way be immune to the impact of national retailer bankruptcies or similar retrenchment.

Our experience so far is that the high demand of our locations is enabling us to successfully and profitably navigate through those re-anchoring that inevitably arise at times like these, such as, in our two former Home Depot redevelopment, one in Carnarise, Brooklyn and the other in Pelham Manor where we have been available to very profitably address the departure of Home Depot.

In terms of the financing of developments, even where tenant demand is strong, the ability to attract affordable financing, especially, for larger projects is a real obstacle to commencing new developments. All projects now are requiring more equity, more pre-leasing and strong sponsorship before the financing will be obtained. Additionally, those borrowers facing significant refinancing exposure over the next 12 months are having a difficult time given that the large loan market is frozen.

Fortunately for us, as I'll discuss in further detail later, other than the largest of our contemplated projects, the balance are either already successfully financed or small enough so that we should be able to obtain what limited financing might be needed. Equally important, we don't have any short-term debt maturities in the development pipeline that we're not in a position to address.

In terms of transaction activity and new investment opportunities for Fund III, we continue to stay substantially on the sidelines in the third quarter. While we completed one relatively small transaction and we continue to hold approximately 80% of our discretionary investment fund capital commitments, we believe that we are getting closer to a period, where our stakeholders will be very well rewarded for our patience and our discretionary capital.

And with respect to transactional activity from an earnings perspective, as Jon is going to discuss, most of our transactional harvesting for this year has been completed, furthermore looking toward 2009, next year was fortunately never intended to be a significant fund disposition or capital raising year either.

So while there are always a host of moving pieces in our earnings bucket, short-term capital markets weakness over the next year or two, as painful as the volatility can be to ride through should provide us more of a new investment benefit than an existing pipeline negative.

So to conclude while we're extremely focused on the challenges of the capital markets and the weakening economy, we feel our portfolio, our balance sheet and our investment platform are all well-positioned to absorb the impact of the challenges we're facing and ultimately capitalize on the opportunities that will arise from them.

With this perspective in mind today, we'll review our third quarter results, and the status of our core portfolio, our balance sheet, and liquidity, and on the external growth side, both our existing projects as well as new investment.

With that I'll turn the call over to Jon

Jonathan Grisham

Good afternoon. As detailed in our press release, our third quarter results are in line with our expectations and there is not much additional color to, to be added to those results. All of our business lines are contributing to earnings as anticipated. There is one item I'd like to point out from the third quarter, which relates to our promote and RCP income. During the quarter we've recognized approximately $1 million after-tax income from our Albertson's investment which brings our total RCP and promote income for the year to $4.5 million, which for this earnings line item, completes our projected activity for the year and it comes in at the high end of our original expectations.

As it relates to significant moving pieces for the fourth quarter, our guidance does include some transactional fee income, primarily leasing commissions, from tenants who are scheduled to open before year-end. So in terms of our various earning buckets, including income from the core, our pro rata share of JV income, asset base fee and transactional fee income, everything is on track for the year. And as a result, we are re-affirming our guidance range of $1.30 to $1.35.

Now, I'll turn the call over to Mike.

Michael Nelson

Good afternoon. As a result of the current economic condition, it has become abundantly clear as we've said in the past that balance sheet strength and liquidity are of paramount importance. That being said, Acadia has always been focused on and has been able to maintain a solid financial position. Our debt to total market cap at September 30th was 38%. And even after the effect of the market meltdown, we're still currently under 50%.

Our year-to-date FFO payout ratio is at 58%. And our fixed charge coverage is 3.3 times. As a result of the current shutdown in the debt markets, managing debt maturities is critical. Over the last three years, we've taken advantage of a strong credit market to extend maturities and limit our exposure to interest rate fluctuations. In the core portfolio, including extension options, we have no debt maturing for three years or until December of 2011.

Turning to our funds, Fund I has total debt of only $23 million. Approximately, $8 million of this debt matures in 2008 and 2009. Of which, $3 million was pay-off at maturity in October of this year and the balance represents Kroger Safeway debt, which self-amortizes in the first quarter of 2009 from operating cash flow. Of the remaining $15 million of debt, $10 million matures in 2012, including extension options, and $5 million in the third quarter of 2010.

Ken will discuss the Fund II debt in connection with our urban infield development projects later in the call.

As it relates to Fund III, the self-storage portfolio has $81 million of debt, half of which matures in 2013. The other half matures in 2009 and given that the current debt represents approximately 50% loan-to-cost we will either refinance it or replace it with advances from our funds subscription line. Additionally, all of our fund level subscription lines are fully collateralized by the investors unfunded capital commitments.

We have limited our exposure to interest rate volatility in the core portfolio by fixing 91% of our mortgage debt at an all in rate of 5.1% at September 30th. Subsequently, we executed $30 million of swaps at an all-in rate of 4.86% through 2012 bringing the portfolio to 95% fixed rate.

Turning to our liquidity levels, at September 30th, we had cash of $41 million and availability on our lines of $53 million, excluding the funds. Subsequent to September 30th, $23 million was returned from our 1031 escrow from the sale of the Village Apartments earlier this year, bringing our total liquidity from $94 million to $117 million.

This covers our remaining Fund II and III capital obligations of $102 million over the next 2 years to 3 years. Additionally, we anticipate retaining operating cash of approximately $10 million annually as working capital.

As I mentioned, we received $23 million from our 1031 escrow account. As has been clearly validated by the recent shifts in the capital markets, we didn't believe that it was in our best, in our shareholders best interest to acquire a replacement property, which had to be identified in the first half of 2008, solely to defer the gains recognized from the sale of the Village Apartments. We are currently reviewing our income tax position for 2008 and I will keep you apprised as to how the recognition of this gain will impact Acadia and its shareholders.

In summary, should the market and economic turmoil continue for an extended period of time, we, as well as all businesses, will not be immune from the effects. Given that the condition of the capital markets, balance sheet strength, high levels of liquidity, and low exposure to refinancing risk as a result of longer-term maturities are more important than ever. We believe that Acadia's balance sheet strength positioned it favorably to be able to continue to execute on our business plan.

I'll now turn the call back to Ken.

Kenneth Bernstein

Thanks, Mike. First, I'd like to review briefly our core portfolio performance. With respect to our same-store NOI growth, our occupancy, our lease spreads, all our solid metrics given the difficulty economic environment we're operating in.

In terms of potential tenant exposure in our core portfolio, to-date we've avoided most of the significant bankruptcy, looking forward we have two Circuit City locations, which if vacated would impact us by approximately $0.03 of FFO per year until they were then replaced.

Finally, while current core results remain solid, ultimately, the depth of the economic slow down will determine whether the defensive profile of our value necessity anchor centers enable to us to withstand this clearly weakening economy.

In terms of external growth, first of all, the key driver of our external growth is our discretionary investment fund business. In 2007, we launched Fund III with $500 million of equity, which enabled us to acquire or redevelop approximately $1.5 billion of assets on a leveraged basis over the next several years. In the third quarter we remained substantially on the sidelines making only one small fund investment.

In fact, to-date we've only put approximately 20% or $100 million of Fund III equity to work. This 20% is less than half of the pace that we would normally deploy over that 1.5 year period and reflects our view that we're still little early for opportunistic investments in that our shareholders will be well rewarded for our patience and discipline.

With respect to existing fund investments, they break out into two broad categories. First is opportunistic, which includes the purchase of distressed debt, distressed assets, our RCP investments and then second is our value add platform which includes our New York Urban Infill Redevelopment.

On the opportunistic side in connection with our Retailer Control Property or RCP venture, we participated in several profitable transaction. First with respect to Mervyn's, we walked through the status of this investment on the previous earnings call, but in short in 2004, as part of our RCP venture and in connection with an investment consortium we participate in the acquisition of Mervyn's, which consisted of 262 stores for a total price of $1.2 billion.

We invested $23.2 million and had ownership interest in both REALCO and to a lesser extent OPCO. Through a series of transactions to-date, about 80% of REALCO real estate portfolio was disposed of. Additionally, we sold our interest in OPCO.

With respect to the remaining 20% balance of the REALCO real estate, we have successfully re-tenanted the majority of that portfolio to tenants other than Mervyn and with respect to that portion of the remaining REALCO real estate, where Mervyn is our tenant, except for one property in Utah, the balance are in California, and our high quality locations with strong tenant interests.

To-date, we have already received approximately two times our original equity investment and as to the amount of additional residual value in REALCO, it's premature and inappropriate to try to quantify it at this time, but we'll certainly keep you posted.

With respect to a second RCP investment Albertson's, as Jon mentioned, during the third quarter, our other significant RCP investment Albertson's close on the sale of 49 assets throughout Florida to public.

Overall, we invested $20.7 million of equity and to-date have received $61.6 million or three times our equity investment for this Fund II investment.

Turning now to our New York Urban Infill development pipeline, notwithstanding the pressures on retail development in general, we still see strong tenant demand for New York City. The density, supply constraints and high level of mass transportation all make New York one of the top urban markets for retailer growth.

In general, our projects are proceeding according to plan, but we are proceeding very cautiously. Those projects in our pipeline had have commenced or in fact completed. Our retail is 90% leased. And for our projects that we have yet to commence, we're going to be very focused on pre-leasing and other risk mitigation before we start.

On Page 44 of our supplement, we describe our current estimation of timing and cost for the projects. And on Page 25 of the supplement, we layout the detail of our financings, including our redevelopment project financings.

Given the concerns in general regarding the financing environment I'd like to discuss the financing status and then update the progress of these projects as well. First is an overview of our development pipeline financings. We currently have total debt of $212 million, $48 million of it is long-term debt with maturities averaging in excess of ten years, and attractive locked in fixed rates. $110 million is construction financing, with no maturities until 2011 after taking into account extension options. Only $54 million of it is short-term bridge debt, which we anticipate will be replaced by our fund equity.

As I mentioned earlier on the call, the debt markets for construction financing are highly illiquid, especially for loans over $50 million or so. In our pipeline, the one development that clearly falls into this category is City Point in Downtown Brooklyn and even in this case there maybe counterbalancing benefits with potential reductions in cost of construction, offsetting the cost of delay or increased capital costs. In fact, a 5% decline in construction costs should fully offset a one-year delay in the project assuming our current carrying costs.

Furthermore, it's very possible; in fact, it's likely that costs savings could be well in excess of 5%. But this might be offset by increased debt cost or potentially weakening fundamentals, nevertheless given the unique location, the fact that we have Target as our retail anchor and strong interest from other retailers, we wouldn't be surprised that our patience and persistence could be well rewarded in City Point.

Turning now to Fordham Road in the Bronx, the construction of this project is substantially complete. The retail is fully preleased. Sears is open. BestBuy will open in about two weeks and the balance should follow over the next few months. The office component is nearing completion of construction and its lease up is also moving ahead according to plan. The existing financing for that project is in place with extension options taking us to April of 2011.

Our Liberty project in Ozone Park, Queens is fully lease and has debt that can be extended until May 2011. 161st Street is substantially leased to the existing tenants pending the commencement of our redevelopment there and has debt with options that extend until April of 2011 as well. 216th Street is fully leased and occupied and we have long-term fixed rate debt with a maturity of 2017 on that project.

Pelham Manor, this project has long-term debt maturing in 2020. With respect to Home Depot on the previous call, we discussed that we entered into an agreement to buy back our anchor space from Home Depot at Pelham for $10 million or about half of Home Depot's $20 million investment in our project.

In the third quarter, we successfully completed the replacement lease with BJ's Wholesale Club at a rent that's going to provide us with mid-teens, incremental return on those costs, and about 100 basis points increase in our unleveraged development yield.

And more importantly, it anchors Pelham Manor with a healthy tenant, well-positioned to gain market share in this economic cycle. We also signed Michaels Arts & Crafts in the third quarter, the center is now fully anchored and 83% pre-leased. These tenants will open in the first half of next year.

Also exciting is the fact that Fairway Foods, a well respected regional supermarket chain will be re-anchoring the former K-Mart space in the center adjacent to our property, adding another highly complimentary anchor tenant for our shoppers.

In terms of our second Home Depot site in Carnarise, Brooklyn. Home Depot paid us $24.5 million out of our $26 million total land purchase price to terminate its obligation to anchor that redevelopment. Due to this buyout, Home Depot was going to represent about 40% of the redevelopment, with other already identified tenants representing an additional 40%, and the remaining 20% was opened to be leased.

We have strong interest from replacement anchors for the Home Depot space and we expect to finalize a development plan in the first half of next year, that will bring us back to the 80% pre-leased, albeit with a lower land cost. And as I mentioned before, this project will likely also be the beneficiary of lower construction cost, which should further enhance the yield. When we are ready to begin construction on this project, we should be able to get the relatively small amount of financing needed for that construction.

In term of Broadway and Sherman in northern Manhattan, we have a $19 million bridge loan that we anticipate replacing with Fund II equity until we can commence the development of this project.

We're working with three commercial tenants to finalize their leases, which would substantially pre-lease the commercial portion and have entered into a preliminary agreement to sell the residential air rights to an affordable housing developer. Provided we can successfully achieve this, we're planning to commence construction in the second half of 2009.

In terms of Sheepshead Bay, Brooklyn, we have no debt on that project and we expect to be able to obtain third-party financing or self-finance whatever debt we need when this project's ready to go.

So, in short as it relates to our New York development pipeline, while we are neither in a mood to over promise or count our chickens before they hatch, we do believe that we have adequately protected ourselves from significant financing exposure. And that our original thesis with respect to tenant demand and cash flow quality remain intact.

In terms of Fund III, we currently have four acquisitions in our Fund III. West Port Connecticut, Sheepshead Bay, our storage post portfolio and our third quarter acquisition in – or investment in Farmingdale, Long Island. West Port and Sheepshead Bay are progressing through the design phase. With respect to the storage post portfolio, it continues to operate consistent with our expectations both with respect to the four stabilized assets and the repositioning as well.

And then in the third quarter, we closed on a small investment for Fund III in Farmingdale, Long Island. While we expect the investment to potentially convert at our option into full ownership of a well located retail development on Long Island, for now it's simply a high-yielding 14% first mortgage, with two year maturity, that with even modest leverage should throw off very attractive yield.

In terms of our mezzanine investment activity, as we discussed in detail on our last call, we made two on balance sheet mezzanine investments this year. The first and the second quarter was a $40 million preferred equity loan on a portfolio of 18 high quality retail properties located in the Georgetown section of Washington DC.

And last quarter, we made a $34 million mezzanine financing on the development property located at Broadway, and 72nd Street in Manhattan. As it relates to both of these investments, these are properties in irreplaceable locations that we would welcome owning at our basis in the unlikely event that, that occur. As for future mezzanine investment it's unlikely that we would do additional mezzanine investments on our balance sheet until liquidity returns to the marketplace.

In terms of future transactions in our pipeline, first, I'd like to touch briefly on the George Washington Bridge development, it's been reported in the newspapers that the Port Authority has preliminarily approved our plans for redevelopment for the Broadway Marketplace at George Washington Bridge in northern Manhattan.

While we are continuing to work with the Port Authority to finalize these plans and documentation, our redevelopment plans include renovating the bus terminal and developing approximately 110,000 square feet of retail.

Tenant interest remains strong and we're making steady progress, but we will not proceed with this project until we are fully comfortable with the confirmation of a cost associated with the redevelopment. We'll continue to keep you apprised and updated as to our progress over the next several months.

As it relates to future activity, while we've remained patient over the past quarter and the past year or two, we expect that we will be moving off of the sidelines in the next several months. There is now too much disruption in the capital markets for it not to translate into attractive investment opportunities.

As always, we remain agnostic as to whether the best opportunities utilize our value added redevelopment skills or our opportunistic acquisition skills. All we're focused on is that the investments provide our stakeholders with the appropriate risk adjusted returns.

So today, to conclude, we're facing what may turn out to be the most difficult capital market environment of our generation and heading into a clearly softening economy. Any CEO who does not appreciate these risks and issues does so at his and his stakeholders' peril.

But without minimizing the severity of the situation, we feel strongly that we are well-positioned not just to respond to these difficulties, but capitalize on them as well. Our core portfolio is stable, our balance sheet is solid with plenty of dry powder, and third, our acquisition platform continues to position us to take advantage of any opportunities as they arise.

I'd like to thank the members of Acadia for their hard work this quarter and more importantly, in the third quarter, we celebrated being a public company for ten years. On August 12th of 1998, we went public through the reverse merger takeover of Mark Centers Trust.

We did it just in time to participate in the REIT melt down of 1998 and 1999 and while now in retrospect that crisis looks like a minor correction compared to this past month, at the time it was quite painful. The REIT market dropped precipitously and many people questioned the future viability of REITs in general and Acadia specifically.

Our team worked through a host of serious obstacles and over those ten years we provided very strong absolute and relative returns for our stakeholders. It wasn't a straight line, it wasn't easy and we had our fair share of luck. But I would remiss if I didn't take a moment to thank and congratulate our team and our board for their hard work, dedication and success in reaching this important milestone.

And as we look forward, notwithstanding the challenges in front of us with respect to our economy and capital markets, we're committed to building on the successful platform that we created over a decade ago.

With that, we'd be happy to take any questions.

Question-and-Answer Session


(Operator instructions) And our first question comes from the line of Christine McElroy with Banc of America. Please proceed.

Christine McElroy – Banc of America

Hey, good afternoon, guys. Ken, just following up on one of our last comments, if you look for opportunities to put additional Fund III capital to work, how is your underwriting and targeted IRRs changed in this environment? So what do you consider to be appropriate risk adjusted returns today?

Kenneth Bernstein

Well, for the equity, we have always targeted mid teens to low 20s returns, and as you've seen from a host of our results, primarily in Fund I but also on the RCP side we've been able to meet those and exceed it. I'm not sure that those returns need to change. What needs to change is the underlying assumptions that go into it, and we certainly are going to assume that debt, which is roughly two-thirds of those investments, debt's going to be more expensive by several hundred basis points. My guess is depending on the profile of the investment between 6% and 8% cost of debt. And that your residual returns are also going to be higher.

Now, there is a debate going on, if you compare stock prices and implied cap rates from that, with respect to transactional activity, that's very limited, there's a debate as to where residual values are, so we need to be very careful about how we view those residual values, and probably we're going to lean pretty darn hard on what will our leveraged return, our AFFO yield, if you will, after a few years out on an investment, and if that isn't close to our targeted IRRs? There's probably a disconnect. In other words, we're – we've got to get to low teens to high teens, leveraged cash flow yields on investments so that we don't have to sit and expect significant residual profit from the sale.

Christine McElroy – Banc of America

So what – in your opinion, what happens to cap rates today to get you to, assuming those different assumptions, to get you to those returns?

Kenneth Bernstein

Keep in mind, while we are thrilled to buy existing cap rate assets and we've done so periodically, the majority of what we have done over the past ten years has been either more value add, where it's going in cap rate is irrelevant and you're looking to develop between an 8% and 11% on leveraged yield and now we would probably head to the higher end of that. Okay? And then on the opportunistic side, we didn't invest in Mervyn's for a cap rate going in. And even in Bloomington, Delaware where we were able to acquire a relatively stable portfolio, there was also a significant lease up of about 30% of that, that provided a lot of yield.

That's a long way of dodging a question, and I guess the short answer is, cap rates today, the high quality retail assets that we want to own may have gone from 6% to 7%, that's not enough for us to be acquires of stabilized retail. We would probably need to see it move a bit, and I suspect that our participation won't be acquiring at cap rates that the market determines that's where yields are today, but in fact has a value add component or some opportunistic twist to it.

Christine McElroy – Banc of America

Okay. That's fair. And then with regard to the extension options on your construction debt, are there any contingencies or costs associated with those extensions?

Kenneth Bernstein

In a couple cases there are one or the other. So we need to make sure and we're working darn hard to make sure that we have the capital reserved for any of those costs, or if there is lease up contingencies that we meet them as well.

Christine McElroy – Banc of America

And then just lastly, given that you've been in the business of extracting real estate value from retailers in the past and there's been some talk in the market about trying to do that with one retailer specifically in the public realm, just wondering if you can provide your thoughts on this type of strategy to create liquidity for a retailer, in an environment when underlying real estate values are so much in question?

Kenneth Bernstein

Right. Well without commenting on any one retailer in particular, I would break it out into two groups – and keep in mind, there's very limited debt available for the type of LBO opportunities that you saw couple years ago. For those retailers that are struggling or for those retailers that have excess real estate that they're not using to operate, I think that there will be real opportunities to assist them in monetizing their real estate value. So those retailers that are strong merchants and have elected to own their real estate, they have a very strong strategic view as to that and we are indifferent as to which direction they elect to turn. If they choose to take their real estate off balance sheet, and retailers have, then we would be happy to participate in it. But there are a host of legitimate reasons that some retailers choose to own their real estate and we're prepared to respect that.

Christine McElroy – Banc of America



And our next question comes from the line of Michael Bilerman with Citi. Please proceed.

Michael Bilerman – Citigroup

Hi, this is (inaudible) it's Michael. Just a question on the demand for future funds from some of your clients. Have you seen any changes in their risk appetite? What kind of leverage they might want? What kind of asset allocation they might want in your future funds?

Kenneth Bernstein

Well, fortunately, we're a few years away from having concrete discussions with our investors and our funds are discretionary. So going in, we outline what is a relatively straightforward and from a financing perspective, conservative 2/3rd leverage point of view. And while 2/3 leverage today is hard to obtain over any 10-year period, it's pretty standard to conservative. There is no doubt that the fund that we raised year and a half ago would be more difficult to replicate today, but most of our investors, which are University Endowments [ph] and Foundation have been long-term investors with our platform and repeat investors. So our assumption is that they would come back. Our expectation is that it would be more difficult, perhaps more pricey, we'll see where the world is three years from now. And as it relates to our current discussions with them, look, everyone's concerned and you have to be out of your mind not to be concerned. We are going through a very volatile time and what we're hearing from our institutions is they are facing a host of rebalancing or denominator effect issues. In other words, their alternative investments compared to the publicly traded assets are now a larger part of many of their portfolios just because of the precipitous drop in the S&P and other index. They're all watching that and they're all concerned about how to underwrite, but fortunately for us, the main investors in our funds have been extremely savvy, very successful and they delegate to us the hard and difficult task of determining when it's the right time to invest and they continue to be fully supportive of that.

Michael Bilerman – Citigroup

And is there any risk of any of that capital being pulled back or that you change sort of the fee structure at least in the interim if you're not able to place up the capital as quickly as you thought you were going to be able to do it.

Kenneth Bernstein

Michael, the days of saying anything is risk free went out the window when mutual funds started coming under attack or money market funds rather. But in fact, these are all rated funds and I have limited concern about their failure to fund our relatively small amount of capital, first of all. As it relates to the fees, we have another 3.5 plus years to put that money to work. If we ever came to the point where we said, it doesn't make sense to invest in real estate for a decade, yes, then we might confront that. But, it doesn't feel like that's even remotely what we're facing right now. What we're facing right now is our decision over this past year that there was so much disruption, it hadn't yet priced itself into the real estate assets that we want to own and invest in, so let's be careful now and then we'll have more fun in 2009 and 2010.

Michael Bilerman – Citigroup

I've got to imagine that there's also probably stronger appetite for your type of returns than the core type funds that some of these investors may be invested in.

Kenneth Bernstein

Yes. We talked about a queue up on investors looking to get into core funds a year or two ago and now I guess the line is equally long for them to get out of them, so – you're absolutely right.

Michael Bilerman – Citigroup

And just on how much capital do you think you need to deploy from Fund III to sustain your current or you're allied level of transactional earnings.

Kenneth Bernstein

Jon, you want to take a stab at that?

Jonathan Grisham

Well, the majority of the big chunk of the fee incomes that we earn off the fund is asset-based fee. It's 1.5% of the total committed equity to the fund, so that, that continues, regardless so that's probably a big chunk of that fee income that continues unabated. In terms of some of the other transactional based fee income, we'll see. We'll see. It's a little bit early to tell right now.

Kenneth Bernstein

I understand why that question is important to you. And obviously the earnings impact from upfront investments is something that you should look at. What we look at is how are we going to invest the dollars most profitably. We're much more focused on value creation. My best estimate of how these dollars get spent and I guarantee you I'm wrong but my best estimate is we will invest the remaining $400 million over 2009, 2010. I would assume it goes out equally and then as we announced transactions, you can readjust that.

Michael Bilerman – Citigroup

Can you talk a little bit about the storage business, especially in New York, if people start pulling back and that becomes less of a discretionary spend in terms of getting into that business and fundamentals, but also thinking about it's just from the standpoint of having the refinancing risk on the loan that comes due next year?

Kenneth Bernstein

Yes. First, the refinancing risk, this is in our Fund III and we're sitting on plenty of capital in line, so if we decided that 2009 was not a year to obtain a 50% loan to value bridge loan, the financing risk wouldn't be an issue. The economic risk is certainly something we're watching carefully. So far in New York what we're seeing both as relates, and it's really our stabilized assets that we can watch most closely, we haven't seen a fall off as a result of the softening economy. And one of two things play out in that. One is that while storage is discretionary, it's not discretionary the same way as shopping at Coach might be. And that a host of people because New York City does not have large apartments and large internal storage in homes, some people are using that as their essential storage space, not discretionary. It may be stickier than what you'll see on a national level. But we just need to see how bad and how soft this economy goes before we discuss anything being overly resilient.

And then on the reposition side, we've expect to take occupancy down as we put climate control into the half a dozen other projects that are part of this, and then we would expect over the next 1 year, 2 years, and 3 years that that occupancy picks up nicely. From an investment thesis perspective and this was the whole genesis of doing this deal with Storage Post. Storage Post is our partner in a host of our urban mixed use developments where we can put self-storage on top of our retail, and self-storage uses very little parking so the retailers don't mind and where we have the rights to effectively own that land, that air for free, it's very accretive to the developments.

So it's a good alternative use where best and highest use for second floor space is not office or residential, and we expect to continue to be able to exploit that. We doubt that we're going to be big investors on our own on buying additional existing self-storage until we have validated this thesis, because it's pretty clear that our core competency is retail and urban development we're not looking to become the next public storage by any means. So we'll see how it all plays out, but the yields going in, the accretion to our developments seems to have this all makes sense.

Michael Bilerman – Citigroup

Right. Thank you.


And our next question comes from the line of Michael Mueller, JP Morgan. Please proceed.

Michael Mueller – JP Morgan

Yes, hi. Couple things, Ken, you talked a little bit about cap rates and trends, but, can you drill down a little bit on the outer burroughs in terms of where you think cap rates are today, and where you think they can ultimately settle out and maybe think about it in the context of your development yields and the value creation.

Kenneth Bernstein

Yes, here's the problem with the burroughs, specifically, and then just other, what we'll call high demand real estate. There's just not been that many transactions, so I need almost take a step back and say. So far what we're seeing is the compounded annual growth of rent in the outer burroughs far surpasses what we see for other high quality retail.

And in general, if you have a cash flow stream with higher growth, it tends to hole on to higher investment values. So I would expect the burroughs not to trade, like Madison Avenue or like 57th Street or like trophy location, but should trade in the spectrum of that retail that has strong market growth, high barrier-to-entry, et cetera. What we are seeing today if you want to get your hands on that kind of real estate, even in this market, it's sub 7 cap, maybe a year ago it was sub 6 cap, so maybe cap rates have moved 100 basis points. But there's not a lot of transactional activity, and I would expect cap rates to remain stickier than that kind of real estate than for more generic retail which we have not been huge fans of.

As to where cap rates go, I'm not really uniquely qualified to tell you. I would expect the concept of positive leverage to reenter the investment environment. So if borrowing costs go to 8% or 9% it's going to be a very difficult conversation. If borrowing costs go to 200 to 300 over the 10-year treasury or between 6% and 7%, you may not see cap rates jumping up as much as the current stock prices indicate. Does that answer your question?

Michael Mueller – JP Morgan

Yes, yes, that's for sure. Secondly, thinking about the core portfolio, based on what you know now in terms of store closings and looking at the rent rolls. Can you make any big picture observations about where you expect '09 to either trail-off to or trend to?

Jonathan Grisham

Looking at our performance to-date, Michael, it's been very resilient in terms of core portfolio performance, but as Ken mentioned it's obviously a lagging indicator. But just to give you a sense of some of the numbers, our bad debt experience year-to-date has been about $0.5 million, which is actually less than it was last year at this time in the year. So and occupancy has drifted down, 10 basis points, 20 basis points, over that of a quarter or two ago. So empirically there's not a lot of data to suggest that there's been significant deterioration. That being said, everything you read suggests that there's a waive coming here, and, and no portfolio is going to be immune. I think our portfolio will stand up as good as just about anybody else is, but no doubt, it's going to suffer along with everybody else to some degree or another if these type of conditions persist.

Kenneth Bernstein

The other point, Michael, is because we've disposed of so much square footage, don't forget the lot small numbers so while our collections are strong – and so far in our conversations with our tenants we're not hearing any real bad news as it relates to their decisions with our properties. I joke that if we lose one dry cleaner we have to make a special announcement, so we're not necessarily a great indicator based on this portfolio. Let's see how the economy plays out, but so far, so good.

Michael Mueller – JP Morgan

Okay. And one other question for Jon. I know you guys don't have an '09 guidance out, but you made the comment about '09 wasn't expected to be a large year or a significant year for harvesting, looking at gains and promote, et cetera, were you implicitly saying that the '09 transactional number coming from that bucket is it was always intended to be less than '08?

Jonathan Grisham

I don't know about intent. Certainly it as – in looking at the pattern, it is not – we don't really anticipate as many transactions next year as this year.

Kenneth Bernstein

It will be less, it will be less about the sale and/or capital raising side, and more about and we touched on this a little bit earlier in the call, more about what new investments and redevelopments we undertake.

Michael Mueller – JP Morgan

Got you.

Michael Nelson

And Mike, it's always been lumpy and we've always said that, so it's not only lumpy quarter-to-quarter, but it's lumpy year-over-year and that's the nature of that type of income.

Michael Mueller – JP Morgan

Sure. Okay. Thank you.


Thank you. And our final question comes from the line of Rich Moore with RBC Capital.

Richard Moore – RBC Capital Markets

Hello, good morning, guys. Ken, did I understand basically that you would be probably paying a special dividend on, on because of the sale of those apartments?

Kenneth Bernstein

Mike, you want –

Michael Nelson

At this point, that is obviously one of the possibilities depending on where we come out in terms of the final tax projections that we're working on now. I mean, there are options. One is a special dividend. We could pay tax or we could be covered for some part or most of the existing gain that's unsheltered, so at this point I think it's a little premature to talk about it. But those are all obviously options available.

Kenneth Bernstein

If you look at what we did last year, and in general, we are big fans of retaining capital, not big fans of paying tax at our level. We made a special dividend last year as we're required to under tax, and we'll certainly look at where this settles out. We felt it was not smart to buy at first half '08 pricing, simply to avoid taxes.

Richard Moore- RBC Capital Markets

Okay. Alright. Very good. Great. And then on the fund, fund structures, for Fund III in particular, how hard is it for you guys to get a loan there? I mean, how hard, I mean, I realize they have, their own credit stand, but how hard is it for them to get a loan and do you still think that you could take $500 million of equity and turn that into $1.5 billion of actual fire power?

Kenneth Bernstein

Yes. And it's an important distinction. One is we do have for short-term bridge situations we do have a line in place based on the fund commitments that we can utilize. So if there was what we perceived to be a short-term bridge issue we certainly could use that. But we need to be cautious about it. The way I do believe we will be able to use $500 million to acquire $1.5 billion is not because we expect to see a $1 billion of new debt directed toward Acadia, it's more than that a host of the deals we probably will be involved with will have debt embedded in them already. There's good to be recapitalizations, there's going to be restructures, there's going to be seller financing, as we sit and scratch our heads and say, how do we work our way through this financial meltdown, all of those components have got to be part of it or else the capital markets will remain frozen, and I doubt that continues indefinitely. So there will be, those different means for us to get to a blended 2/3rd financing or $1.5 billion.

Richard Moore – RBC Capital Markets

Okay. Alright. Good. Thank you. And then was there a, was there a negative lease termination fee in Fund II, Jon (inaudible)?

Jonathan Grisham

That's right, there was some additional costs related to the Home Depot lease buyout and termination that came into the current quarter, so that's what you're seeing in the numbers.

Kenneth Bernstein

But the transaction itself was profitable (inaudible).

Jonathan Grisham

Very profitable.

Richard Moore – RBC Capital Markets

No, no sure. And so that's a one-time thing, I take it, and that's the end of that?

Jonathan Grisham

That's right.

Richard Moore – RBC Capital Markets

Okay. And then staying on that same mean for a second, did you guys calculate the exact impact for 2009 of 14-1, the convertible note?.

Jonathan Grisham

Yes, about $2 million. It's about $2 million.

Richard Moore – RBC Capital Markets

Okay. And we amortize that evenly over each quarter, is that right?

Jonathan Grisham

That's right. Over the entire five years of the debt.

Richard Moore – RBC Capital Markets

Okay. So it's $2 million annually?

Michael Nelson

$2 million annually, that's right..

Richard Moore – RBC Capital Markets

Okay. I got. And then on Mervyn's, I am curious, there's the lawsuit out there, Mervyn's is suing, I guess mostly OPCO, but does that impact you guys at all?

Kenneth Bernstein

I don't want to comment on litigation in general. Anything that negatively impacts one of our tenants, negatively impacts us, but we are not partners in OPCO and we'll just have to see how that all shakes out.

Richard Moore – RBC Capital Markets

Okay. So you guys aren't necessarily named, Ken, in that, in that lawsuit?

Kenneth Bernstein

I think, Rich, I think if you talk about this long enough, you'll be named.

Richard Moore – RBC Capital Markets

I got you. I got you. And then let's see, the last thing was, G&A was higher, is there anything, anything special happening there and what do we think about for a run rate?

Jonathan Grisham

We're still, we're still looking at a run rate of $26 million to $27 million for the year for '08, and we think we're going to come in, in that range.

Richard Moore – RBC Capital Markets

Okay. Alright. Great. Thanks, guys.

Jonathan Grisham

Thank you.


(Operator instructions) And there are no further questions in queue at this time. I would like to turn the call back over to Ken Bernstein for closing remarks.

Kenneth Bernstein

Alright. I'd like to thank everyone for joining us, and we look forward to speaking with you next quarter.


Thank you for your participation in today's conference. This concludes the preparation. You may now disconnect. Good day.

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