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Federal Realty Investment Trust (FRT)

Q4 2008 Earnings Call Transcript

February 19, 2009 11:00 am ET

Executives

Gina Birdsall – IR Coordinator

Don Wood – President and CEO

Andy Blocher – SVP, CFO and Treasurer

Chris Weilminster – SVP of Leasing

Jeff Berkes – EVP and CIO

Analysts

Jay Habermann – Goldman Sachs & Co.

Windy Shaw [ph] – UBS

Jeff Spector – UBS

Michael Mueller – JPMorgan

Chris Lucas – Robert W. Baird

Vincent Chow – Deutsche Bank

Rich Moore – RBC Capital Markets

David Fick – Stifel Nicolaus & Company

William Acheson – Benchmark

Craig Smith – Bank of America

Operator

Good morning and welcome to the fourth quarter and year-end 2008 Federal Realty Investment Trust earnings conference call. All participates will be able to listen only until the question-and-answer session of the call. This conference is being recorded. If you have any objections, you may disconnect at this time. I would like to introduce the conference leader, Ms. Gina Birdsall. Ma'am, you may begin.

Gina Birdsall

Thank you. Good morning. I'd like to thank everyone for joining us today for Federal Realty's fourth quarter and year-end 2008 earnings conference call. Joining me on the call today are Don Wood, Andy Blocher, and Jeff Berkes. These and other members of our management team are available to take your questions at the conclusion of our prepared remarks. Our fourth quarter and year-end 2008 supplemental disclosure package provides a significant amount of valuable information with respect to the Trust's operating and financial performance. This document is currently available on our Web site.

Certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information, as well as statements referring to expected or anticipated events or results. Although Federal Realty believes the expectations reflected in such forward-looking statements are based on reasonable assumptions, Federal Realty's future operations and its actual performance may differ materially from the information contained in our forward-looking statements, and we can give no assurance that these expectations will be attained. Risks inherent in these assumptions include, but are not limited to future economic conditions, including interest rates, real estate conditions, and the risks in cost of construction. The earnings release and supplemental reporting package that we issued yesterday, our Annual Report filed on Form 10-K, and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial condition and results of operations.

I'll now turn the call over to Don, to begin our discussion of fourth quarter and year-end 2008 results. Don?

Don Wood

Well thank you Gina and good morning everyone. I certainly hope you are all hanging in there during this very difficult and unpredictable time and that you have had a chance to go through the press release and the 8-K that we released last night. I think you will agree Federal had held up remarkably well in the fourth quarter, thanks to some very little LIBOR rates benefiting our interest expense and the fair bill [ph] results of some pretty extensive cost cutting company-wide offset to some extent by higher bad debt expense and $1.6 million legal settlement. I hope that you also noted that with respect to our quarterly dividend it is business as usual with payment in cash at the previously announced $0.65 a share.

Let me start a discussion of our operating results with leasing in the retail environment as we see it. While our lease rollover statistics in the fourth quarter weren’t as robust as they have been over the past several years, they are nonetheless very strong considering the environment. We did 74 comparable deals for nearly 320,000 square feet, an average of around $21.62 a foot, 13% more than the rent the previous tenant was paying. And when you break that down further you will see that four out of five of those deals were renewals at 11% higher rent with no downtime and very little capital deals. The other 15 deals were new at 19% higher rent including a new Walgreens drug store replacing its hired party store, one of our Northern Virginia shopping centers at double the outgoing rent, which will have great effect on rest of the shopping centers. And when you look at the entire year of 2008, leasing really stands out as such a core competency of our business that the combination of great properties and a great leasing team really provides such a sense of pride for all of us, 300 comparable deals done in 2008 for nearly 1.2 million square feet of space at 21% more rent. That equates to $5.7 million of annual incremental contractual rent with very little capital to get that. Now, all this addresses our demonstrated ability to continue to fill the bucket from the top right through the end of 2008. The hard part, which began in earnest in the fourth quarter of 2008 and is certainly continuing in ’09, it is a limit to leaks in the bottom of the bucket in the form of bad debt expense, rent relief, and our right tenant bankruptcies. These areas in addition to interest expense are clearly our largest challenges in the least predictable part of our business as we work through the recession. Let me now talk about each of these in some context.

In the fourth quarter, we recorded bad debt expense a bit more than $3 million, which is over $2 million more than our historical average quarterly charge. We finished up a rigorous detail tenant-by-tenant review that considered all sorts of ability to pay criteria. We think we were prudent, we think we were conservative in that evaluation, but there certainly has been any indication thus far in 2009 that the negative trend will continue for some time. The level of bad debt expense will be very difficult to predict with accuracy in 2009. We will talk about that when we get into guidance a bit. When it comes to rent relief, we have seen an increase in tenant request for some sort of reduction in the contractual obligation every month since September of ’08. To date, roughly one in 12 of our tenants have requested relief and only a small fraction of those have actually received some kind of modification to their lease terms. Every one of these requests is handled individually and there are myriad of factors that go into our decision making process. The tenants’ ability to pay, their ability to find other financing sources, our assessment of their long-term viability, their importance to the rest of the shopping center, backfill opportunities for the space and a half-a-dozen other considerations. Our overall decision is always ground in our belief as to what decision results in the maximum cash flow to the overall shopping center will get over the next few years? Every case is different, but we are probably more likely to deny relief and risk a tenant going dark thereby creating the higher vacancy for a time, simply because there are more releasing options available to us in the higher quality shopping centers. In terms of the type of tenants we are seeing who are hurting the most, I’ve got to say this is truly one equal opportunity recession.

Other than the main stream groceries and drug stores that anchor two-thirds of our properties the impact is extremely wide-spread and even handled. While it is certainly true that some restaurants are struggling and then luxury tenant sales are generally off considerably, it is also true that some necessity based retailers in our leased desirable properties are struggling. The only real trend, I guess if I can call it that, that I can really point to is a disproportionate share of retailer in newly developed properties, primarily because of the inability for those new tenants to solidify their customer base before the consumer shut down its spending habits last fall. But other than wide-spread and even handed are really the words of the day and it seems to me that geographical location and demographics remain the most reliable predictor of the shopping centers mid and long-term cash flow help. And finally as it relates to future bankruptcies who knows but there undoubtedly will be more, particularly in the box categories and very proactive and high level management leasing time preparing for those possibilities as required and it is and has been a key focus of ours. And that’s it in terms of leasing in the overall retail environment from my prepared remarks. Chris Weilminster our Senior Vice President in-charge of leasing is also available on this call, he is down at the mid-Atlantic ICFC today, but on the call and he will be available during Q&A to lend additional color.

Now, just a few comments on our operations, before I turn it over to Andy, we have taken a lot of cost out of the company through a painful, but necessary combination of staff reductions and non-payroll related costs. We took most of these actions in the third and fourth quarter and as a result our administrative cost run rate in 2009 will be about $6 million lower that is about 20% of our overall overhead, basically through a combination of sizing departments for lower expected volume, eliminating some nice to have things, but not got to have things, and most importantly asking more senior level people to make real-estate decisions with fewer layers and intermediaries between them we are operating a lot linear and hopefully more efficient at a time when tenant decisions operating decisions, financing decisions only to be made quickly and with sound judgments. The downsizing process isn’t fun, but it was necessary and I think it puts us in a better position to handle a prolonged recession if that’s in fact what we get.

Now in terms of development, our three largest opportunities Assembly Square, Mid-Pike Plaza and Bala Cynwyd shopping centers are all in the entitlement phase and that work will continue as we make progress in all three in trying to increase the land value to work to increase LIBOR what they are and we are possible public assistance at the Federal State, county, or city levels. Fortunately, we are not yet at the stage today where we have to make a go, no go decision on any of these three, those decisions will come in the future at a point where market conditions have sorted themselves out, but we are going to make that land value higher. And the only other item of note from my prepared is an update on litigation; you will notice that during the fourth quarter, we were able to settle one of two unrelated lawsuits against us that we have been disclosing in our 10-Qs for over a year now. The lawsuits that we settled involving a claim by a former tenant for failing to disclose the condemnation action in one of our previously owned New Jersey shopping centers resulted in $1.6 million charge included in G&A. I hope you will remember that our previous 2008 guidance excluded this claim because we had no idea of what the number would be. That same thing will hold true as Andy rolls out guidance for 2009 with respect to the second lawsuit for which we still have no damage ruling from a California judge. That lawsuit relates to a contract dispute (inaudible) on a site adjacent to Santana Row in St. Jose.

Okay, just let me finish up the prepared remarks by assuring our investors, analysts, and all the other interested parties that as a result the following are relatively boring and conservative business plan for the past seven years I really think Federal Reality is uniquely positioned to handle whatever the economy throws at us from a position of strength and comp. The quality of our properties and the markets that they are in, the low level balance sheet with stag of maturities, the lack of reliance and acquisitions in development, and a host of other conservative principles allow us to take a longer-term view. And from that perspective the future looks great. There will be opportunities and a way to pay for them that await a number of companies including this one if we are disciplined and we are patient and we will be.

Let me now turn it over to Andy.

Andy Blocher

Thanks Don and good morning everyone. I like to spend a couple of minutes talking about our balance sheet and the progress we have made in refinancing our ’09 debt maturities, before talking about our ’09 guidance and turning the call over to your questions. Let me give you a couple of highlights first and then we can talk about the details.

First, we feel very good about our ability to access our unsecured bank market and have been gaining strong support for our $250 million term-loan to close hopefully late in the second quarter. Second our high quality balance sheet puts us in a great position to raise additional capital on the secured basis to refinance the remainder of our ’09 debt maturities and provide additional line capacities. Third, as Don discussed earlier we are comfortable with the dividend as well covered to be paid in cash. We finally our $3.80 to $3.92 per diluted share guidance for ’09 reflect some growth in income at the property level and decreased G&A offset by higher interest expense resulting largely from the inefficiency of raising capital well in advance of our debt maturities.

Now, some of the details behind this, first, on refinancing our debt maturities, with the unsecured bond market remaining pretty unattractive we focused our attention on the bank market to refinance our existing $200 million term loan maturing in November. We asked a number of leaders in the bank market to run the traps for credit approval and then sat down with those banks to discuss terms for new term loans. Based on this conversation I expect pricing for new term loans to be significantly wider they are in current levels of LIBOR plus 57.5 basis points and anticipate having to make some modifications to our existing covenant package none of which give me any concern. I would expect that the lease in agents for this facility could commit up to $200 million of their own capital demonstrating support for our credit, business strategy, and management. We are targeting closing in the second quarter and we will pay down the line with any excess proceeds above what is needed to repay the existing term loan. All in all, we are very comfortable that we can replace and in all likelihood expand the term loan with maturity out in 2011.

To filling any gap between our capital needs and what we have raised through in unsecured term loans we are currently looking at secured financing alternatives. We got the flexibility to access the secured market because of the prudent management of our balance sheet over the past several years. The credit metrics remained very strong with leverage at 41% in a market capitalization basis as of yesterday’s close and 45% in a book-value basis. Remember a book leverage takes into account the low historic cost basis of assets that we have acquired as a public company over the past 46 years. We have over $3 billion of unencumbered assets from a book value perspective, the basis of our bond covenant. In addition we have less than $400 million of outstanding secured debt in all our bond and credit facility covenants could support over $1 billion of new secured debt. As a result we are currently in the market exploring secured financing alternatives for our portfolio of properties. We expect to evaluate proposals later this quarter with funding occurring in the second or third quarter.

What I want you to be sure to understand about this financing strategy I just described is that it will result in us refinancing an average of six months in advance of our actual ’09 debt maturities. We are estimating that this will cost us about $8 million to $9 million of additional interest expense this year. In a more predictable economic climate we have never been so inefficient in the management of our balance sheet, but we believe this financing insurance is prudent given current market conditions. Once we get these ’09 debt maturities behind us we will have no additional debt maturities until 2011 given that we are likely to exercise a one year extension option on the lines.

Turning now to the dividend, as Don discussed in his remarks, we currently intend to maintain our current dividend level and continue paying that dividend in cash. We strongly believe that a cash dividend by our REIT is fundamental to its very purpose and essential to the investment rationale of the very large percentage of our earnings. Early dividend payout was a 100% of taxable income by that of our target, in addition the dividend is well covered on an FFO basis at the mid – just from a relationship perspective at the mid-point of a range we will have a 67% payout ratio. We expect to generate positive cash flow in ’09 after payment of the dividend. We believe that our record of 41 years of increased cash dividends the longest records in the REIT sector is a valuable asset we hope to protect and extend during this capital crisis.

Finally a few comments on the 2009 FFO guidance of $3.80 to $3.92 per diluted share we established yesterday. As our management team worked through our ’09 guidance, I really got to say that the process was significantly more difficult than ever before and certainly regarding interest expense and retailer performance makes this range wider than we have ever used before, but please don’t lose perspective of what this range means. This $0.12 range is from top to bottom only a $7 million swing. That’s in the context of a company that will produce over $0.5 billion of rental income in 2009. The primary assumptions in that guidance are our best guess is for operating income from the properties will be slightly better than the $355 million that we posted in ’08. We are projecting a $6 million to $7 million savings in G&A driven by a lower overhead and decreased legal fees and $8 million to $9 million of additional interest cost I discussed earlier as a result of raising funds early to satisfy our ’09 debt maturities. You should certainly flex these top level assumptions as you see fit. We will have the better feel for the operating environment and capital raising as the year progresses and remember these guidance numbers does not include any impact associated with potential damages related to the previously discussed outstanding lawsuit regarding a building at Santana Row.

That’s all we have for prepared remarks operator, we will now open the call to your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Jay Habermann with Goldman Sachs. Please proceed.

Jay Habermann – Goldman Sachs & Co.

Hi Don and Andy good morning.

Don Wood

Hi Jay.

Andy Blocher

Hi Jay.

Jay Habermann – Goldman Sachs & Co.

Don you mentioned obviously the development you know still willingness to move forward, can you give us a sense of how you might reassess just given where yields are or might pencil out in this market, the challenges of leasing and obviously as you think about just alternative uses of capital at this point, it sounds like conserving cash and certainly focusing on near-term maturities?

Don Wood

Yes and that is really fair, you know, sometimes it is better to be lucky than good and in the case of those three big developments that we have, we are lucky in that we don’t have to make that decision today Jay because I mean, gosh, it applies to acquisitions never mind harder development, but trying to figure out where rental rates are going to be for retail, residential, office, what the demand will be is really impossible to do right now. And so if we were at a go, no go decision on any of those things right now, I think the answer would be we are not going to break ground. We are not in that point in any of those things and we are in each of them at Assembly, certainly at Mid-Pike and Bala, each one of them we made – we are making terrific progress in terms of that whole entitlement phase and the whole trick is to create land value there that will allow us to attract partners. To allow us to sell residential or office entitlement rates to allow us to do the retail ourselves or maybe to look at a joint venture partner for the whole thing, but the only way those things are going to work is if those potential partners see some value in the project. So, everything we are doing right now in spending the cash that we are spending is really all about getting through the entitlement process getting the basic grid and infrastructure laid to put us in a position where I can give you a much better answer on the viability of value creation in the future. But today, I don’t think I could do a very good job of telling you that there is absolutely a deal there. We certainly believe that if you are going to – you look and you say do you think we have a deal or do you not, we absolutely believe that there is a very good chance that we will, but having that underwrite that today it is just too early.

Jay Habermann – Goldman Sachs & Co.

In terms of development yield at this point do you think it’s got to be double digit or what is your expectation?

Don Wood

Look I think long-term that our cost of capital is going to be where our cost of capital was a while ago and that’s in the 9% range or so and maybe a little bit higher – 9.25% if you look at, what the long-term debt is going to be, where we think the cost of our equity is going to be and you blend those kind of things and you got to believe that we are going to be – this company will have about 9% cost capital or so that’s the case. IRR had better be north of that and taken through across the appropriate development risk. So, yes I think that is right.

Jay Habermann – Goldman Sachs & Co.

Okay and then just maybe for Andy. In terms of expectations on the refinancing, I know you mentioned the $8 million to $9 million of incremental cost, what are your assumptions for the raising debt capital today?

Andy Blocher

Yes Jay, when you look through it, we are in a interesting position with respect to our refinancing right now, I mean I would anticipate that we would probably be in a position to pick our leads on the terms loan in the next week or so based on the work we have done up to this point. The basic underlying assumption there is our expectation is that probably will raise the capital about six months in advance of when it was needed and that there will be a negative carrier associated with that of about 450 basis points. So you take the 375 million times 450 basis points times half a year here that kind of gets you to right in the middle of that $8 million to $9 million range. The specifics with rate, I certainly don’t want to negotiate against myself with respect to going through the individual assumptions for the term loan or to secured financing position but that’s the basic assumptions that go behind that $8 million to $9 million and as we have more information, we will share it.

Jay Habermann – Goldman Sachs & Co.

Okay and then maybe just a last question. You mentioned sort of the operating performance being somewhat flat, can you comment a bit on what you are expecting I guess from the residential portfolio?

Andy Blocher

Let’s just remind you what the residential portfolio is, you know we are talking about a very small part of Federal – right now I wish we were a bigger part because we are doing really well. We are talking about the unit that at Santana Row, which are 95% Don leasing – 95% leased today probably going we are assuming down in to the low 90s in 2009 with very little rent growth, maybe a little bit, very little. With respect to Bethesda where we had just opened up the new building in Arlington East, is a 180 units there, we are 96% leased there. We actually leased up as fast as we thought we were going to there, which was really, really encouraging not quite at the number, we missed the number by about 7% or so in terms of what we were looking for in asking rents, but still $2.80 a foot or something like that, we are looking at that being staying that strong for 2009. And than a congressional apartment which is here in Rockville, stable occupancy down a couple of points, down a little bit in terms of operating income because of lower expecting rental rates, but not much in occupancy. So, overall about flat, maybe down a little bit for the residential portfolio here.

Don Wood

I think Gina has a question too?

Gina Birdsall

I was just wondering if there was any update on the Linens Boxes that you got back last quarter and what you are just seeing in terms of getting that place re-tenanted?

Andy Blocher

Yes Chris are you on the line, do you want to take Linens?

Don Wood

Chris, I guess you have to hit a number or some – the good news is I think we have Weilminster on line; the bad news is I don’t think he can talk. So, let me tell you –-

Chris Weilminster

Hello?

Don Wood

Go get him pal, Linen.

Chris Weilminster

I am sorry I apologize. We have got a lot of activity on our one Linens boxes down in Chevy Chase right over the Maryland, in the district we have got about eight retailers that are very interested in that box and we are hoping that will be able to announce the replacement tenant on that one sometime by the middle of the summer as it relates to our Mid-Pike Linens Box that being part of our redevelopment we are looking at that on the long-term basis, but we are benefited by the fact that that had a normal [ph] guarantee behind it. So, we are in discussions with CDS and we expect to continue to receive rent on that lease for the remainder of its terms.

Jay Habermann – Goldman Sachs & Co.

Okay thanks guys.

Operator

And our next question will come from the line of Jeff Spector with UBS. You may ask your question.

Windy Shaw – UBS

Windy Shaw [ph] with UBS. Can you guys discuss what’s going on with our higher end tenants, are they mom and pops or boutiques, we have heard a lot of these types of tenants closing stores so just want to get a sense of how they are holding up in your markets?

Don Wood

I tried to adjust this a little bit in the prepared remarks. You know the definition of who they are, the higher-end boutiques, they are not a they, they are a bunch of individuals and the results are all over the place. As you would expect, it depends very much on the shopping centers they are in and how stable they were going into this recession where the rest of their financings come from and things like that. Some of those high-end boutiques as we have seen as much as 20%, 25% reductions in their sales over the past couple of months, others we have seen them hardly hit at all. I really am having a hard time making category statements about the luxury guys are dead or this guy is dying the most, it is really as an equal opportunity recession and we are really seeing a very varied amount of results and amount of struggling based on a lot of other factors other than just the category that they are into. So, it is all over the board in that category.

Jeff Spector – UBS

Thanks Don, it is Jeff, just a follow-up question then on rent relief, is that picking up at all, I mean has there been any change even just in the last couple of months where you are seeing more tenants file and the hit rate is increasing?

Don Wood

No doubt about it Jeff. There is no question that literally every month since September of ’08 the number of requests we have for some sort, the big broad category here some sort of adjustment to the contractual lease that’s already in place has gone up. So, at this point we have – we’ve got about 2,500, 2,600 tenants at Federal. About 200 of those have asked for some sort of rent relief. Now when you break down those 200 and you figure out who they are the interesting part is a huge part of them are well capitalized companies that don’t really need the rent relief, but are using this period of time to be able to negotiate and if you think about it makes all the sense in the world. I don’t know whether you saw or remember seeing, because I sure do, Wall Street Journal Article sometime in the middle of November, basically saying that retail tenants are coming after their landlords for rent relief. You had to see the spike in request for the two, or three, or four weeks following that. It really – there clearly are a lot of tenants both those who need it, both those who, you know would have needed it even in good times and those who don’t need it at all who are coming back to the landlord as the savior here and as I said in the prepared remarks, we’ve given some form of rent relief to about 25 to 30 tenants out of the 200 or so who have asked. We are only doing that in situations where we believe that that rent relief will result in more cash flows to the shopping center over the next few years and we are certainly not giving it to tenants that aren’t going to make it anyway. So, you should expect to see higher vacancy, probably through June of 100 or maybe 150 basis points from our perspective over the next part of 2009, but the combination of higher vacancy and a little bit of rent relief and some higher bad debt together is really the primary set of assumptions that are most difficult to predict in the 2009 guidance.

Jeff Spector – UBS

Okay thanks. So, just one follow-up then if a regional tenant is well capitalized but has an unprofitable store or two are we saying that that’s a situation where they would not get rent relief because the company is well capitalized?

Don Wood

It depends. We certainly didn’t take all that time negotiating a strong lease to – at the first hint of struggles and sales, to say never mind we will clear off that lease. So, it is a very high barrier that you have got to cross to be able to get us to modify the lease, but it is going to happen in certain cases. If you are well capitalized and strong, the barrier is a whole lot higher, sure.

Jeff Spector – UBS

Thanks guys.

Operator

And our next question will come from the line of Michael Mueller with JPMorgan. You may ask you question.

Michael Mueller – JPMorgan

Thanks hi. Few questions. First Andy, can you give a little more color on the refinancing for example, the money that is being raised for the term loan? Is the existing term loan expected to stay outstanding until maturity and you just pay down the credit line in advance of that or do you expect to refinance that in advance, obviously you can’t do that with the bonds though, correct?

Andy Blocher

Yeah that’s correct Mike. I mean one of the real advantages that I think that we have relative to other who maybe trying to access capital through the bank market right now is that we do have an outstanding term loan that is maturing later this year, where thanks for lending us money at LIBOR plus 57.5 basis points, you know probably inside their own cost of funding. So, to some extent if we can utilize the idea that we will prepay that early to existing participants as a (inaudible) we will absolute utilize that to the best that we can relative to somebody else who is looking for incremental bank capital and they don’t have that care. So the proceeds for that because the term loans are pre-payable will be to pay down the term loan, any incremental capital over and above that would go to pay down the line. With respect to other financial alternatives including secured, the ultimate use of those proceeds will largely be used to pay down the 8.75% bonds that are coming due late in the year. We – on an interim basis that capital would be utilized to pay down the line or holding cash or short-term investments that are very low rate, that is the biggest part of that negative spread when I was talking to Jay earlier that 450 basis points.

Michael Mueller – JPMorgan

Okay, both of these should we assume it is out of like end of the second quarter or six months in advance something like that for both?

Andy Blocher

Yes, end of the second quarter, early third quarter.

Michael Mueller – JPMorgan

Okay and then in the prior question as well touched on same-store guidance, I think Don you mentioned occupancy down 100 to 150 basis points, can you comment on Q3 spreads were positive on a cash basis, can you talk about what you have seen so far in January and when you typically talk about same-store guidance, you talk about with redevelopments without redevelopments. If you are looking on an ex redevelopment basis, is that the metric where you think it is going to be flattish this year?

Don Wood

Yes I do, just doing that from the end first, I think that is where it will be a pretty flat year. What I think is going to happen is you will see it really in the lease that is in the term. We normally average on all the leases we do seven-year term, there is some fives, there is some tens, there is some twenties, etc in an average it is, if you look over time, to seven, seven-and-a-half, eight year-leases, you will see in the fourth quarter that came down to five. As you go into ’09 you should expect to see a lot of short-term deals that are about renewing people and moving people of one year and two years at a time here at flat rents or maybe a little bit increases and things like that. So, there will be a bigger proportion of the leases that are done, the deals that are done, I would suspect that are like that shorter term and less in terms of rollovers they will always be in the portfolio though. And Chris can probably comment on this best, there is always demand here and so there will be deals throughout the year that are carrying some real nice spreads. Now, and in fact I know one in the first quarter that we just did that will be a nice thing. Now, how many of those there will be, those will be lower, there will be less of those types of deals this year and so from an overall waiting perspective the short-term renewals at lower lease rollovers are the name of the day, so that is going to happen. So the waiting of this whole thing really is what changes the most, that is why I see it primarily flat better than flat with the redevelopments included in that and offset to a large extent by the interest that Andy just talked about.

Michael Mueller – JPMorgan

Okay, so if you are down 100, 150 basis points on a blended cash basis, you still are probably looking to be up on a blended basis close to double digits?

Don Wood

I don’t know, it is hard for me to say. Maybe you will see seven, eight, nine, ten, and eleven, something in that range probably right. It is very dependent on a particular deal or two or five in any particular period.

Michael Mueller – JPMorgan

Okay, thank you.

Operator

Our next question will come from the line of Chris Lucas with Robert W. Baird. Please proceed.

Chris Lucas – Robert W. Baird

Good morning guys.

Don Wood

Hi Chris.

Chris Lucas – Robert W. Baird

Don, just to follow up on the question, given the shorter lease terms, should we be expecting then actually lighter concessions in tenant improvements or is that market going to be something that continues at the current pace?

Don Wood

You can certainly assume on the renewals that they are very lighter concessions that way for sure. On the new deal, it depends on the new deal and if we are trying to – if the deal is real important to one of the developments that we are doing or one of the shopping centers that really could use it, it is about negotiating leverage and we will do the best that we can, but there is no doubt that even the well cap, especially the well capitalized tenants are the ones that are in a stronger position today to push hard on all things including rent, including TI. We do the best we can on that. You should certainly still expect to see higher rent, you should certainly expect to see TIs as it has been, I would not expect to see a dramatic increase that way. But on the short terms you won’t see very much the idle.

Chris Lucas – Robert W. Baird

I guess the other point I would ask is in the office industrial space, a lot of the landlords are sort of counting the ability to pay leasing commissions and build the tenant improvements out and sort of helping along that way in terms of buying occupancy and competing against their less well capitalized peers, is that something that is a differentiating aspect in the retail side as well?

Don Wood

I don’t know, to some extent it really is all about the supply, demand and the leverage that you have for that particular space, we do have the ability and we have built out spaces for particular tenants on the retail side, but there is nothing going on that is thick in this side for sure. It is all very customized for a particular tenant. So it really is going to depend on the deal and on the tenant that particular shopping center.

Chris Lucas – Robert W. Baird

Andy, quickly on a couple of points of clarification, as it relates to the bad debt expense does that show up as a reduction in revenue or is there something that is allocated to operating expense as well?

Andy Blocher

No, it is rental expense.

Chris Lucas – Robert W. Baird

Okay. It’s rental revenue adjustment down or is it a show off in operating expense?

Andy Blocher

It is in operating expenses.

Chris Lucas – Robert W. Baird

And then on the litigation cost, does that show up in the G&A line?

Andy Blocher

Yes it does.

Chris Lucas – Robert W. Baird

So, you are talking about the savings on G&A over this year or are we talking about with the litigation cost included or not?

Andy Blocher

Yes a portion of the savings in G&A is the fact that the litigation cost will not be in 2009, but they were in 2008 outside of the litigation that we talked about separately with your success at Santana Row.

Chris Lucas – Robert W. Baird

Okay great. Thanks guys.

Operator

Our next question will come from the line of Vincent Chow with Deutsche Bank. Please proceed.

Vincent Chow – Deutsche Bank

Hi guys. Just a quick follow up on the development. We talked about certain bigger projects that are – you don’t have to make a decision today on but in terms of the pipeline for ’09 and your commentary about new developments and retailer tendency on those properties, can you talk about sort of your expectations there, it looks like the ROI conditions haven’t changed, and maybe can you talk about the occupancy in those four projects and what you expect them to be in ’09?

Don Wood

Yes. Let me start with the closest one here which is Hampden Lane, actually – that’s actually ten, but we have made the decision to go ahead with Hampden Lane, which is another that we are doing in the Fed and will include Equinox Gym and some other tenants in one of the buildings in the existing projects that we have. One of the reasons we started to go ahead with that was because we got a basically 65%, 70% pre-lease at a very early stage and so the pre-leasing on our typical retail projects is an important part of the redevelopment stuff that we do. The only one that is not is the one that is going to be a little tougher for us and it is figured in the numbers in fact. There is no income associated in 2009 and that is the Santana Row for 300 at the end of the year – for 300 Santana Row, which is the office building of a retail that we are doing out in the front part of Santana, that building is completely up, no glass on the outside yet but that is about to happen and we have got CB work in the office market there, we did not time that all that well, there is demand but what the rent is going to be and how we are going to break up the floor is still open, we are not nearly as far as I would like to be at this point. Lots of interest as you would expect on the ground floor of that, it is the front door if you will at Santana and we are getting close on getting some deals speed up and done there. So there is a building that overall we took down our expectations to 8% on that basically because it was bought out and built out in the better days and we were assuming that we would be able to get higher rents on the office and I think we are likely to be able to get to see how that works out. Hollywood Galaxy and the last pieces of Houston Street great deals moving along just about done in both cases. So that is where we are, you know one of the interesting things that is going to come out of this is that we are certainly not ready to talk about yet but it is almost inevitable is because of changes in the retailer base in the next couple of years we are going to have a bunch of redevelopment opportunities that we have not thought about so far and they are going to avail themselves by some of the bankruptcies and some of the changes that are inevitable in the next couple of years. So I would expect that that pipeline will start to grow in the out years even though it is certainly going to be softer for the next couple.

Vincent Chow – Deutsche Bank

Okay and then just back to the debt maturities, on the 8.75% coupon bond, it sounds like the plan is to raise some secured debt to address that but you did buy some back closer to the end of the quarter, can you give a little bit more color on that and are you continuing to try to do buy back some of those bonds, at what price are you sort of buying that?

Don Wood

Yes those are kind of one-off deals we were able to buy back $6 million of the bonds roughly at par, yes to the extent that we can get others back we will certainly try to do that. We will like to get the cash in hand with respect to the term loan first, I think that the real – if not issue but the real impact there is really one of our bond holders look at our balance sheet and generally I think that they believe that those bonds are money good until they will much rather earn the yield through year-end but we will certainly evaluate strategies in order to trend our business.

Vincent Chow – Deutsche Bank

Okay so it is just that you can’t buy back more but you would to.

Don Wood

Yes. Federal Realty bonds generally they are not very liquid and they don’t trade all that much.

Vincent Chow – Deutsche Bank

Then the last question in terms of the lease termination fees, it looks like it is down quite a bit this quarter from last quarter, what sort of expectations you are building in for ’09?

Andy Blocher

Yes it is really interesting. Lease termination fees are there every single year. Now, I am only worried about them in ’09 and the guidance reflects that because with the liquidity crisis that is going on there, there are lot of tenants that would normally buy their way out of a lease they want to get out of the store with everybody else will stay in and continue to pay the rent because they are worried about liquidity. So we have only got about $1 million, a little bit more than $1 million assumed for new lease termination fees in 2009. The reason I make that distinction between new lease termination fees is because we do have – we are amortizing a few of them including Home Depot at Flourtown that has an option for a couple of years. So that is still being accreted and I think it shows in that line of other income or whatever it is for ’09, which is locked in there but in addition to that an assumed $1 million, $1.2 million or so of new lease termination fees, but I would not expect that to be that big a number going forward in ’09 unless the liquidity situation straightens itself out a bit.

Vincent Chow – Deutsche Bank

Okay, thank you.

Operator

(Operator instructions) Our next question comes from the line of Rich Moore with RBC Capital Markets. Please proceed.

Rich Moore – RBC Capital Markets

Hi guys, good morning.

Don Wood

Good morning.

Rich Moore – RBC Capital Markets

The activity on the bank debt that you guys are looking at in the near term here, it seems pretty positive so I am curious, how do you see what is going on in the financing sector at this point, are things beginning to loosen up a bit?

Andy Blocher

No, I certainly would not say it is loosening up. I think at the end of the day companies that have got very solid balance sheets with good business strategies and good management teams are going to have an advantage in this environment and a lot of the work that we put into the balance sheet over the last six, seven, eight years in raising equity opportunistically in order to keep our leverage under control, when you look at the bank market in particular, Federal Realty has $300 million credit facility and $200 million term loan. We don’t have a $1 billion plus of bank exposure. I think all of those things combined make certain pockets of capital a little bit more attractive. On the secured side, I think it comes down to, everything that we talk about from an operating perspective as well, the quality of the assets, the quality of the locations, our ability to lease those and generate good solid income streams, I think all of those things are a positive. When you look at the unsecured market it seems like every couple of days somebody will come out and say that the unsecured market is getting better and they don’t necessarily mention the following day when things get a little bit worse.

Don Wood

Hi Rich, I just want to add something on the bank side, I think you are raising a very important point, I think more than we had ever seen before the distinction between the haves and the have-nots here is really playing itself out. I can tell you that when we started with a $200 million, we were sitting there with a $200 million term loan, the idea that we have got the ability to upsize that term loan was not really even considered, we didn’t know. We were hoping to refinance the $200 million that was out there and look we are a long way from being done so I don’t mean to be too positive about this but I can tell you the conversations with the major lenders here including the leads that I suspect we will because Andy said they are announcing in the next week or two have all taken on additional exposure to Federal in terms of where we are heading and that is not something we expected. It is certainly not something that we have heard is widely happening out there because I think a lot of banks are firing a lot of their clients and so they are really concentrating their positions. And so if you feel that that is positive I could not agree with you more, it is one of the real positive things that have come out. I just don’t know that you can take that and say it is real wide spread because I don’t think it is.

Rich Moore – RBC Capital Markets

Okay, thanks Don and I am just wondering it seems that you guys are moving very quickly, obviously you are way ahead of when these maturities come and I am trying to get a feel for, are you concerned that that kind of environment that you are describing for Federal may not be there in September so better to get it done in February, March or by summer?

Don Wood

Rich, who knows, and when you think about the impact to earnings for one particular year, it is such a small consequence compared to the risk of who knows and we are clearly in unprecedented times here.

Rich Moore – RBC Capital Markets

Yes, I agree. It is a very good point. And I want to ask you, it is probably a little bit too early that is what I am guessing but I will let you answer the Don, are we looking at anything on the acquisition front, is there anything out there that is worth even bothering given the capital environment?

Don Wood

No. Usually in this conversation Jeff Berkes who sits down the table a little bit on there, sits there and he is bombarded with tons of questions I cannot thank you enough for asking an acquisition question Rich so that Jeff could comment a little bit in this conversation. Before I turn it over to him though I am going to say this, not until we get the money lined up.

Rich Moore – RBC Capital Markets

Got you, right.

Don Wood

So let’s make sure that we get the money lined up, okay, but let’s hear about the environment by Jeff.

Jeff Berkes

Gee Rich, after that prelude I am not sure I remember the question. Like Don said in his prepared remarks, we are going to be like we have always have been which is very patient and very disciplined. I firmly believe that there is going to be great opportunities to raise [ph] up. Going forward we are starting to see maybe the beginning stages of that right now but it is really in my view too early to make big commitments but we are going to stay the course and do what we have always done which is stay in touch with the owners who own the property so we want to buy and the brokers that handle the sales of those properties and as opportunities arise, evaluate them with very critical eyes and if it makes sense relative to the risk and the property and our cost of capital, we will pull the trigger and then and only then, so I don’t know if that answered your question or not.

Rich Moore – RBC Capital Markets

It does, I am curious too Jeff. Is there anything, are you seeing anything, I mean would you say there is more stuff coming into market, less stuff about the same as it was four months ago, what do you think?

Jeff Berkes

I think there is more but just a trickle more, I mean, there wasn’t really anything going on in the last quarter or so of ’08 and there is some property on the market last year that didn’t trade and that is starting to come back at different prices, lower prices, but we haven’t seen an opening up of the market and we don’t expect to see a real opening up of the market until there is a little bit more clarity on the debt capital side of the equation. So, again I think it is kind of slow and careful and long term or medium term it is going to be a good buying opportunity and we are going to position ourselves so we are very well set up to take advantage of that when the timing is right.

Rich Moore – RBC Capital Markets

Okay, got it, great. Thank you guys.

Operator

Our next question will come from the line of David Fick with Stifel Nicolaus & Company. Please proceed.

David Fick – Stifel Nicolaus & Company

Good morning, I am actually here with Nat Isbee also. Don you made a statement and this really relates to the question that was just answered that you see your wag is something in the 9% range and obviously that is substantially higher than the answer you would have given two years ago, but your debt, your absolute cost of debt and rates are down and I am wondering what are the implications for cap rates if Federal, which has the premium balance sheet and arguably the lowest cost of capital in your space seasonally as its wag where should we be looking at valuation for real estate?

Don Wood

It is a very, very fair point and let me go back a little bit Dave and talk about the 9% and the components of it. There is a lot of guessing in there on the debt side, but when you sit and look today, I think if you go in our 8-K you will see that our average cost of debt is 5.8% or so and do we expect that 5.8% to rise to 7.5% in the next 12 or 18 months, absolutely not. But if you were to take that whole portfolio and you were to say okay, what if you were to mark to market and what if you were to say, the debt portfolio I am saying, what if you were to mark to market and figure out where you think your long-term cost of debt is going to be for anything that is coming during the next seven years or some kind of number like that, I think you will look and say, you know what, I think based on history and based on the future, 7.25% to 7.5% is probably where the overall balance portfolio of debt could very well be in three or four years or some period like that. Then if you come and you say, alright, what is the cost of the equity in this company and I think you and I have had this covered just a bunch of times, there is a whole lot of ways to do that, there is a whole lot of metrics that you consider. When you do, when you figure out what your dividend yield is going to be, what is your share price appreciation should be anticipated and what your growth is going to be etcetera it is hard to imagine that that number is not a 10% number or 10.5% number. And so if you are really kind of thinking about it holistically, I think 9% or so is probably 100 basis points higher than the 8% or so that I would have told you two years ago, and again it is not going to happen overnight, but I think it clearly suggest that cap rates rise. But the distinction again between the stuff you really want to own long term and the stuff that you don’t is going to be a whole lot wider than it already is, a whole lot wider than it is going to be, so that is I think the implication.

David Fick – Stifel Nicolaus & Company

Okay. I know you say that tenant performance is all over the place from top to bottom and not discriminating by category, but I am wondering, you have sort of the unique portfolio with respect to the 25% of row-type locations and 9% or so of restaurant business, are you seeing anything in particular in restaurants at this point?

Don Wood

Let’s break restaurants down. When you are talking about kind of the expensive white table cost of restaurants in great areas and good properties that have been there for a long time, those are down 10%, 8%, manageable amounts in terms of sales losses and their ability to pay. I think when you take that and you add expense of restaurants that really aren’t very good, the buyer is a whole lot more discerning and so those guys are in trouble especially if they don’t have the capital set up to be able to go through a period of this kind of situation. You can then compound that in those situations for lots of different types of restaurants, in fact lots of different types of non-restaurants at properties that never were able to get their lights under. So one of the properties that we have happens to be a road side property that we are struggling with the most right now is Rockville Town Square.

David Fick – Stifel Nicolaus & Company

Right, I would expect that.

Don Wood

You would expect it. It opened up at a time where those restaurants were not able to get their feet under them. Even at Rockville Town Square the most expensive restaurant happens to be, one of the most expensive, is the Sushi guy, a high end Sushi guy says that’s great and some of the lower end products do not. So, I think if you think about it more from the buyer’s perspective, the specific customer in that specific area, I think it helps you think it through though a little. Jeff Berkes made the funniest comment to me that is so true, we keep saying necessity based, I cannot tell you in how many areas restaurants are necessity based, no, maybe not in the middle of the country, there are certain areas that the family will starve if they don’t go to the restaurants and it is a little bit tongue in cheek to say that but what I am trying to say again is while restaurants are clearly an exposed category, so are necessity based categories in poorer areas, in areas that are not going to hold up as well. So that is what I mean they want to say it is all over.

David Fick – Stifel Nicolaus & Company

That is my next question, you say you are getting hit at the necessities and that is where historically if you look back in the last two or three cycles and you experienced at least a couple of those, you have been pretty immune to economic downturns and that is surprising you, it is surprising us, how are people dealing with buying toilet paper and macaroni and cheese, I mean you have still got to eat –

Don Wood

I am not really saying that, in the necessity based stuff that is the grocers, the drug stores, those services are strong but the difference this time is liquidity and capital availability. And so when you are running on – you are a more poorly capitalized operation and you are running with 10% or 12% less topline that kills, and you are not sitting there with a big credit line to be able to draw on or a way to easily find that capital, those are tougher and that is all I am trying to say. I think as opposed to the prior cycles, liquidity is so much more messed up right now that it is adding an extra layer of – it is adding a bigger piece of the equal opportunity in the equal opportunity recession.

David Fick – Stifel Nicolaus & Company

Okay. Last question, you are obviously being told by tenants and seeing reports of sales being down, two-part question, what are you doing – you have audit rights obviously in your leases, what you are doing to verify what you are being told and are you finding discrepancies as you go through the process?

Don Wood

First of all, we are not doing a lot to verify what we are being told when full rent is being paid, okay. When you are requesting something different then not only do we have full audit rights, but it is not an easy process to go through to get that to happen. So we are using financial statements, we are using typical metrics that we expect to see, etc. The premise though, I want to challenge, I just want to not challenge, but I want to make sure you understand the difference in the community based shopping center sector as opposed to the malls is we do not have sales from everybody. In fact, overall we get sales I think from about 40% or so of our tenant base and that leave a big piece that it is anecdotal and things like that. A lot of acquired shopping centers didn’t require that in the leases and it is not always so easy to get. Anything new that we do, we get sales on, so we know every tenant sales in Rockville and in Santana and some of the stuff that we have done recently but overall in the portfolio I have got a limited base from which I am talking. So that order really ties down to those places where folks are unable or unwilling to pay their full obligation.

David Fick – Stifel Nicolaus & Company

As an intern in college I used to do those sales audits for one of your big competitors and I can tell you it was always the Sushi guy who under reported. Thank you.

Don Wood

Check his receivable, thanks David.

Operator

Our next question will come from the line of William Acheson with Benchmark. Please proceed.

William Acheson – Benchmark

Thank you. Good morning guys. We have all been expecting a wave of retailer bankruptcies and aside from a few notables that happened in January it really has not happened, one of the things I am wondering about is the unavailability of DIP financing, a general that is out of the market, etc is that forestalling people filling chapter because they know if they do file now, it is not going to be a bankruptcy probably it is going to be a liquidation.

Don Wood

Yes, it could be. Listen, what we really do have to remember here is while – the world fell off a cliff in September and consumer patterns changed dramatically in September and I know it feels like it was eight years ago but this whole thing takes time to play out and October, November, December, January and here we are in the middle of February, I mean most operations can make their way through a bad period of time for a period of time, it is only those that were really close to not being able to make it fill when times were good and Circuit and Linens are two examples of that that once you take 10% or 15% off the top, it just becomes impossible. So is debt financing a part of what is impacting the world out there retail? Absolutely, it has to be as are all of the liquidity solutions that most companies have to work through this year and you are not ready to – certainly folks are not ready to just give it up if they don’t have to and it has not been all that long yet. So the combination of those things I do think there is more to play out, I think it will play out in 2009 and the only hedge you have got. From a landlord perspective, the only true hedge that you have is the location where there is demand for somebody else to take.

William Acheson – Benchmark

Absolutely. One other thing that I think I need to mention here is the media kind of plays up the current economic crisis that we are in right now, but if you compare the numbers going back to ‘82, ‘83, GDP was down 5%, inflation was running at 12%, unemployment was at 11%, mortgage rates were at 17.5%. You line that up to the situation that we are in right now, we are actually not even close to as bad as it was 25 years ago.

Don Wood

Okay.

William Acheson – Benchmark

I mean, do you guys get the sense that people are just hanging on here waiting to declare, waiting to –

Don Wood

No, I don’t get that sense. When you are in the middle of something not being able to see the other side it is what impacts things the most. We are not going to know until there is some visibility about the other side and that has to start with liquidity and jobs.

William Acheson – Benchmark

One last question, you may not be able to answer it, but in ’82 and ’83 you have an idea of what your AFFO multiple might have been? I actually guys covered you guys back in ’88, so I can look it up, I can go back into my archives.

Don Wood

Give me a call when you know it, give me a call when you find it because I can’t find it. I don’t know.

William Acheson – Benchmark

Okay, I will check that out. Thank you gentlemen.

Operator

Our next question will come from the line of Craig Smith with Bank of America. Please proceed.

Craig Smith – Bank of America

Thank you. I don’t know if this is a question for Chris or the trend setter, but let me go, I am wondering if you look at opportunity for leasing in Federal who will do the trading up of community center and more average centers looking for an opportunity to go to a better center, but I am just wondering just given the environment our retailers are reluctant to make changes like that either because of liquidity or just they want to leave well enough loan and they want to make changes, are you having any opportunity in back filling with tenants surrounding you?

Don Wood

Hi Chris, are you there? You have got to answer that, I can’t talk to Craig on that.

Chris Weilminster

Hi Craig. You are absolutely correct in at least the sense that that is what we are seeing and really what we are seeing at the mom and pops. The mom and pops and the regional chains who in prior markets really weren’t the ones that had the opportunity to get on to a Rock or Pike the ones that are very active right now and at this convention that I am going to go back into when this call is over there seems to be a real buzz of business in those categories and that is kind of across the board that casuals, the service related players, those guys are really out there looking to take some real estate down and to getting those locations that they just didn’t have before. So I would completely agree with you and I think that absolutely resonates and marries up with the Federal Realty’s portfolio as they seek ends – the flight to quality which we certainly have.

Craig Smith – Bank of America

And then do you do anything to make it and incentivize that or did they have to come to you strictly and what makes sense for you?

Chris Weilminster

Yes, every deal has worked independently Craig. Our job is to cut the best deal for the trusts and shareholders and the ones with certain categories we are able to pay more rent and we pushed that very hard and it is an incentive for them to get into some of the A properties along in our districts and we certainly try not to leave anything on the table as it relates to that but each deal is independent, there is no global answer to that question.

Craig Smith – Bank of America

Okay, thanks a lot.

Operator

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

Gina Birdsall

Great. Thanks everybody and we will talk to you soon.

Operator

Thank you for your participation in today’s conference. This concludes the presentation, you may now disconnect. Good day.

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Source: Federal Realty Investment Trust Q4 2008 Earnings Call Transcript
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