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Federal Realty Investment Trust (NYSE:FRT)

Q1 2009 Earnings Call

May 7, 2009 11:00 am ET

Executives

Gena Birdsall – IR Coordinator

Donald Wood – Chief Executive Officer

Andrew Blocher – Chief Financial Officer

Jeffery Berkes – EVP, CIO

Analysts

Jeffrey Donnelly – Wachovia

Paul Morgan – Morgan Stanley

David Wigginton – Macquarie Research

David Flick – Stifel Nicolaus

Alexander Goldfarb – Sandler O"Neill

Jonathan Habermann – Goldman Sachs

Richard Moore – RBC

Jim Sullivan – Green Street Advisors

Operator

Good morning and welcome to the first quarter 2009 Federal Realty Investment Trust earnings conference call. (Operator Instructions) I would like to introduce the conference leader, Miss Gena Birdsall.

Gena Birdsall

Good morning. I'd like to thank everyone for joining us today for Federal Realty's first quarter 2009 earnings conference call. Joining me on the call today are Don Wood, Andy Blocher, Dawn Becker 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 first quarter 2009 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 website.

Certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized information as well as statements referring to expected or anticipated events or results.

Although Federal Realty believes 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 and costs 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 disclosures and 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 Wood to begin our discussion of first quarter 2009 results.

Donald Wood

Good morning everybody. We had a really good start to 2009 considering the state of the economy and capital markets from both a balance sheet and income statement perspective. On the P&L, we generated FFO per share of $0.99 which was 6.5% higher than the $0.93 we recorded in 2008 excluding the legal judgments that we've been expecting for over a year and I'll talk about that later.

On the balance sheet side, we very successfully refinanced and upsized our term loan a couple of days ago to put to bed the financing of all maturities for the next couple of years. Andy will cover that in more detail in a few minutes.

When talking about the quarter, let me first start with leasing and note that we complete 68 comparable deals for 332,000 square feet at an average rate of $31.42 a foot, 16% more than the rent the previous tenant was paying and that's cash basis.

When you break that down further, you'll see that two-thirds of those deals were renewals with old leases at 26% higher rent with no down time and very little capital needs. The Toys R Us renewal in Rockland, Maryland and Wachovia Bank renewal in Persephone, New Jersey are a couple of good examples of the benefit of having held on to great well established real estate over the years where both the shopping center itself and the demographics around it have improved markedly. We're also off to a good start in the second quarter with a couple of similar renewals.

Now the other one-third of the deals done in the first quarter were with new tenants with only a slight increase to the previous rent and are symptomatic of the leverage tenants have today, particularly for space that isn't perfectly situated even in very good shopping centers.

The more deeply you examine the leasing detail behind the statistics in the next few quarters, the more you'll come away convinces that buying and holding only true high quality real estate in locations that continue to improve over time is the best way to partially protect yourself from market conditions that can vary as much as they have in the past 12 months.

That mix of old expiring leases in great shopping centers included with current re-tenanting of those centers really is Federal's point of differentiation.

On our call last February, I spoke about understanding the correlation between our leasing activity and our earnings by thinking about a bucket being filled from the top but with leaks. While we have I think demonstrated that we can continue to add to the bucket from the top in the form of a steady stream of new and renewed leases, the hard part which began in earnest in the fourth quarter of 2008 and which is certainly continuing in 2009, is to limit the leaks in the bottom of the bucket in the form of bad debt expense, rent relief and outright tenant bankruptcies.

These areas are clearly the largest challenges and the least predictable part of our business as we work through the recession. Let me talk about each of these in context.

In the first quarter, we recorded bad debt expense of $2.4 million, over $1.4 million more than 1Q '08, though not as bad as the $3.1 million we recorded in the fourth quarter last year. Each quarter we go through a rigorous tenant by tenant review that considers all sorts of ability to pay criteria.

We think we're very prudent and we're conservative in that evaluation but we believe that the quarterly year over year comparisons will continue to be negative for at least the second and third quarters. We've tightened up our collection efforts substantially and are very much staying on cash in the door.

When it comes to rent relief, we continue to work through some requests on a tenant by tenant basis and we've recently seen a decrease in new requests. Why this is happening is a point of debate around here. Whether it's an indication of a greater level of stability or the relative calm after the first wave of requests but before a second wave comes through after the spring season, remains to be seen.

In all, tenant sales are down year over year in Federal's portfolio in the 3% to 5% range on a limited sample of reporting tenants that we see, and not a lot of optimism on recovery any time soon. At this point, roughly one in eight of our tenants have requested relief and only a small fraction of those have received some modification to their lease terms.

Every one of these requests is handled individually and there are a myriad of factors that go into our decision making process; the tenant's 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, factual opportunities for the space and half a dozen other considerations.

Our overall business is always grounded in our belief as to what decision results in the maximum cash flow to the overall shopping center over the next few years. Every case is different, but we're probably more like than some to deny relief and risk a tenant going dark, thereby carrying a higher vacancy for a time simply because there are more releasing options available to us in the higher quality shopping centers.

The decrease in occupancy from 943 at year end to 934 at March 31 in part reflects this philosophy though the major cause of that reduction was the closing of one of our three former Circuit City locations that remained open at year end and the expiration of a Border's lease at Gaithersburg Square that was not renewed.

And finally, as it relates to future bankruptcies, we're still at the point where we have to say who knows, but there undoubtedly will be more, the latest being Colleen's Basement of which we have three, and we're very proactive and spend a lot of high level management leasing time preparing for those possibilities and it's a key focus of what we do right now.

In terms of leasing in the overall retail environment from my prepared remarks, before I turn it over to Andy to talk about our capital position, let me give you a little color on the lawsuit provision that's included in the P&L in the quarter.

Well it's been a long wait for a ruling, but the California Federal Judge in charge of the Santana Row related action against us, finally issue a damage ruling in late April. The ruling concerns our proposed lease or purchase nearly a decade ago of 350 Winchester Ave., an office building on a parcel adjacent to our Santana Row property at San Jose.

The judge awarded damages totaling $14.4 million plus interest and although the judgment is not final, we've recorded a provision for litigation of $21 million or $0.35 a share in our P&L which assumes in my view, a worst case scenario.

We are as incredulous about the court's logic used in calculating damages as we were when the court upheld the one page proposal letter as a contract in the first place. You can be sure we will vigorously appeal the decision immediately and work through the courts, but we needed to record the full provision in light of the judgment.

As you know, we fully disclosed this contingency for years now in our quarterly and annual filings, including the possibility of an award of up to $24 million. There is more background on this case in the 10-Q as well as the one page proposal letter which we have filed as part of our 8-K supplemental disclosures so you can see where this originated.

Let me just finish up my prepared remarks by assuring our investors, our analysis and all the other interested parties, as a result of following our relative boring and conservative business plan in the past seven years, we're uniquely position to handle this economy from a position of strength and calm.

The quality of our properties and the markets that they're in, the low levered balance sheet with manageable maturities, the lack of un-leased developments in the construction phase except for on $40 million building on the west coast, and a host of other conservative principals, allow us to take a longer term view.

From that perspective, the future looks bright. There will be opportunities and a way to pay for them that a number of companies including this one if we're disciplined and patient. And we will be. Let me now turn it over to Andy for his remarks.

Andrew Blocher

Good morning everyone. As Don mentioned we have now raised sufficient capital to refinance all of our 2009 debt maturities which puts in the position of not having any debt coming due until 2011. The response we got from our lenders as we refinanced our term loan was tremendous and exceeded our expectations.

Even in these extraordinary times, we were able to upsize our term loan from $200 million to $372 million. Let me tell you a little bit about how we got there.

Our $200 million previous term loan had a total of 12 lenders with commitments of between $10 million and $21 million each. Of those 12 lenders, two did not participate in the new loan, principally driven by a change of lending focus on their part or concerns over pricing.

Three lenders in the previous deal rolled their combined existing $32 million of exposure to the new term loan. One lender that was not involved in the old term loan established a new $25 million position in this loan. And most exciting to us, seven lenders in the old term loan who had a total of $133 million of exposure increased their collective commitments to $315 million with individual commitments of between $25 million and $100 million each.

This support was over and above anything we could have imagined and considering the credit situation over the time period we've been working on this deal. The level of commitments are only part of the story.

Not surprisingly the due diligence performed by the banks in this lead as well as our secured lenders on the mortgage financing was far more vigorous than anything we have experienced for quite some time. Obviously those institutions liked what they saw as demonstrated by the increased commitments.

The on the ground diligence done on these deals should provide a level of comfort to all of our investors, both debt and equity as to what is happening with our company and with our properties right now in the current economic conditions.

Finally, while the new term loan technically has a maturity of a little more than two years, practically the upsizing of these commitments and frankly conversations we've had with banks that both did and didn't participate in this financing, make me very comfortable that total unsecured bank commitments for the Trust, that's a combination of our credit facility and our term loan, are sustainable at current levels.

In addition to the term loan, we closed on a $24 million loan secured by Rollingwood Apartments in April and have a commitment and are scheduled to close on a $139 million loan secured by four retail properties in Northern Virginia later this month.

All in, our financing activities will provide over $530 million of capital which allows us to put our 2009 debt maturities behind us and free up additional line capacity. That said, we continue to evaluate alternatives to raise additional capital so that we're well positioned to address future debt maturities and take advantage of the opportunities that will inevitably present themselves over the next period of time.

As we discussed last quarter, the refinancing of our debt maturities well before the actual fourth quarter maturity date and the additional capacity associated with paying down the line, it does come at a cost. We expect to incur about $10 million of additional interest expenses this year over and above what we did last year; $8 million as a result of raising capital earlier than we otherwise would have. This is at the low end of the $8 million to $9 million range that we discussed last quarter, and $2 million as a result of terming out a portion of our credit facility with excess capital that we raised over and above the amount of our maturing debt.

If this were a more stable economic climate, we'd never be so inefficient in this regard, but we continue to believe this financing insurance is the right thing to do to set us up for the future.

In terms of guidance, we're leaving our 2009 FFO guidance range unchanged at $3.80 to $3.92 per diluted share. This obviously excludes litigation provision and anticipated appeal costs that we're estimating at $0.36 per diluted share for all of 2009.

The primary assumptions in that guidance are; first we expect total property operating income to be slightly higher than what we reported in 2008 largely due to the Florida acquisitions. However, property operating income based on a same center basis, that's including redevelopments, should be basically flat to 2008 2ith the positive leasing efforts we've seen so far this year being offset by increased vacancy and bad debt.

We continue to project a $6 million to $7 million in G&A versus 2008 driven by lower overhead and decreased legal fees, obviously excluding the Santana Row litigation. $5 million a quarter in SG&A still remains a good run rate to use.

Finally, approximately $10 million of additional interest cost versus '08 as I discussed earlier, reflecting the inefficiency of raising funds early to satisfy our '09 debt maturities and terming out a portion of our line with additional debt offset by lower floating interest rates.

With all the uncertainty in the operating environment, we're certainly more comfortable at the lower end of the range than we are at the high end. We'll have a better feel for the operating environment as the year progress.

That's what we have for prepared remarks. We'll now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeffrey Donnelly – Wachovia.

Jeffrey Donnelly – Wachovia

First I have a question or two on leasing. I recognize that conditions are soft, to some degree weakness in leasing performance is to be expected but in your supplemental your new leasing spreads were fairly negligible despite some hefty TI's. Is that a function of market fundamentals exclusively or should we expect it to persist, or is it more indicative of perhaps the unique spaces leased or the type of tenants you placed this quarter.

Donald Wood

It's a combination of both. We tried to in the prepared remarks, when you're talking about doing 60 or 70 deals a quarter for us, first of all a couple of big deals matter as they impacted the results this quarter and they have as you look historically that way. But when it comes to the new deals, there is no doubt that today the leverage is far more with the tenant than it is with the landlord.

So when you're talking about great upfront space in a terrific shopping center that they've been trying to get to forever, we still have leverage. When you're talking about more of a secondary space, we don't have that leverage. So it definitely is space by space and when you're talking about a sample size, let's say 60 or 70 leases in a quarter, it can certainly vary in that direction.

What I'm trying to say is it would be very hard to give you a run rate on new leases in terms of roll over. I think if you take the past couple of years and you see where the trend has gone in the fourth quarter of 2008 and now the first quarter of 2009, I would certainly see that trend being around where we are today and maybe improving a little bit as the year goes on but it's so dependant upon the specific transactions from that quarter that it's hard to forecast.

Jeffrey Donnelly – Wachovia

Building on that, in the past you used to always give metrics around the roll over of your anchor spaces because I believe you had made the point that certain large leases tend to be the driver behind your big step ups in rent.

Donald Wood

That shouldn't change. It's pretty symptomatic. You kind of see it in the first quarter too and you'll see it in the second quarter. We've already done a couple of deals in the second quarter on anchor spaces that are rolling up pretty significantly, and that's terrific.

But when you're asking about the math numbers, the trend is clearly in terms of leverage with tenants at this point. You're still going to see what we've given you in the past in terms of a couple of those deals per quarter which are great deals by any historical standard. They're just very hard to time exactly when they're going to hit.

Jeffrey Donnelly – Wachovia

Is it a good thing that a lot of that anchor square footage, it doesn't really accelerate until 2011 or 2012, just looking at your roll over schedule.

Donald Wood

Yes, but you know what? One of the things that we've always said about those roll over schedules is if you look historically, while certainly those are the contractual maturities and you've got options or no options, you make assumptions as to whether the options are exercised or not, lots of stuff happens within that period.

And so even though you can't see it on the schedule, that's after the contractual perspective, everything from tenants trying to take advantage of weakness by other tenants and buying out deals, is absolutely still happening.

You'll see history is a better indication of the volume of deals that you'll see on both the anchor side than that schedule is, because things change from the contract.

Jeffrey Donnelly – Wachovia

On the small shop side, you may not think of it this way but your portfolio is generally running about 100 to 300 of occupancy above your peers, so I guess in real world terms that might be your typical center might have two to four vacant small shop spaces whereas your competitor might have five, six or seven. Does that lead you to think that you'll be less aggressive on pricing or conversely your competitors are going to be more aggressive on discounting to get folks in the door?

Donald Wood

That's probably a pretty good assumption and that ties right down into the value of the real estate. On a portfolio basis, I would assume that we would, and I think that we've demonstrated that we have so far, and I don't see a reason that would change, that we would hold up there and that absolutely would apply.

It probably applies more on the small shops than it does on the anchor stuff because the anchor is; these are national problems wherever they are in some cases, as in the case of Colleen's or Circuit or Linens, those things.

But on the small shops I still think better locations are certainly going to give us more leverage albeit somewhat diminished from where it was. It's still on a relative basis, much better.

Jeffrey Donnelly – Wachovia

Are there any shoots of opportunistic acquisitions out there, maybe out of the pension portfolios or banks, or is it still a little too early for that?

Jeffrey Berkes

I think it's still a little bit too early. We've definitely see more property come to the market in the last 30 to 60 days or so compared with the end of '08 and early '09 but most of what's coming, while it's decent property, it's got a relatively flat or declining NOI stream and not that interesting for us for that reason.

I think it is a little bit too early, but we'll see. There's definitely going to be some pressure on a lot of owners going forward. We think there's going to be a lot of opportunity over the next couple of years, but I think you're right. It's not quite here yet.

Donald Wood

But the point I don't want you to miss is there's a big difference at least from my perspective than it was 90 days ago. We have a whole lot better visibility on the cost of capital and we have a whole lot better visibility on the success we would have in being able to raise money to do that. Those things are immensely more optimistic today than it was 90 days ago.

So when those opportunities avail themselves, and we're not kind of sitting back waiting for them believe me. We're looking hard for everything that's there. I'm far more confident today that we'll find the money, that we've got the money and in a position to be able to take advantage of it. And that to me is a huge differentiator.

Operator

Your next question comes from Paul Morgan – Morgan Stanley.

Paul Morgan – Morgan Stanley

Now that you're comfortable with where you cost of capital is, what's your return hurdle? What price are you interested in in a lot of these deals?

Donald Wood

The way to answer is always at least from my perspective on a NOI basis because when we look at it, on a long term basis it's pretty realistic to think that our overall debt portfolio will be priced somewhere in the 7% to 7.25% range, long term, short term etc. You can tell me what the cost equity of that is, but I suspect it's somewhere up in the 10% range.

So when you mix it, you're looking at an overall cost of capital here of 9% or maybe a little bit higher than 9%, something in that area. So from an NOI perspective to the extent that we're doing an income producing acquisition, certainly we want it to be, it needs to be additive to that number.

The more risk there is associated with a particular acquisition or development as we look in that direction further, the spread needs to be wider. And that's how we look at it. Now whether the going in cap rate for the first year's cap rate is, please make the distinction between NOI and cap rate, but whether the going in cap rate is as far north as you think it need to be to hit those numbers or not is not our sole criteria. It is all about the growth and the particular income stream, redevelopment opportunities in that income stream and we're only going to be doing that in the highest quality properties.

If one thing has come out of this downturn in my head, it cemented what we believed for a long time, but it's really cemented it is you really don't want to give up on quality? It's clear how the quality properties are performing today versus the poorer quality properties. It's crystal clear and with demand, the country is over retailed, without question in my mind.

So you'd better be in places that people want to be in to continue to be viable. So we're not going to be chasing acquisitions simply based on going in yield.

Jeffrey Berkes

I'd caution you about getting too wrapped up about cap rate in this environment because a lot of the properties that we look at, the in place NOI today is most likely not going to be the NOI tomorrow and you're going to hear going forward in this market a lot of cap rates that sound scary high, but when you drill down through the rent rolls and understand what the sustainable NOI is, the cap rate is actually a lot lower.

And like Don said, there's a lot that goes into it and for us, it's really about the quality of the location, the intrinsic of the real estate and our ability to grow that NOI stream going forward which really means finding locations where tenants can do sales and finding properties that have in our view below market rent rolls and/or lease up or remerchandising or redevelopment opportunities.

Paul Morgan – Morgan Stanley

On the vacancy side, from the big box to the mini anchors, how many spaces do you have that are of size and have you looked at the mark to market on those? I know there's bankruptcy obviously, but trying to get a feel for spaces over 10,000 square feet, where are you versus where the market is going now?

Andrew Blocher

Specifically about your question, we've got 10 to 12 what we'd call medium size anchor boxes that we're working on back filling. There is interest in I'd say eight of those boxes, very strong interest that we're just trying to work through the details.

As Don said in his remarks, the best time to be negotiating deals with somebody is the largest tenants because the leverage tends to be in their court, but there is interest from those retailers and we are pursuing the best transactions we can to back fill those spaces.

Donald Wood

And overall, replacing the income level on an overall basis, we think we can do.

Paul Morgan – Morgan Stanley

On the term loan, was there an option that you had to trade off rate for a little bit more term instead of just going two years?

Andrew Blocher

As we talked on the last quarter, obviously term was the only downside associated with this. There really wasn't that opportunity. The rate that we're talking here is a market leading rate. We were able to get people there through their understanding of what our business held, but we were not in a position.

I really feel like we went out with a very solid rate to start with and we were able to hold that rate and just increase the size. There wasn't a viable trade off there.

We couldn't go longer because it was married off the line. The line of credit matures in July of 2010 with a one year extension option and there were concerns that the banks could have that to the extent that things deteriorated in the market, they didn't want to be in a position where the term loan was going past the line of credit and could cause the term loan to become structurally subordinate to the line of credit.

Operator

Your next question comes from David Wigginton – Macquarie Research.

David Wigginton – Macquarie Research

I noticed in the quarter, not the quarter but so far year to date you repurchased $11 million of the 8.75 notes that are coming due in December. Obviously that would give great benefit if you were able to buy back more of those. What is the appetite of note holders at this point to sell those back to you?

Andrew Blocher

We've been kind of taking orders as they come in. We haven't formally pursued any mechanism to go out and tender for those notes in any way whatsoever. I think that generally with Federal Realty paper what you've seen is unsecured notes are generally held long term and they're difficult to get back.

So what you've been able to see from us so far is just the '09 notes showed up on a bid list. Somebody gave me a call. We were able to strike a deal at a good price.

David Wigginton – Macquarie Research

So your expectation for interest expense to be up does not in any way take into account the one off on the purchase of the notes?

Andrew Blocher

That's correct.

David Wigginton – Macquarie Research

Are you buying those back at par?

Andrew Blocher

I think we made three separate repurchases that we bought them at a price that was slightly below par.

David Wigginton – Macquarie Research

With respect to an equity offering, you mentioned in your update a few weeks ago that you were contemplating it but you held off for the time being. At this point going forward, what would trigger an equity offering? Is it merely just a matter of valuation or would it be related to maybe a specifically identified use?

Donald Wood

It's a lot of things. Certainly the capital markets in general, the consumer markets, more in general are certainly not settled and who knows what the next year or two or three are going to bring, although we can see a little settling out now. But there's still sufficient uncertainty in terms of the environment that I wouldn't want to say that we wouldn't issue equity although if we did issue equity, I think it would be a small amount because everything we do is very balanced.

And all capital markets, the transactions that we try to do are very incremental. Whether that would happen, how that would happen would absolutely be bolstered to the extent there was a great use of proceeds that we wanted to jump all over. Absent that, it's an opportunistic kind of position to be in.

It's a great position to be in really, to be able to say how do we feel about the capital markets in a particular period of time and is there an opportunity to issue a small amount of equity. But the single biggest thing that would make that more desirable is a great use of proceeds that we identify that we wanted to act on.

David Wigginton – Macquarie Research

Have you spoken to investors at all to maybe gauge the level of interest? I image it would be high. I was just wondering if you've had those conversations.

Donald Wood

All I would say is we've become very comfortable that we'd be able to have some very good successful execution.

David Wigginton – Macquarie Research

With respect to the Celine locations what specific centers are those in?

Donald Wood

Relocations that we have; one in Queens New York at Fresh Meadows, one is outside Princeton, New Jersey, one here in Rockville at Mid Pike Plaza which is a redevelopment project. So in total it's about 95,000 square feet, $1.8 million worth of rent annual in total. Which or how many of the three will be rejected or assumed, we just don't know yet.

David Wigginton – Macquarie Research

I think I read something about 17 of the 25 locations being bought by a New York investment group. Were any of the three on your portfolio purchased by that group?

Donald Wood

Fresh Meadows.

Operator

Your next question comes from David Flick – Stifel Nicolaus.

David Flick – Stifel Nicolaus

On the litigation, it does sound absurd on its face based on your description. You would expect that at an appeal level if this is truly an irrational finding that you would prevail. Are you being advised of that by council and what do you think the likelihood of it is that you're eventually have to reverse this charge.

Donald Wood

First of all, let me just tell you in the 8-K on pages 22 and 23 there's a lot of good stuff on here including in page 23. You've got to read it. It's literally the one page, nine point letter of terms that are being discussed including the very last line that says, "the above terms are hereby accepted by the parties subject only to the approval of the terms and conditions of a formal agreement." And there never was any such agreement.

And this is still real estate law. So I know I sound defensive about this because I can not believe that liability was found in this case and then further, damages are crazy.

We're in the middle of interviewing appellate council and Don Becker and I just came back from a meeting a day and a half ago with a very strong firm that we're considering who is extremely optimistic in terms of our ability to prevail here.

Now everybody is extremely optimistic when you first look at it and who knows what happens over time, but we will very, very diligently, very, very vigorously go after this and I'm very hopeful it gets reversed. We'll know within 18 months to two years will be the time frame.

David Flick – Stifel Nicolaus

It isn't hard to spend $14 million on legal fees.

Donald Wood

In appeal it is, even with the firm we're talking to. The appellate process right or wrong, and this is Federal Appellate. This is Federal, is a very straight forward process that I'm not saying won't be expensive, but it will be nothing like the damages, a very small fraction of that.

David Flick – Stifel Nicolaus

What is the status of leasing now on the office element of Santana?

Donald Wood

In the building we prospect but there is no leasing done. Now the business is not done, but building is not done yet, but at this point we certainly expect it to be at least in the LOI phase on a couple of deals, and it's soft. Silicon Valley is absolutely soft. Luckily, it's one $40 million building.

David Flick – Stifel Nicolaus

Don't mean to keep opening wounds, but can you review where you stand now on the Rockville project in terms of leasing performance of the upstairs as well as where your yield is going to come out?

Donald Wood

First of all the only thing that confused me about what you just said was upstairs. You know we don't have the residential there. As far as I know the residential upstairs is about 80% to 85%, low 90%'s actually. So what they've gotten, how much people are paying to live there, but the bodies are in the building in the 90% or higher range.

In terms of downstairs, we're nearly 100% leased. We have absolutely given more rent relief and have had more rent relief requests at Rockville than throughout the balance of the portfolio. As the year unfolded and we looked at what was going on in terms of trying to pick up trends, it's pretty clear to us that the stuff that just opened up to us in the middle of the recession, and Rockville is the perfect example, it came out 100% lease, but opened up at a time when retailers were not able to get their feet set.

They just paid to build out the spaces and so they are struggling disproportionately. We've absolutely seen though stabilization there and if you remember, our initial yield on that project was very fat. It was in the 14% range. So even with rent relief and if you will resetting that will happen over the years ahead, this is still going to be a very profitable project for us, just maybe not at the 14% level, more like 11% to 11.5%.

Operator

Your next question comes from Alexander Goldfarb – Sandler O"Neill.

Alexander Goldfarb – Sandler O"Neill

Just finishing up with Santana Row, once you pay this settlement is there any option to get this property or this think just sits sort of in the middle of your complex?

Donald Wood

First of all, it's hardly in the middle of complex. It is wedged in. It has been wedged in. When the conversations were happening back in 1998, 1999, Santana Row was being planned. I would say boy, wouldn't it be cool to include it.

Come 2002 when the property opened, and 2003, it hasn't been an impediment to the property. The reason we didn't buy it is because we really didn't need it. We would have like to have had it, but we really didn't need it. We don't really need it. We've kind of proven that.

But the owner went out and sold the building. And one of the real issues that we have with respect to the lawsuit finding is that we don't believe they have adequately offset the proceeds of the sale of the building to the other buyer. So there's a little bit among all the issues, not just liability, but on the damage calculation, the calculation in our view, doesn't take into account the proceeds that the seller got from somebody other than us.

So if you think about it, you add $14 million of a judgment here plus I think it was a $10 million or so of the building that went through, having the plaintiff here get $24 million plus interest on a building that was worth far, far less than that is almost unjust enrichment. So we feel real good on the ability to win here on appeal.

But we will not wind up with the building as a result of that, nor do we need it.

Alexander Goldfarb – Sandler O"Neill

Switching to the capital markets front, you addressed the equity, but just wanted to get your sense on where you think your credit for unsecured debt would be if you went out to the market today?

Donald Wood

Obviously the market's been moving very, very dramatically especially over the last couple of weeks. I was getting some preliminary thoughts just prior to the call. My guess is we're probably looking at the eights to nines with respect to looking at new tenure unsecured issue. Lower rates seems to be some demand in the five year bucket right now, but obviously that's down from probably 11% to 13% that I would have reported to you three or four weeks ago.

Alexander Goldfarb – Sandler O"Neill

As far as pricing, what's your benchmark? How do you say this is now a good rate versus this is just crazy? I'm not going to pay that rate?

Donald Wood

Obviously part of it is do you need the capital and where we stand right now, we're very good with respect to capital having no debt maturities coming through until 2011 and a fully undrawn line of credit. Then it's just a matter of looking at the alternatives that you have available to you. So I don't know that it's as cut and dry as you're making it out to be.

Alexander Goldfarb – Sandler O"Neill

I guess I'm thinking more on the apartment side where all the apartment guys are looking at GSC's and then looking at where unsecured is.

Another thing is, what's your sense of the appetite from institutional investors or private money to co-invest in retail real estate today?

Jeffrey Berkes

It's a little bit hard to tell and you're talking about a broad variety of investor types and investor objectives. I think there is a lot of opportunistic money kind of sitting on the sideline waiting for things to get worse and waiting for screaming deals and whether or not the market really revolves to that remains to be seen.

I would imagine that there is a fair amount of high net worth individual money that's still in the market that would accept lower yields and just buy into a handful of quality properties. In the middle, the kind of traditional demand that you see from pension funds for core on core real estate, I think that demand is fairly low right now because of everything they're dealing with in their overall portfolios and because of the amount of real estate they've acquired over the last few years.

So a broad question and a broad answer. If you want to talk about it more specifically, we can do that offline.

Alexander Goldfarb – Sandler O"Neill

I think originally there was $8 million to $9 million of debt prepay costs in the guidance. Is that still there?

Andrew Blocher

Like I said, all in that was $8 million to $9 million over and above what we were looking at when we were looking at the smaller number. Now that we've upsized the term loan, that total is $10 million. $8 million of it is the low end of the $8 million to $9 million range associated with doing the financing early.

The other $2 million was excess long term borrowings that are going to be utilized on an interim basis to either pay down the line or being held in cash.

Operator

Your next question comes from Jonathan Habermann – Goldman Sachs.

Jonathan Habermann – Goldman Sachs

In terms of the guidance, just following on the last question, you mentioned pressure over the next couple of quarters on same store and NOI growth. Are you building in an assumption for recovery toward Q4?

Andrew Blocher

A little bit. Part of that for a couple of reasons. First of all, traditionally in the business we do a bit better in the fourth quarter. There's still pressure to get things done at that point for the end of the year and hopefully this year, we'll have some of that same thing, but the other thing is you're going to start to have year over year comparisons that start to look better because it really was Q4 last year where you'd see the big debt expense and things like that that hopefully won't be as bad this year.

So it's not so much that it's a great recovery as it is cyclicality of the business to some extent and better comparisons year over year.

Jonathan Habermann – Goldman Sachs

In terms of CapEx, it sounds like pretty modest so far in terms of leasing activity. How do you expect that to trend over the next couple of quarters?

Donald Wood

I don't expect to see too much change in the renewals for obvious reasons. That makes up two-thirds of our business. Actually it's taking up more than two-thirds of our business these days because of the lack of demand relative to the good old days.

But on the new leases, there is absolutely more pressure to increase TI's for pretty obvious reasons. The key thing for us is to make sure that we're backing the retailers that will be there. I guess I'll give plugs to a particular retailer that I just spent a bunch of time with a week ago.

I went out to California, spent a bunch of time with L.A. Fitness and the principals there, and when you look at that business model, when you understand what they've done, where they've come from, you can feel pretty good that if you are going to invest TI's in a fitness company, that that's not a bad one to do.

But it does show that the process from our perspective has to be improved and increased due diligence because in that respect, you are acting in some respect as a bank, at least partially. And so we better be doing it only with the right credits. That's the part of the business while I think it's unavoidable that more capital will be spent that way, the realization and the allocation of that capital to the right kind of retailers is critical.

Jonathan Habermann – Goldman Sachs

Are you adjusting terms in many cases where your preference is just to keep that retailer for a shorter period of time but perhaps replace that tenant down the road?

Donald Wood

We have a general policy over here to make sure that as best we can where we're unable to have the leverage that we did given the economy, we keep the terms as short as we can.

Jonathan Habermann – Goldman Sachs

Anything in terms of regional variances or is it really just more specific in terms of the tenant, the sales performance, occupancy cost etc.

Donald Wood

I'll tell you what we see. And please, I have to put the biggest caveat I have to put on the whole thing is we're talking about 18 million square feet. Of that 18 million square feet roughly 40% record sales. Of the 40% that record sales, some are annual. So the sample size that I'd be talking to you about is obviously limited, but within that sample size, we are seeing more stability in the Northeast than we are in the west, which is harder hit for us.

And even the Northeast at this point, a little bit better than Mid Atlantic. But for us at least, Northern California, Silicon Valley is hit pretty hard right now. And they really got hit later than the rest of the country from again, our viewpoint.

Jonathan Habermann – Goldman Sachs

I know you upsized the term loan, but 2011 appears to be a bigger roll year than typical. Do you think if we're truly in a capital raising window now, does it pressure you to think about equity sooner than later or is that not really a consideration?

Donald Wood

When we talk about the capital and the capital opportunities of this company, debt equity wherever we go, certainly we are always considering equity as we have over the past seven years. I think we've done it at least five times over that period of time.

Having said that, feeling more pressure because of those maturities is not the case for us. Maybe it should be, but it's not the case for us and that's based on the conversations we've had with our banks. The entire experience that we've gone through over the last six months, and while there is a two year term there, we very, very much expect that those banks and others will be part of our permanent capital structure as we get closer and long before we get to the 2011 date.

Andrew Blocher

When I think about it, the banks really practice two philosophies; either they want undrawn exposure in the form of a credit facility or they want drawn exposure with respect to the term loan. We only had one of those pieces on the table which was the form of the term loan.

I could also tell you that demand for the term loan was hampered to some extent by the consolidation in the banking sector at this point, not so much that we had exposure to two different banks that was outsized when they combined, but really there were a number of banks in our facility who had just very, very recently gone through mergers and this was the first deal they were bringing through their process.

A lot of the conversations that I've had as I said in my prepared remarks with the banks that did participate, and banks that didn't is that even in this difficult market, they want exposure to company Federal Realty who are going to be companies that survive over the long term and a lot of the numbers that were thrown out there are, here's our first step. We expect that we can get to two or three times this amount over the next couple of years.

That's what Don was talking about giving us comfort that this can be a permanent portion of our capital structure.

Jonathan Habermann – Goldman Sachs

Are you seeing any demand from retailers in terms of renewing space as you look out to 2010 at this point, just locking in better terms?

Donald Wood

Absolutely. Here's how it's manifesting itself. It's manifesting itself in good healthy retailers who have expirations in 2011, 2012, saying what do you say we talk about it now. And obviously in exchange for greater term and more stability, they want something for it financially.

And so t hose negotiations are happening. And we talked a lot about on the capital side, the have's and the have not's. There very much is banks firing an awful lot of their clients. Well on the retailer side, it's the same thing, and those healthier retailers are doing deals. They absolutely know they have the upper hand and they're trying to leverage that to the hilt.

The only thing we have that makes that a fair fight along the way is better quality real estate and so that's the balance and the fight all the way through.

Operator

Your next question comes from Richard Moore – RBC.

Richard Moore – RBC

You have a very good list in the supplemental of properties that could be future redevelopments and I noticed that you jumped a bit in terms of construction in process in the quarter and I'm wondering is any of that related to the Out Year redevelopments or where do you stand with some of those. Are we progressing at this point? Is there enough demand? How are you looking at that?

Donald Wood

No. The stuff you see in the quarter is the stuff that is under construction. It's not really stuff on that redevelopment list. It's the Santana Row building that's there. It's the Bethesda building that we're putting Equinox in, real projects that are happening now.

One of the reasons you see that development list growing is because of the added vacancy. When you think about what's going on here, properties that we thought were locked down didn't have the opportunities that you wanted because of Circuit or Linens, are now kind of in play again.

Now it's going to take time as it always does to work through entitlements, to understand where demand is, but at this point there really hasn't been everybody is still in such, and this includes retailers, in such a current mind mode and not in development mode that I don't want to mislead you and tell you all that stuff is right around the corner, because it's not. But it is out there in a way that is actually greater than it has been in the past.

Richard Moore – RBC

So as you think about 2010, do you think some of these are going to make their way into the pipeline or is it just too early to tell if we can get any of this going?

Donald Wood

I would expect some of that stuff to make it's way into the pipeline from the standpoint of planning and in turning them into real more solid projects, but at this point I couldn't tell you which ones and where the demand is yet because the retailers aren't playing the game just yet.

It will be interesting to see what kind of conversation, we've got a lot of meetings at the end of this month and I'm really looking forward to better, more strategic meetings than they've been in the past in terms of understanding.

We're sitting down with a lot of CEO's. We're sitting down with a lot of heads of real estate to make sure we understand where they're heads are going forward and some of the redevelopment stuff we're talking about here could be illuminated a little bit further in those meetings.

Operator

Your next question comes from Jim Sullivan – Green Street Advisors.

Jim Sullivan – Green Street Advisors

On the term loan based on upsizing it from $200 million to $370 million, obviously had a lot of interest from the bank group, I'm particularly interested in the banks that looked at the deal and decided not to participate. I'm curious what sort of objections they provided to you in formulating their decision not to participate. Was it pricing? Did you have credit committees that were concerned about retail real estate at the time you were negotiation the deal? What did you hear from those that took a look and decided not to pull the trigger?

Donald Wood

It depends on what point in the process. I would only classify one bank who just couldn't get the deal over the finish line. The rest of them, we went after them and a lot of them were new banks who since over the last year or two were cutting back some of their exposure to real estate or just don't really feel like this is the right time.

Or, as I said earlier, maybe interested in providing credit but maybe wanting to do it through an undrawn basis through a credit facility rather than through a term loan. There was one bank in our existing term loan who was just like, I'm not in the business anymore. And then there was one I think we could have really gotten over the line, but based on either changes to the credit process, was having a real difficult time meeting our time frame.

Jim Sullivan – Green Street Advisors

What about pricing being an issue?

Donald Wood

There were a couple of deals out in the market at that point in time similar space that were priced somewhat wider than ours. I only heard pricing as a concern from one account, and that was the account that struggled with their commitment at the tail end.

Operator

There are no further questions. I would like to hand the call back over to Miss Gena Birdsall.

Gena Birdsall

Thanks everybody. We look forward to speaking with you again next quarter.

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Source: Federal Realty Investment Trust Q1 2009 Earnings Call Transcript
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