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Executives

Adam Chavers – Director of IR

John Kite – Chairman and CEO

Tom McGowan – President and COO

Dan Sink – EVP and CFO

Analysts

Michael Bilerman – Citigroup

Todd Thomas – Keybanc Capital Markets

Rich Moore – RBC Capital Markets

Jeff Donnelly – Wells Fargo

Nathan Isbee – Stifel Nicolaus

Kite Realty Group Trust (KRG) Q2 2009 Earnings Call August 5, 2009 1:00 PM ET

Operator

Welcome to the second quarter 2009 Kite Realty Group Trust earnings conference call. (Operator instructions) I would now like to turn the presentation over to Adam Chavers, Director of Investor Relations. Please proceed, sir.

Adam Chavers

Thank you. By now, you should have received a copy of the earnings press release. If you have not received a copy, please call Kim Holland at 317-578-5151 and she will fax or e-mail you a copy. Our June 20, 2009 supplemental financial package was made available yesterday on the Corporate Profile page in the Investor Relations section of the company's website. The filing has also been made with the SEC in the company's most recent Form 8-K.

The company's remarks today will include certain forward-looking statements that are not historical facts and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results of the company to differ materially from historical results or from any results expressed or implied by such forward-looking statements, including without limitation, national and local economics, business, real estate and other market conditions; the competitive environment in which the company operates; financing risks, property management risks; the level and volatility of interest rates; financial stability of tenants; the company's ability to maintain its status as a REIT for federal income tax purposes; acquisition, disposition, development and joint venture risks; potential environmental and other liabilities; and other factors affecting the real estate industry in general. The company refers you to the documents filed by the company from time to time with the Securities and Exchange Commission which discusses these and other factors that could adversely affect the company's results.

On the call today from the company are John Kite, Tom McGowan and Dan Sink. Now, I would like to turn the call over to John Kite. John?

John Kite

Thanks, Adam. Good afternoon and thank you for joining us today. As anticipated, 2009 is proving to be a challenging year for our industry. Despite this environment the results for the quarter were within our expectations.

FFO as reported for the quarter was $0.15 per share and was in line with consensus estimates. The mid-point of our revised guidance is also consistent with analyst expectations.

We continue to be realistic about the tough decisions that must be made and have been clear about our strategy and directives. Balance sheet strength and leasing productivity have been and will continue to be the two most significant areas of focus for our company. Today I would like to briefly review our strategy on these two fronts as well as the progress we have made.

During the summer of 2008 we began to aggressively increase our liquidity and strengthen our balance sheet. We closed a $55 million unsecured term loan in August 2008, raised $48 million of net proceeds from an equity offering in October and finished the year by selling two non-core operating assets that netted the company nearly $24 million.

Our equity issuance in May 2009 produced $88 million in net proceeds and in conjunction we reduced our annualized dividend payout by approximately $17 million compared to calendar year 2008. Most recently, we sold two ground lease parcels during the second quarter which generated nearly $11 million in cash for the company.

Our proactive approach enabled us to finish the second quarter of 2009 with approximately $115 million of cash and available credit. This level of liquidity compares favorably to our peers and is a great asset to have as we continue to navigate the property level debt market.

However, we also benefit from an average balance of only $13 million on our remaining 2009 and 2010 maturities as well as the knowledge that a large majority of our refinance discussions are with banking relationships we have cultivated over 20 years of being in this business. It is important to note that only two of our maturities through 2010 are securitized.

As I mentioned, leasing will continue to be the keystone of our success. Tom will speak next in greater detail about our progress but I want to highlight a few things as well. Our 265,000 square feet of leasing for the quarter is the second highest level of square footage production and the highest level of total lease deals since our IPO five years ago. We ended the quarter at 91.1% leased, up 30 basis points from the previous quarter.

Tenant relationships are absolutely critical in this turbulent environment and I think in the second quarter we showed how strong our relationships are. We developed about half of our portfolio, much of it since 2003. As a result, our properties are relatively new and have little in the way of deferred maintenance which could hinder our lease negotiations or make it prohibitively expensive. This is reflected in the small amount of PI and CapEx we have spent in the quarter.

Also, we have selected a large portion of our tenancy through the development process or through the leasing process as opposed through acquisition. We crafted a diverse tenant base where no one tenant contributes more than 3.3% of base rent and our top 25 tenants represent only 40% of our annualized base rent. In fact, if you examine our list of our top 25 tenants, you will see that our base is strong and diverse with retailers such as Publix, Pet Smart, Lowes, Best Buy and TJ Maxx.

As I previously mentioned, one of our primary goals was to build a best-in-class leasing organization. We have made progress to that end and Bud [Morrow] and his team are aggressively targeting tenants that will add value to our portfolio going forward.

I would like to finish up today with a few thoughts of our overall health. There are a couple of metrics that we track closely and I think are important for you to consider when assessing our strength and health. We are currently paying a fully funded approximately 8% dividend yield with an AFFO payout ratio at currently 55%. We have made progress on reducing our debt levels. Our net debt to gross real estate assets was 53% at the end of June and a 900 basis point decrease from six months ago.

More importantly, our fixed charge coverage remains strong. For the quarter it was approximately 2.3 times. The $57 million we have in cash on our balance sheet represents over 25% of our equity market cap and our un-depreciated book value is approximately $8.00 per share, nearly two and a half times our current stock price.

So given these positive metrics, we are optimistic about the future of our company and we look forward to moving forward with our investors and analysts in the future. With that I would like to turn it over to Tom.

Tom McGowan

Thank you. We continue to execute on our strategy of transforming our leasing department into one of the strongest teams in the shopping center business. Understanding our efforts are vital to our mission, we are focused on continuing to take the necessary long-term investment in this group. As discussed on the last call, I noted we expected a substantial increase in our leasing production for the remainder of the year.

Our production increased significantly quarter-over-quarter to 265,000 square feet. The volume of new leases and renewals increased from 17 to 46 quarter-over-quarter. The 50 basis point increase in retail lease percentage for the quarter is a clear sign our portfolio is positioned for ongoing gains throughout the balance of the year.

Spreads on new leases remain positive at 7%. We are still experiencing a soft renewal market. Although renewal spreads faded in the second quarter we executed on our strategy to protect the occupancy of key assets and minimize the outlay of capital during these challenging times. In fact, we committed only $16,000 in tenant improvement allowance for 109,000 square feet of renewals. This heightened emphasis on leasing production as a permanent component of our overall strategy; not just a reaction to current market conditions.

To illustrate, in addition to the leases we have already signed in the third quarter we are currently negotiating 23 new leases and renewals for another 160,000 square feet of productivity. We also have recently added two experienced members to our leasing team and will continue to take advantage of the considerable talent currently available in the market.

Our leasing processes have been improved as well during this down cycle and our assessment of each tenant’s credit has become more stringent. The transition to MRI, our accounting and lease flow system, is complete, which provides real time data on our key metrics. This has substantially improved the time it takes for a deal to be presented, reviewed, modified and ultimately approved or denied.

Turning to same store NOI, we recorded a 3.4% drop for the quarter compared to second quarter 2008. The majority of the reduction in minimum rent is attributed to the Circuit City bankruptcy and the loss of Linens n Things in Texas. For the first half of the year same store NOI was down 3% compared to 2008. We anticipate finishing the year within our guidance range of negative 2-4%.

Our operating retail portfolio is 90.7% leased. We have an opportunity to impact this number through leasing activity on our junior anchor vacancies. The four vacant boxes in our operating portfolio contain approximately 127,000 square feet and represent a potential increase in lease percentage of over 250 basis points. Discussions on all four vacancies are encouraging and remain in various stages of tenant negotiations.

I would also like to point out that we leased our last remaining junior anchor vacancy at Sunland Town Centre and this property is now 96% leased. Regarding the development pipeline, we transitioned the first phase of South Elgin Commons to the operating portfolio at 100% lease. Only two projects remain in the pipeline with a total cost of $82 million. At the end of the quarter $62 million or 76% of the total cost is being incurred leaving only $20 million to fund through our existing construction loans.

Tenants began to occupy Cobblestone Plaza in May 2009. This extremely well located asset in southeast Florida suffered a loss in lease percentage due to the termination by Whole Foods. Our efforts to find a replacement anchor has been productive thus far and we are negotiating LOI’s with multiple retailers to replace the anchor tenant. Eddy Street Commons at Notre Dame remains on schedule with initial occupancy occurring in September.

We continue to focus on the disposition of land holdings. We recently closed on approximately $11 million of land sales which was the first step towards our target of $50 million in the next three years.

Dan will now summarize our remaining operating results.

Dan Sink

Good afternoon. I will summarize a few financial details for the quarter. FFO was $0.15 for the quarter. This compares to $0.31 for Q2 2008. This decrease was primarily due to the diluted effects of the October 2008 and May 2009 equity offerings, a reduction in volume of NOI from land sales and reduced volume in construction and service fee revenue.

I would like to spend a minute on our reported FFO per share this quarter. This quarter we calculated FFO per share based on the year-to-date results which cause a rounding difference for the current quarter. In this quarter there is a difference in the way the FFO rounds for the second quarter and for the first half. Our FFO per share for the first half was $0.33 per diluted share to accurately reflect year-to-date earnings which results in a reported $0.15 per share for the second quarter. The second quarter on a stand alone would be a penny higher than the $0.15 we reported.

Turning to some specific items in the income statement, our fixed charge coverage is approximately 2.3 times as calculated from page 12 of our supplemental. Construction and service fee margin before tax for the three and six months ended June 30 were approximately $745,000 and $1.3 million respectively and was in line with our expectations.

Our NOI to revenue margin increased 3% from Q1 to Q2 due primarily to a $530,000 decrease in bad debt provision and a $967,000 decrease in snow removal costs, a portion of which was non-recovered. The overall bad debt provision across the portfolio calculated against min rent and recoveries for the first half of the year was approximately 2.2%. The comparable amount for 2008 were approximately 0.7%. Our outlook for the rest of 2009 is currently best estimated to be approximately 1.5%.

Our G&A expense increased $204,000 primarily reflecting the timing of public company costs. However, we are still comfortable with our guidance range of $5.7 million to $6.1 million. Other property related revenue includes approximately $1 million from the sale of two land parcels and $438,000 related to a one-time non-cash reversal of a liability for which we are no longer obligated.

On the balance sheet, as of today our remaining debt maturities for 2009 have been reduced to approximately $28 million. We plan to pay off the two loans remaining with the available cash on our balance sheet and contribute those properties into the line of credit, unencumbered collateral pool. The contribution of the properties to the line will preserve or increase our overall cash or available credit.

We have now turned our attention to the loans expiring in 2010 as each loan is currently held on the balance sheet as relationship [lending]. Accordingly, we have no maturing CMBS loans in 2010. Subsequent to the quarter end, we extended the maturity date of the $8.2 million loan on Bridgewater Marketplace from June 2010 to June 2013 with approximately $1.2 million of additional equity. The remaining $82 million of 2010 maturities consist of five loans. As John mentioned, this size of loan works for a number of national, regional and local balance sheet lenders.

At the end of the quarter we had approximately $115 million in cash and available credit. We will continue to focus on increasing our liquidity and generating cash by selling raw land parcels, out loss and selected operating assets. Consistent with our internal practice, we monitor and valuate our assets for impairment on at least a quarterly basis. After our most recent review, none of our properties required impairment charges as of June 30th. We continue to scrutinize this area for both operating properties and development assets.

We are revising our earnings and FFO guidance for the year to a range of $0.57 to $0.61 per diluted share. This revision is primarily attributable to delays in tenant rent commencement on our development properties, the retention of cash balances generated by our May equity offering and an increase in real estate taxes in some of our operating properties. The revised guidance also reflects reduced expectations for land sales for the remainder of 2009.

Thanks for participating in today’s call. Operator please open the line up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Michael Bilerman – Citigroup.

Michael Bilerman – Citigroup

I think you talked a little bit about how the substantial leasing could be done in the March quarter since you went public and how your lease percentage had gone up 30 basis points sequentially. Can you talk a little bit about economic occupancy today relative to that lease rate and when you expect the income from that leasing activity to take hold? Then talk a little bit how Dan you mentioned about 250 basis points of potential vacancy for junior anchors and the expectations of when those could come online?

John Kite

Is that one question? I’m just trying to make my way through it.

Let’s start with the economic versus lease. I think that is probably around 200 basis points. As it relates to the timing of when the leases that we signed in the quarter will generate income I think that was your question. It is going to vary because some of them obviously are renewals which would be fairly immediate and some of them were new leases and the typical build out of a new lease you are talking about at least a couple of quarters before you would begin to see anything. Probably the new lease transactions are really at this level of the game, we might get some rent this year and most of it would be next year is my guess there.

The third question was about the boxes?

Michael Bilerman – Citigroup

That 200 basis point spread between economic and lease that is historically wide respectively to what you see today?

John Kite

I think effectively we have seen that number between 100 and 200 basis points. I don’t know if Dan wants to chime in on that.

Dan Sink

We have in particular in that difference between lease and occupied we really only have one vacant box paying rent at this point. Some of them are in transition to where we are finalizing build out for them to take occupancy. Once they take occupancy obviously straight line rent starts as soon as they take possession of the space. I think the key thing on there is we have got a couple of tiny items but the majority of that we only have one dark box paying rent.

Michael Bilerman – Citigroup

Then there was the, I think you talked about four junior anchor boxes in that 250 basis points to occupancy?

Dan Sink

Right.

Michael Bilerman – Citigroup

Sort of where you are in those and what your expectation is.

Tom McGowan

Just from a timing perspective, all of those are in different time stages of the evolution of ultimately getting them done. On several, really the key for us is getting committee approvals. From a rent perspective we will start seeing the effect of that in 2010. The key for us is to get those deals done this year to then allow us to generate that income in 2010.

John Kite

A little bit anecdotally, clearly the activity level we have on boxes has significantly picked up quarter-over-quarter. Now that activity level obviously doesn’t always turn out to be an executed lease but the more activity we have the better. Really in the last quarter obviously part of it is because we have stepped up our efforts and what we’ve told you we have done within the leasing department but also I think the tenants in general are frankly going to be aggressive looking for deals right now. The window of opportunity for them to get good deals probably is beginning to close a little. Part of it is we are out there doing a good job and part of it is tenants are realizing, in my view, that they are going to try to position themselves well and if they are a good, quality company now is probably the time to make a deal.

Michael Bilerman – Citigroup

If you think about how you talked about the equity raise from a half year basis versus a quarter basis, that impacted your per share number and obviously that is impacting a little bit the full year number rather than the full run rate with the equity offering fully in. If you think about a lot of the initiatives you have on the leasing front and stuff you have on the balance sheet side, where are we a couple of years out in terms of what you think the core earnings power of the company is assuming this level of equity was in the company and there is no additional common equity raises? Where does it go assuming things play out the way you want them to?

John Kite

Well, a couple of years from now assuming the trend continues to stabilize which it feels as though is happening we still are only 91% occupied. You see our same store occupancy is around a little over 90. We have plenty of room to grow NOI from that process. I think we peaked at a 95% range. Just in getting to where we were will grow NOI. We also obviously have the two developments coming on line which we talked about which is Cobblestone and we are very confident that we are getting a good solid replacement anchor and that is very good real estate and we think that will help us in terms of growing NOI on that property.

Obviously the Eddy Street property in Notre Dame is progressing well and we think that will generate solid NOI for us. Those two projects really obviously are generating no NOI today. So you add those two together with what we already have in the operating portfolio and then what we can develop in the shadow pipeline, I think there is tremendous opportunity to grow the core NOI without adding tremendous debt levels from where we are at today. Dan and I have spent a lot of time on our forecast from 2009 to 2012 and we are forecasting strong liquidity all the way through 2012. Obviously as we move through that and want to grow the business we will be looking to partner with people as well. One thing for sure we want to do is protect our capital base. We realize we have issued a great deal of shares in order to ensure the long-term stability of the company.

So going forward we are going to be very picky with where we put our capital. I think we already are seeing deals in the market place and we are clearly being approached and are talking to people about where we are going to be in the future and certainly joint ventures will be a part of that.

Michael Bilerman – Citigroup

Greg has a quick question. On the development pipeline, you have talked about your plans to increase the spending on the shadow pipeline? Perhaps you could provide an update?

John Kite

I think we are where we were last quarter. Tom can expand on this but we have the six properties in the shadow pipeline. What we did was we looked at every property and based on what we think we can sell in terms of land to anchor tenants and ground leasing we can do we think we can reduce the spend by approximately $100 million. So that hasn’t changed. I will let Tom expand on it.

Tom McGowan

Basically what we did was we laid out four projects; Maple Valley, Broadstone, South Elgin and Newhill, as the projects we would really concentrate on in terms of taking the spend away from vertical construction and pass that on to the end user or retailer. So that strategy is still in place. We are focusing on the same four projects. We are simply in the implementation side of this to execute.

Operator

The next question comes from the line of Todd Thomas – Keybanc Capital Markets.

Todd Thomas – Keybanc Capital Markets

With regard to the Whole Foods lease at Cobblestone is there any potential co-tenancy issues with any of the other tenants that signed leases or anything?

John Kite

No.

Todd Thomas – Keybanc Capital Markets

Can you talk about where your expected development yields might fall today for those two projects given the leasing velocity is a little bit slower than you had anticipated?

John Kite

We expect the returns to be in the same range we have always discussed. That is basically 8-9% and we are confident of those ranges at this point.

Todd Thomas – Keybanc Capital Markets

With regard to the shadow pipeline, what type of funding or outlay might be required through the balance of 2009 and 2010 as you look at it right now?

John Kite

Right now we are really just looking at interest carry. Dan?

Dan Sink

We don’t have any commitments. We don’t have to go vertical by any specific time. We are working with two tenants that we have on Delray from a timing perspective. I think if you look at it, it is really carry costs because we tried to change the name of this. We have now gone from visible pipeline to shadow pipeline so we can’t hear any more jokes about visible pipeline. In doing that with shadow pipeline there is no vertical construction entitlements in place. I think it is a matter at this point of completing the leasing and the financing. As far as using our cash and available credit a lot of these projects have the equity already in place. So we are going to be really focused on getting construction loans before we would start some of those visible pipeline projects assuming that as Tom mentioned we need the capital for purposes of not being able to sell it to the end users or execute on that plan.

John Kite

The important point that Dan made there is if you look at the costs incurred on the supplemental page on the shadow pipeline you will see on the consolidated properties it is $83 million against $156 million of projected costs. So what we are pointing out there is the idea of needing additional equity capital. It is just not highly likely. We are really focused on getting the projects to a very high level of pre-leasing where we are comfortable and a third-party construction lender would be comfortable to begin construction. The process is the same. It is just taking longer.

Todd Thomas – Keybanc Capital Markets

Moving over to the balance sheet, what is the most restrictive covenant on your credit facility and term loan? What measure is that?

Dan Sink

I would say the most restrictive covenant is debt to total asset value. The debt to total asset value it is important at the equity raise to get that completed. We can’t exceed 70% but we can exceed 65% for two quarters. For the term loan and line of credit we are in compliance with our covenants at the end of the quarter but we are constantly watching that particular covenant and back filling some of the empty boxes and this kind of thing will also definitely help from an asset value perspective. Managing debt for the long-term which as John mentioned we have a capital plan as we have talked about with the investors and during our equity raise that goes to 2012. We are really keeping track of that and keeping a score card between now and then and making sure we execute on the plan that we have in front of us.

Todd Thomas – Keybanc Capital Markets

As it relates to your mortgage debt, what do lenders want in consideration for the extensions or renewals you are executing?

Dan Sink

I think the biggest thing is it is a negotiation. It is good to have these relationships and being able to get through the extension process and trying to get 3-5 year loans with options to renew. I would say right now, to give you a real time example, one of the CMBS loans we just completed the appraisal process it is a new lender and it is a 70% LTV. We analyze that in comparison to on that particular asset what we can do on our line of credit. The line of credit is an 8 cap at 65% LTV based on the NOI in place today.

In walking through that with the lenders it is all a process of right now the key things for banks are getting pay downs and being a public company being able to offer to pay down or a deposit puts us at such an advantage compared to the private real estate market. Frankly it is very difficult to do either of those when you are a private guy rolling from one project to the next. That gives us a big advantage with both the national, regional and local lenders that we have available capital where we can put a deposit in the bank of $250,000 in a money market account and do those kinds of things to get extensions.

John Kite

The other thing I would tell you is if we go back to Q3 2008 we had over $200 million of debt maturities from that point through 2009. If you look at where we are today with $30 million we obviously have been very successful. We have also tracked the equity and some of the deals are bigger than others. In general we have been putting in 10-15% pay downs which is less than what people thought it would be. I think that will probably continue. That is why we mentioned we really feel confident through 2012 that we have very adequate liquidity.

Todd Thomas – Keybanc Capital Markets

Are the lenders asking for recourse at all?

John Kite

Some deals have recourse. Some are partial recourse. It depends on if it is construction loans.

Dan Sink

I think it ranges typically from 25% recourse to 50% recourse and I think the key thing about managing that from a covenant perspective is when you have construction loans that are 100% recourse rolling to completion a lot of times that 100% construction loan we can negotiate that down to 50% or 25% at completion. So when you weight those together we are reducing our exposure on the construction loan and at the same time we potentially might be having to put a little bit of recourse into some of the rolling mortgage debt.

Operator

The next question comes from the line of Rich Moore – RBC Capital Markets.

Rich Moore – RBC Capital Markets

The line of credit, is the capacity still $200 million? I think that is tied to the value of the unencumbered pool.

Dan Sink

That is correct. The capacity can go up to $200 million. Right now we have the ability to put some additional assets in to increase the capacity. Right now our borrowing capability is about $140 million so that is how we get to cash and available credit. The reason we did that was we looked at our unencumbered pool, for instance Eastgate Pavilion where we put $4 million of debt on it, we wanted to take that particular asset, encumber it out of the line of credit and put project specific financing on it. One of the reasons we did that was to enable us and give us room under the line of credit to use our cash balances to pay any CMBS loans off and put those assets now that would be unencumbered in the line of credit which gets you to the same position from a liquidity perspective.

So, I think our whole goal here under that is we are not at the $200 million but we view that as an opportunity to be able to utilize that cash and available credit if need be on some of this expiring debt.

Rich Moore – RBC Capital Markets

So when you put these two assets that the debt expires on soon into the line you actually also increase the capacity. Correct?

Dan Sink

Correct. I tried to mention that in my script and I am glad you asked because I wasn’t clear. For instance, if we use our cash and pay off one of the CMBS loans expiring in the third and fourth quarter this year we can put that asset into the line then and increase our availability under the line which in theory then with cash and available credit has not been adjusted at all even though you have used part of your cash to expire a piece of debt.

So we are able to enhance our available credit under the line.

John Kite

Also remember that being it is a pool and technically not a secured line we can move these in and out. So this enables us to put the assets in there, create the additional availability, obviously we are not using all of our availability and we are not projecting we would be anywhere near that. It also gives us the ability to pull them out and have them be unencumbered NOI if we so choose. Or if we want to pull them out and we see the fixed rate market improves significantly we will pull them out and put long-term fixed rate debt on them.

That is the real objective to kind of ride through this period and get into next year and see how the debt markets are. Obviously they have slightly improved gradually month by month and then we can take these out and go 7-10 year debt which is really what we want to do. When you look at our maturities in 2013, 2014 and 2015 we have very little in the way of maturities. We are really setting ourselves up to have a real strong position over the next 5-6 years. We can stagger the debt and make these numbers kind of smaller per year rather than having one large year.

Rich Moore – RBC Capital Markets

You have a small loan on I think The Center. I saw a note on it. Maybe you can explain it?

John Kite

From a deal standpoint, I will talk about the deal. It is a shopping center in Northern Indianapolis in Carmel. We own 60% of the shopping center. This is one of the original properties we had going way back. We had a 40% partner in it who is actually managing and leasing the property. We own 60% but they are managing and leasing the property. The debt was coming due. It is a situation where you have a partnership and you kind of have to agree what is going to happen. The bottom line is we ended up stepping up at the end and lending the partnership the money and we are getting a 12% interest rate. So over the next six months that will get repaid. Actually it goes from 12% to 15% after the first 30 days. Frankly with as much cash as we have right now not earning a return it was a very safe thing for us to do and we are getting a good yield.

Rich Moore – RBC Capital Markets

You want to look for more of those deals. In the same vein, maybe you could offer your thoughts to us on the TALF program and as you look at that what it could mean to you if anything. Basically just what you think about that program.

John Kite

I think obviously we are staying in front of it. We are aware of it. We have been talking to people about it. Candidly, I think size adjusted I just don’t see it making sense for us. I think there are some grand ambitions with the TALF program but when you look at how difficult it is to put it together, how much time it takes, I think you have to really need it to use it. We just don’t really need it. I think it is one of these situations where hopefully it will get a little bit better over time but the idea of having a government plan replace the CMBS market I just don’t think that is a very good strategy. We are going to monitor it. If it gets better and we could use it for a couple of these CMBS deals we would. Right now it is a little clunky.

Rich Moore – RBC Capital Markets

On the small shop space, or the shop spaces you noted in your supplemental, we have kind of been tracking what happens quarter-to-quarter. It seems stabilized in this quarter. We always talk about the anchors but have you got any thoughts on what is going on in the small shop space in your portfolio?

John Kite

I will let Tom expand too but I think it has been pretty resilient. If you look at across the board our occupancy in the small shops both in our power centers and in our grocery anchor centers have been stable. The reason I guess we talk about anchors so much is because they move the needle on their own and frankly the small shops are very important. I would guess we are pleasantly surprised but cautious. We had slight decreases in our small shop occupancy in Indiana and Florida and we had an increase in Texas. Those are the three biggest markets. Generally speaking the other thing that is interesting is the power center small shops are performing lock step with the grocery anchored small shops. Despite the popular belief that grocery anchored centers are going to outperform power centers in this environment it is really not happening as it relates to small shops.

Tom McGowan

The only other thing to add is we were a little concerned about rent deferrals early on but if you look at our numbers our rent deferrals have really stayed pretty steady on the small shop side. If you look at it as a total it is still less than one-half of 1%. Small shops are clearly an area where we had concerns. We feel fairly encouraged where we are today and also encouraged about the amount of productivity that is going on from a leasing standpoint with the shops.

Rich Moore – RBC Capital Markets

Can you push those levels higher over the next couple of quarters? The level of occupancy?

John Kite

Again, as Tom referred to in his script, moving the needle in occupancy comes from the boxes because it is such a big percentage. In terms of can we make progress? Yes. The one thing about the small shops is you certainly have to expect there to be continued weakness there. I think the longer it goes, the more we move through this kind of economic reality the more people are adjusting their business plans to survive. One of the things we spent a lot of time on, as Tom said, this rent relief issue really brings it to the forefront in terms of how we need to get involved with our small shop tenants, help them with their businesses. We have a marketing team that helps…a lot of these guys are mom and pop so we try to help them market their businesses. We try to help them understand who their customer is. I think there is some opportunity there but it is probably a little slower.

Rich Moore – RBC Capital Markets

On G&A what are you thinking for the rest of the year? Any changes from what we have seen?

Dan Sink

If you look at the run rate of where we are today for a six month basis and you annualize it we are at the bottom end of our guidance range of [inaudible]. So I think there are some timing things with Sarbanes Oxley costs and other public company costs that pick up here at the end of the year a little bit as we come towards the audit. So I think our guidance range is where we put it and we are still comfortable with that.

Operator

The next question comes from the line of Jeff Donnelly – Wells Fargo.

Jeff Donnelly – Wells Fargo

Just a moment ago you made a comment that you thought power centers aren’t at a disadvantage to small shops to the grocery anchor. How do you think about the competitive landscape for junior boxes? Do you think grocery anchored boxes have an advantage there because of a grocery on site? Is that important to those retailers or is it not that cut and dry?

John Kite

I think whenever you can add a grocery store to a larger shopping center it is good because it generates daily visits. That is what we have done in many of our centers. In fact, in Cedar Hill in Texas where we lost a couple of boxes we replaced one with Sprouts which is a high end regional grocer. We have done it in Traders Pointe in Minneapolis. We have multiple places where we have done it. I don’t’ see there is a disadvantage. Right now the numbers are basically the same. They are generally the same occupancy as it relates to small shops.

They advantage the power center has over the grocer anchored center is if you lose a box you still have multiple other boxes. You still have anchors drawing traffic. If you lose a grocery store you have lost it. You don’t have an anchor drawing traffic for your small shops and it is very important that you back fill that one single space. So you have heard me say this before, there isn’t one perfect format and I don’t think we would ever be 100% into either category. I think they balance each other well. I think they are both value oriented in what they sell to. Grocery stores depending on what they are generally are value players. The boxes we deal with are generally value players. In this environment and the way it is going to be for the next 10 years I think we are in the right space.

Jeff Donnelly – Wells Fargo

I am curious, where are market rents that you have been signing of late versus the $10 anchor rents and $18 shop rents that are expiring in 2009 and 2010?

John Kite

The box leases again a lot depends on how much TI you give. Our experience in general it is between down 10-25% depending on TI’s and depending on the particular shopping center. That kind of been our experience.

Jeff Donnelly – Wells Fargo

Does that hold true for the shop space as well?

John Kite

No. Shop space I think you can see it in the leasing is a little tighter. Tom do you want to expand on that?

Tom McGowan

I definitely feel like it is much tighter on the small shop side. The box side is obviously feeling pressure of supply and demand where the small shop is in a little better position from that perspective. The small shops are in a little better position from that perspective. I think we will continue to see that trend at least over the near-term.

Jeff Donnelly – Wells Fargo

I am curious, of late you have been marketing some land or some projects in the development pipeline you are looking to monetize. I’m curious if there such a need for that more broadly in the industry for the developers to monetize and develop projects. Who out there is buying them and how are they getting financed? Are they being bought in all cash or all equity by folks?

John Kite

We can’t give you our secret on that one. There are people, as it relates to tenants, the large anchor format tenants want to own their real estate. The Wal Mart’s, the Target’s, the Costco’s. Those types of players want to own their real estate. Frankly it is just a cost of capital issue. Obviously that doesn’t happen that much on the junior box side although they do own real estate. Then we are also beginning to see investors move into land again. That is very early. It is happening. Where we saw land prices run up and when anyone can see value I think they want to take it.

Tom McGowan

The only other thing to add to it is sometimes you will see developers come in on a build to suit perspective and represent a tenant. Those are the types of people we talk to as well. We also have unimproved land that ties to multi-family components and we are seeing quite a bit of interest on that side. We are going to talk to all the ones we just mentioned, each and every one but realistically the most logical buyer is going to be that end user retail.

Jeff Donnelly – Wells Fargo

Can you give us some more color on where you are at with repositioning Coral Springs and Galleria and I guess maybe the next steps to get those assets on the right path. I’m just trying to think about the investment need and some of the terms from this juncture.

Tom McGowan

From Coral Springs perspective the key obviously is to get that box dealt with. At this point we feel like that process is moving along very well. We are in deep negotiations with the tenant and are working on the physical side of that deal right now in terms of making sure the numbers work. The other one being Galleria is the same situation. We have to address the anchor situation. That is a deal that we feel like for the most part is completed at this point. Once we get that anchor in then that property will clearly be stabilized.

John Kite

The thing to add to that in terms of Galleria is the reason Galleria is a redevelopment property is because it is a situation where we are not sure exactly where we are going to go with that property in terms of will it be a simple back fill of the box or will it be a total redevelopment tear down, bringing in two tenants instead of one tenant. That is kind of how we judge what ends up in a redevelopment versus what doesn’t. Just wanted to make that clear.

Tom McGowan

I would say if you take a look at the six redevelopment projects we have very, very strong interest on four of those deals right now we are working on and have a little bit of work to do on two of them.

Jeff Donnelly – Wells Fargo

I’m curious if you have seen any discernible shifts on the secured mortgage underwriting on your retail assets? Say Q2 versus Q1? Not so much LTV or debt service coverage but maybe by willingness to lend in certain property types or markets?

Tom McGowan

We are in constant contact with the lenders. There hasn’t been anything that has been a paradigm shift Q1 to Q2. It is all focused on cash flow still. Nobody can really get their arms around cap rates and those kinds of things. I know there have been some big trades that have been talked about. The big trades are not what the bankers are looking at. They are more looking at asset deals. I would say there is nothing that has been a big paradigm shift other than we are just trying to stay in front of it.

Operator

The next question comes from the line of Nathan Isbee – Stifel Nicolaus.

Nathan Isbee – Stifel Nicolaus

Just circling back to your prepared remarks you mentioned the relatively new age of your portfolio as a benefit. I guess I can appreciate you did the leasing on the stuff you developed and that is better than assets leased by others that you acquired. However, we are hearing decidedly conflicting statements from some of your peers this quarter that the newer properties are under performing. You have made some leasing progress. Obviously it is working and you are having some success. Maybe you can comment on why you think this doesn’t present a high risk for your portfolio.

John Kite

First of all the numbers are the numbers. Anecdotally whether you say new is better or old is better you can track the numbers and I think they are fairly equivalent in terms of what has been happening in the peer group relative to same store NOI. In fact, we have outperformed some people that had older portfolios in terms of increasing our occupancy.

As it relates to the differences, I think first of all you have to take into context what is new and what is old. I think if you have a portfolio that is dominated by 20+ year old centers you can say that because they are 20 years old the rents are below market and the demographics are more mature. Having matured demographics doesn’t necessarily make them the right ones, first of all. Relative to rents, it all depends on when the rents were reset.

The point I am making about new assets is, and we don’t get a lot of credit for this, but you track our CapEx and our CapEx is tremendously below the peer group as it relates to what we spend in capital expenditures on the asset and typically what we send in TI’s and commission. So as it relates to same store NOI, as you know I have said often that metric does not take into consideration the capital you spend to get it. We always have to continue to point out if you purely only follow same store NOI you are missing the picture. In a sense you might be buying deals or buying rents. My view is having newer is better because the retailers are going to be attracted to the newer assets and in the relocation game that is being played right now if you are a retailer you are going to look to relocate right now and you are going to look to relocate to the newer center that has the better façade, the better parking lot, the better visibility, that doesn’t have pot holes in the middle of the parking lot.

That is what I’m trying to get at.

Nathan Isbee – Stifel Nicolaus

Just as a follow-up, have you seen any significant shift in bad debt expense this quarter?

Dan Sink

On bad debt expense I covered a little bit on that in the prepared remarks. On bad debt expense we hit bad debt expense pretty hard in Q4 of 2008 and Q1 of 2009 to the extent of in excess of 3% of our mid-rent recoveries. I think this quarter the percentage of bad debt throughout the remainder of the year we are projecting to be about 1.5% for the next two quarters and for the year that would put us at about the range of 1.82%.

It is pretty consistent. I think it has come down a little bit. Obviously our antennae are up. We are watching it very close. We spend a lot of time going through monthly meetings with seven people in a committee meeting going through and making sure we have our arms around each one of the tenants. At quarter end we sit down and even scrub it even further. It is one of those things that year-over-year obviously for everybody in the sector it has increased but I think we are pretty aggressive in getting to it in the fourth quarter of 2008.

Operator

This concludes the question and answer session for today’s conference. I would now like to turn the call back over to John Kite for closing remarks.

John Kite

I just want to thank everyone for joining us and we look forward to talking to you next quarter. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Kite Realty Group Trust Q2 2009 Earnings Call Transcript
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