Kimco Realty Corporation (NASDAQ:SANM)
Q3 2009 Earnings Call Transcript
November 5, 2009 10:00 am ET
Barbara Pooley - SVP, Finance and IR
Milton Cooper - Chairman and CEO
Dave Henry - President and CIO
Mike Pappagallo - CFO
David Lukes - COO
Craig Schmidt - Bank of America/Merrill Lynch.
Michael Bilerman - Citi
Jay Habermann - Goldman Sachs
Michael Mueller - JPMorgan
Ian Weissman - ISI Group
Ross Nussbaum - UBS
Nathan Isbee - Stifel Nicolaus
Alexander Goldfarb - Sandler O'Neill
David Wigginton - Macquarie
Rich Moore - RBC Capital Markets
Good morning, ladies and gentlemen, and welcome to Kimco's third quarter earnings conference call. Please be aware, today's conference is being recorded. As a reminder, all lines are muted to prevent background noise. After the speakers' remarks, there will be a formal question-and-answer session. (Operator Instructions).
At this time, it is my pleasure to introduce your speaker today, Barbara Pooley. Please proceed, Mrs. Pooley
Thank you, Lauren. Thank you all for joining the third quarter Kimco earnings call. With me on the call this morning are Milton Cooper, Chairman and CEO; Dave Henry, President and Chief Investment Officer; Mike Pappagallo, Chief Financial Officer; and David Lukes, Chief Operating Officer. Other key executives are also available to take your questions at the conclusion of our prepared remarks.
As a reminder, statements made during the course of this call represent the company and management's hopes, intentions, believes, expectations or projections of the future which are forward-looking statements.
It's important to note that the company's actual results could differ materially from those projected in such forward-looking statements. Information concerning factors that could cause actual results to differ materially from those forward-looking statements is contained in the company's SEC filings.
During this presentation, management may make reference to certain non-GAAP financial measures that we believe help investors better understand Kimco's operating results. Examples include, but are not limited to funds from operations and net operating income. Reconciliation of these non-GAAP financial measures are available on our website.
Finally, during the Q&A portion of the call, we request that you respect the limit of one question with appropriate follow-up so that callers have an opportunity to speak with management. Feel free to return to the queue if you have additional questions and if we have time at the end of the call, we'll address your questions.
I'll now turn the call over to Mike Pappagallo.
Thank you, Barbara. Good morning. There is certainly no shortage of news to digest with the CEO announcement, quarterly earnings, our portfolio performance and acquisition activity. We issued the earnings press release earlier than planned to allow you to digest it all. Hopefully, we can clarify your concerns and answer you questions.
I will spend a few minutes discussing the quarterly financial results and capital market actions. David Lukes will provide insight to our core shopping center business results and trends. Dave Henry will address our business strategy to grow and enhance that shopping center franchise and specifically the purchase of our partner's interest in the PL Retail portfolio and selected assets from our Prudential joint venture. And finally, Milton will address the leadership actions and thoughts on our future.
Let me be the first to congratulate Dave on his CEO appointment. He has been a great friend and business partner since I first met him in 1991 in the (inaudible) of the last great real estate downturn and I look forward to helping him execute the company's strategy going forward.
Let me cover a few areas. First our operating results. FFO per share of $0.30 represents the solid results from core operations and was consistent with our expectations. The headline numbers versus last year show a large drop which was influenced by a substantial amount of transactional gains in 2008 everything ranging from gains on the Albertson's investment, sales with preferred equity investments and so on. Of the $0.38 drop in FFO per share, $0.25 is due to transactional income, $0.12 related to the dilutive effect of the equity raise earlier this year and everything else was virtually a push.
The 2009 numbers underscore the steady state virtually the entire EBITDA base generated from recurring operating flows. Our results were lower for [Presco] by a $0.01 attributable to the acceleration of the deferred financing costs from the term loan we originated earlier this year that was scheduled to mature in 2011. However, as you are aware, we reentered the bond market in the third quarter by issuing a $300 million 10-year note at a spread of 350 basis points for a coupon of 6.875.
I was more than happy to pay down the term loan even if it meant a hit against earnings with the original loan cost as we were able to improve an already solid debt maturity profile. I will get back to the balance sheet in a couple of minutes.
David will expand upon the dimensions of the portfolio performance, but at a high level we were encouraged by our occupancy levels increasing to 92.4%, a 10 basis point increase from last quarter.
Now, one clarification I need to make on the occupancy statistic. we now include stabilized shopping centers, those that have reached 90% occupancy that were previously part of our merchant building program. We used to exclude them as the concept was that they would move in an out of the portfolio.
However, as we are no longer marketing the properties for sale and will remain in the portfolio for the long-term, the inclusion of these assets was not the reason for the increase. It was due to positive absorption. But I mention it for those tracking the reported occupancy statistics from last quarter, which have been recapped to 92.3% to ensure comparability.
Same-store NOI for the quarter posted at a negative 3.6% and on a year-to-date basis was negative 2.2%. That year-to-date number is within our forecasted minus 1% to minus 3% range and continues to be one of the better performances in the sector in a very tough year.
Our Board of Directors established the quarterly common dividend rate for 2010 at $0.16 per share in cash. The dividend was sized with the idea of preserving operating cash to the extent possible to deal with the still uncertain retail and economic environment, and one that is well supported by the operating cash flow from the existing portfolio of assets.
In setting that dividend, we did not factor in transactional activity or new business generation in 2010. That is not to imply that we won't have any, but our dividend approach was focused on today's book of business adjusted for riskier environment.
Yesterday afternoon, we closed on the acquisition of our partners 85% interest in PL Retail. Dave Henry will talk a bit more about our rationale and new business activity overall, but just a couple of points on the numbers for this deal.
The balance sheet of this portfolio is priced at $825 million including the value of certain development rights. There is $564 million of mortgage debt on the property as well as an outstanding series of preferred stock of $50 million. Approximately $269 million of the debt matured in January.
Our immediate objective was to close the transaction and gain full control of the assets as required funding of $175 million which was accessed from our credit facility. As these are prime assets, we have the luxury of keeping them in our core portfolio or introducing them into a new institutional joint venture program in whole or in part.
We have a variety of alternatives that will be considered to set the permanent capital structure from this transaction ranging from that new institutional capital to common equity as we look to optimize returns and invest the 2,000 debt maturities on the portfolio.
The range of FFO impact in 2010 is tough to say at this point, as it depends on the ultimate capital structure and cost of that capital. We will provide more clarity when we rollout our 2010 guidance during the fourth quarter's earnings report.
In terms of overall earnings guidance for the balance of 2009, we estimate the full year FFO range of $0.79 to $0.82 per share, which includes the impairments taken so far but with no estimate for any potential impairment for the fourth quarter.
This also includes the effect of the PL Retail purchase on the balance sheet and the unfortunate expensing of the transaction costs of that deal in accordance with the new accounting rules for acquisitions. Excluding the effect of impairments to date, the full year guidance range is 130 to 133 per share.
All of that pencils out to about $0.28 to $0.31 per share for the fourth quarter which I mentioned because the quarterly numbers throughout 2009 may not equal the total year guidance because of the math around the average share calculations during the year.
With respect to the balance sheet, the $300 million new bond issuance is debt neutral as we paid off 2011 term loan and construction loans maturing over the next year or so. Overall, debt levels on the balance sheet were reduced by $167 million and we decreased the net debt-to-EBITDA by 4 to 6.5 times.
At the joint venture level, as we announced back in August, the required $145 million installment under a term loan guaranteed by Prudential in Kimco was paid by each party in their respective percentages, hopefully, answering the questions as to whether our partner was good for the money. As of today, there is $409 million remaining on this facility.
Beyond the statistics, I wanted to reinforce a point I've tried to make during the last earnings call. There is a big difference between Kimco's long-term view on optimal leverage and what is in front of us over the next few years in terms of debt obligations.
We have excellent liquidity, over $1.7 billion at the end of the quarter. We have limited debt maturities over the next couple of years, most of it on secured debt. I'm confident that the PL Retail 2010 maturities will be dealt with from the institutional joint venture or the capital market.
It's another way of saying we have flexibility and are not under the gun to de-lever at any cost. I keep reading about Kimco's need to de-lever and immediately, but that's just flat wrong. We will achieve our long range debt-to-EBITDA targets and fixed charge targets over time. But in no way will it prevent us from retaining existing assets or buying new ones that are consistent with our objective maintaining the highest quality portfolio with strong recurring and sustainable cash flow.
With that I'll turn it over to David Lukes.
Thank you, Mike. Good morning. And I would also like to start by offering a congratulations to Dave Henry speaking for myself and the other operating staffs we look forward to the years together.
With respect to our operations, let me give you some insights in our last 90 days of work and then provide some thoughts on what we see ahead and what value creating ideas we're focused on.
Our third quarter leasing production in the US portfolio increased 18% over last quarter and 42% over the same quarter a year ago. We completed 426 leases which totaled 1.7 million square feet and saw a rising activity in most markets, but particularly in those areas hit hardest by the housing bubble.
Two states this quarter, California and Florida, I may not represent the largest percentage of newly leased space which is a comforting sign. Vacant on the other hand also continued a high volume which led this up slightly and occupancy for the quarter at 91.9% in the US proving that stability was really the theme for the quarter.
With the uncertainty of 2009 year-to-date, I think it's best to focus my remarks on the subject that's on most investors' minds, and that's risk. In our portfolio, we view risk through the lens of our tenant base. If we consider our tenants in a pyramid, the foundation of the portfolio was the most secure. It was 40% of our GLA representing anchor leases and 650 ground leases. These tenants rarely vacate, consume very low landlord capital and are highly credit worthy.
The middle of the pyramid is the junior anchor spaces representing 39% of the GLA. In this recent cycle, the category has been under the most pressure with chain bankruptcies and limited demand. Most of us over the past year have been considerably concerned over the lack of activity in these categories and the excess space of this size and many submarkets.
This quarter, however, the trend of new leases has shown a somewhat surprising upswing in demand for quality space as over 490,000 square feet or 66% were of our total new leases for the quarter were in the junior anchor category. The risk of large blocks of available space in our portfolio from chain bankruptcies and the potential for activating Co-tenancy clauses has simply not proven to be a reality to-date.
Going back to our tenant pyramid analogy, the top section of the tenant base is shop space, representing 21% of our total GLA, but only one-third of that group or 7% of the total is local small shop space. The concern over the past year for many was that mom and pop retailers wouldn't have the staying power to last through a tough sales environment and then occupancy would drop fast and small shops would vacate the premises.
It is certainly true that small tenants who are non-credit in nature are facing great difficulty. Almost all of the tenants are on rent deferral program are local tenants and most of the vacates in the most challenged markets are of the same type.
We do know, however, that two pieces of anecdotal evidence are giving us confidence that this risk has also been somewhat muted. Firstly, the net absorption for small shop space was positive this quarter with more shops being leased than shops vacating.
Sometimes this is due to tenant upgrades where national chains are expanding and taking former mom and pop space, such as GameStop, GNC and RadioShack. Sometimes it's due to the fact that we're fairly aggressive in taking our own prosperous tenants from one center and expanding them into a second unit of another shopping center, a real benefit of a large portfolio.
The second data point is that our rent deferral program of which we currently have 256 tenants enrolled have been very successful in helping small businesses through a tough market. Of the active plans, over 70% are current on their payments and over 250 tenants have completed their obligation in its entirety and are back to contract rent having paid us back on their rent loans.
So having given you a fairly detailed picture of our occupancy trend, the final risk category for us is the steady decline in market rents. Certain areas such as the southwest and the southeast continue to glide down an achievable rents and this can be seen by the fact that our leasing spreads for the quarter dropped to a positive 1.3%.
This isn't surprising given the high volume of junior anchor leasing we accomplished for the quarter and will likely continue to be a theme as we work through our current vacancies in the 10,000 to 30,000 square foot ranges. Offsetting the trend, however, is the fact that many of our expiring tenants are far below market and therefore we're seeing a mark-to-market that's generous to the landlord.
Another positive sign that the renewal rate of existing tenants is extremely high given that we've signed 228 renewals and options this quarter, a very good number for us. It's true that market rents are still going lower but it's also true that the vast majority of tenants with profitable businesses have been renewing their leases at higher rents than their currents rents simply because they can't afford to and they want to stay in our centers.
So shifting gears let me mention the flip side of risk and that's opportunity. There's an old adage that says the trouble with opportunity is that it always comes disguised as hard work. Here is what we're working on. Number one, our remaining development staff have been successful in the past cycle in our merchant building program. This timeline is no longer active, but they have developed a strong skill set in entitlements, zoning and community relations.
We're using this theme to work on entitling higher density zoning, mixed-used zoning, special exceptions to current zoning and special use permits for 15 of our best properties in high density markets where land is scares and the demand for space is still quite high. This is hardly equipped boost to analyze we all know. But as we've proven with projects such as Pentagon Centre, West Lake and Manhattan the future growth is considerable if the seeds are planted early.
Number two, our ancillary income department has been growing at a rapid pace and I expect our total income this year to exceed last year's by 25%. We have dedicated staff working on new programs every month and the income we generate takes very little capital and therefore very high equity returns.
Vending, (inaudible) programs, solar energy, billboards, kiosk leasing, cell towers, and construction management are all contributing to the growth. I hope we can continue to add new ideas as we make use of the 120 million square feet of buildings that we manage.
Number three, it's hard to stress enough the value of existing tenants in the low market rent contracts and they are clearly our best source of growth. Even in the most difficult environment in years, we continue to see positive rent spreads on renewals.
Our region operating staff is focused on these tenants are negotiating early renewals before competition can lure then away and are constantly reviewing tenant sales to guide us on what a fair rent should be for a profitable business.
In summary, we're very happy with our production for the quarter. We're trying our best to manage the risk that we do see in the current economy and are hopeful that we can keep our eyes on the opportunities that we do have and improve the stability of our portfolio.
And with that, I'll turn it over to Dave.
Thanks, David. I'm glad I bought you both dinner last night. First, please permit me to comment on the management succession which Mike referenced. I sincerely and publicly thank Milton, Michael and the board as well as David and Mike for their strong support over the years in both the good times and the tougher environment of the past 12 months.
Since the day I arrived in 2001, it was very clear that Milton believed deeply in fostering a true partnership culture among the senior leadership team and I am very happy to be a part of this heritage. We will definitely continue this tradition which has played a significant role in creating the largest portfolio of neighborhood and community shopping centers in North America.
All of us at Kimco are committed to resuming our solid earnings and dividend profile and creating value for our shareholders by proactively managing the portfolio and selectively acquiring additional high quality retail properties.
We have all the ingredients to be successful; talented and then experienced employees, a large and well diversified portfolio and wonderful long standing relationships with our tenants, our lenders, and our institutional partners. Our vision remains the same, to be the absolute best owner and operator of community and neighborhood shopping centers in North America.
With respect to the environment today, we're definitely seeing a change in sentiments. As David discussed, while operating fundamentals remain challenging in terms of effective rents and vacancies, our stronger tenants have begun to expand again and actively look for new sites.
Leasing activity is indeed encouraging. We're also seeing a distinct shift in sentiment among our institutional joint venture partners. Six months ago, very few institutions were willing to consider core acquisitions and most were dealing with significant mark-to-market issues.
Now, we are seeing a large number of both domestic and foreign institutions, aggressively looking for high quality portfolios of retail profits. Prices are affirming with numerous bidders for well-located and well-leased retail properties.
In this environment, we are very pleased to have been able to acquire a significant number of assets from several of our existing institutional joint ventures. As announced, we have purchased full ownership of seven shopping centers from seven of our Prudential partnerships and 21 shopping centers from our PL Retail partnership, aggregating 6 million square feet at a combined total price of $896 million.
We believe these negotiated transactions represent a good outcome for both our institutional partners which wanted to sell their interest expeditiously, and Kimco which currently manages the properties and believes strongly in the long-term outlook for these assets and locations.
Mike Pappagallo deserves special recognition on the PL Retail transaction which came together very quickly and involved a very large complicated closing process. The PL Retail portfolio itself is a premiere collection of shopping centers and we are especially pleased to have purchased our partners ownership interest in this portfolio.
Strong anchor tenants like Costco, Wal-Mart, Home Depot, PJX and Ross Stores comprise 84% of the gross leasable area and 75% of the base rent of the centers. The portfolio has consistently maintained a high occupancy and even in today's environment, the properties are 94% leased and well-located in dense desirable retail markets. The purchase maintains our standing as Costco's largest landlord and helps the demographic profile of our gross revenues.
The six Oregon assets we purchased from one of our Prudential join ventures are all located within the urban growth boundary of Portland. They are generally gross re-anchored shopping centers, a total 148,000 square feet; 85% of the space is leased to national credit tenants, while only 15% is local shop space. The purchase price of $69 per square foot is attractive and Portland is an excellent market because the land use restrictions are quite high.
In Novato Fair, the seventh property, is 134,000 square foot safely anchored shopping center in Marine County, California and is effectively the main retail property in the town. The demographics are strong and as you can imagine from Marine County, the constraints on retail supply are very high. Safeway as a result has sales volumes in excess of $800 per square foot.
As we move forward we anticipate that our joint venture portfolio, combined with potential acquisitions from property owners, lenders, pension funds and other institutions where we have strong relationships will be an excellent source for future acquisitions and growth. Most institutions recognize that shopping centers require operating expertise in both property management and leasing.
Core strengths of Kimco since 1959. Looking at our two large international markets, Canada and Mexico, occupancy and leasing activity ranges from strong in Canada to moderately soft in Mexico. In Canada, our portfolio occupancy increased from 97.7% to 98%, with same space leasing spreads of 4.2%.
The Canadian economy with its natural resource and strong financial system, is adding jobs and both U.S. and Canadian retailers are expanding in the market. With half of the retail square footage per capital of the U.S., our Canadian portfolio is expected to continue to perform very well over the next several years. In Mexico, by the end of the year, all of our development projects with the exception of Hermosillo will be substantially completed.
During the quarter, 116 new leases were signed as we make progress leasing recently completed properties. In general, leasing activity is picking up across the portfolio with several large sub-bank releases in advanced negotiations. During the quarter, four new grocery store anchors opened successfully in our development projects; three new Wal-Mart super centers and one HEB grocery store.
As evidence of the long-term prospects for retail in Mexico, Wal-Mart announced, yet again, an increase in its expansion plan for Mexico. Their quarterly retail sales increased by 11.9% and same-store sales increased 4.7%. Wal-Mart expects to open 270 new stores and restaurants in 2009 in Mexico. Overall, Wal-Mart operates 1344 stores in the country.
With respect to our non-core portfolio, we're committed to an accelerated but orderly liquidation of our investments. Since the beginning of the year, we have monetized $106 million of our non-core assets. We have carefully reviewed each of the non-core investments and we have created business plans and targets to monetize these investments. Let me assure you that we will indeed exit from these non-retail assets and our future growth will be solely tied to our strong retail platform and core expertise.
Now I'd like to turn to Milton for his thoughts and comments.
Thanks, David. Our strategy is simple. One, monetize expeditiously our non-shopping center assets. Two, grow our shopping center portfolio and enhance its value. We have a good portfolio to work on with many defensive and stable characteristics. Much of the space is occupied by discounters, warehouse clubs, supermarkets, truck stores and off price retailers such as Ross and T.J. Maxx.
These retailers sell non-discretionary essential items or accommodate the consumer who is now trading down. Notice that last month, Dillard's and Macy's had comp store declines while and Ross and T.J. Maxx has 10% and 9% increases. As a point of interest, our largest tenant is Home Depot with 44 stores; 33 of the 44 are ground leases, where Kimco has leased the land to Home Depot and Home Depot paid for all improvements.
Another defensive attribute relates to our long history. Many leases were entered into over 15 years ago and there has been inflation in rents. The lease rents are substantially below the market rents. A platform of 900 centers is geographically in tenant diverse. Most importantly, we have a superb group of associates functioning together in a collegial atmosphere, a team of partners and not a team of rivals and there is great bench strength to boot.
Dave Henry, Mike Pappagallo, David Lukes, and I feel that we are four horsemen pulling together to create great value for our shareholders and our institutional partners. I also want to thank all the people who called or emailed me over the past several days. I am indeed turning over more of the day-to-day responsibility to Dave and the team, but I remain committed, involved, energized and very excited about where we're going. We have a good plan and we will deliver the goods.
Now, we're pleased to take your questions.
(Operator Instructions). Our first question comes from Craig Schmidt with Bank of America/Merrill Lynch.
Craig Schmidt - Bank of America/Merrill Lynch.
This should go to Dave. I'm just wondering, the 76 cap rate on the PL transaction, I realize that it may not be total exemplary, but where do you think CapEx have moved for quality coming into the neighborhood centers, say, in the last two years, as you start to see the transaction market open up again?
We've seen a distinct change. Six-seven months ago cap rates were definitely in the mid-eights and probably heading towards nine for even the best quality shopping centers. But as you know, there weren't a lot of transactions happening.
Over the past several months, it's really opened up and Westbury is a good example. I think there were more than 20 bids on that particular shopping center, which is a high quality shopping center. So we've seen a substantial shift in the demand for high quality retail. The investors we meet with are definitely being much more aggressive today than they were, especially foreign institutions which have seen the value of their currency increase compared to ours and feel today is an excellent time to invest in high quality retail in the United States, especially with a hint of inflation down the road for good hard assets.
The cap rate is only one function of acquiring properties. The quality of the properties themselves is a factor. Secondly, the debt that can be assumed. Many investors are looking at below market debt that can be assumed as an attractive feature. And third, replacement costs. If you can buy assets significantly below what they can be replaced for down the road, that's an [awesome] element.
We think the 76 cap rate for this quality portfolio is a fair cap rate and we're happy with it. We're exceptionally happy to keep these crown jewels in our portfolio. As Mike pointed out, we have the time to either put this with other investors or do something else with them and we will do that. We moved expeditiously and this was a negotiated purchase and we preempted an auction process.
Craig Schmidt - Bank of America/Merrill Lynch.
How long do you think it would be before you get the final financial structure for the PL Retail?
Very quickly. I think over the next couple of months we will decide exactly what we're going to do with this long term.
Our next question comes from Quentin Velleley with Citi. Please go ahead.
Michael Bilerman - Citi
It's Michael Bilerman here for Quentin. Mike maybe, just as you talk about the leverage stats and I do appreciate your comments that it's not an immediate impact but it's a long-term process. I think last quarter you talked about getting your debt-to-EBITDA down by two turns which would affect lowering leverage, selling non-core assets but also increasing EBITDA.
I guess I just want to understand the mindset as we relate to this deal specifically as the PL deal taking it all on balance sheet today effectively increases debt-to-EBITDA by about 0.3 and I can understand that your thought process is to either raise common equity or sell it down into another fund. Given the speed of this transaction, you want to get it closed and then evaluating your options.
As you think about common equity related to this deal and given where your stock is trading, you're looking at almost the double digit cost relative to the initial yield on the portfolio in the [severance]. So I'm just trying to put it all together and really understand how much you're willing to stress the balance sheet upfront versus a longer term goal of deleveraging.
There are a couple of things, Michael. The points you had made in referencing what adds, it previously still holds true as we think about the longer term, the overall improvement in the metrics, lower net debt-to-EBITDA, increased EBITDA are all and continue to be part of the program.
The other point that you alluded to is that we were able to move very quickly on this transaction and because we have flexibility and good liquidity, we were able to make this preemptive strike and buy it at a fair price.
As I look forward, we do have alternatives, and because of the quality and the interest in this portfolio, we feel very confident that the institutional joint venture approach is one viable and real way to structure this on a permanent basis.
That said, I will continue to look at the equity market and to the extent our price improves, then that becomes a better alternative as well. So I have a couple of arrows in the quiver clearly and a couple of directions to go. We don't feel at least constricted or restricted or boxed into the corner here. And it's primarily because of these assets, their quality and their attractiveness. We'll see where it goes over the next couple of months.
Michael Bilerman - Citi
Can your just reconcile just on the NOI, if you were to annualize the nine months NOI that's in your stuff, you get to about 57 million of NOI and you're quoting 61 million, so it would look like a nine-month number as a seven cap. But your quoting seven-six.
One of the interesting things in the underwriting is that what you don't see in those numbers Michael, is there is a series of leases that have been signed. They are just not flowing. In Pentagon, we signed a Nordstrom Rack to price a limit. In Smithtown which is a center that was vacated we put in a box furniture and a pets mart, so now that's fully leased again.
In total, about eight centers, there is over $5.5 million of annualized pace rents that you don't see in the current number when you do the annualization. Not only were they baked into the underwritten NOI but as part of the contract negotiations from today until the rents actually start to flow, we and our partner agreed that we would get a rents credit for the loss in interim rate. So when you think about that underwriting NOI recognize it's real, its not speculation. It's based on real leases that have been signed and just not flowing.
Our next question comes from Jay Habermann with Goldman Sachs.
Jay Habermann - Goldman Sachs
Mike, sticking with you, I guess just on the price legacy. Can you give us some details on how the price was negotiated and if other investors were considered and again, I guess, in-place rents versus market. I know its 94% lease. Its very high quality tenants, but what sort of upside do you see to that 7.6 initial lead?
From an upside perspective, recognize that even with those built-in leases, you're only achieving about a 94, 95% occupancy. So it's only because you are dealing with quality center. And there at one point this shopping center portfolio was close to the 97% of lease. So I think some of the downdraft in current occupancy is just due to the market in general. So, we believe to see very good growth in this portfolio. David, would you like to comment about some of the other occupancy.
A couple of things I could add that whenever we look at an acquisition, notwithstanding going in cap rate. The real issue is, what can we do with it over time, and this portfolio there is probably three different areas that we're most enthusiastic about. One is the fact that several of them have additional density available, particularly Pentagon. One on the East Coast and one on the West coast that have a lot of upside through zoning density that's fully entitled.
A second aspect is true occupancy pick up since we're in a period in this portfolio that's lower than its historical norm. So you get some true upticks, especially given the back of the market rents are quite high around a lot of these properties. And then lastly, when we looked at the rollover schedule, it has a very defensive nature and not whole lot rolls in the next couple of years but those leases that do roll are effectively seven, eight, nine, 10 years old and they're significantly below market.
So when you add those three things together there is an awful lot to work on and you have to remember that the visibility we have to the gust of the properties is fairly deep considering we've been owning and operating and managing it for several years and we have regional offices near most of the properties. So we feel very good about being able to be credible with ourselves on the underwriting and look forward to creating some value.
Jay Habermann - Goldman Sachs
Does it relates to long-term strategy? I guess maybe for Dave Henry, you've discussed the sale of the non-core assets but we've heard about simplify and your focuses on the strategy remains the same, but as you any about your longer term strategy beyond the non-core asset sales, I mean do you anticipate further changes to the Kimco structure at this point?
No. We've been tested by fire over the past 12 months and we have a strong consensus on where we want to go. Number one, as we've mentioned repeatedly, we are a shopping center company from 1959 forward. We are vertically integrated. We have a strong property management leasing. We have redevelopment expertise. We have relationships with retailers that are second to none. Our portfolio is enormous.
Secondly, we're very comfortable with community and neighborhood shopping centers. We are not regional mall or outlet operators. We're very comfortable in our sector. Our retailers sell necessities and off price. We're very, very comfortable with that profile of the tenants we have. We like our North American footprint. This is where our largest tenants are, Canada, Mexico, and the U.S. We like that. We're going to stick to that.
We like the investment management model. We like being able to team up with institutional partners that have a cheaper cost of capital. It makes us competitive in going after the very best properties. It enhances the returns for our shareholders and it helps build scale overtime. As Mike mentioned, we will operate with lower leverage, both in the core and in our joint ventures over time and we'll get there over time. There is no magic to a straight line to get there, and things like PL Retail opportunities will come up and we're determined to jump on that.
Forever, this company has had an opportunistic culture and many of you know, deals like Montgomery Wards and Gold Circle and Albertsons and so forth. We do not hesitate to buy vacant space when we know we can do something with it and that will be part of our strategy going forward as I grow the portfolio. So I think we all hold hands here and we've agreed on this core strategy going forward.
Our next question comes from Michael Mueller with JPMorgan.
Michael Mueller - JPMorgan
I was wondering if you can comment on any additional acquisitions coming from joint ventures because, obviously you picked up some pro-assets. You picked up these assets from DRA. Anything else on the horizon from either funds looking to sell that you may step-up or just any commentary on that front?
Yes, if you think about it. Our joint venture portfolio is very large and we have probably 15 or so large institutional partners, and some of them have different objectives. Some of those are long-term holders. Some of those need to liquidate earlier for other reasons. The ones especially that have large commingled funds with redemption requests these days have some pressure to sell assets.
These joint venture portfolios are excellent sources for acquisitions for us and we're determined to help our partners where we can liquefy these investments and sometimes the very best way to do this is to sell those assets to Kimco rather than place them on the market. In many cases the debt can be assumed easily by Kimco as opposed to being assumed by a third-party purchaser which would take time and in many cases involve extra costs to have that debt assumed.
Secondly, we feel our preferred equity portfolio is also a potential source of acquisitions over time. As we unwind these preferred equity positions, some of these partners have expressed their interest in selling the assets to us 100%. Third, we like our relationships with lots of lenders, pension funds, life companies. Many of these have turned to us as they have struggled with the loans they have taken back and other things to ask our assistance in managing these assets. We believe those also represent opportunities for us over time to acquire them on a negotiated basis.
Our last choice is to join an auction market and become one of 37 bidders. So where we can, we will continue to do negotiated transactions.
Michael Mueller - JPMorgan
Then what's the magic in terms of how you look at this and, let's say, another fund, another joint venture partner wants to liquidate. How do your guys sit there and determine what you would allow to kind of hit the open market and sell versus something that you would want to actually step up and allocate capital to buy and assume the debt, et cetera?
Generally, our partners are very sophisticated institutions with extensive retail expertise and personnel and these transactions are heavily negotiated. They have their objectives. We have our return thresholds and so forth. We pride ourselves in being good partners. We're not looking to take enormous advantage of these partners and we've been successful working out a fair arrangement and we expect to continue to do so.
One other thing I'd mention to that, Mike, is that in your question about what we would keep versus what we would sell. Every deal is looked at using our traditional conventional underwriting approaches and if you think about the Prudential sale categories, most of the accidents that have been in our portfolio, we and Prudential have agreed to sell. But in the example of the Portland area, as if that we just acquired, David felt that as a good long-term potential in those assets. They were just good assets.
Prudential wanted to sell to monetize their position, but we felt that over the long-term these were great assets and we were going to acquire them at very low per square foot number. So every deal we do that separately, but we don't arbitrarily or uniformly decide we are going to buy all of our partner's assets because they need to sell. We go through it rigorously one by one. As Dave mentioned, we negotiate in good faith and come up with fair compromise.
Our next question comes from Ian Weissman with ISI Group.
Ian Weissman - ISI Group
In the current environment, we've clearly seen the greatest tenant fallout and bankruptcy filings across the big box category and specifically, you've seen a lot of pressure on big box rents. So I guess with the DRA transaction, you are basically increasing your exposure to big box retail. Maybe, you could just talk a little bit about your strategy and your thoughts on big box retail today and what sort of the tenant demand is on the go-forward basis?
So, let me broaden up a little bit. I think six months ago, or nine months ago, the demand was so de minimis for the junior anchor category and I would like to separate junior anchors from big box. If you look at spaces, that are over 60,000 square feet. There has actually been very little vacancy and the demand hasn't really changed a whole lot.
It's really the categories that are the category killers or the tender of 50,000 square feet. We saw a lot come back to the market. There was a huge negative absorption and yet 45 days ago the world really turned around and we had a lot of tenants not only move locations to better real estate, but also have true growth in their footprint. I think that really stabilized market rents and it certainly stabilized in our portfolio, the occupancy level that we were worried about with certain junior categories starting to go down.
In general, big picture, there is a lot of space on the market still in those categories, but when you start to look at each trade area, you can pretty quickly tell the haves from the have nots. Given the credit behind these tenants, the way the American consumer shops and will likely continue to shop in certain big box chains, it's unlikely that you'll see us shy away from the entire big box category because a lot of them are very, very secure assets.
But we're pretty selective and careful about which ones we want and which ones we don't want. In the case of the PL Retail, it does come with some sizable large tenants like Costco and Home Depot, but it also comes with Ross and T.J. Maxx. Those are two tenants that we would be happy to own a lot more given what they sell and how they run their business.
When you combine that with the fact that the real estate is in a very good trade area and very good locations in those trade areas and it's almost been tested by fire, as Mike would say, in the past 12 months to prove that the sales are sustainable in those sites. So I don't think you'll see us shift away from entire category, but you'll us start to look very closely as to which ones we think are stable and which ones we think are at risk.
Ian Weissman - ISI Group
When you underwrote the portfolio about, what was your assumption for, call it either a mark-to-market or rent growth for that type of real estate in those markets?
It's hard to give you an average and the reason I say that is because, for instance, there is an anchor paying $2 in this portfolio and there is an anchor paying $25. So the spread is so large between the different tenants, it's probably better to answer that question by saying, do we think that there are above market rents. Generally speaking of this portfolio, we do not.
The reason that we're comfortable with that is that we've been running the assets for the past four or five years, so we've got a lot of letters to attend. There are lot of background history of exactly what's been happening at the property level.
So to me, knowing that once we buy the stuff then I need to get to work pretty hard on making sure we hit our numbers. There is no question the most thing is, of the tenants that are rolling and of the ones that are at risk, where do those stand in relation to the current market rent and in that sense, I'm very comfortable.
I think what you're really getting at is the entire junior category going down at rent? I think the answer is no. Half the time the rents have stayed flat and not gone up and the other half of the time they've gone dramatically down. You can look at that from our new leasing. Our new leasing spreads are down 20 basis points, but that's primarily driven out of several 100 leases, that's driven by three leases; two former linens N Things and one, a former Circuit, they were down about 40% from the prior tenants. So those three tenants really dragged down the average. It would have been a little over 5% rent growth and I think that's probably a good example that you can choose the properties to buy that don't have that mark-to-market downside. Then the cap rate is probably less of an issue. It's more about what you can do in the future.
Our next question comes from Ross Nussbaum with UBS.
Ross Nussbaum - UBS
I've got Christy here with me. In looking at the purchase and sales agreement that you filed this morning on the PL portfolio, it looks like there was a $60 million loan that went from Kimco to the JV. What exactly is that?
That is nothing more than an internal loan that was structured in connection with the price legacy subsidiary from a tax perspective. This entity will ultimately be liquidated internally and that's really in one pocket, out the other. The way you should view it, Ross, is that it was ultimately part of the consideration that was paid to DRA adviser and should not be viewed as any sort of financial structure or retained loan.
Ross Nussbaum - UBS
If I could follow-up...
It's either (inaudible) in your evaluation, but it's more just a tax structure issue.
Ross Nussbaum - UBS
If I can follow-up on the question that Michael Bilerman asked earlier, I'm trying to reconcile what's on page 34 of the supplemental and I know Mike that you had talked about 5.5 million of annualized base rent that's going to be flowing based on leases signed. But that still doesn't look like it reconciles the difference between your 61 million of underwritten NOI and the 51 million or the annualized here. I would have thought that that 51 million of annualized supplemental would have also included Woodbury.
Let me just clarify one thing for you. I know you are looking at the net operating income for the quarter of $12.8 million, correct?
Ross Nussbaum - UBS
That number does exclude Westbury, as the Westbury numbers are all in the discontinued operations line. As it is a discontinued operation as of the end of September. The other point that you obviously are not aware of is in the $12.8 million of net operating income, there is a $1 million charge for an increase to our allowance for bad debts. We felt we had the room and we thought it was prudent to increase the reserve and it was really a one-time item.
So I think to be fair, if you wanted to see the annualized rent or annualized NOI add back a million, so if you take the 13.8 and times that by four; I know that's what you are doing. That will bring you out to $55 million. That's really the right starting point to then add the additional rents that you don't see from the leases that I had mentioned earlier and that get you pretty darn close to the $61 million on our under rent NOI.
So again, I emphasize that 61 was not a high end of the sky number. It was clearly based on cash flow to-date. Leases that were signed and going to flow in the future and you need to make that adjustment for the bad debt. I certainly understand how prior to this call you wouldn't know that and hopefully, this call clarifies that for you.
Ross Nussbaum - UBS
100%. If I could ask one just, final question, why wasn't Westbury included in this whole transaction?
Westbury, we and DRA did agree few months ago to put that property on the market. Then it was a very good and deep bidding process and there were many bidders. Equity One was the winner. We felt from all perspective, it's a very good property and a very good market.
We had a different perspective on long-term in terms of the relative growth, risk and reward profile. I mean that ultimately drives value by a value, sell an asset but we do ultimately and our partners DRA ultimately were looking to monetize the entire portfolio. So Westbury was a step one and then obviously, there is transaction for them with the big step too.
Our next question comes from Nathan Isbee with Stifel Nicolaus.
Nathan Isbee - Stifel Nicolaus
I have David Fick here with me. Can you talk a little bit more about the rent spreads? Then clearly, you have below market status and you're still seeing a positive mark on your leasing unit last quarter. That's I think in part the nature of older assets.
How confident are you in your stated remark going forward and can you talk a little bit about how that's staged. I'm not asking for guidance for next year as much as sort of is your portfolio big enough that it sort of just ratably and steady in terms of that spread quarter over quarter?
I think the last couple of quarters, if you look at the rent spreads, they've been fairly consistent on the renewals and they've been all over the map on the new leases. Most of that is driven by the fact that there were a couple of bankruptcies and I think you and I have discussed several times that below market rents can be good if you get access back from the space, but it can show up as nothing if you don't have control for the next 20 years.
When we lost Linens N Things in particular and also Value City, they had opposite effects. Last quarter we had a very high leasing spread of 17% or so and that was driven primarily because we got that space in low single digits and leased it in mid-to-high double digits. The opposite happened three times this quarter which is, we got back to Linens and Circuit. We released them at about 45% to 40% less than the prior tenant.
So at those several hundred leases, it's very easy to have two or three swing the pendulum very quickly. But if you blend everything together, I do think that we are seeing that the volume of leasing is allowing us to capture back some of the spaces that are below market every single quarter, quarter-in, quarter-out. But I don't see market rent growth, and that's a big difference. I think we're going to see mark-to-market be positive for us for the most part with the exception of some of these junior anchors we're still trying to get through, but I don't see true rent growth out there and that's probably the big difference.
When you look at the Linens and Circuits, we're really through most of them in terms of what's under (inaudible), what's been leased. We've only four left out of 39 that don't have activity right now in form of a negotiated NOI. So I think as soon as we can burn off some of those rent downticks that will help us a little bit. But 2010 is still a long ways away in terms of visibility as to what happening with market rents and that's still to have an effect on how much mark-to-market we can capture.
Our next question comes from Alexander Goldfarb with Sandler O'Neill.
Alexander Goldfarb - Sandler O'Neill
Just going back to the JVs, it would seem like you guys are now sort of a natural buyer from your joint venture partner standpoint. How do you make sure that they're just not trying to sort of put product on to you? Is it that you have sort of walk away from a portfolio and let one fall out of bed and go to the open market in a trade? How do you manage the reception on the part of the joint venture partners for liquidity?
As one example, we've sold an awful lot of properties out of our Prudential JV this year and last year, so these in general were properties that we did not choose to bid on and together we agreed to put them on the market. So it is a very cooperative, positive relationship with these institutions. As I mentioned before, they're very sophisticated and have a very large asset management staff that we work with. So we try to be good partners and we work with them in liquidating the assets.
Just one other point, Alex, there is no structural issues here where we're forced to buyout our partners nor do we view it that we have to buyout our partners. These earlier points, we look at opportunities when those partners are in need of liquidity. It makes all the sense in the world to look at us first as the natural buyers, but there are no particular restrictions or no obligations or forced sales that's involved in any of our joint ventures.
So, because of our very good relationships with each of these investment partners, we will have a cogent discussion, make a decision as to sell or if Kimco would like to buy it. And so far, it's worked swimmingly well.
Another good example is GE joint venture in which we acquired 42 shopping centers and we sold 37 and I think we brought maybe half a dozen out of that but we sold more than 30 into the market. So it is a mutual decision that we arrived at and for us, sometimes it's a good opportunity because we really like the asset and in some cases, we mutually agree to put it on the market.
Our next question comes from David Wigginton with Macquarie.
David Wigginton - Macquarie
Most of my questions have been answered but just staying on the topic of JV asset sales, do you typically have some sort of first right of refusal if any of your JV partners do decide to liquidate or would the assets essentially be open to competitive bid at the outset?
It varies. The joint venture agreements range from in some cases we do have a right of first refusal or in some cases a last (inaudible), if you will. Others there is other dispute resolution mechanism, such as buy-sells and so forth. So, in general, we have certain rights and in some cases, but again our first choice is to work it out on a very mutual basis with these partners.
Our final question comes from Rich Moore with RBC Capital Markets.
Rich Moore - RBC Capital Markets
First of all, Dave, congratulations, and secondly as a follow-up, you guys talked about buying various partnerships, buying assets out of partnerships. Would you also think about selling in mass one of your partnerships? In particular, I'm thinking about the guys in Canada who have obviously expressed some interest in U.S. real estate. They seemed to be acquisition hungry. Any thoughts on the RioCan venture
RioCan remained one of our favorite partners in the portfolio. We own together in Canada has performed exceptionally well. Our 50% interest in that portfolio remained a crown jewel for us for the long-term, so that we will definitely hold onto. In terms of working with them in the U.S., RioCan is certainly a candidate to work with and they have expressed interest in teaming up with us as we find the right things to buy in the U.S. So we do have discussions with them.
Thank you. That concludes our question-and-answer session. At this time, I'll turn the conference back to management for additional or closing remarks.
Thanks, everybody. As a reminder, our supplemental is on our website at www.kimcorealty.com and we appreciate everybody's participation today. Have a great day.
This concludes today's conference. Thank you for your participation.
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