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Executives

Dawn Benchelt - IR

Mark Zalatoris - President & CEO

Brett Brown - CFO, VP & Treasurer

D. Scott Carr - President of Inland Commercial Property Management, Inc.

Analysts

Mark Lutenski - BMO Capital Markets

RJ Milligan - Raymond James

David Wigginton - Macquarie

Jeffrey Donnelly - Wells Fargo

Steve Swett - Morgan Keegan

Inland Real Estate Corp. (IRC) Q4 2009 Earnings Call February 11, 2010 3:00 PM ET

Operator

Good day and welcome to the 2009 Fourth Quarter Earnings Conference Call and webcast. All participants will be in a listen-only mode. (Operator Instructions). I would now like to turn the conference over to Dawn Benchelt. Ms. Benchelt the floor is yours ma’am.

Dawn Benchelt

Thanks Mike, and thank you for joining us for Inland Real Estate Corporation’s fourth quarter and year 2009 earnings conference call. The fourth quarter earnings release and supplemental financial package have been filed with the SEC today, February 11, 2010, and posted to our website www.inlandrealestate.com. We’re hosting a live webcast of today’s call, which is also accessible on our website.

Before we begin, please note that today’s discussion contains forward-looking statements, which are management’s intentions, beliefs, expectations, representations, plans or predictions of the future. There are numerous risks and uncertainties that could cause the actual results to differ materially from those set forth in the forward looking statements. For a more complete discussion of these risks and uncertainties, please refer to the documents filed by the company with the SEC, specifically our Annual Report on Form 10-K for the year ended December 31, 2008 and our report on Form 10-Q for the quarter ended June 30, 2009.

Participating on today’s call will be Mark Zalatoris, Inland’s President and Chief Executive Officer, Chief Financial Officer, Brett Brown, and Scott Carr, President of Property Management.

Now, I’ll turn the call over to Mark.

Mark Zalatoris

Thank you, Dawn and good afternoon everyone. On the call today, I want to touch on our performance for the quarter and the full year. I’ll then outline the actions we’ve taken to strengthen our financial position as well as portfolio operations within the current environment. Scott will follow the report on our portfolio results and additional color the operating environment and then Brett will review our financial results in more detail as well as provide an update on financing initiatives.

For the quarter, funds from operations were $0.23 per share compared to $0.24 per share reported for the fourth quarter of 2008. FFO for the year ended December 31, 2009 was $0.87 per share versus $1.29 per share for 2008. Our FFO results for the first year were inline with the analyst consensus estimates published by First Call.

After adjusting form non-cash impairment charges, net of taxes and gains on extinguishment of debt asset corporate share for quarter was $0.24 versus $0.31 for the year ago period. The majority of the decrease approximately $0.06 per share is due to the dilutive impact of additional shares issued in conjunction with our equity offering last May.

On a full year basis, FFO excluding gains on extinguishment of debt and net impairment charges was $1.03 per share again inline with the guidance we provided last quarter. This was a decrease of $0.40 per share from the prior year and reflects the impact of dilution from our May equity offering, lower top line revenue from the core portfolio mainly as a result of certain big-box tenant bankruptcies along with an increase reserve for bad debt and smaller gains from the sales of IREX JV properties, as well as lower rental income from consolidated IREX JV properties.

From a broader perspective, our performance for the year primarily reflects the hit that certain of our retailer tenants took as a result of this protracted economic downturn. As an example, Wicks Furniture filed for bankruptcy early in 2008 and then liquidated. As conditions worsened within both credit markets and overall economy, certain other big-box tenants filed a suit, these included Linens ‘N Things, Circuit City, Filene's Basement and Bally's Fitness.

Now we worked quickly to return it to former Wicks store within our portfolio and today we’ve been successful leasing four out of the five spaces at rates on average higher than those that Wicks was paying.

Unfortunately, filling vacancies created by the other big-box bankruptcies has taken longer as a supply of available retail spaces increased and retailer demand has contracted.

To-date, we have returned over 50% of the GLA returned to us via big-box chain failures and we’re negotiating leases or have letters of intent out for another 35%. With respect to a few of those big-box vacancies, we made the difficult but practical decision to sign replacement leases at rates lower that the formal rents.

However, those deals were executed with credit quality retailers that in an addition to paying rent, we will also pay their share of shopping center operating expenses. In addition, the centers will benefit longer term from the improved tenant quality. I'd like to take a moment to make an important point.

The occupancy decline within our portfolio is primarily a reflection of the economic downturn impacting certain retailers, not the strength of our real estate. We’ve executed on our resilient and proven business model through many market cycles over the years and fully expect to prevail through this cycle as well.

I'd like to highlight some key components of our strategy. First, our portfolio has always placed strong emphasis on necessity and value base retail. Looking through this recession appears to have resulted in a fundamental shift into consumer behavior.

In addition to saving more, there is a marked preference for discount and value retail. We believe this shift will benefit our company over the longer term particularly as the current surplus of available retail space is observed.

Second, we’ve located in our assets in the stable markets, principally throughout the upper Midwest. Our shopping centers are primary located in infill locations characterized by dense populations and the strong incomes. These factors make our locations compelling to retailers.

And finally, within our core markets we have assembled a critical mass of properties and have clustered assets in key sub-markets. This portfolio scale facilitates retailer market launches, expansions of relocations. Market concentration also provides property management efficiencies including pricing power with vendors.

In 2009, we reduced same-store property operating expenses by over 10% for example. Taking as a whole, we’re confidents this operating strategy along was solid balance sheet and continued access to capital ensures our long-term success.

Turning to the balance sheet, despite one of the most capital constrained environments in recent history, we’re able to leverage strong banking relationships to access the equity markets in 2009.

In May, we strengthened our financial position by completing an equity offering that yielded net proceeds over $106 million. We used the proceeds to pay down the balance outstanding in our line of credit at that time and to repurchase certain of our convertible notes at discounts to the face value. In addition, last quarter we excused an agreement with BMO Capital Markets. This agreement provides at upon our request BMO will offers shares of our common stock to our institutional clients at prevailing market prices. These at the market are ATM offerings are generally considered less disruptive and more cost efficient in overnight or one-day offerings.

We planned to use the proceeds from measured ATM offerings to continue to retire debt and for acquisitions through our joint venture entities or wholly owned subsidiaries. During 2009, we also made substantial headway on refinancing and repositioning our outstanding debt.

In total, we successfully addressed approximately $226 million of debt maturities; much of this had attractive discounts to face value. We also laid the ground work in 2009 for additional financings that would take place this year and Brett will provide more details on that later in call.

Looking ahead in 2010, we expect to leverage our reputation as an experienced owner and operator of quality, retail real estate, and our banking relationships to obtain additional financing and the extensions our credit facilities.

With respect to portfolio management, we will leverage our portfolio strengths to keep healthy tenants while we fill vacancies with credit quality retailers that drive additional traffic and strengthen in our centers.

Our focus would be on restoring on occupancy and income and improving operating efficiencies through 2010, we expect to continue our work to build a solid foundation for future growth.

Now I’d like to turn the call over to Scott to discuss the operating environment and our portfolio performance. Scott?

Scott Carr

Thank you, Mark and good afternoon everyone. Fourth quarter ‘09 and early January retail sales reports indicate that the unprecedented sales decline of the past 18 moths seemed to have hit a bottom. While this is an encouraging sign of recovery, there also must be an acknowledgment that this sales growth is by no means robust and sales will not be restored to pre-recession levels for some time.

They’re appears to be a new normal in the retail business and in 2009 many retailers adjusted to this reset of sales expectations with great agility and success. By strengthening balance sheets, adjusting inventories and cutting costs, retailer failures over the course of the past year were far less than anticipated and many may have been averted long-term,. as retailers have revised their operating platforms and set a course to restored profitability in an era of lower retail sales.

As Mark mentioned, consumer spending habits have shifted from a pattern of conspicuous consumption to one of its risks. For the foreseeable future, success and growth in retail will rest a necessity-based, value-oriented retailers, which are the core of our portfolio.

These are the retailers that they are focusing on opportunities to open new stores that fit their adjusted business models and strengthen their market share and establish trade areas with strong population densities and household incomes. These are the characteristics of our primary markets.

Clearly over the past 18 months, retailers have had the advantage over landlords, as the supply of quality retail space has outpaced demand. While retailers are capitalizing on this unprecedented pricing power, there appears to be a realization on the part of retailers that this market dynamic will not last forever.

The increase in leasing activity in the later half of 2009 and building into 2010 is indicative of this trend. As mentioned on the last call, we are seeing increased leasing interest across the portfolio.

Our 2010 deal pipeline is gaining momentum and we’re currently in active lease negotiations for a total of 365,000 square feet of GLA. Even with building confidence in positive momentum, the continuing economic uncertainty is surely evident in the deal making process.

Retailers remain cautions and deliberate in their decision-making and their analysis of the marketplace and sales projections. As a result, the process of advancing from letter of intent to completed lease is more lengthy and arduous than we have ever seen.

While showing signs of the improvement, the operating environment for retailers still remains challenging. We expect additional re-entrenchment in certain retail segments this year and potentially some national chain failures as well.

In addition, although rent-relief requests have decreases significantly, certain Mom 'n Pop tenants are still under pressure. When a struggling small shop tenants prospects for success appear limited and given the decline in the formation of new small shop startup retailers, we often look to competing centers for placement tenants.

Our opportunity in the small shop space lies in encouraging good businesses and less desirable locations to move to our centers. To that end, beginning in 2008, we reinforced our leasing team with professionals that specialize in leasing space of 10,000 square feet or less.

Despite the difficult leasing environment, during the quarter we executed a total of 82 leases with a rental of nearly 259,000 square feet of GLA. This represents increases of 67% in total leases signed and 26% in total square feet leased over the fourth quarter 2008. 24 new leases were signed during the quarter, an increase of 118% in new leases signed from the fourth quarter 2008. Looking at the full year, we signed the total of 311 leases in 2009 aggregating over 1.5 million square feet.

This is an increase in leases signed of 5.4% over 2008. 91 new leases were executed in 2009 representing an increase of 42% over the prior year. Of note, 70 of the 91 new leases signed 2009 were with tenants occupying 5,000 square feet or less thus proving the desirability of our established locations and the effectiveness of our leasing team.

Looking forward into 2010, we expect the strength of our small shop leasing to be further enhanced by increased transaction volume in the big box spaces. As Mark noted earlier, we are currently in active negotiations for over 300,000 square feet of the anchor space and aim to close several of these deals within the next few months.

The leasing velocity we are now experiencing and the quality of tenants with whom we are dealing indicates that we are building a strong foundation for restoring occupancy in growing rental income within the portfolio.

While market realities have dictated reduction in rental rates, there is an obvious accretion in replacing lost income, which also includes the tenant’s reimbursements of real estate taxes and operating expenses. Offsetting these rental declines is the prospect that with better retailers and increased consumer traffic overall, retailer demand for our centers will continue to increase.

I would like to highlight a few examples of the new leases we signed within the past 15 months in just one sub-market. Schaumburg, Illinois, because these leases illustrate certain of our key competitive advantages, mainly market concentration and location strength. Both of these factors enhance our ability to lease the quality retailers.

During the fourth quarter, we signed the lease with Casual Male Rochester Big & Tall for nearly 12,000 square feet of GLA at Schaumburg, Promenade.

During the vacancy created by the bankruptcy Robbins Bros. Jewelers, this combination Casual Male Rochester format is a new retail concept, the second such store in the Chicago market and is expected to open this summer.

As mentioned on the last call, we also recently signed a lease with Ashley Furniture for the 32,000 square foot space formerly occupied by Linens 'n Things at this same shopping center.

Our key competitive advantages of locations strength and market concentration, work to our advantage and replacing bankrupt retailers at Schaumburg, Promenade, as well as filling other vacancies in this trade area.

Although the Schaumburg sub-market has a large surplus of available retail space, it is one of the most dynamic trade areas in Chicago land. Schaumburg’s population density retail traffic in the locations of our assets within the trade area resulted in our attracting new tenants like buybuy BABY, Hobby Lobby, Casual Male and Ashley Furniture as well as enhancing our ability to renew leases with existing tenants such as DSW, David's Bridal and Tuesday Morning.

With this recent success at Schaumburg, Promenade, to-date we have re-tenanted over 143,000 square feet of the 153,000 square feet of big-box vacancy within our Schaumburg portfolio. Had we not re-tenanted that vacancy, the occupancy rate of our Schaumburg portfolio would have been 79% versus the December 31, 2009 occupancy rate of 97%.

The full financial benefits from this re-tenanting will come online over the course of this year.

With regard to rental rates, during the quarter we signed 52 renewal leases within the total portfolio with an average rental rate increase on a cash basis of 9.1% over expiring rents. 24 new releases were signed with an average base rent that decreased 11% from the former rent.

Most of the decrease in new lease spreads for the quarter was due to the lease we signed with Casual Male, excluding that deal new lease spreads declined 3.6% for the quarter. On a full-year basis, 208 renewal leases were executed with an average rental rate increase of 4.4%.

We signed to total of 91 new leases during the year with an average rental rate that decreased 13% from expiring rents. The declines in new lease spreads are indicative of the current supply demand imbalance of available retail space. We are disappointed that in 2009, we recorded negative leasing spreads for the first time in our corporate history and we expect continued pressure on rental rates through 2010.

This new reality is in start contrast to the double-digit increases and leasing spreads we have historically recorded. Turning to occupancy at December 31, leased occupancy for the total portfolio was 92.1%, a decrease of 200 basis points from the year ago quarter and 80 basis points from the third quarter occupancy rate excluding temporary leases of 92.9%.

This quarter’s decrease in leased occupancy reflects the closing of 78,000 square-foot local grocer and 30,000 square-foot Julian store. It is noteworthy that the closing of the Julian store was due to the relocation of that store from one of our properties to another one of our centers located closer to the epicenter of that particular trade area.

On a positive note, we are already having subsequent discussions with retailers to fill both those vacancies. Excluding those two move outs, total portfolio leased occupancy would have been 92.9%, essentially level with the third quarter occupancy rate as adjusted for temporary leases.

Moving to same-store performance, net operating income for the same store portfolio decreased 10.8% from the fourth quarter of 2008. Same-store net operating income for the full year 2009 declined 7.9% from 2008. This is within the guidance range we’ve provided, which anticipated a decrease in same-store NOI of 4% to 8% for the year.

The declines in same-store NOI for the quarter and the year are due to decreased occupancy and lowered expectations of tenant recovery income. There is no disputing the fact that the operating environment was difficult from 2009, challenges still lie ahead.

However, as the economy gains momentum, the environment is presenting certain opportunities to capitalize on our fundamental strengths and retail real estate. In the year ahead, we are focused on revitalizing those centers that have been impacted by retailer bankruptcies. We will do that by attracting healthy best-of-class retailers to these locations. Portfolio-wide, we will also continue to plan strong emphasis and operations by maximizing efficiencies and continuing to cut expenses.

Now I’ll turn it over to Brett for a view of the company's financial performance.

Brett Brown

Thank you, Scott and good afternoon everyone. First I’ll provide details on the company's performance for the quarter and year ended December 31, 2009 including some drill down on what impacted these results. I will then review our balance sheet efforts and provide guidance for 2010.

As Mark stated, FFO per share for the quarter was $0.23, this compares to FFO of $0.24 per share for the fourth quarter of 2008. For the quarter, we recorded non-cash asset impairment charges, net of taxes of $1.9 million.

In addition, we accounted for a gain on extinguishment of debt of $1 million. After adjusting for these items, FFO per share was $0.24 for the quarter compared to $0.31 for the fourth quarter of 2008.

The primary reason for this decline is due to the dilutive impact of the May equity offering of approximately $0.06 per share as absolute FFO adjusted for the impairments and gain of extinguishment of debt was essentially equal to the prior year quarter.

While FFO as adjusted was basically even from quarter-to-quarter, I'd like to provide some additional detail on the items that had either positive or negative effects on the FFO for the quarter.

First, total revenues decreased 8% to $41.5 million for the quarter. This was due declines of $1.7 million of rental income and $1.9 million in tenant recovery income reflecting increased vacancy and lower revenues from certain current tenants.

During the quarter, we also recorded lower gains on extinguishment of debt of $1 million representing a decrease of $2.4 million from what we recorded the prior year quarter. The gain recorded in the fourth quarter of 2009 related to our retirement of $11 million consolidated mortgage note on advance of its maturity date and a discount to the original loan amount.

And finally, FFO for the quarter was negatively impacted due to the real estate tax expense that was $2 million higher than the amount recorded in the prior year quarter. The increase in real estate tax expense for the quarter reflects adjustments recorded in the fourth quarter of 2008 related to Cook County, Illinois tax bills that were lower than the estimated amount.

That being said, I'd like to now highlight the positive items that partially offset the negative impact of the items that I just discussed. We’re pleased to report that our ongoing efforts to retire debt at a discount contributed to the $3.3 million decrease in interest expense from the fourth quarter of ‘08.

In addition, we recorded an asset impairment charge of $1.9 million for the quarter, which represents a decrease of $6.5 million from the amount recorded on investment securities in the prior quarter. $1.9 million charge was recorded to recognize an impairment on the Tuscany Village unconsolidated joint venture project near Orlando, Florida.

As we explained on last quarter’s call, we regularly review our investments and development, joint venture projects and when our review indicates an investment has experienced a loss in value that is considered to be other than temporary according to the accounting rules, we recorded non-cash impairment charge to reflect investment at fair value.

Approximately, $800,000 of the $1.9 million impairment charge is recorded as a provision for asset impairment on the income statement and the remainder is recorded in equity and earnings or loss on unconsolidated joint ventures.

In addition, we have categorized this property as Land Held for Development and although we have signed a contract for a (inaudible) sale to a national discount retailer and discussions with other interested retailers continue. We view this categorization as a prudent move.

Now, looking at performance for the year ended December 31, 2009, FFO per share was $0.87 and as Mark mentioned, this result was inline with First Call consensus estimates and that compares to the FFO per share of $1.29 for ‘08. The impact of additional shares issued in our May equity offering accounted for approximately $0.13 per share of this variance.

After adjusting for non-cash impairment charges, net of taxes and gains on extinguishment of debt. FFO per share for 2009 was $1.03 versus $1.43 for 2008 and the FFO per share result as adjusted was inline with our guidance.

FFO for the year was impacted primarily by lower revenues including decreased rental income from consolidated IREX joint venture properties, higher non-cash impairment charges, increased reserves for bad debt expense and smaller gains from sales of joint venture interests.

I’ll now walk you through the major items that negatively impacted the FFO for the year. First total revenues were $170.8 million, a decline of 9.5% or $18 million from the prior year and this decline was primarily due to decreases in rental income and tenant recovery income of $9.6 million and $8.3 million respectively. Revenues were impacted by big-box retailer bankruptcies, increased vacancy overall and lower income from certain tenants.

In addition, approximately $5.3 million of the decline in rental revenues from the prior year derived from lower rental income from properties owned to the IREX joint venture while those properties were consolidated and if I can add a bit of color only one IREX joint venture property was consolidated during 2009 compared to 10 IREX joint venture properties that were consolidated at various times during 2008.

Total revenues for ‘09 were also impacted by a decrease of $1.2 million in fee income from unconsolidated joint ventures from the prior year. This can be attributed to a decline of $1.5 million in acquisition fees earned on sales of IREX joint venture properties and I would like to note that this decline in acquisition fee income was partially offset by an increase in fee income from the leasing and management of sold IREX joint venture interests.

Performance for the year was also impacted by impairment charges and in ‘09; we recorded non-cash impairment charges of $22.1 million, an increase of $9.4 million over ‘08. Impairment charges recorded in ‘09 included a charge of $2.7 million to reflect the other than temporary decline in value of certain investment securities.

We also recorded non-cash impairment charges totaling $19.4 million on four unconsolidated development joint venture properties and two consolidated assets that were subsequently sold at prices below our carrying value.

Also impacting FFO for 2009 was an increase an expense in bad debt expense of approximately $3.1 million over the prior year. This relates the certain tenant bankruptcies in the overall impact of the economic downturn on our tenants.

During 2009, we increased our reverse for bad debt to reflect a conservative estimate of collectable receivables. In 2009, we also recorded gains on sale joint venture interests of $2.8 million and that’s a decrease of $2.3 million compared to ‘08 and this decrease is primarily due to the one-time gain of $3.2 million recorded in ’08 that was partially offset by some gains related to our IREX joint venture in ‘09.

Now I’ll take a brief look at the positive items, which partially offset the negative impacts of these items I just outlined and first we recorded higher gains on extinguishment of debt. The $8 million gain in ‘09 as an increase the $4.6 million over the gain recorded in ’08. The gains we recorded in ‘09 related to the repurchase of $39.5 million in principle of our convertible notes at discounts and discounts received for early payoff of certain mortgages.

As well, interest expense for the full year of ‘09 decreased by $11.9 million from the prior year. This is due to lower outstanding balances on our mortgages payable inline of credit facility as well as lower interest rates on our variable rate debt.

In addition, interest expense on our convertible notes decreased due to the repurchases I just mentioned. Here’s worth noting that as a result of the increased market value of certain investment securities at December 31st, we recorded a net unrealized gain of $3.8 million on the consolidated balance sheet.

Speaking of the balance sheet, during 2009, we successfully addressed over $226 million of debt maturities both consolidated and unconsolidated. We retired a significant portion of that debt at discounts to the original loan amounts and the amounts included the purchase during 2009 of the $39.5 million and principle of our convertible notes at discounts of the face amounts.

In addition, in the fourth quarter we retired our last remaining 2009 consolidated secured maturity of $7.4 million and like I mentioned during the quarter, we also retired consolidated mortgage note of $11 million prior to its maturity date at a discount recording a related gain of $1 million, including those two mortgage loans in 2009, we retired nine consolidated mortgage loans totaling over $94 million.

Turning to unconsolidated debt, as we reported on the last call. In 2009, we extended $80 million of construction loans for certain development joint venture projects, we invested $19 million and preferred equity to pay down the principle of these loans and we negotiated dollar-for-dollar reductions of guarantees to reduce potential future risk associated with the projects.

In addition, through our joint venture with New York State Teachers Retirement System, we replaced an $11.8 million secured maturity due last month with a $12 million amortizing loan for the fixed rate of 6.5% in a 5-year term. There is no other mortgage debt maturing in the NYSTRS joint venture until March of 2011.

Looking ahead approximately $160 million of our consolidated secured debt matures in 2010, and we are in active discussions with several lenders with more then enough proceeds to address the amount of consolidated debt maturing this year. We anticipate closing on the various loans with timing corresponding with the maturity dates.

As expected the average rate will be resetting higher by approximately 100 to 200 basis points as the average rate of maturing debt is just over 4%. Our consolidated unsecured debt includes the $140 million term loan that matures this September and the $155 million line of credit facility that expires in April 2011. We are in active discussions with the existing members of our banking group and we are very pleased with the initial terms and indicated committed levels from our lending partners, with no expected reduction in capacity.

We expect to finalize the credit facility well in advance of the September maturity, and as of December 31, our line of credit facility had an outstanding balance of $45 million was up to $110 million available.

With respect to our convertible notes, since December of 2008, we have reduced the balance of the original $180 million issuance from $164.5 million down $125 million through the repurchase of notes at attractive discounts. We continue to explore opportunities to refinance or extend the remaining convertible notes at beyond the November 2011 for [date].

To sum up, during 2009 we worked hard to improve our balance sheet strength and we did so despite adverse market conditions. We reduce total debt including our pro rata share of joint venture debt of more than $200 million. In the year ahead we expect to continue productive discussions with lenders to extend our credit facilities and address upcoming debt maturities. We are very pleased with the results of our efforts to strengthen our financial position and we expect additional progress in the months ahead.

Finally, turning to guidance, we anticipate FFO per common share will be in the range of $0.83 to $0.90 for fiscal year 2010. We expect same store NOI to be flat to down 3% for the full year 2010. For the year we expect average financial occupancy to be between 90% and 93%, with rental rates spread similar to what we achieved in ’09. In addition, our guidance assumes that we will sell the remaining interest in Bank of America properties we have sourced for the IREX joint venture.

With that, I’ll turn the call back over to Mark.

Mark Zalatoris

Thank you Brett, we are approaching the year ahead with cautious optimism. The fourth quarter GDP reported 5.7% growth is reportedly the best quarterly gain since 2003, while this was in large part due to slower inventory declines, nevertheless it could be a signal that the words is behind us.

Within this current environment we will continue to protect and position the company for the future. As outlined, we’re working to further strengthen the balance sheet. We’re also committed to improving portfolio occupancy and income. While we take care of our current tenants we will be focusing on signing credit quality retailers to fill the remaining bankruptcy related vacancies.

Our business model centers on the type of retailer that consumers are increasingly favoring. Our properties are concentrated in stable markets with diverse economies and are supported by healthy demographics. We believe this business model is not only resilient, but places us in a very good position when the healthier economy emerges.

And with that I’d like to open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Mark Lutenski - BMO Capital Markets.

Mark Lutenski - BMO Capital Markets

Question on the 1031 exchange market, it looks like the Bank of America or at least it seems like that transaction is taking a little bit longer than usual. I was wondering if you could comment on the timing of that and then the 1031 exchange market overall?

Mark Zalatoris

I would say that, 1031 exchange market definitely slowed down in 2009 over 2008, number of reasons the economy prompted the majority of it obviously there were less profitable sales for sellers to need the shelter gains from number one. That being said, these were a couple larger offerings probably the largest that our partners has putout and it probably will take a little bit longer and have taken longer than we all expected, but there have been sales each and every month. There was a great month in December and they expected to pick up again in the spring and actually with the economy looking to strengthen and potential tax law changes on the horizon particularly in capital gains tax rates changing et cetera, they feel there is going to be increased demand. So we believe that these are very attractive assets to invest in; as a matter of fact, it is evidenced that there have been a number of non-tax advantaged investors, pure cash investors that have invested into these properties alongside the tax advantage investors. Our expectation is that, we’ll sell out by the end of this year.

Mark Lutenski - BMO Capital Markets

And how much are you contemplating in guidance this year?

Mark Zalatoris

Well, our guidance basically anticipates the remaining equity in those properties to be sold out, which is roughly about 30 some percent in both assets, 30% to 40% left. Our guidance does not include any additional offerings which we actually believe will probably going to be asked by our partner to source for them, because they do anticipate increased demand. So that comes around and they sell these out, we will be in the market looking for additional products for them and that will only improve our bottom line.

Mark Lutenski - BMO Capital Markets

Geographically, where do you think you'll be seeing more transaction activity?

Mark Zalatoris

For the IREX venture?

Mark Lutenski - BMO Capital Markets

Yes.

Mark Zalatoris

Actually, we're continuously looking in the Midwest where we operate most of our properties. Our first priority is to find retail that would otherwise fit right into our portfolio, because we’re best equipped to manage retail, that’s what our company is if there are attractive net leased opportunities with credit quality tenants that are located elsewhere if there is single asset, single tenant kind of things, we’re not adverse to that at all, we certainly would pursue it. Again, it has to have the right kind of profile return wise for these investors, but primarily we’re still focusing our attention in the Midwest.

Mark Lutenski - BMO Capital Markets

And Brett, I was wondering you said 100 to 200 basis points increase on the rate the debt maturing in 2010, can you break that down between mortgage loans and unsecured?

Brett Brown

Well, that's basically on the mortgage loans; I was looking at average rates basically where we are. Obviously, the variable rates, that's going to be lower than the fixed on the secured side and then definitely on the unsecured that will be resetting higher in total, but on average it's looking between 100 and 200 basis points.

Operator

Your next question comes from RJ Milligan - Raymond James.

RJ Milligan - Raymond James

Quick question on the guidance for occupancy for 2010, are you guys at, I guess, 91.5 now if you average at the low end of 90, probably a tick down of 300 basis points over the year. It sounds like you guys have a pretty good idea of what's in the pipeline, what is the down side to get to that 90% is it national retailer bankruptcies unexpected, is it mom and pop or is it a delay in the leasing up of what you guys have in the pipeline?

Scott Carr

Primarily it’s the unknown of the retailer bankruptcies that could occur. We feel pretty comfortable modeling a good portion of the pipeline coming through and we feel we have a good handle on the retention rate with this small shot tenants. The reason the variance is just that wildcard of the economy and the retail health overall.

RJ Milligan - Raymond James

Now, is there anybody, in particular that’s on you watch list for national retailer bankruptcies?

Scott Carr

Yeah, we do I am hesitant to name names, but we watch the categories. I mean, obviously video is that’s happening as we speak with movie gallery and potentially their competitor. We are watching the book sector, the office sector some of the apparel players, but again when we look at our exposures they are pretty much 1% or lower. So, we think anything that we do incur should be fairly manageable.

RJ Milligan - Raymond James

Just one quick question on the guidance. Does that include any draws on the ATM?

Brett Brown

No, it is not.

Operator

Your next question comes from David Wigginton - Macquarie.

David Wigginton - Macquarie

Just staying on the guidance front, I guess, so can you maybe talk a little bit about the, what the impacts would be on FFO if you don’t exit or liquidate your positions in the IREX, you are not able to sell off the remaining interest in those properties?

Mark Zalatoris

Marginal, because we do enjoy actually a pretty nice yield on that investment, so it’s just a direct offset than you’d have higher interest expense because of we would not be paying down line of credit, but you have positive impact of the rental income from that property. So, it doesn’t have a huge impact, obviously the biggest impact is the fee income that you would not receive and so that’s the biggest driver if you do sell those out, so marginally down, I guess I would say.

David Wigginton - Macquarie

So, impact is going to continue (inaudible). Okay. With respect to bad debt expense, can you give us forecast for that for 2010 and are you starting to recover any of the rents that you reserve for in 2009?

Mark Zalatoris

Start the first part was for 2010 we’re looking at $4 million bad debt reserve that’s just down from five, just over five for 2009 and as far as recovering I think it's too early to look at that.

David Wigginton - Macquarie

Just looking at your press release from this morning, a partner explained the decline in same-store NOI and talked about extended abatement period on new leases. Is just delaying the opening of the lease, is that all he was referring to or is there something else there?

Brett Brown

As we’re signing new deals the tenants are basically negotiating longer abatement periods when they sign us. It’s not that they are getting in there later; it’s just that they are in there; they don’t have to pay contractually for a little later than what we typically experience.

David Wigginton - Macquarie

And then just sort of on the rents front, your peers that have reported so far have talked about rental relief requests slowing down. I assume you are experiencing the same in your portfolio. Is there any noticeable or meaningful trend that you're seeing at this point with respect to that or are you just starting to see gradual signs of improvement?

Brett Brown

We’ve definitely seen a slowdown in the requests and we've always taken the aggressive posture in responding to them, but we do think it's indicative of things stabilizing to some degree and with our Mom N Pop tenants, the ultimate price that we extract is a right to recapture their space and that's a tough decision for someone who has a successful business that just needs to carry themselves through and we’re finding a lot of those Mom N Pop retailers seeing light at the end of the tunnel and even backing off with some requests when we put that ultimate test to them. So, we’re cautiously optimistic that the stabilizing trend continues.

David Wigginton - Macquarie

And then I just wanted to circle back to your fourth quarter occupancy. I think you mentioned that about 120 basis points of the 200 was a fallout that was related to temporary tenants. Where was the fallout, what was the fallout, where did the fallout come from for the other 80 basis points?

Brett Brown

That was in particular from third quarter to fourth quarter, we lost two large tenants. One being a grocery store at 78,000 feet and one being a Julian store of 30,000 square feet and the Julian actually relocated within our portfolio, the difference with the temporary leases, our end third quarter occupancy was inflated due to those, so when we back it out the normalized for third quarter was about 92.9 versus the 90.3 that we ended the year at.

David Wigginton - Macquarie

And then finally, I guess I read a lot of things about the Chicago end-market in general about real development with respect to community centers and big-box centers and what not. Do you anticipate or are you seeing any increase in demand for space as retailers are starting to look to grow again at this point and do you anticipate, I mean where are you in your big-box releasing efforts and where do you expect to be at the end of the year?

Mark Zalatoris

We’re actually making a lot of progress on the big-box leasing front and right now as I mentioned earlier, we have 300,000 square feet of space and space of 10,000 square feet or larger that are currently in negotiations. And most of that is in the lease stage, we’re actually negotiating a lease.

We have seen a good pickup in demand for that type of space and I think we’ve had some good absorption, retailers are realizing that this window is going to close, so to get the right location they have to move. We’re also seeing some new market entrants, which is very encouraging and when we look at the activity we’re doing a good portion of it, is retailers’ right-sizing and relocating, but almost an equal half are new market entrants. We have a couple of major boxes, which due to confidentiality reasons I can't mention right now that are new market entrants to Chicago and it’s very encouraging.

Operator

Your next question comes from Jeffrey Donnelly - Wells Fargo.

Jeffrey Donnelly - Wells Fargo

I guess the first question I don’t know if it’s for Mark or for Brett, but maybe just a point of clarification on the development JV debt. Looking at your supplemental, I think there is 30 million with North American real estate, 24 million with Pine Tree and I think 22 million with Tucker.

Can you break out for us just maybe I’m not reading it correctly, this might be your share of the debt, but how much of that is actually recourse to IRC and I guess, what’s your next maturity that falls within those portfolios?

Brett Brown

Well the next maturity is August of 2010, that’s the deal up in Lakemore there. We have about $4 million guarantee on that piece. So, that's one deal we will take a look at again and probably have to pay some of that down again, but hopefully be successful again in negotiating dollar-for-dollar reduction in guarantees as we, it is something we have to pay some of that down. After that, December of 2010 is the next one and that is at Westfield, Indiana. And that one again has a $3 million guarantee on a $9 million balance and we will probably be looking at a similar situation there.

Jeffrey Donnelly - Wells Fargo

I'm curious in aggregate; do you know what is your guaranteed total?

Brett Brown

About 25 million. That is not all; on consolidated joint ventures that includes some in the end-retail venture as well.

Jeffrey Donnelly - Wells Fargo

And then I guess maybe to switch over to Scott, just a couple of questions on leasing. In your initials comments and I apologize if you touched on this, somehow I just missed it, but you mentioned that average rents on new leasing were up, but when you look at it from a standpoint of the initial rent on new leases versus the expiring rent on the departing lease, I guess how does it look on that metric as opposed to sort of the comparison of the averages, if you will the mid-points of the lease?

Scott Carr

Actually, we stated our rental rate on new leases, the spreads are negative, and for us this is the first time they’ve been negative. We do it on a cash basis average-to-average, so what we report is a pretty clear picture of what was in place for the prior term as compared to the new term and for the year across the portfolio, we are down about 13% on new leasing activity.

Brett Brown

And then I guess it will probably still be down if you were to look at the expiring, the one rolling off and the new one rolling out of the first shot, I bet it is still down.

Jeffrey Donnelly - Wells Fargo

Oh yes. I think most people expect that is going to persist, I think the question is maybe on just purely on market rents. What’s happened in the last few months I mean, have you seen any signs that you have reached a bottom for market rents or you think your markets are closing in on one?

Scott Carr

I wouldn’t say we are closing in on a bottom, because we’ve dropped pretty far. If you look across deals we’ve done anecdotally, in the market you hear people say anywhere from 10% to 50% depending on the sub-market and the space involved. And that has surely been our experience as we look at deals. Retailers do realize that they can only go so low if they are going to have a viable landlord and one that can participate in a deal in terms of building on of space and CI and what not.

So, I do think we have hit a bottom definitely on the small shop there seems to be a little more opportunity to push rents on renewals and new leases, but overall in terms of when we start trending up I think that’s going to be a much lower trajectory than it was coming down.

Jeffrey Donnelly - Wells Fargo

And what’s been the outlook I guess for leasing demand, I guess I’ll call it Mom N Pops versus the more established or more regional and national tenants. Are you seeing sort of better demand in one of those categories than the other?

Brett Brown

Right now, the national demand in the bigger boxes has been strong and those are tenants 15, 000 square feet and above and that’s been our primary focus in the deals we are trying to get closed right now. Our Mom N Pop traffic has remained fairly steady, it was real strong last year and I really equate the differential year-over-year of just being the time it takes to the get these national deals done. I mean the national deals we have in the pipeline right now we’ve been talking to since last summer with just a little more impetus coming on and actually additional locations being added as we heat up the process.

So, overall right now, the most active sector for us in our portfolio is that 15,000 square feet and above, the activity with Mom N Pops remains pretty stable and we are seeing some signs of life in that mid-range regional national tenant that 5,000 to 8,000 square foot mainly apparel type users. There are few out there that are starting to come back onto the field.

Jeffrey Donnelly - Wells Fargo

And just one last question then, so when you are looking at new leases just to get financing is still certainly more restrictive than it was a few years ago. Are tenants doing a preference for having landlords, foot the bill for tenant improvements, because they can’t get the cash to do that or I guess what does it come out on concessions, what is their preference?

Scott Carr

We haven’t seen a dramatic shift in what they have demanded in terms of TI and landlord work. There is always been a stronger preference for landlords to foot the bill, what we are seeing is the dynamic of the smaller tenants, there are definitely more people looking to landlord participation. And that’s where a lot of due-diligence comes in on our end of determining, which of those tenants are credit worthy, but we really haven’t seen a significant change in the profile of national deals, when it comes to their expectations for tenant improvement.

Operator

Your next question comes from Steve Swett - Morgan Keegan.

Steve Swett - Morgan Keegan

Brett, first question for you also related to guidance, it’s a fairly wide range of occupancy assumed for 2010 and that obviously has a bearing on the tenant recoveries. What have you assumed in terms of the tenant recovery line relative to the occupancy?

Brett Brown

That is basically going to track with it, obviously lower as you noticed for ‘09 compared to ‘08 and then it basically tracks in-step with that occupancy.

Steve Swett - Morgan Keegan

If I just assume simply that the occupancy in place in the fourth quarter were to continue flat across the year. Then the relationship between the recoveries and the expenses in the fourth quarter would pretty much carry across?

Brett Brown

Not the quarter I’d look at the year.

Steve Swett - Morgan Keegan

Second question on the maturities for 2010. Do you have an average loan to value on where those loans are relative to the assets?

Brett Brown

Right now they are between 50% and 55%

Steve Swett - Morgan Keegan

And then the last question for Mark. To the extent, things are trading in your Chicago, Minneapolis, Midwestern markets. Do you have a sense for where cap rates are on decent quality assets that maybe trading in your market?

Mark Zalatoris

Well we have seen things trade in the 8s, low 8s to middle or higher 8s depending on the quality. I’m talking about the profile of properties that we are looking at with a good grocery or a mix of some good national credit, as well as the small shops space on anchored strips are trading at higher caps in the 9s and above.

Operator

This concludes our question and answer session. I’d now like to turn the conference back over to Mr. Zalatoris for any closing remarks.

Mark Zalatoris

Well, thank you. We appreciate your time and interest on today’s call and I’m sure our retailer tenants would appreciate me reminding everyone to get out this weekend, take advantage of the President’s Day sales that are occurring as well as shop for Valentine’s Day on Sunday. Couldn’t pass that opportunity up. Thank you and we look forward to talking with you next quarter.

Operator

Thank you, sir. The conference is now concluded. We thank you for attending today’s presentation. You may now disconnect.

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Source: Inland Real Estate Corp. Q4 2009 Earnings Call Transcript
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