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Executives

Barbara Baker – VP, IR

Robert Taubman – Chairman, President and CEO

Lisa Payne – Vice Chairman and CFO

Analysts

Christy McElroy – UBS

Craig Schmidt – Banc of America

Quentin Velleley – Citi

Michael Bilerman – Citi

Ian Weissman – ISI Group

Jay Habermann – Goldman Sachs

Michael Mueller – JP Morgan

Cedric Lachance – Green Street Advisors

Tayo Okusanya – Jefferies & Company

Ben Yang – Keefe, Bruyette & Woods

Andrew Simpson – Credit Suisse

David Wigginton – Macquarie

Taubman Centers Inc. (TCO) Q1 2010 Earnings Call Transcript April 23, 2010 11:00 AM ET

Operator

Good morning. My name is Robin and I will be your conference operator today. At this time, I would like to welcome everyone to the Taubman Centers first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Ms. Barbara Baker, you may begin your conference.

Barbara Baker

Thank you, Robin and welcome everyone to our first quarter conference call. Joining me today on the call are Robert Taubman, our Chairman, President and CEO and Lisa Payne, our Vice Chairman and Chief Financial Officer. Yesterday, we released our first quarter’s results and our supplemental information package. Both are available on our website www.taubman.com. As you know during this conference call, we will be making forward-looking statements within the meanings of the federal securities laws. These statements reflect our current views with respect to future events and financial performance of our actual results may differ materially. Please see our SEC filings including our latest Form 10-K and subsequent reports for discussion of various risks and uncertainties underlining our forward-looking statements.

During this call, we’ll also discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures are included in our earnings release and in our supplemental information. In addition, a replay of the call is provided through a link on the Investor Relations section of our website. If you haven’t been to our website lately or if you didn’t receive an earnings release in your e-mail this quarter, I would encourage you to take a look at our new investor room and sign up for our broaden menu of investor alerts. We’ve added many new options including SEC filings and stock price alerts as well as our press releases and supplementals.

For our agenda today, first Bobby will be providing an overview of the quarter followed by a discussion of the company’s operating statistics and internal growth – external growth. Then Lisa will discuss our financial performance and our balance sheet. Bobby will return to discuss guidance and provide closing comments. Then we’ll be available for your questions.

With that, let me turn the call over to Bobby.

Robert Taubman

Thanks, Barbara and thank you all for joining us today. This quarter we reported assets as per share of $0.60, compared to $0.70 last year. This is fully consistent with our original annual guidance. But the big news was the strength in tenant sales.

Last quarter, we expressed cautious optimism, the retail sales hit bottom. This quarter they came roaring back – up 10.8%. All three months were strong. January up 8, February up 10 and March up 14%. Most retailers believe the early Easter accounted for 3% to 5% of March, about 1% to 1.5% of quarter. As we said in the press release, we were especially pleased that Michigan and Florida lead the sales increases. The increases were broad based and for the first time in years, our core Women’s Ready Wear concept showed real strength. This bodes well for the future.

Other strong categories included Home Furnishings, Accessories, Men’s, Unisex and Children’s Apparel. Many tenants with multiple locations had exceptional increases across our portfolio. These include Abercrombie & Fitch, Aeropostale, Aerie, American Eagle, Brooks Brothers, Burberry, Chico’s, Express, Foot Locker, Gap, Justice, Louis Vuitton, Restoration Hardware, Pottery Barn, Victoria’s Secret and William-Sonoma. All of these increased more than 15%, many over 20% and some more than 30%.

Leasing has continued to be active. The number of deals signed was up 13% from the first quarter of ‘09. We recently signed a 5-store for every 21 package that upsizes the stores at Beverly, Dolphin, Great Lakes, Sunvalley and Twelve Oaks. While larger, the stores are not anchors and will occupy space within the mall.

Scheduled openings are from July of this year through early 2011. At International Plaza, Urban Outfitters is moving from another location in the area. At Twelve Oaks, we signed a White House/Black Market deal.

At Sunvalley, we just signed a 20,000 square foot Odyssey store and at Beverly we signed Prada which joins Fendi under construction and Burberry, Gucci, Bergamo, Louis Vuitton and Mont Blanc open at the center. We’ve successfully moved the top end of merchandising at Beverly to a true luxury price point as the retail community has now accepted as a luxury venue. We anticipate a number of similar deals.

All these deals that were signed by March 31 are showing up in our leased-space statistic which includes tenants with signed leases that are not yet open. Lease space was 91.2% at March 31, up 50 basis points from last year. Consistent with our guidance our ending occupancy was 88.2%, 60 basis points below last year. We continue to expect midyear occupancy can be down about 100 basis from prior year and to end the year even with 2009.

Our temporary tenant leasing continues to be strong ending the quarter at 3.2% of tenant area. Given the seasonal nature of this business this is very high, in fact the highest first quarter we’ve seen in seven years we’ve been keeping this statistic. Keep in mind this 3.2% is additive for occupancy but not additive for lease space. It is an additive to lease space because some of the spaces we have leased to permanent tenants will open future periods and are currently occupied by temporary tenants.

Rent per square foot across the portfolio was $43.20, down 2.9% from last year. For the full year, we expect average rent will be down about 2%, a slight improvement from prior guidance.

We are seeing a significant reduction in new requests for rent relief, although the annualization of relief previously granted continues to impact our average rents. If sales continue to improve, we’ll have the opportunity to replace some of these tenants with stores that can afford better rents.

Even with a strong sales performance, a portion of the unprecedented rent relief related to the financial crisis will likely extend well into 2011 and in some cases, into 2012. Rent spreads for the combined portfolio were flat with the quarter, with opening rents down from the prior year.

Remember, we are now calculating rent spreads on a trailing 12-month basis, so these statistics still include three quarters of 2009. While we had projected a 5% increase in opening rents for 2010, over the $46.63 combined opening rent for 2009, we now believe opening rents will be up modestly to as much as 2.5%.

This statistic tends to be very sensitive to the final leasing of the year. In any event, it will have nominal impact on reported FFO for 2010. During the first quarter, only one tenant filed for bankruptcy. This is very unusual as the first quarter is generally the most active period for bankruptcies.

We believe this is indicative of the improved health of retailers as well as the proactive way that landlords worked with troubled retailers last year, such as rent relief, to keep them open, effectively restructuring outside of bankruptcy.

Our comp NOI, excluding lease cancellation income, declined 5.1% for the quarter. The biggest factors were average rent, occupancy and CAM recoveries, which Lisa will discuss later. We continue to expect NOI to be lower by 2% to 4% for the year. And I remind you that over 100 basis points of the negative variance is the result of CAM capital accounting.

Now, let’s turn to external growth. As we said in our recently issued annual report, development is one of our most important differentiating core competencies. It has been the primary driver of our external growth since our company was founded in 1950.

We are proud of our development track record. Over the last decade, we’ve invested about $2 billion in U.S. development. This includes the opening of nine centers, cost related to projects in Sarasota and Oyster Bay and all pre-development spends. This investment delivered a leveraged internal rate of return of approximately 26%, assuming a terminal cap rate of 7%.

On an unlevered basis, the internal rate of return is approximately 13%. On average, these centers are at least equal in quality to our portfolio average. This is why we like development and are enthusiastic about pursuing it once the environment improves.

We have one project currently underway, City Creek Center in downtown Salt Lake City. The underground parking is essentially complete and steel is going up on the mall and both the Nordstrom and Macy’s stores.

The new food court is open for business with seven tenants serving the adjacent office building in greater downtown and two additional tenants to open soon. In the broader project, the first street-level retail store, Desert Book, opened with great fanfare.

The first two residential towers are now complete with occupancy beginning this month.

Construction photos of the project which also includes office, residential and hotel, are available on our website under Investing on the Events and Presentations page. The retail center will open in spring 2012 and we are very pleased with the initial leasing and merchandising. We expect to invest $76 million in the project with an 11% to 12% initial unlevered return.

At Willow Bend, we are pleased to be moving forward with a new 25,000 square foot Crate & Barrel store in the location of the former Lord & Taylor. The demolition of the building is now nearly complete with pad turnover in Crate scheduled for mid June.

The construction will include a pedestrian plaza and a new mall entry to be built at the point with the former L&T building interfaced with the enclosed mall. This will provide both visibility and easy, convenient access between the new store and the mall.

The Crate & Barrel store is expected to open in spring 2011. We believe this is a very positive result for Willow Bend as Crate will add significantly to the merchandising of the center. The project will also include an additional 6500 square feet of retail space with a tenant to be announced soon. The overall project will have an attractive financial return.

Moving to Asia, our search for a new president is well underway and we continue to expect a new leader by midyear. Meanwhile, our strategic analysis of market opportunities is moving along and we remain committed to the region an enthusiastic about our prospects.

Now, I’d like to turn the call over to Lisa. Then I’ll return at the end of the call for some closing comments.

Lisa Payne

Thank you, Bobby. This quarter, our FFO per share was $0.60, a $0.10 decrease from the first quarter of 2009 which included $0.03 of restructuring charges. Here are the variances from 2009.

First rent, down $0.0550 from last year. This is due to the 2.9% decrease in average portfolio rent per square foot along with a decrease in occupancy. Percentage rents were flat to the first quarter of 2009. Net recoveries, down $0.02. This is primarily due to lower collections and decreased CAM capital.

We continue to expect CAM capital variances to impact our results by about $0.08 to $0.10 this year. Lease cancellations, up $0.03. This is the result of one large collection and not indicative of the year’s trend. We are maintaining our 2010 guidance at nine to 11 million for this line item.

Other operating expense was unfavorable by four and half cents. This is primarily from increased consult fees and travel related to our strategy work in Asia. In addition, predevelopment expense in the first quarter of 2009 was particularly low due to reimbursements received for work that had been done in prior periods. We continue to expect predevelopment to total about 15 million for the year.

With the default rate on the loan, the Pier Shops impacted our results unfavorably by $0.02. Finally, our diluted share base is up due to exercising of options and other share-based compensation. This negatively impacted the quarter’s results by one and a half cents.

Now, turning to the balance sheet, our debt-to-market capitalization stood at 46% at quarter end compared to 66% a year ago. Obviously, it helps when your stock price increases from $0.17 to $40. We’re making good progress on our fall 2010 debt maturities.

There are many data points supporting a marked improvement in the secure debt market, and this is providing us with very attractive options.

At Partridge, we had a very solid deal with the current bank group to refinance the asset’s $74 million loan which matures in September. However, with the significant positive shift in the markets, we now expect to place a new 10 year fixed-rate loan on the property with another lender. The refinancing of the $128 million MacArthur loan, due in October, of which $122 million is our share, is also moving along. Again, we are working on a 10-year loan. Also maturing in October is the $131 million loan on Arizona Mills, of which 50% is our share.

We’re working closely with our partners at Simon to achieve an attractive refinancing of this loan. The proceeds on all three loans are expected to be equal to, or in excess of, the current principle amount. And I will add that that was not where we were even 60 days ago. The market has definitely improved.

At the Pier Shops, we continue to work with the special service to transfer title as soon as possible. Meanwhile, we’re doing our best to maintain the value of the asset. In April, as part of the process, the mortgage lender filed a lawsuit exercising its right to order the property to be sold at public auction. We anticipate this will result in a foreclosure sale of the property at which time the ownership will be transferred.

Although we are not funding any cash shortfalls, we continue to record the results of operations as well as interest on the loan. The interest is now at a default rate of approximately 10%. To the extent that NOI does not cover debt service, we have an accrual on our balance sheet. This will increase the gain on extinguishment of debt when ultimately we hand back the keys. While timing is uncertain, we currently anticipate ownership transfer at the end of the second quarter, or early in the third. However, this process is not in our control. Keep in mind, the Pier unfavorably impacts FFO by about a penny a month for as long as we own it. However, it has no impact on our cash.

With that, I’d like to turn the call back to Bobby.

Robert Taubman

Thanks, Lisa. As we said in the release, for the full year 2010, we expect FFO per diluted share to be in the range of $2.55 to $2.75. We are now including six months of the Pier Shops in this guidance. So effectively, we are increasing our guidance by $0.06.

In conclusion, the retail environment is improving. Our tenant sales were up sharply. Bankruptcies were at record lows. Lease space was up. The credit markets are clearly improving and we expect to fully refinance our 2010 maturities. And we believe our development capabilities will uniquely position us for future external growth, both in the U.S. and in Asia.

Now, we’d be happy to open the call for questions. Robin, are you there? Robin.

Operator

Yes, sir.

Robert Taubman

We’d like to go ahead with questions, please.

Question-and-Answer Session

Operator

Okay. (Operator Instructions) Our first question comes from the line of Christy McElroy with UBS.

Christy McElroy – UBS

Hey, good morning. Just following up on the rent abatements, can you provide a little bit more detail on the extent that the impact should be recovered over the next year or so as we’re able to replace – as you’re able to replace those tenants and how much of that is more permanent? And is it possible to see some reversal of that impact as sales improve? Just trying to get a handle on how to make the mechanics of the abatements work and the timing of recovery of some of that income.

Robert Taubman

Well, as we said in our comments, it will burn off as sales improve. But some of the rent relief was contracted relief but will continue into 2011 regardless of sales and then a small portion in 2012. But most of the annualization that is occurring right now in 2010 is going to occur and then it will begin to burn off especially as sales continue anywhere near the pace they’re at right now.

Lisa Payne

Let me add what Bobby was saying. It really is all going to be dependent on sales and what happens with sales. And these are individual deals, individual tenants and it matters what happens individually for those tenant sales as to whether we can really get them off rent relief. And what we have found historically is it tends to be a little sticky trying to get them off the rent relief and that’s why we’re saying don’t expect at all to be wiped away in 2010.

Christy McElroy – UBS

So between annualizing the negative impact and sort of any pickup you expect, what sort of a net impact does it place it in your guidance?

Lisa Payne

Well, in our guidance, we are assuming the annualization of the rent relief. And then with some modest – depending on what sales happens in 2010, but very modestly replacing those tenants. So really 2010 is the impact of the annualization more than it is any kind of recovery from rent relief. The rent relief recovery will be projecting when we get further into 2010 and we’re doing our budget for 2011.

Christy McElroy – UBS

Okay. And then with regard to your comment about retailers being more aggressive in their expansion plans, what types of retailers are you referring to? And would you expect we could see a resurgence of aggressive store opening plans this year? Or are retailers looking more into 2011 and beyond when talking about new store openings?

Robert Taubman

Well, you have to remember that we were nearly committed a quarter ago to our openings already for 2010 and I think most people in our industry are in similar positions, because you’re working out at least 12 months typically, if not more than that. So, we’re really talking about this sales environment making retailers more aggressive about future openings in ’11 and ’12. There is some amount still that’s not signed that will in fact open for 2010, but it’s modest against the overall expected opening in our budgets and guidance for 2010.

Christy McElroy – UBS

Sure. Okay. And then, just lastly. With a 300 basis point difference between lease space and occupancy, how much do you expect that spread to compress this year, assuming the pace of closings doesn’t accelerate?

Robert Taubman

I would say that historically the spread between lease space and occupied space, it has sort of circled around 150 to 200 basis points. So I do think you’re going to think some closing of that gap as we go forward.

Christy McElroy – UBS

Great. Thank you.

Operator

Our next question comes from the line of Craig Schmidt with Banc of America.

Craig Schmidt – Banc of America

Thank you. I have a question. I mean, given that your highest exposure in GLA is to Forever 21, that it sounds like you are expanding. Is there a level of exposure of Forever 21 where you start to feel uncomfortable?

Robert Taubman

Good morning, Craig. You know, I think with any tenant, yes at some point. But, we’re very heartened by the fact that the company has no debt. It has terrific cash flow. It is not spending anywhere near that cash flow in its expansion and opening program, which is very robust. They are really performing well as a company. They have expanded into their accessory business and they’re looking at other classifications of merchandising. And at the end of the day, it’s less than 4% of our GLA today. Maybe it’ll grow to 5%. And historically, we have had tenants that have approached much greater than that in the last 20 to 30 years. So, I still don’t think that we’re in any danger zone at all and especially when you look at the balance sheet and the health of this tenant and the capability of the tenant overall.

Craig Schmidt – Banc of America

Great. And then just, you mentioned stronger sales performance, particularly out of Florida. I’m wondering, did Wellington Green participate to that same degree as some of your more upscale centers?

Robert Taubman

I was really across the board and I don’t want to pick out one individual center but it really was across the board. All of Florida is doing very well for us and I would – generally the answer is a yes with respect to Wellington Green.

Craig Schmidt – Banc of America

And are you seeing any tenant interest, focus in certain geography or are there certain geographical areas they’re not ready to run into?

Robert Taubman

We really didn’t have a single center that didn’t participate in some positive increase and we did say in terms of geography Florida and Michigan performed very, very well and as you all know it’s a significant portion of our income stream comes from those two markets.

Craig Schmidt – Banc of America

Okay. Thank you.

Operator

Our next question comes from the line of Quentin Velleley with Citi.

Quentin Velleley – Citi

Hi. Good morning. Just in terms of the increase in guidance and how small that’s extends, but just wondering if you could run through what some of the items are that are causing the increase in guidance, whether it’s higher occupancy at year-end or some temporary leasing or maybe some other income?

Lisa Payne

Quentin, I’d say – I’d start with saying that obviously we started the year with a big range, which is typical and is indicative of the environment we’re in. So we have a big range. We’re now a quarter into it. We’re in a very strong sales environment. We’re feeling even better about leasing and we’ve already collected a good chunk of lease cancellation which was also a big part of the wide range. So we’re quarter in, we’re more confident on leasing and we’re more confident on making our lease cancellation budget which is a big factor in the range that we’re offering.

Robert Taubman

And I would add that we mentioned in our comments that the whole incidence of new rent releases is really down at this point. It’s just a question of, as sales increase we may actually get some of that back by the end of the year as we talked about earlier. So all of these things helped us raise guidance.

Lisa Payne

Having said that, I want to highlight again, we still have a range and we are very comfortable within the range.

Quentin Velleley – Citi

Okay. And then just secondly, in terms of The Pier at Ceasars and the potential write-back and how that impacts FFO, can you just walk us through the math again and maybe give us some kind of range of outcomes? How many cents that brought back monthly?

Lisa Payne

I’m sorry, Quentin, you broke up a little bit here. Could you repeat the question?

Quentin Velleley – Citi

Just in terms of the Pier phases, the potential hand-back of style, can you just run us through the math on what the write-back could be and how that impacts FFO and maybe give us some kind of range whether it’s 10 or $0.20, for example?

Lisa Payne

Well when we give back the Pier, we are going to have a large gain that will – I mean, first of all you know the penny is share per month?

Quentin Velleley – Citi

Yeah.

Lisa Payne

So when we give back to Pier, we’ll take the debt balance that’s on our books which is 100, roughly I think 100 and...

Robert Taubman

$135 million roughly.

Lisa Payne

135 million. Less our book basis in all accruals that we have, we don’t really – I don’t have an estimate right with me. We don’t have it in our guidance. We’re kind of assuming it will be through FFO but we’re not – it’s obviously a one-time unusual occurrence and are not looking at it as obviously recurring operations.

Quentin Velleley – Citi

That’s fine. We can work it out. And Michael Bilerman is here. He’s got a question.

Michael Bilerman – Citi

Lisa, I was just wondering just on the financing side, I guess you’re already probably in discussions on some of the loans that mature this year, whether it be Partridge or Arizona and then starting to thinking about year ’11’s which probably have extension options but just trying to advantage of the marketplace today. Could you talk a little bit about what’s happening on the secured financing front, what you’re finding in terms of rate and loan to values and what we should expect the company to do?

Lisa Payne

Sure. First, I’d say that the market is changing really by the day and is getting better particularly over the last really two weeks to 30 days. And I’d say what you can do is very dependent on three things, the term that you want, the quality of the asset which is obviously and then your proceeds level. So when you see deals getting done you’re going to – as you’re looking at them, be very careful to understand what proceeds people bought at the percentage of value. I think the two big shifts in the last 30 days is you are able to get higher proceeds, greater loan to value as well as, frankly, they’re underwriting higher values, but are able – at one point, we were saying you had to be at 55% to just under 60%. Clearly today you can go up to 65% to 70% LTBs.

In addition, overall the rate – the spreads are tightening within that range and I’d say a 10-year deal today on good assets, they don’t have to be the best even, but good, good assets and depends on the level of proceeds, you’re in the 6% to 7%. If you’re pushing up high on the proceeds, I think you’re still at 7% which is where I would have said you were 30 days ago but for much lower proceeds.

So if you’re really pushing the edge of proceeds, you’re still up the 7% range but you’re getting a lot for it. If you’re a little more conservative, you can drop the rate down in the 6% range. And I think that’s like a spread of something in the 225 to 250 range in that kind of range we’re talking about today.

Michael Bilerman – Citi

And then as you think about your individual plans for the balance sheet in terms of the loans that are coming due and...

Lisa Payne

Yeah. We tend to want to get, I’d say, full proceeds within the range of not overpaying for that effective mezzanine piece, so I think we’re going to be within that 6% to 7% range, probably and it depends on the asset, I think MacArthur, the loan balance we have on it is a pretty full loan balance so I don’t think we’re going to get some – get proceeds out, but we’re going to refinance the whole deal which I’m not sure we would have said we would have done that 30 days ago. But we’re going to stay in that 6% to 7% range.

Michael Bilerman – Citi

And so you won’t have to for whether it be MacArthur, Partridge or Arizona Mills, you won’t have to put in any equity, you’ll be able to take out – you may be able to take out either 5% or maybe take out some proceeds?

Lisa Payne

Yeah. And for sure in Arizona, I think we’ll be able to take some out. I’ll say that hopefully my brethren at Simon is on the phone and know that they’ve got to get out there and get us some excess proceeds since they’re driving the bus on that one. On Partridge and MacArthur, I think we’ll be able to refinance this. And Partridge is doing great, the sales performance has been outstanding. It still is a Michigan asset and I am very pleased to see what we’re able – we’re seeing on that asset versus where we were 60 days ago.

Michael Bilerman – Citi

Then the last one from us, just on Atlanta and I think you sent out the new supplemental this morning where I guess now you basically shifted about 17 million out of CIP, you left 7 million and you put the rest into peripheral land. Can you talk a little bit about what exactly is going on there? Why that didn’t necessitate a potential write-down and how you think about that development and the value of that land? What you’ve left in the CIP versus what you now deem to be peripheral?

Lisa Payne

Yes. I guess I’d say that a little bit of this is classification. We clearly feel good about the value and we did have to look at that as we – whether we moved it around or not, we always had to be comfortable with the value of what’s in there. There’s been a fair amount of improvements done and zoning progress made. The part that we moved into peripheral land was, frankly, never going to be part of the mall. There’s – and I can let Bobby talk more about the space, but there’s another part that we control that would be part of the project. So, the part that we moved into peripheral land is the part that we will end up selling and still be able to build the mall that we’d intended. And I don’t think there’s anything else that I would add to that.

Robert Taubman

Yeah. The key uptick value was that number one, we got the entitlement.

Lisa Payne

Right.

Robert Taubman

And but just as important to the entitlement is a road that connected the property, in essence, between two interchanges that had to be built. And the county has now built that road. And we contributed to that road, the cost of that road, as part of our overall development agreements with the county. So, you know, but that’s part of the uptick in value since we bought the property, even in the context of the world, the environment that we’re in right now.

Michael Bilerman – Citi

Thank you.

Operator

Our next question comes from the line of Ian Weissman with ISI Group.

Ian Weissman – ISI Group

Hi. Yes. Good morning. Two – just a few questions. It seems like obviously there’s a greater bias for retailers to open stores today, but clearly the parameters are probably a bit strict. Maybe you could just give us a preview, with a month away until ICSC, about your meetings and what you’re hearing from retailers.

Robert Taubman

Well, we have a very, very full agenda. And everybody is coming. There’s nobody not coming. And, I mean, I think it’s as robust a group of meetings as we’ve ever had. And I do think that you’re going to see a lot of aggressiveness now by stores to open. You know, everybody loves rent relief and everybody loves lower cost deals. But with the sales uptick and you’re going to start to see pricing power move a little bit more towards the landlords.

And, I think, especially if we can sustain this kind of sales growth. And I would say anecdotally that April appears to be a very good month from all the retailer conversations that we’ve been having. So, they’re entering into the ICSC in a very positive mood. And what we need to do is start to push back on rents as the demand pushes for our supplied space.

Ian Weissman – UBS

You talk about rent and it seems like retailers are a bit price sensitive, so how do they balance? If they look at an A mall versus the B mall, I mean what is the mandate? Is there still a bias because rents have come down as much in the A mall certainly at the B malls to just really focus on A malls at this point in the cycle?

Robert Taubman

They’ll always focus on A malls. I mean that’s where they can make most profitability. Normally, rent is only one line item in the P&L. The cash flow on a successful store could be four, five, six times what it is in a more normal store. So you can’t – the A properties are extremely important. And anytime a retailer can get good locations of properly size on all the things that they look for in an A center, they want to be there. And that is always their priority.

Ian Weissman – UBS

And last question, obviously there’s a lot more deal talking in the marketplace today for acquisitions. I notice you didn’t mention that in your comments about your plans. But maybe you can talk about what you’re seeing and what potential opportunities might be out there and you think this is a good buying opportunity.

Robert Taubman

Well, we wish we would see some class A assets that were for sale. But in this whole financial crisis, there hasn’t been a single 100% sale of a great asset anywhere in the country. So the better assets are going to be rare and very scarce. And even when there is a difficult time like we’ve just gone through, you don’t see distressed sellers in this kind of an environment. I mean good assets just aren’t trading, going to trade at distressed prices. I think you can look at GGP’s trading right now and depending on your view of EBITDA, it’s trending with 7% or less. And that’s not all quality assets.

So you’ve really got to think about is there going to be something for sale? A year ago we thought there would be. Today, we can’t make any expectations that there will be. And part of the reason that we’re so focused on development is that we don’t need acquisitions to make it work for us. Our external growth has been based on development largely. It’s going to be in the future.

Ian Weissman – UBS

Okay. Thank you very much.

Operator

Our next question comes from the line of Jay Habermann with Goldman Sachs.

Jay Habermann – Goldman Sachs

Hey good morning, everyone. Bobby, could you update us on Asia at this point and what sort of activity you’re seeing there?

Robert Taubman

Well, as we said in our comments, Jay, we’re spending a lot of time looking at our options and are sharpening our – we want to really sharpen our focus both geographically and on the products and the services that we’re offering out there. We’ve said on the previous calls that we’ve been much more focused on Korea and sort of the broad, Pan-Asia efforts that we’ve been making.

Our interim management plan has been working very, very well. If you want to talk about individual projects, Macao is still in litigation and the partners still have to resolve between themselves, the force can go forward. And Riverstone, we’re optimistic but we still need to get the financing resolved on that project in order for it to begin construction again.

Jay Habermann – Goldman Sachs

Okay. And then just turning back to the U.S, I mean you mentioned obviously the cap rates for Class A assets are very low. It sounds like development at this point is still premature just given where retailers are. Can you give us a sense of maybe even acquisition opportunities that might involve some redevelopment? Is that something you’ll consider?

Robert Taubman

Absolutely. We’ve looked at countless redevelopment ideas. Remember there were about 9 projects that were either had started construction like Sarasota that we didn’t stop or that were on the verge of starting construction. And many of those have been looking for homes but not all of them are going to go forward. So yes we have set a lot of time looking at redevelopment but we have nothing to announce at this time.

Jay Habermann – Goldman Sachs

Okay. And then just lastly just to clarify you talked about the increase in sales, but did you say you expect rent to increase 2.5% this year? And I guess are you looking for greater increases should this level of sales sustain?

Robert Taubman

Well, what we said was that on opening rents we expected them to be slightly up over opening rents from '09 as much as 2.5%.

Jay Habermann – Goldman Sachs

In your anticipation for I guess rent toward the second half of this year, should the sales productivity continue at this pace?

Robert Taubman

Well, again, it’s very sensitive. Opening rent number is very sensitive giving the size of the portfolio to sort of the ending numbers that we do open up. So I don’t and it’s not going to impact FFO dramatically either way, certainly not in 2010. So I would say that average rents we expect to be down about 2% which is a slight increase over our guidance previously.

Lisa Payne

And that’s from the rent release.

Robert Taubman

And that’s from the rent releases, as Lisa said.

Jay Habermann – Goldman Sachs

Okay. And for those rent release tenants are you starting to see a noticeable improvement in their performance?

Robert Taubman

Well. I think as we said, it's two quarters of good positive sales, up 3.8 and now up 10.8. And I think that you’re also seeing total occupancy fall. A year ago in our first quarter our total occupancy was 17.7%. This year it was 15.4. So we think that we’re estimating our total occupancy for the year to be somewhere just below 15%, if we’re at that level that will create good opportunities for leasing and rent growth.

Jay Habermann – Goldman Sachs

Okay. Thank you.

Operator

Our next question comes from the line of Michael Mueller with JP Morgan.

Michael Mueller – JP Morgan

Yeah. Hi. Following up on the last question, I remember in prior calls, Lisa, you talked about how closing rent levels can bounce around a bit and make the spreads a little more difficult to talk about. But given the visibility, so far into this year Bobby mentioned opening rent levels up maybe a 2.5% over '09. Do you have any firmer opinion on the rent spread for 2010 in terms of how you think that could pencil out?

Lisa Payne

Well, I would say what’s most difficult is what are the closings and unspecified openings. Even at this point in the year, our budget, there is still some unspecified openings and we don’t know what may close. So that’s very, very difficult which is why what we do feel comfortable saying is that opening rents because we do – we budget those and we even budget an unspecified number, are going to be up, up to 2.5%. It’s very hard for me to know what closings are going to be. One could be very – you could say you could look in the 10-K and we disclose closing rents, but that’s a very small pool. You know what the average rents in the portfolio that’s a conservative number and come up with your estimate from that.

Michael Mueller – JP Morgan

Okay. And then secondly in terms of the guidance increase, is there anything specific that drove it? Is it maybe a little bit of the rates at the back half of the year on the refinancing being a little bit better, just you think you’re going to have better pricing power than you thought at the beginning of the year? What were the drivers there?

Lisa Payne

Well, I said I think it is the leasing environment. On financing I will say that because Partridge is currently floating that interest expense is going to be negative when we refinance that asset. So we do have some floating rate, interest floating rate loans that will be positive if rates stayed low this year. But it’s really more on the leasing front. I will say that our sponsorship revenue is up above what we budgeted. I’m not saying it’s up over last year, but it’s up over of what we were budgeting when we did the outlook which is also because of the positive sales environment. So it’s going to be the NOI, in that 2 to 4 range, we’re feeling a little better than we were back in February when we gave the guidance.

Michael Mueller – JP Morgan

Okay. Okay, that’s it. Thanks. Bye.

Operator

Our next question comes from the line of Cedric Lachance with Green Street Advisors.

Cedric Lachance – Green Street Advisors

Just returning to the development a little bit, Bobby, how much growth and sales do you think we need into the future for you to put the shovel into the ground again and be able to go for new developments?

Robert Taubman

Well, I’ve been very cautious on the opportunity for new development for anyone in the U.S. over the next 3 to 5 years. I think that it’s going to – there are going to be very few projects built. I think in the ensuing 5 years, 6 to 10 years from now, we’ll probably get at least two projects a year, maybe two to three projects a year that will be built in the United States. Our hope is that over the next 10 years we’re going to build a handful of those projects for this company.

Now, in terms of starting construction, there really are three or four gates that you need to come through before you can build anything. The first is that you’ve got to have department store interest and the department stores are now refocused on expansion. But I don’t know, with very few exceptions, a couple of our sites maybe, that they would be willing to actually starting construction right now if the other gates opened up. That they want to see a little better – another few quarters of good sales growth in their businesses before they’re ready to actually start construction on something new.

So that will be the first gate. The second gate is that in order to have sort of economics and the return levels that are attractive to us and you as our shareholders, for us to go forward, we need to have the proper level of specialty store interest at rent levels that will make sense. So it’s – those specialty stores aren’t going to, even though there’s a lot more demand and people are feeling a lot better, I don’t think they’re ready yet to approach a brand new project with very few exceptions.

And then I think the final gate is just capital availability. There’s simply no construction financing out there. Now at one point right before the – just as the financial crisis was emerging, we thought that we would build Sarasota for cash. We made a decision to stop construction to Sarasota, because we were concerned that the specialty store interest would fall off so much, which it would have, that the rent levels would not have been high enough to really achieve the economic returns that we had originally planned. So capital availability, to find construction financing right now is very tough.

And then we’d have to look at it on the basis of almost a full equity investment. And that, obviously, that increases the risk reward and increases the level of return that you want. So, you really need all of these gates to open up. How far away do I think we are? If we get another couple of quarters and have good sales increases, I think the retailer interest both the anchor store and specialty store interest will be there. And I also believe that that will say that the economy is doing well and capital availability, which has just begun to flow again, will in fact be flowing so that something that is a well conceived regional mall with pre-leasing of those anchor stores will be able to find construction financing.

Cedric Lachance – Green Street Advisors

And then, what level of un-levered return would you target to be able to start a new project?

Robert Taubman

Well, we’ve always talked about finding a 300 basis point spread, both on long term debt costs as well as valuation, at exit. And I think that that’s the kind of thing we would look for. And certain types of projects will have lower cap rate assumptions than others. But that’s what we’re looking for and we want to build projects that are consistent with our portfolio average that we have today. We think that’s also very important.

Cedric Lachance – Green Street Advisors

Okay. Finally on Pier Shops, do you intend to participate in the bidding for the property, or are you walking away for sure on this one?

Robert Taubman

I would say that our plan is to not participate in the bidding. And, but, sometimes you get dragged into things.

Cedric Lachance – Green Street Advisors

Okay.

Lisa Payne

But at the present time, we are not planning on bidding on the property.

Cedric Lachance – Green Street Advisors

Sounds good. Thank you.

Operator

Our next question comes from the line of Tayo Okusanya with Jefferies & Company.

Tayo Okusanya – Jefferies & Company

Yes, good morning. Just a follow-up in regards to the rent relief and how quickly you expect it to burn off. Could you give us just a better sense of – based on your internal budget and what you are seeing, whether you’re thinking it’s going to be 70% burn off in 2011 and 30% in 2012 or something of that nature?

And then Lisa, I believe you mentioned that a lot of it will depend on sales. So if you could give us a better sense of just how these rent relief contracts were constructed and how our sales ultimately impact – if a tenant hits a certain amount of – a certain sort of rent level then the rent relief totally goes away or exactly how does it work?

Lisa Payne

Well, I’ll take that part of the question. I’ll let Bobby, do the first part. No, the way the rent relief is structured. There’s no trigger with sales. But when the rent relief request that was granted comes due or they want to – they come back to us and say, okay, it’s up. The rent’s going to bounce back to what it was originally. They come and they say, we can’t make it; we still can’t make it we want to have you extend the rent relief.

We look right then at that tenant’s sales and we say, what? Your sales have improved. We’re not going to give them all that tenant rent relief, we may give them half. We may be able to give them zero highly unlikely. And what we try to do is ratchet at the rent relief down based an individual sales performance of that tenant, because it’s all based on their profitability. Many of these tenants are not nationals, they are the more regional and local tenants that say are not making a buck in your space aren’t going to be able to pay the rent.

So that’s what I mean by if that individual tenant’s sales are rebounding 10 to 15%, we’re able to negotiate a reduction in that rent relief and eventually reduce it down to zero. I will say that the more likely scenario is that we release the space. Because many of these tenants get to a point where it is just better for us to release to a new tenant and that obviously take a little longer to do.

So it’s a combination of both. We – I don’t really have a percentage number that I can say. I mean we do feel if we wanted to get guidance that it’s going to take a period of time over the next year and a half to two years to really fully reduce rent relief down to the levels that we had historically.

Tayo Okusanya – Jefferies & Company

Got it. Okay. Appreciate it. Thank you.

Operator

Your next question is from the line of Ben Yang with Keefe, Bruyette & Woods.

Ben Yang – Keefe, Bruyette & Woods

Hi, good morning. Bobby, in your prepared comment you mentioned recently signing some new leases some very high-end retailers, including Prada and Fendi at Beverly Center. Can you talk about your expectations for the luxury segment in general based on these recent negotiations and then maybe also comment on how these new rents compare with rents that you would have signed today maybe two to three years ago?

Robert Taubman

Well, I do think our expectation in the luxury sector is very good right now. When you look at some of the public comments that are being made by companies like Louis Vuitton or Gucci and others, I think that you see a renewed optimisms and in the numbers you see good numbers.

So I believe that the luxury segment is coming back as well and there is tremendous interest in good locations and we’re delighted with what we’ve done at Beverly. It’s taken a little while for us to really establish Beverly as a true luxury venue. But it is absolutely established as that now. I mean Louis Vuitton is one example, upsized twice already. They’re on their way to a third time. So I mean it’s very positive.

Now, your second question was about rent. And I do think that just generically, not just luxury rents but across the board. We believe the rents have bottomed out and we’re beginning sort of that long climb back and we’ve talked in previous times about sort of the hit in rent that has occurred and you can see it in our trailing 12-month statistics when you start looking at the first quarter of ’09, which was at $52.47 and you compare to this trailing 12-month first quarter of 44.80, you see a significant difference. And there’s been a sequential drop in the quarterly trailing 12-month sales.

So then what you’re really looking at is a bottoming out and now we expect as we look at the ensuing quarters for that trailing 12-month statistic to begin to climb. And you hear that reflected in the opening rent number where we talk about opening rents over opening rents being up, up modestly to 2.5%. That increase certainly by year-end, we expect to see.

So now that’s opening and the reason that it was so high at 52.47 the first quarter of ‘09 is that all of those deals had been made before the financial collapse. So now all of the deals you’re seeing now were made during the financial crisis and now if we come out of it in the recovery as you face these things rents opening in 2011 and ’12, you should see a return to higher levels of opening rents. And so I think that sort of answers the question generically.

Ben Yang – Keefe, Bruyette & Woods

Okay. That’s helpful. And then just last question. It sounds like Sears is taking steps to either sell several dozen of their stores or even rent out space within their stores to retailers. And I wonder if you have an opinion on what they’re doing? Specifically the part where they are seeking tenants to open within their stores because it sounds like you’re going to potentially compete with them as the landlord for retailers interested in opening stores in your malls. Is that the case? Or is that not the case?

Robert Taubman

Well, first of all, we only have I believe five Sears stores in our shopping centers. I think whatever the outcome is less of an issue for our portfolio than perhaps others that you may follow in our sector. Secondly, I would say that concern with concessionaires in department stores is forever. It’s been going on for 100 years and to a less or greater extent in whatever country you’re in. We mentioned Korea earlier. There are department stores there that are almost 100% consignment.

So we are always leasing against the option of distribution for manufacturers within department store sale or large specialty store space. So a store like Louis Vuitton to take a luxury merchant is often found in a Macy’s store and certainly found in Nordstrom’s or a Neiman Marcus.

So they always have that option to either go free standing or have a distribution point within the department store itself. So I don’t think that what they’re doing is that unusual. I think it’s more unusual and new for Sears that in the past has had more private label goods has been more in the hard good business and less in the soft good business. So I think it’s more unique for Sears. But it’s not uncommon historically in the department store world.

Ben Yang – Keefe, Bruyette & Woods

I mean but do you have any say on who they consign that space to because I guess from what I understand they signed some of that space to a golf retailer. And I wonder if you have another golf store right aside that Sears store how that might impact the merchandising mix at your center?

Robert Taubman

Well, we don’t have any control over any of the department store spaces from what I’ll call the natural extension or expansion of their merchandising. I mean obviously there’s certain types of products, they can’t run a flee market and they can’t run bordello. So I think that when you talk about golf merchandise I think golf merchandise is something that would be common.

Frankly, in our sporting goods stores which had been more limited in malls because of their large space required. We would welcome something like a golf store in a Sears store because we wouldn’t otherwise have it within the mall. But I think generically, we always had that problem of department stores selling competitive merchandise. We think of ourselves, the mall, as a true department store with just deeper departments than more normal department stores.

And if you think of us as having like 400,000 square foot average store space and the department store being 150 to 200. We’re essentially two department stores versus one competing in almost every category.

Ben Yang – Keefe, Bruyette & Woods

Great. Thanks, that helps.

Operator

Our next question comes from the line of Andrew Simpson with Credit Suisse.

Andrew Simpson – Credit Suisse

Good morning. Given the improved financing environment, do you have any plans to redeem preferred shares this year?

Lisa Payne

We at the present time do not have any intent. We’re clearly always monitoring and looking at the market. Our preferred is obviously perpetual preferred and while it has rebounded quite well in its pricing. I think we still feel in order to redeem it; we would really want a pretty significant reduction for the cost of – reduction and new issuance. Because we do think it is a part of our capital structure as a fully secured borrower that’s very cost effective. And so we are always looking at it, and if it becomes compelling and we think that over time we can reissue it at much better rates, we would potentially look at it.

Andrew Simpson – Credit Suisse

Okay. And has the upward trend in sales continued into April?

Robert Taubman

Well, as I commented earlier, anecdotally we’re hearing from specialty merchants that it is, that April is another very good month. And we’re much more optimistic about the overall year than we started the year with given how good this last quarter was.

Andrew Simpson – Credit Suisse

Great. Thank you.

Operator

Our next question comes from the line of David Wigginton with Macquarie.

David Wigginton – Macquarie

Good morning. Regarding the releasing spreads in your unconsolidated portfolio, the trailing 12-month spread at the end of the fourth quarter was positive 246 but fell to negative 735. Can you maybe just talk about what caused that shift?

Lisa Payne

Well first, that is a rolling 12-months and so you clearly had, when we moved in to March of ‘010 the drop-off of a quarter in March of ‘09 that was a very strong quarter. And so it was a much weaker opening this quarter. So and given the numbers of openings and closings during those, a lot of it was because of falling off of a very, very strong quarter.

Having said that, there were some openings that were unusually low that did drive that number. And as we keep saying, even with those rolling 12 certain things can make it still a pretty volatile statistic.

David Wigginton – Macquarie

Okay. And so then you just said openings were, you mentioned, openings were lower in the first quarter of this year? Did I hear that correctly?

Lisa Payne

Yes, correct. We had a weak – we had some weak opens just – in a couple of assets the openings were particularly low for this quarter. We then also dropped off particularly a very strong quarter when we did the rolling 12 versus the 12-months you’re looking at, at year end.

David Wigginton – Macquarie

Okay. And then how are openings looking for the current quarter?

Lisa Payne

Well, what we said is we’re expecting generally opening rents for the year. Again, we don’t really want to focus quarter-by-quarter. But when you look at for the year, we’re expecting opening rents for the year to be up over, on a combined basis up over last year. And if you look at last year’s opening rents, last year’s opening rents were 46.63. And so we are expecting for the year, opening rents on a combined basis to be above that.

Robert Taubman

Yeah. I think a good way to think about this, for all of you. If you said, before the financial crisis became real. We were making good deals. And that was off of ‘07 and ‘08 sales and expectations. As we move into ‘08 and the world was increasingly nervous with Bear Stearns and then with Lehman, the ability to close deals at the level of rents that we’d been doing in ‘07 and early ‘08 became more difficult.

Then we went into the financial crisis and then we had a weaker demand and therefore pricing would fall. So what you’ve really got is sort of the rat moving through the snake. And until it moves through the process, which will be – real estate lags a couple of years to the economy. So until you move through this, you move it completely through the company then you’re not going to see us moving back up. That’s why I called this a floor. We’re at the beginning of the long climb back.

David Wigginton – Macquarie

Okay. And then moving onto the second question, it sounds like sales were up across the board in your portfolio. On a relative basis, can you talk about I guess the performance of the properties in the lower part of your portfolio and maybe the level of interest among retailers in those centers at this time?

Robert Taubman

Well, we don’t talk specifically about specific assets and we love all our children. But I would say that what you heard in my comments about sales and really about leasing. When your lease based statistic is over 91%, up 50 basis points. You’re doing well across the portfolio and there were 16 or 17 different tenants that I mentioned that when you look at their average with all of their locations in our portfolio. People like Abercrombie, American Eagle they all were tenants that I mentioned. When you look at them across the portfolio and all of those tenants were up more than 15% then that tells you that it’s really across the board.

David Wigginton – Macquarie

Okay. Thank you.

Operator

(Operator Instructions) And at this time, there are no other questions.

Robert Taubman

Well, Robin, thank you. And we’re delighted you all joined. Hopefully, this sales trend’s going to continue and the capital markets will continue to be more open and we’ll have a much better 2010 than we had in 2009. So thank you all, we look forward to meeting you soon. Bye-bye.

Operator

That does conclude today’s conference call. You may now disconnect.

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Source: Taubman Centers Inc. Q1 2010 Earnings Call Transcript
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