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Executives

Kenneth Bernstein – President and CEO

Jon Grisham – SVP and Chief Accounting Officer

Michael Nelsen – SVP and CFO

Analysts

Christy McElroy – UBS

Todd Thomas – KeyBanc Capital Markets

Quentin Velleley – Citi

Michael Mueller – J.P. Morgan

Craig Schmidt – Bank of America/Merrill Lynch

Sheila McGrath – KBW

Andrew DiZio – Janney Montgomery Scott

Rich Moore – RBC Capital Markets

Ross Nussbaum – UBS

Acadia Realty Trust (AKR) Q2 2010 Earnings Call Transcript July 28, 2010 12:00 PM ET

Operator

Good day, ladies and gentlemen. And welcome to the second quarter 2010 Acadia Realty Trust earnings conference call. My name is Alicia, and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We’ll facilitate the question-and-answer session towards the end of this conference. (Operator Instructions)

Please be aware that statements made during the call that are not historical may be deemed forward looking statements within the meaning of the Securities and Exchange Act of 1934. Actual results may differ materially from those anticipated by such forward looking statements. Due to the variety of risks and uncertainties which are disclosed in the company's most recent Form 10-K and other periodic filings with the SEC. Forward looking statements speak only as of the date of this call and the company undertakes no duty to update them.

During this call management may refer to certain non-GAAP financial measures including funds from operations and net operating income. Please see Acadia's earnings press release posted on the website for reconciliation of these non-GAAP financial measures with the most directly comparable GAAP financial measures.

Participating in today's call will be Kenneth Bernstein, President and Chief Executive Officer; Michael Nelsen, Chief Financial Officer; and Jon Grisham, Chief Accounting Officer. Following management discussion, there will be an opportunity for all participants to ask questions.

At this time, I would like to turn the call over to Mr. Bernstein, please proceed, sir.

Kenneth Bernstein

Thank you. Good afternoon. Thanks for joining us. Today I’ll start with a brief overview of the progress we made in the second quarter and the trends we are seeing. Then Jon Grisham will review our earnings, operating metrics and key drivers. And finally, Mike Nelson, Jon and I will take questions.

As an overview, we’ve spent time reviewing our second quarter results in the context of the improvements in the economy and financial markets over the past year, but also in light of the more recent mixed macroeconomic data on housing, employment, consumer spinning and the resulting market volatility.

As we said in our last quarterly call, while we’ve been experiencing a strengthening or recovery in most aspects of the business, we also felt that it was prudent to be prepared for a bumpy road ahead before we entered into a full blown recovery.

Now, halfway through the year, we’re seeing a continued year-over-year strengthening or stabilization of the key drivers of our business. In many instances in excess of our original forecasts but our economy has certainly also experienced its fair share of recent turbulence.

So today we’ll discuss what we’re seeing in key components of our business. First our core portfolio, secondly, our balance sheet and third, finally, our external growth platform. And when we compare and contrast this performance with the headline data, what we’re seeing so far is that the volatility associated with macroeconomic reports is not translating into new operational softening.

Now, we recognize that most of our internal information is more often than not a lagging, not a leading indicator and it’s heavily anecdotal, so some level of caution appropriate. And probably most importantly, our view is however bumpy this recovery may remain to be, we believe we’re well positioned both in terms of our existing portfolio, our balance sheet and our external investment platform.

So, first, in terms of our portfolio performance in the second quarter our same store performance for the quarter and year-to-date were stronger than we had originally forecasted. This is primarily due to fact that our team was able to retain a higher percentage of tenants with lower default rates than was originally anticipated.

As we previously discussed our same store NOI declined was concentrated in our two previously discussed vacancies of Absecon, New Jersey and Chestnut Hill, and excluding them, the portfolio would have produced otherwise positive results more or less across the board.

Furthermore in the second quarter, we also saw continued stability and consistency in the performance metrics of our existing tenants both in terms of defaults, evictions, bankruptcies and collections and our more anecdotal conversations and negotiations with our retailers seems to be consistent with a stabilizing economic outlook.

So, in short, as opposed to our original year-end more conservative expectations, we see the impact of the recession on occupancy declines having been shallower and in shorter duration than we originally anticipated.

Furthermore, we’re beginning to once again see opportunities to harvest value within our portfolio by recapturing space from underperforming tenants and then releasing that space for positive spreads. In the second quarter our leasing team successfully negotiating the recapture of co-anchor in our New Loudon shopping center.

This was a 65,000 square foot on time department store box. It was terminated and taken back, and simultaneously, we entered into two leases, one to expand our existing and thriving price chopper supermarket bringing that tenant to 88,000 square feet, and the balance going to Hobby Lobby.

Now, due to Acadia's somewhat unique loss small numbers as Jon will discuss, is the, there will be a short-term negative impact on occupancy and NOI while this re-tenanting takes place. However, upon the two tenants opening, which will be in the middle of next year, this transaction will be meaningfully accretive.

The second component our balance sheet and liquidity. The improvements in the capital markets also benefited our already strong balance sheet. If you review the financial ratios and data set forth in our earnings release and on page 23 of our supplement you’ll see that we are in a healthy capital position.

Third and finally, our external growth platform. First in terms of our existing investments where along with the positive momentum in general, in the second quarter we made solid progress. Most significantly was our CityPoint development in downtown Brooklyn. Please note that a brief PowerPoint presentation on CityPoint has been added to the website on the Investor Relations section of our homepage.

As you may recall, in 2007, Acadia, through our Fund II originally acquired a 75% interest in the half a million square foot retail component of a 1.5 million square foot mixed use development. Our original joint venture partner led by MacFarlane Partners acquired the balance or the 25% of the retail component and 100% of the approximately 1 million square foot residential component. Thus Acadia's interest represented just under 25% or $30 million of the total original purchase price which was $120 million.

At the end of the second quarter, Acadia purchased all of our joint venture partners interest in CityPoint for approximately $29 million. Now, while Jon will discuss the financial impact, this purchase gives us full control at an attractive cost basis of all 1.5 million square feet of the project and it’s allowing us to proceed on a simplified and expedited basis. So those of you looking at the PowerPoint presentation, you’ll be reminded that our CityPoint development is just one component of the ongoing transformation of downtown Brooklyn.

Since 2008, over 3,000 residential units have been added to this market and it’s expected that there will be 16,000 new residents in the downtown area by the end this year. Along with the future home of the New York met, downtown Brooklyn is also home to 10 colleges and universities enrolling over 57,000 students. And even prior to these more recent changes, the Fulton Street retail corridor that CityPoint is a part of is already a strong draw to the downtown area with more than 100,000 shoppers a day and retail sales of over $1,000 square foot.

Its story [ph] now includes a larger pool of national, international retailers including H&M and (inaudible) who both have announced that they plan to open stores on the Fulton Mall by the end of 2011.

With respect to the development of CityPoint, as we’ve discussed on prior calls, we are now contemplating developing the project in three phases. Phase I, which as of the past quarter, construction is now underway for a 50,000 square foot four-story retail building located on the Fulton Mall. Our goal is to complete construction of this phase within the next 18 months.

During this time we also expect to finalize the design for and the significant pre-leasing of Phase II, so that we may commence construction of Phase II prior to the completion of Phase I. Phase II is going to consist of approximately 450,000 square feet of retail as well as up to 200 units of affordable housing and contain at least one major anchor and several junior anchors and it’s likely that the major anchor will span the fourth and perhaps even the third level of both Phase I and Phase II.

Finally Phase III will likely be a standalone residential parcel containing up to 650,000 square feet of residential units. Upon completion the redevelopment going to contain 1.5 million square feet of retail, commercial, residential space, including affordable end-market rate housing. And in short, we’re very excited about the re-launching of this development, our newly reinvigorated CityPoint has the opportunity to create a critical mass of new retail that can capitalize on the residential and commercial growth in the area.

Elsewhere in our existing investment pipeline, we’re also making steady progress for instance in our Pelham Manor project, which you recall is one of the two projects in our New York development pipeline that is already construction completed, but that had significant lease up. In the second quarter and more recently, our team has executed three leases that will bring that properties occupancy up to just above 90%.

Now, turning to new investment opportunities, we are seeing an increase in deal flow, while our patients is being tested and in general, we’re continuing to see an imbalance where on a very limited volume there remain more buyers than sellers. We are starting to see enough indications that the kind of transactions that we have historically participated in are beginning to materialize.

While the increased liquidity in the market may make it less likely that there’ll be the wholesale 1990s RTC like liquidation of high quality real estate distressed prices, irrespective of precisely how this cycle plays out, we believe we’re well positioned.

The impact to Acadia of a continued recovery is likely to be positive in term of our existing core portfolio and even more so our redevelopment pipeline and in terms of deploying our dry powder, given our size, competencies and discretionary fund structure, we don't need the flood gates wide open to create value. So, in any event, even a moderate amount of opportunities enables us to significantly move the needle.

To conclude, we’re pleased with our performance and the continued improving climate in the second quarter. While we remain well prepared for a bumpy road ahead before full recovery we do feel strongly that will well positioned both in terms of our existing inventory, as well as, for new investment opportunities.

I’d like to thank the team for their hard work in the second quarter and now, I’ll turn the call over to Jon Grisham.

Jon Grisham

Good afternoon. Consistent with the positive trends experienced during the first quarter this year, the second quarter saw continued strengthening with within our core portfolio. We’ve already hit occupancy of 93%, which is at the high-end of our original expectations for yearend 2010 and same store NOI is tracking markedly better than our original 2010 forecast which was minus 2% to minus 4%.

Looking closer at same store NOI, year-to-date 2010 NOI is down roughly 1% against 2009, and this is primarily from the impact of the two anchor locations that we discussed last quarter at Absecon, New Jersey and Chestnut Hill, Philadelphia properties. But for these two locations, same store NOI would have been positive 1.5%.

Additionally a positive factor for 2010 was the relative improvement in tenant credit issues as measured by bad debt expense and even tenant defaults. Year-to-date, bad debt expense in the core of approximately $250,000 is tracking at about half of that from last year and there's also been a significant decrease in the tenant default rate in the portfolio. Currently, we have about 20 tenants that are in default, in the core which is about half the number of tenants in default at this time last year.

So, looking at our 2010 NOI forecast, we originally forecasted minus 2% to minus 4% same store NOI. And recall that minus 2% plus alone was attributable to Absecon and Chestnut Hill. To date the positive performance of the balance of the portfolio has largely offset, the effects of these two locations and we’re now forecasting that same store NOI performance should range from flat to minus 2%, or 200 basis points better original.

We also noted on our first quarter conference call that occupancy was trending stronger than the original forecast. Following the opening of Best Buy at our Bloomfield Hills, Michigan property during the second quarter, our occupancy now stands at 93%, which already puts us at the higher end of the 2010 year-end target.

As Ken mentioned, during the second quarter, we initiated the re-anchoring of our New Loudon shopping center in Latham New York, and although it’s clearly a long term positive it will negatively impact occupancy and NOI on a temporary basis. We finalized and executed the agreement with Fulton, whereby the lease is terminated and they pay us $225,000.

This will generate incremental annual NOI of $140,000 which represents about a 30% incrementally churn on the net installation cost about a $0.5 million. And this cost is inclusive of the associated down time through the middle of 2011 until rent commences on the replacement leases. Long term, the 140,000 of additional annual rent represents about a 30 basis point increase in our overall portfolio NOI.

However short term, during the downtime period this deal will negatively impact NOI by $120,000 in the fourth quarter of this year which is minus 25 basis points of NOI and do keep in mind that our updated NOI guidance already takes this into account. And then in the first half of 2011, this will create as much as $240,000 of NOI drag or minus 50 basis points of portfolio NOI.

As the leases with Price Chopper and the Hobby Lobby for the entire 65,000 square feet have already been executed, there is no negative impact on the leased occupancy within our portfolio. However, as we report on physical occupancy, this will impact our reported occupancy during the period of downtime by the 65,000 square feet or approximately 170 basis points starting late next quarter.

So you will see our current 93% fiscal occupancy come down to 91% plus next quarter and this will continue to create a drag on occupancy until mid next year. Looking at leasing spreads for the quarter, we reported average leases spreads on a cash basis with minus 11.7, I previously mentioned the opening of best buy and 30,000 square feet during the second quarter of Bloomfield Hills, which as you recall replaced a former circuit city. Excluding the impact of this one lease, cash basis leasing spreads for the portfolio would have been positive 4.5% for the quarter. And these same leases also the primary reason behind the 12% range between cash and gap leasing spreads.

Turning briefly to earnings, as Ken discussed fund 2 bought out the third party joint venture interest in city point during the quarter and as we previously disclosed, we were required to report a non-cash gain of approximately 34 million as a result of the transaction. This was based on recent third party valuation of 108 million, in comparison to our cost basis of 74 million which was comprised of our original acquisition, carrying predevelopment cost of 45 million, plus the $29 million buyout that Ken mentioned.

The REIT share of this gain net of the non-controlling interest share which is primarily our fund investors amounted to 6.3 million or $0.15 per share, which is included in second quarter FFO. So lastly, related to 2010 guidance, we had already increased our guidance for city point gain in an 8-K filing earlier this month. We are now increasing 2010 guidance by an additional $0.10 as a result of the continuing out performance of our core portfolio and mezzanine investments versus forecast as well as our continuing efforts to tightly control G&A.

Accordingly, we have now increased our original 2010 forecast range which was $0.95 to $1.525 such that our current guidance range is $1.20 to $1.25. Do note that consistent with our previous guidance, these amounts are before any contribution from potential acquisitions or from our other income category which can include promoting come from our funds and income from our RCP investments.

Again, not to suggest that we don't expect any activity in these areas in 2010 rather that any specific prediction is difficult and therefore we have not included. So to conclude, we do see continuing signs of recovery in our portfolio which is translated and deposit year-to-date results, we do recognized that the sector operating fundamentals are not necessarily real-time. And we will remain concerned about the fidelity of the economic recovery. As such, we remained focused on maintaining the strength of the portfolio and the balance sheet.

With that, at this time, we’ll be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Christy McElroy from UBS. Please proceed.

Christy McElroy – UBS

Hey, good afternoon, guys. Since you continue to have some level of caution on the recovery, is it fair to say that there's still a little bit of buffer in your guidance and the event that you do see a modern softening in retail demand?

Kenneth Bernstein

There is not much of a cushion at this point in time. What we’re currently guiding to is our expectations as it relates to balance of the year and to the extent that there is a downturn in the economy, certainly it would impact our numbers.

Christy McElroy – UBS

Okay. And then, wondering if you can just give a little more color on the higher than expected interest income in your guidance and where your cash is invested and if you have any marketable securities?

Kenneth Bernstein

Yeah. Recall that back when we were putting this forecast together, late 2009, I think, Mike, it was a case where the Government actually…

Michael Nelsen

They charged you to lend their money.

Kenneth Bernstein

Right, to invest in short term treasuries. Obviously, that situation is improved a little bit as well as in term of what we are currently investing…

Michael Nelsen

And what we’re currently investing is high rated certificates of deposit, money market accounts, some short term municipal funds that are AAA rated and I think those are basically where they are. There are no quote marketable securities, not investing in common stock; we’re not investing in individual bonds. And what we have seen basically is over the six months interest, we have been able to put this added interest rates, significantly higher than we anticipated back in October or November when we put in the original together, the original forecast together.

Kenneth Bernstein

So as it relates to our – it's our $0.10 earnings increase, Christy, probably a couple of cents relates to this increased interest income primarily from the treasury function.

Christy McElroy – UBS

Okay. And then just lastly, I’ll ask the obligatory question on storage. The book value on the storage portfolio went from 174 million to 186. Did you add or open another storage facility?

Kenneth Bernstein

We did not. And in fact, the 180 is the correct amount. The amount last quarter, at the last quarter sup was not quite the correct amount.

Christy McElroy – UBS

Got you. Okay. And then, can you comment just on how you're stabilize storage post assets performed this quarter and progress on lease up of the un-stabilize stuff?

Kenneth Bernstein

Sure. And we break out just in terms of occupancy growth that we saw over the past quarter and we’re seeing through year, gains in occupancy in most – well all of the components, so on an overall basis just about 4.5% occupancy gain over the past quarter. The most significant is in the initial lease up component because that is the easiest to gain occupancy, but we are seeing it even in the stabilize portion. The key now is to be able to not just drive occupancy but to start to drive rent, top line and bottom line again and control the expenses. And that's really the, the team's focus at this point now going forward.

Christy McElroy – UBS

Okay. Thank you.

Kenneth Bernstein

Okay.

Operator

Your next question comes from the line of Todd Thomas with KeyBanc Capital Markets. Please proceed.

Todd Thomas – KeyBanc Capital Markets

Hi. Good afternoon. I’m on with Jordan Sadler as well. Jon, just following up regarding the increase in guidance, you just mentioned a couple of pennies, I guess on higher yielding short term securities, but how much of the increase or maybe you can reconcile the $0.10 in general is related to better performance in the core wholly owned retail portfolio versus the mezz portfolio and then the funds as well?

Jon Grisham

Sure. So in the core, we are looking at $0.3 to $3.5 in terms of the $0.10 coming from that and related to the improved improved performance in the quarter. Related to the interest income, $0.01 to $0.02 some additional interest income for the mezz, maybe another $0.01 and then you know, G&A another $0.01 and then there's a combination of other items that make up the remaining $0.01 to $0.02.

Todd Thomas – KeyBanc Capital Markets

Okay. That's helpful. Ken, at City Point regarding your partners motivation to sale its interest there, have you had discussions with other partners either in down the funds, pension funds or other investors that are also looking to shed assets or reduce exposure where there could be other opportunities for something like this to happen?

Kenneth Bernstein

Sure, but let me make a very important distinction between an outside joint venture partner buy out which was the case in City Point, as opposed to our fund investors who are loyal long term investors with and our effective limited partner and they give us full discretion. I would view it as unlikely that you would see us enter into buy outs from those limited partners, as opposed to our various different joint venture that we have, where a various different joint venture partner might say, you know something, I either don't have the desire or the capital to continue through to completion of a project and that’s certainly a possibility. And then even more significantly is there are a host of joint venture partners out there, not our current one, but partners in undercapitalized projects that are going to need recapitalization where because of our relationships, because of the kind of, yields we do we can also participant in those type of transactions. So I do think that you will see a certain amount of we will call it joint venture partner fatigue and our ability to help recapitalize those partnerships is something that we’re certainly focused on.

Todd Thomas – KeyBanc Capital Markets

Okay. And then just lastly, it sounds like the corner, the property you have, the mezz investment with in New York here is doing pretty well. I was just wondering, you know what your thoughts are for that to potentially get refinanced by the end of year, you guys to get repaid?

Kenneth Bernstein

It is certainly possible. There is what I view and I’m speaking from my own point of view not from the borrowers, attractive first mortgage financing in front of us. So, a total refinancing of the entire project is something, I’m sure that the borrowers would look at and take into account the costs associated with replicating that first, vis-à-vis the cost of paying back or mezzanine. Thankfully, the project is doing well considering it was only a few calls ago we were all sitting around or certainly the outsiders were saying jeez, what kind of risk or impairment might your position have. Now we’re all sitting and saying jeez maybe you get repaid. Considering, we made this investment in 2007, 2008 when we were on excess capital and weren't comfortable investing that into junior equity long term, the fact that we’re parking this money at very high returns and now contemplating could it come back this year, could it come back next year, high class contemplation, certainly possible and I can't speak for the borrowers, but not as simple as it sounds.

Todd Thomas – KeyBanc Capital Markets

Okay. I understood. Thank you.

Kenneth Bernstein

Sure.

Operator

Your next question comes from the line of Quentin Velleley with Citi. Please proceed.

Quentin Velleley – Citi

Following on 72nd street, I’m just curious if you do get your preferred investment back, if you get the cash back, how should we be thinking about the rate deployment of that capital and what kind of returns you might be hoping to get as a replacement?

Kenneth Bernstein

In general, and I think that is the right way to think about it, in general, we have been successful whether it’s through the coinvestment into our fund or in other types of investments not unlike 72nd street, we have been able to redeploy that capital in very high teens long term returns plus, if you look at what our last fund acquisition Portland Manor, what the current yield to our 20% coinvestment it’s high teens right now. Now, I’m not saying we can replicate Portland’s everyday of the week and I’m not saying it gets there immediately on a given quarter, but from a value creation perspective, whether this gets redeployed into the $350 million our pro-rata share of the $350 million of dry powder that we have, keep in mind of that 350 Acadia is 20% or $70 million. So whether it goes toward that redeployment, whether it goes to another 72nd street like transaction, I’m relatively agnostic about it. I don't see us growing our mezzanine book. We felt at the time and where the risks and risk adjusted returns were, 2007, 2008 that that was the appropriate place to park some money. We think that there's another other potential opportunity that are created by doing those, kind of, mezzanine deals. So we’re glad we did them. The returns compared to almost any other 2007, 2008 transaction are going to look great. But whether some of it goes to mezzanine, some of it goes to redeployment into fund 3; I don't know that I really care, what I care about is that we do we deploy capital aggressively and profitably.

Quentin Velleley – Citi

Got you. Just the few questions on the guidance number, G&A came in a penny or so. Just wondering, sort of, where that came from and when we are modeling with that, should we be thinking that, that will be a recurring savings in 2011 and beyond?

Kenneth Bernstein

I mean, barring any – any exorbitant increases in management salaries, the $22.5 million is a good run rate number going forward. So, I think that is, that’s again, a good benchmark to use in terms of 2011.

Quentin Velleley – Citi

And where do these savings come from?

Kenneth Bernstein

Again keep in mind, we are talking about $400,000 to $500,000 and not millions of dollars and it is fairly broad based. Some in the area of, of the compensation line item but then really across the board in terms of G&A?

Quentin Velleley – Citi

Okay. And then lastly on guidance, I know that you exclude any Promote income. I’m just wondering, if you could give us a feel for what the probability of achieving some Promote income might be and what the amount might be?

Kenneth Bernstein

Well, we know that Fund I in total and this is in the sub has probably somewhere in the range of 6.5 to $7 million of embedded Promote income in terms of timing. Again, the reason it is not in our forecast – I really can't speak specifically as to the timing. Could something happen late this year conceivably but it could have easily happened next year. So when that $7 million hits the bottom line, again it is difficult to predict with any specificity.

Michael Nelsen

And so it is not just being coy but he is being a little coy. In Fund I, for example, you have assets ranging from redeveloped shopping center here in Westchester that when we monetized, we will monetize at the right price and on our terms. To the Kroger Safeway portfolio, which there are a series of events that play out over the next several quarters thankfully and that deal has been hugely successful.

That will determine how in the best way to monetize that investment and then finally, half of our Mervyn's investment where the timing of that is far less in our control. But the good news is for fund one, for instance, we are fully in our Promote. So those dollars are just simply a function of when the dispositions occur. Some of the other Promote or other income ranging from Albertsons to our New York urban pipeline, that will take some time. And we have to be very thoughtful about the best way to maximize the value. We are far less focused on its contribution to any quarters FFO than we are to the overall value creation.

Quentin Velleley – Citi

Okay. Great. Thank you.

Kenneth Bernstein

Sure.

Operator

Your next question comes from Michael Mueller from J.P. Morgan. Please proceed.

Michael Mueller – J.P. Morgan

Hi. Few things, first of all, John, can you run the numbers again on the, I guess, the Bon Ton termination and the new leases? How much is dropping off in the third quarter and then what's the amount that gets added back once they come online again?

Kenneth Bernstein

Yep. So let's just get straight to when it all comes back online to start with and the incremental income or NOI from the re-anchoring is $140,000.

Michael Mueller – J.P. Morgan

Okay.

Kenneth Bernstein

Which represents based on our NOI base about 30 basis points of portfolio NOI accretion.

Michael Mueller – J.P. Morgan

And is that 140 after you lose income or 140 above what's in place now before you lose it?

Kenneth Bernstein

That's net, right. So that's, that’s…

Michael Mueller – J.P. Morgan

Okay.

Kenneth Bernstein

net of the income that's replacing.

Michael Mueller – J.P. Morgan

Okay. So that's 140 positive net.

Kenneth Bernstein

Correct.

Michael Mueller – J.P. Morgan

Okay. Got it.

Michael Nelsen

But in terms of the dilute during the down time period for NOI, it is about $120,000 a quarter.

Michael Mueller – J.P. Morgan

Okay.

Michael Nelsen

Right. So, we expect Bon Ton will leave end of the next quarter. So it is 120,000 for the fourth quarter of 2010 which is about minus 25 basis points.

Michael Mueller – J.P. Morgan

Got it.

Michael Nelsen

NOI and then it is as much as the first six months of next year which is 240,000 of lost NOI temporarily.

Michael Mueller – J.P. Morgan

Okay. Got it. Okay. And then – so it seems like it is 120 plus 140. So once you get to Q3 next year you would have call it a net 250 pick up or something.

Michael Nelsen

That's correct.

Michael Mueller – J.P. Morgan

Okay. Got it. And then I guess, Ken, in your comments you were talking about you were seeing more activity in terms of the term you used was traditional Acadia transactions. I mean, should we read into that. Does that mean more buying something that is not really cash flowing as much up front and it’s really reposition opportunity as opposed to something that is more like Cortlandt where it’s cash flowing immediately and what did you mean by that exactly?

Michael Nelsen

It is – the short answer is yes. We were able to buy Cortlandt for $78 million during the dark days of the financial crisis and my hunch is that it would trade based on the increase in NOI that we have in place in the 110 to $120 million level and that probably isn't historically where you’ve seen us participate in terms of that price level.

So it’s either going to be transactions where there is a need for recapitalization. The asset could be stabilized like Cortlandt but there has to be some structural and capital restructuring necessary or it likely is not, it’s going to have some level of heavy lifting because there is still more capital chasing, highly stabilize existing cash flowing assets, than those that have hair on them that require redevelopments that require re-anchorings et cetera. And it is just a function of where we see the market.

Now, if we are going to take on more risks as we traditionally have to do. If we are going to do more heavy lifting, we have felt that our stake holders need be well rewarded for all of that and that is why you have seen us be patient to date and be disciplined to date because the fact is that the markets have been surprisingly stagnated in terms of the type of opportunities out there. Thankfully, we are beginning to see enough lender, enough partnerships, enough projects in need of recapitalization that we think we get to go back to work.

Michael Mueller – J.P. Morgan

Okay. And in terms of the heavy lifting, these types of projects with heavy lifting, is it more along the lines of Cortlandt where the heavy lifting is finding tenants and just kind of more of a quicker fix or something where if you, kind of, go back to four years ago where it is multiyear process of heavy lifting?

Kenneth Bernstein

Hard to tell. But not to make light of the great job that our leasing team did on Cortlandt, taking the vacant linens and things box and putting it in a bed, bath, the heavy lifting in Cortlandt was having the discretionary capital and the guts to step up in what we all remember were really dark days and close the transaction. I don't think that we’re going to get the same reward because the risks aren't there. The risk continued melt down the financial institutions. On one of the calls that concern on Cortlandt was, could you put any type of a first mortgage on real estate.

Some of those risks are now fortunately greatly reduced, so it is going to be re-anchorings, it might be re-development, it’s not likely to new – brand new Greenfield development because we still believe overall that in the retail sector, the best performance will come from high-barrier entry assets in supply constraint markets. And if it means that we acquire those assets and have to restructure balance sheets and do debt restructures great but also if it means we have to redevelop as long as we’re getting well paid for the risks we’re taking, we have the capability to do that, we can do that as well.

Michael Mueller – J.P. Morgan

Okay. Great. Thank you.

Operator

Your next question comes from the line of Craig Schmidt from Bank of America/Merrill Lynch. Please proceed.

Craig Schmidt – Bank of America/Merrill Lynch

Thank you. Given the positive movement at CityPoint and the sort of modest stagnant acquisition environment, is it possible that you could have more investments in development and redevelopment than acquisitions over the next two years?

Kenneth Bernstein

You know, Craig, it is hard to know and we don’t sit there and precisely balance how many new developments versus – although there is certainly a limit to the amount of any one type of food group that we want to spend all of our resources on. What I would say is we are seeing a combination right now. We’re seeing lenders say to either to their borrower or to us, a year ago we were not sellers of our position of our debt at any price because of the financial implications.

Now, we have the ability to ask what I view as rationally and in the instances where there is borrower fatigue, if you will, where they're saying you know something this borrower is not going get it done or this partnership needs recapitalization. We are seeing opportunities there and that wouldn't necessarily fall into the category of heavy lifting redevelopment. The flip side is we are hearing both from our national tenants and from various different owner of properties and projects.

The interest in having a well capitalized team that can put both capital and complete a project that has the balance sheet and the experience to do it and so we will periodically do that as well. And then finally, remember that even though we are hopefully past the toughest of times vis-à-vis the retailing environment. There may also be retailers whose assets are worth more, their real estate is worth more than the retailer themselves and that's a space we have played in, in the past and that's also a space we could play in, in the future.

Craig Schmidt – Bank of America/Merrill Lynch

Great. And just real quickly, do you know when (inaudible) is actually opening?

Kenneth Bernstein

I apologize, I don't. It shouldn't be that long off. I believe it is this year.

Jon Grisham

It should be – it should be – I think it is before November but I don't know.

Craig Schmidt – Bank of America/Merrill Lynch

But in March, you pretty much turned it over to them, so it is them that controls that, right.

Kenneth Bernstein

Correct. And, and again we are the Mezzanine there. So when we say we the borrower.

Craig Schmidt – Bank of America/Merrill Lynch

Okay. Thanks.

Kenneth Bernstein

Great. Thanks.

Operator

Your next line comes from Sheila McGrath from KBW. Please proceed.

Sheila McGrath – KBW

Yes. Ken, I had a couple of questions on CityPoint. It seems you were able to reduce the land costs pretty substantially there from 120 to 74 million for the venture. I’m just wondering what the dynamics were. Were you the only person that they could sell to or were they in a hurry to sell? How did that all happened?

Kenneth Bernstein

A combination of a bunch of events. Some of which are worth giving some color on and I will do now and others that frankly are secondary to us getting the project moving forward. So probably not appropriate for the call but in general, as I outlined, they owned 25% of the retail. So you ought to assume that was a highly ill liquid, far less transferable piece. And then as we laid out, they owned a million square feet of residential layer right on top of that commercial which also rendered that far less liquid.

So to say that we were absolutely the only opportunity for them, I think is an overstatement. We had been a very good and transparent partner through the process. There had been a change in terms of their management, the team that was handling that. We’d outlined that in the past and I think there was a desire for them to move past this and there were certain time hurdles that incentivized them to do it.

So there was a general understanding in agreement as to where we thought long-term valuation where we thought land valuation would be. But we are committed to this project, so we weren't going to simply allow for the liquidation of it. And they couldn't force that unless they were somewhat constrained into that process and we are now comfortable and satisfied that we are in a very good position to push this forward. So it works for us. I think that joint venture partners accomplish their goal and so now we all get to go about our business happily.

Sheila McGrath – KBW

And then on the residential component, is your plan to sell that or you want to stay in on that?

Kenneth Bernstein

So what – what we have done and you can see we’ve laid it out into three phases, which now that we control all of it, we can do that. We can minimize or reduce the footprint of the pure retail component that they just wanted to and then that leaves a simple Phase III of a footprint for a pure residential component which our view of the world now having learned a lot from the past several years is keeping it simpler, probably makes sense.

We are not a residential developer. There are a host of good and great residential developers, who I think that’s in highest use would be for them to be involved. The precise timing of when that would occur and the precise structure and for a whole host of reasons, I won't add to the speculation right now. But when you look at the 3,000 residential units that have recently come online and the positive traction well in excess of, as most of their expectations as I speak to those developers, the opportunity at some point in the not distant future for someone to come in not at 2007 land prices but at rational 2011 prices or 2012, I think is going to be pretty exciting.

Sheila McGrath – KBW

Okay. And one last question on the promote. So in the supplement, you give specific details on Fund I Promote, I was just wondering if you can give us an idea of how you or frame work of how you think that people should view Fund IIs promote at this point. And if you plan on you know, kind of hammering out any detail and additional detail in the supplement on that?

Kenneth Bernstein

The way to think about it right now, Sheila, is if you look at Fund II, you have the RCP investments and you have the urban redevelopment platform. And looking at the RCP investments, to date we have invested $50 million and we have realized 50 million of profit. We have gotten a 2X. So, to the extent we can get our equity back from the urban redevelopments then we are ahead of the game. And potentially to the extent that we have covered the preferred return, there's potentially promote there in fund too. To the extent we make money on the urban redevelopments, even more promote.

Michael Nelsen

Don't sound so surprise, Jon.

Kenneth Bernstein

A year ago, it wouldn't have been so easy to say, right? And obviously to the extent that we make more profit on the RCP investments, more promote as well. So, a little bit early to be throwing out numbers and ranges, but, but conceptually that's certainly is the way we look at it and think about it right now.

Sheila McGrath – KBW

Okay. Thank you.

Operator

Your next question comes from the line of Andrew DiZio from

Janney Montgomery Scott. Please proceed.

Andrew DiZio – Janney Montgomery Scott

Yeah. Thank you, good afternoon. Last week’s A&P said they are publicly looking to raise capital through sale lease backs and we are hearing that other gross grocers are looking at similar transactions. That’s the transaction they’ve been involved in before. Obviously, can you comment on whether you are looking at potential grocery deals?

Kenneth Bernstein

I can't comment on any specific tenants. You can assume if there are interesting real estate plays embedded in retailers, that we certainly would be looking at that and A&P is a company we know well, their existing tenants of ours, we have done a lot of different businesses with them. You may recall that the A of PA associates – Aaron Malinsky was there former Vice Chairman, so. We watch most of these retailers. First and foremost because they're tenants of ours, but also because as often as not, whether it is due to financial stress or opportunistically, these tenants can be a source of good to great investment opportunities.

Andrew DiZio – Janney Montgomery Scott

Okay. That's fair. Thanks. And then just one other question, can you talk all about how lease ups are going on the office portion of Fordham?

Kenneth Bernstein

It is taking time because we are dealing primarily with the agencies and various different city state tenants. And it is taking more time than I would like. But the good news is, it’s heading in the direction that we pre-formade [ph]. It appears as though because if for no other reason, then the Fordham office building is the only new construction in that area of the Bronx that we will achieve our goals. But dealing with the bureaucracies, especially at this time, is something that take a lot of patience from our time and they are doing a good job of pushing that along.

Andrew DiZio – Janney Montgomery Scott

Okay. Thank you.

Kenneth Bernstein

Sure.

Operator

Your next question comes from the line of Rich Moore from RBC Capital Market. Please proceed

Rich Moore – RBC Capital Markets

Hello, guys. On the OP-spends [ph] front, is the lower operating expense in the quarter all due to lower bad debt expense?

Kenneth Bernstein

Majority of it is, Rich. There was some reduction in Cayman and also real estate taxes. We were successfully – appeals in assessments in the portfolio, but the bulk is indeed due to bad debt expense.

Rich Moore – RBC Capital Markets

Okay. Because John and I had noticed that tenant reimbursement had dropped pretty substantially as well. I know you guys are good but I am sure you weren't getting your tenants to pay for your bad debt expense. So as we look forward, to both of those line items pick up, you think we balance in Q3, in terms of operating expenses and commensurately in terms of tenant reimbursement as well.

Kenneth Bernstein

I think that in terms of operating expenses that will vary from quarter-to-quarter. My expectation is that bad debt expense will continue to trend favorably year-over-year and I guess I’m trying to get tenants to reimburse us for bad debt expense, Mike, we should think about that. I think that’s what we expect, Rich, going forward

Rich Moore – RBC Capital Markets

I think you guys will be heroes if you figure out how to do that. Now, on the maturities of the – I the lines of credit for the funds mature next year. Is that right?

Kenneth Bernstein

Yes.

Rich Moore – RBC Capital Markets

And then how – I mean I guess A, you are having discussions on those lines already and really more what I’m interested is, how are the lenders perceiving lines of credits for those kinds of things as opposed to directly for the company itself?

Michael Nelsen

Yeah, we are in fact having conversations and what you will find is they're looking at those – a little bit riskier than the real estate. So I think you are going to see, we are not going to be able to replace these lines of the favorable rates that we are at today and clearly in front through that.

Kenneth Bernstein

Rich, The Fund III for example, these are acquisition like and they get replaced with the equity as we call it down. So these aren't long-term financings that would have any meaningful implications in terms of our total return, whether they go from their very tight spreads that we were fortunate enough to have, great but that doesn't drive our acquisition return and a conversely if it widens to a couple hundred basis points over, it wouldn't have a negative impact. And differentiated from corporate lines at the company level where there is a longer term carrying costs of that.

Rich Moore – RBC Capital Markets

Okay and then Ken, the capacity would probably be cut somewhat as well, I guess, I’m right.

Kenneth Bernstein

Yeah. They are just not relevant. In other words, when we say we have 350 million plus or minus, the buying power the size of the line doesn't increase it. And the fact that the line were to go away, doesn't decrease it. And that's our buying power. The use of the line, historically and generally, it is just to facilitate the acquisition, so we came very close short time period, close as we did in Cortlandt, for instance. And then subsequently put more traditional debt financing in place.

That's how we have historically used those lines. That’s how they are supposed to be use and thus whether you borrowing at 1% or 3%, from 90 or 120 day is not a key driver. Some people use their lines differently and then it can be and then it is worth thinking about but that's not historically been our mode of operation.

Rich Moore – RBC Capital Markets

Okay. Good. I got you. And then on the spaces like Bon Ton, was Bon Ton expiring? And I guess basically you guys went to them and said let's go ahead, move this more and more quickly or are you guys actually finding tenants that have some duration left at the lease and you are talking to them and say this is a bad idea for both of us, why don't you leave. What is exactly happening there?

Kenneth Bernstein

It runs the gamete. Bon Ton, my recollection was it had a significant amount of lease term. And you can assume that our team has on their watch list, good and bad throughout our portfolio and as we do our monthly and quarterly reviews, we are analyzing where there's opportunity embedded and there's a host of those. We talked about some of them in the past, our cross roads center feels like it has permanently embedded opportunities of below market anchors and where there's exposure the other way.

And then in our on going conversations with the tenants, we’ll take their faults so they make our faults to the different opportunities. In the Bon Ton case, I think there was a dialogue that predated the recession, as to different potential opportunities. So when we know that, for – when we were afforded an opportunity, a look at our lease few can move quickly and put in replacement tenants.

In the case of the Bon Ton deal and only at Acadia, would 165,000 square foot box have as much magnitude moving a needle. But we felt that we wanted to have it pre-leased before we would take that lease back and we did that accordingly. In other cases, you’ve seen us take the box back, some time even pay for it to get it back and take the leased up risk.

We may do some of those as well. And what's nice is, as the economy gets better, our retailers are coming to us and saying we recognize we can't simply wait the next circuit city to provide us with additional real estate, if could get us into this center or into this property, we're there for you. And our team is very good then about signing or pre-signing those up and then negotiating. So Richard it will run the gamete and as things get better, we hope to see more and more opportunities to harvest embedded growth that way.

Rich Moore – RBC Capital Markets

Okay. And you didn't have to pay Bon Ton to get out, right?

Kenneth Bernstein

No. As Jon pointed out they made a small payment to us but it helped.

Rich Moore – RBC Capital Markets

Okay.

Kenneth Bernstein

Yes.

Rich Moore – RBC Capital Markets

All right. Great. Thanks, guys.

Kenneth Bernstein

Sure.

Operator

Your next question is a follow-up question from Christy McElroy from UBS. Please proceed.

Ross Nussbaum – UBS

Hi guys, it is Ross here with Christy. A couple of things, I just want to confirm. At city point, all of the costs to fund Phase I and II are going be done at a Fund II, is that correct?

Kenneth Bernstein

Correct. This case I missed both. There's Phases I, II and III but it’s all capitalized by Fund II.

Jon Grisham

I just wanted to be clear on that because, obviously, Fund III is the one with more capacity but Fund II is taking care.

Kenneth Bernstein

Yeah. We tend not to mix.

Ross Nussbaum – UBS

Okay. Then with respect to Funds III, you've put give or take a little under 100 million of equity to work. You've got 500 million to play with. So a 400 million differential and you've got two year with the clock ticking. Do you believe that you are going to put 400 million of equity to work which could be upwards of 800 million of total capital in two years or you are going to have to be asking for extensions on that investment period from your partners?

Kenneth Bernstein

First let me clarify the numbers, which is even though, you are correct is 400 remaining and this goes to that line of credit conversations. We view it really as only 350, in other words 50 are going into the existing investment. So we feel we spent 150 of the 500 and there's 350 remaining, but that 350 could be up to a billion dollars of buying power, Ross. So then the question is do you think you can do a billion dollars of buying power of acquisitions in 23.

Ross Nussbaum – UBS

In 23.

Kenneth Bernstein

Right. And if you extrapolate what we’ve done in Fund III over the past year, which is euro, you say well that doesn't look too likely. If you look at our historic run rate, both and take into account our performance, which has been quite strong relative to our fund peers et cetera, you can see both in terms of volume and returns we ought to be. But to break it out, I think there's four possibilities and you touched on a couple.

One is that we spend the money. Two is that we don't and we go to the investors for an extension, three is that we don’t and we simply create a fund four. The fourth and the only one that’s unacceptable to me is that we rush to put this money to work simply for the sake of putting it to work because we’re in this business to create for our shareholders and stakeholders profits that then result in meaningful promote value to our shareholders.

So a few unwise investments really takes all the fun out of this. I absolutely am concerned about how long it has taken for in general the investment environment to ripen and surprised and frankly, I have been wrong. I thought we would see it financed but our focus is going be to find great investments and then whether it is strategy one, two or three. How we deal with whether we spend it or not, I don't really care as long as we avoid number four.

Ross Nussbaum – UBS

So do you think it is fair to say that your investment focus is on larger deals than you may have traditionally looked at in the past in that doing a bunch of 10 and $20 million interesting deals just frankly doesn't do anything for anybody in that fund?

Kenneth Bernstein

Yeah. We didn't do a lot of pence in Fund II either and Mervyns and Albertsons, I don't know even know how many zeros above ten you have to add to it. I will go back to – our focus is going to be to do profitable deal at a $10 million level, it’s not about how do we get 350 to work as much as it takes time and effort to do a $10 million deal as it does of $50 million deal or 100. So if you look at Fordham, if you look at CityPoint, if you look at our participation in Mervyns et cetera, you get a decent sense of size and my hunch is those are going to be the size deals that you will see in terms of equity deployment.

Ross Nussbaum – UBS

Do you have anything under letter of intent or contract at the moment that you didn't close on and announce at this call?

Kenneth Bernstein

Is it just the two of us talking or …

Jon Grisham

No. Ross, you know, we don't comment on that.

Ross Nussbaum – UBS

And lastly, I don’t know if I missed this, what is the targeted deals on CityPoint phase I assuming some reasonable allocation of overall land or ground lease for us.

Kenneth Bernstein

It is a little complicated to do it that way because as I mentioned in my prepared statement, it is likely that Phase I will have assuming we do, the same type of anchoring that we had originally had contracted for you, may recall a few years ago, we had a deal with target that spanned phases one, two and three. And our anticipation is that certainly phase one and two would have that. So I am not sure we broke it out specifically, but our expectation would be – if you try to do that, I’d be surprised if you didn't see a number somewhere in the eights.

Ross Nussbaum – UBS

Thank you.

Kenneth Bernstein

Thanks, Ross.

Operator

There are no further questions at this time. This concludes the question-and-answer portion of the call. I will now turn the call back over to management for closing remarks.

Kenneth Bernstein

Thank you everyone for taking your time in the summer. I look forward to seeing everybody soon. Thank you.

Operator

Ladies and gentlemen, this concludes the presentation. Thank you for your participation in today's conference. You may now disconnect. Have a great day.

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Source: Acadia Realty Trust Q2 2010 Earnings Call Transcript
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