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Inland Real Estate Corporation (NYSE:IRC)

Q2 2014 Earnings Conference Call

August 7, 2014 3:00 PM ET

Executives

Dawn Benchelt – Director, IR

Mark Zalatoris – President and CEO

Scott Carr – EVP and Chief Investment Officer

Brett Brown – EVP, CFO and Treasurer

Analysts

Paul Adornato – BMO Capital Markets

Todd Thomas – KeyBanc Capital Markets

Juan Sanabria – Bank of America

Tammi Fique – Wells Fargo

Operator

Good day and welcome to the Inland Real Estate Corporation’s second quarter 2014 earnings conference call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Dawn Benchelt, Director of Investor Relations. Please go ahead.

Dawn Benchelt

Thank you for joining us for Inland Real Estate Corporation’s second quarter earnings conference call. The earnings release and supplemental financial information package have been filed with the SEC today and posted to our website, www.inlandrealestate.com. We are hosting a live webcast of today’s call, which is also accessible on our website.

Before we begin, please note that today’s discussion contains forward-looking statements, which are management’s intentions, beliefs, and current expectations of the future. There are numerous uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. For a discussion of these risks factors, please refer to the documents filed by the company with the SEC, specifically our Annual Report on Form 10-K for the year ended December 31, 2013.

During the presentation, management may reference non-GAAP financial measures that we believe help investors better understand our results. Examples include funds from operations, EBITDA and same-store net operating income. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings release and supplemental dated August 7, 2014.

Participating on today’s call will be, Mark Zalatoris, IRC’s President and Chief Executive Officer; Chief Financial Officer, Brett Brown; and Scott Carr, Chief Investment Officer.

Now, I’ll turn the call over to Mark.

Mark Zalatoris

Thanks Dawn, good afternoon everyone and thank you for joining us. On our call today I’ll comment on our second quarter results and joint venture activity. Scott will then discuss transaction activity, portfolio performance on leasing activity during the quarter. Finally Brett will review our balance sheet and capital markets activity.

As we look back on the first half of the year, we believe we have made measurable progress on our 2014 objectives. These objectives are to one, continue to enhance portfolio, performance and value; two, increase the size and diversification of our operating platform; and three, improve our financial flexibility and credit profile.

In our remarks this afternoon, we will highlight our achievements in each of these areas on why we believe we are well positioned to continue to make progress towards these goals in the remainder of 2014 and beyond. This morning we reported recurring FFO per share of $0.23 for the second quarter of 2014 representing an increase of 9.5% over the second quarter of last year, driven by gains in occupancy and double digit rent spreads.

These gains are the result of our aggressive leasing efforts and repositioning initiatives we have been executing throughout our portfolio. We leased more than 529,000 square feet within the total portfolio during the quarter, with strong spreads on new and renewal leases.

This leasing volume was an increase of nearly 11% over the average of the prior four quarters. As a result, we achieved significant increases in total portfolio leased occupancy, which rose to 95.8% at quarter end, the highest rate we’ve reported in almost 7 years.

Additionally, financial occupancy increased to 94.3% at mid-year, which is the highest level reported since the start of 2008. Well I could note that the delta between total portfolio leased and financial occupancy narrowed to 150 basis points to quarter end, which is now back in line with historical spreads prior to the recession.

Finally, I’m pleased to report that we have improved our cost of capital, liquidity and financial flexibility with the recast and expansion of our unsecured credit facilities. Brett will provide details about the amended agreement during his comments later in the call.

We believe these substantial increases on leasing volume, rent growth and occupancy, can be attributed to our leasing and portfolio management strategies, which lever our significant presence in core markets, strong portfolio demographics and the strong retailer relationships. As we approach peak occupancy, we will continue to look for opportunities within our portfolio for incremental value creation.

Turning to acquisitions, we continue to see transactions that are additive to the overall size, quality and diversification of our operating platform. During the quarter, we acquired Phase I of the Newport Pavilion Shopping Center for our joint venture with PGGM located in the desirable Cincinnati MSA newly developed Class A asset as an outstanding market position and attractive tenant line up of leading national retailers.

With this acquisition to-date we’ve acquired $681 million of assets for our joint venture with PGGM. At full investment the PGGM joint venture portfolio was expected to total $800 million to $900 million in gross asset value and provides us with a captive acquisitions pipeline of high quality properties and infill locations.

Joint venture agreement gives us the right to acquire 20% of PGGM’s 45% ownership interest annually beginning in 2016. To augment acquisitions, we have formed joint ventures with developers with the intention of acquiring brand new shopping center product at a discount to market pricing.

We believe this is an attractive option for us at this point in the cycle. An example of this activity is the Evergreen Promenade development in Evergreen Park, Illinois where we expect to deliver space to anchor tenants Mariano’s and PetSmart toward the end of this year.

Additionally, we’ve formed a joint venture with MAB American Retail Partners, the developer who has an existing retail platform and relationships in the Southeastern United States that we expect to use to grow our presence in that region of the country. Today we have five sites under control and continue to work on entitlements for the leases with the glory of acquiring our first development by year end.

Through these joint ventures, we believe we have positioned our company for transformational growth well locking in attractive returns and avoiding competitive bidding pressures. We will continue to work and supplement our joint venture activity with on balance sheet acquisitions and what is currently a heated acquisition environment.

Although overall low cap rate environment makes external growth more of a challenge, we’ve been successful in sourcing attractive opportunities by leveraging our deep knowledge of our core markets and long-term relationships with experienced developers.

In summary, we are pursuing a balanced creative approach to growth that is additive in terms of portfolio, quality and diversity while meeting our blended yield requirements. We are acquiring competitive rates in primary markets and balancing purchases of market downing assets and secondary markets where we can get better yields.

We’re purchasing stabilized properties as well as value add assets, where we can increase income through lease up or adding GLA and we are partnering with developers in both of Midwest and Southeast to acquire state-of-the-art product and the discount to market pricing.

Finally, I would like to note that we are funding this growth activity first with recycle capital from proceeds and sales of non-core assets, which is the most attractive source of capital availability to us.

Now, I’ll turn it over to Scott. Scott?

Scott Carr

Thank you, Mark and hello everyone. In my comments today, I will provide an update on our acquisition and disposition activity, discuss our operating and leasing results for the second quarter and review our current redevelopment and development projects which are our can list to provide long-term incremental growth for our company.

In the second quarter, we acquired Phase I of the Newport Pavilion Shopping Center located in Newport, Kentucky within the Cincinnati MSA for our PGGM joint venture portfolio. Newport Pavilion is in a fortress location with high sales volumes and best-in-class tendency.

The total acquisition cost is $80 million with $43.3 million being paid for Phase I and the balance subject to our scheduled closing of Phase II in October of this year. Newport Pavilion totals 337,000 square feet including ground leases and is 98% leased to Kroger, Michaels, PetSmart, Ulta, Famous Footwear, Dick’s Sporting Goods, TJ Maxx and a variety of complimentary retailers, service users and national chain restaurants.

The center is also shadow-anchored by a 134,000 square foot Target store. Situated one mile from Downtown, Cincinnati in a densely-populated infill location, Newport Pavilion is the third asset we have acquired in the Cincinnati MSA, which we have targeted because of its strong demographics and diverse economy.

Overall, we continue to see very strong competition for retail assets that meet our quality and location requirements. In this competitive environment, we remain disciplined in our underwriting and we’re utilizing a variety of sourcing strategies. As mark noted, we are balancing acquisitions of both stabilized and value add assets with new development in both primary and secondary markets to achieve our blended return requirements.

We continue to review a large pipeline of opportunities with approximately $100 million in assets under contract or letter of intent in the Midwest and Southeast and others in negotiation. Timing and certainty of closing are dependent on a number of factors including completion of our in-depth due diligence process.

With that said, we do expect to announce additional investments over the next several quarters. While the competition for high quality retail assets requires us to imply creative acquisition strategies to advance our growth objectives. The flipside is that we can take advantage of robust buyer demand to recycle capital through dispositions of non-core assets.

During the quarter, we sold four properties for a total price of $42.1 million and recorded net gains on sales of $10 million. For 2014, we had anticipated dispositions in the range of $50 million to $70 million, which is in line with the level of sales completed last year.

Year-to-date we have sold seven non-core assets for a total sales price of $65.2 million and recorded net gains on sales of $22.6 million. While we have achieved our 2014 target for disposition, capital recycling remains an ongoing strategy for us to continually improve the overall quality and growth profile of our portfolio.

Turning to portfolio results for the quarter, for the consolidated portfolio which includes 81 properties same-store net operating income increased 0.3% for the quarter and 1.1% for the first six months of the year. This was in line with our expectations that income from certain new leases will be weighted towards the second half of 2014 with a full year benefit of their leasing activity recognized in 2015.

As a reminder, we are proactively capitalizing on retailer demand for space and last year took offline approximately 350,000 square feet for redevelopment and repositioning. The space that came back into production towards the end of the quarter, help to drive consolidated same-store financial occupancy to 93.2% as of June 30, an increase of 260 basis points over one year ago.

Rental revenue from these tenants was not fully captured in the quarter and will be realized in the latter half of this year. Our asset management strategy remains focused on replacing underperforming retailers and creating opportunities for new leasing in the portfolio.

To-date this year we have taken an additional 117,000 square feet offline to pursue repositioning. For the total portfolio which includes 135 properties, leased occupancy was 95.8% representing increases of 60 basis points and 140 basis points respectively over the prior quarter and one year ago.

Of note, total portfolio leased occupancy at quarter end was the highest since the third quarter of 2007. Financial occupancy was 94.3% representing increases of 80 basis points over prior quarter and 250 basis points over one year ago.

Driving this occupancy growth was another quarter with strong leasing volumes. During the second quarter, we executed 76 leases aggregating more than 529,000 square feet within the total portfolio. Of these 53 were renewal leases for over 421,000 square feet with average base rents that increased 10.8% over the expiring rents. And 10 were new leases for over 70,000 square feet with average base rents that increased nearly 15% over expiring rents.

We also signed 13 non-comparable leases for nearly 38,000 square feet at an average base rent of $16.54 per square foot. This marks our 14th consecutive quarter of positive spreads on new leases and extends our history of always achieving positive rent spreads on renewals within the total portfolio.

Leasing demand remains steady across all retail categories, including national apparel retailers, specialty retailers, local and franchise restaurant operators and non-retail service providers.

Specific to our anchored tenants, anchor-leased occupancy was 98.8% at quarter end up 70 basis points and 230 basis points respectively, over last quarter and one year ago. Given the high level of demand for space by anchored tenants and nearly 100% occupancy of anchor space within our portfolio, we are actively creating opportunities to displace underperforming tenants and back there them with stronger retailers at high rents.

Now I’ll provide a brief update on our progress re-tenanting former Dominick’s stores in the Chicago market. At the start of the year, we had five operating stores that closed as a result of Safeway’s decision to exit the Chicago MSA. One property was sold and three Dominick’s leases have been assigned to better performing grocers including Mariano’s and two independent grocers.

The remaining stores in Schaumburg attach Chicago submarket and we are pursuing non-grocery tenants for this location. Overall, we believe the exit of Dominick’s from the Chicago market has been a net positive for our portfolio. In two of our centers the entry of the new grocer as spread transformative leasing activity that with significantly enhanced the long-term value of our assets.

Specifically at Woodland Commons and Buffalo Grove of Illinois, we leveraged the replacement of Dominick’s by Mariano’s to attract Marshall’s as a co-tenant in the center. We terminated an existing lease with a day care center, in combined existing shop space to create a junior anchor box from Marshall’s.

With Marshall’s opening anticipated in early 2015 we’re actively marketing to other national retailers to further enhance the retail mix at Woodland Commons. Likewise Thatcher Woods and River Grove of Illinois, the former Dominick’s lease has been assumed by an independent grocer that is a proven operator in the Chicago market.

In this instance, we terminated an in-place lease with CW Price and send a new lease with Ross Dress for Less at an average base rent that is 24% higher than the rent paid by the former tenant. This center is now 100% leased.

These are two examples of how we’re replacing and underperforming retail with a stronger one drives complimentary leasing activity, revitalizing and enhancing the value of the center.

We have now signed 10 leases with Ross, since they entered the Chicago market, where Ross as said they may eventually operate as many as 85 to 100 stores. Our traction with Ross in the Chicago area illustrates how we leverage our strong locations in top submarkets across the MSA to accommodate demand from its standing retailers.

We believe our success with anchor leasing is likewise benefiting our non-anchor tenancy. Non-anchor leased occupancy was 88.7% at quarter end, an increase of 50 basis points over the prior quarter. 70% of new non-anchor leases were signed with national retailers.

One of the new non-anchor leases executed during the quarter was with PetSmart for 8,000 square feet at the Marketplace at Six Corners in Chicago. The new lease was signed at an average base rent that is 38% higher than the rent paid by the former tenant and brings the center to 100% leased occupancy.

As we have communicated in the past, we continue to see strong demand from new stores from 5,000 to 8,000 square foot apparel retailers. During the quarter, we signed a lease with Rue 21 for 6,700 square feet at Four Flags Four Flags in Niles Illinois and a rent that is 19% higher than the prior tenant.

In addition, at Orchard Crossing in Fort Wayne, Indiana we relocated two shop tenants and combined their space with other shop space to create an 8,000 square foot opportunity to bring five below into the center at a rent that is 14% higher than the prior in place rent.

Turning to our development and redevelopment activity, at our Evergreen Park Promenade development in Evergreen Park, Illinois construction is progressing well and we are on track to deliver space to anchors PetSmart in August and Mariano’s in October.

The PetSmart store is expected to open in the fourth quarter 2014 with Mariano’s expected to open in the first quarter of 2015. At Dunkirk Plaza in Maple Grove of Minnesota, we expect the four tenant building we are constructing to be completed by the end of August and look forward to the opening of Caribou Coffee, Hallmark, Jersey Mike’s and Dollar Tree over the next several months.

And finally, at Aurora Commons in Aurora Illinois, we have redeveloped a former jewel store to accommodate three new junior anchor retailers. I’m pleased to report that new tenants Ross Dress for Less and Fallas Paredes opened for business and began paying rent in July. We expect to finalize a lease for the remaining redeveloped space during the third quarter.

In closing, we continue to diversify and upgrade our portfolio and improve our occupancy and tenant quality while driving strong spreads on new and renewal leases. In addition we are increasing the long-term income potential of our current portfolio through development and redevelopment activity.

I’ll now turn the call over to Brett, who will discuss our balance sheet and financial results.

Brett Brown

Thank you, Scott and good afternoon everyone. I’ll begin my comments today by noting that the improvements we’ve achieved in portfolio size, quality and occupancy have provided significant benefits as we work to enhance our financial flexibility and liquidity.

To illustrate, I would like to review our financing activities since the last earnings call. During the quarter, we closed the construction loan for our joint venture with PGGM totaling $20.1 million with the variable rate of 225 basis points over LIBOR and maturity date of May 2016.

The loan provides additional liquidity to fund construction cost for the development of the Evergreen Promenade Shopping Center in the Chicago MSA. And subsequent to quarter end, we closed amended and restated unsecured credit facilities totaling $475 million with an expanded lending group that now totals 8 banks with the addition of Fifth Third Bank and associated bank.

The amended credit facilities include a $275 million unsecured revolving line of credit with a four year term plus a one year extension option and a $200 million unsecured term loan with a five year term. The new agreement includes revised pricing grids with rates that lower our effective interest cost by 5 to 15 basis points for the revolver and 10 to 20 basis points on the term loan depending on our leverage levels at the time of borrowing.

In addition, the new agreement applies a lower capitalization rate to the underlying collateral and improves several financial covenants. The improved terms we’ve negotiated significantly enhance our financial flexibility by providing additional liquidity lowering our cost of debt and expanding our average debt maturities.

Additionally, we have continued to focus on unencumbering assets, looking for opportunities to pay-off secured debt at the earliest opportunity with little to no prepayment penalties using our revolver and cash on hand. In June, we repaid the $11.3 million loan on Marketplace at Six Corners in Chicago in advance of its September maturity date.

For the remainder of 2014, excluding the two loans on Algonquin Commons our debt maturities include just $11.3 million of mortgage loans and $29.2 million of unsecured convertible notes that can be called by or put to the company in November. Our long-term goals include achieving an investment grade profile and we continue to improve key financial ratios as we execute on our strategies to enhance our portfolio performance and reduce leverage.

At the end of the quarter, our unsecured debt to total debt ratio including our share of joint venture debt was 38.5%, an improvement of 7 percentage points over the second quarter of 2013 metric of 31.5%. Our debt to total market cap was 47.2% at quarter end, an improvement of 20 basis points over one year ago.

Our net debt to recurring EBITDA including our share of unconsolidated joint ventures was 7.0 times for the quarter, an improvement from 7.2 times for the same period in 2013. And our fixed charge coverage ratio pro rata consolidation, improved to 2.6 times compared to 2.4 times for the year ago quarter.

Turning to our liquidity position after expansion of our credit facilities we’d now have $160 million available under the revolver and an additional $200 million available under the [indiscernible]. Our most attractive source of capital is proceeds from our disposition program which we continue to recycle into larger, higher quality properties with stronger long-term growth profiles.

We also have access to incremental liquidity through our investment plan at the market equity program and institutional partner capital. Next I’ll review operating results for the quarter.

On a per share basis, we reported FFO of $0.23 for the second quarter of 2014 compared to $0.28 for the same period of 2013. Our recurring FFO per share was $0.23 per diluted share for the three months ended June 30, 2014 compared to $0.21 for the three months ended June 30, 2013.

Recurring FFO rose 9.5% year-over-year primarily due to higher property NOI from the consolidated portfolio and lower income tax expense partial offset by higher interest and G&A expense. The variance between FFO and recurring FFO was due to gain from settlement of receivables and lease termination income both totaling $6.4 million that was recorded in the second quarter of last year.

For the quarter, we recorded total revenue of $48.8 million, an increase of $7.5 million or approximately 18% over the prior year quarter. Rental income increased by $6.1 million or 21% primarily due to the consolidation of properties formally held in the joint venture with NYSTRS.

Tenant recoveries for the quarter were increased by $2 million year-over-year or 20% due to an increase in property operating and real estate tax expense primarily from the consolidation of the NYSTRS portfolio.

I would like to note that on a year-to-date basis, our recovery rate increased substantially driven by a continued gains in occupancy. On a same-store basis which excludes bad debt expense, our tenant recovery rate was 82.1% for the six months ended June 30. This was an increase of 220 basis points over 79.9% for the first half of last year.

Fee income from unconsolidated joint ventures for the quarter was $1.3 million a year-over-year decrease of $651,000 and that’s due to lower transaction fee income from the IPCC joint venture. Total expenses for the quarter were $40.2 million, an increase of $7.2 million or approximately 22% over the second quarter of 2013.

Property operating expense, real estate tax expense and depreciation and amortization expense all increased primarily due to the consolidation of NYSTRS joint venture assets. I’ll note that operating expense also rose due to higher snow removal cost and weather related maintenance expenses.

General and administrative expense increased by $700,000 year-over-year primarily related to additional staff required to manage our expanding portfolio. Our annualized G&A expense as a percentage of total assets under management was 0.8% for the quarter consistent with the last few quarters.

Interest expense for the quarter was approximately $8.9 million an increase of $600,000 over the prior year quarter and again the increase was due to consolidation of NYSTRS joint venture assets, as well as higher balances maintained in the line of credit during the quarter, partially offset by a decrease in mortgage interest from [indiscernible].

Additionally, income from discontinued operations decreased by nearly $4 million from the prior year quarter, this is because the second quarter of 2013 included lease termination fees related to the former Cub Foods Store in Buffalo Grove. As I discussed on our last call, as a result of our early adoption of the accounting standards update for reporting discontinued operations, operations from properties sold after January 1, 2014 are included in gains on sale of investment properties.

Therefore for the quarter we recorded a gain on sale of investment properties of $10 million, which includes the gains recognized in conjunction with the disposition of four assets during the quarter.

Finally, turning to guidance, we continued to expect recurring FFO per share to range from $0.93 to $0.97 consolidated same-store net operating income to increase between 2% and 4% and consolidated same-store financial occupancy at year end to range from 91% to 92%.

With that, we’ll open up the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question will come from Paul Adornato of BMO Capital Markets.

Paul Adornato – BMO Capital Markets

Hi good afternoon.

Mark Zalatoris

Hi Paul.

Paul Adornato – BMO Capital Markets

Mark in your remarks you said that competition or acquisitions is still very intense, I guess a lot of us in the public markets hear a lot about the coastal shopping center markets, so I was wondering if you could drill down a little bit on some of your markets a little bit more, where our cap rates and at what level, do you think that it just gets too rich to make new investments in your markets?

Mark Zalatoris

Well three there in competitive in our markets Paul, Chicago Minneapolis primary markets. The cap rates are, for Class A type assets are in the mid 6s sometimes lower depending on, the credit quality and the mix of the national credits there in the center. So, we’re seeing competition by many of our brother and fellow REITs as well as institutional owners, pension funds buying directly and their bidding those prices. So, what we’ve done is try to blend a little between our primary markets and the secondary markets in the Midwest such as in Cincinnati and Cleveland where we’re buying with PGGM.

And, we’re constantly evaluating all opportunities in these markets as well as, the new target markets that we have into the Southeast to see where we can pick up better buying opportunities and obviously we continue to work with – in a relationships we developed overall the years with developers owners, so that we can buy with them off-mark as much as possible and we’ve been successful even recently. So, the developer we bought some properties from Wisconsin and we ended up buying a property in Orlando from at the end of last year.

So, and hopefully better pricing I believe and we see in fully marketed deals. To tell you the truth where is, the staffing point, I mean we’re certainly trying to maintain a discipline as with our partner to keep somewhere 6, 6.5 range up and it’s hard. So, we look to be creative about it.

Scott Carr

And one other true competitive advantage we have is also investing with our partner PGGM, because while we meet their return hurdles we layer on that level of fees that are near to enhance our yield in the investment. And then we’re also supplementing the competitive nature of the market by our development joint ventures. We are able to source brand new product, in infill markets with best-of-class retailers and really better than market pricing, because we’re getting in on the development.

So we have the project in the Oaks in Chicago and we’re pursuing another one in Chicago and again our broader platform strategy of expanding into the Southeast with MAB as a partner, which will be focused on developing grocery anchor tenants throughout that region.

Mark Zalatoris

But I will maintain Paul, I believe pricing is still as better here in the central part of the country than it is in the coastal markets. And, clearly that’s where we’re more comfortable participating in.

Paul Adornato – BMO Capital Markets

Okay, great. Thank you for those comments.

Scott Carr

Thank you.

Mark Zalatoris

Thank you, Paul.

Operator

And our next question comes from Todd Thomas of KeyBanc Capital Markets.

Todd Thomas – KeyBanc Capital Markets

Hi thanks, good afternoon. Just a couple of questions, I guess following up on acquisitions. Mark, the deals that you are doing with developers to facilitate your acquisition efforts is there any risk being taken by the company on the development itself and what kind of discount to market do you feel that you are seeing on these properties?

Mark Zalatoris

We’re not taking any risk Todd, as a matter of fact typically the kind of structure we do on the new developments, as we buy it upon stabilization, so we have minimum amount of occupancy high 80s low 90s. And then we typically allow the developer to have an earn out situation whereby if they bring in additional tenants to round it up even up to 100% occupancy we’ll pay additional value to them for some finite period of time. After that we obviously will take over and, we’re not going to pay them anymore. But then incentivize the developer to finish or find the local tenants to make it completely occupied.

So there is no risk, if they don’t perform we don’t pay, and we are paying a cap rate on income in place. So no, we don’t take that any risk beyond that.

Scott Carr

And Todd this is Scott, with regard to the deal structure, we require our partners to participate in the equity it’s usually 90-10 or 85-15 and we don’t commit any equity until the project is ready to go. So we’re not closing on land in any speculative manner, it’s with leases in place, it’s with entitlements. So the real development risk is mitigated down to construction risk and with there we feel we’ve protected ourselves by choosing very qualified partners and again if it was a situation where we had to step in that’s something we could step in on.

We had some velocity to the leasing process, which helps the project get along a little quicker gets stabilized faster. And from an ultimate yield, we’re looking getting into these assets at our cost well above an 8 cap. And it’s a product of, we have a predetermined acquisition cap rate, but we also share in the development profit. So when you layer on those different elements of discounted acquisition cap rate for further return on equity and a spilt of development profit, the going in yields for us on acquisition is well above an 8. And these are assets that would easily trade 200 basis points below.

Todd Thomas – KeyBanc Capital Markets

Okay. And this is outside of the MAB, for a more development venture that you’ve that you’ve announced, these are other deals in other markets outside of the Southeast is that correct?

Scott Carr

Evergreen Park is outside of the MAB structure it’s with a developer with whom we’ve done partnerships before. We’re pursuing another one in Chicago with that same group. MAB is primarily focused on the Southeast and that’s the one where we have five projects under contract right now and we’re working on entitlements and anchor leases. Then we’re looking at other opportunities with the same development groups, again focused both in the upper Midwest and the Southeast.

Todd Thomas – KeyBanc Capital Markets

Any plans to sort of formalize an additional arrangement in other markets, in Chicago and/or somewhere else in the Midwest like you’ve done with MAB?

Scott Carr

Well, in Chicago we are really – it’s a continuation of our development agreement with Pine Tree. We actually struck that back in 2006 and the deal structure itself for each individual development was structured at that time. So we’re really going under that same guys and we have them working with them in the Midwest markets. We’ve been talking to other developers, but again that adds the layer of us wedding them and becoming familiar with them and that level of comfort. But, right now it’s our activity is with both Pine Tree and MAB.

Todd Thomas – KeyBanc Capital Markets

Okay. And then Mark, you mentioned the gradual, I guess ratable buy out of PGGM to interest in that venture that will begin in 2016. I guess first when in 2016 does that right kick in and how is pricing established?

Mark Zalatoris

Todd that really begins in the middle of the year I think in June of 2016. We built in a lot of flexibility in that that buy out arrangement, it’s that our choice we can test on that year and then we can pick it up in 2017 and buy out 20% for 2017 and the 20% from 2016 depending on capital, cost of our capital the pricing of the assets. Because, we have a foreign partner, they are subject to the international accounting rules, which is fair market value of accounting. And so they need to have appraisals done every year on the assets, we get them done quarterly in a sense with an outside appraiser, so they can mark-to-market these properties on their financial statements every quarter. That is the fair market value of the assets, there is no discussions that’s what we’re going to use to value of the assets when we buy them out.

Todd Thomas – KeyBanc Capital Markets

Okay, all right that’s helpful. And then just one last question for Scott, I was curious sounded like there was a significant amount of leasing that commenced towards the very end of this quarter. Are you able to quantify what sort of mid-quarter rent commencements look like just to help us understand the magnitude of the ramp that we should expect, under the third quarter or the back-half of the year here?

Scott Carr

Well overall, I mean the same-store is performing as we had anticipated, and despite you saw financial occupancy did come at quarter end, so we had 94.3% financial occupancy. We are going to see the income benefit of that activity over the second half of the year. And again, it’s in line with our guidance, which was 2% to 4% for the year. And, I’ll tell you the reason for that range was the timing of bringing the space online. A lot of our income growth this year is being driven by the 350,000 square feet we took offline last year for redevelopment and repositioning. And it’s the timing of that coming online, which we’re seeing now with the income weighted to the second half of the year.

So, we’re looking for again the same-store NOI range of 2% to 4% we’re reiterating that, and then in terms of occupancy it’s another point in time measure, because we again are saying year end 91% to92%, so a decline in financial occupancy. That too is being driven by the timing of space coming offline. So while we have the income benefit and increased occupancy in the latter half of this year, at the tail-end of 2014, we have additional space coming offline which I mentioned in our prepared remarks. But again most of that space is space that we proactively taken offline. We have leases in place to back-fill the space. So in 2015, we’ll see that cycling back on.

Todd Thomas – KeyBanc Capital Markets

Okay, great. Thank you.

Mark Zalatoris

Thanks Todd.

Operator

And our next question will come from Juan Sanabria of Bank of America.

Juan Sanabria – Bank of America

Hi good afternoon. Just hoping you could elaborate a little bit more on that occupancy sort of movement from now till year end and then kind of, how we should think about same-store NOI, I guess for 2015 will there be the same sort of seasonality next year is this year with, I guess a depth in the same-store numbers given it sounds like you’re going to be taking space offline again and then as it comes back on to be accelerated?

Scott Carr

We’re not in position to discuss for 2015 in terms of the same-store. But again what we – we’re very confident that the second half of this year will show the income benefit of the occupancy that’s come online. And the trends we see into next year, we see, the space coming offline at the end of this year and then being brought back on.

Juan Sanabria – Bank of America

Could you just remind me, what how much space you’re going to take offline at the end of this year and how does that compared to what you took offline last year at around the same time?

Scott Carr

Last year was a high watermark for us. We took 350,000 square feet offline. And of that space, about a 140,000 of it was sold, we sold it Wal-Mart for redevelopment, we demolished about 30,000 and we had a 179,000 to come back online. Over the course of this year, 48,000 will be back online and the remaining is in the Oaks. And as we head into the end of this year, we’ve targeted a total of about a 117,000 square feet to come offline and again that’s a bulk of that has been already preleased, but we will have the downtime transition between it coming offline and coming online.

Juan Sanabria – Bank of America

Okay that’s helpful, thank you. And then on the MAB joint venture in the Southeast, can you talk a little bit about the five sites you have under contracts, are those urban or more suburban, are they and sort of new development areas, residential development areas. What type of gross reserve you are looking to – to do, I know one of your peers just announced a new development in the Carolinas with the publics and if you could speak to that that would be great?

Scott Carr

Sure Juan, we are targeting really at tenancy Alabama, the Carolinas, Georgia and Florida. And with the projects we have in the Oaks. It’s actually in all of those states except tenancy right now. There are variety of what we would call suburban and more infill locations, the mix of both. And we’re really following the growth of not only the economy and the population trends, you’re seeing a lot of good job formation in these areas hence you’re seeing more population growth and more build out of suburban areas.

But we’re following the grocers who are following that growth. So we’re working right now with everyone who is active in that area, which namely is public, Whole Foods, Cedar, Wal-Mart. So, without getting into specifics until we have deals ready to announce that’s pretty much the platform that we have in the Oaks.

Juan Sanabria – Bank of America

Okay great, and just my last question on the balance sheet. I know you’ve got a long-term target of becoming investment grade, should we be thinking about any further deleveraging for the next whatever 12, 18 months from the current levels here?

Brett Brown

Juan this is Brett, we do just continue to make progress in the financing objectives that we’ve laid out to become more in line with our investment grade peers. We’re generally targeting lower leverage, looking to just move along that spectrum there and so it will be a lower leverage model going forward, yes.

Juan Sanabria – Bank of America

Is there any sort of compensation for on the management side for getting that investment grade over a said time horizon or anything like that that you guys have in place?

Scott Carr

No there is not.

Juan Sanabria – Bank of America

Okay, thanks for the time guys.

Scott Carr

All right, thank you Juan.

Mark Zalatoris

Thank you.

Operator

And the next question comes from Tammi Fique of Wells Fargo.

Tammi Fique – Wells Fargo

Thank you, good afternoon. I thought you mentioned this, but I think you said you had $100 million of assets under contract for acquisition today, is that all in the PGGM JV?

Scott Carr

No, it’s really blended, we’re looking to acquire both for balance sheet and PGGM, so it’s a mix of properties for both and it’s consistent with our strategy both in our core markets and in our target markets. And we’ll look to be, announcing some closings over the latter half of this year. And these are assets on various stages under contract in NOI and due diligence.

Tammi Fique – Wells Fargo

To assume kind of an even mix between what you do on balance sheet and for PGGM for the remainder of the year?

Scott Carr

Yes.

Tammi Fique – Wells Fargo

Okay, great and then, you have met your disposition target for the year but, I think you indicated it is the most attractive source of capital available to you. So as you complete these new acquisition should we expect additional dispositions in the back-half of the year and then do you have anything else currently under contract?

Scott Carr

Yes, we have met our disposition target for the year having hit just over $65 million year-to-date and actually did that ahead of schedule, so we’re very pleased with that progress. We have a few more smaller sales that may occur before the end of the year. And then I would say this is just a continual part of our business, we’re always assessing the assets and looking where we can, where we have maximized profits or have assets that we no longer consider non-core don’t meet our growth profile going forward, dispositions will always be a part of our business and you’ll see it on a continual basis, in terms of announcing a new target, we don’t have that ready at this point. But again, it’s ongoing for us as part of regular asset management.

Tammi Fique – Wells Fargo

Okay, so near term financing for additional acquisitions could just to go on to the line of credit, is that fair?

Mark Zalatoris

Absolutely we have plenty of billable capacity there, yes.

Tammi Fique – Wells Fargo

Okay, great and then just one last question, you mentioned that you hired some additional staff as you’ve kind of ramped up the portfolio here, is it fair to assume that the second quarter G&A is a good run rate?

Mark Zalatoris

Second quarter G&A is usually typically a little higher than the other quarters in that we have our annual shareholder information there with the annual report and proxy and that as well as conferences with ICSC and NAREIT. So, third and fourth quarter should be marginally lower than second quarter.

Tammi Fique – Wells Fargo

Okay great, thank you very much.

Mark Zalatoris

Thanks Tammi.

Operator

I’m showing no further questions, this will conclude the question-and-answer session. I would like to turn the call back over to Mark Zalatoris for any closing remarks.

Mark Zalatoris

Thank you, operator. And just want to thank you all for listening to our call today. We look forward to talking with you again in November, when we report third quarter results. Have a great evening.

Operator

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

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Source: Inland Real Estate's (IRC) CEO Mark Zalatoris on Q2 2014 Results - Earnings Call Transcript

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