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Forest City Enterprises (NYSE:FCE.A)

Q2 2011 Earnings Call

September 09, 2011 11:00 AM ET

Executives

David J. LaRue - President and CEO

Robert G. O'Brien - EVP and CFO

Matthew L. Messinger – EVP of Investment Management

Analysts

Sheila McGrath – KBW

Jay Habermann - Goldman Sachs

Paul Adornato - BMO Capital Markets

Richard Moore - RBC Capital Markets

Operator

Welcome to Forest City Enterprises Second Quarter 2011 Earnings Conference Call. The Company would like to remind you that today's remarks include forward-looking comments that are covered under Federal Safe Harbor provisions. Actual results could differ materially from those expressed or implied in such forward-looking statements due to various risks, uncertainties and other factors.

Please refer to the risk factors outlined in Forest City's annual and quarterly reports filed with the SEC for a discussion of factors that could cause results to differ. This call is being recorded and a replay will be available beginning at 2:00 PM Eastern Time today. Both the telephone replay and the webcast will be available until October 9, 2011, 11:59 PM Eastern Time.

Also, please note that exhibits referred to during today's call are available on the Investor Relations page of the Company's website www.forestcity.net. At this time, all participants are in a listen-only mode. Participants on the call will have the opportunity to ask questions following the Company's prepared remarks.

I would now like to turn the call over to Forest City's President and CEO, David LaRue. Please go ahead, Mr. LaRue.

David LaRue

Thank you operator. Good morning everyone and thank you for joining us today. Sharing remarks with me today is Bob O'Brien, our Chief Financial Officer. Matt Messinger, EVP of Investment Management in our New York office is also on the call and available to answer questions during the Q&A. By now I hope all of you have seen our second quarter press release and filings which went out at the close of business on Wednesday.

In a few minutes, Bob will review our financial and operating results and give you an update on our financing and capital raising activity. After that I'll review our openings and under construction pipeline, offer some closing thoughts and then we'll get to your questions.

As we indicated in our press release, we're pleased with our second quarter results. Our portfolio performed well with comparable property net operating income increases across all major property types. We made additional strides in our ongoing effort to strengthen the company and improve the balance sheet and overall debt metrics. We have continued to make progress on our under-construction pipeline, and we are selectively adding new projects primarily multifamily by taking advantage of existing entitlements at some of our large mixed-use projects in core markets.

Clearly, our outlook is impacted by the uncertainty of the general economy, so I'd like to separate the way we feel about our business from the way we view the economic outlook. We're cautious in our outlook when it comes to the economy. The persistence of high unemployment, slow to negligible growth, falling consumer confidence, global debt and political posturing in Washington are all very real concerns for us. Solving those issues will take time and improvements will come slowly, so there is a reason for caution in the near to mid-term. In the meantime, we are focused on factors within our control on running a core real estate portfolio with well over 200 assets in an efficient, profitable manner while selectively taking advantage of new development opportunities and creating value for our shareholders.

I also point out that current conditions have presented important opportunities. The first is increased demand for our multifamily products. The general economic uncertainty in housing crisis have created a new generation of renters, some due to necessity, some by choice. Combined with limited new supply this has driven our portfolio performance and opened up growth opportunities in our existing pipeline. In our core markets and key mixed use projects such as Denver and Stapleton, Atlantic Yards in Brooklyn and the yards in DC, we have existing entitlements that we are able to activate judiciously. Financing is accessible for these new multifamily projects. Demand clearly exists and we are poised to meet it. I have more to say on that later when I talk about the pipeline.

The second opportunity created by our current conditions is historically low interest rates. We have the ability to access capital at attractive rates to refinance existing properties and lock in long term rates that lead to improved earnings and cash flow from the portfolio. Low interest rates have also allowed for our newly opened projects to absorb the lease up phase with less impact on our income statement. Bob will have more to say about this later.

In short, the challenges that exist do not deter us from feeling good about the business and about our opportunity for future growth. We put in the hard work over the past several years to strengthen the company and position it for future success.

With that, let me turn it over to Bob for a review of our financial and operating results and to talk about our view of the capital markets. Bob?

Robert O’Brien

Thanks, Dave. Good morning everybody. On today's call I'll be referring to our results in our earnings release, our 10-Q filing and our supplemental package. If you don't have access to them, you can contact us for a copy or visit our website for reference during the call. I'll also refer to our EBDT bridge which depicts the positive and negative factors impacting our results. It's in our supplemental package and also available directly through a link on the investors page of our website.

I want to remind everyone that we will be using non-GAAP terminology such as EBDT, comparable property net operating income or comp NOI and pro rata share in our discussions today. Please refer to our supplemental package for a thorough explanation of these terms and why the company uses them as well as reconciliations to their comparable financial measures in accordance with generally accepted accounting principles. As most of you know, we use EBDT as a key indicator of our performance.

Second quarter net earnings attributable to Forest City Enterprises were $8.1 million, compared with a $122.8 million in the second quarter of 2010. The net earnings variance was driven primarily by the timing of asset dispositions and joint ventures between the comparable periods.

Net earnings for the six months ended July 31, 2011 were $55.7 million, compared with $107.3 million for the same period in 2010.

Total EBDT for the second quarter was $70.7 million, compared with $105.6 million for the second quarter of 2010 and total EBDT year-to-date was $198.1 million compared with the $176 million for the six months ended July 31, 2010.

I'll refer to the year-to-date EBDT bridge on Page 25 of the supplemental package and on the Investor Relations page of our website for detail on the factors impacting our EBDT for the first six months of 2011. Factors impacting the quarter were covered in the press release, but we'll be happy to provide additional color on the quarter during the Q&A.

On the left hand side of the bridge you see our EBDT for the first six months of 2010 of 176 million. The next seven blocks show the Company's combined commercial and residential segments, what we also refer to as our rental properties portfolio. First block shows the $42.6 million positive impact of our first quarter Cleveland Casino land and air rights transaction. Continuing from left to right we had increased EBDT of $8.3 million in a fair market value of certain derivatives which are marked to market through interest expense. $4.7 million in increased income from the sale of tax credit, $4.6 million in increased NOI from the portfolio, $3.3 million in lower interest expense on the matured portfolio and $1.6 million in increased EBDT from a variety of other sources. These positives were partially offset by $9.5 million in reduced EBDT from properties sold to joint ventures as anticipated from our capital raising activities.

Continuing to the right, you can see that the Company's land segment was up marginally for the first six months compared with the same period in 2010, primarily due to some increased sales. The nets had a pre-tax EBDT increased to $7.6 million compared to the first half of 2010 due to the decrease in Forest City's share of allocated losses. This was offset by the 2010 gain of $31.4 million related to the sale of a majority Forest City's interest in the team with no comparable transaction in 2011.

Before I leave the nets, in our first quarter filings we disclosed that we expected to reach the $60 million cap for commitment by the Prokhorov entities to fund team losses in the second quarter. As our second quarter filings indicate, we have funded roughly $20 million of losses year-to-date. For 2011 and 2012, we anticipate that losses impacting EBDT will be in line with pre-sale loss ranges.

Our corporate segment had a pre-tax EBDT increase of $2 million compared with the first quarter of 2010, offset by $19 million in lower EBDT primarily as a result of an inducement payment to note holders related to the exchange of $40 million of our 2016 convertible notes for common stock that we completed in early May. Inducement was accounted for the loss on early extinguishment of debt.

Finally, we had a larger tax benefit of $6.7 million compared with the prior year, which brings us to our first half EBDT of $198.1 million.

As Dave mentioned, our operating results for the second quarter reflected continued solid performance in our portfolio. Overall, comparable property net operating income increased 2.5% during the second quarter compared with the same period a year ago. Comp NOI increased across all of our major properties – rental property types, up 1.6% in retail, 3.1% in office, and 3.1% in apartment.

Second quarter comparable retail occupancies were 90.3%, compared with 90.2% at July 31, 2010. The comparable office occupancies decreased to 90.3%, compared with 90.9% last year, primarily due to the timing of lease expirations between the periods.

In the residential portfolio, comparable average occupancies for the six months ended July 31, 2011 increased to 94.8% compared with 93% last year. Year-to-date, comparable residential net rental income, defined as gross potential rent less vacancies and concessions, increase to 91.9% compared with 89% in the same period in 2010.

Our regional mall sales averaged $418 per square foot on a rolling 12-month basis, and year-to-date comparable mall sales increased 6.5% compared with the same period in 2010. This is the 14th consecutive month of comp mall sales increases dating back to June of 2010, a very encouraging trend.

Of course, as I'm sure, as many of you on the call saw, consumer confidence fell steeply in August according to the most recent reports and continuing low levels of consumer confidence can certainly have an impact on retail sales.

As we indicated in our supplemental package, beginning this quarter we've removed our federally subsidized senior housing properties from the calculation of comp, NOI and occupancy for apartments and we updated historical comp, NOI and occupancy results in the second quarter supplemental package to reflect this change. We think this will improve disclosure by allowing investors to see results for our conventional apartment portfolio separated from those of the limited dividend senior housing properties.

In the senior housing properties, government contracts control rents and distributions to owners. In addition, the timing of and accounting for capital improvements for these federally assisted properties, tends to yield lumpy results. The senior housing portfolio today represents 35 properties and approximately 4,832 units at our share, but their results can distort the overall trends in our residential business. This has been and continues to be a good business for us, but the results can be somewhat volatile. Going forward, we believe this change will improve visibility of comp, NOI and occupancy for our conventional apartment portfolio.

I’ll turn now to a review of our financing, capital raising and debt reduction initiatives. This has been a major focus as we strengthen the balance sheet and position the company to take advantage of future growth opportunities.

In the second quarter we executed three significant transactions. As we discussed on our first quarter call, the first transaction occurred in early may when we completed private exchanges of $40 million of our 5% convertible senior notes due 2016 for approximately 3.4 million shares of our Common A stock, leaving only $50 million of notes outstanding.

Second, we expanded our relationship with the National Electrical Benefit Fund, NEBF and National Real Estate Advisors at two of our New York apartment properties. This transaction was a real win-win. NEBF recognized the substantial equity value in both these assets and chose to convert their mezzanine debt into an increased ownership position at 8 Spruce Street and a 49% interest in our DeKalb, Brooklyn property. By recapitalizing, we reduced our share of the committed debt levels by $320 million, while extending the loan maturities for both properties. The transaction evidences the value of these core assets and furthers our goal of deleveraging our balance sheet.

Finally, in mid-July, we took advantage of a window of opportunity in the debt market to issue $350 million of 4.25% convertible senior notes due in 2018. As it turned out, the timing of this offering was quite fortuitous. Shortly, thereafter as mostly you're well aware, the debt and equity markets changed considerably. It would be difficult to execute a similar transaction in today's market. We obviously did not foresee what would happen in the market, but certainly we've learned that the time to tap the capital markets is when they are open and pricing is reasonable. The bottom line is that we are glad we exited the market when we did.

The transaction was a great opportunity to secure capital at an attractive cost. As we indicated in the offering documents, we intend to use much of the proceeds to reduce other more expensive debt. Let me give you a few examples of what we've accomplished thus far.

As you may have seen in our filing subsequent to the end of the second quarter, we were able to resolve a challenging loan maturity in Las Vegas by repaying a $42 million non-recourse mortgage loan at a discount for $27 million.

We will also use some of the proceeds of the offering to advantageously refinance existing property mortgage loans to lock in lower interest rates as Dave alluded to. As an example, we currently have commitments to refinance three properties where we will make relatively modest pay downs, approximately $50 million in total across all three properties to refinance each of those properties at lower loans to value. By doing that, we can secure substantially lower interest rate that will generate a double-digit return on the incremental capital invested through reduced interest expense. Not only is this in keeping with our deleveraging strategy, but it also improves our cash flow and generates a great return on the capital deployed.

With that, let me turn it to Dave for an update on the pipelines and some closing thoughts. Dave?

David LaRue

Thanks Bob. As you saw in our press release, we continue to lease up 8 Spruce Street and begin the initial phased opening of Westchester's Ridge Hill, a mixed-used center in Yonkers, New York. We're extremely pleased with the pace of lease-up at the Frank Gehry-designed 8 Spruce Street, Lower Manhattan. As of August 30, more than 450 leases have been executed, or over half of the total units in the building. Rents on these leased units are at or above pro forma. More than 350 units are already occupied and build-out continues for units on the upper flows with final delivery expected during the first quarter of 2012.

Turning to Westchester's Ridge Hill, the best way to describe progress here is steady. Progress continues on both construction and leasing and the center is currently 52% leased. We've discussed how difficult the overall economic environment has affected the pace of our leasing efforts, but we continue to make progress based upon the efforts of our team and the strength of the Westchester market. Tenant Cinema de Lux and REI opened during the quarter as did WESTMED Medical Group, an anchor office tenant. Additional tenant openings are anticipated before yearend leading up to the opening of Lord & Taylor in February 2012.

At the end of the second quarter, we had four projects under construction at a total cost of $1.7 billion and our pro-rata share at $1.8 billion in full consolidation. In addition to 8 Spruce Street, Westchester's Ridge Hill, the progress on the rest of the pipeline is detailed in our press release. I'll hit some high points here, but we're happy to provide more details during Q&A.

Work continues on Barclays Center at Atlantic Yards, which will open in late September next year. 56% of the forecasted contractually obligated revenues are currently under contract. In Washington D.C., Foundry Lofts, the first residential building at The Yards is nearing completion. Initial leasing began August 15th and the first movements are anticipated in November. Early interest has been very strong.

After the close of the second quarter, we began construction on Novella Apartments, the 220 unit apartment project at Stapleton in Denver adding to the more than 500 apartment units already at Stapleton. Additionally, the interchange from the Interstate 70 opens in November 2011 at Northfield providing access to additional land for residential and commercial usage.

In Brooklyn, design and engineering work continue for the first residential building at Atlantic Yards and we recently applied for building permits. Finally, after close of the second quarter, we broke ground at The Yards in Washington D.C. on the Boilermaker Shop, an adaptive reuse project that will include approximately 41,000 feet of ground-level retail and mezzanine office space.

Before we go to your questions, let me take a moment to address the volatility we've seen in the equity markets over the past weeks and months and the degree to which our stock appears to have taken more than its fair share of impact over that time. Of course, we're all well aware of the elevated risk aversion among investors, and the general flow of investment dollars out of the stock market. Development, leverage and complexity continue to be barriers for certain investors, we understand that. To counter those concerns, we would point to the fundamental changes we made to strengthen our company through the improvement of our balance sheet and positioning for our company for future growth.

When we meet with key investors face to face, the feedback we get is positive and very supportive of the steps we have taken. We understand the external factors may have changed and we are carefully evaluating those changes in terms of how they will impact our business. Despite volatility in the markets, in general and the corresponding impact on our stock, we continue to execute on the strategies we’ve put in place and we continue to see opportunity both within our portfolio and in new growth.

Like any management team, we know that in long run the most important thing we can do is run a good business and that the stock price will react accordingly. We also know that we need to tell our story clearly and consistently which we will continue to do. There is no question that our view of the economy is cautious and that clearly tampers our overall outlook, but let me stress that we continue to see solid fundamentals in our business. We feel good about the performance of the portfolio and about the progress we’ve made on deleveraging and strengthening the balance sheet and our ability to take advantage of opportunity to grow the business going forward. Most importantly, we have the talent and skills in our company to execute on these opportunities.

In closing, let me take a moment to comment on my transition into my new role. This was announced in March and actually took effect in June. The support I’ve received both internally and externally has been tremendous. The new relationships are dynamic and energizing. I want to thank our associates, my team and especially Chuck for making this transition seamless and I don't think we've missed a beat. I especially want to thank our investors for your ongoing belief in Forest City Enterprises, our strategy for value creation is fundamentally sound and we will continue to execute on that strategy. As always, we welcome your input and we appreciate your support.

Now, let's get to your questions.

Question-And-Answer Session

Operator

Ladies and gentlemen, (operator instructions). Our first question will come from the line of Sheila McGrath. You may proceed with your question and please announce the company you’re representing.

Sheila McGrath – KBW

Yes, this is Sheila McGrath from KBW. First on Ridge Hill, David, you mentioned that lease-up is steady. I was just hoping that you might give us a little more detail on the pace of conversations and when we might see some more signed leases?

David LaRue

Sheila, thank you for the question. Ridge Hill as I said is steady. We continue – I think we went from 50% to 52% leased over this past quarter executed leases and the conversations that we are having with the tenants are continuing. We have openings scheduled as I mentioned in the script during October this year and by October we expect that we'll have over 400,000 square feet opened for business at the center as we move forward. Going into the February 2012 time frame when Lord & Taylor is expected to open, we believe majority of that 52% or a large majority of that 52% of the tenants will be open and between now and then some major conversations that we're having with tenants we hope to finalize and move that leasing percentage on.

Sheila McGrath – KBW

Okay, thanks. And then on 8 Spruce, the lease-up was certainly well ahead of what we had expected, half the building in about six months. Just wondering, going into when people have been more concerned about the economy, have you seen any slowdown in the pace or do you expect because it's the higher price point units that it will take longer> Just wondering if you could give us some insight there.

David LaRue

Again, good question. We, as we said, are very pleased with the progress we made to this point. Being over 50% leased in a little over seven months or just at seven months is well ahead of our projection. As you would imagine, when we put the pro forma together, we had a much longer lease-up. Over two years was our original anticipated lease-up for 900-plus unit building. At this point we believe we will be ahead of that pace clearly and as you mentioned, the higher price upper floor units are coming on to the market, but again I think we have enough room in our projection and in our pro forma that we will be able to absorb any effect that the current market condition could have and still meet that pro forma.

Sheila McGrath – KBW

Okay. Last question, Bob, you do mention that you continue to expect to move leverage levels lower. I was just wondering if you could frame that comment. What metrics are you focusing on; where are you now, what's your target and how do you plan to get there?

Robert O'Brien

Sure. Great question. Sheila. Look, I think as we've said and have been pretty public about, there is no magic bullet that's going to take our leverage down to levels that investors are supportive of other companies. I think we have a distinct philosophy about debt. The vast majority of the debt that sits on our balance sheet is non-recourse. The benefit of that obviously is probably demonstrated best by our recent transactions in Las Vegas. There is no property that we have to feed. We can look at that opportunistically, but as you saw on the commitments that I referenced in my remarks, taking things from 70% to 75% loan-to-value down to 60% loan-to-value can have a pretty dramatic impact on interest expense and interest rates. That's a sweet spot, that 60% plus or minus loan-to-value is a sweet spot for most lenders today and they're paying for it or they're willing to provide capital at very affordable rates, in the 4% to 5% range, very attractive capital. So, in terms of metrics we're looking at, there is probably two primary ones that we're looking at. One is debt yield, the inverse of an EBITDA multiple that others look at.

We're targeting obviously low double-digit debt yield and expect to get there over a period of time. We also look at coverage ratios and we expect over the next few years that the interest rates, assuming they stay within a reasonable range of where they are today, to continue to drive down our overall weighted average cost of capital, driving up our debt to risk and fixed charge coverage ratios. So I feel like we're making good progress. You saw by bringing NEBF into a partner in the two apartment projects in New York had a pretty dramatic impact in a single transaction and on overall debt levels. We're going to continue to do that, but our expectation honestly and part of the reason we use the convert market this past quarter as we've used in the past is a clear expectation that over the life of those convertible instruments those will convert to equity, further deleveraging our balance sheet and improving ongoing cash flow and minimizing or reducing fixed charges.

Sheila McGrath – KBW

Okay. Thank you.

Operator

Our next question comes from the line of Jay Habermann. You may proceed with your question and please state the company you are representing.

Jay Habermann - Goldman Sachs

Good morning guys. Jay Habermann, Goldman Sachs here with Connor as well. Just a question. I know David you mentioned clearly the stock price and what's sort of transpired since late July, your stock is down about 35%. You are now trading below your discount to net asset value. Can you just give us some sense at this point what you are thinking about maybe in terms of further asset sales or even debt reduction? Because you talked about achieving perhaps low double digit debt yield, but that would seem to indicate a fairly substantial decline in leverage from where you are today, but maybe walk us through what you are thinking in terms of perhaps further asset sales in the near term?

David LaRue

Thanks, Jay. From an asset sales perspective, we are not contemplating any major transaction like we have done over the last 18 months, whether that's bringing a partner MIT, or a partner in our New York retail portfolio. We very much like the portfolio we have. There are as always assets on our radar regarding core and non-core and those I think will be more on the margin. We do have opportunities as we've expressed or stated in the past at Tower City where Rock Gaming for example does have an option to purchase some assets here at Tower City and so if they exercise that option that would further move us to more of a core market portfolio balance. So the asset sales aspects are going to be focused – continue focus the portfolio in our core markets that we've outlined. From a leverage standpoint, I'll let Bob address that.

Robert O’Brien

Yeah, Jay again thanks for the question. One of the things that clearly is going to happen over the next 18 months is Dave referenced the three major projects that are under construction today. Beekman is well underway with its lease-up. Most of that debt sits on our balance sheet today, but there’s obviously no income there. So, it isn't just a – to go after and continue to reduce, reduce, reduce debt. That's part of our – deleveraging is part of our plan, but it's a combination of reducing debt at the property level, reducing the debt corporately, but also growing NOI and I think you've seen demonstrated by our portfolio over the last few quarters good and significant growth and continued growth and that is going to be supplemented as we add the arena, as we add Beekman, as we add Ridge Hill, as we add (inaudible) to the NOI side of the equation. So really feel like there is some visibility to the fact that our debt levels, our leverage levels particularly when you look at it from an income and NOI basis, should improve.

Jay Habermann - Goldman Sachs

Okay, that’s helpful. And maybe Bob, just to further expand on what you are seeing in terms of maybe changes in cap rates or even changes in terms of the debt market financing. I mean clearly the disruption we've seen in CMBS and the widening of spreads. I mean have you seen much of an impact in the last 30 days?

Robert O’Brien

Well, clearly spreads gapped out there for a bit. Again, as I try to allude to, I think it's – you see the widest spreads on the highest point of values. Lenders are using conservative cap rates to determine values against which they will lend. Certainly much more conservative than certainly where the market is, the sales market is. Coverage is given where interest rates are substantial, but again I think the sweet spot in the marketplace is in that 60%, 65% loan to value. We're getting transactions done in the 4% to 5% range. I think others are as well. Lenders have money to lend, banks have money to lend. They're going to lend in very conservative structures. They are maintain a pretty strong discipline in terms of how they are looking at that, but thankfully capital remains available to real estate, provided it's a relatively conservatively structured transaction.

Jay Habermann - Goldman Sachs

Just last question on – I guess on the apartment portfolio, separating 8 Spruce, can you give us some sense of what you're seeing in terms of demand? I know it’s an area of strength, but perhaps what you're anticipating in terms of NOI growth going forward?

Robert O’Brien

Well, without getting into the specific NOI growth, Jay, we see the support from the general demographics that are in the marketplace. The renters by choice that I mentioned, that age-group of 18 to 34 particularly, especially college educated, the unemployment that's affected them is much different. I think college educated unemployment is 4.5% or so and that demographic are key renters. We looked at our portfolio where it's positioned and the ongoing decisions that individuals are making is to rent rather than buy. Even with historically low interest rates than historic affordability in the whole market, the choice is to be unthetered. So looking forward, we see continued strong demand that the market I think in general, other multifamily companies see that as well. That's why I think you see a pickup in building and development in that particular product site. At some point that will come more into balance where new supply is starting to service some of that demand and that will again tamper the growth that we've seen in our own NOI. So all the fundamentals as we look at it are very strong going into the next midterm period until new supply can come onto the market.

Jay Habermann - Goldman Sachs

Great. Thanks guys.

Operator

Our next question will come from the line of Paul Adornato. Please proceed with your question and state the company you are representing.

Paul Adornato - BMO Capital Markets

Hi, thanks. From BMO. Morning. First on the multifamily side. I was wondering if you could talk a little bit about the apartment that you're contemplating at Atlantic Yards. What's the concept, what's the price point, and will there be an affordable component to this project?

David LaRue

Paul, thanks for the question. I’m going to ask Matt to address that please.

Matthew L. Messinger

Sure. Hi Paul. Yes, the first tower at Atlantic Yards that we're playing with is anticipated to be a 50-30-20, which is a 50% affordable, a combination of middle-income and low-income. So the same 20%, you would find in an 80-20 building, but a targeted middle-income component in bands as well. In general, Atlantic Yards and the market components of Atlantic Yards, as well as the low income for that matter, T2 is just a few blocks from our DeKalb building which we are very pleased with the result, has just stabilized in the last year or so. A few blocks away that building performs very well in what ended up being a fairly competitive time in terms of new openings at the same time and we have a great data point there and great success to sort of draft behind.

Paul Adornato - BMO Capital Markets

Okay. I guess as a follow-up, what specific incentives are related to this project? I mean to this building as opposed to the rest of the project?

Matthew Messinger

I don't know that there is specific incentives for the Tower per se. There is a 50-30-20 program encouraged by the city which with any 80-20 type program there is obviously the federal law income tax housing tax credits that come along with it. There is certain taxes against financings that bonds that are made available subject to layering in a third-party credit enhancer and depending on where markets are, and there is a city provided small second mortgage which could act as an additional inventive to encourage that middle income component.

Paul Adornato - BMO Capital Markets

Okay, great. And looking at the potential to streamline some lines of business and geographies as was mentioned in the past, I was wondering if you, David, had any additional comments in that regard and also what the potential G&A implications of such streamlining might be?

David LaRue

Paul, thanks for the question. What we’ve talked about in the past is part of our strategic plan update that we have been going through for the last eight to 12 months and as we look forward and as we've talked about on prior calls and in prior meetings with investors, our focus continues to be on our core portfolio and what we have done is, we are evaluating if we should stay in certain business lines and that evaluation continues. We continue to look at how we are internally processing information which is an important part of the cost structure. We are looking at how we purchase supplies and et cetera across the enterprise. So there are a number of initiatives that we are undertaking currently and we'll continue to undertake to help us continue to focus and streamline on true value creation in parts of the real estate business which is the development and again proper operation of the portfolio. Other than that, I don't have any specifics that we are ready to announce right now.

Paul Adornato - BMO Capital Markets

Okay, and just one more kind of big picture question. Do you have any preference for fee income streams versus rental income streams and any plans to perhaps change the mix going forward?

David LaRue

Well, again as a real estate company, real estate development and operating company, we clearly like the rental income stream the best. We do have significant fee income streams coming from our military housing business. Again, that is another area that we look at as very secure because of the length of the contract that we have signed with the military to manage and lease these almost 14,000 housing units across the portfolio now when we've had a new opportunity that we are working on. So those types of fee streams I think truly create value over the long-term as well. As we look at some of the other things we have done recently, whether it's third-party management of shopping centers. Again, if we can add that income to our business without incrementally adding cost in markets where we already operate on commercial assets, that can be accretive as well. So, it is an analysis that we look at every time an opportunity does come up and again if it is associated with core market, or a core piece of our portfolio, we're more highly likely to move forward and if it's something that potentially sits on the fringe, it's something that we'll probably not do and move onto other more value-added things.

Paul Adornato - BMO Capital Markets

Okay. Thank you.

Operator

Our next question comes from the line Rich Moore. You may proceed with your question and please state the company you are representing.

Richard Moore - RBC Capital Markets

Hello guys, good morning. RBC Capital Markets. The Rock Gaming option that you guys are talking about, that's more Cleveland Casino land, I assume. Is that right?

David LaRue - President and CEO

Well, Rich, thanks for the question. Well, there’s two piece of the transaction. One, Bob mentioned that occurred in the first half of this year with the $43 million sale that we executed for them to take the first parcel. There is another sale that we'll close associated with additional land for the casino of approximately the same amount that will happen in the first half of next year, 2012. They also I think, we've talked about in the past have signed a 300,000 foot lease in the Higbee building. They are currently working on that asset right now with a targeted opening of the first phase of the casino for March of 2012. There that is currently structured as a lease. As part of the overall negotiation, we have entered into an option with them for the purchase of the hotel and they have paid option money and that is right now the bulk of the agreements we have with Rock Gaming here at Tower City.

Richard Moore - RBC Capital Markets

Okay, I got you Dave. Thank you and then the timing on that option on the hotel as far as when then they would have to exercise that. I mean, how long do they have for that?

David LaRue

They have till the fourth quarter of 2012 to execute that right now.

Richard Moore - RBC Capital Markets

Okay. And going back to then land for just a second, the second half of the land transaction. Is that all signed, sealed and delivered? Are there any issues at this point with them executing that second half payment?

David LaRue

No. One of the things that I answer quickly Rich, because one of the things that happened with Rock over the last month or so is that they were able to close on their financing that they needed to move forward with the casino projects and that solidified in our minds that that sell transaction will close as we have under contract.

Richard Moore - RBC Capital Markets

Okay and I remember the last call you guys had; there was at that point some state issues associated with casino taxes. Is any of that causing a problem of any kind?

David LaRue

No. As I think been widely reported here in Ohio, the governor, Rock Gaming and Caesars and the other casino operators in the state have come to an agreement where they will pay some additional fees to the state over a 10 year period and what it did was it cleared the way for the four casinos that have been authorized by the voters in the state to move forward. Again for us the most important is that they are going to build the first phase here hoping that it would be the first casino opened in the state here at Tower City and then their goal is to start on the expanded casino which will be attached to the south side of Tower City and get that opened as soon as they can.

Richard Moore - RBC Capital Markets

Okay. Good, got you. Thank you. And then the Vegas land that you guys just renegotiated, the loan on I assume that's LiveWork, Las Vegas is that right?

David LaRue

That's correct.

Richard Moore - RBC Capital Markets

Okay. And it's kind in your future development projects. I mean do you guys have a status of how that's coming at this point? I mean just where you guys are I guess in the development process?

David LaRue

Rich, where we are right now I think as we'd talked about in the past, we are currently on land that we had sold to the City as part of the LiveWork project. We are developing for them and building their new City Hall and that project will be turned over to them by the first quarter of 2012 and that will be again I guess the anchor for what we hope to be a government center around the property, the contiguous property that we own. As markets go, if you look at Las Vegas, it obviously has been impacted in a greater degree than a lot of other ones in terms of single-family housing, in terms of unemployment. Those are at the high-end of the scale. I think employment is 14%, but that has not stopped some very good things happening in Las Vegas.

One of the things being that Zappos is moving their headquarters from Henderson, Nevada to down town, specifically the old City Hall site and with that bringing all those employees. That's I guess the bright spot with regard to the development that's still ongoing in Las Vegas. The casinos in the market have started to recover. I've read reports recently that their earnings are up and they are starting to hire back slowly based upon improved gaming revenue. As we all know that's a very risky I guess or consumer-related discretionary spending thing, but they have reported improvements. So we continue to talk to potential tenants on our side and again based upon the things that have happened, we thought it was a good transaction that we were able to execute with the lenders and keep that development opportunity alive.

Richard Moore - RBC Capital Markets

Okay and I assume it's going to be or it looks like it's going to be a lot bigger than a $27 million project. So, I assume, Bob, you don't have to write down the project at all, is that right?

Robert O’Brien

Yeah, that's correct. As we do every quarter, we look at all the investments we have and future development opportunities and doing evaluation and clearly there's no impairment there. We have substantial amount of development right there, clearly Dave's description is appropriate. Now we're enthused about the city moving to the new building. It's a great building. We had a chance to visit it when we were in Vegas for the shopping center convention in the spring. I think it's going to bring a lot of folks downtown. Likely other additional potential office opportunity there, we see that as more likely governmental users or governmental related users and we're in the process of pursuing those. It's going to take some time, but long-term we feel like it's a very good opportunity for us.

Richard Moore - RBC Capital Markets

Okay. All right. Good. Thank you. And then if I could, you guys have – we have the luxury as analysts to hearing from you guys who have a July month in your numbers and I'm curious from especially a retail standpoint I guess, how would you characterize what happened in July versus the two or three months prior to that because we started to see the economy, I guess, begin to slow kind of middle of the summer? How would you characterize July from – particularly a retail standpoint, really from any standpoint?

David LaRue

That’s a good question, Rich. From a retail standpoint since that's where the question started, we were pleasantly surprised about the ongoing strength in the retail comp sales. The consumer has remained resilient. We think that's the combination of unemployment isn’t getting any better, but it hasn't been getting any worse to a great degree. Obviously if it does shift with all the uncertainty, with continued gyrations in the stock market, which is now a major source of wealth for a lot of households. It had been hit but recovered. That could change because that discretionary spending is the most obvious place that the consumer could cut back. We keep again in the general outlook we're cautious as we said.

We think it's going to benefit our diversified portfolio in different ways. Again we talked about the multifamily where we think this is going to continue to help. We talked about how the lower interest rates continue to allow us to both increase earnings and cash flow as well as delever our property level of debt. So the outlook is cautious and again so far so good. Consumer confidence had a big drop in August. I think retail sales reported up in general in August, but I think was car sales that led that, not so much general merchandise, and again we are going into the year with a portfolio where you see we've maintained pretty good occupancy levels and we continue to be able to get deals done with the productivity levels that we have in the shopping centers.

Richard Moore - RBC Capital Markets

Okay, good. Two quickies if I could, guys. The interest and other income line, Bob, seems to be running much higher certainly than we're estimating, but higher than the first half of last year. Is there anything we should be thinking about for 3Q, 4Q in there?

Robert O’Brien

It's also around there. I think we've referenced it in our disclosure, Rich, is a tax credit. Obviously we've had some both historic low income and new market tax credits running through there. I have to say our goal is to try to maintain a level similar to that. I think that it’s going to run reasonably consistently through the balance of this year and I don't have as much visibility yet into next year.

Richard Moore - RBC Capital Markets

Okay, good. Thanks, and the last thing is on the theater business, you guys obviously have some exposure on the theater side of things in your retail centers. What do you guys think about theaters at this point? Any issues with the theater guys?

David LaRue

No. The theater operators again in the urban portfolio in New York, again, the volumes are always high and the demand that we’ve seen based upon the product coming out has been good. Those businesses I guess restructured earlier in the past cycles and are profitable. As we look across the new theater that opened at Ridge Hill, it’s doing well. Our theater portfolio is just reflective of the quality of the movies and they've had pretty good years recently. So right now we are thankfully feeling good about their business.

Richard Moore - RBC Capital Markets

Okay, great. Thank you guys.

Operator

Our next question comes as a follow up from the line of Sheila McGrath. Please proceed with your question.

Sheila McGrath – KBW

Yes. I just wanted to ask you, you are trading at one of the bigger discounts to net asset value of the real estate companies which generally implies the market perceives a higher risk profile for Forest City. I was wondering, either David or Bob, if you could discuss how you view your risk profile today either from a balance sheet or development project standpoint?

David LaRue

I'll just answer generally and let Bob add on here. As we look at the work that we put in and the progress that we made from a risk standpoint, Sheila. Again, I think we were over $3 billion under development and construction when this recession first hit. We have opened those projects. Bob talked about moving them from basically assets and liabilities to actually income producing valuable assets. When you look back what they are, the most current example is 8 Spruce as it continues to transition. So we continue to derisk the business by making assets produce income and that's what's happening. Second is, and Bob and I both talked about is, the deleveraging that we continue to focus on and it's both deleveraging in absolute dollars of debt, but also in growth of NOI and getting additional debt service coverage, but Bob could add his perspective as well.

Robert O’Brien

Yeah, I suppose it's a great question and investors are going to choose for themselves and make a judgment on their own as to the perception of risk for the companies that they look to invest in and it certainly would appear given what's happened to our stock price over the last four to six weeks that the perception is that there is a substantial amount of risk for Forest City, but you've got to compare your bases and certainly we used leverage differently than many do and that gives people, if they just take a quick look, perhaps a different picture than some of our competitors, but I had an interesting call with an investor just a few days ago who asked, well gee, if I look back to the last time you guys were trading in this current range, seems like you guys have taken a lot of steps. So we actually did, I went back and ask Dale and Mike to take a look and it was a little over a year ago we're trading in this range and since that time we exchanged $150 million of convertible notes for equity. We announced and closed our joint venture with Madison International on our New York retail portfolio, evidencing value, creating liquidity. We did the NEBF transaction at both 8 Spruce and 80 DeKalb, again evidencing value, reducing debt and bringing in liquidity, and we raised our most recent convert, substantially improving overall liquidity position at what we think was a reasonable cost.

So we have probably, certainly over the last three years probably the highest level of cash and liquidity that we've had in some time. The risk in our development pipeline has certainly come down, from a cost exposure standpoint it clearly has. I think the evidence of the lease-up at 8 Spruce is just indicative of the embedded value in the development pipeline, which for quite some time people have discounted and I think not given us much credit in terms of value opportunity there. Clearly, it's being proven at Beekman. The progress while steady at Ridge Hill is not on a pace that we would prefer, but I think it's reflective of the economic conditions, but again continuing to make progress there. I'm anxious to get that arena open. I think it's going to be a great asset for us. All three of those transactions I just talked about are very large obviously and not producing any NOI to help evidence the fact that the leverage levels are at least reasonable and then again as we referenced earlier, the fact that we have an opportunity in today's environment to drive down the cost of our debt portfolio.

I'm pushing hard for our guys to do that and we've got some evidence of that. We'll continue to show that. So again, to your point, I think certainly from my perspective as CFO, the risk profile of Forest City is dramatically different certainly than it was not just at the beginning of the recession in late '08, early '09, but even from just a year ago and our heads are up and then as Dave said, we're cautious about the general sense of where the economy is, but I'm feeling very good about the fundamentals of our business and what our team collectively has been able to do to help derisk the business. So I appreciate the comment and the question. I hope that investors dig in a little. I would certainly encourage everybody to take a look at that portfolio that supports this business. It's something of which we are very proud. It's in the best markets in the United States and it's going to continue to grow. So we feel like we have great opportunity here and are going to continue to mind the store and de-risk the business to run a very solid and profitable real estate company.

Sheila McGrath – KBW

Okay. Thank you.

Operator

We have no additional questions. At this time, I would now like to hand the conference back over to Mr. LaRue for closing remarks.

David LaRue

Thank you. I want to just take this moment to thank all of you for your ongoing interest in supporting the company and for all the questions that we’ve received. As we said throughout the call and what we continue to message is that Forest City Enterprises has a very fundamental, sound strategy which we are executing. The core portfolio that we have continued to show improvement in from a fundamental operating basis, is the foundation for which we move forward. We have additional value embedded in our development pipeline and as we said, we will judiciously execute that and continue to create shareholder value. So thank you very much for your time today and everybody have a good weekend.

Operator

Thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.

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