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Developers Diversified Realty (NYSE:DDR)

Q3 2007 Earnings Call

October 26, 2007 11:00 am ET

Executives

Michelle M. Dawson - IR

Scott A. Wolstein - CEO

William H. Schafer - CFO

Daniel B. Hurwitz – President, COO

David J. Oakes – EVP, CIO

Analysts

Ambika Goel - Citi

Jay Habermann - Goldman Sachs

Christeen Kim - Deutsche Bank

Michael Mueller - JP Morgan

Matt Ostrower - Morgan Stanley

Jeff Miller - JMG Capital

Rich Moore - RBC Capital Markets

Jim Sullivan - Green Street Advisors

Operator

Welcome to the Developers Diversified Realty earnings conference call. (Operator Instructions) I would now like to turn the call over to our host, Michelle Dawson. Please proceed, ma’am.

Michelle M. Dawson

Thank you, Lacey. Good morning, and thanks to everyone for joining us. On today’s call, you’ll hear from Scott Wolstein, Dan Hurwitz, Bill Schafer and David Oakes.

Before we begin, I’d like to alert you that certain of our statements today may be forward-looking. Although we believe that such statements are based upon reasonable assumptions, you should understand those statements are subject to risks and uncertainties and actual results may differ materially from the forward-looking statements.

Additional information about such factors and uncertainties that could cause actual results to differ may be found in our press release issued yesterday and filed with the SEC on Form 8-K, and in our Form 10-K for the year ended December 31, 2006 and filed with the SEC.

I’d also like to request that callers observe a two question limit during the Q&A portion of our call in order to give everyone a chance to participate. If you have additional questions, please rejoin the queue.

At this time, I’ll turn the call over to Scott Wolstein.

Scott A. Wolstein

Thank you, Michelle, and good morning, everybody. I am pleased to report this quarter’s funds from operations of $0.80 a share. This figure includes approximately $0.03 per share, or $4.2 million of aggregate gains. This transactional income compares to approximately $0.15 per share or $16.8 million of gains in the same quarter of 2006.

After adjusting for these items, our core FFO per share increased by more than 12% from the prior year. Similarly, on a nine-month basis after adjusting for these items, core FFO per share increased by approximately 15% as compared to the prior year, reflecting the quality of our portfolio and the continued strong demand for well-positioned retail space.

As you will hear throughout the call, our accomplishments over the last three months reflect our continued focus on creating value for shareholders as follows:

(1) By improving the quality of our portfolio through active portfolio management.

(2)By increasing the size and scope of our development pipeline.

(3)By formalizing and growing our funds management business.

(4) By broadening our investment strategy to include select emerging markets with high growth profiles.

(5) Strengthening our balance sheet to levels at least comparable to where we were prior to the Inland acquisition.

These initiatives clearly leverage our core competencies and national platform in an efficient and profitable manner that will enable us to grow long-term earnings, dividends and asset value.

At this point, I’d like to turn the over to Bill Schafer for his comments on the balance sheet.

William H. Schafer

Thank you, Scott. To add to Scott’s remarks, I’d like to highlight a few important items from the quarter and their impact on our financial position. As we indicated on our second quarter call, we sold approximately $600 million of assets in late Q2 and early Q3, including three redevelopment assets acquired from Inland that were sold to MDT for approximately $50 million.

The remaining assets were non-core, smaller, older assets in more remote locations with limited growth potential and higher capital and management requirements; and therefore, were sold to a third party. This portfolio included assets acquired from Inland as well as our existing portfolio.

While the sale of these assets was slightly dilutive to current FFO, the result had a significant positive impact on the quality of our asset base, the effectiveness of our operations, and the strength of our balance sheet as sales proceeds were used to repay debt.

We continue to operate with a conservative balance sheet and have already returned our debt and coverage ratios to levels that existed prior to the Inland acquisition. Over the last few years, the company has grown significantly, providing us with considerable and stable critical mass and strengthening our position as a leader in our industry. This growth has been achieved without any deterioration in our balance sheet. In fact, the balance sheet is much stronger than it was a few years ago simply due to the significant increase in total equity.

Our growth has been, and will continue to be, financed through various sources of capital. We’ve demonstrated this broad access to capital through all our previous acquisitions over the last few years including JDN, Benderson, CPG and now Inland. As our development pipeline continues to grow, having access to both public and private debt and equity capital will continue to provide the funding necessary while enabling us to maintain a solid balance sheet. We have made great strives to diversify our sources of funding and limit our reliance on any one source, especially the most costly source, common equity.

I would like to comment more specifically on our capital position given the recent volatility in the debt markets. During the last few months, spreads have increased to levels higher than I can remember. In fact, there was a period of time in which certain CMBS financings may not have been available at any price.

This uncertainty reemphasizes the need to access diverse sources of capital, maintain liquidity and stage debt maturities carefully. Most significantly, it underscores the importance of a conservative balance sheet that provides flexibility and access in capital and enhances our ability to manage assets with limited restrictions. This position consequently allows us to be opportunistic in our investment strategy and in accessing the most efficient and lowest cost of financing available.

With regard to debt maturities, I believe we are in a strong position that will help insulate us from continued volatility. On our balance sheet, we’ve addressed all remaining 2007 maturities, which aggregate less than $10 million. Our 2008 aggregate maturities are less than $400 million, approximately 75% of which relates to mortgage debt.

We’ve also made sure our liquidity continues to be strong. At September 30, 2007 we had over $600 million available on revolving credit facilities. In addition, we expect to increase our secured term loan facility through our accordion feature by over $100 million within the next few months to incorporate certain Inland assets that are already subject to low loan-to-value first mortgage loans. This capacity, combined with our retained cash flow and additional asset sales, will provide us with flexibility in funding our development pipeline and other investment opportunities.

With regard to joint venture debt maturities, I also believe we are in a good position. The remaining $85 million in debt that matures in 2007 is already being extended. I’d also like to emphasize that over half of the $600 million in 2008 debt maturities are not scheduled to mature until December of 2008 and more than half of the remaining 2008 maturities have extension options available.

I believe we have effectively mitigated our refinancing risks and maximized our flexibility. Our banking relationships, which are broad and competitive, will reduce the impact of volatility in capital markets, and we have taken proactive steps to maintain and improve the strength of our balance sheet in recent quarters. We will continue to do this in the future.

Now I’d like to turn the call over to Dan.

Daniel B. Hurwitz

Thank you, Bill and good morning. The third quarter was another successful quarter for our leasing and development teams. Strong occupancy and leased rates, continued rental growth with modest capital expenditure, and record volume of leasing have all been a function of our continued focus on improving the quality of our portfolio through active asset management and a consistent demand from tenants, which we continue to see across our portfolio.

Of particular note this quarter, our leasing team had a record quarter in terms of number of deals signed, volume of space leased, and rental spreads on new leases. Specifically, there were 179 new leases signed representing over 940,000 square feet of GLA with an average spread on a cash basis of over 41%.

As mentioned, the 41% spread on new leases is the highest level we’ve achieved within our portfolio. This impressive figure was driven by many deals at many different locations across the country, but a few highlights include: in Amherst, New York we had added a 15,000 square foot Eastern Mountain Sports where the former tenant was paying a $1.55 a foot and the new rent was $21 a foot; in Monaca, Pennsylvania we added Office Depot and Circuit City to re-tenant a former Shop ‘n Save Supermarket where the old rent was $3.80, with the new rent being $12.95; and in Chester, Virginia, we had a former Rite Aid that was paying us $3.23 on 15,500 square feet that was replaced with a Petco with a new rent of $15.

We also executed 299 renewal leases comprising 1.6 million square feet of GLA at an average spread of 7.4%. In total, our leasing teams executed 478 leases aggregating 2.5 million square feet of GLA at an average spread of 13.8%. The 478 leases signed and the 2.5 million square feet of GLA are record highs for our leasing department.

Our leasing team has consistently performed at a very high level, and this quarter is obviously no exception. The record leasing activity this quarter is a testament to the hard work of our leasing professionals in the various support departments with whom they work within our company. I’m justifiably proud of what they have all achieved this quarter.

We’ve all seen the headlines recently lamenting the plight of sub-prime borrowers and the general troubles in the housing market, and how this has the potential to impact overall consumer spending and the retail industry in the midst of the current economic turbulence. The reality is that our portfolio is well insulated from this uncertainty and has consistently performed well throughout many economic cycles.

Broadly speaking, national retail sales have grown very consistently since World War II including during several recessions and housing slowdowns, a fact that we believe is missed in most press coverage of the current environment. More specifically, over the last seven years, we’ve had over 20 quarters of overall leasing spreads in excess of 11%. Similarly, we’ve had very little volatility in our long-term portfolio lease rate, which has remained at approximately 96%.

Moreover, we’ve been able to consistently achieve these results without significant capital investment in tenant improvements or leasing commissions. While tenants may come and go over time, shopping centers that are well located and actively managed will continue to perform well.

Clearly, we are very conscious of and sensitive to the risks posed by the current economy. But we feel comfortable with where our portfolio is positioned and the general diversity and credit quality of our tenant base.

On the development front, I’m pleased to report that we continue to find opportunities in under-served regions. The shakeup in debt markets has clearly impacted lower-tiered developers to the benefit of larger ones and as a result, we are rapidly seeing more opportunities and less competition.

Due to these current conditions, we have increased our investment in development where spreads between development yields and acquisition pricing still reflect prime opportunities to create value. Our development pipeline has grown considerably from $3.5 billion in the third quarter of ‘06 to over $4 billion today. Total construction in process has increased from $450 million in the third quarter of ‘06 to over $600 million in this quarter. As a result of this ramp up in our development pipeline, we are anticipating record deliveries in 2009 and 2010.

In addition to our robust domestic pipeline, we have also increased our presence in faster growing economies through investments in development projects in Brazil, Canada and Russia. We have pursued investments in these markets in a prudent and strategic manner, allocating a nominal amount of capital to these markets relative to our total domestic asset base.

Of particular note this quarter, we entered Canada through a 50% joint venture with Rice Construction, a strong Toronto-based developer. The joint venture’s first development project will be a 74-acre mixed-use project, comprised of approximately 700,000 square feet of lifestyle, retail, office and residential uses in suburban Toronto. The estimated cost of the project is expected to be approximately $150 million Canadian, with construction expected to begin in spring of 2009 and retail tenants opening as early as fall of 2011.

We are pleased to be able to enter the market in this manner because the opportunity presents a very attractive development project in a market with strong demographics and considerable supply constraints due to recent greenbelt regulations that permanently restrict new development in areas surrounding the Toronto MSA.

This is an exciting opportunity to control one of the limited remaining large parcels of developable land in this rapidly growing and nearby market. We look forward to finding additional attractive investment opportunities to increase our presence in Canada. There was a presentation on our website that illustrates the many reasons why we believe this is an attractive investment.

In addition to the myriad of leasing and development initiatives that were ongoing throughout the quarter, we also completed a very successful company-wide portfolio review. At this two-week annual event, more than 100 departmental representatives, alongside Scott, David, Bill, and myself evaluated each asset’s strategic position within our portfolio, identifying opportunities and challenges based on the assets’ performance and competitive market positions.

This comprehensive asset management exercise resulted in over 300 action items to improve portfolio performance, pursue opportunities to create value, and generate better shopping venues for our tenants and consumers. Importantly, the portfolio review identified additional assets to consider for disposition as well, continuing our capital recycling initiative.

This quarter was a very active and successful quarter for our company on many fronts. Our leasing department produced record results. Our development pipeline expanded. Our international footprint increased through our joint venture in Canada and finally, we completed a very important asset management review of our portfolio, which will help us add additional value going forward.

We look forward to building on these successes and maintaining the positive momentum that we clearly enjoy in the current market. With that, I will turn the call over to David.

David J. Oakes

During the quarter, we continued to sharpen our capital allocation strategy, further implementing the relative value framework, executing key transactions, and broadening the scope of opportunities that we are evaluating.

For example, we completed the sale of three value-added redevelopment assets to Macquarie DDR Trust. Our current portfolio has a considerable number of potential redevelopments on which we expect to execute and we were happy to find a partner whose refined investment strategy lined up ideally to participate with us. This preserves our capital, while also generating attractive returns for us and our partner. Further, these property sales and the accompanying list of assets to which we gave MDT a right of first offer underscore our long-term commitment to this relationship.

We also continue to formalize our funds management business, which includes our long-term relationship with MDT as well as Teachers TIAA, the investors in our first commingled fund, as well as many others. Our joint venture program has historically generated significant returns for both us and our partners, and we recognize that continuing to operate with the same performance-driven philosophy is crucial to our growth in this arena.

While there may be some softening in the demand and pricing for lower quality assets, we continue to see strong investment demand from our institutional clients for well-positioned properties with a visible growth profile. We also continue to see very intense demand for our platform and expect to see our assets under management increase in the coming years, and we are staffing the department appropriately to ensure its success.

Also during the quarter, we repurchased more than $100 million of our stock at prices that we believe represented a material discount to the value of our assets.

Now, I will turn the call back to Scott for his concluding remarks.

Scott A. Wolstein

Thanks, David. The strategies and achievements we’ve highlighted during the last few minutes are initiatives you’ve been hearing us talk about for several quarters: improving the overall quality of our portfolio through disposition, development and acquisition; returning the balance sheet to levels comparable to or better than where we were prior to our Inland acquisition; increasing our investment in development where our capital can earn the highest return; selectively investing a reasonable amount of capital in international markets that offer superior growth and outstanding value creation opportunities; and investing in our stock at prices many cents below the value of our assets.

As we look to the coming year, we’re refining our strategy to focus on further upgrading our portfolio through active portfolio management, including redevelopments and dispositions, which will have a long-term positive impact on our internal growth and cash flow; improving the quality of our FFO; growing our funds management business through execution for existing partners, and by adding new clients; using the current dislocation in the credit market to our advantage by finding broken developments or redevelopments or other unique investment opportunities created by the dramatic change in liquidity and the repricing of the risk; deepening our domestic development pipeline and broadening our international investments.

Based on this activity, we expect FFO per share for 2008 to be in the range of $3.95 to $4.05. The key assumptions that drive this guidance are as follows: same-store NOI growth of 2% to 2.5%, which is in line with 2007 and driven by consistent leasing spreads and stable occupancy; anticipated disposition of additional non-core assets; and a consistent level of transactional income.

In addition, 2008 development deliveries will be well below the 2007 level and well below our expectations for 2009 and beyond. There is no particular driver for this other than the projected timing of completions. In fact, we expect 2009 to be by far the strongest level of development deliveries in the company’s history by a rather wide margin.

We acknowledge that this FFO growth is slightly lower than our historic norms, but we believe that the constitution of 2008 FFO will be higher quality and we would expect our FFO growth to accelerate dramatically in 2009 and beyond. The strategies and assumptions I just mentioned reflect the constant and strategic evolution of our business model as we continually strive to create value and enhance returns for our shareholders and clients. We are looking forward to putting these strategies to work at all levels throughout our organization.

With that, I would like to open the phone lines for questions.

Question-and-Answer Session

Operator

Your first question comes from Ambika Goel - Citi.

Ambika Goel - Citi

Can you comment on the level of transaction volume that’s embedded in 2008 guidance? Is it specific deals that you have already set up that you expect to occur? Given that the level of transaction activity in 2007 was quite high, I just wanted to see what got you comfortable with 2008 levels.

David J. Oakes

We expect, at this point, the transaction volume in 2008 to be lower than the record volume in 2007. We’ve budgeted some expected asset sales, continuing to recycle capital and work on the assets that Dan mentioned specifically that came out of the portfolio reviews that might be good candidates for sale and do not have acquisitions identified at this point. So our budget currently is to be a net seller of real estate for 2008.

Ambika Goel - Citi

Specifically focusing on the gains, do you have deals in place that make you comfortable with transactional profits to be in line with the previous year?

David J. Oakes

We are comfortable with our guidance that transactional gains would be consistent with or somewhat lower than the level of 2007 that support the range that Scott provided.

Scott A. Wolstein

Ambika, most of that is merchant building gains based on actual development completions that already exist, which will probably be conveyed into joint ventures with financial partners, as we’ve done in past years. So yes, we’ve identified actual properties, the yields on those properties are already in place. We pretty much know what the cap rates would be on any sale or contribution to a joint venture.

Operator

Your next question comes from Jay Habermann - Goldman Sachs.

Jay Habermann - Goldman Sachs

Good morning, everyone. On the ‘08 guidance, calling for 5%, 6% growth year over year which again looks reasonable, but a bit of a deceleration. Can you just comment to what degree being a net seller next year, what sort of dilution you’re expecting there? To what degree will you be a net seller in 2008?

David J. Oakes

Right now, for the budget we are expecting to be a net seller of several hundred million dollars of real estate in 2008.

Jay Habermann - Goldman Sachs

Can you just characterize the pipeline of acquisitions that you’re actually looking at today?

David J. Oakes

I would say despite the slowdown a few months ago, there continues to be a healthy amount of products on the market and we continue to evaluate a very large number of acquisition opportunities across the spectrum of retail that are available today.

Scott A. Wolstein

Jay, just to elaborate on that a little bit, I think what you’re seeing in the marketplace today is we are seeing an acceleration of portfolio opportunities, largely from private developers who are facing a liquidity crunch. The conundrum is, of course, that our cost of capital is high today as well, and the core co-investors that we typically invest with are little bit nervous about going heavily into core at low cap rates because of risk in terms of potential inflation of cap rates. So, it’s going to be an interesting year to see how all that plays out.

There are going to be a lot of assets in play. We’re certainly not going to be issuing equity to buy those assets. We would invest in core, as we said in many prior conference calls, only in a joint venture with private capital. Our ability to execute on those transactions will be largely dictated by whether private capital has an appetite to buy core assets in this environment. Right now I think it’s a little unclear and that’s why we haven’t included any of that in our guidance.

Jay Habermann - Goldman Sachs

Can you just talk about the decision to enter Canada and obviously go with a joint venture with Rice and pursue mixed-use? Just talk about the expected returns there?

David J. Oakes

I think the decision to enter Canada was a recognition that while we see the greatest opportunity and the greatest need around the world for new development in some of the emerging markets that are meaningfully underserved for retail space, that there are also some opportunities closer to home. The reality is, Toronto is closer to our headquarters here in Cleveland and three-quarters of the rest of our portfolio. I think it was a natural extension in many ways.

The project overall is a mixed-use project. However, the net cost of roughly $150 million that we’ve outlined -- so the great majority of the overall budget -- relate to the retail section of about 700,000 square feet of lifestyle space. Demographics of this particular site are extremely attractive, and also the greater comfort that we feel, especially due to new supply constraints in the Toronto market. So, we feel like those sides of it line up very well in addition to having found a partner that we feel extremely good about.

I think we would continue to look for those sort of opportunities in all the markets in which we operate, but particularly in and around Toronto.

Jay Habermann - Goldman Sachs

Is this a one-off transaction or do you expect to pursue additional projects with Rice?

David J. Oakes

This is a one-off transaction, but we’ve had a very positive experience with the Rice Group so far and would be very open to working with them on additional projects. They have additional land bank in and around Toronto, and I think that’s a conversation that we are very willing to have.

Jay Habermann - Goldman Sachs

Dan, any pullback from retailers in terms of the development business?

Daniel B. Hurwitz

We’re not seeing a real pullback from retailers from a desire to open new stores. What we are seeing is retailers are using the current economic climate as an opportunity to renegotiate or at the very least, poor mouth a little bit the deals that we’re working on with them. Retailers have gotten a little tougher. I think they are trying to grab back some of the pricing power that we’ve enjoyed over the last four or five years. Sometimes that works for them, sometimes it doesn’t.

One of the beauties of our business right now is that there’s still a lot of competition for space. So if you have a desirable location and you can generate competition and an auction for the space, you’re still able to get your price. So even though they’re getting tougher, the deals are getting a little tougher, but there are other parts of the development business that are getting a little less tough.

One of the things that we are seeing is a little less competition for land. One of the things that has been driving costs up and margins down a little bit in development is land costs. With some of the dislocation in the capital markets, we’re starting to see that lighten up a little bit which should give us the opportunity to recapture some of the margin.

Operator

Our next question comes from the line of Christeen Kim - Deutsche Bank.

Christeen Kim - Deutsche Bank

Scott, you’d talked a little bit about how investors are feeling a little bit more nervous about getting involved in these larger portfolio acquisitions. Is there any price differentiation between the different asset classes; A quality product versus B?

Daniel B. Hurwitz

Yes. I mean, there’s always been a clear differentiation among institutional investors between A and B quality assets. There’s never been a broad institutional bid for B quality assets unless they had a value-added component to them where there was an opportunity to create A assets out of a B asset and have a great opportunity for value creation.

I think today, the appetite among institutional investors is clearly more towards the value add than core, to protect themselves from possible changes in pricing. I haven’t seen it necessarily translate into transactions being priced at lower prices yet on A assets. I haven’t seen that and I don’t know if we will. But there certainly is a less voluminous demand from the capital side to invest in blind pools to go out and acquire core assets, if you will, vis-à-vis value-added opportunities.

Christeen Kim - Deutsche Bank

Does that imply that you haven’t seen much movement in cap rates then?

Daniel B. Hurwitz

We haven’t seen it yet. But what I am saying is there clearly is some concern that might happen, and that has an impact on the depth of demand on the institutional private equity front.

David J. Oakes

I think also in terms of the institutional demand for real estate at this point, we’ve clearly gone through a great period of uncertainty. The reason that we have such great interest in working with us and our platform in general is because we are able to go out there and take some of the risk out of these opportunities, and that’s what a large portion of the core investor universe wants. I think in the uncertainty we’ve seen in the market in the past few months, it just causes this slowdown in activity as everyone somewhat waits to see where it settles out.

I think another aspect is just a calendar issue, in terms of this time of year you either get to a point where institutions have put out the capital they need to for the year, in which case they are focused on ‘08 planning, or they haven’t and they’re fighting for deals to close in these last couple of months. As it stands today, given the incredible record volume of transactions across all property types in the first half of 2007, I think many institutions are simply done with the allocation that they needed to invest for 2007. And are making their plans for the best ways to put out capital in 2008 and very actively having those conversations with us and others about what opportunities we are seeing to invest more capital.

Christeen Kim - Deutsche Bank

Just quickly on the ‘08 NOI growth guidance, given how much portfolio re-positioning you have done this year, why isn’t that range a little bit higher?

Scott A. Wolstein

You are talking about the same-store NOI growth?

Christeen Kim - Deutsche Bank

Yes.

Scott A. Wolstein

It really takes time for that to resonate. I mean, a lot of our assets are new developments either that we built or that we acquired. Leases don’t roll every year. They roll every three to five years. I think you will be seeing that in the coming years. There’s no question about it. There’s also a little bit of -- to be quite candid with you -- our budgets come from our leasing people. They have to perform as they guide us to what will happen at the portfolio level. We certainly hope that they will do better than what they project. They are not likely to give us forecasts that are major stretch from what they think they can achieve. So oftentimes we do better than what we guide to at this point in time.

Daniel B. Hurwitz

I also think one of the things to consider along the leasing budgeting that Scott mentioned is that we were more conservative for 2008 primarily because we have an economy that people are concerned about. So, we think it would’ve been imprudent for us to be overly aggressive in 2008. So we did go through the portfolio and we did make some projections on some tenants that we may have had concerns with. If it proves out that the economy is better than people think and the world actually isn’t coming to an end, we hopefully will be in a position to outperform.

Operator

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

Michael Mueller - JP Morgan

Dan, going back to the question about tenant demand in the development pipeline, when we look out at the ‘08, ‘09 pipeline, can you give us a sense as to what’s under letter of intent? What’s pre-leased? If the economy softens further and -- I don’t want to say it’s going into recession, but gets a little bit weaker -- what should we think of as being at risk? Or is the visibility high enough where you’re not necessarily worrying about that?

Daniel B. Hurwitz

Well, the visibility is pretty high so we are not overly concerned about it. If we are buying land out there, Michael, which is the ultimate in exposure to a development project, we have a very, very good understanding of the majority of the tenants that are going to be on that site. We may not have every lease signed or even every letter of intent signed, but we clearly have visibility as to who the tenants are; and in some cases, the tenants sent us to those markets, so that makes it even easier from that perspective. We know who the supporting cast will be around those tenants.

When you talk about ‘09, for example, and in particular ‘10, which is we have a number of deals also that we’re working for ‘10, it a little early to be pre-leasing those sites other than the actual anchors. So we have great visibility on our anchor interest and we have a lot of confidence on who the followers are after you secure those anchors. If we don’t, to be honest with you, we won’t close on the land. If we don’t have a good feel for what we can do there based on the marketing that’s currently going on within our development or leasing departments, we will pass on the site. We do that on a regular basis.

There are times when we had projects that tenants just won’t commit to at this time or they feel that the market is too green, or in some cases, the housing projection seem unrealistic from a development perspective, particularly in the current climate. If that’s the case, then we move on.

The good news is that the pipeline is very, very full and probably even exceeds our capacity if it all were to hit. So therefore, we continue to work the ones that are most profitable and where we have the most tenant interest. We’ve never really done a project, quite frankly, where it’s been built that we haven’t been able to lease it. I don’t see any change in that.

Michael Mueller - JP Morgan

When you talk about the pipeline getting bigger in ’09 and ‘10, should we think of that as popping or running at a higher level? You are hitting your stride and that seems to be a good number for the foreseeable future?

Daniel B. Hurwitz

Well, it’s going to continue to accelerate. As Scott mentioned, ‘08 on deliveries is going to be lighter than ‘07, but ‘09 will be a considerable acceleration and ‘10 should be as well.

Michael Mueller - JP Morgan

You did some stuff with MDT; is their access to capital better these days?

David J. Oakes

You can see where the stock trades on the AFX and where the reported MTA of the company is. Clearly there is a relatively meaningful spread there that I think they have to evaluate if they are thinking about equity capital. Overall, our view is that their balance sheet continues to be in very strong shape. I think they clearly have access to capital, but I think in general that question is much better posed to Nick Ridgewell and the MDT team.

William H. Schafer

I’d like to lever in a little bit on what Dan was talking about with respect to our development pipeline. I think it’s important to note that when we are talking about 2009 deliveries, that’s typically a project that’s been in the pipeline now since 2006. The gestation period for our projects at this point tends to be about three years. So by the time we’re sitting here at the end of 2007, we have a very good idea of the anchor lineup for all of those properties and probably have letters of intent with the anchors in most of them.

That is different from the way it used to be where we used to have a year to year-and-a-half gestation period. The leasing was going on as we were going through the entitlement process. At this point in time, sometimes the leasing is actually preceding the entitlement process and gets done quicker. So we have a much higher visibility on leasing than we do on entitlements in many places.

The other thing relates to your other question about whether the increase in volume in 2009 is indicative of a trend. It very clearly is for no other reason than we broadened our universe of opportunities by adding international development deals to the mix. We have several deals in the pipeline in Brazil. As David mentioned, we have one in Canada and others that we’ll look at beyond that. We have a few deals in Russia queued up as well. So the development pipeline going forward quite naturally is going to become larger just because it’s a greater universe that we are dealing in.

Operator

Our next question comes from the line of Matt Ostrower - Morgan Stanley.

Matt Ostrower - Morgan Stanley

I may have missed it, but just looking at your guidance, it looks like the midpoint is in the 5% range, 4% to 5%. If I look at your same-store NOI growth we’re talking about 2%, 2.5% growth there; lever that up to the 4%, 5% growth level. Transactional income is flat but then gains go down. Doesn’t that get you below the mid-point of your guidance? What’s the offset there? If you already answered this question, I apologize.

Scott A. Wolstein

Matt, we did answer it, I think. That is, that we are a net seller which is dilutive to earnings. So while we have a same-store NOI growth in the core assets that continues to be held in core, the amount of the core assets in the core will decrease under our guidance.

Matt Ostrower - Morgan Stanley

Right. I’m actually wondering, the guidance is a little high to me given that you will be a net seller and that your development gains are going down. Why would you still be in the mid single-digit range guidance-wise? Why wouldn’t you be lower than that under that base case scenario?

William H. Schafer

Well, that’s a very difficult question to answer on a conference call. There are so many things that go into the budget. You’ve just got to trust us that in all the moving parts, this is where it comes out.

David J. Oakes

Mid-point this year to mid-point next year of 5.5% growth, I think, based on the assumptions we’ve outlined is a level that we’re very comfortable with.

Matt Ostrower - Morgan Stanley

You guys disclosed your capitalized G&A. You’ve talked about, I think, it is $8 million to-date of Construction Associates. Are there more administrative costs that you capitalize there, senior management and other stuff that’s in there or is that really your full capitalized G&A?

Scott A. Wolstein

That is really the full capitalized G&A. There is not senior executive capitalization in there. It’s basically the development and related leasing activities that are associated with development that are pretty much capitalized there.

Operator

Our next question comes from the line of Jeff Miller - JMG Capital.

Jeff Miller - JMG Capital

What’s your liquidity at this point? You mentioned, I think, over $600 million?

Scott A. Wolstein

Yes. At the end of the quarter, we had over $600 million available on our lines. There’s not a whole lot of re-financings that we have for the balance of the year. I think there’s $100 million of notes that comes due in the first quarter of next year and we continue to evaluate options on a daily basis.

Jeff Miller - JMG Capital

You said of that just under $400 million in ‘08 coming due, maturing, most are mortgages, mortgage debt and half had extension options available?

Scott A. Wolstein

I think that was with regard to the joint ventures as to where we had half of the joint venture maturities of about $600 million were in December of ‘08. The remaining half of that, more than half of it was subject to extension options.

Daniel B. Hurwitz

I think it’s important for you to know that all of the joint venture debt is project debt. There’s no unsecured corporate debt. There are no corporate guarantees on any of the joint venture debt.

Operator

Your next question comes from Rich Moore - RBC Capital Markets.

Rich Moore - RBC Capital Markets

Dan, you sound a little bit hoarse. I assume that’s from rooting for the Indians, or at least I hope that’s the case.

I’m curious a little bit about the dynamics of the merchant building sales. When you guys complete these projects, everybody knows you are ready to sell. So in this tougher environment for pricing, does it pressure the selling process just to put more pressure on the pricing? If so, might you pull back on some of the actual sales and put the product inside the portfolio rather than sell it?

David J. Oakes

I think from our perspective, we’re focused on doing the right thing with the asset. It’s a strategy decision in terms of where we want our capital allocated. The merchant building program has worked well because brand new, high quality assets fit exactly what some institutions are looking for, for that relatively low growth, almost no CapEx profile of very visible cash flows over the coming years.

To the extent that pricing for some reason that we absolutely have not seen today would not make selling those assets acceptable. I think the reason we were in the development projects from the beginning is that we had an interest in owning them. So if the pricing for some unforeseen reason is not there, I think there’s absolutely a willingness to own it and not just try to push our quality product out the door at prices that we don’t feel comfortable with.

Rich Moore - RBC Capital Markets

Dave, you don’t think there’s any reason to think we’d see lower margins on sales in 2008 than we’ve seen previously?

David J. Oakes

I don’t think so. The pro forma for the project get us to relatively comparable returns and cap rates are in a relatively comparable range. Generally, we would be in the same range. We sold some very high quality assets in this year and I think we would think about doing the same next year and so could expect margins to be comparable.

Rich Moore - RBC Capital Markets

I’m curious as well guys, how the stock buyback is working for you? You bought back $100 million worth of stock. You have another, I think, $400 million you could buy back. Is that still an attractive option, do you think? Or is that sort of meaningless at the current share prices? How are you thinking about that?

David J. Oakes

I absolutely don’t think it’s meaningless. The board authorized a $500 million repurchase. The balance sheet is in a strong position where we could comfortably execute on that based on all the opportunities we are seeing, that was the best opportunity to buy the stock at a big discount to net asset value. With the exception of our blackout periods, I think it is something we absolutely consider very, very regularly.

Rich Moore - RBC Capital Markets

So we can anticipate probably more buybacks in the coming months?

David J. Oakes

You can anticipate that it’s something we’re going to think about every day.

Operator

Your next question comes from Jim Sullivan - Green Street Advisors.

Jim Sullivan - Green Street Advisors

Can you give an update on Nampa, Idaho and your bigger development projects?

Daniel B. Hurwitz

J.C. Penney opened in Nampa and is doing extremely well. We’re under construction with the lifestyle phase of the project, and we’ll have store openings in ‘08 on that portion. We’re in active negotiations with another department store for a second anchor on the site.

Jim Sullivan - Green Street Advisors

What kind of pre-leasing do you have on what you’re constructing?

Daniel B. Hurwitz

We’re about at 40% to 45%; not executed leases, but strong indications of interest and letters of intent.

Jim Sullivan - Green Street Advisors

Following up on a question raised earlier, can you comment on the pre-leasing for your overall development pipeline at this point?

Daniel B. Hurwitz

Well, like I mentioned earlier, our pre-leasing is focused on the anchors because once you have the anchors committed, the other tenants usually follow if you have the right merchandise mix. We have yet to have a problem with a project where we had anchors committed where we couldn’t lease the additional GLA.

So that being said, if we are proceeding with the project, you can be very comfortable with the fact that our anchors are committed and that we’re very comfortable that we can lease the rest of it up.

One of the things that I’d mentioned on past calls, one of the mistakes that we’ve made in our development pipeline overall is in some cases bowing to market pressure to pre-lease at a high level too early, where you leave money on the table because a project that’s coming on the ground leases a lot better than a project off a piece of paper. So, we gauge that interest from tenants. We have a dialog with these tenants every day. We understand what their expectations are from a co-tenancy perspective and we go get it when it’s the appropriate time to do so. But overall, you should keep in mind our portfolio is 96% leased, and overall, we’ve opened up our development projects, in many cases, mostly in the mid to high 90s, unless we’ve made a conscious effort not to because we felt that the space would be higher value after the project has some operating history.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Good day.

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Source: Developers Diversified Realty Q3 2007 Earnings Call Transcript
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