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Executives

Adam Chavers - IR Manager

John Kite - President and CEO

Tom McGowan - COO

Dan Sink - CFO

George McMannis - SVP of Finance and Capital Markets

Analysts

Ambika Goel - Citigroup

Thomas Baldwin - Goldman Sachs

Steven Rodriguez - Lehman Brothers

Paul Puryear - Raymond James

Philip Martin - Cantor Fitzgerald

David Fick - Stifel Nicolaus

Nat Isbee - Stifel Nicolaus

Kite Realty Group Trust (KRG) Q4 2007 Earnings Call February 8, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Kite Realty Group Trust earnings conference call. (Operator Instructions)

I would now like to turn the call over to Mr. Adam Chavers, Investor Relations Manager. Please proceed, sir.

Adam Chavers

Thank you, operator. By now, you should have received the copy of the earnings press release. If you have not received a copy, please call Kim Holland at 317-578-5151 and she will fax or e-mail you a copy.

Our December 31, 2007 supplemental financial package was made available yesterday on the corporate profile page in the Investor Relations section of the company's website at kiterealty.com. The filing has also been made with the SEC and the company's most recent Form 8-K.

The company's remarks today will include certain forward-looking statements that are not historical facts and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results of the company to differ materially from historical results or from any results expressed or implied by such forward-looking statements, including without limitation national and local economics, business, real estate, and other market conditions; the competitive environment in which the company operates; financing risks; property management risks; the level and volatility of interest rates; financial stability of tenants; the company's ability to maintain its status as a REIT for Federal income tax purposes; acquisitions, dispositions, development and joint venture risks; potential environmental and other liability; and other factors affecting the real estate industry in general.

The company refers you to the documents filed by the company from time to time with the Securities and Exchange Commission, which discusses these and other factors that could adversely affect the company's results.

On the call today from the company are John Kite, President and CEO; Tom McGowan, Chief Operating Officer; Dan Sink, Chief Financial Officer; and George McMannis, Senior Vice President of Finance and Capital Markets.

And now, I'd like to turn the call over to the President and CEO, John Kite.

John Kite

Thanks, Adam, and thank you for joining us this morning for our fourth quarter and yearend conference call.

We finished the year strong with year-over-year FFO growth of 8.6% on a per share basis. Our financial metrics, including portfolio leasing percentage, G&A to revenue, earnings per share and fixed charge coverage compared very favorably to our peer group and were consistent with our expectations.

While we are pleased with our 2007 results, we are focused on 2008 and beyond. And as I've told you many times before, when it comes to committing capital, we see ourselves as risk mangers. This isn't a new policy initiative in reaction to the economy, this is simply how we have always done business.

Our focus on risk management is clear when you look at our disciplined development approach. Every project that we take on is put through a systematic process and must meet a series of hurdles before we will commit capital.

As you know, we break out the pipeline into three components: the first being the current development and redevelopment pipeline, which is made up of 11 projects. All of the projects are fully entitled and under construction. These projects are 80% leased or committed, including all of the anchored tenants.

It's important to note that only 27% of the owned square footage is currently occupied.  This means that the leased but unoccupied space will be a source of growth towards the end of this year and into 2009. The pipeline is approximately 80% funded with the balance of the necessary funding available under in-place construction loans.

As you can see, the vast majority of the risk in the current development pipeline has been mitigated. We are now positioned to realize the majority of the growth from this pipeline as we stabilize the assets in 2008 and 2009.

Next, we have the visible shadow pipeline that consists of six projects. We own the land at five of the six projects and have acquired all of the land at market and below-market values. Majority of the projects are fully entitled, and we are in the final stages of completing anchor leasing.

These are all well located land parcels that are generating strong tenant interests, and we remain confident that we will finalize anchor leasing entitlements and commence construction on the majority of the projects throughout 2008.

Finally, we have the shadow pipeline. The projects in this pipeline are subject to strict evaluations before significant resources are committed. In the fourth quarter, we tightened the parameters of our review process and cut the size of the shadow pipeline by five projects, which resulted in an after-tax write-off of approximately $270,000.

We elected to proactively drop these projects in the predevelopment stage because the economics and risk profile no longer had merit in the current environment. Of the remaining five projects in the shadow pipeline, all of which are in our core markets, we own the land for three and control the land for the other two. We will continue to actively monitor the viability of these projects before additional capital is committed.

As I have recently said in regards to capital, we were confident that we would aggressively manage our current and future debt maturities. We have already refinanced in excess of 80% of the debt originally scheduled to mature throughout 2008 and the remaining '08 maturities will not expire until the end of next year.

We have access to the capital necessary to carry out our strategic plan for 2008 and into 2009 via our current credit facility, construction loans, the Prudential joint venture, and capital recycling.

Recycling non-core assets to pay down debt or to redeploy in the core opportunities with upside potential is an important part of this strategy. For example, just last week, we completed a like-kind exchange in which we sold a single tenant operating property and used the proceeds to help acquire Rivers Edge Shopping Center on the north side of Indianapolis.

Rivers Edge was acquired from a private owner in an off-market transaction. It's 80% leased and positioned within the strongest retail quarter in Indianapolis and presents an excellent opportunity to add value through redevelopment.

In the current backdrop of economic concern and potential recession, we see our operating portfolio as a real source of strength. Our operating portfolio is well located with respect to income and population demographics. An average of 125,000 people live within a 5-mile radius of our shopping centers, and with average household incomes of nearly $80,000, this target group of shoppers enjoys substantial purchasing power.

In addition, our operating portfolio has a low average age of approximately seven years. Accordingly, only 4% of our annualized base rents roll this year and only 6% will roll in '09. The combination of these factors makes our operating portfolio even more attractive in these uncertain economic times and helps insulate us against a potential recession.

Approximately 60% of our annualized base rent is generated by anchor tenants and ground lease tenants, which we view as particularly stable because of the longer terms and the strength of their credit. In addition, we have seen strong rent growth in the last two quarters.

Although, this growth is calculated in our small base of leases, it gives you some visibility of the impact that we expect to see in 2010 through 2012 when the leases at our younger properties will begin to roll. Obviously, this lines up nicely to the timeline of a potentially recovering economy.

As I have said before, we have excellent opportunities for growth in the current pipeline in late '08 and '09 and through the visible shadow pipeline in late '09 into '10. The development pipelines and increasing rollover in our operating portfolio will be a source of much of our growth over the next five years.

And now, I'd like to turn the call over to Tom to further discuss the development details.

Tom McGowan

As John mentioned, our development process focuses on the systematic deployment of capital and risk management. Three projects met our hurdle to advance through various stages of the process in the fourth quarter: Tarpon Springs, the second phase of Spring Mill Medical and Eddy Street Commons.

Tarpon Springs is 100% leased and has transitioned to the operating portfolio. Spring Mill Medical Phase II moved from the visible shadow pipeline to the current development pipeline, because the site is now fully entitled and the project is 100% leased. We are on track to deliver the 41,000 square foot expansion in December 2008.

The first portion of Eddy Street Commons at the University of Notre Dame, our $200 million mixed-use development, recently moved from the shadow pipeline to the visible shadow pipeline.

We moved the first component of the project, the retail, office and multifamily buildings, because we satisfied three important previously announced benchmarks. First, the 25-acre parcel had to be fully entitled with a plan unit development designation. This task has been accomplished.

Second, we needed to secure significant public incentives. I'm pleased to announce that we have received the final approvals from the City of South Bend and the necessary oversight approvals from the State of Indiana to proceed with the TIF. The specific details of the TIF will be announced once the bonds have been sold, which we anticipate will occur in the next 30 days.

Third, we've completed negotiations with the University of Notre Dame on the final deal structure. By limiting the outflow of capital until these benchmarks were accomplished, we have effectively managed our risk on this project.

Another example of our disciplined approach is Delray Marketplace in Delray Beach, Florida. While all entitlements are complete, we've chosen to delay commencement of construction until we have both anchor leases fully executed.

Frank Theatres recently a signed 55,000 square foot lease for a 14-screen theater and an entertainment center. We are also in late-stage lease negotiations with a high-quality grocery operator with a significant presence in Florida. We remain enthusiastic about the long-term prospects of this project.

In addition to our external growth strategies, we continue to enhance internal growth initiatives by focusing on improving efficiencies in our operating platform and have already identified $800,000 in operating expense savings.

We remain focused on maximizing ancillary income sources and anticipate that these opportunities will become more impactful over time. We're also continuing to evaluate the portfolio for redevelopment opportunities such as Bolton Plaza in Florida and Four Corner Square in the State of Washington.

At this point, I'll turn it over to Dan to summarize our financial results.

Dan Sink

Good morning. For the three months ended December 31, 2007, funds from operations were $0.34 per diluted share. This is an increase of 6.3% over the $0.32 per diluted share for the fourth quarter of last year. For the year, FFO was $1.26 per diluted share or 8.6% increase over the prior year.

In the quarter, our same property NOI, which includes 49 properties, increased 1.4% over the same period in 2006. And for the year, same-store grew 1.5%, which is the midpoint of our previously provided guidance of 1% to 2%.

For the year, excluding proceeds for the fourth quarter sale of a single tenant build-to-suit in Washington, construction and service fee revenue totaled $31.2 million with the margin of approximately $3.2 million before tax and that is in line with our budgeted expectations.

G&A expense for the fourth quarter was approximately $1.5 million or 4.6% of total revenue. For the year, G&A expense was approximately $6.3 million, which was at the low end of our expectation and continues to compare favorably to our peers.

In total, for the quarter, we received approximately $800,000 from the settlement of Ultimate Electronics bankruptcy. Approximately $280,000 was the recovery of a previously written-off receivable and the remaining $520,000 was in other property related revenue.

In addition to the recovery from the Ultimate Electronics, other property related revenue includes land sales of approximately $1.47 million and overage rent of approximately $943,000.

Cost of construction and services includes a write-off of approximately $444,000 of predevelopment cost related to the termination of our shadow pipeline projects. The net effect to FFO after-tax was approximately $270,000.

Summarizing some of the more significant financial metrics for December 31, our fixed charge coverage ratio was approximately 2.9 times. Our floating rate debt was 26% of our total debt and approximately 14% of the total debt was in floating rate property-specific construction loans.

The FFO payout ratio was 60.1% and the AFFO payout ratio was higher this quarter as a result of the fact that the Indiana Supreme Court took possession of the space in our 30 South property and the majority of tenant improvement lease commissions were incurred in the fourth quarter.

Now, I want to take this opportunity to walk through our availability of capital to complete our 2008 plan as well as our objectives to reduce leverage while continuing to maintain a healthy fixed charge coverage ratio. At the end of the fourth quarter, we had approximately $50 million of availability on our line of credit before utilizing the accordion feature or negotiating additional opportunities with our lending group.

We have approximately $1 billion of debt and equity capital available in the Prudential joint venture, and we have the option to present several projects in our shadow pipeline to Prudential to further expand the relationship.

We also intend to analyze non-core low-growth assets for recycling opportunities to pay down debt or redeploy into higher growth assets. Good prospects for this strategy are the single-tenant projects with limited rent growth opportunities, non-core medical office and commercial buildings, and our continued focus on recycling land holdings.

In addition, we are in early discussions with potential joint venture capital partners to seek market-driven opportunities with private developers or assets with a value-added component. These fund relationships would allow us to sell assets into the fund while maintaining an ownership percentage and management responsibility.

Also in the fourth quarter, we sold a single-tenant build-to-suit asset for a net gain of $1 million after-tax and our partners' 20% minority interest at a 6.2% cap rate. And we sold a single-tenant operating property for a net gain of $2 million at a 6.19% cap rate.

Lastly, we are reaffirming guidance in the range of $1.28 to $1.33 for the full year of 2008.

Thank you for participating in today's conference call. And operator, we'd like to open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

And your first question comes from the line of Jonathan Litt with Citigroup. Please proceed.

Ambika Goel - Citigroup

Hi. This is Ambika with Jon. Could you give us some more color on the projects that were dropped from the shadow pipeline, just exactly what criteria did they not fit, and how has that changed their criteria that they are requiring for their new development project?

John Kite

Ambika, it's John. Basically, the shadow pipeline projects that we said, that we dropped, the criteria is essentially the timelines that we see, the length of time that we think it's going to take for lease up, the demand for tenants, kind of the cost structure associated with that. So really, there is a multitude of things we are looking at there.

But the bottom line is that we've always said that we have a very active shadow pipeline. And obviously, we had 10 projects in that pipeline, and we cut it in half. And also, there, we are looking at kind of a market-driven approach too. There is one particular project in the pipeline that was in a new market that would have been a merchant building. It would have been merchant building with TRS. And so that, at this point in time, didn't seem to make too much sense. So, I think it was really a combination of us wanting to be conservative, the returns that we're seeing and the activity that we have going on in the current pipeline and in the visible pipeline. We obviously have enough going on there. But then also, some of these projects can be a distraction. So, we tightened it up. We still have five projects there, they represent great opportunity. And I think going forward though it will be a real good thing for us.

Ambika Goel - Citigroup

And is this specifically related to specific tenants or is it just generally looking at the market and saying, let's pull back on this development and this project?

Tom McGowan

Ambika, this is Tom. The answer to the question is when we see compression in rents and unstable conditions in specific markets, as John said, we have a very strong list of pipelines and we have the ability to pull back when we need to, and this was simply a situation, it did not meet the risk parameters. We saw some compression inside the rents. And at that point, it was an easy decision for us, based upon the key parameters that we have established.

Ambika Goel - Citigroup

Okay, great. And my last question. Who are you seeing right now as the biggest retailers that are expanding at this point? We've heard that Target, JCPenney, various big box retailers have been reducing their store expansion plans. So, I just wanted to see where you are seeing the demand from at this point?

John Kite

Well, I think clearly, the larger box guys you are talking about, Target, Wal-Mart and Kohl's, obviously they are taking a more conservative look, but they are also still opening a lot of stores. And I think, when you look at it on an impact basis, particularly when we're talking about our pipelines, I mean, again, remembering that our current development pipeline and our visible shadow pipeline, those projects are going to be delivering, as you know, into '09 and '10.

So, you really kind of move beyond some of this. But in general, the junior box guys are still actively looking for new opportunities, even the guys that have had disruption in their space, the Best Buy and the Circuit City, the Bed Bath, Linens 'N Things, Michael's, PetSmart, all those guys are essentially staying on plan. I mean Circuit City has obviously had restructuring. But in general, the junior box guys will continue to look for opportunities and may even see this in certain cases as an opportunity to get into deals that they otherwise couldn't have. So, I think in general, it's really more about the larger users.

And again, for a company like us that has 16 projects between the current construction pipeline and the visible pipeline, we have enough going on there, that as we move through this period of time over the next two years, it shouldn't be a massive impact. But clearly, there is caution. So, that's why we're using caution as well.

Ambika Goel - Citigroup

Okay, great. Thank you.

John Kite

Thanks.

Operator

Your next question comes from the line of [Thomas Baldwin] with Goldman Sachs. Please proceed.

Thomas Baldwin - Goldman Sachs

Good morning, guys. How are you doing?

John Kite

Good morning, Tom.

Thomas Baldwin - Goldman Sachs

Just following up, can you clarify how long it takes today to take a development from conception to completion versus how long it might have taken previously?

Tom McGowan

This is Tom. I would say the process as a whole takes approximately the same amount of time. The issue that ties back to that process is how difficult a municipality or county may make the entitlement process as a whole. There are certain areas of the country that are pushing very hard on very restrictive entitlements that may tie back to mixed-use components, etcetera. I'd say that the actual timeframe and the sequence is the same, it just becomes a bit more challenging as you go through that process, to make sure they end up with a plan and a return that ultimately works for the company.

Thomas Baldwin - Goldman Sachs

Okay. So extended lease-up periods don't really factor into that, because we've been hearing from some of your competitors that the time to take a development from inception to stabilization has really lengthened, and that that was the result of longer lease-up periods. Are you seeing any of that on your end?

John Kite

Tom, I think that the bottom line there is these projects have always kind of had that two to three year process from when we take down the ground to stabilization. And really as Tom said, it's more about the entitlement process, the leasing process. That's why we spend so much time explaining that, that's why we have the visible shadow pipeline. That's our holding area for the pre-leasing requirements that we have. I think our pre-leasing requirements have always been maybe a little more stringent than some others. So, we are doing the leasing there, and that's always taken some time, and that's kind of why the current pipeline is 80% leased.

So, we don't view it as a huge differential between now and what it was a year ago. Perhaps on the small shop space, you might see a little bit of a lag there, but the bottom line is the anchors are the anchors and the time it takes to lease the anchors is essentially the same, either you have them or you don't.

Thomas Baldwin - Goldman Sachs

Okay. Thanks a lot guys. I know you have spoken about this in the past, but institutional demand, and I'm referring specifically to your joint venture, is that still as strong as it was, say early 2007, given the widespread perception that cap rates may backup over the course of 2008?

John Kite

Well, I mean when you are referring to our joint venture, you are referring to our current joint venture with Prudential, and that's really a development joint venture or it's orientated towards development. And that's not really a factor relative to that, because that's kind of a higher returning JV with the idea that we're going to get development returns.

In terms of us looking at new joint ventures, which would be more orientated towards us ceding it with some assets and then using that to go out and acquire things that have redevelopment opportunities or have re-tenanting opportunities, there is still strong demand there. I think what you've got to realize and what everybody has got to realize is that all this cap rate talk at this point is essentially conjecture.

Clearly, there has been movement, because of the capital disruption, but interest rates have moved down significantly over the last six months to nine months. So, there is a disparity there between what originally started off this talk about rising cap rates was rising interest rates. While all those projections that in 10 year, it would be at 6 aren't quite correct right now. So, I think that disruption allows for that talk, but the bottom line is we have good interest in our conversations about creating a joint venture to do something like that. So, there is still a lot of liquidity. It's just a debt issue. Quite frankly, the equity is greater today than it was six to nine months ago in terms of the total capital that's out on the sidelines. It's just a debt disruption.

Thomas Baldwin - Goldman Sachs

Okay, great. Thanks a lot for that, guys.

John Kite

Sure.

Operator

Your next question comes from the line of Steven Rodriguez with Lehman Brothers. Please proceed.

Steven Rodriguez - Lehman Brothers

Hi, good morning, guys. I was wondering if you can talk a little more in detail about the potential size of joint venture setup with these commercial and healthcare assets without getting too specific, obviously.

John Kite

Steven, this is John. We are not going to get into too greater detail right now on that. As Dan mentioned, we are in early discussions. I think we're going to continue to have these discussions to see where it goes, but let's just say that it would be very meaningful for us. I mean our objective is to have a meaningful pool of capital that we can go out and utilize and deploy. So, I think it's early to get into size, but we kind of want to approach this cautiously and we are in early discussions, however, it is very important for us to execute on this eventually.

Steven Rodriguez - Lehman Brothers

Okay. And, Dan, regarding your guidance, what kind of LIBOR assumptions did you make for '08?

Dan Sink

When we presented the '08 guidance, we utilized the one-month forward curve for LIBOR. And as you look at that, we put that together, end of December, early January. And I think as you work through and you are looking at the forward curve as compared to when we finalized our guidance, I think there is interest rates and the economic environment, those kinds of things are items that you can't your arms around completely, because there is a lot of variables. So, that's primarily why we give a range. And I think that's where we sit today from a guidance standpoint.

Steven Rodriguez - Lehman Brothers

Okay, thanks. And my last question regarding Circuit City, the lease term fee; have you guys provided or disclosed when that possibly will be, what quarter?

Dan Sink

Yes, the Circuit City lease term fee will be in Q1 of '08.

Steven Rodriguez - Lehman Brothers

'08? perfect.

Dan Sink

Yes.

Steven Rodriguez - Lehman Brothers

Thanks.

Dan Sink

Thanks.

Operator

(Operator Instructions)

Your next question comes from the line of Paul Puryear with Raymond James. Please proceed.

Paul Puryear - Raymond James

Hi, good morning, guys.

John Kite

Hi, Paul.

Tom McGowan

Good morning.

Paul Puryear - Raymond James

Could you update us on your tenant watch list? Who do you have on the list, any anchor tenants bothering you here?

John Kite

Paul, it's John. If you look at our top list of tenants, I think the one that we are paying the most attention to and obviously with the recent lease term is Circuit City. That's the one that we spend the most time discussing. The thing that we're reasonably confident about there is we terminated the one lease that we had with them, which was their old format store. The remaining leases that we have with them are the newer format. So, we feel reasonably good about that. And frankly, the rents are reasonable. So, in that particular case, we feel pretty good.

Beyond that, we've got a pretty strong list of tenants. And as you know, no tenant exceeds 3% except for Lowes. And even in despite of the current residential debacle Lowes still remains strong, and they are talking to us about new deals. So, in general, that would be the one that has any material impact that we were watching.

Paul Puryear - Raymond James

So, are you getting any indication from the small shops at this point? How are the leasing trends there?

John Kite

I mean small shops are generally same. The good cursor there or the good thing to look at is when you see what our rent growth was on a cash basis in the last two quarters. Majority of that comes from small shops, and our rent growth has been firm and strong.

Again, it's a property-by-property with us, Paul. The Naples properties that we have, we still have tremendous demand from small shops and we have good leasing spreads. The Indianapolis portfolio is strong. So, in general, it's pretty good. Perhaps we'll see some of that as this plays out over the next few quarters, but we're at 95% occupancy. And one of the things we refer back to is, we've been through several cycles and this is the highest occupancy we've been at, going into any kind of tough cycle. So, I feel pretty good about that.

Paul Puryear - Raymond James

Alright. Thank you.

John Kite

Thanks a lot.

Operator

Your next question comes from the line of Philip Martin with Cantor Fitzgerald. Please proceed.

Philip Martin - Cantor Fitzgerald

Good morning, everybody.

John Kite

Good morning.

Philip Martin - Cantor Fitzgerald

First of all, Dan, could you give us some sense of discussions you are having with your banking relationships, more specifically with respect to refinancings? And how they are now looking at the whole underwriting process, underlying valuations? Are they coming back wanting to -- how are they approaching valuation in this market versus lets say a year ago?

Dan Sink

Well, I think, Philip, we've been very fortunate as John talked about that we were able to refinance 82% of our debt that we had maturing in '08. We have listed a separate page in the supplemental that references back to the subsequent refinancings after December 31 of '07. It's on page 17. And I think when you look through that list; I think we've been very fortunate. George McMannis and his group have been working hard on these. And I think the key thing to look at when you look at how we were able to get these done so quickly, is I think it's a flight to both relationships and a flight to quality of assets.

And when you have got both of those things and we've been working with these banks for a long time. We've always done what we say we were going to do. And that pays off in times like this, when you need to get refinancing, get construction loans. So, we feel very positive about those relationships and don't have any concerns about that going in to future.

Now, that being said, I think if the economy stays as it is today, you might see some of the spreads on the construction loans widen a bit, but we still think there is opportunities for us to get that capital.

Philip Martin - Cantor Fitzgerald

And you are still dealing with many of the same people within each one of these banking relationships that we've heard or at least anecdotally heard, many of the banks get rid of lot of the people that were underwriting, both residential and commercial real estate. But the relationships you have are still with many of the same people you've had for years.

Dan Sink

Yes, for the most part. We've actually had some growth in relationships, because there has been some turnover in some of the larger banks, and some of the people that we have had strong relationships have branched off into new ventures with new banks. So, it's actually with the relationships we've had and how long we've been around, the number of growth versus shrinks. So, we've seen that from a very positive standpoint.

John Kite

Philip, this is John. One of the things that we've always done for the past 20 years, and you got to realize maybe we have an advantage here. And that we were a private company doing business for a long time, depending on commercial banking relationships. And because of that we've always made it a priority to have relationships at the top of the bank.

And I have done that with George and Dan over the past 15 to 20 years. We've always made sure that we didn't focus on one relationship manager, but that we knew the President of the bank, the Chief Lending Officer, the Chief Credit Officer. So, these are deep relationships. And frankly when you look at the schedule that Dan was referring to, you'll also see that they are unique relationships. We aren’t just totally dependent on the large money center banks. We have relationships with regional banks. We have relationships with local banks. And we feel that that's probably one of our greatest strengths is having had to be a user of capital when we weren't a public company. Those are deep, long relationships.

Philip Martin - Cantor Fitzgerald

Okay. Secondly, Tom, on the shadow pipeline, five properties were taken off here and we've talked about leasing compression, and that makes some sense certainly in this environment. But from a catalyst standpoint to get those projects kind of back in the pipeline, is it really tied just to leasing? My guess is that a lot of the retailers are probably taking a step back here, reevaluating plans, etcetera, and that's probably slowing the leasing volume, which leads to rental rate compression potentially. Is that a fair characterization?

Dan SinkJohn Kite

Phil, we'll both comment here. First of all, it's not just leasing. I mean --.

Tom McGowanPhilip Martin - Cantor Fitzgerald

It's several things.

John KiteDan Sink

And Tom mentioned compression in rents, and obviously when you look at that, you've got to take that into consideration, but it's also in the environment we are in today, it's the complexity of the deals.

And some of the projects that we dropped were complex, mixed-use projects. Frankly, could we have continued on? Absolutely, there is no question we can't continue on. And each one of them had various levels of leasing interest. So, we don't want to over-focus on that.

I mean it's more of a fact that we have so much going on that we are fortunate, as Tom mentioned, that we have a very viable and active pipeline in the current pipeline and the visible pipeline.

It was really more a decision on our part to refocus our efforts there and to execute there, which is I think why we're 80% leased in the current pipeline. So, I don't want anyone to think that to over play this, it really was just a matter of turning inward, as Tom said, and focusing on execution. And having so much going on, I think that was a great decision.

And look how small the after-tax amount was. It shows you how conservative we are on deploying capital there.

Tom McGowan

The other part of your question really ties back to the ability to then replenish the shadow pipeline, and we have absolutely no concern of that. We have a very vibrant list of properties. What we need to focus on is securing A-sites and the best real estate possible.

Once you accomplish that, then the retailers will come. It's the issue of having site that may not attract the type of rent growth that we need. So, we're very well positioned in terms of our future growth.

Philip Martin - Cantor Fitzgerald

Okay. So the shadow pipeline throughout the year we would -- if we could expect to see a couple of more projects enter that shadow?

Tom McGowan

Absolutely, we will continue to pursue our opportunities. We're going to pursue in a very conservative approach based upon these very stringent parameters.

Philip Martin - Cantor Fitzgerald

Okay. Thanks for the clarification, guys.

Operator

Your next question comes from the line of David Fick with Stifel Nicolaus. Please proceed.

David Fick - Stifel Nicolaus

Hi, I'm also here with Nat Isbee. He has got a couple of questions. My question is, given that you've done a lot of leasing in your pipeline recently, just with reference to the current pipeline, where do you stand in terms of anticipated yields?

Tom McGowan

David, this is Tom. From a yield standpoint, we feel very comfortable that we're going to maintain our current band between that 8%, 9% overall return on cost parameter that we've talked about many times. And as John mentioned, we have 16 to 17 properties between the two pipelines. And as you look at those as a whole, that's a very comfortable range for us.

David Fick - Stifel Nicolaus

Isn't it fair to say that half of your profit has just evaporated in cap rate shifts?

Tom McGowan Dan Sink

Half? What's your --?

David Fick - Stifel Nicolaus

If cap rates have moved up a 100 bps, you just lost half your spread. That's a pretty tight current target for a development pipeline. It seems to me on a relative basis, your yields are pretty low?

Tom McGowan Dan Sink

I guess you are assuming cap rates are, what, 7?

David Fick - Stifel Nicolaus

Yes, I think that's probably reasonable. Maybe Florida Publix-anchored center is still closer to 6, but clearly up from the low 5s earlier last year.

Tom McGowan Dan Sink

Well, I mean, I guess, David, we would obviously agree to differ there. We don't see cap rates right now at 7. I mean if you look at any transactions of high-quality real estate, which we believe we obviously have, when you look at our portfolio, you look at how new it is. We just go through a deal by deal and the demographics associated with it. We still believe that our quality products is in the low 6s. And that obviously -- who knows what it is right now based on the fact that the capital disruption exists. But if you think…

David Fick - Stifel Nicolaus

Is 200 basis points enough or shouldn't you be, as the market has moved, changing your targets, increasing your hurdles and perhaps going back on your development pipeline?

Tom McGowan Dan Sink

No, I think 200 basis points is a great spread. I mean you also got to look at the margin percentage, which is anywhere from 20% to 40% margin depending on where that cap rate is. And if you compare our high point and the risk associated with our pipeline to other product types who are much more dependant on speculative leasing, who have traditionally depended on executed at that 100 to 150 basis points spread even at the best of times, I think we compare very favorably to that.

So, we have pulled back on the pipeline. And so, the answer to the second part of your question, absolutely we pulled back. That's why we eliminated those five projects. And the other thing to notice that we did is acquire the Center in the last quarter, which was an excellent acquisition for us, using equity from a net lease project that's got a great upside in it and obviously has less risk associated with that.

So, when you look at risk-adjusted returns, I think we need to do both of these things. But that is particularly why we are looking at the pipeline very closely, and we still think that it's in a great place, but we are going to continue to monitor that. And if cap rates ultimately come out in the 7s as you suggest, then you got to look at that even tighter.

David Fick - Stifel Nicolaus

Okay. Well, it would seem to me that you are having to make commitments today for things that are going to be delivered three to four years out. And certainly within the next two years, your current construction pipeline, it would just seem that four, five years ago, we were talking about buildings to double-digits and that it would seem reasonable to be pushing your hurdles down dramatically given where things stand today.

I think Nat has a couple of questions.

Tom McGowan

Let me follow-up on that before Nat asks. David, when you make a comment like that, you assume everything is static. And everything is not static, and we aren't really making new commitments by buying land. That's why we terminated those five deals.

The land that we have in our balance sheet now and the land that we have in our pipelines are at attractive values relative to the spreads. If it truly does turn down as dramatic as some people wish that it will, ultimately this is a cycle and land values will react to that turndown.

And as that happens, spreads will go up, and I should say returns will go up. But the value spread is what we are focusing on, as you know. And if that value spread can stay within that 200 basis point range, we have a great deal of comfort there. But if it really does turn down, as people think it might, ultimately it will react, and landowners and developers will react to that.

So, we are not terribly worried about that future commitment. But that is why we declined to purchase sites in this last quarter, and we dropped those sites.

You've got something, Nat?

Nat Isbee - Stifel Nicolaus

Yes. Hi, good morning. Dan, what is your '08 guidance assumed for construction fee income?

Dan Sink

Construction fee income, it's a range. We didn't give a revenue projection. Construction service fee profit before tax was $3 to $5 million.

Nat Isbee - Stifel Nicolaus

Okay. Thanks. And of the $70 million cost for the Eddy Street Commons Phase 1, how much of that is in the retail and office portion that will be absorbed by Kite?

Tom McGowan

This is Tom, Nat. From a retail perspective, just using round numbers, it's about $25 million. And then if you look at the other two components, they would then combine to be somewhere around $50 million. So, we've got a good comfortable range between the three from a risk perspective.

Nat Isbee - Stifel Nicolaus

Okay. Thank you.

Operator: Your next question comes from the line of Rich Moore with RBC Capital Markets. Please proceed.

Rich Moore - RBC Capital Markets

Hi. Good morning, guys.

John Kite

Good morning.

Rich Moore - RBC Capital Markets

Dan, real quick, on the refinancing that you did, they are all variable rates, and I realized the construction loans are going to be variable rate, but I was looking like Indiana State Motor Pool's variable rate used to be fixed. Is there some reason that you are doing variable rate on these?

Dan Sink

I think the primary reason, Rich, is to keep some flexibility. I think if you look through these new debt maturities that we have in '09 and '11, we've really tried to stagger this.

And what we've been doing and doing in the floating rate debt is we've used the opportunity to use hedging and swap out the rate on a forward basis for a year, 18 months, two years. So, it really helps us with flexibility and gives us an opportunity to use the floating rate while the rates are low with the opportunity to fix the projected balance sheet. So, we're just doing it from a flexibility standpoint.

Rich Moore - RBC Capital Markets

Okay. So, some of this could be hedged as I was just saying?

Dan Sink

Absolutely.

Rich Moore - RBC Capital Markets

Okay. And then on that same topic, Dan, the other comprehensive income was down. Is that got to do with hedging or what is that?

Dan Sink

Yes, that completely has to do with hedging, because with where our hedges are, where we finalized with the hedges, the interest rates have gone down, which affects the OCI.

Rich Moore - RBC Capital Markets

Okay, good. Got you. Thanks. When you guys think about your out-parcel inventory, stuff that you might consider for selling soon in the next year, how big is that?

John Kite

Well, in terms of the number of them, Rich, I think we typically average, we have around 60 or so that are either available or have ground leases in place. And I think we've probably sold 7 or 8 of them a year in general. But remember, we kind of keep that average based on the fact that the development pipelines generally have anywhere from 5 to 10 out lots at each of our new developments. So, it's always going to be there, and it remained fairly consistent. So I would expect that to continue.

Rich Moore - RBC Capital Markets

Okay, very good. Thanks, John. And then on the Supreme Court build-out, when does that end again, so that we can kind of readjust our CapEx spending?

John Kite

The Supreme Court took possession of their space in December. So the majority of the TI and commissions have already taken place in Q3 and Q4. The only thing that we'll be leaking over would be punchless-type items or small items that didn't get completed prior to the end of the year.

Rich Moore - RBC Capital Markets

Okay, good. Thank you. Got you. And then, you had two projects that kind of increased in cost. And going back to David's question for a second, do the return parameters at Delray and at Bayport, do those change as the costs go up or is that just sort of like cost overrun, if you will?

John Kite Tom McGowan

Well, as you tie back specific to Bayport, we just had two small factors that really increased the cost about $13 a square foot. One just tied back to the final design parameters as established by Hillsborough County, that's a fluid process as you go through the final approval set of drawings.

And then the second one ties back to a component that we don't know at the beginning of the project, which is really how will the final TI package play out as part of the lease negotiations. So, those are the two components of the cost increase in Bayport.

As it ties back to Delray marketplace, that project is in the visible shadow pipeline for a reason. We have not finalized costs. It's a never-changing figure as it ties back to total costs. And as we get closer along to the start date of the project, we have a better handle on that, and then we'll move to the development pipeline. So, that's a never-changing process until it moves through the next step.

John Kite

Rich, in general, when you got 17 projects in various stages, it's a very, very comfortable range for us to say between 8 and 9. Obviously, deals may exceed that, deals may be slightly below. But that's why we give you that, and that really hasn't changed at all. And typically, it's going to depend on geography as well.

I mean, obviously the Florida projects costs more money. But in some cases, they may be worth more. So, in general, that's a very comfortable range. And we're still very comfortable with that kind of 200 basis point spread in each direction, and more importantly, kind of that 20% to 40% margin.

Rich Moore - RBC Capital Markets

Okay. Good. Thank you, John. And then the last thing for me is did you guys talk at all about the cap rates on Puyallup. I don't have any idea how to say that one exactly and Rivers Edge?

Dan SinkJohn Kite

That was close.

Rich Moore - RBC Capital Markets

That's right someone from Washington.

Dan SinkJohn Kite

Yes, that was good.

 

Dan Sink

 

The single-tenant property that we sold in Washington that we used in like-kind exchange was at a 6.2 cap, and the Rivers Edge that we acquired was at north of a 7, like a 7.25.

John Kite

But the reason that that cap rate on Rivers Edge that we acquired was where it was is the anchored tenant expires in less than two years, and the owner was not a sophisticated retail owner. So, that's why we got that there. But both of the single tenant deals were 6.1, 6.2. And those are flat rents. So, that ought to give you an indication where cap rates are. You've got two flat rent deals trading at 6. So, that's our live information.

Rich Moore - RBC Capital Markets

Well, that's good information. Thank you, John.

Operator

(Operator Instructions)

Your next question is a follow-up from the line of Steven Rodriguez with Lehman Brothers. Please proceed.

Steven Rodriguez - Lehman Brothers

Hi, guys. I had a follow-up on the refinancing. Really, five out of eight deals or soare atthe same rates? I was wondering is Eddy just one-year renewals or they are actually just complete one-year new contract.

Dan SinkJohn Kite

They are one-year renewals.

Steven Rodriguez - Lehman Brothers

So, they had an option embedded?

Dan SinkJohn Kite

They did not have an option embedded.

Steven Rodriguez - Lehman Brothers

Okay.

Dan SinkJohn Kite

We just renewed them and worked through with the banks to get an extension.

Tom McGowan

But remember that the philosophy here is to renew these to buy the time that we think is appropriate for the markets to stabilize. And as Dan said, we are also using it as a great opportunity to take advantage of that steep yield curve with the hedges. So, it really makes sense for us to do that.

And if you look at the maturities, we also have done a pretty good job of staggering those throughout '09. So, I think we are really in a good position relative to stabilization of the credit market.

Steven Rodriguez - Lehman Brothers

Okay. Thanks. Another question on the redevelopment that you mentioned in your guidance on two assets that you are putting into the plan of redevelopment, can you talk about the timing of those two assets? At what points during the year are you going to take them offline?

Tom McGowan

From a timing standpoint, one of them that was mentioned is Bolton Plaza. And Bolton Plaza, we are in that process right now of going through the specifics of the plan. But our hope would be to try to commence that sometime in the third or fourth quarter of this year.

The second project that was mentioned is Maple Valley, and that was really a part of the Four Corner Square project. That's a project that may even have an opportunity to commence a little bit early, possibly towards the end of the second quarter. So, these are both very active projects, and we are pushing toward start dates as quickly as possible.

Steven Rodriguez - Lehman Brothers

All right, thanks. And my last question is, you've just mentioned regarding the acquisition, the anchored tenant is expiring in less than two years. What are your thoughts? Are you guys planning on renegotiating with them or what's the upside there, is kind of my question?

Tom McGowanJohn Kite

Well, the bottomline upside is, first and foremost, the real estate is outstanding. This is located in Northern Indianapolis, in between the Fashion Mall and Castleton Square, towards Simons properties in the market, Fashion Mall being the highest producing shopping center in the state, and Castleton Square probably not far behind.

So, first and foremost, we loved the real estate. And as I said, the owner was not a particularly active retail owner, but the anchor is the opportunity. The anchor is at slow market rent. So, that's where we have a great opportunity to come in and actually redevelop the whole center by re-tenanting and kind of repositioning.

So, that was our opportunity, and it gave us good current income for the next two years to establish that plan, so just an outstanding potential deal for us.

Steven Rodriguez - Lehman Brothers

Okay, great. Thanks.

Operator

(Operator Instructions)

At this time, there are no additional questions in the queue. I would now like to turn the call back over to Mr. John Kite for the final remarks.

John Kite

Well, again, thank you for joining us today, and we look forward to joining you next quarter. Thank you.

Operator

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

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Source: Kite Realty Group Trust Q4 2007 Earnings Call Transcript
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