Kite Realty Group Trust Q1 2008 Earnings Call Transcript

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 |  About: Kite Realty Group Trust (KRG)
by: SA Transcripts

Kite Realty Group Trust (NYSE:KRG)

Q1 2008 Earnings Call

May 9, 2008 10:00 am ET

Executives

Adam Chavers - Director of Investor Relations

John A. Kite - Chief Executive Officer & President

Thomas K. McGowan - Senior Executive Vice-President & Chief Operating Officer

Daniel R. Sink - Executive Vice President & Chief Financial Officer

Analysts

Steven Rodriguez of Lehman Brothers

Tom Baldwin - Goldman Sachs & Co.

Jeffrey J. Donnelly - Wachovia Securities LLC

Analyst for Michael Bilerman - Citi

Nathan Isbee - Stifel Nicolaus & Company Inc.

Philip Martin - Cantor Fitzgerald LP

David M. Fick - Stifel Nicolaus & Company Inc.

David Harris - Lehman Brothers Holdings Inc.

Richard C. Moore II - RBC Capital Markets

Tom Baldwin - Goldman Sachs & Co.

Operator

Welcome to the first quarter 2008 Kite Realty Group earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Adam Chavers, Director of Investor Relations.

Adam Chavers

By now you should have received a 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 email you a copy.

Our March 31, 2008 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. A filing has also been made with the SEC in the company’s most recent Form-8K.

The company’s remarks today will include certain forward-looking statements that are not historical fact 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 the 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 including access to capital at the desirable terms; 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 Commissions, which discusses these and other factors that could adversely affect the company’s results.

On the call today for the company are John Kite, Tom McGowan, and Dan Sink.

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

John Kite

We are pleased with our operating results for the quarter, when compared to the first quarter of 2007, diluted FFO per share increased by nearly 7% and total revenue increased by over 9%. Obviously the market is a lot tougher than it was a year ago, but despite this reality, we continue to believe that forward-thinking, strategic, and creative company’s like ours have the ability to thrive in these kinds of challenging environments.

We’re very focused on growing our business by leveraging our strengths as a flexible organization to take advantage of those very market disruptions.

Our three most recent deals are all off market transactions that demonstrate our conservative approach to development and capital deployment. For example, in February we acquired Rivers Edge Shopping Center in Indianapolis. We believe that this property has been under valued and under managed and represents an excellent opportunity for us to add value. Two other examples of our creative strategy are the development of Eddy Street Commons and the acquisition of Pan Am Plaza in downtown Indianapolis.

Eddy Street is a great example of a project that should thrive in good times and bad due to its location on the University of Notre Dames campus and its unique capital structure. Tom will talk more about these two projects in a few minutes.

As we all know, one of the most challenging aspects of the current environment is the availability of capital. This is a major focus of ours and we are executing a strategy with the twin goals of reducing debt and increasing available capital for future acquisition and development opportunities.

We are currently analyzing various joint ventures that would include the contribution of several existing operating properties into a joint venture, with the ability to expand the portfolio through the acquisition of new deals. We have long-standing and mutually profitable relationships with institutional investors, including several major pension funds. We’re exploring new opportunities with these partners and others who are interested in working with companies with a proven track record like ours.

We’re also closely monitoring retailer activity. Although retailers are showing signs of significant slowing in terms of new deals, we’re encouraged by our first quarter closing with Wal-Mart as an anchor in our Broadstone station development at Apex, North Carolina. In addition, we have site approval from another major big box retailer for Parkside Town Commons in Carrie, North Carolina and that retailer is also evaluating a third shadow development project in North Carolina.

We understand this in this environment some retailers are going to close stores and may ultimately go out of business. For example, we recently experienced the closure of Circuit City in our Sunland Town Center in Al Paso, Texas. The Circuit City closure, combined with the transfer of two development properties into the operating portfolio, which are still in the leasing phase, were responsible for 130 to 200 basis point decline in our lease percentage quarter-over-quarter; however, we are encouraged that we are already negotiating a lease with a replacement tenant for the Circuit City vacancy.

These tough situations are not unique to us. Everyone in this industry is facing the question of how to deal with the inevitable loss of certain tenants. We’re particularly mindful of the effect on our small shop tenants. We’ve tightened up our default process in order to quickly identify those tenants in distress and aggressively pursue collection and re-tenanting efforts. We believe our focus on leasing to strong credit tenants remains one of our core strengths and we believe it is important that no single tenant constitutes more than 3.4 % of our base rent and our top 25 tenants comprise less then 40% of our annualized base rent, which is significant when taking into consideration the size of the company.

We’ll continue to work to capitalize on these unfavorable market conditions by implementing our conservative and flexible strategies that have proven to be the right path through both favorable and difficult market cycles.

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

Thomas McGowan

As John mentioned we are in the midst of a challenging economic cycle, but we believe the market pressures are highlighting some of our inherent strength and are providing significant opportunities for us.

In the first quarter we moved the recently acquired Rivers Edge Shopping Center into the redevelopment pipeline. We acquired this property, which is approximately 80% leased, as a redevelopment opportunity. The anchor tenant is nearing the end of its term and we are looking forward to revitalizing the center as part of the re-tenanting process. Additionally, we have moved the first phase of our Eddy Street Commons Project at the University of Notre Dame into the current development pipeline.

In our last conference call, I explained the three internal criteria that we needed to meet before commencing construction. We have now met all three of those criteria. One, the property is fully entitled. Two, we finalized our business deal with the University and three the tip is now complete.

We recently closed on the tip bonds and secured incentives from the city of South Bend, which together totaled $35 million of net proceeds. Preleasing interest is strong in the retail and office components of the project. We signed a lease in the first quarter with our anchor tenants, Follett Higher Education Group for 20,000 square feet of the planned 90,000 square feet of retail. Follett is a strong credit tenant and the top University Bookstore Company in America. This college bookstore will be the perfect anchor for this project and will compliment our various niche use components.

With respect to the office component, we are in lease negotiations with the University of Notre Dame to take the majority of the office space. Since we have met our three internal criteria and preleasing remains strong, we anticipate beginning site work by the end of next week.

The Eddy Street Commons project is an example both of our creativity and our conservative approach to capital deployment in the development process.

The current development pipeline is approximately 72% preleased and 21% occupied. Our risk in this pipeline is largely limited to construction execution and timing of deliveries. We think the realities of this environment demonstrate that we have had the right development strategy all along.

We’ve always been willing to delay construction starts in order to make sure we have the right anchor tenants. Our preleasing success in our current development pipeline proves that small shops follow strong national anchors like Target and Whole Foods. As we work on preleasing the visible shadow pipeline, we’re finding that junior box and small shop tenants are hesitant to commit to a site before we have a signed deal with an anchor.

At Parkside Town Commons we have site approval from a premier big box anchor tenant and we have a signed lease with Frank Peters in the first quarter.

Wal-Mart closed on a 20-acre parcel at Broad Sound Station in Apex, North Carolina in February. LA fitness signed a lease in the first quarter at South Elgin Commons near Chicago. The bottom line is that high quality anchor tenants like ours are being very selective and deliberate about their sites and we believe in our real estate.

Finally, we acquired Pan Am Plaza in April through a joint venture. This four-acre parcel is a premier undeveloped parcel in downtown Indianapolis and is located in the heart of the central business district. $1 billion of new construction is underway within one block of Pan Am Plaza, including the Colts new stadium and the expanded Indianapolis Convention Center.

Other properties in the cores of the central business district have recently sold for more than $100 per square foot and we acquired Pan Am plaza in an off market transaction at a per square foot price in the low $20’s. This deal is another great example of our creative, opportunistic strategy and focus on great real estate.

Dan will now summarize our financial results.

Daniel Sink

For the three months ended March 31, 2008 funds from operations were $0.31 per diluted share. This is an increase of 6.9% over the $0.29 per diluted share for the first quarter of last year.

In the quarter, our same property NOI increased 50 basis points over the same period in 2007. Excluding two boxes previously occupied by OfficeMax and Circuit City at Sunland Town Center, the 50 same store properties were leased 95.5% at the end of both March 31, 2008 and 2007 and the net operating income increased 1.7% between the quarters then ended. We are currently in negotiations with replacement tenants for the two vacant boxes.

G&A expense for the first quarter was approximately $1.7 million or 5.2% of total revenue. We still anticipate G&A expense for the year to be in the range of $6.5 to $6.7 million.

A construction and service fee net margin in the quarter was approximately $525,000 or 13.9% before tax. With the increased activity commencing on the Eddy Street Commons project, as well as other third party and unconsolidated joint venture construction contracts, we still anticipate being within the annual guidance range of $3 to $5 million before tax.

Other property revenue for the quarter includes net gains on land sales of $4.1 million, before income tax expense of $1.2 million for a net impact FFO of $2.9 million. A portion of the land sale gain was derived from the sale of our land to Wal-Mart anchor in Apex, North Carolina.

Our financial metrics continue to be in line with our expectations. Our fixed charge coverage ratio was approximately 2.7x, our floating rate debt was 30% of our total debt and approximately 14% of that total debt was in floating rate property, specific construction loans. Our AFFO payout ratio for the quarter was 78%.

At the end of the first quarter we had approximately $40 million of availability in our line of credit before utilizing the cording feature plus $19 million of cash and cash equivalents.

In this constrained credit environment, we are fortunate to have established and strong long-standing relationships with local, regional, and national banks and other institutional investors. Our recent experience has demonstrated that this is giving us a competitive advantage during the current credit crunch.

As John mentioned, we are continuing to look for ways to strengthen our balance sheet by reducing our leverage and increasing our liquidity. We are evaluating the potential sale of several assets into a joint venture, in which we would own a minority interest to generate market fees and promotes. We are also constantly monitoring the equity markets for low-cost capital alternatives.

We were successful in the quarter on refinancing $83 million of debt to 2009 and beyond. Our 2008 debt maturities are limited to two construction loans for approximately $18 million that mature in December. In addition, we have built in extension options for approximately $75 million of the debt scheduled to expire in 2009.

Lastly, we are reaffirming guidance in the range of $1.28 to $1.33 for the full year of 2008. This guidance does not include any material acquisitions or dispositions that may occur during the year.

Thanks for participating in today’s call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steven Rodriguez - Lehman Brothers.

Steven Rodriguez - Lehman Brothers

Could we talk about this joint venture, possible size and is there going to be a regional focus of it?

Thomas McGowan

In terms of the geography that John’s talking, in terms of the geography, what we’re doing here is we’re looking at the opportunity to expand into markets that we’ve been looking at for quite some time. Also, to come into markets and get more strength than markets that we’re currently in.

There is no restriction to the geography of what we’ve been discussing, but again we’re early in the process and we’re moving through it, so that would also be the same answer for size. We’re looking at the contribution of three or four assets and we would also be looking at the idea of the investor investing probably another $100, $150 million of new equity, so that should give you a general idea.

Steven Rodriguez - Lehman Brothers

But, overall it seems pretty early on?

Thomas McGowan

Yes, now we’re in discussions and we’re usually very conservative about that. We’re in discussions, we have good conversations going, probably we’re moving towards the idea of one particular investor, but we’re talking to multiple people.

Steven Rodriguez - Lehman Brothers

Regarding your guidance on, you have a pretty substantial outlook there, $200 million of variable rate debt. What LIBOR assumption did you underwrite in your guidance early on in the year?

Daniel Sink

When we underwrote guidance at the beginning of the year, we reused the forward curve, which we typically do at the time, that we produced the guidance. We’re I think, consistent with other of our peers, that’s what we utilized at that point in time.

Operator

Your next question comes from Tom Baldwin - Goldman Sachs.

Tom Baldwin - Goldman Sachs & Co.

On Bridge Water Marketplace, what’s happening there, why the preleasing level is still low at 17.3%, and what progress do you think you’ll be able to make over the course of the year to get the occupancy there up?

Thomas McGowan

In terms of Bridge Water, it’s located at a great spot great intersection with a tremendous amount of traffic in a high-growth area. Our struggle has been, we have been unable to secure an anchor and a center like that really needs an anchor. There’ s obviously not a lot of square feet, but it’s a position that we need to address and we’re comfortable with the fact that this year we’ll make significant progress, but the specific answer is, we need the end cap anchor.

John Kite

One thing I’d add to that and we mentioned this before, this project was one of several projects that we did with Walgreens as the anchor to the small shops and I think we said this before, that’s not something we will continue to do. In environments like this you need a bigger draw then that. As Tom said, the whole center is only 26,000 feet and we really just need an end cap that we’re working with a couple different end cap users and once we do that is should be fine.

The bottom line is it’s a great market in a good neighborhood. It’s just a small neighborhood shopping center, so it’s not material, although it’s something that we really are focused on executing.

Tom Baldwin - Goldman Sachs & Co.

More broadly, one of the things I do each quarter, prior to your call is compare your preleasing levels in your development pipeline from the prior quarter to the current quarter looking for progress. This quarter I noticed that the preleasing levels really haven’t changed much from the close of 4Q ’07 to the close of 1Q ’08, if you can just comment on the velocity of leasing and your broader outlook for progress of lease up of your current development pipeline.

Thomas McGowan

If you take a look at our preleased or committed number, right now we’re at 71.5% and in the previous quarter we were at 76%. The big difference there is the fact that we brought Eddy Street Commons over to the development pipeline in a fairly early stage of the development, so that obviously had an impact on it, but we do feel like the leasing inside the pipeline is going well:

in the 71% we see a nice progression of that, especially when Eddy Street commences that we’ll see that number move up considerably.

John Kite

If you look at it deal by deal, a couple of these deals aren’t even open and you’ve got Cobblestone Plaza that’s just under construction at 75% leased and we’re not even close to being finished with the construction.

You were actually doing pretty well when you looked at it that way and it breaks down to a couple of individual projects, for example Deacon Hill in Northwest Indiana where it’s one small shop building that we built which was an expansion.

I really feel like we’re doing pretty well there and considering the fact that these projects are just opening and some of the small shops aren’t even completed construction. It’s very difficult to lease small shops until they’re actually up, the concrete floors are poured, and people can come in and look around. Frankly, I think we’re doing pretty well there.

Tom Baldwin - Goldman Sachs & Co.

The Circuit City closure, were you able to extract any term fees there?

Daniel Sink

Yes, we were able to get $525,000 of lease term fees, that it’s going through other property related revenue, but the net impact to FFO of that termination this quarter was about $290,000, because we had to write off straight line rent and the market rent adjustment was a negative for that particular tenant. The net FFO impact of the Circuit City vacancy in this quarter was about $290,000.

Tom Baldwin - Goldman Sachs & Co.

What do you think that the time frame for getting those two vacant boxes leased up is if you had to handicap it?

John Kite

Well as far as the Circuit City boxes we mentioned, we’re in late stage lease negotiations with a national credit big box senate and junior box senate that, it’s hard to predict exactly when, but let’s just say we’re well down the road in exchanging the lease documents.

Then as far as the former Office Max space, we are in the letter of intent stage. So, all I can say is we’re happy that we’re actively engaged in two deals on the two boxes. Obviously we think to be quite frank, it’s a strong center, the sales are strong in the center, K Mart sales were up almost 9% in the year, Ross’s sales were up almost 12%, the shops are averaging around $300 a foot.

It’s an opportunity for us, but in the sense that in a slow market people will want to be in this property.

Tom Baldwin - Goldman Sachs & Co.

Have you considered structuring this joint venture that you’re currently working on, such that it has a take out vehicle aspect to it?

John Kite

Yes, as I said we’re early in the stages, but the idea of the JV is to go out and find new opportunities, so we would certainly be thinking about the fact that we did try to do that within the framework, but again it’s going to depend on the make up of the deals that we’re looking to add to it, the deals we’re looking to buy, the IRRs, so it’s a possibility, but I wouldn’t tell you that it’s done.

Operator

Your next question comes from Jeff Donnelly - Wachovia Securities.

Jeffrey J. Donnelly - Wachovia Securities LLC

John, do you have a sense for how the institutional JV market has changed maybe in the past 6 to 12 months for folks in your position? Specifically, have you seen any shift in returns thresholds, CDs, or participations?

John Kite

Well again, macro, the encouraging part Jeff is that there definitely seems to be interest that continues to be there for opportunities. I think that probably that interest is more aligned with companies like ours in that can create value, than it would be just to go in and buy something that is gotten no opportunity to create value. The nice thing about is that we can bring both of those things to the table and that’s the idea in the JV is that we can acquire assets that we think are just really high quality that would just have the basic rate growth and then some potential turn over and below market rents and then we can acquire things like Rivers Edge where there is a real redevelopment opportunity.

The biggest thing is there’s still a lot of capital out there and that capital is really queuing up, Jeff, there just aren’t a lot of places to put it right now and people are hesitant, so as they hesitate the capital builds. I think that we’re going to see that we’ll be able to take advantage of that.

Jeffrey J. Donnelly - Wachovia Securities LLC

Do you have a sense for, at this point I know it’s still early on, but what returns their looking for the core, core plus, to use that vernacular, is there a range that you are looking around?

John Kite

No, we’re going to be careful of that right now. I think people are realistic, let’s just say that. People are realistic on returns, it’s going to depend on whether there’s a value creation component to it, but obviously we still believe that acquiring high quality class A retail in decent markets is going to be in the six’s, going in. As to where exactly that is in the six’s I’m not sure, but I think that if you can get something like that with a little bit of leverage where interest rates are, you can obviously generate decent high single digit returns on just cash and then you can generate higher returns on a terminal then.

Jeffrey J. Donnelly - Wachovia Securities LLC

If I can switch over to Lee thing, if you are on that residential housing business, if we looked at map, a lot of exposure to markets, apples to apples and even Raleigh Durham areas where just you see a lot of press attention on sub prime exposure and falling home prices and job losses and all those sorts of things. I’m curious about those, whether or not you are actually seeing that in your leasing activities. Among the big national retailers, are they do you think they’re shifting away more than you might see in other areas or maybe just decreased mom and pop activity or is it just not much impact at all?

John Kite

I’ll give you a little bit of color on that and Tom too, but basically when we look at how, when we look at our occupancy and we looked at the drop in the occupancy and we carved that up pretty good for you hopefully, in the press release. There’s a percentage of the drop in the occupancy that does come from small shops and that, when you look at it, the interesting thing, a study is that it was pretty well spread out through out the portfolio, almost right in line with where our base rents were coming from on a percentage basis.

From my personal perspective, obviously there’s pressure in certain markets, but the small shops in our portfolio seem to be holding up generally well and it seems to be spread across and part of that small shop drop, for us, is being much more aggressive about kicking tenants out. I think we’re making a point of being aggressive in this market, because we don’t want it to build upon itself. My personal belief is obviously Florida, Naples , has been an area that people have focused on, but we have not seen a greater degree of loss of occupancy in Naples than we have per se in Indianapolis or Dallas, so that’s my view.

Thomas McGowan

Yes, Jeff, I think part of your question tied back to new deals as well and I think the way we look at it, with junior boxes, big boxes etc… is when they come into markets, similar to the ones that you mentioned, the bottom line is they’re being more selective in the process and the time it takes for them to deliberate and try to determine the best place to be, this isn’t an extended period of time from what we may have seen two years ago.

The retailers are out there, there are people doing deals. The bottom line is it just takes us a little bit longer, we have to work a little bit harder, help on research etc… but the activity is still there.

Jeffrey J. Donnelly - Wachovia Securities LLC

I’m curious what you are aiming to accomplish at ICSC, its ten days away. How should we be thinking maybe about, I’m trying to think about where it manifests itself? How should we be thinking about your percentage leased and the development pipeline, in all of it’s forms and maybe the overall size of your development pipeline as we look out to Q2, Q3, should we expect to see jumps in those areas, maybe could you get some work done at ICSC?

Thomas McGowan

Well, as far as ICSC goes, we’re taking ICSC extremely seriously. We have I think over 300 meetings scheduled for ICSC, but everybody throws those numbers out Jeff, everybody’s there to have meetings, so I don’t know that that’s a huge win. The bottom line is we’re looking to do deals.

We have a 90-day initiative right now in the company to aggressively get stuff done and that means not just talk about deals, or that means not just have LOIs that means execute leases. I think that we’re in an environment where it’s critical to execute deals when they’re in front of you, to get deals done, because obviously this isn’t going to turn around overnight, but the economy has got lots of various issues and so we get into this hesitation mode and when people are, as I said, if they’re hesitating, you have to push the deal forward, so ICSC is extremely important this year.

In the past years it hasn’t been like that, the markets been well and it’s just another month. I think this is a critical ICSC and as far as how it represents our pipeline going forward, it’s all about execution. It’s all about leasing, because we have the product, we have excellent properties and now we have to execute so, my perspective is it’s never been more important.

Jeffrey J. Donnelly - Wachovia Securities LLC

Dan, I think as the last quarter Naperville market place, at least in last quarter’s release, I think it was around 45%, 50% occupied and I think 80% to 85% lease, that may have changed subsequently, but you have a $14 million loan maturing in the property, I think at year-end. How are you handling that and do you think there might be some issues in rolling that over?

John Kite

I don’t think there’s going to be any issues particularly. We’re in deep discussions on that again. I think in the conversation, it is benefiting us to have these long-standing relationships and we’ve done business with these banks for a number of years. So I think if we look at that particular property, it’s nothing material on a renewal basis other than potentially there may be a small debt pay down to renew their loan, but I don’t think there’s any issues to the fact that we’re going to have to find $14 million to replace the whole loan. Depending on debt service coverage, where we’re negotiating with the bank from that standpoint.

Operator

Your next question comes from Analyst for Michael Bilerman - Citi.

Analyst for Michael Bilerman – Citi

You briefly talked about the projects on the visible shadow pipeline, but given that you’ve spent about 40% of the total estimated costs, how would you characterize your preleasing for those projects relative to the capital that’s invested?

Thomas McGowan

We talked about on the development pipeline being about a little over 71%, as it ties back to the visible shadow pipeline, we’re just over 50% and that includes the key anchor tenants, so from a tracking standpoint, we feel pretty good about where we are as these projects than move to the development pipeline.

Analyst for Michael Bilerman - Citi

In the current redevelopment pipeline there is a wide gap between the occupied and the lease/committed. Can you talk about the timing of when those leases start to kick in and we should expect to see the NOI of those projects ramp?

Thomas McGowan

You really have to look at it from a property perspective, each one individually. John mentioned Cobblestone, that’s a project that’s really just starting to get out of the ground, but projects like Bay Four where we have the final box under construction with Best Buy and others are moving along very quickly. Then you’ll see some trailing from a project like Eddy Street Commons, but for the most part the projects that are underway are moving quickly; but we do have, with the inclusion of Eddy at $70 million, that ones going to obviously take some time.

John Kite

We always look at the projected opening dates and we look at that every quarter and are still comfortable with that in the supplemental, so you can track it that way. But, remember that the opening date is the first tenant paying rent, so if you think about it on a full year basis, these deals aren’t going to really start generating significant NOI until late this year into next year, which is what we’ve always said, so obviously, that’s gotten pushed back over time, but I’d say Q4 into the next quarter of ’09, they begin to start paying rent.

Analyst for Michael Bilerman - Citi

How does it work on the capitalization of these assets? When do you decide to move it into the operating portfolio and not capitalize interest on these projects?

Daniel Sink

The capitalized interest is really on a pro rata basis, so as a tenant occupied column, we pro rata move that asset out of CIT into fixed assets and correspondently take that same percentage of interest and taxes, etc., and run it through the P&L.

Analyst for Michael Bilerman - Citi

So, for example, for a project like Beacon Hill, when would you say, I know it’s not a significantly large project, but when would you say, “okay well, at this point, it looks like it’s going to be difficult to lease up the remaining part of the project, we’re going to move it into the operating portfolio”?

Daniel Sink

Right, typically from that perspective, due to one year from the first tenant opens or basically construction completion or 85% occupied. When one year commences and I know some of these, because they’re phased, makes it difficult to follow, but from an accounting record perspective, one year from the date the first tenant pays, or 85% and then we transfer it to operations and then all of the costs related to that asset are running through the P&L.

Analyst for Michael Bilerman - Citi

So the fact that Gateway, has two phases, that’s the reason why it wasn’t necessarily moved into the operating portfolio this quarter?

Thomas McGowan

That’s correct.

Operator

Your next question comes from Nathan Isbee - Stifel Nicolaus & Company Inc.

Nathan Isbee - Stifel Nicolaus & Company Inc.

Dan, what was your bad debt expense this quarter?

Daniel Sink

Bad debt expense this quarter was about $180,000.

Nathan Isbee - Stifel Nicolaus & Company Inc.

How does that track to Q1 last year?

Daniel Sink

Q1 last year was about $200,000, so we’re right about even to where we were last year.

Nathan Isbee - Stifel Nicolaus & Company Inc.

You generated 42% rent spread on the new leases. Obviously it’s not a huge amount of leasing, but if you’d just give me a little color what was going on in there.

Daniel Sink

On the new leases, what we do with the 42% on that is we’re comparing the leases signed to our portfolio average, so we’re giving some color on how, the new leases we have in the development portfolio compare to our averages, both anchors and shops from that perspective.

John Kite

That’s first generation stuff, Nate.

Daniel Sink

And we’re just showing that if you look at the last page of our supplemental and look at the anchor leases and the shop leases, we try to get a comparison to how we’re doing on the new leases compared to our overall averages per shops and anchors.

Nathan Isbee - Stifel Nicolaus & Company Inc.

Can you give a little more detail on this downtown Indy land you bought? It’s obviously not your typical type project and what you, how you got it and what you plan to do there?

Thomas McGowan

Pan Am was an incredible opportunity for us, because in an urban atmosphere it’s so tough to assemble multiple pieces and particularly on a full city block. So this is a situation that you had a single owner that owned that entire parcel and due to a relationship we were able to secure a first right opportunity in terms of working with another party, so that was really the way we secured the inline approach to getting the property. It’s a piece that we can take a little bit of time on in making sure that we’re able to secure the highest and best use for the property. The nice thing about it is the real estate will continue to improve as all this construction goes around it.

We’re really looking at our options right now. We’re looking at probably three or four different concepts and are really waiting at this point to see the best way to move forward.

Operator

Your next question comes from Philip Martin - Cantor Fitzgerald.

Philip Martin - Cantor Fitzgerald LP

With respect to the 2009 debt maturities, what discussions, certainly it’s not unthinkable to be thinking about 2009 at this point, given your pipeline, your growth trajectory, etc., what discussions are you having with respect to 2009 debt maturities and how are those discussion proceeding?

Daniel Sink

We are very much in discussions on each one of the projects that had debt maturities in ’09. I think on of the things that we tried to do with the 2008 debt maturities is build in some extension options. So what we did on some of these loans was extend them for 12 months, with a 12 month extension option based off some underwriting criteria, to give us an opportunity to hedge that particular piece of debt and when the hedge rolls after one year than we can see how the market is, whether we want to extend the construction loan for another year or potentially look at some type of permanent financing.

I think our whole objective when we did the 2008 debt maturities was to keep flexibility and leave our selves an opportunity to extend the construction loan, because the majority of these banks, with the projects that we have in place, their not fighting us to keep these on the balance sheet, because obviously these are quality projects where you’ve got shadow anchored target as well as various box tenants and high quality national shops.

I think when you go through that scenario; we’re in discussions with the banks. We right now feel comfortable that we can continue to do the same thing we did in 2008 whether it be extend the loan or exercise on the options we had in place.

Thomas McGowan

I think it’s somewhat been misunderstood in terms of the strategy there. We had other options available to us, but as we sat down and talked about it, exactly what Dan said there, we were in an environment in the fourth quarter of last year and the first quarter of this year where the majority of the activity was, that doing this was the most logical step to take because visa ve the swap process, the majority of that debt was sub five and having gone longer term would have really affected that rate and also would affect proceeds.

When we looked at the curb and we thought about where things were going to be in the environment, it was a much smarter play to give us that flexibility over that 12 to 24 months, with the idea the chances were higher that the long-term debt markets would be back into par in 12 to 24 months. I think it was a very smart move that we talked a lot about.

Philip Martin - Cantor Fitzgerald LP

The discussions have been going well. You have good relationships with your bank relationships from what you said on your last call and just talking to you over the last couple of months, and also these assets are good assets. At this point it’s more positive than negative given the environment we’re in. Is that a fair characterization?

John Kite

Yes, we would agree with that.

Philip Martin - Cantor Fitzgerald LP

In terms of the Circuit City and Office Max leases. Can you talk a little bit about where you think rents will be there when these are released and in terms of the cost to get that space ready for a new tenant, where do you think you’ll shake out versus previous rents etc…

Thomas McGowan

Each space is different. The Circuit City space is actually on the end cap of the shopping center. It was s 33,000 square foot place. And by the way, the reason that Circuit City left the space is that they’re moving into 20,000 square foot spaces and we couldn’t accommodate that. So they moved just down the road into a 20,000, 21,000 square foot space.

Circuit City was paying about $11 a foot. So the idea we have here is that we are going to take that box and the national guy that we’re negotiating with who has far greater credit than Circuit City and is taking a smaller space as well. We’re going to carve up part of it into shops, which will face the street on the end cap and we think those are great shops.

All in we see that we’ll be somewhere slightly above where the rent was before basically. Then on the Office Max space that they vacated last year, that was only a $10 a square foot space and the LOI that we’re in negotiations with, we still haven’t agreed upon that rent. We think it is likely to be above that. It’s a very good shopping center, in a very strong, unique market with the Juarez border very close by and the activity that happens in El Paso, the sales that we have. It’s a good center, so if we’re going to get box vacancy that’s a pretty decent place to get it.

As far as the cost, it’s going to be a typical turnkey deal, maybe $35 or $40 a foot range.

Philip Martin - Cantor Fitzgerald LP

I just saw the one-liner last night on Heightman’s 13G filing is there anything to read into that?

Thomas McGowan

No I don’t think, again, its two small shareholders don’t make a practice of calling us up and telling us why they’re doing things, in fact the data that we get is always fairly delayed.

I think first of all, I think it was Heightman and one other investor were slightly above our cap on ownership and I think they were above nine and I think our cap is 7.8% so they had to work that position down anyway to be below that. I think I would look at that as probably the primary driver. You could always call them.

Operator

Your next question comes from David M. Fick - Stifel Nicolaus.

David M. Fick - Stifel Nicolaus & Company Inc.

Your institutional JV was production is now over a year old, is that correct?

John Kite

That’s about right, David.

David M. Fick - Stifel Nicolaus & Company Inc.

Can you just give us the status of that, any funding that they have made and projects that you’re working on?

John Kite

The first project that they’re in is the project in Raleigh, North Carolina, Parkside and, that project we took down to land and there is a loan in place of which our partnership is in that loan. As a matter of fact, we’re meeting with them next week to discuss new projects. They are currently in the first phase of the Parkside deal.

We have another deal that we’re talking to them about right now and we also have some deals in the visible pipeline that we’re also going to discuss with them and as I said last quarter our intention is to move more of those deals into joint ventures, the first primary JVs on those deals would be Prue. I can give you a better feeling for it later as we’re going to meet with them next week, but they’re obviously very active in the business and are very aware of the stresses in the business and I think we feel still reasonably good about the partnership.

David M. Fick - Stifel Nicolaus & Company Inc.

The whole world is different in the last 12 months, have you had to modify in any way or their still as interested in this act as with that capital they were a year ago?

John Kite

Well we haven’t had to modify anything in the deal in any way, but again as we were very clear, they look at each deal on an individual basis and that’s the way we’ll continue to present deals to them. I think no question, they’re going to look at deals tougher, and they’re going to look at deals longer just like we are, so I would say that they’re reacting with the environment.

Operator

Your next question comes from David Harris - Lehman Brothers.

David Harris - Lehman Brothers Holdings Inc.

What are you looking for today when you’re underwriting developments in terms of the spread over the mid six’s cap rate I think you referenced earlier in the conversation?

John Kite

Yes in terms of the spread, we’ve continued to think that we can get 200 basis point range over that. Most of the deals in the various stages continue to be between 8% and 9% returns on costs. Just to clarify that a little bit: the returns that people talk about, there doesn’t seem to be a lot of parity in how it’s discussed. Our returns on costs are fully loaded development costs with initial stabilized rents without any rental increases, etc., no GAAP and also we don’t make any assumptions on sales of out parcels. That’s why I think those numbers are so different.

The bottom line is they continue for us to be in that range, so that means we’re going to continue to be 200 to 250 over where we see the exit. That gives us significant cushion as that may decline so we can continue to monitor that.

David Harris - Lehman Brothers Holdings Inc.

How can you put that into context using your experience John and Tom too? Where were those spreads a year or two ago, arguably at the peak of the market and what do you think is the norm over the duration of your career, is it $150 maybe?

John Kite

I think the spread a year ago probably could have approached the higher 200’s, 200, 275 and sometimes if you hit it right even 300 basis points. But I think, you have to look at product types. I think community-shopping center, which to me has the most liquidity in it in terms of the buying market has tended to have, for whatever reason, higher spreads.

So we’ve consistently been in that150 to 250 basis point spread and 150 I think would be the low end of what we’ve seen.

Thomas McGowan

We’ve talked about this a lot and both having been in the business 20 years, we talk about the old days where you had the 10 caps and things were real simple to calculate and what we always talk about internally is it’s not about the cap, it’s not about the return but it’s what you talk about, which is the ultimate spread. We do feel like the 200, 250 is going to continue on because as some of these market forces occur, we do hope and I think we’re starting to see land prices come down, you’re starting to see municipalities hopefully become more and more realistic so I think we’re in a pretty reasonable range right now.

John Kite

That value spread is really higher now, even with cap rates creeping up than it was 15 years ago like Tom’s talking about when cap rates were nine and north of nine, it’s pretty hard to get a return on costs at 11 to 12, so I think it’s one of these things where there’s been somewhat of a systemic change in that. The business is still extremely cyclical, but the expected institutional yields, when they look at global returns, have definitely come down.

I want to highlight again that community shopping centers that we own and develop, even though we do some of these larger projects, the bread and butter is between $20 and $50 million. That creates a tremendous amount of liquidity when you’re looking to sell it because a lot more players can play in that field and can play at a field of trying to buy a single asset that costs $500 million.

It’s an interesting situation occurring there.

David Harris - Lehman Brothers Holdings Inc.

As you look out from this point in time, are you more nervous about your returns being threatened by slow lease up and rents falling short of our pro forma’s followed by lumens up in cap rates?

John Kite

Mathematically, the impact on cap rate is probably more of a hit than the impact on some percentage drop in rent because it’s not going to be as great, but when I look at the reality of the situation, we’re feeling more and we’re seeing more the timelines stretching out and the rents being pressured and dramatic cap rate changes at least today. The fact that the market is basically saying that it is not willing to meet the bid in the ash spread. It shows you that the seller still controls the situation. If it was controlled by the buyer, I think that bid in ash spread would be met.

Bottom line is we continue to be concerned about the timelines associated with the decision making. The market has been attacked by fear, so that slows down decision making which also puts pressure on real estate managers to come in with better rents, then the landlords have to make decisions.

My view on it is that’s a more realistic problem than a massive back up in cap rates. We believe that we’ve seen the 25 to 50 basis points that everybody talks about in class A. I think we have seen that.

Daniel Sink

David, just one more thing and John talked about the 90-day initiative that we have. The bottom line is it ties back to time duration. We can battle that one, we can’t battle market forces as it ties back to cap rates, but on time duration we can get on planes, we can get research putting together information, we can hump harder than the next guy to try to shorten that period, so that’s really what our teams focus on.

David Harris - Lehman Brothers Holdings Inc.

In respect to the JV you referenced in your opening remarks. I appreciate that its early days, but you must have a feel for this question. What do you think investors are looking for by way of their leverage returns?

John Kite

I think with class A retail, if you assume that an investor is going to buy an asset on a cash basis, in that mid six’s range and he’s going to lever the property realistic numbers 50 to 65 basis points, that’s a higher single digit IRR that could lead to a double digit IRR with rent growth.

When you look at what’s going on in the world and you look at the disruptions in the capital markets and the disruptions in the commodity markets and the problems we have trying to identify where everything is going on a price basis, those are good returns with realistic numbers and they’re also on a risk adjusted basis safe on a relative basis.

David Harris - Lehman Brothers Holdings Inc.

The number I’m assuming its 10% or 11% type number is what you’re alluding to.

John Kite

I think so, when you’re looking at more of an IRR situation? And I’m saying that you’re looking at the higher single digits on a levered cash basis, but when you’re looking at IRR’s, yes you can get there, but it’s not easy. I think their going to have to build to that 10% to 11% return and they’re going to start at a lower number.

David Harris - Lehman Brothers Holdings Inc.

That number would have been a couple hundred basis points lower if we’d been having this conversation 18 months ago, because I know you were in the JV market then too.

John Kite

Yes, when things got really heavy, you heard the same numbers we heard about taking mid-single digit deals on the IRR basis. Those deals didn’t make sense and it didn’t happen a lot in community shopping centers. That was happening more in other products because the cap rates were being driven down into the fours and fives.

I don’t think that we ever saw in community shopping centers realistic cap rates sub six. There were deals done at 590 and 580 and 550 even, but rare, so yes you’re right, the math was correct that you put out there.

Operator

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

Richard C. Moore II - RBC Capital Markets

Do you think the economy affects out parcel sales in any way?

John Kite

That’s a good question. If you look at the history of our company since we’ve been public, I think it’s been about 15 quarters and I think we sold out parcels in each of those quarters. I think one of our big concerns when we looked at numbers in the beginning of the year was how the economy would affect transactions and out parcels was one of those thoughts.

Getting back to my liquidity discussion, there’s a great deal of liquidity in smaller numbers and these out parcels trade $1 million, $2 million, $3 million, that create liquidity that goes well beyond when you’re trying to sell shopping centers.

I think the bottom line is the 1031 market we all know slowed down a little bit because of the debt but again, think about what people are thinking about today: where are taxes going, where are capital gains taxes going? That’s a factor in the 1031 market, because if that’s what driving it, that may create more volume.

That’s a long way of saying we’re concerned about it, we think about it, but we’re still doing transactions.

Richard C. Moore II - RBC Capital Markets

The tenants that might end up on those out parcels, you think they’re still active. They’re not the tenants that are pulling out.

John Kite

Well there are tenants that are being stressed, because you’ve got national restaurants, sit down restaurants, you’ve got fast food restaurants, you have banks, regional banks, national banks.

We’re actively doing deals, some of the restaurants; probably the fast casual may have felt some impact. When we think about the ground leases we’re doing, but then again it’s interesting, some of the new deals we’re doing we’re seeing new restaurant concepts come up. We’re seeing the national, Blinker and people like that create new concepts.

I think the market is a little bit better on the restaurant side than people think and I think a lot of people shorted a lot of these casual restaurants; the Gardens doing pretty well when you look at the number. Rich, we’re definitely still doing deals as you can see, but the volume will be impacted like every other retailer we deal with.

Richard C. Moore II - RBC Capital Markets

On that same vein, you were higher in the first quarter than you typically are in a quarter. Is there any reason to believe that maybe you got some done that are going to steal from other quarters? In other wards, should we expect a level on an annual basis that was similar to last year and maybe it was just heavier weighted toward the first quarter or could we be higher maybe this year.

Daniel Sink

I think when you look at the first quarter numbers, the FFO impact was about $2.9 million after tax and of that there’s only two parcels of land, one being Wal-Mart and Apex and one being an out lot. So in the first quarter we only sold one out lot to generate that type of return. A larger portion of that was the Wal-Mart sale, which when you look at this environment and you’re able to secure that Wal-Mart deal on a 20-acre parcel in our development pipeline, from an earnings perspective that helped, but from an overall developers perspective it was even better.

Richard C. Moore II - RBC Capital Markets

For the year then, what should we think about for land sales?

Daniel Sink

Consistently I think we’ll be in the sevenish range, I think that’s typically what we’ve done, land sales in a year.

Richard C. Moore II - RBC Capital Markets

And you feel good about that still?

Thomas McGowan

Yes, we have a group of investors that we’ve worked with historically who contact us, that’s going right now. I think some of these people are gravitating to smaller deals because they want to stay active and the leverage is available at lower levels, so it’s like a almost on an absolute cash basis, what can I continue to invest in ? These deals are easier for them to get done from a capital outlay standpoint. It seems to still be going, but we’re going to watch it.

Daniel Sink

One thing to look at in that regard, I think when we walk through our net operating page of our supplemental and we detail out what our EBITDA is, I think as John mentioned, we’ve been consistently having other property related revenue for 15 quarters. So, when we look at our fixed charge coverage and we quote numbers such as 2.7x, that’s because we view that as part of the business, no different than our construction line of business. We have out lot sales, we have lease terminations, it’s part of being a developer and that’s why those things factor in to what we view as the overall return from an EBITDA perspective.

Operator

Your last question comes from Tom Baldwin - Goldman Sachs.

Tom Baldwin - Goldman Sachs & Co.

In terms of the evolution of the credit crisis, it seems like much of the pain in terms of write-downs is shifting from the investment banks to the regional banks. In looking at your debt summary it looks like you’ve relied on this class of lender quite a bit historically. So I’m just curious if you’ve seen an increased hesitancy on the part of the regional banks to originate new loans or any decline in their appetite to continue lending to owners of commercial real estate.

Daniel Sink

We do monitor that and do watch the banks and watch like everyone else does the issues that all of the banks are having with various write-downs. I think one thing, when you look at these banks, they’re looking for opportunities to deal with very transparent companies that they can easily get to their numbers and feel comfortable that you’ve got the liquidity to both complete projects, pay back loans etc…

I think when you look at a public company who has an audited financial statement versus a private company who is generating a type of financial statement from a tax basis perspective, it’s very difficult for the lenders to get their arms around That’s why when you look at that we have a definitely competitive advantage, because we are transparent earnings, transparent financial statements and these banks are wanting to do deals. They’re stepping up in their quality of people.

I think that helps us in that regard, but we are definitely watching how these banks are transpiring and how their business is going. I don’t think we have any concerns in the group we’re looking at right now, but we are watching it.

John Kite

The other thing to think about there Tom is that when you start trailing the credit quality and you start looking at how the credit crisis has mushroomed. The reason that you’re seeing that is that the investments bank operated at a much higher leverage ratio than some of the regional banks and also the regional banks that you’re referring to, it comes down to their exposure in residential real estate.

When you look at the situation that happened at National City and how quickly that occurred it was really residentially driven. That is something that is very easy to track for you. The people that we’re working with at this point don’t have massive exposure in the residential mortgage market.

I think we feel pretty good about that and I think commentary wise the US banks are in pretty good shape and they’ve been very transparent. Although it took them awhile, they’ve been very transparent on that recently, certainly more so than the European banks.

Right now as we look at it, we’re fortunate that we have this 25-year history of being an active borrower with both money-centered banks and regional banks and banks you’ve never heard of that are $1 billion or $2 billion of assets. We’re feeling pretty good about that.

Tom Baldwin - Goldman Sachs & Co.

There’s no plan to alter your mix of lenders in any way, after seeing how the credit crisis has played out and affected different parties in the lender environment?

John Kite

I think as Daniel said, we’re monitoring that very loosely and we’re looking to expand. Look, capital is capital and the bottom line is where we get that capital, we want to get it from as many places as possible and that is something that we’ve always done. So, the idea of expanding that base of borrowers is definitely one of those goals that we talked about.

I think we’ve done a very good job of expanding that base of borrowers and again, because of the size of stuff that we do that pulls in a much greater number of lenders that we can go to, because we’re not every single deal isn’t $100 or $200 million.

The answer is we’re definitely looking to expand that base, but we’re not doing it out of weakness, we’re doing it out strength.

Tom Baldwin - Goldman Sachs & Co.

My follow up again just relates to the joint venture you spoke about on the call. Can you elaborate a little bit on the profile of the three or four assets that you spoke about possibly contributing to the joint venture if its formed, in terms of the geography, the growth profile of those assets as well as if those would be assets you acquired versus developed?

John Kite

I think it across the board. Fortunately we have a very high quality portfolio, so it’s not as though we’re looking to pick and choose the geography will be mixed; the type of product, we’re still discussing that. There are different investors that are interested in different things and the growth profiles are something that we’re going to look at too.

From our perspective, this JV is not all about just what we contribute to it, that’s a portion of it and it’s a portion that’s important to us for alternative capital, but probably the most important thing is that it creates a platform for us to continue to grow in a challenged environment. Again, we’re fortunate that we have this long history of relationships with various pension funds and capital sources that know that we’re a good partner.

So that’s what we’re focused on is what we can do with it going forward. Our track record of finding acquisitions that other people didn’t find, people are aware of that, so it’s more about that probably than anything else.

Tom Baldwin - Goldman Sachs & Co.

The leasing environment right now is very difficult. I’m just curious if you are doing anything right now to incentivize tenants to enter your retail space in the form of concessions. If so, could you elaborate on any initiative of that nature and talk about the impact it might have on leasing spreads?

John Kite

No, our view on this right now, as both Tom and I have said is that we’re in attack mode and we’re out there going after deals every possible way that we can go after deals. We’ve been through this cycle before and if you sit around and wait you’ll get eaten alive. So I can’t tell you that we’re out there throwing specific concessions around; we don’t really have to offer that because tenants are pursuing as aggressive deals as they possibly can pursue.

It’s more how do we get creative on these deals to get deals done, but we were very candid with everyone that there is significant pressure for the retailers to get the best possible deal they can get and they’re going to use this environment to do that. But, by the flip side we know what we can do and what we can’t do and that’s what we’re all about is getting these deals done in the next 90 days like we talked about.

Thank you all for your interest in the company and we look forward to talking to you on the next quarterly call.

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