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Acadia Realty Trust (NYSE:AKR)

Q2 2008 Earnings Call

July 31, 2008 12:00 pm ET

Executives

Kenneth F. Bernstein - President, Chief Executive Officer, Trustee

Michael Nelsen - Chief Financial Officer, Senior Vice President

Jon Grisham - Chief Accounting Officer, Investor Relations Contact

Analysts

Michael Bilerman - Citigroup

Michael Mueller - J.P. Morgan

Paul Adornato - BMO Capital Markets

Rich Moore - RBC Capital Markets

Christine Mcelroy - Banc Of America Securities

Operator

Welcome to the second quarter 2008 Acadia Realty Trust earnings conference call. (Operator Instructions)

Please be aware that statements made during the call that are not historical may be deemed forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to the variety of risks and uncertainties which are disclosed in our most recent Form 10K and other periodic filings with the SEC. Forward-looking statements speak only as of the date of this call and we undertake no duty to update them. During this call management may refer to certain non-GAAP financial measures including funds from operations and net operating income. Please see Acadia’s earnings press release posted on its website for reconciliation of these non-GAAP financial measures with the most directly comparable GAAP financial measures. Please note the FFO numbers for calendar year 2007 have been adjusted as set forth in the reconciliation.

Participating in today’s call will be Kenneth Bernstein, President and Chief Executive Officer, Michael Nelsen, Chief Financial Officer, and Jon Grisham, Chief Accounting Officer. Following management’s discussions there will be an opportunity for all participants to ask questions.

At this time I’d like to turn the call over to Mr. Bernstein.

Kenneth F. Bernstein

Before we discuss our quarterly results I’d like to comment briefly on where we see the current market environment and how we’ve been positioning Acadia accordingly. With the commercial credit crisis now over a year old we’re beginning to see the impact on our industry both in terms of debt availability and in terms of asset values. Simultaneously we’re also beginning to see the slowdown in the economy impacting industry fundamentals. However, neither the credit crunch nor the sluggish economy are impacting all properties or all companies equally and that differentiation process which we’ve been talking about for the past several quarters is beginning to play out. And while both asset pricing and fundamentals for secondary assets clearly began to soften in the second quarter, pricing and fundamentals for the higher quality locations, the kind that we generally are interested in acquiring either as opportunistic purchases or via redevelopments, those did not yet sufficiently shift in pricing to pull us off the sidelines as buyers.

So with this in mind here are the actions that we’ve been taking to position ourselves with respect to our core portfolio, our balance sheet, our existing development pipeline, and new investment opportunities.

First in terms of our core portfolio, as a result of aggressively culling our portfolio over the past several years and rotating into higher barrier-to-entry supply constraint properties in strong markets we’ve so far seen little negative impact in our core results which year-to-date remains stable. In fact, the small drop in our quarterly occupancy this quarter was not driven by economic weakness but rather the re-anchorings in two of our properties which subsequent to the second quarter were completed and should add back about 50 basis points of occupancy when they open later this year. Furthermore, while we remain very cautious as to retailer performance in general and don’t expect any portfolios to be immune to a longer term or severe consumer slowdown, we expect the majority of the pain to be felt in secondary and tertiary properties and that there’ll be even a further widening of the performance gap between the higher and lower quality properties.

Second, in terms of our balance sheet, balance metrics, strong access to debt inequity, and limited debt maturities are going to continue to be of increased importance. At Acadia we’re carefully using our capital so as to ensure that our balance sheet remains in a position to take advantage of the opportunities as they begin to materialize. More specifically, and Mike will walk through this, we’ve had no on balance sheet debt maturities for almost two and a half years; we have enough capital to internally fund all of our growth initiatives for the next several years; and finally, our discretionary investment fund platform has plenty of drive power.

In terms of our existing development pipeline, while all development pipelines are coming under some level of pressure, New York City still remains a highly supply constrained market with strong tenant demand. The high demand of our locations enables us to continue to sign tenants such as Target for our Downtown Brooklyn project and the quality of our locations and the quality of our leases also seem to enable us to successfully and profitably navigate through those re-anchorings that inevitably arise such as in are Canarsie, Brooklyn and our Pelham Manor locations.

In terms of transaction activity in new investment opportunities in the second quarter we spent most of our investment efforts on shorter-term preferred equity and mezzanine investments focusing on properties and projects that we would love to own at our basis. While our stakeholders are not yet being sufficiently rewarded for us to make significant new long-term investments, in the interim and on a selective basis we do like the risk adjusted returns of mezzanine investments. With respect to transactional activities from an earnings perspective, and Jon will discuss this in further detail, most of our transactional harvesting for the year has been completed. Furthermore 2009 was fortunately never intended to be a significant fund disposition year either.

So while there are always a host of moving pieces in our earnings bucket, short-term capital market weakness over the next year or two should provide more of a new investment benefit than an existing pipeline negative. Notwithstanding the challenges of the capital markets and the weakening economy we’re well positioned to absorb the impact of these challenges and capitalize on the opportunities. With this perspective in mind today, we’ll review our second quarter results, the status of our core portfolio, our balance sheet and liquidity, and on the external growth side both our existing projects as well as our new investments.

With that I’d like to turn the call over to Jon who will discuss our second quarter results.

Jon Grisham

Our second quarter and year-to-date earnings have been at the high end of our expectations with contributions from all of our business activities. There have been a number of moving pieces to date and I’d like to review where we’re at as it relates to our major income buckets. And as an additional reference, I’d like to refer people to page 20 in our supplement which details some of our 2008 guidance.

The first area is transaction fees which includes our development, construction and leasing fee income. Recall that we originally projected $14.5 million to $15.5 million of transaction fees for 2008. During the second quarter we recognized lease termination income at the fund level of $24.5 million from Home Depot at our Canarsie project. Acadia’s share of this income net of our fund to investors and other minority interest shares was $4.5 million or $0.13. As a result of the Home Depot termination agreements at both our Canarsie and Pelham projects, construction and leasing activities and the related fee income at these projects has now been deferred, not for gone but deferred to 2009 and beyond. For 2008 the deferral of this fee income will be fully offset and replaced by the lease termination income received from Home Depot. Keep in mind that had we not entered into these termination agreements with Home Depot we would have realized the construction and leasing fees on these projects in 2008. As a result of executing these agreements and consistent with our original guidance, we are projecting for the year combined transaction fee and lease termination income of $15 million. The fees from our Fordham project will be contributing most significantly to the second half of the year.

The second major area of income is RCP and promote income. Our original full year 2008 RCP and promote income expectation was $3 million to $4 million. As of the end of the second quarter we’ve already achieved this. During the second quarter we received $1.2 million or $0.04 of promote income from Fund I which is principally from the sale of the Haygood shopping center in Virginia Beach. When this is added to our first quarter promote and RCP income of $2.3 million, year-to-date we’ve realized $3.5 million. We are not forecasting any additional RCP or promote income in the second half of 2008 at the lower end of our current guidance.

The third area or income bucket is income from our core activities which along with core portfolio NOI includes income from our treasury and mezzanine investments. As we discussed at the beginning of the year, holding significant cash on the balance sheet would be dilutive but we said we anticipated that mezzanine investment opportunities would be available to counter balance some of that dilution in 2008. Fortunately we’ve been able to close on two such opportunities.

As Mike and Ken will detail further, we made preferred equity in mezzanine investments during 2008 which should generate approximately $2.5 million of interest income for each of the third and fourth quarters. This activity was contemplated in the upper half of our original guidance. We also forecasted same-store NOI growth of 1% to 3% in our original guidance. And as we’ve said before, given the size of our portfolio and the law of small numbers any given quarter may be positive or negative. But year-to-date our portfolio performance has been stable and we expect our annual NOI performance will be consistent with our original forecast of 1% to 3%. So as a result of our recent preferred equity in mezzanine investments and the stable performance of our core portfolio, we anticipate achieving the high end of our original guidance of $42.5 million from our core activities.

So to summarize, to date our earnings have been at the high end of our expectations with contributions from all of our business activities and accordingly, we now have a bias to the upper end of our original guidance.

Now I’ll turn the call over to Mike.

Michael Nelsen

As Jon mentioned, at year end 2007 we had a surplus of cash waiting to capitalize on future investment opportunities. During 2008 we have been able to take advantage of attractive investment opportunities in the mezzanine arena and have converted some of our cash into short-term attractive risk-adjusted investments. Importantly we have done this without compromising our liquidity and balance sheet. We continue to believe that liquidity and balance sheet strength are an important component of our strategy. And given the current economic environment, these are now paramount.

At June 30 we had cash on hand and availability under existing lines of credit of approximately $131 million which was after funding the $40 million Georgetown preferred equity investment. Subsequent to the quarter end we drew down $40 million on our line and made a $34 million mezzanine investment in the Broadway and 72nd Street project in Manhattan and liquidated the $3.7 million mortgage at our Lincoln Park Chicago asset. Additionally, we’ve collected $18 million of prior mezzanine loans at maturity. As a result we currently have cash on hand of approximately $42 million and availability under lines of credit of $67 million for a total of $109 million of liquidity. Included in our line availability is $30 million which is attributable to our Ledgewood, New Jersey mall which is currently held for sale. Our current level of liquidity should be sufficient to meet our capital needs to fund our growth initiatives primarily our capital commitments to our funds over the next several years.

As our core portfolio debt was all fixed rate at June 30 we have not benefitted from the current low floating rate environment. The current $40 million draw against our line is floating rate but only represents approximately 10% of our total debt. However, over the long run we still believe that fixing rates and managing maturities is the more prudent approach to financing long-term real estate investments. Given the continuing volatility in the debt markets we believe we have positioned ourselves well with no scheduled maturities in the core portfolio until December of 2010.

In summary, while the capital environment remains unstable, we believe this current uncertainty represents an environment for real estate enterprise with liquidity, a solid balance sheet, and access to capital to take advantage of profitable investment opportunities as they arise.

I’ll now turn the call back to Ken.

Kenneth F. Bernstein

First I’m going to review our core portfolio performance; then I’ll discuss external growth both in terms of new investments and our existing pipeline. Our same-store NOI for the quarter increased by 1% and 3.9% for the six months. The second quarter occupancy was 93.9% which is 20 basis points down from last quarter. And as we discussed on our last call, the primary drivers for our decrease in occupancy and thus impacting our NOI were the recapturing of space at two of our New York properties in connection with the re-anchorings of them. And that represented about 50 basis points of occupancy. First was our Crossroads property in Westchester, New York, and the second our Smithtown/Long Island location. Following the close of the second quarter we signed leases including one with TJX to open a home goods store at our Crossroads property. That lease alone more than makes up for this 20 basis points decline.

Looking forward with respect to our portfolio, so far we do not yet see any material impact on our properties from the sluggish economy. All our scheduled anchor maturities for 08 have been renewed; our collections and delinquency rates have not moved materially; however, the depth of the economic slowdown will ultimately determine whether the defensive profile of our value and necessity anchored centers enable us to withstand this clearly weakening economy.

In terms of asset and capital recycling over the past several years, we’ve focused on opportunistically disposing of assets that are inconsistent with our long-term growth strategy. Over the last 18 months we just disposed of 15% of our core portfolio and recycled the proceeds from those sales into properties in higher barrier-to-entry markets. The last property that we’re currently holding for sale is our Ledgewood Mall property. We have the property under a firm contract for sale and expect to close that during the second half of this year. The short-term dilution from the sale transaction should not be significant and it’s in our numbers.

So in short, as it relates to our core portfolio whether through aggressive leasing, re-anchoring, recycling, we’re committed to see that our portfolio remains of the highest quality so as to best be positioned to weather whatever storms may lie ahead.

Turning now to external growth, one of the key drivers of our external growth is our investment fund business. In 2007 we launched our third fund with $500 million of equity and that’s going to enable us to acquire or redevelop approximately $1.5 billion of assets on a leveraged basis over the next several years. That’s a significant growth profile relative to our current size. To date we have put approximately 20% or $100 million of funds re-equity to work and this 20% is about half of the pace that we would normally deploy over the same time period and reflects our view that we’re still in the early stages of price discovery and that our patience and discipline will be well rewarded.

And while the second quarter was not ripe with opportunities for longer-term equity investments, we did see compelling opportunities in the form of opportunistic mezzanine debt an area that we’ve spent a lot of time over the past several years and with important caveats we’re very comfortable participating in. We’re beginning to see opportunities to provide capital and in some cases expertise to owners and developers who due to changes in the availability of the debt markets are in need of mezzanine capital to finance their projects. And where we can achieve attractive risk-adjusted returns for assets that we would love to own at our basis, we’re happy to do that.

We’ve recently completed two of these types of transactions. First in Georgetown, Washington D.C. during the second quarter we executed a preferred equity loan for $40 million into a fabulous main street retail portfolio in Georgetown; 18 properties, 17 of them are in Georgetown and 1 is in Alexandria, Virginia. As many of you know Georgetown is a densely populated high quality retail market with significant pedestrian traffic, strong residential and tourist demographics. The transaction provides us with the opportunity to acquire a preferred equity interest in a 300,000 square foot portfolio consistent with our main street retail and probably most similar to our Greenwich Avenue property. Several of the leases are below market and roll over the next few years. The properties include top tier tenants such as Sephora, Puma, Pottery Barn, BCBG, Diesel, and additional tenants in the market include Juicy Couture, Coach, Kate Spade, and Apple.

The term of the loan is for a period of two years at an interest rate of 13%. In our view the properties are worth in excess of $185 million today and in excess of $200 million in a few years when the releasing of the few below market leases occur. The properties have senior mortgage debt of $115 million, thus we’re providing approximately the 65% to 85% loan-to-value piece and less than the 75% loan-to-value on maturity. And while we don’t have the upside of owning the properties outright, we’re excited to make investments in properties that we would be thrilled to include as part of our core portfolio. We made this investment with the Eastbanc Group. They are the existing owner/developers of the properties. Over the past 10 years Eastbanc has emerged as one of the dominant owner/redevelopers in the Georgetown retail market. They have successfully assembled and remain the largest non-mall landlord in Georgetown. And as excited as we are about the assets and potentially expanding our ownership stake in these assets, we’re equally excited about the opportunity to do further business with Eastbanc in the future.

After the end of the second quarter we made a second mezzanine investment totaling $34 million. It is collateralized by a mixed use retail and residential development on 72nd Street and Broadway on the Upper West Side of Manhattan. Construction has commenced and will be completed in approximately 18 months. The project will include approximately 50,000 square feet of high-demand retail and 196 high-end residential rental apartments. The project is being developed by the Gotham Organization. Gotham is a successful and well-respected multigenerational player in New York City development and construction with very strong capabilities in the building of luxury residential high-rise, retail and other urban commercial developments.

The term of the loan is for a period of three years and the rate of the return is in excess of 20%. Our mezzanine loan will be behind up to $185 million of senior construction financing with the completion guaranteed by Gotham and with our piece effectively being the 60% to 80% piece with substantially all of the land value and all of the development value being subordinated to us.

Turning now to existing fund assets, they as you know break out into two broad categories. First is opportunistic which includes our RCP investments and then value-added which includes our New York urban infill program.

On the opportunistic side, in connection with our retailer control property or RPC venture, first I’d like to touch briefly on Mervyns. As you know on Tuesday Mervyns announced that it filed for bankruptcy protection. We’ve walked through the investments on previous calls in detail, but in short in September of 2004 as part of our RCP venture and in connection with a larger investment consortium we participated in the acquisition of Mervyns department store chain which consisted of 262 stores and for a total price of $1.2 billion. Through our investment funds we invested $23.2 million and had ownership interest in both the real estate or REALCO and to a lesser extent the operations or OPCO. There were a series of transactions, the three largest which were previously announced where we disposed of approximately 40% of the real estate portfolio for about 80% of our initial purchase price. Through those transactions and several other smaller transactions, we’ve sold more than half of the real estate off and we’ve received approximately two times our original equity investment. Last year there was a restructuring of our Mervyns investment and now Acadia’s entities have no direct OPCO ownership but OPCO or Mervyns remains a major tenant in the remainder of the portfolio that we’re invested in. We are extremely pleased with our Mervyns investment. In fact, the returns already received are in excess of our original total expectations. As for additional remaining value, it’s premature and inappropriate to try to quantify it at this junction but we will certainly keep you apprised.

Our second largest RCP investment, Albertsons, is even more impressive. We invested $20.7 million of equity and have received to date $53.7 million or a 2.6x on our investment. During the second quarter Albertsons announced the sale of 49 assets throughout Florida to Publix. That transaction’s scheduled to be completed in September.

Turning now to the value-added side of the platform with respect to our New York urban redevelopments. Notwithstanding pressures on retail development in general we still see tenant demand in New York City and while many tenants are rethinking their growth strategies nationally and including in New York, other tenants are using this window to continue to expand their presence in New York City. The density, supply constraints, and high level of mass transportation all make New York one of the top urban markets for retailer growth. As of the end of the second quarter we now have 10 projects totaling about 2.5 million square feet. In general our projects are proceeding according to plan and on page 42 of our supplement we describe the estimated timing and costs of the projects. But I’ll discuss a few of the projects now.

First, our Downtown Brooklyn development known as CityPoint, during the second quarter we entered into an agreement with Target to anchor CityPoint. Target has agreed to occupy the third and fourth levels of the project. They’ll occupy over 200,000 square feet of the approximately 500,000 square foot retail component o the development. This is both a significant positive step for our CityPoint development and also further confirmation of the continued tenant demand for the right New York City assets.

Next I’d like to discuss Home Depot. You may recall that we have two New York City redevelopment projects with Home Depot as the anchor tenant - Canarsie, Brooklyn and Pelham Manor, New York. Home Depot announced in May of this year that they would record a charge of $400 million related to terminating certain leases and closing certain stores nationally. It appears to us pretty clear that Home Depot’s decisions are a reflection of a shift in their national strategy rather than a reflection on New York or urban development. And while in general it’s fair to assume that the loss of the key anchor to a project is a negative, in our two instances that is just not the case.

First, Canarsie during the second quarter, we reached an agreement with Home Depot to terminate their lease at our project in Canarsie, Brooklyn. Home Depot paid us $24.5 million to terminate their lease. The entire property was originally acquired for $26 million and Home Depot represented about 40% of the total redeveloped [geolay] of the project. Given the stringent opening covenants and limited assignment rights that we negotiated for in our lease with Home Depot, we were able to achieve a resolution that was fair to all parties. More importantly, given our significantly reduced land costs in that project we can afford to be patient as we pursue the redevelopment of the project.

In our Pelham Manor redevelopment, we also entered into an agreement after the second quarter to recapture that space. First a little background on that project. In Pelham we delivered Home Depot their pad in August 2007. They made an upfront payment to us of approximately $5 million and they proceeded to build their building at their expense. So Home Depot’s investment in our project is now in excess of $20 million and as was the case with our Canarsie project, this lease has opening covenants and limited assignment rights. Subsequent to the close of the second quarter we entered into an agreement to purchase Home Depot’s building back from Home Depot at an attractive discount. Since the development of this project is near completion and thus the immediate re-tenanting of the space is viable, we structured the transaction as contingent on our successfully replacing Home Depot with another tenant. We’re in the final stages of lease negotiations with a replacement tenant on terms that are attractively accretive to us with any additional capital that we’re investing into this project receiving a strong incremental return on investment. In the event that a replacement lease is not signed or we do not receive all of the other necessary approvals, Home Depot will open pursuant to their current obligation.

As we see with our two Home Depot developments, a combination of strong leases and strong locations enables us to profitability negotiate and re-anchor projects if necessary clearly in our view distinguishing the New York development process from most other development locations. While we generally developments to proceed as planned, often that’s just not a reality and in these instances at least our stakeholders are being well compensated financially for the brain damage associated with re-anchoring these projects.

I’d like to talk briefly on our Fund III. We currently have three acquisitions in Fund III - Westport, Connecticut, Sheepshead Bay, and our Storage Post investment. Westport and Sheepshead Bay continue to be in the design phases and are going according to plan. Storage Post as we discussed on our first quarter call we closed on an 11-property self-storage portfolio where we bought out the previous institutional capital partners of our existing self-storage partner Storage Post. The portfolio was acquired at 70% occupancy and it breaks out into four effective categories. First, four of the properties are fully stabilized; three are in various stages of lease-up; three are currently being repositioned to add climate control or other changes and those three may have certain occupancy fluctuations due to that; and one is under construction.

At the end of the second quarter the occupancy increased up to 75% from 70% and with respect to the stabilized portion comparing first half 07 when we were not in ownership to first half 08, the same-store NOI increased 15%. Occupancy increased from 90% to 91% but the rental growth was obviously the main driver of that strong same-store NOI growth. The portfolio continues to meet and exceed our expectations and with our financing fixed at 5.5% the project’s already positive cash flowing and still has significantly sub potential which should bring our unleveraged yield upon stabilization to between 9% and 10% and the leveraged deal into the mid-teens.

So to conclude, notwithstanding a difficult capital market environment and a softening economy, we feel we’re well positioned not just to respond to these difficulties but to capitalize on them. Our core portfolio is stable with quarterly fluctuations having more to do with two re-tenantings and the law of small numbers than implications of the economy on the portfolio. Our balance sheet is solid with plenty of drive power to execute our growth strategies. And third our acquisition platform continues to position us to take advantage of any unique opportunities as they may arise.

With that I’d like to thank the members of Acadia for their hard work this quarter, and I’d be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Analyst for Michael Bilerman - Citigroup.

Analyst for Michael Bilerman - Citigroup

Can you give some color on the mezza investments that you made in the quarter? Are those cash interest that you’re getting or are they accrued interest?

Kenneth F. Bernstein

Two different investments and one of them is cash flowing right now, the Georgetown properties, although there’s significant rental growth so it will go from cash to the extent available and some accrual over the next couple years to full cash flowing. Now on 72nd Street, it’s a development project and there are interest reserves that will pay about two-thirds of the total expected return and then the back third is an exit payment on seller refinancing. But obviously since it’s construction there’s no current cash flow on that.

Analyst for Michael Bilerman - Citigroup

Can you update us on the re-leasing of the Home Depot boxes, just give us a sense of how long you think it’ll take to get a new tenant lined up? And then at Pelham, if you do not find a tenant to re-lease or to take the space, if Home Depot has any contingencies where they could just open and then subsequently close?

Kenneth F. Bernstein

First, Canarsie. That’s an earlier stage deal and that’s why we structured it as we took a lump sum payment and a very attractive lump sum payment to take the risk of re-tenanting because there are some moving pieces. My guess is we ought to assume it takes us six to 12 months to work with the tenants that we’re talking to now, and I expect one of them will step up, but also work through the planning and construction issues associated with that.

As it relates to Pelham where the building that Home Depot constructed at their own cost is substantially completed, the re-tenanting there, as I said we’re in the final stages of lease negotiations and getting the necessary approvals, so we hope to count that process in weeks not months and then there’s just the refitting for that specific tenant. In the event that that didn’t occur, Home Depot has an obligation to open. But as you pointed out, they could at some point close. However, it’s not that simple because if they close then we have various recapture rights. And we negotiate very hard for these and there’s a cost potentially to it but the cost depending on how long they stayed open ranges from $0 to up to the $5 million initial payment that they made to us giving them back that. So in that eventuality, it could be even more economically attractive. However, it feels like a higher risk game of poker because we have tenants interested today. It’s an overall center with co-tenancy. I rather get the right tenants in at a very attractive incremental return for us today than kind of go through that process.

Michael Bilerman - Citigroup

Can you talk a little bit about the mezza preferred investments? How much more do you have on your plate that you’re looking at and making the decision to do it on balance sheet versus potentially in the fund?

Kenneth F. Bernstein

First in terms of the pipeline, we are seeing continued interest and continued opportunities in this space but it’s not clear to me when the risk-adjusted returns will shift from being best executed in the preferred equity mezzanine space as opposed to our more traditional long-term investments. If there were more, then I’d be highly inclined to make up a different platform strategy. Now first of all we could do them in our funds. In general while we have the right to do it, both our view and our investors’ view is the dollars we’ve raised are finite life funds and once you take that money, with some exceptions, if it comes back quickly you may make a high IRR but you’re not necessarily going to make a high equity multiple. So if we thought this was a recurring business that had long-term legs to it, we might either create a separate fund or talk to our fund investors about changing the dynamics of the fund so that we could recycle that capital. We’re just not certain if it’s meaningful enough and consistent enough to do that, but that’s kind of where we are at this point. We like the risk-adjusted returns for these two; we’re happy to use our excess capital for it; but going forward we would probably either contribute those into something or talk with our fund investors or other investors.

Michael Bilerman - Citigroup

How did these deals come about for you?

Kenneth F. Bernstein

In the case of Georgetown we had done a much smaller transaction about a year ago that we got to know the Eastbanc people and really enjoy comparing notes and we view the world similarly and we agreed to disagree as to the ultimate disposition value; thus they weren’t sellers and I don’t blame them. We’re constantly in the market looking for interesting partners and interesting assets. And P.A. & Associates for instance has been a fabulous partner of ours for our New York City developments and we developed that relationship with [Aaron Malinsky] when he was the head of real estate for A&P. These are relationships that Joel Braun, who’s our Chief Investment Officer, works on, that I worked on, and the entire company works to cultivate. And sometimes they create mezzanine opportunities; other times they create pure investment opportunities.

Michael Bilerman - Citigroup

You talked about the leases that you had with Home Depot and how strict they were and the terms, and I assume that when they were negotiated the environment was a lot different and Home Depot’s appetite to come in urban was a lot different. How would you say the leases that you have within the rest of the infill and also that you’re negotiating today compare in terms of a lot of the terms that you’re benefitting from today?

Kenneth F. Bernstein

First of all, there’s a huge distinction, and we had to even get up on a learning curve, of what we could get from our New York City deals in terms of negotiating points compared to suburban development. So at the best of times the Home Depots of the world would never give us the kind of covenants that they give in New York and that was just a New York City tradition and also to the credit of our partners at PA and our leasing team, we negotiated very hard. I would expect common sense would tell us that if demand starts to decline in New York City, and I say if Michael because yes there are fewer players out there but there are enough that you’re still seeing very attractive leases done, but if it really slowed down, tenants would be able to command more strength and perhaps things would shift. But we really haven’t seen that yet. We are seeing it certainly outside of the urban markets and it may eventually then also occur in New York and then we’ll just have to structure our deals accordingly.

Operator

Our next question comes from Michael Mueller - J.P. Morgan.

Michael Mueller - J.P. Morgan

Ken, I think you mentioned the transaction harvesting was largely done for 2008 and maybe that 09 was more of an investment year. If we’re thinking about the bucket of income coming from transactional items including lease term and if we’re thinking about 08 versus 09, do you think 09 the early read on it is at least comparable to what the 08 level is?

Jon Grisham

It’s a little bit at this point in terms of 09 guidance. We really don’t have a number to throw out at this point.

Michael Mueller - J.P. Morgan

Going to the Pelham Home Depot, could there be or will there be a lease termination fee there? I know you mentioned you’re buying the building back at a discount or you would be. Would a portion of that from an accounting perspective be deemed income or what’s the accounting for that?

Kenneth F. Bernstein

We don’t think so. None of that is in our numbers. Deals can always be restructured I guess but we didn’t structure the Canarsie deal to achieve the lease termination income. We structure it because when a tenant who represented 40% of your development is willing to pay you 90% of your purchase price, you take it. In Pelham as you pointed out we would be effectively buying back the building they constructed and that’s an additional investment which will make a very attractive incremental return on but doesn’t create upfront FFO, and that’s fine. It’s more important that it’s creating an improved overall unleveraged and leveraged return.

Michael Mueller - J.P. Morgan

For the Albertsons sales that’ll be concluded in September, do you expect any distribution to come from that or other sort of promote or income?

Kenneth F. Bernstein

Not specifically, no. We have in the high end of our current guidance maybe another $1 million or $2 million of income from various potential sources. It could be from one or several of many different sources but nothing specifically per se that relates to that transaction.

Michael Mueller - J.P. Morgan

Any general commentary going back to Pelham for a second about the rent levels for new tenant or new tenants versus Home Depot on par higher or lower?

Kenneth F. Bernstein

Remember, Home Depot did two things that almost by definition kept their rent low. One, they made an upfront payment to us and secondly, they built their own building. So looking at the Home Depot rent relative to market today doesn’t really give a sense of any market changes. It sure as heck better be below market. In general we are seeing the rents that we are achieving elsewhere in the center to be consistent with our overall goals. So we have not seen a softening yet.

Operator

Our next question comes from Paul Adornato - BMO Capital Markets.

Paul Adornato - BMO Capital Markets

In looking at the New York City pipeline, I guess I’m sold on the attractiveness of building the big box space and the kind of lack of new big boxes out there, but could you comment on what you think is happening to smaller shop space especially perhaps newly-built more expensive smaller boxes in New York City?

Kenneth F. Bernstein

Paul, it runs the gamut and a lot of this is more based anecdotally because just in terms of where our pipeline is, we haven’t had much small space recently come to market to test if there’s any major variations. But for the prime locations with the prime anchors we are seeing significant interest for small tenants to be around a Target on Fulton Street for instance. And keep in mind, it’s easy to look at the diminishing number of larger box players in the US as a result of some of the changes in the economy, but there are a plethora of smaller tenants, some coming to the United States for the first time, others establishing strong presence in New York City, that so far we haven’t seen any issues associated with it. But it’s really going to be case by case and we’re going to have to see overall what happens to the economy over the next few years to determine if we see any softness or change.

Paul Adornato - BMO Capital Markets

Is it still too early to start to talk to the smaller tenants?

Kenneth F. Bernstein

No, we talk to them. It’s just too early to in Fulton Street start leasing to the smaller tenants because we’d be leaving money on the table.

Paul Adornato - BMO Capital Markets

Also in New York City, is there anything to report on the Port Authority at the George Washington Bridge?

Kenneth F. Bernstein

Yes. We’re continuing to work on it. I was tempted to discuss it in my very long opening so I’m glad you asked. We are making progress; we are being appropriately careful that we understand the costs before we proceed; and that while the Port Authority is negotiating in good faith we all have to be on the same page as to what we’re building. So that’s another prime example where in that case, because we are talking to smaller tenants, the demand is unbelievable. So we have a very strong retail site; we just need to make sure the costs and the returns to us are appropriate.

Paul Adornato - BMO Capital Markets

Are you waiting for engineering studies or has that all been done?

Kenneth F. Bernstein

We’ve done multiple engineering studies. And if you think about all the issues associated with building in any urban market plus the moving pieces of cost, etc. and getting this done right so that it’s a high-quality project that the Port Authority can be proud of, that we can be proud of, it takes time. And we’re dealing with a municipality and so there are also issues associated there. So it is taking longer than I might like but the flip side is better to be careful and get this right to have rushed into it.

Paul Adornato - BMO Capital Markets

Moving on to the mezz investment, is this something that you guys structured? It’s not existing mezz debt that you purchased, is that correct?

Kenneth F. Bernstein

Correct.

Paul Adornato - BMO Capital Markets

Given what everyone is reading about, the Wall Street firms dumping all sorts of mezz debt and other debt onto the market at pennies on the dollar, do you have access to that flow and does any of that appeal to you?

Kenneth F. Bernstein

Yes, we have access to the flow. Some of it appeals to us. We look at a lot of it. Not to paint with a broad brush, but we’re pretty finicky about the kind of loans that we would buy because these are assets that we need to be prepared to own. And if you think about the securitization process historically, it maybe wasn’t consistent with the kind of documentation and kind of collateral that we may be interested in. That being said, we’ve made a lot of money. Think about our Kroger/Safety portfolio; think about some other opportunistic deals; at the right price. If in fact we can get asset loans, not pools but B notes, for assets that we feel we’re getting at either pennies on the dollar or very attractive risk-adjusted returns, we’d certainly do it. That process is still playing out and I think what you’re also reading is while stuff is trading at pennies on the dollar, it’s really only beginning to evolve through for the higher quality commercial and especially retail.

Paul Adornato - BMO Capital Markets

Just looking at Mervyns and Albertsons, when you first made those investments a couple years ago I always envisioned you eventually recapturing some of that real estate and then working your magic to create value. Don’t get me wrong; it’s nice to see the 2 and 2.6 times of returns, but what are the prospects at this point of ever recapturing the real estate in those situations?

Kenneth F. Bernstein

Anything is possible. We like to work magic but when someone else is willing to pay us and they’ll work the magic, great. So we’re just happy to be part of the sales. If the right opportunity came especially, because we’re not necessarily the best buyers of stabilized lease buy-backs, but we think we’re pretty darn good at buying well-located real estate with maybe no cash flow and redeveloping it. So if that opportunity arose, we’d certainly entertain it whether it’s into Mervyns or otherwise. The timing wasn’t right for that and thus we just made a lot of money and now we’ll just have to see how it plays out.

Operator

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

Rich Moore - RBC Capital Markets

On the New York City mezz loan, Ken, is there any yield based upside or any promote kind of thing at the end?

Kenneth F. Bernstein

Yes, kind of. Let me be clear because I don’t think I was. About two-thirds of the total return is in the form of upfront annual interest rate paid from the interest reserve. Then there’s a back end piece that is senior and is due on sale for refinancing. But we have the right at our option to convert that into a minority kicker if you will into the retail project. So when the time comes in a couple years we’ll decide whether or not we take our back end exit payment or convert it into a kicker. And I won’t know for a couple of years which way we go on that but we thought that was a kind of fair way to hedge our position and make it work for all sides.

Rich Moore - RBC Capital Markets

On the Georgetown mezz loan, how do you have 18 properties in 306,000 square feet? Are these individually-owned or individual pieces of property in each of these boxes?

Kenneth F. Bernstein

Yes. I encourage anyone who hasn’t spent time in Georgetown to go there and shop especially at the locations that Eastbanc owns. But Georgetown is effectively an open-air high-end retail mall and each of these, very often their old historic buildings that have been refit to include all the various different tenants I discussed. And Eastbanc to their credit over the past 10+ years assembled this portfolio of assets and converted them to upscale retail. Because the market rents have grown so significantly, some that they converted 10 years ago, when the leases mature shortly the rents are going to double.

Rich Moore - RBC Capital Markets

Are they cross-collateralized?

Kenneth F. Bernstein

Yes.

Rich Moore - RBC Capital Markets

It sounds like a very valuable project. How is it that Eastbanc needed this money I guess or was in the market for this money? Had they already put on the senior piece of debt and they still needed additional capital? Is that what’s going on?

Kenneth F. Bernstein

The latter, although I don’t know if I’d use the word need. They’re a very capable dynamic development company and they put this debt on a few years ago and the assets have appreciated in value and with securitized cross-collateral-like debt it’s not easy to then pay it off and then refinance, so this was a way for them to monetize, take some dollars and put that to work in some of the other projects that they’re working on and looking at.

Rich Moore - RBC Capital Markets

Jon, on your guidance for transaction fee income that includes lease termination income, correct?

Jon Grisham

Yes.

Rich Moore - RBC Capital Markets

Does that include all lease termination income now going forward or just this one chunk of the $4.5 million from Home Depot?

Jon Grisham

For this year that’s the only lease termination income that we anticipate, so that’s it in our current guidance for 08.

Operator

Our next question comes from Christine Mcelroy - Banc Of America Securities.

Christine Mcelroy - Banc Of America Securities

In underwriting potential preferred in equity investments kind of going forward, how has your return requirements changed for these types of investments over the last year given the greater inherent risk in this environment?

Kenneth F. Bernstein

Well let’s talk about where the market was where we were priced out of the market a year ago or so. Several hundred basis points, 300 to 500 basis points lower was achievable. Thus in Georgetown, and that’s the easiest probably to discuss, the mezzanine for that market would have been high single-digit returns. And at those rates we weren’t that excited. So if it went from 9 to 13 or 8 to 13 that’s about where that would have played. Then for 72nd Street we wouldn’t have been competing with mezzanine. This would have been done by first mortgages and thus you would look and you’d say a construction loan for the amount of the current construction loan plus our piece would have been achievable at 200 basis points over LIBOR and you would extrapolate what that piece would be and again you’d come in saying that was a single-digit return. And that’s been the big shift in the capital markets right now is the debt markets have gone from an easy 80% execution to a difficult 60% to 70% depending, and that gap while it exists for now is something that we can selectively plan.

Christine Mcelroy - Banc Of America Securities

So that kind of leads me to my next question. What kind of compensation are you seeing in the market today for preferred equity and mezz? It seems like everybody’s in the opportunity fund business today.

Kenneth F. Bernstein

Everybody is. There are a host of very capable players who do this and there are a host of very capable players who are focused elsewhere either in terms of their existing inventory that has maybe sidelined them or in terms of actually buying pools of loans. And as I said before, that’s not what we want to do. So I think there’s plenty of competition out there. We’re really more focused on not just finding loans but finding the right assets and equally importantly the right partners in the case of Gotham which is a fabulous company or in the case of Eastbanc, groups that we can do future business with, multiple different ways. On new business it may not be in the form of mezz; it may be in the form of our more traditional venture platforms like we have with PA Associates, etc.

Christine Mcelroy - Banc Of America Securities

You’ve spoken in the past about retailers that get or understand the New York City outer borough urban story. Home Depot used to be one of them. What are those retailers today that you’re still seeing significant demand from as you continue to underwrite new projects?

Kenneth F. Bernstein

Certainly Target is at the top of the list and Home Depot gets it. I give their real estate guys a lot of credit. They were very tenacious. They also understand when their mandate is to get out, how to get out. Target, Costco, BJs. On the mid-size box, Best Buy is doing a tremendous job of filling out its footprint in New York City, Walgreens, and the list goes on. There are several fashion players that are also doing a good job of penetrating the urban markets. You’re seeing H&M open in various locations. A wide variety.

Christine Mcelroy - Banc Of America Securities

Just kind of following up on Mervyns and Albertsons, given the retailer environment today what’s your current appetite for partnering on another deal like that where the retailer remains operational?

Kenneth F. Bernstein

The world is so much different that it’s hard to talk broadly. Our appetite to do additional business with our RCP partners remains very high; they’re great partners; but my guess is first of all the debt level that the private equity operators could achieve right now don’t exist so that changes it. Our view of the fundamentals would be extremely conservative so that would cause us some level of caution. But if there was some significant imbedded value in the real estate side of an operator and we could correctly structure the deal and felt we had the right partners, we would certainly go ahead.

Operator

We currently have no more questions in the queue at this time. I’d like to turn the call over to Mr. Ken Bernstein for closing remarks.

Kenneth F. Bernstein

I’d like to thank everybody for joining us and please enjoy the rest of your summer.

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