Inland Real Estate CEO Discusses Q2 2012 Results - Earnings Call Transcript

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Inland Real Estate Corp. (NYSE:IRC) Q2 2012 Earnings Call August 2, 2012 3:00 PM ET


Dawn Benchelt – IR

Mark Zalatoris – President & CEO

Brent Brown - CFO

Scott Carr – President, Property Management


Todd Thomas – KeyBanc Capital Markets

Jeffrey Donnelly – Wells Fargo

Josh (Potankin) – BMO Capital Markets

(Kebin Kem) – Macquarie

Tayo Okusanya - Jefferies


Good day and welcome to the Inland Real Estate 2012 second quarter earnings conference call and webcast. All participants will be in listen-only mode.

(Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Ms. Dawn Benchelt, Director of Investor Relations. Ms. Benchelt, the floor is yours madam.

Dawn Benchelt

Thank you Mike, and thank you all for joining us for Inland Real Estate Corporation’s second quarter earnings conference call. The earnings release and supplemental financial information package have been filed with the SEC today and posted to our website which is We’re hosting a live webcast of today’s call, which is also accessible on our website.

Before we begin, please note that today’s discussion contains forward-looking statements, which are management’s intentions, beliefs, and current expectations of the future. There are numerous uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. For a discussion of these risks factors, please refer to the documents filed by the company with the SEC, specifically our Annual Report on Form 10-K for the year ended December 31st, 2011.

During the presentation, management may reference non-GAAP financial measures that we believe help investors better understand our results. Examples include funds from operations, EBITDA and same store net operating income. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found on our earnings release and supplemental dated August 2, 2012.

Participating on today’s call will be Mark Zalatoris, Inland’s President and Chief Executive Officer, Chief Financial Officer Brett Brown, and Scott Carr, President of Property Management.

Now I will turn the call over to Mark.

Mark Zalatoris

Good afternoon Dawn, good afternoon everyone and thank you for joining us today. In my remarks, I will focus on highlights for the period, and provide an update on our growth initiatives. Scott will follow on portfolio operations and then Bret will cover financing activities and the income statement.

We believe the operating platform we have in place today is stronger than before the great recession, and is the best position in our 18 year history. This portfolio has been revitalized through our aggressive leasing and repositioning activities, the acquisition of new high quality assets, and a disposition of targeted non-core assets. Predominant presence in core mid-west markets enables us to maximize the productivity of our property management team and to capture significant cost savings from vendors.

In fact, we capitalize on a town within our market stem [inaudible] strength to our in-house team of leasing and asset management professionals. As a result, the steps we’ve taken today we’re managing a more resilient portfolio, equally resilient to geographic markets.

This portfolio meets the needs of consumers for necessarily and value oriented retail. It’s well positioned to handle the still challenging economic environment and evolving retailer landscape. The positive impact of our [inaudible] is evident that the healthy performance we reported for the three and six month periods ended June 30. These results included adjusted FFO per-share of $0.22 for the quarter and $0.42 for the six-month period.

We also reported a substantial increase in consolidated same-store financial occupancy over the prior year quarter. This increase contributed to gains and consolidated same-store NOI of 4.2% for the quarter and 4.7% year-to-date.

In addition, average base rents on total portfolio new and renewal leases increased 5.2% and 8.2% respectively.

Of note is that we achieved a sixth consecutive quarter of gains in both consolidated, same-store NOI, and rent spreads for new leases signed within the total portfolio.

I’d like to take a few minutes to discuss our approach to growth, which we believe sets us apart from a number of our peers. Over the past 24 months, we’ve acquired more than $600 million in assets for our consolidated portfolio and for our joint ventures. As a result, we’ve grown our total portfolio for approximately 12 million square feet, 2004, to nearly 15 million square feet today.

For our consolidated portfolio and the joint venture with PGGM, we’re balancing acquisitions in our primary markets of Chicago, Minneapolis/Saint Paul, where competition is currently driving from press cap rates with purchases of Class A assets in a strong secondary markets like greater Cincinnati and suburban Cleveland.

In these secondary markets, with demographics similar to our core markets, we’re acquiring the same high quality rent roles, and we are achieving a higher return on investment. By acquiring premier assets in both our primary and select secondary markets, we expect to achieve a blended levered deal of over 9%.

Our joint ventures play a pivotal role in our growth strategy providing a capital efficient way to increase assets under management. These ventures also leverage our asset management expertise in extensive mid-west market knowledge, to generate a valuable acquisition in management fee income stream.

For the first half of 2012 total fee income from the joint ventures, with NYSTRS and PGGM are approximately $1.4 million. In addition, these experienced and well regarded institutional investors provide an important source of equity.

It’s also important to note that we retain a ownership interest of at least 50% in the properties owned through our joint ventures with our institutional partners.

As you are aware, we have two asset based joint ventures with institutional partners, one with New York State Teachers Retirement System, or NYSTRS, and another with Dutch Pension Fund Advisor, PGGM.

The venture with NYSTRS has been a fully invested since 2006. This portfolio is outperforming well under our management, and in June we extended our joint venture agreement with NYSTRS for a ten year term.

Turning to the joint venture of PGGM, the growth capital originally committed by PGGM was fully invested as of this past April, and the gross book value of the portfolio is approximately $470 million.

I’m pleased to report that the boards of IRC and PGGM have approved proposals to increase the size of our existing joint venture. Under the amended agreement, PGGM would contribute up to 100 million of additional dollars, of equity to be used for new acquisitions, and IRC would contribute similar amount in line with the 45 to 55% ownership structure of the existing joint venture.

IRC will not contribute or sell additional consolidated assets to the PGGM venture, with the possible exception of the West Gate Shopping Center in the Cleveland market we closed earlier this year. This asset was sourced with the PGGM venture in mind, but the acquisition closed after the first phase the venture was fully invested.

We expect to finalize and execute the amended joint venture within the next couple of weeks, and we’ll provide additional details at that time.

I’d like to note that it’s to our advantage to acquire new properties through our joint venture with PGGM, as the fee income we receive from our partner typically boost our yield on investment by approximately 100 basis points.

Now, lets turn our asset management joint venture with Inland Private Capital Corp. This venture was formed in 2006 to capture business from 1031 exchange investors, and over time the pool investors has expanded to include cash investors. I want to note two important points with the IPCC JV.

We’re not investing in IPCCs business and we do not expect to have a long-term ownership interest in the properties acquired by the venture. Our role in the venture is to provide balance sheet capacity and asset management’s services, while IPCC provides syndication expertise.

The primary benefit of the venture is the recurring fee income we receive for managing the properties for investors on a long-term basis. This management fee income stream grows as additional assets are acquired by the venture.

For 2012, we expect the IPCC joint venture to generate more $1 million in property management fee income. And we also receive one time acquisition fees for properties purchased by the venture, which is recorded as interest in the properties are sold to investors.

As of June 30, the venture had closed acquisitions totaling approximately two thirds of our annual acquisitions goal of $100 million.

And finally, in line with our long-term strategic plan, we continue to look for other opportunities to grow our company in a transformational way. Our objective is to replicate the business model we have successfully executed in Chicago and Twin Cities markets. That model’s based on achieving a critical mass of assets and resilient markets, supported by dense population bases and strong incomes and leveraging our scale to achieve leasing and operating efficiencies.

As we grow the company in a well-considered and accretive way, we expect to broaden our investor base and to generate strong return for our stockholders.

Now, I’d like to turn the call over to Scott, who will provide more detail on portfolio performance. Scott?

Scott Carrols

Thank you, Mark, good afternoon everyone. As Mark: noted, we continue to improve portfolio performance through on-going repositioning activities, and aggressive leasing throughout the portfolio.

In addition, we have enhanced the overall quality of our real estate platform by adding class A assets in demographically strong markets, while disposing of non-core assets. In the first half of 2012, we acquired a total of approximately $165 million of assets, comprising nearly 700,000 square feet of GLA, for both our consolidated portfolio and the PGGM joint venture.

Over the past couple of months, we have also sold three non-core assets in Michigan, Indiana, and Missouri, which no longer fit our long-term strategy. We intend to recycle the proceeds from these dispositions in to higher growth opportunities that will enhance overall portfolio value.

The benefits of our efforts to improve portfolio operations can be seen in our results for the quarter. For the second quarter, net operating income for the consolidated same-store portfolio, increased 4.2% over the prior year period. As noted, this is the sixth consecutive quarter of increases in same-store NOI.

Financial occupancy for the same-store portfolio was 88.4%, an increase of 120 basis points over the prior year. The gain in same-store NOI was due to increase base rental income, from over 130,000 square feet of new tenants commencing rent payments, along with higher lease termination fee income, related to our [inaudible] initiatives.

This positive trend was achieved notwithstanding the contribution of the Four Flagg Shopping Center to the PGGM joint venture during the quarter. I would like to note that Four Flaggs is the last asset scheduled for contributions to the PGGM joint venture, and full investment of the initial capital commitment by PGGM was accomplished three months ahead of schedule, and it’s contribution of assets to the venture was match funded with new acquisitions. Our PGGM joint venture has been immediately accretive.

Turning to leasing activities for the total portfolio, we executed 112 leases for approximately 378,000 square feet of space in the second quarter. A total of 105 leases were signed with non-anchor tenants. This represents an increase over the second quarter 2011 of 34% in lease executions with non-anchor tenants, occupying 10,000 square feet or less.

These non-anchor leases comprised over 74% of the total square feet lease for the quarter. Nearly a quarter of this non-anchor leasing activity was a quick serve and fast casual restaurant concepts, such as Noodles, Chipotle, Caribou Coffee, and Potbelly. All have sustained popularity with consumers, despite a sluggish economy. Our non-anchor lease occupancy rate has consistently outpaced that of many of our peers, and we believe the primary reasons for this are first, our portfolio is located in relatively stable mid-west markets, which have recovered better than some of the former high-growth markets, which were hardest hit by the recession.

Second, we have deep local market knowledge and small shop leasing expertise. And third, with an average portfolio population density of over 90,000 consumers with household income in excess of $66,000. Our centers generate the high traffic volumes necessary to support small shop tenants.

In the quarter we also executed four new anchor leases, including a lease with Party City for 12,000 square feet at the Schaumburg Plaza, in Schaumburg Illinois. Party City will join co-anchor Jo Ann Fabrics and Crafts, which signed a lease at the center late last year.

On previous calls I have talked about looking for opportunities across our portfolio to accommodate retailer demand, by combining smaller spaces in to larger spaces. The lease with Party City is notable because it is an example of this type of activity.

To accommodate Party City at this center, we combined two smaller spaces and expanded the building by 200,000 square feet. Last year we targeted Schaumburg Plaza for repositioning, and have already accomplished our key objectives for the property, which include reducing our exposure to Sears, by replacing Jo Ann stores, decreasing small shop space by creating a box for Party City, and increasing not only the amount of income generated at the center, but also the credit quality of the income.

Schaumburg Plaza is yet another example of a center where we have leveraged our prime market position, to sign new leases with better quality in demand retailers.

During the quarter, we also signed leases with anchor tenants Michaels and Pier 1 Imports, and executed a renewal lease with TJ Max that included a rent bump in the high teens, at our recently acquired Brownstones Shopping Center in Brookfield, Wisconsin.

Moving to rents spreads, for the total portfolio in the second quarter, we executed 23 new leases with an average base rent that increased 5.2% over the prior in place rent. This marks the sixth consecutive quarter of improved rent spreads for new leases signed within the total portfolio.

The 65 renewal leases we signed, bring our tenant retention rate to 82% year-to-date, and have an average base rent that increased by 8.2% over the expiring rent. We have maintained positive rent spreads and renewal leases for the total portfolio, throughout the past years of challenging economic conditions.

Total portfolio lease occupancy at June 30, was 92.9%, representing an increase of 20 basis points over the prior quarter, and a decrease of 180 basis points from one year ago. This decrease from the prior year was primarily due to lease expiration and terminations, of big box spaces, which are currently under contract or being marketed for sale.

Total portfolio financial occupancy was 90.4% at quarter end, representing increases of 20 basis points and 60 basis points over the prior quarter and the second quarter of 2011, respectively. The spread between total portfolio lease occupancy and financial occupancy, was 250 basis points, compared to 490 basis points at the end of the second quarter of 2011.

As we evaluate portfolio performance at this mid-year point, we are pleased with the consistent increases in same-store NOI, financial occupancy, and rent spreads that we have achieved. We recognize there is more work to be done, and we expect our on-going value initiatives will further enhance portfolio performance.

Now, I would like to address a subject that we believe may be top of mind for many of our investors. This is the recent announcement by Super Value of it’s intention to explore strategic alternatives for their company, primarily the sale of all or some of its assets.

Super Value is the third largest grocer in the nation and operates multiple regional grocery chain, license grocery operations and a grocery distribution business. We have Super Value as a tenant in both the Chicago land and Minneapolis/Saint Paul markets, under the Jewel-Osco and Cub Food banners respectively.

It is very important to note that these operators represent two of the strongest and most established brands in the super value group of grocery operations. They are the long-term market share leaders in their respective Jewel-Osco capturing over 30% of the Chicago land market, and corporate owned Cub Food Stores, holding approximately 20% market share in the Twin Cities.

In the consolidated portfolio, we have three Jewel-Osco stores and two Cub Food Stores, one of which is sublet to a non-grocer retail. These five stores represent 2.4% of annual base rent for the consolidated portfolio.

In addition, we have a total of 15 Super Value stores in the unconsolidated portfolio, including eight Jewel-Osco stores and seven Cub Food stores, comprising 15% of annual base rent for the unconsolidated portfolio.

All of our Cub Food locations are relatively new stores, and the majority of our Jewel-Osco stores have been refreshed or completely remodeled within the past few years.

Out of the operating Super Value stores within the portfolio, ten report sales with a healthy average sales volume of $500 per square foot.

As with all tenants, our on-going strategy with Super Value is to monitor individual store performance and manage exposure. In 2011, we negotiated the early termination of a lease with Cub Foods, at a single tenant property in Indianapolis, which is now under contract to sell.

This year, we set our sights on two underperforming stores in the portfolio, with 2013 lease expirations. One location will be redeveloped with multiple non-grocery national retailers, completely transforming that center.

The second location is anticipated to be released to a well-established Chicago based grocer. We are also encouraged that Super Value is taking steps to reinvigorate their operating platform of the various brands.

An example of this renewed focus on fundamental operations, is Super Values recently initiated fair price plus pricing structure. This program is designed to drive consumer traffic and restore customer loyalty, by highlighting more competitive pricing in conjunction with the virtues of the individual brands.

Cub Foods, true to its roots as a discount grocer, has long had this operating philosophy at its core. The Jewel-Osco banner is the first of the Super Value traditional grocers, to have officially launched this new repositioning effort.

As Super Value explores strategic alternatives for the company, we believe Jewel-Osco and Cub Foods represents two of the most valuable operating entities that Super Value owns. We therefore expect these brands to maintain their value and relevance as grocery operators in the Chicago and Twin City’s market.

Overall, retailers remain focused on their businesses, and the macroeconomic headlines are not effecting their expansion plans. To the contrary, with the lack of new supply, the retailer trend of right-sizing, a desire to grow store account, and new market entrance, the demand for well-established retail locations continues to increase.

Our portfolio is well-positioned to capitalize on these trends, and we are working today with financially stable tenants to grow their platforms, and in turn, we connectivity to improve both the retail quality and the credit quality of our tenant base.

With that, I’ll turn it over to Brett.

Brett Brown

Thanks, Scott, and good afternoon everyone. At more than half way through the fiscal year we’re on track to achieve our balance sheet objectives for the year. These objectives, which are a part of our long-term capital plan are one to reduce the cost of our secured and unsecured debt. Two, extend and rebalance our debt maturity profile. And three, source well priced capital for accretive investments.

Since the close of the first quarter, we’ve secured commitments from the banks participating in our amended consolidated unsecured credit facility, we’ve reduced our unconsolidated joint venture debt by nearly $20 million, and we refinanced or closed new loans on three consolidated properties and five unconsolidated properties.

In line with our efforts to further strengthen our financial position, we’ve been working with our bank group to amend our existing credit facility agreement. As of last week, the banks were fully committed on the deal, or fully committed and the deals oversubscribed, and subject to the standard closing conditions, including documentation.

We plan to finalize the amended agreement in the coming weeks, and we expect the terms of the amended agreements to include improved pricing, extended maturity dates, and increase capacity under the facility.

As of today, we have up to $70 million available on the existing line of credit facility.

Turning to secure debt financing activity, on behave of the joint venture with North American Real Estate, we negotiated a discounted payoff of the construction loan on the North Aurora Towne Center, previously unconsolidated development joint venture project.

We paid $10 million to the lender to repay the $30.5 million outstanding mortgage, resulting in a gain on extinguishment of debt of $20.5 million, in addition to reducing unconsolidated debt by more than $20 million. We have reduced our cost basis in the project, with this discounted payoff.

The North Aurora Towne Center development is a shadow anchored by operating national retailers, including Target, JC Penny and Michaels, among others. Our development currently includes a Best Buy and two completed multi-tenant buildings, one of which is well leased, and one that is vacant. And the remainder of the land is pad ready.

We are confident that there will be opportunities in the future to recover more of our investment in the property.

During the quarter, we refinanced for our joint venture with New York State Teachers, the Woodfield Commons Retail Property in Schaumburg, Illinois with a loan of $17.5 million, and a fixed rate of 4.75%, and the Cobbler Crossing Shopping Center in Elgin, Illinois, with the loan of $6.4 million and a fixed rate of 4.6%. And both of those were for seven year terms.

In addition, on behalf of the joint venture with IPCC, we closed a $5.9 million loan with a fixed rate of 5.25% on the property of Pick ‘n Save in Sheboygan, Wisconsin.

Of note, we continue to reduce our total weighted average interest rate with each quarter, as well as increase our weighted average term of our debt.

I’d like to take a few minutes to address the status of the loans on our Algonquin Common Shopping Center, in Algonquin, Illinois. As background, in July of 2010, we entered in to a loan modification agreement with a special servicer of the loan, on one phase of Algonquin Commons. The loan modification changed the monthly payments on the loan from principal and interest, to interest only for a period of two years, expiring July 1, 2012.

This modification was done to reduce the cash required to service the debt, and redeploy the capital to partially fund the cost of new leases signed during the past two years. However, due to on-going vacancies and certain co-tenancy issues, the property is not generating sufficient cash flow to resume paying both principal and interest payments on the outstanding debt.

The total outstanding balance of the debt on both phases of the property is $90.2 million, of which $71.6 million is non-recourse, and $18.6 million has been guaranteed by the company. In an effort to expedite discussions with a special servicer, we engaged an advisor regarding a plan of action and to represent us.

On June 1, we stopped payment of monthly debt service on the loans of both phases of the center, as they are cross-collateralized. And in May and June, the Master Servicer requested and was provided property level data for their internal analyst.

Master Servicer notified us on June 20, that both loans were transferred to the Special Servicer, then July 3, the Special Servicer contacted us to provide a point-of-contact for the loans, while they’re with the Special Servicer.

We’re currently in discussions with the servicer – Special Servicer, and hope to arrive at a modification of loan terms the property’s income can support. As of today, we have not concluded our discussions with the lender, and therefore we cannot estimate what the impact of the consolidated financial statements will be, at the time a final agreement is reached.

Moving on to maturities, at June 30, we had only $61 million of consolidated secure debt maturing for the remainder of 2012. And as of today, only $50 million remains, as we recently closed two refinancings. And only one $15 million secured loan matures in 2013. So in total, our remaining 2012 and 2013 consolidated maturities represent 9% of our total consolidated debt outstanding.

At quarter end, our debt to total market capitalization rate was 54.2%, which compares favorably to 56.2% at the end of the second quarter of 2011. Our capital plan goal is to achieve a debt to market capital rate closer to 50% through stock price appreciation, and directing a portion of future equity raises toward deleveraging.

For the quarter, our interest expense coverage ratio was 2.8 times compared to 2.7 times last quarter, and 2.4 times for the second quarter of 2011. Our fixed charge coverage ratio was 2.1 times, and that’s consistent with the prior quarter as well as the year ago quarter, even with the issuance of $110 million of preferred stock. These ratios continue to improve with gains and operations and lower interest expense.

Our total net debt to total EBITDA ratio was 7.3 times, compared to 8 times for both the prior quarter and the year ago quarter.

As a reminder, last quarter our debt to EBITDA ratio was impacted by increased debt related to the large number of acquisitions completed at the end of the first quarter. As expected, this ratio improved for the second quarter, as the corresponding income from those new acquisitions was recorded, and due to improvements in overall portfolio performance.

Now let’s turn to the income statement. For the quarter, total revenue decrease by $1.5 million from the second quarter of 2011. This was primarily due to a decrease of $1 million in rental income, related to the contribution of consolidated properties to the PGGM joint venture, which was partially offset by income from new acquisitions.

Fee income from unconsolidated joint ventures decreased by $300,000 compared to the second quarter of 2011, due in most part to the timing of acquisition fee income from the IPCC joint venture. And as I’ve mentioned on prior calls, we expect the majority of acquisition fee income, from assets purchased by the IPCC venture in March, to be weighted toward the second half of this year.

Lower acquisition fee income for the quarter was partially offset by a higher asset and property management related fee income. And this was due to additional properties under management, through the PGGM and IPCC joint ventures.

And its worth noting that asset and property management related fee income from our joint ventures was NYSTRS, PGGM , and IPCC, increased by $322,000 or more than 58% over the second quarter of 2011.

Turning to expenses for the quarter. Total operating expenses decrease by $4.4 million due to the contribution of consolidated assets to the PGGM joint venture and a decrease of $976,000 in bad debt expense, as well as the impact of a prior year – in the prior year of $5.2 million of asset impairment charges, related to the North Aurora Towne Center Development Project.

A decrease in total operating expense was partially offset by an increase of $1.1 million in depreciation and amortization expense, related to new acquisitions, and the write-off of tenant improvements as a result of early lease terminations.

General and administrative expenses increased over the prior year due primarily to marginal increase in headcount, and increase acquisition cost expense, from more properties purchased this year compared to last year. And I expect the second half to be slightly lower than the first half for 2012.

Interest expense for the quarter decreased by $1.7 million over the year ago quarter, due to the repurchase of our 4.58% convertible notes during 2011, favorable rate changes on our debt and the contribution of consolidated properties to the joint venture with PGGM.

For the quarter, we recorded a net gain from changing control of investment properties related to the North Aurora Towne Center development joint venture project. As I discussed earlier, the company negotiated the discounted payoff of the debt on the North Aurora Towne Center Development, and recorded a gain on the extinguishment of debt of $20.5 million, which was included in gain from changing control in investment properties on the income statement.

In conjunction with the discounted payoff of debt, the company consolidated the property that was previously owned through our joint venture with North American Real Estate, and recorded a loss from change of control of investment properties of $19.5 million to record the property at fair value.

To reflect the net impact of these two items, we recorded a gain on changing control of investment properties of approximately $1 million.

Turning to FFO, on a per-share basis, we recorded FFO adjusted of $0.22 compared to $0.20 for the second quarter of 2011. And this result was in line with our expectations and beat analyst consensus estimates for the quarter./

And finally, focusing on guidance for 2012, we continue to expect adjusted FFO for common share to ranch from $0.84 to $0.89. Consolidated, same-store NOI to increase between 1 and 3%, and average total portfolio financial occupancy to range from 90 to 91%.

And now I’ll turn the call back over to Mark.

Mark Zalatoris

Thanks, Bret. Our position of strength today is the result of effective tactics to revitalize a portfolio, executing on a long-term capital plan, and taking steps towards growth. We’re working from the advantage of a competitively strong foundation. That foundation, our original vision, is a portfolio of assets focused on value and necessity, with in an established west markets.

This particular emphasis on retail is important within the new reality, of more conservative [inaudible] spending by consumers. We booster that foundation by establishing a dominate presence in our primary markets, leasing to healthy in-demand retailers, and extending our footprint in equal resilient secondary markets.

The fruits of these efforts are being realized in consistent gains in same-store NOI, financial occupancy and rent spreads. With regard to the balance sheet, we’re on track to complete our objectives for the year, as part of an intrigue and long-term capital plan.

And finally, with the acquisition to date this year, of approximately $165 million of assets comprising 700,000 square feet of GLA, we are making measurable progress on our growth strategy.

We appreciate your time on today’s call, your interest in the company. At this point, we’d be happy to take your questions. Operator.

Question-and-Answer Session


(Operator instructions). And the first question we have comes from Todd Thomas of KeyBanc Capital Partners, please go ahead.

Todd Thomas – KeyBanc Capital Markets

Hi, good afternoon. Hi, I was just wondering, you know, with regards to Supervalu, and you comments on sort of how you think about your exposure given that your stores are primarily Cub Foods, and Jewel Stores with higher market share, do you think that say that either Cub or Jewel could result in store closures as you look at the gross or landscape in Chicago, Minneapolis?

Scott Carr

Todd, this is Scott, you know, as we assess the portfolio, I guess to address it on, you know, the two different funds, first being Cub foods in Minneapolis, we look, ultimately, to the location, and our stores are, you know, more modern, state of the art stores, they are in good, strong, locations, and more importantly, every indication that they are very strong sales performance. So, we think there’s inherent value to those stores in an operating portfolio for any grocery operator – likewise is with Jewel here in Chicago. A lot of our Jewel locations are in very dense, in fell areas with very high barriers to entry, and again with their inconsistency in sales performance, where we’re marking, you know, $500 per square foot as an average on our stores, so some are higher, some are lower than that number. We think that they are operating value is strong, and as I mentioned, the two that were weaker, we’ve already identified those will not be renewed in 2013, and we’re working at our [inaudible] potential, and one of those who is going to remain a grocery. So, ultimately, we look at the components of Supervalu, and perhaps their value is greater as the sum of the parts, and we look at the parts that we own, being Cub and Jewel, and feel that those are the most valuable that – you know, looking at Jewel, alone, it contributes 28% of Supervalu’s EBIDA. So, we think there is a considerable value there, as well as the fact that Jewel owns approximately two-thirds of their real estate that they occupy. So, we think ultimately this will play out by someone seeing value in the operating frans.

Todd Thomas – KeyBanc Capital Markets

Okay, and then, I think – so, if I heard you right, 10 of the 20 Supervalu stores report sales in those 10 average $500 a square foot?

Scott Carr

That’s correct.

Todd Thomas – KeyBanc Capital Markets

Right, okay, so – and how does that compare to the other grocers in your portfolio that the Dominic’s round these, and I guess Kroger.

Scott Carr

We generally see the Dominic’s doing a tick below that in the mid 300’s, and the [inaudible] generally do kind of in between approaching, you know, mid 400’s to 500. And Kroger, we – our exposure to Kroger is the food [inaudible] banner, which is their new account for them, and those are running about $400 a foot, they have three of those.

Todd Thomas – KeyBanc Capital Markets

All right, great, that’s helpful. And then in terms of acquisition, it sounded like you were planning to acquire properties outside of Chicago and Minneapolis, and really try to create, you know, sort of a similar critical mass that you have in those two markets. Am I reading that right, and if so, what kind of time frame are you expecting that may take, you know, to build a critical mass in a new market, and what markets have you identified?

Mark Zalatoris

Well, let me start, Todd, this is Mark - and you know, what we did already so far this year is kind of expand within our Midwest geographic territory by buying a couple of properties in the Cincinnati area, and adding a very large class A asset into Cleveland suburbs – we already own a couple of shopping centers in the Cleveland suburban markets, so, you know, we’d like to continue to expand in those somewhat secondary markets of the Midwest where, again, if we’re buying the class A assets in very sore demographics to what we have here in Chicago and Minneapolis, dense in full areas with good incomes, but slightly overlooked by, you know, the national peers that we compare ourselves to. The pricing seems to be, you know, a bit better, and yields are better, and clearly our institutional partner believes in that strategy as well. So, that is going to be a focus for us, and we’ll build – continue to build, you know, a critical mass in those areas. If you’re more less referencing are we going to go outside the Midwest footprint into new areas and build a critical mass, that’s something that’s down the road, and I think we’re always examining opportunities for that, but it’s not going to come from a single – purchase from a single center, and then add a single center, you know, a few months later, and then six months later another one – it’s going to be more of a portfolio type of transaction then they come from a private developer, owner, et cetera. And we’re constantly exploring those opportunities, but we just haven’t come upon the right one at this point.

Todd Thomas – KeyBanc Capital Markets

Okay, and so when you think about pricing in some of those Midwest markets relative to, you know, Chicago, you know, what is that spread today, and you know, have you seen a narrowing of that spread at all in recent months?

Scott Carr

This is Scott, generally, we are seeing 50 to 100 basis points spread as we go into these markets – you know, here in Chicago, we’re seeing class A properties trade in the low sevens to high sixes and we are going into the Cincinnati and Cleveland market and seeing properties trade, you know, in the mid sevens to high sevens. We have seen a little bit more of interest in properties in those markets from other institutional type buyers, but again, you know, right now the spread seems to be holding, and we think that’s a justifiable spread to go into these markers. We’re not talking about, you know, vast open green field, we’re talking about trade areas that have the demographic profile very similar to where we own assets today, and these are still in the top, you know, 40 or 50 markets in the country, their just not, you know, the number two or three gateway cities that a lot of people seem to be focused on today.


The next question we have comes from Jeff Donnelly of Wells Fargo.

Jeffrey Donnelly – Wells Fargo

Good afternoon guys. Scott, thanks for the color on Supervalu, that was great – you know, just maybe to ask some of the questions a little different – you know, I presume that you have your own guesses as to which of your sights might have more risk of closure in the event that there were some – somewhat of a severe scenario – I don’t expect you to identify them, but in those instances, you know, how do you think about the rents versus market, and maybe even co-tenancy clauses?

Scott Carr

This is Scott, Jeff. For the most part, our rent levels, especially in the Jewel portfolio, either stores that have been in existence for a while, and the rent levels are, a lot of them, still in the single digits. So, there’s some potential to market in that scenario, and you know, we feel confident in being able to replicate, or improve the income in almost all of the Supervalu sites, both Cub and Jewel.

Jeffrey Donnelly – Wells Fargo

Are there any sites that are, you know, I guess I would say, some of them in your ownership that are maybe about too close to an existing Supervalu concept, so that there’s opportunity for you, or a risk for you in the event that someone might look to consolidate store count given market?

Scott Carr

You know, as we look at the potential players who would want to do that, you know, I don’t think there’s an existing player in Chicago who’s going to look to take over a great number of the Supervalu sites. I think it’s going to be driven by some, you know, out of town ownership, that [inaudible] measure capital driven, or another grocery operator driven. So, I think the likelihood of overlap with any exiting grocery players is minimal.

Jeffrey Donnelly – Wells Fargo

You know, I guess when you flip it around, do you think there is going to be any opportunities in your target markets, like Chicago or Minneapolis, where, you know, Supervalu’s departure can actually create something of a redevelopment opportunity, and you know, maybe even something that you know of today, or you kind of hope for today, and it could be something of an acquisition opportunity for you, or are those just kind of few and far between?

Scott Carr

No, that’s definitely front of mind to us, both within our existing assets as well as, you know, some of those Jewel owned assets. Jewel owns, like I said, two-thirds of their real estate, and a lot of that real estate can be very valuable [inaudible] they’re another grocery user, or you know, broader retail development, and it would definitely be an opportunity that, you know, we would explore with any kind of new owner, or [inaudible].

Jeffrey Donnelly – Wells Fargo

And I don’t want to leave others out, I – just a question about occupancy during the quarter, maybe you could just explain to me a little bit more clearly is- your financial occupancy was up about 120 to 150 basis points, you know, same store and for total portfolio wide, but the lease rate was down about 180 basis points because of the lease expirations and terminations. I guess what’s going on there ultimately underneath – so, is it sort of the inclusion of lease termination fee income that’s maybe setting those numbers in different directions, or – I was just trying to think about how that may be working.

Scott Carr

Yes, the lease to occupancy has been impacted by, particular, big box vacancies, one being the Cub Food that we terminated in Indianapolis, it’s about a 76,000 square foot vacancy that is currently under contract to sell, but then also we have a property in Lancing, Illinois, where we have close to 150,000 square feet of vacant space, a portion of which we’ve been holding vacant pending a new opportunity, and 100,000 plus which came back vacant to use at the later part of last year with the expiration of an in place Sam’s Club lease. We’re currently negotiating under contract to sell that as well. So, I think once we move that vacant space out of inventory, we will have a little bit more of equilibrium there, at least, occupancy would improve not the basis of just removing that vacant space from the denominator.

Jeffrey Donnelly – Wells Fargo

Okay, and final question, I’ll yield the floor to someone else, is – what’s your attitude – you know, you have some change in the composition of your debt right now, a big chunk of it is variable rate, I know – or voting rate. I know much about it in your line, but at this point where interest rates are, do you look to maybe term up more of your debt, or fix rate, or had your [inaudible] exposure a little bit?

Brett Brown

Hey, Jeff, it’s Brett. We explore that all the time, and really clearly where the floating rates are so low, and the expectation of any increases I believe are going to be [inaudible] over time as, you know, the other fed is indicated the holding rate’s low for again the continued period of time. I think really have to increase substantially, and I just think right now, where we are, it’s very favorable – I mean, we always review, and it’s possible, you know, that it might be more favorable to fixing some of that variable rate, defiantly right now we are quite comfortable with…


Next we have Josh (inaudible) – BMO Capital Markets.

Josh (Potakin) – BMO Capital Markets

Hi, Good Afternoon. Looking at – there’s been some buzz here about Safeway’s new app “Just for you”, and how it’s changing shopping patterns. Do you have a view point on that with

Dominick’s and how it might affect your business?

Scott Carr

You know Dominick’s has been incorporating that into their platform, and again we think anything that can drive consumer loyalty to a brand, is a positive. So, you know, it’s something that when we look at our retailers who are incorporating these new platforms and digital media into their operations, we think it’s a net-positive.

Josh (Potakin) – BMO Capital Markets

Is it some game in your opinion, in other words Dominick’s just steal market shares from Jewel?

Scott Carr

Well, ultimately most people do view the grocery potential in any given market, as a fixed amount and it does get spread around to the various players, and each operator has a competitive platform which they’re trying to take a piece of those sales. So, I would expect in any competitive environment, that each operator would adjust their program to try to maintain gain, and keep that market share in place.

Josh (Potakin) – BMO Capital Markets

Okay, thanks. And on the tertiary markets or the secondary markets that you’re looking at, would you consider doing any amount of portfolio deals there, or across different markets, more portfolio?

Mark Zalatoris

Josh, it’s Mark Zalatoris. Yes, we would, we would always consider a portfolio acquisition that made sense to us and particularly in markets we’ve already targeted, and we already have a presence. And if it included, you know, a couple assets spread out a little but close to those target markets, we would not shy away from that.

Josh (Potakin) – BMO Capital Markets

How do you feel about public-to-public M&A at this point in the cycle?

Mark Zalatoris

As an acquirer? You know I haven’t seen much activity recently, and maybe stock prices being where they’re at is one of the things holding back some companies. We’re always looking at any opportunity that makes sense for us, let’s put it that way.

Josh (Potakin) – BMO Capital Markets

Okay great, thanks guys.

Mark Zalatoris

Thank you.


Next we have (inaudible) – Macquarie

(inaudible) – Macquarie

Thanks. For the tenant (inaudible) or is that (inaudible) fails for Jewel’s. Where would you guess, that sales volume to be at?

Scott Carr

(inaudible) it’s Scott. You know from our conversations with the people at Supervalu, you know, we’ve been told that our stores are performing well, they’re in the upper percentiles. And I think that’s evidenced by those that are not, are the three that we’re pursuing (retenating) options on, and have terminated our renewing leases. So, I think our stores are definitely the top percentiles of performers.

(inaudible) – Macquarie

Scott, if I heard you right, you said (inaudible) the stores that aren’t reporting, three are the ones you’re redoing leases on? Is that right?

Scott Carr

We took back one store, we did an early lease termination, and then we have two stores that were weaker sales that are expiring in 2013, and we are not renewing those leases with Jewel, and we’re pursuing other opportunities. One will be a redevelopment to non-grocery. And the other will be replacement with a grocer.

(inaudible) – Macquarie

Okay, and on average are Jewel’s and multi Big Box format power centers, or there are other anchors that could maybe pick up some of the slack, or how many of them are grocery anchor centers (inaudible) two anchors?

Scott Carr

I would say, our operating stores of the total of 20, about a third of those are in multi-anchored centers. The rest are more traditional grocery anchor type centers.

(inaudible) – Macquarie

Okay. And just for my own education, in your co-tenancy clauses, especially the ones where maybe Jewel is the only one, or two anchor in that center. If you had theoretical ramp, you know, of $20.00, where would that fall to if the anchor left?

Scott Carr

It’s difficult to put an exact number on that. Co-tenancy clauses vary, and they’re a negotiated item in each leaf. So, I really can’t put a number on that without really digging into things a little deeper.

(inaudible) – Macquarie

Okay, that’s fine. So just given that you do have some kind, some risk on the horizon with – you’re not sure how many more might come back to you with the Jewel anchor centers, and given that you’re overpaying a dividend (inaudible) you know, relative to your FAD. Why not think about cutting your dividend right sizing it early on to maybe save some capital for, you know, redevelopment funds, or tenant allowances that you eventually will have to meet?

Mark Zalatoris

(inaudible) it’s Mark. You know, I think that actually we will have a pretty healthy spread of cash flow available to us in case that happens. Our spend on tenant improvements, is down significantly this year over the past couple of years, and I expect that trend to continue, because we’ve accomplished all of our Big Box leasing that we had from the vacancies during the downturn of a few years ago. So, we’re in a position now, where we got some significant cash flow I think available to us. I don’t really see a reason to cut the dividend any further at this point.

(inaudible) – Macquarie

Okay. And my last question. On your JV extension with NYSTARS, is there any change to the few structures or what kind of pricing are they looking for, for (inaudible) that you’re going to buy. And I might have missed this, but was there a increase in the overall fund size?

Mark Zalatoris

No. This is Mark again. What we did is just did a straight up extension with no change in the fee structure. We’ve not really talked – unlike the PPGM venture where there was a commitment of additional dollars to be invested, there’s not commitment at this point on the table for additional dollars. But consider properties that make sense and we talked to them about, but there’s no obligation to bring them properties either at this point.

What we are kind of considering, and it’s a possibility. Is, they may want to upside their investment in existing portfolio. Right not it’s a 50/50 venture. And it may be an opportunity for them to increase their investment in existing portfolio to a higher percentage than 50%.

(inaudible) – Macquarie

And how would you determine if they did that, on the pricing, would it be a pace base or is there a contractual rate already?

Mark Zalatoris

It’s not a contractual rate, it’s more or less negotiated thing based upon market pricing, today’s income in place, or anticipated next year’s income. And looking at market pricing, market cap rates, so it’s something that we’ve had some discussions about, no definitive talks, but there’s acknowledgment at least that it would have to be based on current conditions, both in the market and in the portfolio.

(inaudible) – Macquarie

Okay, thanks for all the collar.


Next we have Toyo Okusanya – Jeffries.

Toyo Okusanya – Jeffries

Yes, Good Afternoon. A couple of questions. When I take a look at the lease occupancy, which is the financial occupancy (inaudible) the gap has been closing, but it’s still at the level of 150 basis points. Could you talk a little bit more about, you know, how much more that gap can close over the next six to twelve months?

Scott Carr

Hi, Toyo this is Scott. Yes it is – I mean this is a (inaudible) plan improvement from the over 400 basis points that it was at this point last year. And as the new space comes online, we look for kind of normalizing in a historical spread, which is about 150 to 200 basis points. So, we’re pretty close to where we think, you know it would normalize out. Our objective would be to raise both numbers, both lease occupancy and financial occupancy, and look for that spread to run, you know, at that 150 to 200 basis point.

Toyo Okusanya – Jeffries

Okay, thanks, that’s very helpful. Then the second thing, small shops I know it’s about a quarter of all your leasing this quarter. Just curious whether that kind of true mom & pop pizza type stores, or one that was really more national retailer, that were making up a majority of that leasing?

Scott Carr

You know, it’s fairly evenly spread. We’re seeing, I would say about 50/50 between nationals and mom & pop’s. The mom & pop’s includes some of the franchise concepts like a Jimmy John’s or Subway or a (Inaudible). But you know one of the encouraging trends, you know, in addition to the likes of Chipotle and Noodles, which are the great national names we like. We’re seeing new business formation from mom & pop tenants a lot of whom have an existing store and are looking to open additional locations. So there’s some financing available, there’s some confidence available, and the leasing activity in that segment of that portfolio still remains strong. And it’s important to note too, that when we look at space below 10,000 square feet, that includes the apparel players in that 5 to 6,000 square foot range who’ve also become very active this year. You know bolstering out business rather nicely.

Toyo Okusanya – Jeffries

Got it. Okay last question. Kind of ex-Supervalu, can you talk a little bit more about the rest of your watch list and if anything has changed there, particularly Best Buy, that has kind of put out some incremental bad news since last quarter?

Scott Carr

Yes, you know Best Buy is definitely one of those retailers with whom we are keeping in constant touch. We have six stores in our portfolio, and you know, per our most recent conversations, all of them are in the size range they want to be in the exception of one, where we are negotiating a downsize. And performance wise, they’re doing well.

Other than our watch list, you know obviously Barnes and Nobles is an exposure that we’re cognizant of. We have three of those locations. We’re very active in speaking with the office players, meaning; Office Depot, Office Max and Staples. There’s some opportunity to perhaps right size and relocate some of those stores, freeing up larger boxes for you know the likes of Ross and other players like that. So, we’re active doing that. On the smaller end Radio Shack is one that we’re looking at, that’s almost like a Blockbuster, we’ve been waiting for them to go out of business for many many years but the keep reincarnating. And those again are small stores. We actually have been trying to wait a few out, with that option, because they’re at lower rents and we think we could do better, so. Right now, those are probable the top of mine, outside of the major.

Toyo Okusanya – Jeffries

All right, thank you very much. Congrats on a great quarter.


Next we have Todd Thomas, KeyBanc Capital Partners.

Todd Thomas – KeyBanc Capital Markets

Yeah, hi. Just a follow up. You mentioned some of the non-core dispositions, you completed a handful of the in the quarter and it sounds like you have a few more teed off, the Cubs Foods you mentioned in Indianapolis and then the Sam’s Club, Boxes also potentially, you know, for sale. How active do you plan to be with non-core dispositions and what kind of proceeds are you targeting and are there any sales embedded in guidance?

Scott Carr

Todd, this is Scott. Year to date the sales we’ve closed have been smaller, you know, non-strategic assets and they’ve generated about $7.7 million in proceeds, gross proceeds. Pending right now with the Cub, which is under contract, that’s a little under $2 million and then we have another $10 million in properties that we’re negotiating contracts right now. I would look for us to ramp up disposition a little bit as we go into the latter part of this year and into 2013. Part of our objective has been to get some of these properties stabilized and in condition to get the best value when we go to sell them and a lot of them are reaching that point. You know, in terms of dollar amounts, we haven’t concluded what that business and portfolio may ultimately be but also in terms of guidance, I think it’s well within our current guidance range, the activity we have, you know, completed and have in the works.

Todd Thomas – KeyBanc Capital Markets

Okay, and so just a follow up on that then, it sounds like, you know, you may have $10 million or so of proceeds coming your way with some things that, you know, are either under contract or you’re negotiating. You have availability on the line, but how should we sort of think about funding acquisitions with PGGM going forward and anything, you know, for Inland’s balance sheet going forward?

Unidentified Company Representative

Hey, Todd, it’s Fred. We would – as mark mentioned, on the – for PGGM, we have the one property [inaudible], which we would likely sell then to the venture. That would give us a substantial portion of capital then we would use to co-invest going forward as well then, we do have, as you mentioned, some availability on the line and as far as what we have projected for the current year, there’s plenty of capacity under the facilities to handle that.

Todd Thomas – KeyBanc Capital Markets

Okay, thank you.

Mark Zalatoris

You’re welcome.


We’ll go next to Kebin Kim – Macquare.

(Kebin Kem) - Macquarie

Thanks. A couple of quick follow ups. The Four Flags contribution, can you talk about what cap rate did that – that’s supposed to be one of your – I would guess your higher-quality assets right now?

Mark Zalatoris

That is correct. It was when we negotiated this venture with PGGM, that was back in early 2010 and we signed that up in – I think it was July 1st of 2010. So we negotiated a cap rate at that time on all of the assets that were contributed and that was at an 8% cap rate for all of those contributions. Now, that was negotiated because of the time rather than contribute all the assets at once up front, some for the dilution initially, we were able to offset, you know, the higher cap rate with contributing assets on a piecemeal basis when acquisitions became available to not endure any of the dilution there.

Scott Carr

And this is Scott, it’s also important to keep in mind, you know, the 8% cap rate for the PGGM contributions represents an aggregate of the portfolio that was provided. It did consist of, you know, some of our best assets but it also included some B, lower-tier assets, non-national anchored assets. So the 8% end on the whole portfolio is really a blend of a strata of quality that came out to an 8% cap rate as well as Four Flags was one that we contributed purposely last as we wanted the opportunity to maximize the value through our releasing strategy there. I mean, that was a property that’s been almost completely retenanted and we really did get in at maximum value.

(Kebin Kem) - Macquarie

I mean, I get it, it was a tough time, so 8%, you wouldn’t do that today, but it was what it was I guess. Now, when you extended the PGGM joint venture, did you change that 8% contribution cap rate to something more market – closer to market?

Mark Zalatoris

There’s no contributed assets for phase two. It’s just…

(Kebin Kem) - Macquarie

Oh, that’s right, that’s right. You’re going to buy it third party. Okay. And just last question, if you could kind of quickly just comment on what’s going on with the small shops in the Chicago/Minneapolis market? It looks like your small-shop occupancy improved a little bit in the – from last quarter, I was wondering if you’re going to start any programs or if there is any kind of signs of additional growth there?

Scott Carr

Hi, it’s Scott again. Yeah, our small shop portfolio occupancy’s, you know, approaching 87%, which is very strong. You know, that’s restored itself by a good 5 – 5 basis points – 500 basis points from the low turn of the economy. We’re encourage by the stability we’re seeing in the existing base of small shop tenants and I think that’s reflected in our tenant retention rate with renewals, our retention rate is up at 82% and that’s a nice uptick, you know, closer again to our historical run rate as compared to what we saw during the downturn. And again, we’re encouraged by the momentum we’re seeing in, you know, new business formation, so we’re looking for the stability to maintain and we think we have a bit more room to grow our small shop occupancy. And again, you know, that includes the players under 10,000 square feet, beyond the mom and pops, and we’re seeing encouraging activity across the board.

(Kebin Kem) - Macquarie

What was it at your peak?

Scott Carr

At our peak, we were about 88% on small shop occupancies. So we’re very much back to what used to be the normal.

(Kebin Kem) - Macquarie

Okay, thank you, guys.

Mark Zalatoris



That will conclude our question-and-answer session for today. I would now like to turn the conference back over to Mr. Mark Zalatoris for any closing remarks. Sir?

Mark Zalatoris

Thank you. I thought I would close out today’s call with a few remarks about one of the retail world’s more important seasons of the year, the back-to-school sale period that is happening right now. Two recent studies, one from Deloitte and the other from the National Retail Federation, both indicate that consumers are planning to increase their spending on back-to-school shopping this year compared to the past couple of years. In fact, the National Retail Federation study indicates that the average family with children in school will shell out about $688 this year, a 14% increase from last year. As the parent of a high school graduate going off to college this month, I can only concur with the study and wish that my average spend was only $688 and applaud those best-in-class retailers like Bed Bath and Beyond, that not only aggressively promote this period but assist in the process by encouraging shopping in your hometown store and arranging pickup in the store closest to the school or by providing free shipping directly to the student’s new campus address. There certainly is a reason why some retailers like Bed Bath and Beyond are flourishing and expanding and we look forward to continue new store leasing with them.

Thank you for joining us today. We hope you enjoy the rest of our summer and look forward to meeting with some of you at the BMO and Bank of America Real Estate Conferences next month.

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