Centerspace (CSR) 2010 Q2 法說會逐字稿

Hello and welcome to the Investors Real Estate Trust second quarter fiscal 2010 earnings Conference Call.

(Operator Instructions)

I would now like to turn the call over to Michelle Saari. Please go ahead.

Good morning, and welcome to Investors Real Estate Trust second quarter fiscal 2010 earnings conference call. IRET's quarterly report on Form 10-Q for the quarter was filed yesterday, December 10th, and our earnings release and supplemental disclosure package were posted to our website, and also furnished on Form 8-K yesterday as well. In the 10-Q earnings release and supplemental disclosure package, Investors Real Estate Trust has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures, in accordance with the requirement set forth in Regulation G. If you have not received a copy, these documents are available on IRET's website at www.iret.com in the Investor Relations section. Additionally a webcast and transcript of this call will be archived on the IRET website for one year.

At this time, management would like to inform you that certain statements made during this call which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Investors Real Estate Trust believes the expectations reflected in the forward-looking statements are based on reasonable assumptions, Investors Real Estate Trust can give no assurance that its expectations will be achieved. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements are detailed in Thursday's earnings release, and from time to time in Investors Real Estate Trust's filings with the SEC. Investors Real Estate Trust does not undertake a duty to update any forward-looking statements. With me today from management are Tim Mihalick, President and Chief Executive Officer, Diane Bryantt, Senior Vice President and Chief Financial Officer, and Tom Wentz, Senior Vice President and Chief Operating Officer. At this time, I would like to turn the call over to Tim Mihalick for his opening remarks.

Thank you, Michelle, and good morning. It is my pleasure to speak to you this morning in my new role as President and CEO of Investors Real Estate Trust. This past June, I completed my 28th year with IRET, and have served in various capacities with the Company. I have been lucky enough to have been part of a culture here at IRET that is focused on our mission statement, which is creating shareholder value. That statement has been and will continue to be at the heart of all that IRET stands for. This morning, I will give you an update on a strategic plan that was put into place earlier this year, which we believe allows us to build on the solid foundation that IRET has established over the last 39 years. I will then ask our CFO, Diane Bryantt to discuss this past quarter's financial results, and our COO, Tom Wentz, to discuss operations, debt issues and market conditions.

The first of our major goals, which we have talked about repeatedly, is to internalize property management. I'm happy to report that on the commercial side of our portfolio, we expect that by the end of IRET's second quarter of fiscal year 2011, we should have that task substantially complete. On the residential side of our portfolio, we expect to have approximately 75% of our portfolio in house by the end of IRET's first quarter of fiscal year 2011. As we have stated in the past, we have modeled this transition to have a neutral effect on our income statement but do believe that by gaining control of the day-to-day activities at our properties we will be able to enhance property performance.

Goal two is to make better use of IRET's personnel as we internalize our property management division and move IRET into a fully operating real estate company. We currently have those people in place and on the payroll but feel that by using best in industry practices and procedures, we can create more synergies throughout the organization. This will allow IRET to take advantage of the local knowledge in the markets we do business in, by having a more defined presence on the ground in which we currently manage through third party contacts.

Goal three is to stay focused on the underlying acquisition fundamentals that IRET was built on. We have developed a plan to grow IRET profitably over the next five years by using a combination of investment and acquisition strategies designed to deliver stable income and reasonable asset valuation growth. This will allow us to stay consistent with our mission statement as I mentioned earlier. We also intend to look to make acquisitions in the Upper Midwestern part of the US, as those are Markets we currently do own property in and that we understand quite well. Some of the states we do business in were recently mentioned in an AP article regarding the analysis of economic stress to states, and of the states mention with the least amount of stress, North Dakota, South Dakota, Montana, Nebraska and Vermont, we do business in all but Vermont. Unfortunately, that does not mean we are not seeing states -- stress in some of our markets, and Tom will touch on that later in his call.

The last of our major goals is concerned with our capital structure. As we have in the past, we intend to use our operating program as a tool to acquire properties by offering the contributor the tax advantage benefits of IRET's current REIT and up REIT structure. Also, we intend to take advantage of the traditional methods of raising capital as evidenced by the recent offering we completed in early October. Although we have yet to deploy that capital, we have identified acquisitions that are discussed in the recently filed 10-Q that we will-- that we expect will put that money to work soon. And finally, a couple of questions that I'm asked quite frequently are 1), are you seeing distressed buying opportunities in your market and 2), what is the status of your dividend? As for the answer to question one, we have not yet seen an overwhelming amount of distressed buying opportunity in our Markets.

At this point, we continue to explore all of our contacts, whether as a broker, a lender, or an owner trying to keep our finger on the pulse of potential acquisitions. I do believe we will see buying opportunities and will continue to search them out. As for the status of our dividend, at this point, we are committed to continue the dividend history we have established. But as Dianne and Tom will touch on, we are seeing our operating results soften somewhat, no precipitous declines, just an overall slow grind. If this continues for an extended period of time we will have to reexamine whether operating numbers could continue to sustain our current level of our dividend. With that, I will now ask Dianne to review our second quarter financial results.

Thank you, Tim. This morning, I will highlight the most significant areas of financial results of operations, for both the quarter and six months ending October 31, 2009. The most significant financial items for discussion this quarter are real estate revenues for the quarter remain relatively flat at $59.6 million. Even though we are seeing decreases in our occupancy, most notably in our multi-family segment, rents from newly acquired properties are covering the increased vacancy lots. Total Real Estate expenses increased 2.1% to $24.5 million from $24 million. This resulting in a small net increase in net operating income from our Real Estate portfolio; however, this small increase in net operating income from Real Estate, was offset primarily by increases in interest expense, depreciation amortization expense, and impairment charges taken that represent a $2 million increase in overall total expenses.

For the first six months of fiscal 2010, Real Estate revenues were $120.4 million compared to $118.4 million, a 1.17% increase. Again, the decrease in occupancy was offset in total rents received from acquired properties in the previous fiscal year. Total Real Estate expenses increased 2.3% from $47.8 million to $48.9 million. Thus resulting in an $854,000 increase in net operating income from our Real Estate portfolio. This increase in net operating income from Real Estate operations of $854,000, is offset primarily by the same factors that affected the quarterly results, interest expense, depreciation amortization and impairment. As detailed in the 10-Q, page 20, factors impacting net income, interest expense comparative increase was primarily due to less capitalized construction interest in the current year as we are not in development of significant properties as we were in the prior fiscal year. Capitalized construction interest when recorded is a reduction in expense.

Depreciation and amortization is a non-cash expense that has an implied negative effect on our net income, however, is added back to funds from operations. During the six months ended October 31, 2009, we incurred a loss of approximately $860,000 due to impairment of two properties. The Company recorded charge for impairment of approximately $152,000 on its former headquarters building in Minot, North Dakota, based upon receipt of market offers to purchase. The Company also recorded impairment charge of approximately $708,000 on a retail property located in Kentwood, Michigan. This properties tenant has vacated the premises, but continues to pay rent under a lease agreement that will expire on October 29, 2010. As we mentioned in our last earnings call, a concern to IRET and all Real Estate owners is the issue of impairment during the current cycle of reduced trades, increased cap rates and lower operating fundamentals.

Moving to funds from operations, on a per share and unit funds from operations basis for the three and six months ended October 31st, were $0.16 and $0.36 per share in units respectively, as compared to $0.21 and $0.41 in the second quarter and six months of our prior Fiscal Year. Total FFO for the six months was $85.2 million, compared to the year earlier amount of $79.4 million. Although in total, absolute FFO was higher but total weighted average shares in units outstanding were also higher than a year ago. As discussed earlier, for FFO calculations, guidance provides that depreciation and amortization of Real Estate is added back to compute FFO, however, the non-cash expense of impairment is not. As described in footnote five of the funds from operations notes on page 31 in the 10-Q, impairment charges represented $0.02 and $0.01 respectively for the three and six months ending October 31st.

Moving to the Balance Sheet, the most notable events affecting the balance sheet in the quarter were the common share underwritten offering completed in October 2009, which resulted in the issuance of 9.2 million shares, and netted cash to IRET of $72,105,000. As of quarter end, majority of the proceeds are held in cash, bringing cash on hand to approximately $103 million. Mortgages payable as of the quarter end were $1.06 billion, with a weighted average interest rate of 6.27%. Finance activity in the quarter included the closing of five refinancings of multi-family properties, with the interest rate ranges of 5.69% to 5.98% and 12 commercial properties with interest rate ranges of 6.18% to 7.3%. Gross new loans were $66.1 million, net pay off of $44.6 were approximately $29.3 million of cash out during the quarter. Looking ahead for the remainder of the fiscal 2010, we have $45.9 million of mortgage debt maturing. And we have loan application and commitments to refinance and close on $17.2 million of maturing debt, as well as new debt on unincumbered properties. We will continue to monitor our refinancing strategy and pending maturities in order to protect our shareholders as the credit Markets continue to be challenging.

During the second quarter of Fiscal 2010, IRET acquired two properties, a 42,100 square foot showroom warehouse property located in the western suburb of Des Moines, Iowa. This is a triple net leased property to a single tenant, for which we paid a total of $3.4 million. We also acquired a 15,000 square foot two story office building on 1.5 acres near IRET corporate head quarters in Minot, North Dakota for a total of $2.4 million. Subsequent to quarter end, we acquired a vacant parcel land in Fargo, North Dakota for $395,000. We'll be constructing a new facility that will be leased to a single tenant with an estimated all in cost of $4.2 million. We have several possible acquisitions in the pipeline as discussed in Note 12, subsequent events in Form 10-Q.

We are also working on dispositions in markets that we plan to exit , as we move forward with internalizing all property Management. We are currently marketing for sale a 504 unit Dakota Hill multi-family residential property in Irving, Texas. The Company is also pursuing refinancing options for the mortgage loan on this property that matures on February 1, 2010. In October of this Second Quarter, IRET paid a regularly quarterly distribution of $17.10 per common share in units. Subsequent to our quarter end, the Board of Trustees declared a regular quarterly distribution of $17.15 per common share in units to be paid on January 15, 2010. The January distribution will be IRET's 155th consecutive quarterly distribution at equal or increasing rates. Now I will turn the discussion over to Tom Wentz Jr., Senior Vice President and Chief Operating Officer.

Thank you, Dianne. From a strategic standpoint, this past quarter was very positive for IRET, despite the continued economic pressure on all aspects of the portfolio. It has now been over 12 months since the credit crisis appeared, and almost two years since real estate fundamentals began to decline. Even though IRET continues to see very meaningful near term pressure on top line revenue, we believe that the two material threats to IRET's continued long term success have been resolved by IRET for at least the foreseeable future. Despite what may well eventually be the most restrictive debt market in the generation, IRET has and continues to be able to refinance the vast majority of its commercial and multi-family assets on acceptable terms, and in many cases on better terms than the maturing debt. Additionally, on the residential side, IRET is still able to access its equity by pulling cash out at loan closings.

The second important event was IRET's ability to raise a significant amount of capital for purposes of taking advantage of current accretive acquisitions and development opportunities in our market as they appear. By demonstrating how our leverage strategy enabled us to deal with maturing debt, now combined with significant cash on the balance sheet, we are able to focus a majority of our time on growing the portfolio and improving operations. In reviewing the past quarter once again, no positive change in that we continued to experience negative pressure on operations, as confirmed by the supplemental information provided in the 8-K filed yesterday. Perhaps the only positive news is, we don't see an acceleration or further deterioration in most of our markets, rather just dragging across what hopefully will be the bottom for the economy.

This morning I will cover the credit markets as applicable to IRET. And then provide a brief overview of IRET's property level operations as well as pending acquisitions and dispositions. Like the market conditions, it is the same story line on the debt side in that placing new or refinancing existing debt is very challenging, with the only real bright spot being interest rates. We are still pursuing the same debt strategy of placing long term debt, secured by single or groups of assets. We continue to view bank loans as a last resort. But the longer traditional lenders remain less than fully active, this is a source of leverage we may yet ultimately be required to implement if the traditional longer term lenders such as life companies and CMBS lenders remain out of the market for another 18 to 24 months. The issue with banks becoming the main source of leverage, will require a modification of IRET's leverage strategy, as bank lending is traditionally shorter fixed terms, shorter amortization periods. And at least for now in contrast to lending practices earlier this decade, much lower leverage.

Current lending terms will limit IRET's ability to pull cash from its commercial portfolio at the time of refinance. Each of these requirements do not match up well with IRET strategy of long term fixed debt, long amortizations to maximize cash flow, and the positive impacts of inflation and rent growth. And of course the protection afforded by non-recourse debt as it pertains to the balance of the portfolio. While this won't change IRET's debt structure overnight due to IRET's staggered debt schedule. As each quarter goes by and existing long term commercial debt rolls, it is generally being replaced with bank debtor IRET is using cash out for multi-family debt to pay off maturing commercial debt. The end result has been a deleveraging of the portfolio, and a reduction of IRET's target leverage levels, with an increased level of equity.

Currently for IRET, equity has a higher cost than debt so by deleveraging and being forced to move away from IRET's traditional leverage model, we'll eventually require top line revenue growth to support increased amounts of equity, assuming our current costs of equity remain the same. We are still maintaining our modified debt strategy to account for the decline in commercial lending, by increasing leverage on our multi-family portfolio in order to maintain our overall leverage targets. We are doing this carefully, and to a level that is still well within what our multi-family portfolio can handle from a coverage standpoint. We still believe that the proper long term business model for real estate in general and IRET specifically requires long term fixed leverage at 55% to 65% of our investment cost in real estate.

To the extent possible, IRET's debt strategy will remain unchanged. Even by increasing our multi-family debt levels to offset a reduction in commercial leverage levels, we expect it's will be difficult to maintain our desired leverage levels under current credit market conditions. As well as due to the fact that after the coming fiscal year, IRET's maturing debt is tied more to commercial real estate than multi-family. However, I would note that the amount of maturing debt in the next 24 months is actually only slightly more than what IRET has successfully handled over the previous 24 months. IRET provides a detailed debt maturity schedule each quarter as part of its 8-K filing, so I won't spend any time discussing specific assets or the schedule of debt. Despite the challenges presented by the current credit markets that first appeared over 18 months ago, we still don't see any material liquidity or refinancing risk to IRET in the next 12 months, for the same reasons previously discussed. Dianne provided details on recently closed loans. Currently we have approximately $17 million of pending loans, which represent close to 40% of the maturing debt coming due during the balance of the current fiscal year, or over the next four months. While no assurances can be given that this debt actually closes, we fully expect that it will.

Before moving to property operations, I will briefly discuss sales plans and acquisition activities. IRET currently has two apartment complexes under contract, for a total cost of approximately $4.3 million. Both are located in an established IRET market in Rochester, Minnesota with closing expected early next year, subject to debt assumption approval by the current lender. Additionally, IRET is in the final stages of due diligence on five senior housing facilities located in Wyoming. Consistent with prior quarters IRET has no active plans to sell assets, except perhaps those in markets where we have a limited presence.

IRET does have a number of smaller properties for sale in various locations, but the only significant asset for sale is a 504 unit apartment complex located in Irving, Texas which is currently under contract for sale. The current debt on the Texas property is $22.5 million maturing on February 1, 2010. The purchase is still subject to buyer due diligence, so there's no assurance the transaction will close. As a result, we have also started the process to place new debt. If refinanced, we are projecting new debt in the $25.5 million to $27 million range, assuming either a sale or a refinance, IRET will have successfully handled the majority of its fiscal 2010 year debt maturities.

Now moving on to operating activities. We provide detailed information in the 8-K on occupancy, new and renewal rental rates, and expiring leases, so I'm not planning to discuss any particular buildings or transactions in detail. Over the past quarter, IRET has seen no meaningful positive changes in any of its markets, other than reports seem to indicate that the pace of job loss has slowed. And in some markets such as Minneapolis, there have been recent reports of small job increases in the most recent months. However, as stressed in prior calls without job growth, IRET sees no improvement to any of its commercial Real Estate segments. As a result our approach has not changed, in that absent top line growth we are focused on securing the tenants we have. And reducing expenses in such a manner as does not impair the buildings competitive abilities or long term physical aspects of the asset.

Despite the continued pressure on gross revenue, we plan to continue to hold off on any meaningful reduction to discretionary capital improvements. We are in the business of long term assets and plan to operate them as such even though we are dealing with very real term revenue pressures. As in past periods, this approach has left IRET in a very strong position when the market improves, as well as when or if an asset is sold. We still believe capital investments in our Real Estate now will result in stronger revenue growth in the future. Of course, we continue to watch this very closely as the longer the market remains depressed, the sooner this policy will need to be adjusted. We expect our strong cash position and policy on capital improvements will prove to be an advantage in retaining commercial tenants. At this point we see no better alternative to our strategy of focusing our capital on retaining current tenants, securing new tenants provided the credit is acceptable, and improving our assets for the long term.

On the medical segment side, the situation in the market is most tenants are on hold, as the confusion and uncertainty concerning healthcare reform has resulted in near paralysis and new leasing, and a wait and see approach on expansion. Overall, we view current expansion of healthcare coverage as a positive for on-campus medical assets, which constitute the vast majority of IRET's medical investment. The senior housing assets continue to remain stable, with some downward pressure on occupancy that can be traced to potential residents waiting longer to make a decision on assisted living. However, the demographics remain good in all our markets, and new competition has basically disappeared with many announced or planned projects being abandoned for lack of equity and debt capital. This is an area where we believe IRET's balance sheet will result in a good advantage going forward, as demand is likely to clearly outpace supply with no new senior housing products in the pipeline in almost all of IRET's senior housing markets.

Unfortunately, as the current economic climate persists the strong performance in IRET's medical and multi-family segments have flattened, and even declined in some markets. In residential, the decline in occupancy on a portfolio basis is being driven by weak economic conditions in the Minnesota market, first time home buyer credit which was recently extended, and IRET's generally stronger markets. And as amazing as it seems, new competition coming online in those North Dakota, South Dakota and Montana markets that continue to remain economically strong. In these markets, the economies have remained good to excellent for such an extended period of time as compared to the balance of the country, new projects have been developed and are coming online. So far, the markets appear capable of positive absorption. And of course IRET has also built into these strong markets. However, the result has been to reduce the occupancy levels from close to 100%, to the mid to low 90% range.

Residential operations are still strong for IRET, but have flattened out overall with some decline in certain markets. Even though we are clearly not experiencing the same conditions in most of our residential markets as many other parts of the country, we have always maintained our focus on improving our residential operations, knowing that eventually the overall US economic decline will find our markets as well. Employment in IRET's apartment markets is the number one driver of occupancy. While unemployment is not significantly increasing and still well below that of the national number and most other markets in the United States, just like commercial Real Estate, until employment growth returns and people feel more secure in their jobs, IRET's focus will be on improved residential management and cost control, as a way to maintain and grow bottom line in the residential portfolio. Thank you, and I will now turn the call back over to the moderator for questions.

Thank you.

(Operator Instructions)

We have a question from Carol Kemple of Hilliard Lyons.

Good morning. In the multi-family market do you think you're being hurt most by the unemployment or the home buyers credit?

This is Tom. I would say it's a combination of both, depending on the market. In the markets where the economies have remained good to strong, the first time home buyer appears to have the most negative impact on occupancy. And in other markets, you take Minnesota for example, Rochester, St. Cloud, that's clearly employment related.

Okay, and at this point, do you have any thoughts on calling the preferred, since it is a higher yield in the interest rate you're paying on your debt? Would you want to save your cash for acquisition opportunities?

Carol, this is Tim Mihalick. I think at this point our intent, is not to call that debt but to hold and take a look for additional opportunities as you just stated.

Okay, thank you.

Yes.

Do we have any questions submitted by e-mail that you would like to go over, sir?

We do. This is Tim Mihalick again and we've had a request from an investor to address the use of proceeds from October 2009 Common Stock offering. And as we said at that time, we completed our offering in October that we believe we would be able to identify opportunities to put the funds raised to work for our shareholders. And in our quarterly report filed yesterday, and as Tom and Dianne have noted, we have discussed several potential acquisitions that are currently pending. Most notably, the potential acquisition of a portfolio of assisted living facilities in Wyoming for a purchase price of approximately $45 million. As we state in our 10-Q, we are in the final stages of negotiating a purchase agreement for this proposed acquisition, and there are a number of contingencies and conditions to closing. And accordingly we cannot guarantee this transaction will be completed. But we are working hard on that potential opportunity as well as the proposed acquisition of two apartment properties in Rochester, Minnesota.

We continue to see deal flow. And we continue to believe as we said at the time we concluded our share offering, that the additional equity capital we raise through our stock offering positions us to take advantage of potential acquisition opportunities that we believe will be available as the current difficult economic cycle persists. The offering proceeds also gives us greater flexibility to manage through this cycle. As Tom Wentz has just outlined, IRET has long followed a conservative strategy of financing its Real Estate portfolio, primarily through single asset mortgages with staggered maturities. As a result, we do not face any current material refinancing risks. However, we continue to watch with concern for limited ability available to the real estate sector. Accordingly, we are pleased to have been able to augment our existing capital base with the last equity raise. With that, I would ask if there are any other questions?

We have a question from [Gilaramo Guru] of RBC Capital Markets.

Good morning guys, I'm here with Michael Salinsky. Going back to the dividend, where do you guys calculate your current chart flow, and is there any particular timeline to grow into this dividend. I know you mentioned you'll assess the dividend, is there a particular time line like a year, or anything to assess that?

I think at this point we're looking out over the next 12 months, where we begin to evaluate the status of our dividend and operating results, so 12 months out.

And then I guess with regards to your current capital expenditures, what's your rate for the commercial portfolio and multi-family portfolio?

Well, as far as what we're spending per unit, as you know we don't break out discretionary versus required capital improvements from that standpoint. But again, we're watching it very closely and we're investing money with the understanding that it's going to have the long term pay off to the portfolio.

Okay, and then going back to acquisition activity, you mentioned you talked a little bit about the fundamentals of each sector. Assuming that you actually close on all the pending acquisitions, and I didn't consider in the opportunities held during the market, where will you expect to focus your acquisition efforts in the future?

Well, this is Tom again. I mean really what we're seeing in our markets, the assets with the best operating fundamentals are on the multi-family side and the senior housing. I guess really, the difficulty we've had is finding assets that reflect return requirements that the investment community are expecting. We're just not seeing distressed assets with income attached to them for sale. There's a lot of bad assets for sale, but they have no income attached to them. At this point it appears just due to the constriction of capital and the demographics, that housing, residential housing and senior housing. and once the healthcare bill works its way through Congress, medical appear to have the best opportunity because they appear to have stable income attached to them.

Okay, that's very useful. And then I guess a couple of housekeeping questions. With regards to acquisitions that closed during the quarter, and the expected development that you announced, what other cap rate requirements or yield requirements that you guys are looking into that, or what are your expectations with regards to cap rates?

Well on the acquisitions that closed that the transaction in Iowa was a nine cap, the acquisition in North Dakota was approximately an eight cap on our adjusted basis. And the development which is just under way, which occurred after the close of the quarter, that's expected to be at a nine cap or above, depending on final construction costs.

Okay, and then lastly looking at your commercial leasing schedule, your new and expiring leases, is that a cash or cap basis?

That's an actual cash cost basis, so the costs of the transaction costs that are reflected on the commercial leases, that's actual cost. And then are you asking about the face rates on the leases?

Yes, the renewal rates and the expiring rates, are those just cash rates?

Yes, those are the actual cash net rental rates.

Okay, and then lastly, looking at your leasing activities subsequent to quarter end, is there anything worth noting from that end?

No. I mean, we provide our lease maturity schedule from a commercial standpoint and an operating standpoint. And like our debt strategy, we do spend some time trying to stagger our leases, so from a material standpoint, there's nothing that isn't in the K or the Q.

And what about leasing activity with regards to available space already excluding, I guess the ones that are due to expire during the quarter?

Well, I mean as far as pending leases that we're negotiating?

Yes, or space that was just available that's not I guess won't be included in the leases that are maturing in your schedule.

Well, no, nothing significant, nothing out of the ordinary. I think as I indicated we're seeing in our markets really is low activity, low leasing activity. So there's no material pending leases or anything that is out there, that's going to dramatically swing the operation one way or the other that we're aware of. And now obviously you've always got credit risk, but at this point, we just aren't seeing anything that's material. I think the theme that we're trying to convey is it's pretty much dragging along the bottom out there. There isn't a lot of positive activity. There isn't a lot of negative activity. I think most of that has worked its way through the system on the commercial side with tenants. Those that were stressed credit, they've been smoked out. Those that are still there, appear to be the survivors. And the trick is really going to be when the economy improves, and they start adding payroll, that's when we expect to see demand return to all segments in our commercial portfolio.

Okay, thanks again. That was very helpful.

Our next question is from Chris Lucas of Robert W. Baird.

Good morning guys.

Hi, Chris.

Just kind of a follow-up question there. On the bad debt reserves, what's the trend line been for that?

Bad debt reserves, you're talking for the allowance for past due and type of reserves?

Correct, yes.

Our overall past due reserves are -- we maintain a level around 2%, very low. We do have some commercial retail write-offs but nothing significant. Mostly in the retail sector where you'll see some tenant move out, but the trend line is staying relatively flat. Of course it raises slightly as revenues increase, and we increase the allowance but nothing significant, relatively level trend line.

And then Tom, just on the commercial side, as you're looking -- well first off, for the first half of the year, what's been the tenant retention rate? And then sort of what are your expectations for the remainder of the year on that number?

Well I think as we've mentioned in the calls in the past Chris, we track our retention rate and our success, and that's really remained stable. We haven't lost more tenants these past 12 months than in prior periods. I think what we're really seeing is, the tenants that remain are really taking a very careful look at their space requirements. And I would say the trend really is renew the tenants, but they want to downsize, or renew the tenants, and they want rent reductions. That's really what we're seeing out there. Not tenants just disappearing or going to other competition and I think really that just goes to the fact that tenants generally don't like to move if they are going to remain in business, and we have a very diversified product mix in our markets.

We've got a lot of alternatives so if it's not going to be their existing building, we generally have other alternative which is can range from build-to-suit, which we've done in the past, to other buildings that are less expensive. And again that goes back to our strategy in our markets that we're not all, a) suburban, or we're not all core downtown. As we try and maintain a spectrum of Real Estate to give our tenants solutions whether they want A, B, or various types of other space inside the commercial. So long answer. But I guess the renewal rates have remained the same but as you can see the net income associated with them has gone down, because of pressure on the rates, and pressure on the total amount of space.

Okay, so then thank you, and going forward as you, what is your sense as to the in place cash rents, versus where market rents will be on the renewals for the expiring leases for the next two quarters?

Well, just looking at that and looking at what the trends are going to be, it's hard to make any predictions because a lot of rent is driven, face rates are driven by tenant improvements, abated rent. There's a lot of things that go into that number. But the other factors is IRET tended to buy buildings with longer lease maturities and more stable at the time of acquisition. So again like our debt, fortunately we're coming out of periods that five, six, seven years ago, and so from that standpoint, there isn't as big of a decline. I guess what I would expect to see going forward is consistent with what we have seen, and that's about a 5% to 10% knock off from the existing face rate. The one benefit we've seen is the scarcity of capital among a lot of our competitors, has really moved the commercial leasing market away from extensive and expensive TI, or tenant improvement packages.

A lot of real estate owners are a little reluctant to commit that level of capital to retain commercial tenants. They would rather have their commercial tenants buildout, or contribute more heavily to their buildout and reduce the face rate. I guess the end result for us as a long term holder is basically neutral. It doesn't work out that way on the income statement because of expense versus amortization. But from a cash investment standpoint, I think we're seeing a little bit positive movement from our tenants. We're putting less cash into deals, and we end up with a lower face rate, which of course could impact your building sale price. But again as a long term holder, we're focused on the cash flow aspect of the deal than we are driving the face rate, and putting a cap rate on it, and saying this is what our building is now worth.

Okay, thanks. And then just in terms of financing strategy, your Q noted that if you're successful in the senior housing transaction, that you would look to put mortgage debt on that transaction. Would there be a sense to wait on that -- to use the all cash that you have on your books right now for the acquisition, and work on the refinance later? Or would you do that immediately? What's your thoughts right there?

Well I think, Chris, at this point, assuming the project actually clears due diligence and closes, we would not anticipate placing leverage, long term leverage immediately. And that would be a process we would work on. However, based on our expectation of pipeline and other projects that are in preliminary stages, we would expect to leverage those assets, even if we had the cash on the balance sheet. And the reason I would say that, is I think competitively long term in that market, with the rates that are available from the agency lenders, and also from FHA, it just is going to be such a tremendous competitive long term advantage to have that leverage in place and fixed, because competitors will return to those markets. But our expectation is they will return to the markets with a higher capital cost, and so I think the answer to your question, we will leverage that regardless of what the cash is on our balance sheet.

Okay, and then just trying to think through the opportunities. What's the general sense of the health of the banks in your footprint? And are there opportunities that you see coming out of there, or are they sort of a wait and see, extend and pretend, like much of the rest of the country, as it relates to the loans on their books?

Chris, this is Tim here. I would say in that sense we're still in a wait mode up in this neck of the woods, and things continue to move along. And as I mentioned earlier, we stay in touch with lenders and all those that do business in our states and our markets. At this point we're not seeing those opportunities, but certainly are staying in front of those lenders and banks.

Okay, and last question for me is what sort of underwriting in terms of either an IRR or return on invested capital are you looking for an acquisitions at this point, in the areas you are focused on?

Again, I think we've talked about our cap rate or our underwriting parameters in the past, where we underwrite a piece of property with -- based on our cost of funds, and add back 2 to 2.5 points on top of that, to arrive at a cap rate based on 60% to 70% debt. And that's the fundamentals that we've dealt with over the last 40 years, and we'll continue to use our underwriting parameters.

Okay, great. Thanks, Tim.

Thanks. (Operator Instructions)

At this time, we have no further questions. Do you have any closing remarks for today?

Sure, this is Tim Mihalick again. Just to thank those of you that participated this morning and we appreciate your interest in IRET. And certainly want you to know that you're welcome to call directly to IRET with any questions you have in the future. We're here for that purpose. Thanks again for participating this morning.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.