Centerspace (CSR) 2011 Q1 法說會逐字稿

Good morning and welcome to the Investors Real Estate Trust first quarter fiscal 2011 earnings conference call. All participants will be in a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Michelle Saari, VP of Marketing and Communications. Please go ahead, ma'am.

Good morning, everyone and welcome to Investors Real Estate Trust first quarter fiscal 2011 earnings conference call. IRET's quarterly report on Form 10-Q for the quarter was filed Thursday, September 9 and our earnings release and supplemental disclosure package were posted to our website and also furnished on Form 8-K on September 9 as well. In the 10-Q earnings release and supplemental disclosure package, Investors Real Estate Trust has reconciled all nonGAAP financial measures to the most directly comparable GAAP measures in accordance with the requirements 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 filings with the SEC. Investor 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 Jr., Senior Vice President and Chief Operating Officer. At this time I'd like to turn the call over to Tim Mihalick for his opening remarks.

Thank you, Michelle, and good morning. It is my pleasure to bring you up-to-date on the activities of IRET since our last earnings call. Much has changed but much has remained the same. The stalled prolonged economic environment remains constant and in my opinion we will continue to fight this climate for the next couple of years. What has not stalled is the continued effort at IRET to reach its long range goal to be the landlord of choice in the Upper Midwestern part of the United States. The implementation of internalizing and hiring of personnel to complete the in-house property management initiative is substantially complete and we expect the increased awareness of having our own people on the ground in our markets to be beneficial to IRET's overall operations.

Acquisitions continue to be a challenge in the markets we operate in. I mentioned a few calls back that we will use all avenues to search out acquisitions. We are investigating other avenues to add property our portfolio by examining the opportunity to build into underserved markets, such as those that currently exist in the western half of North Dakota where energy activity continues at a rapid pace. This type of acquisition would require careful due diligence on our part due to the boom and bust cycles that the energy industry can experience, but certainly worth the effort on our part.

We continue to seek out portfolio transactions that would impact our overall financial condition in an accretive manner. These transactions take time, so as mentioned earlier, a stepped up effort to increase IRET brand awareness is underway. Our hope is that this increased awareness will allow potential sellers to recognize IRET as an avenue to exit their holdings. Additional-- additionally, we will be more active in the second tier markets we currently have holding in-- holdings in. We believe that potential acquisitions we have not-- that we may have not seen in the past will now make their way to IRET via our people on the ground. This should give us more opportunity to increase our holdings in those markets.

On the disposition side, we continue to have under contract the Dakotas Hill Apartments in Texas, and the three apartment complexes in Colorado, that helped to close those sales in the second quarter of fiscal year 2011. Additionally, we continue to identify other properties which we feel may also be candidates for sale.

IRET continues to meet its capital needs as evidenced by a strong balance sheet. Over the last 12 to 18 months through prudent management of our debt and capital raises when needed, we've been able to position IRET to withstand the uncertainty that has existed and allow IRET to be the leader in our markets as the slow recovery occurs.

Before I turn the call over to Diane, I would like to offer my thoughts to questions I field on a regular basis. I'm asked quite often about the markets IRET operates in. Specifically, what do we see currently and what does the future hold for those markets? When I answer that question, I believe it is important to remember that IRET has by design operated in markets which we feel do not suffer the economic volatility that the rest of the country does. Remember that previous states we do own property in also have the lowest unemployment rates in the nation. Slow and steady has long been a driving force behind IRET and we are not inclined to abandon that philosophy in a knee jerk reaction to the market.

As I mentioned earlier, we may choose to build into an underserved markets at this point and if so, we will adhere to the slow, steady mantra, recognizing that putting dollars to work will not have an immediate impact on our income statement but will allow us to build for the future. It is also important to remember that IRET has long been a yield driven investor and has not been afraid to venture outside its existing asset class if the opportunity exists while [running] along the (inaudible) due diligence process.

Over the years, IRET's use of debt has been atypical to the REIT industry. And although it was looked upon unfavorably by the industry, we thought the method of placing (inaudible) asset loans made sense and that method has served IRET well especially through the recent debt crisis. I submit that our process took place amortizing debt on our properties was quite unique but then again, we discovered long ago that we are different than most of the REIT markets. We have long felt that as those loans have matured our ability to refinance those loans allowing us to take out equity was our way of funding CapEx throughout the portfolio. Again, different from the industry but a method that has a 40-year history of working for IRET.

That brings me to my final question. Can you sustain your dividend. As you're aware we have maintained our dividend at the same rate as we paid on July 1. I will again emphasize we will continue to examine our operations on a quarterly basis and make our dividend declaration based on those and anticipated financial results. I still believe we will need to see job creation to pull us out of this prolonged slump and when that will happen remains to be seen. Although we have seen a positive increase in operating results, albeit small, in the fourth quarter of fiscal year 2010 to the first quarter of fiscal year 2011, we hope that we are seeing a positive move. I'm well aware that IRET shareholders have built this Company into what it is today and fully believe that unless there are debt issues to handle, our need to buy back IRET stock or to fund acquisitions that will have a substantial impact on IRET's income statements, that the dividend should be paid out to the shareholders.

I am confident that IRET is well positioned in the markets we compete in and that the goals I discussed today and in previous earnings calls are being met. I also recognize that the global economy, including the USA, continues to be fragile. You can rest assured that IRET will continue to monitor the ever changing economic condition and will keep at heart the interest of our shareholders. We intend to work hard to meet our goal to be the landlord of choice for the Upper Midwest. Thank you and with that I'll ask Diane to review our first quarter financial results.

Thank you, Tim. This morning I will discuss the overall financial results of operations for the first quarter of fiscal year 2011 and the comparative period. I will also comment on events that affected the reported results. Our balance sheet continues to show very strong liquidity with available cash on hand of $56 million as compared to the year end available cash of $55 million. During the quarter we acquired two commercial medical facilities in Billings, Montana and Missoula, Montana for a total acquisition price of approximately $5.2 million using $957,000 of our available cash and assumption of $4.3 million of existing debt. Transaction closing costs that were expensed as a result of the acquisition was approximately $52,000.

Financing activity in the quarter resulted in the closing of five commercial and two multi-family loans with cash out of $8.8 million. The average interest rate on the commercial loans was 6% with maturities of five years and the multi-family loans with an average interest rate of 5.3% with five and ten-year maturities. Subsequent to quarter end, we also closed on a secured line of credit facility of which Tom Wentz Jr. will discuss in more detail.

During the first quarter we sold approximately 1.8 million common shares under our On Demand Continuous Offering program for net proceeds of approximately $15 million. The proceeds from this offering were applied in early August to pay off an $8.1 million existing mortgage on a commercial medical facility which carried an interest rate of 9.75%. And the remaining funds have been designated for the $2.6 million development project at our Edgewood Vista facility in Spearfish, South Dakota and our pending acquisition of the Edgewood Vista facility in Minot, North Dakota. Accordingly all proceeds will be applied to income producing and interest expense reduction in the near future.

Moving on to our income statement. Real estate revenues for the quarter were $62 million compared to $60.8 million in the first quarter of fiscal year 2009, an increase of $1.2 million. The actual increase in revenues due to recent acquisitions and properties placed in service was approximately $3 million. However, our stabilized properties in the comparative period have a decrease in revenue due to vacancy and concessions of $1.8 million. As Tim stated earlier, we continue to see the effect of increased vacancy affecting results of our operations and revenue, especially within our multi-family and commercial office segment.

Total expenses for the quarter were $2.1 million higher than the comparative first quarter 2009. This increase in expenses was primarily due to these factors. One, increases in depreciation, amortization expense of approximately $414,000 due to acquisitions and tenant improvements. We also realized a decrease in insurance expense of $468,000. This decrease was due to a reduced premium expense of approximately $268,000 in the comparative period and a one-time quarter adjustment to the loss reserve of $200,000. We've also seen an increase in property management expense of $1.3 million in the first quarter.

Factors for the increase in property management expenses were primarily as a result of operations within our Wyoming Assisted Living portfolio of $1.4 million. This increase for Wyoming was offset by increase in revenue generated from these same properties. Also, we've seen internal property management transition expenses of approximately $362,000 in the first quarter. These two line item increases were offset by lower expenses in the aggregate for the other categories within the property management expense. And finally, an increase in administrative expense of $401,000 due to increased salary expense primarily because of the increased staff.

Regarding the internalization of property management, as of quarter end all significant internal property management expenses have been recorded and we do not anticipate these expenses to affect future quarterly results as we are no longer paying the third-party managers to provide the same services during the transition period. We have determined that the overall cost to execute the plan was $1.7 million.

We also are achieving success in lowering our interest rate expense due either to financing at lower rates or paying off mortgages using available cash. Interest expense on real estate decreased by $639,000 in the first quarter compared to the same period in the previous year. We are and will continue to focus on managing our debt and maximizing the use of cash and paying off higher rate mortgages or using a line of credit at a lower interest rate on unincumbered assets.

Moving to funds from operation and per share results. Total FFO for the first quarter per share was $0.17 compared to the year earlier of $0.20, however, equal to fourth quarter of April 30 of $0.17 per share. These per share results have been impacted over the prior year because of lower net income and the lagging effect of applying capital raised through the issuance of common shares. However, we maintain the per share FFO of $0.17 from the previous quarter as a result of operations and net income in the first quarter showed positive results.

On July 1, we paid a quarterly distribution of $0.1715 per share and unit. Subsequent to our quarter end, the Board of Trustees also declared a regular quarterly distribution consistent with the prior distribution of $0.1715 per common share in units that will be paid on October 1, 2010. The October distribution will be IRET's 158th 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, Diane. Consistent with my past presentations, this morning I will provide a general overview of the recently completed first quarter and then cover the credit markets as applicable to IRET and conclude with an overview of IRET's property level operations. From an operations perspective, this past quarter was a continuation of the overall challenging operating environment we have endured for close to three years. Top line revenue growth remains depressed, so we remain focused on tenant retention and attention to tenant credit quality on the residential side as well as operations. We continue to see a generally overall weak real estate market in all segments with the exception of medical office which has experienced some modest growth over the past few years.

Despite the negative operating pressure on revenue, the first quarter was positive for IRET in the areas of expense control, cash flow and debt. While transitioning to internal residential property management represented a huge undertaking both in the terms of work load as well as financially, we remain confident that the time and money invested will result in a much better overall operating platform and improved operating results.

On the debt side we have a lower level of maturing debt than in prior years with a large portion involving well leased medical assets and multi-family, the two sectors which are still able to be financed on the most favorable terms in today's credit markets. Again, we have the benefit of higher fixed rate debt maturing over the coming 12 to 18 months which will provide us with the opportunity to not only access our built up equity after a decade of principal pay down, but also in many cases lower our interest expense by very material margins on individual properties. This will in turn translate into a decline in our overall weighted interest expense.

On the approximately $1.1 billion of debt of the recent reduction of 18 basis points over the past 12 months has resulted in approximately $1.9 million of reduced interest expense on an annualized basis. Over the coming 18 months, the approximate weighted interest weight on the roughly $165 million of maturing debt is about 7.2%. We further expect, given the current interest rate environment, we will be able to secure replacement debt at levels below our current weighted overall rate of 6.13%, generating further interest expense reductions going forward. We have been actively contacting those lenders holding higher rate debt covering the assets that could be refinanced about early prepayments. We expect these efforts to continue to result in additional interest rate expense reductions. We are not planning to further reduce our overall leverage going forward as our debt as measured against our portfolio cost has declined slightly over the last several years, primarily due to changes in the lending environment.

Additionally, I would note that we have added almost $76 million in real estate to our portfolio between the first quarter of last year and the end of this first quarter while our overall mortgage and credit line debt increased by slightly less than $1.3 million and our overall liabilities by only slightly more than $2 million. Again, this is consistent with our primary focus over the past three years of protecting our balance sheet and maintaining operating flexibility.

With the lack of high-quality acquisitions, new equity and excess cash has been banked using debt reduction due to the higher returns available by reducing debt than simply holding as cash. We are confident that this equity can be accessed through sales of assets or debt placement when needed as confirmed by the recently established secured credit facility at $47 million committed and the ability to expand to $60 million. We now have a reliable mechanism to access the equity that we have created on our balance sheet at a relatively low cost.

Finally, and in keeping with perhaps the most important accomplishment over the past year and one which continues our standard policy of many years, during the first quarter IRET did not materially reduce discretionary capital expenditures and improvements to our portfolio in order to conserve cash. We are now providing quarter-by-quarter information on what we consider reoccurring capital expenditures necessary to maintain our residential portfolio in a market leading physical condition for each assets category. While the length and severity of the real estate downturn has exceeded almost everyone's predictions and has now impacted all areas of the country including the few remaining relatively healthy markets that make up many of IRET's core areas of operation, I continue to believe IRET has the ability going forward to maintain our business as usual policy and not risk a long-term physical deterioration of our portfolio. Our primary committment is to remain positioned for future growth when our markets recover.

In reviewing the past quarter specifically in the trailing 12 months, we continue to experience negative pressure on operations as confirmed by the supplemental information provided in the 8-K furnished yesterday. While we have had some modest job growth in most of our markets as well as the country overall during the last several months, there is certainly a long way to go before growth and ultimately real estate demand returns. On a positive note, there is very little new construction taking place in any of our markets. Combined with interest rates at historic lows and our demonstrated ability to continue to access the credit markets, we have been able to offset some of the revenue decline with a reduction in operating expenses.

We continue to see new leasing and renewal leasing activity in the commercial segment that exceeds on a square footage basis our expiring square footage. I would note that this leasing does include early renewals of leases that would have otherwise expired in future periods.

Unlike commercial, our residential segment remains strong up until the second half of the past year. We did not realize as much recovery as we had anticipated or expected during the early summer months as we attempted to defer new leasing in many communities to layer in the season so it would occur under our Management operations, and we also had a number of complexes going through very significant physical renovations that resulted in taking some units off line. The delay in residential leasing combined with a higher than ordinary amount of capital projects involved in our residential communities impacted our physical occupancy numbers by 270 basis points. But from an income standpoint, the decline when compared to the same period last year was approximately $200,000, or about 2%.

Now moving on to operating activities. We provided detailed information in the 8-K on occupancy new and renewal rental rates in expiring leases, so I'm not planning to discuss any particular buildings or transactions in detail. We experienced no positive change in the conditions that continue to negatively impact our operations. As we stressed in the past, demand for commercial and multi-family residential real estate is driven by employment.

An area of concern is the rapid deterioration in our multi-family portfolio this last spring where leasing activity essentially disappeared in all but a handful of mashes. We did experience a slight recovery later in the first quarter than we expected for the reasons I previously discussed and we see this recovery trend continuing through the fall. We were able to hold average rental rates approximately steady even in the face of the occupancy decline and we are optimistic that with the removal of the uncertainty created by the transition from our long time third-party managers to our internal Management operation, our residential portfolio will see occupancy improvement during the coming fiscal year.

There is no question that the continued poor economic conditions in the Minnesota region negatively impacted our apartment portfolio in those markets. However, as discussed in prior calls, without strong and consistent job growth, IRET sees no significant improvement to any of its real estate segments in the near term. 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 that will not impair the buildings competitive abilities or long-term physical condition.

On the medical side, we've experienced some small gains as the uncertainty over the healthcare overhaul has given weight to the larger demographic forces of a growing senior population, which is and should remain a major driving factor in this segment. On the senior housing side, we are now beginning to experience a number of the negative pressures that we discussed in our previous call. Weak job growth and especially weak housing conditions in the Minnesota region have impacted occupancy as seniors and their adult children lack the confidence to make the transition to senior housing alternatives. Additionally, State budget decisions, especially in Minnesota, have reduced revenues as our operating business model does accept Medicaid tenants, but we have worked to limit this portion of our tenant base to no more than 20%. We do believe going 100% private pay is not the best operating model for our senior housing in the markets that we serve.

Our renewal success remains strong as does our ability to hold or increase rental rates. There is very little competitive building plan for most of our markets and many medical tenants and senior residents have fewer alternatives. The demographics remain good in all of our markets. We believe IRET's balance sheet and access to equity and debt will result in a solid competitive advantage going forward as demand will eventually outpace supply.

One of our top projects has been moving toward an operating real estate Company with internal Management capabilities. We substantially completed this transition during the first quarter. We are now focused on improving and increasing the efficiency of our Management platform. We have modeled internal Management to be revenue neutral from a cost structure standpoint with the benefits coming in the form of better building operations, more sensitivity and control of on site activities and a better structure to grow each targeted market. During our last call, we outlined a number of projects designed to improve our operations with the goal of capturing as much increased revenue as possible, but also to hold and even reduce expenses. Those projects are now well underway.

Our plan is to aggressively focus on cost control and operating efficiencies as a counter balance to declining and flat revenue in all of our operating segments. We have been successful with this strategy. Even though it is reactive in nature, it has worked for the last several years. However, as everyone understands, costs can't be cut to zero and the longer the economy remains stuck in neutral, the more difficult it becomes to stem the pressure on net income and cash flows. For now we remain in a healthy position with cash and maturing debt. Our assets are in good physical shape and most importantly, we have an operating structure that can now proactively address both current and anticipated economic conditions as well as take advantage of growth opportunities as they present themselves in our markets. Thank you, and I will now turn the call over to the moderator for questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from [Jim Dieter] of RBC Capital Markets. Please go ahead.

Hi, good morning. Can you hear me okay?

Good morning, yes.

Hi. You gave some good color there on some of the occupancy there especially in the multi-family segment. I was just wondering if you could talk a little more about maybe some of the other segments and some of the drops you've seen there? And over the past couple quarters, has there maybe been any disruption from the transition in the property management or what might be the strategy here to sort of gain some occupancy in some of those other segments?

This is Tom. I think the other segments really those have been internally managed for quite some time and-- but really it's just a lack of demand. On the commercial side, primarily commercial office, it's just been a slow, steady reduction in demand from existing tenants as those leases roll, we're either seeing the potential downsizing but primarily it's pressure on the revenue. We're really not seeing credit quality anymore. It's just a function of no job growth and commercial tenant demand for space.

Same story in retail. Medical has been flat to slightly up there. And I think really to answer your question about the strategy, I mean what we really stress in our markets is as a landlord, a lot of tenants have now become conscience of the financial strength. They've seen buildings go back to lenders. They've seen deals not honored. I think one of the things that we've really stressed out into the market is our financial stability, the fact that we've not defaulted on any loans and that we have the ability to implement and see through tenant improvements and the payment of leasing commissions. And all of those I think send strong signals to the deals that are out and available.

Okay and I guess but on the multi-family segment there the, sort of the disruption you mentioned there, but also was some of the lack of leasing activity you also mentioned maybe caused by some of the transitions or is that also just a no demand factor?

Well we had a combination. We did see some flux and some temporary impact on demand. I think in prior calls we attributed that and our research really went back to the first time home buyer credit--

Okay.

Which was particularly attractive in a lot of the communities we operate in where $8,000 versus the average home price is very significant. And so that caused a significant amount of disruption last year in the winter months. And then obviously with the transition where we duplicate services we brought in a lot of new staff, even though we did hire some of the staff from existing property managers, we primarily brought in new infrastructure and new staff. We brought in different leasing policies, credit standards, and as a result we made a conscience effort in the number of communities to defer some of the leasing into our management period confident that it would be there.

So we're relatively optimistic that we'll address that occupancy decline that occurred during the summer months in these coming quarters. And what I pointed out is even though we saw a relatively significant decline in occupancy of 270 basis points, it didn't translate into a dollar-for-dollar decline and we were relatively confident that we could maintain rental rates not be forced into a concession environment on the residential. So we're very optimistic that we're going to address that and residential is going to get back on its feet quickly.

Okay, and a little more generally, you mentioned some of the-- by geography you mentioned Minnesota, one you pointed out there as maybe being a little weaker. What else might you be seeing from different geographies? Are there any that are as strong or maybe others that are lagging right now?

This is Tim speaking. I guess as I mentioned earlier if you take a look at the map of the unemployment, certainly in North Dakota, South Dakota, even down in Nebraska and Montana, we continue to be relatively economically strong and those are markets obviously that we're very familiar with and will continue to search out acquisitions in. The Western half of North Dakotas I touched on briefly continues to experience a tremendous energy boom from both oil and gas, so those are markets that we'll certainly look to see if it makes any sense for us to be a part of. But generally as I mentioned the Upper Midwest, the economic volatility is a little bit left and it's (inaudible) the coastal markets, but we'll continue to be active and search out both acquisitions and opportunities to raise (inaudible) rents if possible in those markets that we're a part of.

All right, thank you for taking the question.

Thanks.

Thank you. Our next question comes from Chris Lucas of Robert Baird. Please go ahead.

Good morning, everyone.

Good morning, Chris.

I guess maybe to follow up Tom just on the apartment transition process, were you able to dig a little deeper into the performance as it relates to the internalization and determine whether or not those areas-- those assets that you had brought the third-party managers over to the internal Management team, did they do-- did those assets do better or worse than those where you brought in a whole new team?

Yes, I think the transition basically was completed over the final quarter of last fiscal year and this first quarter so we really don't have the ability to measure at this point with a material amount of data. We're really anywhere from 30 to maybe 45 days in under our complete control. With any property management transition, especially when you're talking approximately 7,000 units covering about five states done in less than six months or so, I think we want to be very careful to track that data. We have the systems in place and I guess at this point we're seeing some indications that yes, our Management is going to drive some better overall results.

Again, I just want to get back and stress that we didn't view internal Management as less costly. We don't think we can operate internal Management any less expensively than the third-party manager. Where we're anticipating the benefits is on the top line and that gets a little bit more difficult to track back to internal Management . But what we're expecting, as I highlighted, is better sensitivity to our markets, complete focus on our own portfolio and not some of the distractions you get with third-party managers where they operate buildings for other owners. And so that's where we really anticipate it, so I think the proof will be can we grow the top line, hold expenses the same, and that's all data that we release in the 8-K. And then sure we'll take credit for it if it's due to internal Management but it's going to be hard to scientifically prove that fact.

Chris, I'm sorry, it's Tim. Just to follow up on that, I actually visited two of our communities yesterday and certainly the feeling I get is that the internal Management will allow us to improve as Tom mentioned just the feel in the communities versus what I've experienced in the past from the third party was much better. You get much more of an attachment to your tenants when you have your own on site people and that measurable number is hard to quantify but I think we'll see a positive impact on that.

Okay and I guess maybe to quantify a little bit, how many of the communities did you end up bringing in new people versus just sort of converting the third-party managers over to internalized staff? Do you have a sense as to what that ratio is?

Well, we only-- I don't know what the ratio would be. We didn't track it at really the rank in file on site building. I would say it was probably 50/50 just if I was going to guess but we didn't track it at the building level. We tracked it more from a Management standpoint which would be the regional Managers or the market Managers that we placed in each of the communities. Those were all new people and that's really where I think the significance is, is where your leadership is new as opposed to what's going on at the building, that we didn't track.

And then Tim or Tom, just on the acquisitions front, are you seeing any changes in the marketplace as it relates to availability of product and in terms of the cap rates being asked?

Yes, Chris, this is Tim speaking. We are seeing some more activity. Cap rates even in some asset classes, commercial office up in that 8 to 8.5 range. We are seeing activity that we're interested and certainly are pursuing and expect to pursue over the next 30 days to make some business with some properties. So it seems like things are picking up and moving in the right direction. I know we've talked about this a number of times but this go around, we are out in the markets and actively looking at properties versus previously just talking to potential sellers. So there is activity and things that we're excited about taking a look at that are occurring in our markets.

And then I think it was mentioned that one of the drivers of sort of the use of cash has been the ability to prepay or repay maturing debt and/or refinance maturing debt at attractive spreads. Is there an opportunity to accelerate that activity in terms of prepayments in order to lock in sort of that spread now versus having to wait until those mortgages are maturing and potentially miss out on that spread opportunity?

Well, Chris, this is Tom. As I mentioned, yes. I mean we're-- we've got the list of all of our lenders and we've been prospecting in that lender list for quite some time. A lot of those lenders have repaired their balance sheets. We primarily were an agency Freddie and Fannie borrower, of course they have no external pressures because they are now wards of the US Government, so prepays are not possible with that-- either of those organizations. And then we primarily were a life insurance company borrower and we did have some very good opportunities there. Those have lessened somewhat as those firms have repaired their balance sheets and really are not under the pressure to raise cash immediately.

But we're still prospecting actively. I mean we've contacted lenders that have loans that mature six, seven years from now about early prepays to lock in. So we're picking our debt that is advantageous to us, assets that can be refinanced or that potentially could be listed for sale and of course, where we have debt on assets that are not necessarily ready for the credit markets right now, we're keeping that debt in place.

Okay and then can you maybe give us a sense as to the terms that you're seeing sort of between and then sort of what is being done on the commercial side and then what's done on the agency side?

Well, as you know, the agency debt that's probably as low and as attractive as its been in the past decade. You can see mid to low fours depending on the asset leverage to 75% to 80%, if you go variable you're down in the threes on the agency. Commercial for good quality commercial assets the life companies appear to be back to a certain extent. We're seeing low fives, mid fives and that's the same with the banks. We're seeing terms with banks of three to five years, leverage up to 70% maybe 75%, same with the life companies, terms of up to ten years. And again, the higher the quality asset, the better the tenant profile, the longer the term. So in fact for good-quality assets we're seeing commercial lending abilities at the frankly the best rates we've seen in a decade.

Okay, very good. Thank you, guys.

Thanks, Chris.

Thank you. Our next question comes from Carol Kemple of Hilliard Lyons. Please go ahead.

Good morning.

Hi, Carol.

Do you also expect to complete all the internal property management in the second quarter of this year?

Carol, this is Tom. There's a few lagging properties but for the most part its substantially done. We have some other portfolios, Topeka, our Topeka portfolio is still externally managed. Colorado, which is under contract to be sold, is externally managed and then Dakotas Hill is externally managed in Texas. So depending on how those sales proceed with the assets in Colorado and Texas, those may be possible internal Management candidates, same with Topeka, given the size of that portfolio. Outside of that, we've got some smaller assets here or there that have unique circumstances either contracts that need to burn off with property managers, joint ventures or others. But of our 9500 units, the vast majority that will be internalized or complete and done.

How is that on the commercial side going, when do you expect it to be done there?

Commercial with the exception of a few remaining portfolios, we're basically done there too and that's just again a function of our presence in the market. So again, that's going to be on a case-by-case basis but there, the infrastructure is in place. There's no primary initiative to pick up some of these remaining buildings. Again, we have some legacy contracts involving some medical buildings that would probably need to be burned off in the Twin Cities, but for the most part the commercial, Carol, is done as well.

Okay, and what caused an increase in G&A expense in the quarter?

Carol, the G&A, the administrative type expense as I talked was about $401,000 higher. We do have some increased asset management staff people that were brought on for finance, for real estate tax, some corporate type employees too that were not here in the prior year, so basically it's increased staff that would have increased that G&A.

Okay, but any new property managers that you all would get due to internal property management would go into that line item, right, the property management expense or would they go into admin?

No. They would go into property management expense, correct, correct, but not the administrative type.

Okay, that makes sense. Thank you.

Yes.

Thanks.

(Operator Instructions) Our next question comes from James Bellessa of D.A. Davidson. Please go ahead.

Good morning.

Good morning, Jim.

Over, or approximately nine years ago you had an offering at $8.75 a share and after that I started picking up coverage of your Company. Your FFO at that time was higher than it is now. And you told us here you took pride on your balance sheet being strong, your having cash in the bank and a growing cash position, but the stock is no higher or maybe even lower than it was then and FFO was lower. So I'd like to challenge a little the issuance of additional stock that you again came out with the additional issuance this year in the most recent period, saying that you raised about $15 million through 1.8 million shares that you issued.

You indicated that some of those funds were used to pay off mortgage that had a rate of 8.1% and that sounds great because mortgage rates are lower than that now. But at the same time, it appears to me like your cost of equity capital is greater than 8.1%, so why should you be issuing stock to make a move like you just did? And is there another way to get this stock where-- higher and give investors a greater return than just the dividend? Is there a way to move this stock higher because maybe you're getting your FFO going higher? We haven't seen an increase over extended period of time of the FFO, so I'm just trying to challenge to see what you have to say on that point.

Jim, this is Tim speaking. The plans going forward at this point are not to go back into the continuous offering but to put to work that funds that we have raised and to use other avenues to go out and acquire property, to pay down debt. And obviously our ultimate goal as you talked about quite well is to increase the FFO in our challenge in front of us. A lot of that's going to come I believe out of the increased sufficiency through operations on the property management side. Our ability to be on the market and make acquisitions that have a better strategic impact on our bottom line and our FFO number. I think the market is maybe somewhat reflected the challenges that they perceived in front of us of our ability to continue to pay the dividend at the rate that it was and that may cause us to see a decline in our stock price. We hope to continue to educate the way we've operated IRET for the benefit of the shareholders that we're able to maintain that.

Ultimately, the biggest recovery needs to come, I believe, on our residential side and we've been through this-- I've been through this cycle now for three times and the last time we came out of this as recovery occurred in the multi-family as those continued to lease up and those costs already exist and that's an automatic filter down to the bottom line. And at this point, that's what we're trying to improve our operations and our occupancy numbers. And I believe seeing that will allow us to see an increase in the FFO as well as our stock price. Certainly what you've spelled out is a true statement.

The transition to in-house Management looks like it's aging a little. At what point do you not have duplicate cost and when can we see the full benefit occur from the in-house migration?

Well I think again, this last quarter we'll complete that migration and the duplicate costs associated with the set up and bringing it in-house. Having going forward you'll see the benefit of that.

Did you say the last quarter was the end of that or the current quarter is the end of it?

The last quarter.

Okay. And then finally this is a minor question but it's an oddity, you paying taxes for the first time, a very minor amount, $19,000 of income tax, what triggered that?

Jim, that would be a result of our TRS facility, Wyoming Assisted Living facility is held within a taxable REIT subsidiary. And so that is the income tax accrued for the operations for the first three months of this year for that facility or those facilities.

So it's just not a one quarter event? It's going to be every quarter we're going to see a little tax payment?

Correct.

Yes, Jim, this is Tom. Approximately 18 months or two years ago with recovery bill they changed the rules allowing healthcare facilities to be operated inside a taxable REIT subsidiary, and that allowed us to migrate as those leases roll our senior housing portfolio into taxable REIT subsidiary where in essence we're the operator and the landlord, which allows us to capture the upside. And so since Wyoming was a new acquisition we immediately went to that structure. So only the operational activity above the lease payment to the parent Company which is IRET is subject to tax from that standpoint. So I guess to confirm what Diane is saying is yes that will be a line item but it's on a very small incremental amount of income going forward.

But as you transfer your existing leases and they come due and you reprice your portfolio or refinance your portfolio, then does that trigger you putting it into a taxable REIT?

Our plans are to ultimately migrate the entire senior housing portfolio to taxable REIT subsidiaries and again, that allows us to capture the upside. Currently, we receive a lease payment and if the operations at the building exceed that lease payment, that benefit goes to the third-party operator. Based on our senior housing portfolio, we're anticipating that going forward we'll be able to capture that and in essence it looks like an apartment building. You experience the good and the bad in those markets as you control the operations.

Say five years from now when you've transferred these into taxable status, would you conceive how much your tax might be on a quarterly basis? Could it be $0.5 million a quarter?

Well, that's hard for us to project and I guess the only guidance I would give, Jim, is there's some Safe Harbor rules that are promulgated not by the IRS but by the REIT experts that say if you're going to run a taxable REIT subsidiary you need to be somewhere in that 5% to 10% net income of the overall operation. So I would say we're not anticipating the tax consequences to be that significant, assuming those are correct recommendations from the REIT attorneys and the REIT councils or I would guess the consultants that advise us on the TRSs. So we're not anticipating it to be meaningful and again I would stress it's going to be on the revenue that we're not capturing now. So I guess our prediction would be incrementally we're going to grow our revenue but it's going to have the lag or part of it is going to be taxable, but this is new revenue that we don't have now, so I don't see it as materially impacting us or taking us backwards.

Thank you for your responses.

Thank you. And there are no further questions. We will now conclude our question-and-answer session. We did have one party dial in. Would you like to take that party?

Sure.

Okay. We have a question from Chris Lucas of Robert Baird.

Hi, just one last question, guys. Sorry to keep you. It relates to just the dispositions. Any sense as to the value of the-- the dollar value of the assets that you're contemplating selling and what the expectations are in terms of timing?

The-- I'm trying to think, do we have the contract, or Diane do you have those numbers?

Rough would be good.

Okay.

The dollar value of what?

Of the apartment complexes, Chris are you--?

Yes, that's what's under contract, correct, the Colorado and Texas?

What our net book is into those?

No, no, what the value-- what the gross value of the transactions are roughly expected to be, if you can give me kind of a range it would be fine.

Seventy nine--

Yes, we have-- Texas is under contract for approximately $36 million and Colorado, those three properties are under contract for approximately $43 million.

Okay, and then the-- are those assets encumbered by mortgages?

Yes, and so the buyer would be assuming those. So again, I think if you go back, you can piece it together, if you look in our 10-K, we're going to have the list of each assets and the corresponding debt.

Okay.

Of course we paid down a little principal--

Sure.

Over that period of time but that should give you pretty good approximation.

And then expectations for closing on those, any sense?

I touched on it. Hopefully in the second quarter if all goes well.

Are you waiting-- is this a point where you're just waiting on lender consents to move the transactions along or is there something-- is there some other issue still to be resolved?

Well, there's still some open due diligence items on the Colorado portfolio and the same with Texas. So I guess in the current acquisition sale environment best advice I could give is it'll close when it'll close. As you've seen we've struggled getting loan assumptions done and of course buyers you just never really know until they show up with the cash. So I guess the answer to the question, there are still outs for these buyers, if they want to exercise them.

Okay, that's helpful, thank you.

Thanks.

At this time we show no further questions, so we will close the question-and-answer session at this time. Do you have any closing remarks today, gentlemen?

Again, this is Tim. And just again thanks for your interest and your participation in our call today. Jim, I do accept your challenge that it is important that IRET continue to move forward and grow our FFO and to grow our overall stock price. We see that in front of us and accept it and realize that again this is a Company created and for the benefit of the shareholders and we intend to do all we can to improve on both of those categories. With that, thank you for participating.

Thank you. This concludes today's conference. You may now disconnect. Have a good day.