Kimco Realty Corp (KIM) 2007 Q4 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the KIMCO's fourth quarter earnings conference call. Please be aware that today's conference is being recorded. As a reminder, all lines are on a muted status to prevent background noise. After the speakers' remarks, there will be a formal question-and-answer session. If you would like to ask a question, please press star one on your touch-tone telephone.

At this time, it is my pleasure to introduce today's speaker, Ms. Barbara Pooley. Please go ahead, ma'am.

Thank you, Anthony. Thank you all for joining the fourth quarter 2007 KIMCO earnings call. With me on the call this morning are Milton Cooper, Chairman and CEO; Dave Henry, Chief Investment Officer; Mike Flynn, Vice Chairman and President; Mike Pappagallo, Chief Financial Officer; and David Lukes, Executive Vice President. Other key executives are also available to take your questions at the conclusion of our prepared remarks.

As a reminder, statements made during the course of this call represent the company and management's hopes, intentions, beliefs, expectations or projections of the future, which are forward-looking statements. It is important to know that the company's actual results could differ materially from those projected in such forward-looking statements. Information concerning factors that could cause actual results to differ materially from those forward-looking statements is contained in the company's SEC filings. During this presentation, management may make reference to certain non-GAAP financial measures that we believe help investors better understand KIMCO operating results. Examples include, but are not limited to, funds from operations and net operating income. Reconciliations of these non-GAAP financial measures are available on our Web site. And finally, during the Q&A portion of the call, we request that you respect the limit of two questions with appropriate follow-up so that all of our callers have an opportunity to speak with management. Feel free to return to the queue if you have additional questions.

I'll now turn the call over to Mike Pappagallo.

Thank you, Barbara, and good morning.

As unsettling a feeling as we had during the third quarter earnings season with the industry reporting good earnings in the face of a nasty credit market and investors running for the hills, the last three months have created more heartburn as stock prices have decoupled from all reasonable estimates of asset values. The KIMCO team, like all REIT managements, has another challenge to deal with -- to not allow an avalanche of negative sentiment and the piling on effects of bad news and its effect on stock prices to distract us from pursuing our strategies for long-term growth and value. For sure, the current market and economic conditions are not good and warrant skillful navigation, which compels us to use our flexible business model for maximum advantage. At this juncture, we continue to be focused primarily on protecting and maximizing cash flow from existing assets, maintaining balance sheet flexibility, and carefully evaluating opportunities so as to allocate our investment dollars to capture returns that compensate us for an increasing risk premium attached to our capital costs.

First, some comments on 2007. It was an outstanding year from a financial and operational standpoint, as evidenced by growth on our investment platforms in both the U.S. and Mexico in capturing handsome profits in our capital services business. We finished the year as expected, with a 17% year-over-year increase in FFO per share at $2.59, which was at the upper range of guidance provided to the investment and analyst community throughout much of 2007 and at the full-year consensus. With respect to some of the notes this morning about the fourth quarter consensus miss, I just wanted to point out the difference between $2.59 and the nine-month FFO of $2.06 comes to $0.53. It is unfortunate that the first quarter reporting process is mathematically challenged. Acquisition volume, excluding transfers among and between KIMCO and the joint venture has exceeded $2.2 billion. We started 10 new Mexican developments with an estimated project cost of $275 million, as well as 11 U.S. projects with an estimated cost of $225 million. Like the rest of the market, our U.S. activity was skewed through the first half of the year, whereas the Mexico investment program continued at an even pace throughout the year.

As to our current focus, allow me to comment further on each of the three areas I mentioned a minute ago. First, with respect to our existing asset base, I would underscore the stability and quality of the portfolio. Occupancy closed the year at 96.3%. Internal growth for the quarter was 4.1%, representing the eighth quarter in a row of 4% of better same-store growth. The spread on new leases for the quarter was over 23%, and when combined with renewals, showed growth of over 13%. We'd be kidding ourselves to pretend that a recession in the U.S. will not have an effect on portfolio, occupancy, and roll rover, but we feel it will be limited because of the quality and diversity of that portfolio in generally below market range positions.

Another reason to be confident that we can withstand economic stress in the U.S. is the balance sheet flexibility and liquidity we have in place, resulting from the actions taken over the past few months to expand our various credit facilities and bolster our equity base with a new preferred stock series, but also benefiting from the actions taken over the past few years to space out debt maturities on both the KIMCO balance sheet as well as our joint ventures and fund programs. Our annual debt maturities as a percentage of total debt outstanding range between 8 and 11% per year over the next three years, which includes the pro rata portion of the debt in our join ventures. Also, the maturing debt that is of the non-recourse mortgage variety, the loans and values of the mortgages to be refinanced are only about 45%, giving us further confidence of the ability to access external capital even if the CMBS market remains in its deep freeze for an extended period of time.

And the final point, using the liquidity to invest wisely and opportunistically will require us to be both patient and move quickly at the same time. We feel very confident about our ability of our portfolio and our recurring management team stream to withstand this downturn. We are also encouraged by our non-U.S. business activity and potential, where patience and discipline will be required as in the core asset-oriented investment funds in the U.S. as well as ground-up development. Countering that are the opportunities in new investments and reprice debt and equity, where we could use our experience and relationships to evaluate the long-term value of the underlying assets or business and to move quickly to capitalize on any mispricing.

Finally, as to 2008 earnings guidance, we have previously offered a range of $2.70 to $2.78 per share, representing an increase of between 4 and 7%, and we are maintaining those estimates. As always, the variable is a nature and extent of transactional activity, mostly in our capital services business. We recognize that our estimates always contemplate the realization of embedded value in our asset base in Retailer Services, KIMCO Select and Preferred Equity and other trading activities. A dramatic example this past year included $78 million contribution to FFO from our investment in Albertson's or almost $0.30 per share, which was significantly more than we expected from the first year of this investment. Recognizing that the earnings growth comes from the combination of our in-place shopping center holdings, funds management, new business generation, profits from merchant building and the capital services business, we have outlined each of the major assumptions in our earnings press release that builds to this estimate, essentially breaking down the EBITDA components between the major sources with relative contributions from in-place cash flow streams versus new business generation and other transactional activity. Regardless of our new business and transaction-related activities pan out, I'm particularly comforted by the fact that flows from our in-place asset base well exceeds what's required to pay our dividend and to continue to grow it over time. Our business is truly structured for what Milton once called income plus. And we have every confidence that with our access to capital relationships and track record, that profitable new business generation will continue.

With that, I will turn it over to Dave.

Thanks, Mike.

Before reviewing some of our new business accomplishments during the quarter, I'd like to take a minute and expand on one of Mike's themes -- the relative stability of the net operating income of neighborhood and community shopping centers. With darkening economic clouds, analysts and investors have focused on retail as being particularly vulnerable to a slowdown in consumer spending. We are asked with great frequency about science of retail weakness and associated cash flows. As someone who has spent most of his career lending and investing in all types of real estate properties and geographic areas, I sincerely believe that neighborhood and community shopping centers represent an attractive defensive property type during economic downturns. With relatively long leases and what Milton likes to say bond-like characteristics, shopping centers are relatively well-positioned in tough times. Hotels have to lease up every night. Self-storage customers average four months. Apartments have 12-month leases. And suburban office and industrial tenants generally have intermediate term leases of five to 10 years. On the shopping center side, anchor tenants sign 15 to 20 year leases, with multiple options and annual rollover is usually only 3 to 5% of the portfolio.

In our case, we have close to 14,000 leases with an average remaining lease term of seven years without options, and 22 years including options. Approximately 70% of our tenants by square footage are regional or national companies. Home Depot, our largest tenant, and many others, have strong balance sheets and will continue to pay rent regardless of a decline in their same-store sales. In our portfolio, we are also heavily focused on neighborhood and community shopping centers or big box discount centers, where our tenants tend to sell basic goods and services. The local grocery store, drugstore, barbershop, pizza parlor, dry cleaner, regional bank, Starbucks and deli will all perform relatively better than high-end merchants of luxury goods in an economic downturn.

On Tuesday this week, The New York Times published a front-page article which highlighted this concept by saying, "The return to reality is on vivid display at shopping centers, where consumers used to trading up to higher-priced stores are now heading to discounters. Wal-Mart and TJ Maxx are thriving, but business has slowed at Coach, Tiffany and Williams-Sonoma." Today's Wall Street Journal also chimed in by saying, "Some retailers are expected to fare better than others. Discounters, wholesale clubs and off-price retailers should outperform as consumers seek bargains. " At KIMCO, our tenants are largely in the business of selling staples and are oriented to local neighborhoods and trade areas. While not immune from the effects of a possible recession, KIMCO enters this downturn with record portfolio occupancy, long leases with many below-market rents, and a focus on neighborhood and discount retail tenants, which will all stand us in good stead. It is also worth mentioning that less than 5% of our FFO is related to our merchant-building activities in KDI.

Turning to new business, we are very excited about our new strategic alliance with Valad Property Group in Australia. The company is a blue chip organization which is significantly undervalued, and quite frankly, unappreciated due to the very public problems swirling around Centro. Similar to our joint venture with RioCan in Canada in 2001, we are joining forces with a high-quality firm in a new international market at what we believe is an opportune time. Like Canada and Mexico, we like the long-term prospects of quality real estate in Australia, and we particularly like the funds management business which Valad has successfully grown. KIMCO has a long record of investing in the debt and equity of public companies which are also our joint venture partners. In Canada, in addition to our Rio Can equity investment, we have purchased convertible debt and/or equity in other public platforms such as Plazacorp, Sterling Centrecorp, and Whiterock. In Mexico, we continue to have an equity interest in the formerly-public company, G. Accion. In our new Valad partnership, we see a terrific opportunity to accelerate our assets under management by teaming up with their funds management platforms in both Australia and the U.K. As we move towards the co-mingled funds model ourselves, we have much to learn from Valad, which has successfully introduced many value-add and core funds across the world.

With our emphasis on the U.S., Canada and Latin America, and with Valad's focus on Europe and Asia, we believe there is a wonderful opportunity to cross-sell fund products and form relationships with new investment partners. The Valad team is first class, and the company was a terrific customer at GE Real Estate while I was there. Two members of the GE Real Estates's Australian office in 2000 are now senior executives of Valad. And I strongly believe our organizations will work well together and enhance our respective business models. We are committed to truly making this a great deal for both Valad and KIMCO.

In Mexico, our strong momentum continues, and we have a record number of closings during the quarter. It is great to see the local operating partnerships we have formed over the past six years delivering opportunities across the board. As we have previously mentioned, retail in Mexico is largely a development opportunity due to the lack of existing high-quality shopping centers. As such, it has taken us years to form the right relationships with tenants, local development partners and landowners. We are now seeing these relationships deliver real results in FFO income. Across Mexico, we now own equity interest in 140 properties, comprising 21 million square feet. While competition is coming, we continue to feel very good about our head start and our strong pipeline.

As a final new business comment, I would like to point to KIMCO Select, KIMCO Retailer Services, and KIMCO Preferred Equity as businesses that should benefit from additional opportunities if the economy slows substantially. In Preferred Equity, we are already seeing better pricing and more opportunities as some of the traditional mezzanine competitors drop out of the market. In Retailer Services, our recent investments, albeit modest, in the bankruptcies of Levitz and Sofa Express illustrate the types of opportunities that may arise for us if major retailers have increasing difficulties. KIMCO has a long track record of being opportunistic in difficult times, and we have the experience and expertise in the bankruptcy process to successfully underwrite these opportunities.

Thank you. And now I'd like to turn to Milton.

Well, thanks, Dave. I will be very, very brief.

Notwithstanding the current credit crises and problems in the banking systems, there is substantial liquidity worldwide and there is substantial demand for hard assets. It is my view that this liquidity, coupled with long, relatively low long-term interest rates, will keep cap rates low for quality assets. I also believe that this disconnect between the market price of REIT shares and the underlying value of the real estate and REIT zone cannot continue forever.

Two other comments. We were successful in establishing Mexico Land Fund, which was very well-received by investors. We have launched a fund to invest in real estate in Latin America, other than Mexico. And this also is being very well-received. Secondly, I'm delighted that we will be establishing a strategic relationship with Valad. We have enormous respect for Steve Day. And I've always said that if I give you a dollar and you give me a dollar, we each, at the end of the transaction, have one dollar. But if I give you an idea and you give me an idea, at the end of the exchange, we each have two ideas. And so it will be with Steve and Valad and KIMCO, and I think good things will come. And finally, the current economic environment. I was a child of the Great Depression. It always pains me on a personal level to see unemployment difficulties. On the other hand, we have been through many cycles and have always done well in times of stress. We have the liquidity and talent to seize opportunities, and I am confident we will continue to deliver the goods. Now, if you let us know what's on your mind, we'll be happy to respond.

Operator, we're ready to take questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Christy McElroy with Banc of America.

Dave, you talked about the defensive nature of strip centers, but just with regard to small shops, have you had or do you expect an uptake in store closings and bankruptcies on some of the local or regional tenants, or those that are less well-capitalized?

Well, we're certainly are starting with a record occupancy for us, 96% plus. And we haven't seen it yet in either delinquencies or bankruptcies or shop closings. But I would expect from a common sense perspective, if the recession grows, that we will see some of that. But right now, we have not seen it.

Okay. And then, just on your development pipeline. Can you talk about your future pipeline? Do you see your pace of development activity changing over the next few years and have there been any changes in your views on where they're developed and what types of centers to build?

Well, in terms of our current pipeline, it is fair to say it is significantly slower than it was at this time last year. We are screening opportunities a little more selectively. We are staying away from some of the larger mixed use projects, where they are dependent upon a residential developer. And in effect, we are going back to some of the basics. So I would say, in all fairness, our pipeline is significantly less than it was this time last year. Most of our development right now is in Latin America and Mexico. We continue to see great opportunities with wonderful, wonderful partners. And though I expect in 2008, our development activity will grow in Mexico and it will drop in the U.S.

Great. Thank you.

Our next question comes from Nathan Isbee with Stifel Nicolaus.

Hi. It's Dave Fick here with Nate Isbee also. David, we had a chance to listen in on the Valad call, and obviously a very interesting investment for you with a very high yield. Can you talk a little bit more about their intended use of proceeds beyond initially just paying down debt?

Well, David, exactly initially, they will pay down the debt. And then, they will redraw that over time to meet their own capital budget needs. For us, it is more than just what we think is a good investment in a company that's been beaten down -- a good company that's been beaten down because of the Centro controversy. We truly believe that marrying up with them and teaming up with them in the funds management, that we can both enhance each other. They have investors that we don't have. We have investors they don't have. They have funds and co-mingled and joint venture opportunities that we don't see and vice-versa. So we are accelerating our plans to work with them. We've been talking with them for quite awhile. And we really feel that long-term, both of our successes are tied to the funds management business. This will help grow our assets under management worldwide by teaming up with them. And in many cases, I was very serious. They are ahead of us in some of their fund products then. So we are excited about this opportunity. And they are very good people that I've known for a long time, and we are going to make this work on both sides.

Great. Thank you. The reserve you took on the two preferred equity investments, can you walk through those, and also discuss anything else that you might have on your watch list there?

David, actually, those reserves were part of our Retailer Services businesses, which essentially is our just whole complement of mortgages and the debt component of our marketable securities and the like. And for us, it was just the reevaluation, knowing there are tough economic times to hear, providing some reserves against potential uncollectability. I am certainly not implying that there are some problems in the portfolio. But it certainly made sense with what's ahead of us to establish some reserves for accounts, treating it like a financing portfolio, which is what it is. And just for your other question, there is another reserve on the operating statement, which relates specifically to our development business. And again, we are evaluating and reevaluating the time frames for the completed development. We took a look at some of the non-retail components of some of the larger products programs, and we did an evaluation of recoverability. And on a few occasions, we decided to prudently take a reserve, recognizing that the timing and extent of some of these projects were going to draw out longer than anticipated. So really, that was the long and short of it, trying to acknowledge that there are going to be tough economic times and that we really needed to review all of our assets and conservatively evaluate them for full collectability and recoverability.

Do you anticipate readdressing and adjusting those reserves on a quarterly basis? And are there any development projects where you might have abandonment charges at some point?

The evaluation process is something which is integral to our control framework. And we do it every quarter. So at this point, we feel we are in a good spot, relative to our evaluation. But because of that very point, David, we will continue to evaluate. We'll monitor all of our projects and our financing assets. And if we see that there is additional reserves that are required, we'll take them, we'll disclose them, but I certainly don't see any material issues there. We are not abandoning any development projects. We are just taking a fresh look at all of our underlying assumptions in terms of length and carry costs and recoverability of non-retail components from our potential developers and the like, and just reassessing the carrying costs.

Right. Last question. Do you anticipate, given the current environment, being able to perhaps step up your opportunistic lending business?

Yes. Yes, we do, David. And we are already seeing that the number of inquiries have ramped up greatly. And some our competition that, quite frankly, we've lost a deal or two over the last couple of years, they are not in the market right now. So not only do we think we are going to get better pricing, we think we are going to see more opportunities this coming year.

Thank you.

Our next question comes from Christeen Kim with Deutsche Bank.

Hey, good morning. Going back to the development pipeline, I mean, based on the progress you are making, by the end of '09, 2010, could it be almost completely Mexico? Maybe some sprinklings of Chile and Brazil, and almost no U.S.?

No, I don't think that is the case. We still have wonderful joint venture partners across the country that continue to show us opportunities. And we will do them selectively. We are taking a harder look at development yields, but in general, these yield are still -- have a nice margin. If you can develop to a 9 to 10% and still sell the centers at 7, you've got a nice built-in margin. And we are just going to be careful that these projects are largely pre-leased and relatively simple projects. But we like the business, we are committed to the business, and we anticipate that KDI will continue to be a very important part of our business model.

Are the 12 to 16% yields in Mexico pretty sustainable for the next few years, though?

Well the 16 is probably a little high today. I would say most of the new projects we are approving are the unleveraged development yields that are somewhere between 12 and 14%.

Great. And my last question, David. You mentioned that on Valad, they are already ahead of you guys in some of their fund products. Could you maybe seek about what they are doing differently from what you are doing -- from what you are doing now?

Well, as a very general comment, we have emphasized core real estate in our joint venture and our funds. We have bought stabilized properties on behalf of investors like Prudential and GE and others. What Valad has focused on is what the market wants today, which is value-added funds, development funds, opportunities to make higher returns. We have started down that path ourselves with the Mexican Land Fund and some of the other co-mingled funds we are introducing. But when I say they are ahead of us, only to the extent that they have developed these value-added products and higher-return real estate products for years now, and they have the investors already for those funds. We're just entering that.

Great. Thank you.

Our next question comes from Jonathan Litt with Citigroup.

Hi. This is Ambika with Jon. All right, can you comment on the demand for core product? Last time we spoke, you mentioned that there is a lot of liquidity but it's currently on the sidelines. Are you seeing more a pick-up in that demand?

It's mixed. I think it's fair to say that in general, the core buyer has slowed down. Many investors that were active and very strong buyers of core real estate are on the sidelines and waiting to see which way cap rates are going to go. There's a general concern that the cap rates will move up and mark the market problems. So we do have investors that have told us for the time being on the core side that they are they are on the sideline. Having said that, we have sold some of our KDI projects recently to core buyers. So we know they are out there. [Callister's], for example, bought one of our projects recently so we know that there's core buyers out there and cap rates on first class product continue to be in the sixes. That's for sure. But I think it's also fair to say that core real estate doesn't hold a tremendous appeal, and the lower returns of core real estate don't hold the tremendous appeal it had over the last several years.

Okay. Great. And then, given that condition in the credit markets, could we see investments like the Valad investment in other regions? And could you specify what other regions you are looking at?

Well, obviously, we have invested across the board. And we continue to like being opportunistic in working with the good companies, whether they are public or private. So we'll certainly look for these kinds of opportunities. To date, we have stayed in the Americas, Canada and South America and Latin America. Australia is a new territory for us. Europe remains intriguing to some respects. We are not quite ready to go to India or China or anything like that. But we'll look over time.

Can you talk a little further about what exactly is looking appealing in Europe? Yes. That's great.

Well, as everybody has followed, the U.K. and other markets have had a severe price adjustment in terms of real estate and public companies that own real estate. So by definition, Europe has become more intriguing than it was perhaps six months ago.

Okay. Thank you.

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

Hi. A couple of numbers questions. First, Mike, I was wondering if looking at the interest dividend and other income line, it went close to zero this quarter. What happened sequentially?

The primary reason there is that we had no marketable security gains. And some of the other reserves that I had alluded to before are placed in that category, so -- at that line item. So it kind of brought that down to virtually a nil result for in this quarter versus sequential prior quarter and last year's quarter.

Okay. Okay. And then, [annuity] your breaking guidance out in terms of in-place and then incremental business. Can you put it in terms of KIMCO capital services as a whole? And just seven KCS did X millions of dollars and we are looking at a range of X to Y or something for '08? Is it possible to break it out that way?

If I break it out in too much detail, we'll probably go past the hour. I'm only paying for an hour here. But I guess I'm looking at KIMCO capital services, which really encompasses those three primary businesses and incorporate both recurring income flow as well as the transactional related activity. You are really probably talking a total on an EBITDA basis, about $250 million of the $1 billion of EBITDA. And as you look into 2008, there will be an increase, but it will be shifted much more towards the recurring flow as opposed to the transactional. I think one of the things we pointed out in the guidance ranges is that the comparable number for our new business and transaction-related activities is slightly lower in 2008 than we had planned, than we had showed for 2007. And the shift is that we are getting more flow in that KIMCO capital services business, primarily because of the InTown Suites transaction and the triple net lease portfolio transaction that we had closed during the summer of '07. So there certainly is an increase overall, but there is a shift from transactions to recurring. And that is not to say the transactional activity is not insignificant because we've laid it all out in the press release, but we are definitely shifting more towards the recurring pause even in the KCS business.

Okay. That's really helpful. Thanks.

Our next question comes from Michael -- sorry, Thomas Baldwin with Goldman Sachs.

Good morning, guys. Overall acquisitions trended downwards over the course of 2007. Can we expect volume to tick back up in 2008? Or is it safe to say that given the challenges in the market, acquisitions volumes both for your investment management programs as well as for the operating portfolio will be substantially lower this year than last year?

Well, it's certainly early. But if we look at activity today, it will be significantly lower than what we accomplished last year. Very early last year, we closed the Crow portfolio so that was in our numbers for last year even that was -- even though that was really an '06 transaction. So I would anticipate if the market continues to be a little frozen with sellers wanting yesterday's cap rates and buyers wanting tomorrow's cap rates and the difficulty in the debt markets and so forth, I think the number of transactions will be a lot less. And on the institutional side, they are still trying to figure out exactly the level of volume they want. So at least, based on our current institutional partnerships, we would anticipate a lower level of acquisition volume. And I think Mike has probably dialed in a lower volume.

When I made a comment last conference call that the look of the new business generation is probably going to be very different in '08 than it was in '07, and just using the example of the part of the Valad transaction with the dollars out, namely the convertible instrument that we with funded, that is A$200 million, that is going to be, I think, a little bit more typical at least for the next few months of the type of investment profile that we see, and not the aggregation of traditional core product for our investment management programs and the like. But to Dave's point, it is still early. There is a lot of things that are going on across all of our business activity. And as we sit here a year from now, the profile may be very different than even I'm thinking about now. That clearly is the short-term. You are not going to see a lot of what we'll call the bread-and-butter core acquisitions for our core fund programs.

Thanks, Mike. Thanks, Dave. One more question. You guys mentioned on the call that only about 5% of your FFO comes from merchant building. But as I look at your supplemental, it looks like your current development pipeline is pretty heavily weighted towards merchant building. Can you talk about the decision-making process surrounding developing for your operating portfolio versus developing on a merchant building basis, and whether if the market, in terms of demand doesn't meet your expectations, whether there would be a willingness to take some that merchant building product and contribute it to your operating portfolio?

It's really rather simple. In the U.S., our KDI business model is a merchant building business model. The only thing that has changed a little bit is we have looked at some of those projects and sold them into some of our joint ventures that we have with institutional partners. But in general, these are joint venture partnerships with local developers that are built on a merchant building basis, so when they are finished they are sold. Win, lose or draw, they are sold. And the only thing that is changing is some of the better projects where we can negotiate and buy out our partner at a good price. We will spend them into some of our longer-term joint venture so that we get both the building -- the development gain, if you will, as well as keep the asset long term under an asset management basis. In Mexico, it's really a build-and-hold strategy. We do not intend to sell our properties there. We like the FFO income. And as we pointed out before, the leases in Mexico have the upside of cost of living increases, they have percentage rent, things that we don't have in the U.S. which is a much flatter income stream. So for now, I think we are still that the KDI model is still a merchant build model and that Mexico is a build-and-hold.

It is possible that if we view development as a much longer process, we may create a development fund for investors whose time frame could be much longer. That is one of the things that we'll constantly explore and modify as the circumstances require.

All right, guys. Thanks very much for that color.

Our next question comes from Jeff Donnelly with Wachovia.

Good morning, guys. I've got a question actually for Dave and Milton on capital allocation. I'd love to hear from both of you on it and how you think about real estate returns. I guess in my perspective, there's been somewhat of a long-standing difference of opinion between the two of you around how you guys think about cap rates. I think Milton in the past has said that he felt the interest -- the industry would see low borrowing costs that would continue to place downward pressure on cap rates. And Dave, I think you always kind of felt real estate would retain its cyclical traits. How have your views changed and what is driving your capital allocation decision right now? How are you guys thinking about allocating money given that in the past you've had somewhat differing views?

Jeff, if you start with the premise that my job is to invest money people trust us with and spread to the cost of capital, it is very difficult find plain real estate -- or any REIT to invest in. So we start with -- and particularly, if we feel that cap rates will not substantially increase and that there won't be that spread. So what we have done is we have shifted to be an investor manager with a combination of the fees, and the returns are in excess of our cost of capital. So I think that Dave and I really are on the same page on that. And then, what we are doing in allocating capital, if we can find equity yields but in debt instruments where the underlying real estate are there and we can invest in yields in the teens, we are seeking those, too. So we are going to be fast on our footwork, and real estate can take all different forms. Dave?

Jeff, we are in heated agreement that in the future, because of our cost of cap, I mean, we are 70% equity, only 30% debt. We have to manage money for other institutions that have a lower cost of capital. Some of those institutions may want core stabilized shopping centers at today's cap rates and we will do our very best to find the very best properties for them and manage them and try to increase that income. Others may want higher-yielding products, as Milton mentioned, possibly even development. And we will try to form funds and joint ventures for those institutions. But we are both very much agreed, notwithstanding where the cycles go, notwithstanding where the cap rates go and the credit markets, that our long-term business is managing other people's money.

I guess, as a follow-up to that. I would have expected, Dave, in this environment you guys might have announced plans to maybe explore a large fund focused on assisting distressed retailers from what you have done in the past or overleveraged retailers which maybe is your preferred equity business. Is that the time for trying to do a specialized vehicle like that and how deep is the interest in that niche right now?

Well, historically, we have made so much money in those distressed opportunities, including Albertson's, that we'd prefer to keep those for our own shareholders. Longer term, yes, we might look at something like that. But we have done such a good job making money for our shareholders in those very much distressed situations and they are such higher yielding products. But for now, I think we are going to do them for our shareholders.

I'd just ask a second of Mike, actually. You know retailers are voluntarily and involuntarily rationalizing their existing store base. Can you give us a little more detail on what your expectations are for occupancy, lease termination fee income, and maybe bad debt expense for '08 versus '07?

At this point and looking at the projections for 2008, we just kind of looked at it from an occupancy and same-store growth perspective, and some same-store growth that we're expecting at about 4% incorporates what may happen in terms of some slower retailers shifting out or rolling out and then the downtime of potentially putting new ones in. So our occupancy level does not appreciate really at all. And in fact, the organic growth of the same-store growth is due to leases that have already been signed up, and it is just a question of either having started or will be started soon or reasonable expectations on what the rollover is and the renewal rates. So there is nothing terribly significant with respect to our expectations of the future, either for good or for bad, because a lot of what 2008 is all about has already been somewhat accounted for and taken care of.

So you are not modeling deterioration in your occupancy or loss of tenants, per se?

No. I mean, there is always going to be expectations of tenants leaving and the downtime. And on the margin, we have increased the amount of downtime in terms of that rollover. But we are not expecting any significant deterioration in occupancy or declines in rents. Because remember, Jeff, I mean as a basic principle, most of the rents that are rolling over are low market. And there has always been that shock absorber, that cushion dynamic, that we and others in the neighborhood community shopping center sector have experienced. So that's why we feel confident that we are not going to take any sort of significant hit on our portfolio, even if there is a downturn. We built in those expectations and we still feel pretty good about where our growth trend is going to be for' 08 on the core portfolio.

Thanks, guys.

(OPERATOR INSTRUCTIONS) Our next question comes from Jeffrey Spector with UBS.

Good morning. Dave, you mentioned that cap rates for a first quality product is in the sixes. It seems a little high according to the transactions I've seen. Can you comment on that a little further? And then, I guess, just give us a feel for how far that cap rate has moved from peak pricing.

Well, I think it's fair to say cap rates have moved even for the highest quality. But we have seen transactions close at the low six levels. We have sold them ourselves and we compete for high quality properties. It is fair to say that the total number of transactions, the volume of transactions, has gone way down. When I mentioned the [Callister's] sale we recently did, that was in Boise, Idaho in the low sixes. So if first class retail is selling in the low sixes in Boise, Idaho, that still gives us some confidence that there is core buyers at these lower cap rates. We don't know what tomorrow will bring. And it is fair to say the debt markets are in turmoil and people are having trouble borrowing, so that may have an impact. But for now, we can't tell you that cap rates have increased substantially on first class real estate. We haven't seen it.

Okay. That helps. Thanks. And then, can you talk a little bit more about Canada?

Sure. Canada remains a country we want to continue to invest capital for the long term. In many ways, it's much stronger than the U.S. They have a surplus, they have a trading surplus. They have a relatively strong economy. The only thing that's hurting them a little bit today is their strong Canadian dollar, which has hurt their exports a little bit. But their markets, especially in retail, are very strong with high occupancy. Our RioCan portfolio is about 99% occupied. We've had great rent growth up there. We've got some strong relationships and strong joint venture partners. We announced going over 10% equity ownership in Plazacorp. We like those people a lot and are looking at -- actively looking at deals with them, as well as Sandalwood and some others. So we continue to look opportunistically. Their credit markets have changed a bit. Their CMBS market has totally disappeared. It is rather amazing. So that should lead to some opportunities for us. So we have an office there, we have people there, and our job is to find some opportunities to continue to put money out in Canada.

Great.

With a long-term market force.

Great. Thank you.

Our next question comes from Steve Sakwa with Merrill Lynch.

Thank you. Good morning. Dave, could you just elaborate a little bit more on sort of the Valad acquisition and sort of maybe how it came about, timing, who approached whom, and how much due diligence did you really get to do before you decided to make the investment?

Okay. Well it goes back 10 or 11 years when Steve Day and Valad were customers of mine at GE. And they were our largest customer for a period of time in Australia and our transactions were very successful and very profitable to GE. We did participating loans with them. They bought B office buildings in Sidney and other markets and created value by making them A buildings over time. About three years ago, I ran into Steve Day in London at a UBS conference. We started talking. We bought a few shares of Valad, and I expressed our interest in maybe doing something bigger with him over time. Milton and I both talked to Steve about a year ago at the city corp conference in Florida, and I think we both continued to get comfortable with them and also expressed the desire to do something with them a year ago. In December, this was after the Centro situation and their stock have been [pummeled], Steve did reach out to me and we started talking about a possible transaction and that's how it came about.

In terms of due diligence, we did quite an extensive amount of due diligence. And we sincerely believe the company is undervalued in many respects, and we are very comfortable with our dead instrument and the upside probability embedded in the conversion of feature. And an added plus is that fact that we are going to learn together and grow together on our co-mingled funds business. For me, it is a wonderful opportunity to get back together again with a good customer who really knows what he is doing in a good international market. I mean, Australia is very similar to Canada. It is a resource-rich country with good economic long-term prospects, landlord-friendly laws, English-speaking, so forth, so it is a good country for us to go to.

Yes, I guess form a valuation standpoint. I mean, it looks like a very good deal for you. I guess, the question from their point is can they put that money to work creatively over time and I guess time will tell.

Don't be fooled by the 9.5% interest rate too much. Interest rates are a lot higher Australia. So for them, they are not losing that much by paying down some of their short-term debt temporarily while they look for their longer-term opportunity. They have a business plan and they have a good business plan. The Scarborough acquisition was something, quite frankly, that was impressive. They bought a money management business oriented towards the Europe and U.K. with many existing institutional customers that are good customers. They have the products those customers want today, the value-added products. And I mean, we saw it when we introduced our Mexican Land Fund. This is what institutional investors in real estate want today. They want the higher yields. They are saying if they are going to stay in real estate, they are willing to take a little more risk but they want a higher yield. Those are the products that Valad already has. Those are the products that we are trying to introduce ourselves.

Okay, thanks. And then just a follow-up on a comment that Mike made, it sounds like you are not pursuing core acquisitions, but looking for, I guess, other potential opportunities like Valad. Is it fair to say there are other potential [things] like this maybe in the works? And if so, would they be more domestic-focused or internationally-focused?

Let me take a stab at that. We are not exiting the core acquisition market at all. We have a number of good customers, including SCB bank group, which we continue to look actively for portfolios for them. Europeans look at our cheap dollar and say, maybe it's not a bad time to buy at all. So we do have customers that are looking for core real estate. We just are acknowledging that the level of that activity will be a lot lower than the $6 billion we did in '06 and so forth. It's reasonable to assume that the level of activity is going to be lower. But it still represents a business for us. We have an acquisition team that is out in the market. We see most things today, and we have some good partners. So that's going to continue to be an activity for us. I think Mike was just commenting that when you see big dollars of our own capital being put to work, it may be more at situations like this. Even when we are actively in our core real estate, our co-investment is relatively low, 15% or so. So we are not putting a lot of our own dollars to work, even when we have heavy acquisition of core real estate.

I guess, is it fair to assume that other opportunities like this are being pursued? Or was this really viewed as a one off type investment?

I tried to explain that Valad was very similar to things we have done in the past, with RioCan, with G. Accion and others. So we continue to always look for good partners and good deals.

All right. I want to go to the next question.

We've got two more.

And our next question comes from Steven Rodriguez with Lehman Brothers.

Dave, just a follow-up question on Valad. You have mentioned that you have been looking at opportunities everywhere. Obviously, you are concentrating on Latin America and domestically. Are you precluded from looking at any of Valad's concentrations, whether they are in Australia or Europe or anywhere in Asia?

No. No. One of the things, in addition to sharing institutional investors and products, is the idea of co-investing with them. In fact, we are going to look at some co-investment opportunities with them in Australia, as well as Europe and some other markets. So yes, we fully intend to use their expertise to look at opportunities in the markets that they have experience in.

Is there any one market that you are favoring more? Europe versus Asia? Or it could be either one?

As we mentioned, Australia is intriguing to us. It is a good time to invest. But they have had some turmoil in the UK as well.

Okay. Great. Thanks.

And it appears that our final question comes from James Sullivan with Green Street Advisors.

David, with respect to the merchant building business, you talked about developing to a 9, selling at 7, creating a sizeable margin. With respect to that, when I looked at your KDI margin for the quarter, it is something under 10%, which seems surprisingly low, especially since the majority of the proceeds came from [Napa] where I think you said the cap rate was in the low sixes. Can you comment on the margins in KDI for the quart officer.

You have to understand a couple things, and Mike can jump on me if I don't say them exactly right. But first of all, ours is a joint venture model. We do not get 100% of the profits. We share those profits with a partner, generally 50/50. We get our capital back, we get a preferred return on that capital, and then we split the profit. Secondly, these are done in our TRS subsidiary. And there are taxes that need to be paid on the gains. So the net amount that actually we book as income may look like a smaller margin. That doesn't change the fact that these projects are built at a 9 plus and being sold at a 7 or less.

I think Dave distinctly summarized the economics of the deal. It's one of the reasons why merchant development is not a significantly large contributor to the overall FFO base. But as Milton suggested earlier, it is a business we still want and like to be in and we still -- that over time, it will continue it add the raw material into our investment management programs. That's our business model.

So after your partners' participation, after taxes, 10% margins are sort of what we should expect from what you have in your pipeline today?

Yes. Now remember that the reason we are very comfortable giving half of the profits to a partner -- the partner is the guy that finds the opportunity, generally buys the land, carries the land, takes the land through an entitlement process, gets an anchor lease in place, all before we fund. So we believe we have much less risk with our joint venture model. Plus, we are teaming up with people that have experience and expertise in their local markets. We don't believe that we can parachute into Tucson, Arizona and know all about developing in that market. We'd much rather team up with somebody who's been in Tucson for decades. And so we like our joint venture model, and that is the economics of it at the end of the day.

My second question relates to your record high occupancy. Was that something you achieved deliberately in the expectation of a slowing economy? And then maybe, can you share your philosophy with respect to increasing occupancy versus the alternative of perhaps being more aggressive on rent growth?

Well, obviously it's an objective across the board for us to have the highest possible occupancy. Vacant space is something that is not producing income. So we are very focused on it. It is fair to say that we have had some benefit in terms of our occupancy and our record occupancy by deliberately, over the past several years, selling down the bottom part of our portfolio. Historically, we were never particularly good sellers. We thought we could operate everything ourselves. But beginning two years ago, we intentionally focused on selling the bottom parts of our portfolio. And luckily, we sold them into a very hot market. And we are now seeing the benefit of selling some of our more problem properties that had lower occupancies and they are not in our portfolio any more. So we've got a better portfolio with higher occupancy because we have sold some of the bottom out.

And if there is any thought that we are somehow giving away space to puff up an occupancy number to make up a nice headline out to dispel any concern that you might have, our job here is revenue maximization. And that is a combination of getting vacant space lease and trying to get the highest rents possible.

Okay. Thank you.

And it appears we have time for one final question from Rich Moore with RBC Capital Markets.

Hi. Good morning, guys. Actually, a quick follow-up to what Jim was asking. Are you offering any concessions or are any tenants that are in place currently -- not new leases, but currently in place, are they looking for concessions from you guys? I mean kind of whimpering that it is a tough environment and they'd like to get something from you?

I think anytime -- this is David Lukes -- anytime the newspapers say that retail sales are down and then some of the local retailers call and say, "My sales are down." So it is a fairly common event and it usually happens every time there is news of some submarket that has issues. But the realities for a landlord to offer concessions for an in-place tenant usually requires that they show you their sales for the last year or two. And there have been more requests in the last 60 days than there were in the 60 days prior to that. But when you sort through the real ones, they are pretty few and far between. And the only ones where a concession is made in the last on 30 days would be shops that are fairly small in square footage, and they happen to be in a center that was relying heavily on some housing growth. And as you all know, our portfolio is primarily in mature markets, and it is really not very much in the high-growth residential markets. So because of that, the shops bases and the anchors are fairly stable. And it tends to be more of an [in-place] portfolio than it does new product portfolio.

I think we're done.

Okay. Thanks, everybody for participating today. And as a reminder, our supplementals are on our Web site.

That does conclude today's conference call. You may now disconnect.