NNN REIT Inc (NNN) 2004 Q3 法說會逐字稿

Good day everyone and welcome to today's Commercial Net Lease Realty Conference Call. This is the Third Quarter Earnings Conference Call and today's call is being recorded. For opening remarks and introductions I would like to turn the conference over to the CEO and President, Mr. Craig Macnab. Please go ahead, sir.

Thank you. Good morning and welcome to our third quarter 2004 earnings release call. My name is Craig Macnab and I am the Chief Executive Officer of Commercial Net Lease Realty. I have with me on this call, Kevin Habicht, our Chief Financial Officer who will report on third-quarter financial results and then I will follow Kevin's remarks.

Thanks Craig. Let me start with typical boiler plate, that we may make certain statements that may be considered to be forward-looking statements under Federal Securities Laws. The company's actual future results may differ significantly from the matters discussed in any forward-looking statements and we may not release revisions to the forward-looking statements that reflect changes after the statements are made. Factors and risks that could cause actual results to differ from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and this morning's press release.

With that, good morning, as indicated in the press release, FFO was $19,525,000, or 38 cents per share for the third quarter 2004. That compared with 37 cents for the same period last year. Third quarter's 38 cents also compares favorably with the 35 cents for the second quarter of '04 which excluded the previously recorded management and transition charge of 6 cents. Total revenues for third-quarter were $33.4 million. That represented a $5.7 million increase from a year-ago. The increase in total revenues is primarily results of increased rental revenues as well as gains on sales which I'll talk about more in a minute. Rental revenue increased 10.8%, or $2.8 million. Largely due to the acquisitions we had made in the 2003, including D.C. office properties. Total occupancy was 96.5%, which is down ten basis points, but rounding ten basis points from the immediate prior quarter. The real estate expense reimbursements increased largely due to lower security reimbursements on our D.C. office property, which our tenants now paying directly for those expenses rather than reimbursing us.

The gain on properties held for sale in our revenue section increased $2.4 million. This gain came from the sale of one property in our taxable subsidiary. Additionally during the quarter we sold five properties from our core portfolio, with 21,000 square feet of GLA, with average cap rate in the mid-8s. These were primarily restaurants properties and a part of our ongoing portfolio pruning. And that particular gain on those five properties are included in our discontinued operations. Unfortunately, GAAP is requiring us to report our gains on sale of properties somewhat, in my opinion, a little confusing way, but let me explain it. The gains on sale in our properties which were developed or acquired in our taxable sub are now reported in two places. If rent had commenced -- if rent had not commenced when we sold the property, it gets reported in the revenue like this quarter's $2.4 million I mentioned. If rent has commenced before the time of sale, it gets reported in discontinued operations. Again, I apologize for that, but that's GAAP. As we have indicated, there's going to be some choppiness in this number from quarter to quarter, depending on the timing of sales. Lastly, interest income from real estate transactions increased $1,158,000. This is largely related to our mezzanine loan investment made in October 2003 on a California office portfolio that we had discussed on previous calls, and it's offset by a one time development fee in last year's third quarter of $550,000.

G&A expense was $5.8 million for the quarter. That's up from 5.6 million the year-ago period. As we have previously mentioned beginning January 1 of this year, this line item includes all the G&A from the REIT and our development and acquisition activities and our taxable sub. We expect G&A to be approximately $22.8 million for the year. Property expenses increased to $2.9 million, compared to last year's $2.5 million. This increase was pretty much evenly split between our Washington, D.C. office buildings and all of our other properties combined. In other expenses in revenues, again, this is broken out from the other income and interest income from real estate transactions as a result of some GAAP accounting change.

The interest in other income was 1,000,238. That represents primarily interest from one of our taxable sub entities as well as interest on a note in some third party management fees and development fee income. The increase from 2003 was largely attributable to interest income from our taxable sub. Interest expense increased $1.8 million from year-ago levels to 8.6 million as a result of higher outstanding debt balances and let's less short-term floating rate debt. That's [9304] or 48 million or 8% of 573 million of total liabilities was floating rate debt. This compares very favorably with 31% a year ago. And floating rate debt as a percent of total gross assets, which frankly I believe is a more meaningful metric is down 3%.

The equity of earnings from unconsolidated entities was $1,155,000, that's down from prior year amounts but fairly flat with prior quarter amounts. With our taxable sub, consolidated into the REIT as of 1/1/04, this line item really represents two things. One is interest income on mortgage investments that we have made that are held in LLCs which are capitalized with 100% equity, as well as our 25% equity interest in our headquarters office building and we expect this line item to be fairly consistent over time.

Lastly, with regard to the P&L, let me just talk about guidance for 2004. We previously provided FFO guidance of $1.39 to $1.42 for 2004, which included the previously discussed $3.2 million charge connection with the senior management changes made and recognized in the second quarter. Adjusted for this charge, FFO guidance would be $1.45 to $1.68, a 6 cent delta, which we are not revising that guidance. We continue to evaluate a range of things, alternatives at the company to improve these results. The acquisition environment continues to be difficult, and Craig will talk more about that. We currently see 2004 acquisitions of $85 million to $100 million. The market for disposition of properties, we've developed or acquired for sell continue to be robust and we expect good gains for the balance of this year. This is in part has made up for some of the lost earnings from our lower acquisitions volume in '04. For 2005 we are providing initial FFO guidance of $1.48 to $1.52 per share. This value is based on portfolio acquisitions, investment properties of $150 million, dispositions of $30 million to $40 million, modest improvement in our taxable sub operations in terms of gains on sales, and G&A of $23.5 million. These projections are based on a number of factors and uncertainties discussed in our public filings.

Moving to the balance sheet, there was little change in the capital structure during the quarter. We finished the third quarter with total liabilities of $573 million, that's up $10 million from second quarter '04. Of this amount, $161 million was mortgage debt. Approximately 22% of the company's total assets are encumbered about mortgages leaving 78% of the company's assets unencumbered. We do not anticipate encumbering additional assets at this point in time. Total debt total to total assets on a gross book basis, which is the way we look at it, is 40.9%, which is up slightly from last quarter's 40.7%. I know a number of investors look at on market, on a market cap base leverage was 37.7%.

In terms of coverages excluding the transition charges from earlier in the year, our interest coverage for the third-quarter, was 3.6 times, fixed charge coverage was 2.8 times for the third quarter. We're pleased with these levels of coverages, but expect them to probably moderate a bit with rising interest rate.

In closing, as I mentioned, the acquisition environment is not exactly what we would like, but we're redoubling our efforts to improve the long-term operating performance. The company is in good financial position and the core property portfolio is performing very well. We had a very solid portfolio of properties and equally solid capital structure. Our challenge really is to grow the bottom line for share results and we're optimistic we'll be able to deliver on that in 2005 with a moderate amount of acquisitions.

That's all I have for now. I'll turn it back to Craig.

Kevin, thank you very much. I'm pleased with our performance in the most recent quarter. Also, based on what we know today, I'm encouraged about the fourth-quarter, and more importantly, the outlook for 2005.

As you heard from Kevin, the initial guidance that we're providing for 2005 does suggest FFO per share growth, which is a positive departure from the trend of the most recent years. As we evaluate our strategic plan in business for 2005, we are refocusing all of our energies and those of our team on the retail marketplace. Our focus on retail real estate is consistent with our core competencies and the expertise of our experienced associates.

In the most recent quarter, we acquired 11 properties for 25, slightly over $25 million at a weighted average cap rate slightly in excess of 9.75%. As Kevin discussed earlier, the acquisition environment continues to be difficult, but as we increasingly focus on a broader universe of retailers, including more opportunistic retail real estate, we are seeing a number of interesting transactions. At the present time, we are pursuing a couple of small portfolio transactions. Based on what we know today, I am encouraged that between now and the end of the year we may be able to announce at least one of these transactions.

Our development group had an excellent quarter and continues to execute on budget and the visibility for that business in the current quarter and for 2005 looks promising. Our development business is a small, well managed unit that focuses primarily on single tenant opportunities, including a significant amount of drugstore development. We're gradually expanding the type of development projects that we pursue to include small number of multi-tenant retail development projects. In the third-quarter, a healthy component of the gains that we generated from our development operations came from the sale of multi-tenant projects. Realized gains from our development division will be difficult to predict on a quarterly basis but as I indicated earlier, I'm encouraged about the pipeline of projects we have either under review or in development.

Lori, with that we'd like to answer any questions that people may have. Thank you very much.

Thank you. The question and answer will be conducted electronically today. If you would like to ask a question, please press star one on your touch tone telephone. And just a reminder that if you're joining us on a speaker phone, make sure your mute function is disengaged so that your signal may reach our equipment. Once again that is star one. We'll go first to Michael Dillerman with Smith Barney.

Good morning, John Litt is here with me as well. Craig, I want to know, you sounded like you're going to redouble your efforts now focus primarily on retail, although broader in the universe. Does that mean you will pare back some of the investments you have made?

I'm not sure about that. In our office portfolio we have two assets, by far the biggest is the acquisition of the TSA building in Washington, D.C. with the benefit of hindsight, it was an excellent acquisition given the cap rates that prime Washington real estate is going for. I think right now we're pleased with the performance of that assets, and it's something we talk about internally every day, but right now we're probably going to stay with those two office assets that we have, Michael.

How much do you think cap rates have come in since you bought that asset? If you were going to market it

Solidly 150 basis points in about a year.

If you're presented with some larger portfolio transactions would you use that to fund expansion of retail activities?

It's certainly an opportunity that we have and will consider.

Looking at the held for sale, you've got $63.5 million, can you give us a little bit of color what's contained in there and the timing of potential gains that may hit FFO?

Sure. The inventory that sits in our held for sale category, as we discussed really have two components, one, properties we've developed for sale and others we have acquired for sale, either bought a larger portfolio and we're going to keep some, sell some kind of thing. In the development side of the equation, we have about $43 million worth of properties in the completed -- in the acquisition inventory, if you will, there's about $20 million. So 43 and 20 roughly in round numbers. Included in the development portfolio would include a couple of completed drugstores as well as a small center in Jackson, Tennessee, and the pipeline under construction are a couple more more drugstores, a Best Buy, PetsMart kinds of properties in a small center in the Denver area. In the acquisition inventory, if you will, it consists primarily of several drugstores, Rite-Aids that we acquired in the past quarter that we are remarketing for sale. The timing on those, it's a little difficult to predict. We try to manage that from a global perspective. We think next year's gains on sales will slightly exceed this year's, but the timing of individual asset sales is tough for even us to predict with great precision.

The total gain that you're expecting for 2004?

The total gain on sales from 2004 would be in the range of about $13 million to $14 million.

Okay. Just one small question on the lease expiry schedule. Looks like 2005 went up from two properties to six. I was wondering if that's a factor of renegotiation of leases or is that stuff that you bought?

Some of it we bought. There's a couple of them, I think, very small, it's all very small, 2005 we have very little maturing, I think it's about a half million dollars of annual rent, and I think a couple of were it was vacant properties where we just have short-term leases.

Great. Thank you.

Uh-huh.

And moving on our next question is from Banc of America Securities, Ross Nussbaum.

Good morning.

Hey, Ross.

First question on the cap rate on acquisitions during the third quarter of 9.75%, can you give me color on the types of assets you acquired? It seems like a pretty high cap rate.

It's significantly influenced by one opportunistic purchase of a small portfolio of drugstore-related properties, and it's just a function of being in the right place at the right time.

What kind of credit is this drugstore? Seems to me it would imply a weaker credit, that kind of a cap rate.

It's clearly not Walgreens, yeah.

Kevin, on the accounting side, can we go over the TRS again an the gains? It is showing up in different pieces. I want to make sure we're understanding it correctly.

Sure

Does the 2.4 million gain on disposition, that was that one asset, that was a development asset where income was not flowing yet, correct?

That's correct. I would typically view that in the real estate held for sale bucket, if you will, and so part of a sub activity.

Then the equity in earnings, you said interest income and what else is in there?

Largely interest income plus our 25% share of this office building which we occupy and own a portion of.

And then the gains on properties that you've acquired that you're holding for sale, part of that is showing up in the 2.7 million number?

The 2.7, which?

The real estate held for sale under the discontinued operations. Because it looks like you didn't add back, I'm trying to figure out --

Yeah, the real estate held for sale under the discontinued operations, that's the net number and second page or the next page of that gives you detail of the revenues and expenses related to that 2.762 million, which is kind of a net earnings from discontinued operations on real estate held for sale.

So the $7.4 million gain there --

Is embedded in that, yeah.

That is in FFO?

That's correct. We've always on our merchant building and [foot] business, properties held -- acquired with the intent to sell, we've included in FFO. Properties that came out of our portfolio held for investment do not get back down of FFO.

Okay. Why the large minority interest line both there and on the consolidated income statement?

Two of the properties that we sold during the quarter were actually a part of a joint venture with a developer in which we may have owned 40% to 60% interest in the project. You're seeing the gross gain number and significant back out, via the minority interest to offset the partner share.

Sorry for beating this to death. It is a little confusing.

I apologize. It is confusing. We've tried and we'll maybe try to work on a better reconciliation as a supplemental disclosure, but it's unfortunate twist of GAAP fate here I think makes the income statement a little difficult to follow.

If I'm reading this correctly, you said 13 million to 14 million of gains for the year, kind of what you're expecting from the TRS?

Yes.

About 4 million has showed up for the nine months ended, up in the revenue line. And then there's another 5 million or so down in discontinued ops, so should we read there's another four or 5 million expecting to come in the fourth quarter?

That's what I was talking about for next year, really. I think this year there will be another significant amount of gains in the fourth-quarter.

Okay. I think I've got you. Thank you.

Ross, just staying with that question for a second longer that you asked earlier, about the cap rates. As we focus on broadening the categories of retail properties that we evaluate for acquisition, we are clearly looking to move the average cap rate up, which means that to your question earlier, not all of these properties will have have have perfect credit. However, we're going to continue to underwrite these very cautiously and carefully, location, market rates, etcetera, the rent coverage and those types of factors are items that could take into account. We were very pleased with the cap rates and the risk adjusted return that came out in the most recent quarter. Just to say one more thing on that, obviously as we migrate this number up higher, it becomes less necessary to have large volumes of acquisition to grow FFO per share.

And moving on, we'll go to next to Paul Puryear with Raymond James.

Hey, good morning.

Hey, Paul.

I guess my first question is an extenuation of what you were just talking about, Craig. Could you give us more color on the cap rates on more specific properties? In other words, if you took out the drugstore portfolio, what were the cap rates and sort of where do you think the market is and what kind of numbers do you think you can achieve going forward?

Well, Paul, it obviously depends on the specifics of the property and the market it's in. But just to spend a little more time on how we got to where we ended up in the most recent quarter, that drugstore portfolio, which had a number of moving components, was well north of double digits. But I think more specific -- which dragged that whole weighted average number up and represented about 25% of the purchase price of the portfolio in the most recent quarter. You know, I think going forward, we are striving to produce cap rates that on a weighted average basis, that come in in a range of somewhere between 8.5 to 9.5% over a period of time. And -- we're not going to get there by buying Walgreens. In the current environment where credit is available, people are putting -- in big amounts, cap rates for high credit tenants, are very, very aggressive.

So is that in a property that's a similar size to the historical targets, that medium box tenant? Obviously your tenant profile of what you're buying is changing if you're going to get cap rates like that versus what Commercial Net has gotten historically. But is it the same size property?

I think generally, yes. But let's spend a little more time on it, Paul. We are clearly adapting and changing, there's no doubt about it, that is a starting point and you need to be very aware of that. We are clearly adapting and changing in the new environment. We're continuing to focus on having a high quality retail portfolio. The size of properties, the most competitive segment right now is the low-dollar amount, small credit tenant type of property that drugstores personify. Cap rates of those, we're very blessed that our development team has done a good job of originating a healthy amount of drugstore projects that we're able to sell and produce the types of gains that we have this year and are encouraged that we're going to do next year in that environment. So as we look to grow the portfolio, we need to find alternative types of categories within retail. But they are not identical to the types of tenants that make up the bulk of our current portfolio.

Are you prepared to talk about that some more this morning? In other words, defining the categories, for example? Are you looking to go back into restaurants and sort of, you know, can you talk about the categories that you see here on the horizon?

Yeah, Paul, we're happy to do that. I think restaurants clearly is a category is not a near-term focus of ours. We're pleased with the amount of restaurants that we currently do have. If anything, at the margin we've been trimming that back. Kevin mentioned that we did sell a number of assets in the most recent quarter at cap rates basically in the mid -8s. Several of those were restaurants that frankly from a credit standpoint, a risk standpoint, we felt it was just prudent to sell them into this current environment. But as we go forward and evaluate types of categories of retail in the more opportunistic areas, there are plenty of them. They include, for example, two categories that we talked about I think on the most recent call include convenient stores. The other is automobile dealers. Again, we don't expect to become the dominant player in any of these sectors. We did add an automobile dealer in the most recent quarter from one of the major national public companies that operates in this segment, just a small incremental acquisition in the context of our portfolio as a whole. It came in at an attractive cap rate. Convenience stores, we have not yet made an acquisition in this segment. We've pursued a couple. We've come close. And expect going into 2005 that we'll have additional opportunities. And then there are some other types of categories that we're targeting.

Okay. If I can ask one more question about your development sub. If you could just lay out the model to us, Craig. I know I mean you're obviously new and changing some things. There was a historical model that kept "X" number of people at a G&A run rate of Y and a pipeline of X that was going to create X amount of profit. Can you kind of run through that math for where you see that going?

I'm not quite sure I'm able to quantify it as precisely as that. Let me tell you how we're doing it which might be different from what you want. We're very focused on what the pro forma yield based on the all in dollars will be on any project that we evaluate. If it's a free-standing drugstore for a credit tenant, that number is clearly lower at that level of risk than it would be for a small multi-tenant operation or development with a credit tenant as the anchor. For that latter type of category, to me it need to have double digits pro forma types of return. In the current cap rate environment, if you accomplish that of that yield, all else takes care of itself because that spread right now is sufficiently wide. I think in a more normalized environment, we're probably going to need to have a spread there of at least 150 basis points in order to satisfy ourselves to proceed on a project. In terms of the number of people, I think we are making a couple of changes of a gradual basis. We're probably going to add, in the next couple of months, one experienced development director to pursue projects that have a little more complexity than free-standing single tenant projects. Obviously all of this needs to -- these types of returns I'm talking about are after an allocation of overhead.

Not to belabor the point but to we understand it, in the G&A run rate, the carrying cost for that business is how much and how much would you expect to make on an annual basis?

Let me, I guess speak to that. I think this probably -- it's not necessarily the best way to look at it as a totally discreet business. The acquisition and development activities, we do to flip properties as well as invest in the properties in the REIT portfolio are the same groups of people. So it's not a discreet business that has, you know, costs directly associated with producing gains and then there's costs associated with acquiring properties for our portfolio. Having said that, I think if you look at our G&A, probably a round number is probably, you know, 40% of our -- 35% to 40% of our G&A is in that activity. But like I say, that comes to the benefit of our involvement portfolio as well as these gains. I think for longer term historical perspective, Paul, you probably remember a few years back, we had I think some question as should we be in the business of flipping properties for gains. We had a concentration of Eckerd drugstores at a time when Eckerd started to have heartburn that obviously all turned out well. But we realized we needed to be more diversified in that particular business. We took corrective actions there. It's now producing gains that are very significant and exceed its G&A. So this -- we view the company, the core activity of our company is to acquire properties and collect rent. The core is not to create lots of gains on sales and I guess we could do more than what we're doing now. But we're trying to produce a level of gains that covers overhead and then some a little bit, but it's the icing on the cake and not the cake. So I don't know if that helps.

Just add one more piece to it. Historically, we have not developed projects for long-term ownership in the REIT. And I think going into 2005 we hope to begin to change that

Okay, so that's a change. Alright, we can talk about it some more later. Thank you.

Thank you.

Our next question is from David Fick with Legg Mason.

Good morning, gentlemen.

Hey, David

You said something I'd like to pursue a little bit further if you don't mind. You talk about bring in a development director in the next few months, for some more complex projects. Would those be, for example grocery anchored shopping centers?

No, sir. We're really not going down that path. The particular individual that we're pursuing has had some experience in doing free-standing single tenant development, including drugstores, but including a couple of other categories or other lines of trade within the retail sector. It's somebody in a slightly broader experience. This person's background once upon a time was actually at a grocery developer, but that's not where we're going. Just to stay on it, David, a little bit more, as Kevin mentioned in his discussion of the accounting, our development function has successfully partnered with other developers at points in time, as evidenced by the discussion of that minority interest on the gain in the third quarter.

Right.

That's a program that we plan to continue and we're having some success in that segment.

Okay. Great. Can you talk a little bit about how your sourcing deals right now, what's different about your process, how you're staffed to source deals? Everybody seems to have an ad in virtually every journal. Bringing triple net bought here kinds of signs out there. What are you all doing in terms of that pipeline?

We -- as we adapt to more opportunistic -- obviously we've got a significant presence which we've built up over a number of years of marketing to the traditional distribution channel for these types of properties. We're going to continue with that. However, that segment, obviously, is the most price competitive. And that's an area which, I won't say we're de-emphasizing, but we're looking to augment and add other layers on top of it, which include targeting different segments and making direct calls on some of the retailers in these types of areas, attending trade shows where they're participating and so that's illustrative of where we're going there.

And you have an acquisitions group that is tasked with those sort of new responsibilities?

We do indeed. And it's well underway. And we hope to be able to announce some of the fruits of that in the near term. As I mentioned, we're looking at a couple of portfolio transactions as we speak, and we're cautiously optimistic in the next couple of months we'll be able to announce the first of these. These are small portfolios. Nothing that's going to totally change the risk profile of Commercial Net Lease Realty.

Well, okay. And that leads right into my next question, which is, you know, NNN historically has focused on quality location with very high land cost where there would be an alternative use should there be any credit issue. There was a blip in credit about three years ago and a need to in fact re-tenant. It wasn't even a lot of -- maybe a dozen or so sites. But that stood you in good stead. I guess what I'm hearing a little bit here is that the portfolio could actually afford a little bit more risk and you have perhaps too few roll-overs and too few vacancy opportunities. Is that fair? I mean, to some extent you are stepping out a little bit on the risk curve with these new acquisitions.

I think you stated it very succinctly. That's exactly the opportunity we have. Our portfolio is high quality and we've got some opportunity as we strive to increase our return on invested capital, to take a little bit more risk in areas that we have the expertise to underwrite.

Great. My last question is, I guess for Kevin, I presume it involves everybody there, Sarbannes-Oxley 404 is an issue that every CFO of a public country is dealing with right now. We're hearing it's having a big impact on how people are spending their time this quarter. I wonder if you can comment what it's meant to you all, what you've spent and what you've learned from the process.

No. It's been a little bit -- it's been a project that has seemingly, you've kind of grown in scope over the last nine months and I think for us, you know, we view it as a good exercise to go through. I'm not sure it's something that should be done necessarily annually, but it's good to go through it once to make sure everything is well-documented. We are well along in the process. We've really -- when they rolled back the implementation a year, we were charging full speed to make sure we were darn close to meeting the original schedule. So we're well down the road, feel good about, you know, the process and hopefully the outcome is not all done yet, obviously, but what we've spent to date is probably about $500,000, which is mostly third party cost, but includes internal cost that we've had to incur, just in terms of people. It's significant. It's a penny for us. You know, like I say, we always welcome additional scrutiny. My personal opinion is it's gotten -- I think it has the potential at some shops to get down into levels of detail that aren't meaningful, we're trying to keep it focused on the real key drivers of controls and make sure we're covered there. As I said, if it were up to me, I think this is a great process to go through. I think I would do it like every third year and the intervening two years do something a little lighter than what's been currently done. But that's okay. It will be easier next year, obviously.

Let me ask you, is it reasonable to expect a company of your size is going to be able to staff to a level where you're going to have sufficient internal controls that you wouldn't have, you know, significant number of disclosures or weaknesses?

No. That's clearly an issue. Separation of duties is one of the key controls, that's something we have to be mindful of. I think that the number of people that we have on staff, we're okay at the moment, but I clearly hear you, you get much smaller and I don't know you create those separations necessarily to create those controls. And so -- but at our current size, we can easily meet the control requirements.

Okay. Great. Thanks, guys.

Our next question is from Sam Muran with Jim Value Fund.

Hi, folks, congratulations on the quarter. I was hoping you guys can clear some things up for me a little, because I'm getting a little confused between near term goals and long term goals. Can you give me a cohesive picture on where you want to take the company medium to longer term?

I think that the plan is to capitalize on the strength that we have right now. We've got a very strong balance sheet. We've got a terrific portfolio, which gives us the flexibility to, as we've mentioned earlier, to begin to take slightly more risk, focused in the retail area, with the goal of increasing our return on invested capital over a period of time, which ultimately will lead to consistent FFO per share growth while continuing to stay focused on the triple net retail arena.

Gotcha. So no more acquisitions or projects say in other areas such in office? It's going to be focused in retail from here on. Can you discuss your minimum ROE targets going forward?

I think what we're focused on right now, is, as we look to acquire property, a slightly different as you mentioned, the question you asked, is if we're pursuing acquisitions which have, a number 8.5% to 9.5% range on an unlevered basis with the leverage that we have, that's going to produce ROEs over a period of time which are double digits and higher.

Okay. And then there's talk on potential sale of the company eventually, but from what I understand you're saying right now that the plan is to execute on your idea about going up the risk curve, keep the company independent for, you know, the time being, and just improve returns in the company going forward; is that right?

I think that's correct.

Okay. Fantastic, thanks.

Our next question is from Eric Rothman with Wachovia

Good morning, guys. Question for you, with respect to the the mezzanine loan portfolio, do you envision, I guess, keeping that, harvesting that or will you continue to do this financing but strictly on the retail side of things?

I think on the mezzanine, the existing portfolio is over a period of time going to run its course. As the owner of the properties to whom we provide mezzanine looks to either refinance or cash out their equity I have no doubt that over a period of time we're going to get paid off. The current no interest rate environment, I suspect that time frame is into the next calendar year. Now, in terms of opportunities in that segment, I think on a selective basis where we are prepared to own the underlying real estate to whom we extend mezzanine credits, I think there are some opportunities there, and I think in the near term we are actually pursuing some opportunities there in the aggregate, it's not going to be a big part of our portfolio. But it's category that we are spending some time on, Eric.

So -- I'm sorry. So did you -- did I hear you right that much of the loans that you have currently may actually be repaid as early as next year?

I'm just saying that that those loans do not have a average lease life of the 10, 11 plus years that we have in our portfolio as a whole. They're 3-year loans I believe. Albeit with repayment penalties, people can refinance them. So as we look at our business plan going forward, those are expensive debt securities. 11% current cash pay, 3% accrual, I have no doubt that the owner is always evaluating opportunities to pre-pay.

Sure.

With that being the case, if we want to have some level of mezzanine on our portfolio, we're already anticipating and planning for some of those being pre-paid. And I just anticipate that some of those will get pre-paid, yes.

Great. That clears that up. With respect to the development of as you called them, multi-tenant centers, particularly I guess the one in Jackson and the one in Denver, are these traditional shopping centers or are they one box split into two tenants? Or is it -- I guess can you give us more color on exactly what it is you're doing in Denver and Jackson, and is that, you know, typical of what you expect to do forward?

Both of these projects were with experienced development partners. The one in Jackson, Tennessee is a traditional power center anchored by some of the big brand name retailers, and the good news is it was sold at a terrific cap rate right at the end of the third quarter. We do have a second phase that is held for sale at the end of the third quarter, and that -- the construction, or the tenant has taken possession of that. The project is Denver is a much smaller project with a small mid-sized tenant, one or two smaller tenants contiguous to that.

And then, I guess --

It's barrier to entree market.

Sure. With respect to the merchant build, you mentioned you may actually begin to keep some of your development. Do you expect that sort of these more traditional centers you'll be keeping or are these something you'll continue to flip?

I should have clarified that earlier. I think on the multi-tenant, these types of projects, particularly those that come to us through development partners, we're probably going to continue to build and sell those projects. Where we do have a small number of free-standing single tenant projects under evaluation right now for delivery in the second half of 2005 and if we can find a way to get some of those into the existing REIT portfolio, we will do that.

Great. Then one last very quick housekeeping question for you. Your occupancy number, I assume it was 96.6% at quarter end?

I believe it said 96.5.

96.5. Does that include dark but rent paying space?

Yes. The only thing it doesn't include is unleased vacant space.

How much of that is dark but rent paying?

I don't have that number handy. It's not a lot but I can circle back with you.

Great, I would appreciate that. That's all I've got. Thank you for your time.

We do have a follow-up from Ross Nussbaum of Banc of America Securities.

Hi guys. Couple of quick follow-ups. What was the after tax margin on properties being sold in the TRS on the year-to-date?

Yeah. I mean, we had a tax loss carry-forward from the prior years, so it's a little -- on kind of a cash basis, probably not particularly -- let me just tell you what we kind of target generally. We're trying to achieve about a 10% to 15% basis. 10% to 15% profit gross margin if you will, for what we sell a property versus what we develop third party costs we have embedded in it. If you apply a 40% tax rate to a 15% margin, then you're looking at somewhere in the, you know, 6% to 9% kind of range after tax profit margin on developing properties and flipping them.

And The carry forwards have burned off so you'll actually be taxable in '05?

Yeah, they've largely, once we get through '04, it'll burn off in '05 is when they should burn off. Obviously for GAAP purposes, we're still booking full tax burden on these properties. We have a deferred tax asset on our books, a small amount.

And you're got $63.5 million, I guess, marked as held for sale. Is that kind of the size of the inventory you expect to carry going forward?

I think that's been fairly typical. We've always said somewhere in the $50-100 million range as something that we're comfortable with. That's for both our build to suit development, and our -- any properties we've acquired with the intent to sell, and so that's pretty typical.

Okay. If my math is right, the gains from the TRS were close to 20% of FFO this year. That number should go down over time, just as you keep that business steady and grow the rest of the portfolio?

I don't know how you're applying cost to, you know, G&A, et cetera. I'm not sure how you're getting net profits from the TRS, if you will.

Right. I was working off the $14 million, 13-14 million gain.

And then after tax and then minus G&A.

Ross, that's a gross number from which tax and overhead needs to be subtracted

If I can make a suggestion, I think it would be helpful to broaden the disclosure in this front, maybe to break out for people this business separately. Because it is hard to decipher from the multiple line items.

No, no, I understand.

Okay, that's all, thank you.

And we'll go back to David Fick.

Hi. Can you talk a little bit about what this stay the course strategy is going to mean for your dividend policy going forward?

David, I think starting point is that we're very proud of the 15-year track record of having increased dividend that I'm sure we're going to do nothing to damage that over a period of time. Having said that, our payout ratio is on the high end, and if we execute the way we want to, we'll have opportunities to grow our FFO per share a little bit faster than our dividend increase so our payout overtime will begin to decline slightly.

Okay, thank you.

And that does conclude our question and answer session for today. I would like to let the audience know a replay will be available starting today at 1:00 p.m. Eastern Time and run through midnight on November 5th. To access the replay for this conference, please dial 888-203-1112, and enter the confirmation code of 858036. And gentlemen, I'll turn the conference back to you for any additional or concluding remarks.

Thanks very much. We wish you all happy holidays and look forward to talking to you in the new year. Thanks very much.

And that does conclude today's conference. I'd like to thank everyone for joining us today.