NNN REIT Inc (NNN) 2008 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the National Retail Properties Incorporated first quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Craig Macnab, Chief Executive Officer for National Retail Properties Incorporated. Thank you, Mr. Macnab, you may begin.

Thanks, Manny. Good afternoon, and welcome to our first quarter 2008 earnings release call. On this call with me today is Kevin Habicht, our Chief Financial Officer, who will review details of our first quarter financial results after brief opening comments from me. We are extremely pleased with our record financial performance in the first quarter, which obviously positions us well for the balance of 2008. Also we are delighted to be raising guidance in this economic environment. Our portfolio continues to be in great shape with occupancy around 98%, plus we have very little lease turnover in the remaining eight months of 2008. These are challenging times for both the consumer and retailers. However, in this environment the defensive attributes of our portfolio are clearly a strength of NNN. With over 930 investment properties, we own a fully diversified portfolio.

Also the average lease duration of our portfolio is 13 years. And as I mentioned a moment ago, we have a modest number of leases coming due later this year. In the first quarter we acquired 33 properties for $150 million for our investment portfolio, at an average cap rate of just over 8.9%. These properties were acquired from 11 different tenants and I should point out that we previously completed sale lease-back transactions with eight of these tenants. It's worth highlighting a couple of additional details regarding our acquisition activity and the environment in which we operate. As evidenced by the high level of activity, our acquisition team continues to look at a large volume of transactions that allow us to selectively acquire carefully underwritten net lease retail real estate. Most importantly, we are now participating in what I like to characterize as a more normalized environment where cash is king and portfolio purchasers who were using large amounts of debt are no longer active in our marketplace.

Less competition is obviously beneficial to NNN. To be sure, there are fewer deals out there, but with less competition our hand is strengthened. Our weighted-average yield of approximately 8.9% was higher than we had guided towards and reflects two things. Firstly, we are obtaining higher cap rates from our longstanding tenants. And, secondly, we have on occasion been able to capitalize on special situations where certain of our competitors do not have access to capital to close a transaction. In this type of situation there are very few companies that can react as quickly and as diligently as NNN and, in those transactions, we have obtained slightly higher cap rates. The first quarter was an unusually productive quarter for us, both in terms of volume and the initial cap rate. This activity early in the year is obviously integral to our ability to raise guidance in 2008.

We continue to be active selling properties, realizing $82 million from selling real estate in the first quarter. The majority of these sales occurred in our T.R.S., directly off our 1031 website at very good prices. These sales are a continuation of our capital recycling strategy, which we will be continuing in 2008. We have achieved very low cap rates on our dispositions in the first quarter. For example, the cap rate on our T.R.S. sales thus far this year has averaged around 6.25%, which speaks to the core competence of our team and our web-based disposition platform. By the way, we currently have several properties from our T.R.S. under contract for sale at cap rates that are comparable to what we received in the first quarter. As a reminder, our ability to sell properties directly at excellent pricing is an invaluable tool that enables us to execute our capital recycling program, plus selectively sell assets from portfolios that we might acquire.

In summary, we had a great quarter, realizing the benefit of the tenant relationships that we have established over the last several years. As we look at National Retail Properties, our portfolio is in excellent shape. Our acquisition activity in 2007 is off to a -- I'm sorry, 2008 is off to a great start. Our pipeline of acquisition opportunities is solid and our capital recycling activity remains robust. Following our convertible debt offering, our balance sheet is very strong and we have plenty of capacity under our bank credit facility. We are optimistic about the way that National Retail Properties is positioned to continue to grow our FFO per share in 2008, on top of two very good years of growth. I'll now hand over to Kevin.

Thanks, Craig. I'll start with the cautionary statement that we will 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 these forward-looking statements and we may not release revisions to these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the Company's filings with the SEC and in this morning's press release. With that, as indicated in the press release, we reported first quarter 2008 FFO results totaling $37 million or $0.51 per share, representing a 4.1% increase from $0.49 per share in the first quarter of 2007, which will be our toughest comp this year.

We are pleased with these improved results and have raised our 2008 FFO guidance by $0.02 to $1.97 to $1. -- I'm sorry, from $1.97 to $2.02 per share. That represents a 5% to 8% growth over 2007's $1.87 per share. Our business plan continues to produce good results and we have good visibility on '08's guidance. The balance sheet is in good shape and our property portfolio continues to produce the rent we anticipated, even in this tough environment. We are not changing any of our primary assumptions with our new guidance. As a reminder, for 2008 we were projecting $300 million to $400 million of acquisitions, $80 million of core portfolio dispositions, G&A expense now $24 million to $24.5 million, mortgage residual interest income of $4.5 million to $5 million before minority interest, net property expenses net of tenant reimbursement of $3.1 million, and pretax pre-overhead gains on sale from our T.R.S. Properties of $10 million to $10.5 million, which is a little less than what we had last year.

We believe the visibility is fairly good on this guidance, but as always these projections are based on a number of factors and uncertainties discussed in our public filings and can have some choppiness from quarter to quarter. Let me quickly go through some of the details in the first quarter and we will take some questions. Looking at the income statement, total revenues increased to $55.2 million, driven obviously by additional rent from net new investments we've made over the past year, as well as accretive capital recycling from our disposition. The acquisitions in the core portfolio was $150.6 million in the first quarter, as Craig just discussed. The occupancy at quarter end was 97.9%, which was flat with year ago occupancy. We have only four properties leased to tenants in bankruptcy and three of those four properties' leases have been affirmed, so that just leaves one out of 931 properties at risk of lease rejection.

Page five of the press release includes some additional disclosure regarding contingent percentage rents, straight line rents and capital lease earned income for your information. In the first quarter percentage rents were down to $58,000 below 2007 amounts, largely due to a couple of thing. A., the timing, some timing issues which will catch up over the balance of the year and, B., a couple of properties which were primarily percentage rent payers in the past which will be primarily contract base rent payers in the future. During the first quarter we also recorded $404,000 of lease termination fees. It's all in continuing ops and rents and that compares with $764,000 in the first quarter of 2007. Interest and other income from real estate transaction was flat with prior year amounts. At the end of the first quarter we had $14 million outstanding in our structured mezzanine loan.

And mortgage and notes receivables increased to $99.9 million, primarily due to some short-term seller financing we provided in connection with sales of a couple of properties. The interest income from mortgage residual assets was $1.4 million for the first quarter. That was flat with the fourth quarter of '07 and up slightly from the $1.2 million in the first quarter of '07. And that was due to increased discount rate assumption that we mentioned in the third quarter of last year. Over time this line item will decline as the underlying loans in the mortgage securitization pools amortize. We are estimating a total of $4.5 million to $5 million for this line item in 2008. We did also book a $758,000 non-cash impairment based on our most recent third party valuation on the mortgage residuals.

Just as a reminder, these are commercial mortgage residual assets which reside in our 79% owned Orange Avenue mortgage investment entity, which we bought in May of 2005 for $9.4 million. Since that time our cash flow generated by that entity has been over $24 million and we can expect to receive potentially over $15 million more in cash flow given the remaining residuals on the balance sheet. Also note that the entity, this entity no longer has any outstanding debt, as we paid off $12 million of 10% notes payable at the end of February, 2008. So despite some accounting noise from these investments, the returns on this investment have been oversized, which is what we expected and why we pulled the trigger on our option. Detailed information on this entity can be found on page nine in our press release. G&A expense was $7.6 million for the first quarter. That is up from prior year amounts largely due to some seasonality of expenses and the write-off of some dead deal costs.

For the year we see G&A at $24 million to $24.5 million, that compares with $23.5 million for '07 and $24 million for '06. Property expenses net of tenant reimbursements was $861,000 for the first quarter and that compares with $950,000 for the immediately preceding fourth quarter and $594,000 for the first quarter of '07. Interest expense for the first quarter increased to $15.4 million, that's up from $11.1 million a year ago, due primarily to higher average debt balances. At the end of the first quarter '08, $123.5 million or 10% of our $1.237 billion of total liabilities was floating rate. If you look at that on a gross book basis, which I think is more meaningful, floating rate debt was only 4.4% of our total assets. During the first quarter, as Craig mentioned, we reported the sale of four properties from our core investment portfolio and that's reflected in the investment portfolio disc ops on page six of the press release.

This capital recycling generated net proceeds of $10.3 million and produced a gain of $3.9 million. These gains are not included in our FFO results but obviously create value as we reinvest proceeds at higher cap rates. In disc ops inventory properties, which is our T.R.S., we sold a total of eight properties from our taxable subsidiary with net proceeds of $71.8 million. Four of the eight properties were out of our development unit and four were from our 1031 exchange unit. For the quarter total pretax, pre-overhead gain on sale from our T.R.S. was $5.6 million compared with $4.7 million for the first quarter of 2007. The total T. R.S. inventory is down $43 million from year-end 2007 and we have over $50 million of additional T.R.S. properties under contract or L.O.I. for sale. Just a side note about dispositions generally and I'm talking about core portfolio and T.R.S. here.

As you know we've been very active capital recyclers. As we look back over the past three years, our total dispositions have funded 43% of our acquisitions and development activity during that same time period. We do think we have one of best disposition platforms in our niche and it's an important tool for us in managing our Company and portfolio. While it produces some very modest FFO after tax, it more importantly allows to us better actively manage the core portfolio. It demonstrates imbedded value in our portfolio. I think it makes us better acquirers of properties. It creates some positive ongoing income spread, as we by wholesale and sell retail. And it does reduce our need to tap the capital markets to fund new investments. So it's an important part of our business and it looks like continue to be performing well for us in 2008. Moving to the balance sheet. We finished the first quarter with total liabilities of $1.237 billion. Of this amount, only $27 million was secured debt. 98% of the Company's total assets are unencumbered.

During the first quarter we did complete a $234 million 5.125% convertible note offering as a five-year deal. And late 2007 we anticipated that we would be executing a dead deal in the first half of 2008, and when the ten-year treasuries dropped below 4%, we locked treasury rate on $100 million. Well, when the unsecured debt market remained comatose, we decided to go the five-year convertible debt route, which did not perfectly match up with our hedge of ten-year debt. So we recognized an $804,000 loss in the first quarter, which totally wrote off this hedge. As of March 31, '08, total debt to total assets on a gross book basis was 44.3%, that's up slightly from 42.5% the prior quarter. On a market cap basis this leverage was 42%. We did pay off $100 million of 7.125% debt that came due in March. Our next material debt maturity is not until September, 2011.

Obviously, the value of maintaining a balance sheet flexibility is more apparent in times like these and we believe we are in very good position, which will enhance our competitiveness at the margin. Interest coverage was 3.5 times for the first quarter, fixed charge cover is 3.1 times for the first quarter. Lastly, just note we did increase our quarterly dividend by 5.6% a couple of weeks ago, which will pave the way to mark 2008 as the 19th consecutive year of increase in our annual dividend per share, while at the same time reducing our dividend payout ratio to 74.2% based on the midpoint of our 2008 guidance. We believe we are in good position to deliver solid results for 2008 and our portfolio and balance sheet are in very good shape. With that I will turn it back to you, Craig.

Manny, if you will please poll the audience to see if we have any questions.

(OPERATOR INSTRUCTIONS) First question comes from Michael Bilerman with Citigroup, please proceed with your question.

Good afternoon, Ambika Goel is here with me. Kevin, can you talk just a little bit more about your T.R.S. portfolio? You have about $205 million, I think you mentioned you had $50 million sort of on the market right now. What's the current yield on cost of the portfolio, both what you have for sale and the totality of the $205 million?

A lot what we buy obviously and develop in that N.V. is no different than what we would buy or develop for our own portfolio. So the yields that we acquire and develop property that typically is close to what we would be acquiring for our own portfolio. So that's generally the case. As you look at the balance of $205 million in that inventory portfolio that's held for sale, about half of that is related to development properties, two-thirds of which is completed and we are just marketing for sale. And the other half are what we call 1031 exchange properties. In total out of that $205 million, like I said, we have north of $50 million of properties under contract or L.O.I. for sale. But there's a variety of reasons why properties are in the T.R.S. Some obviously we make some money doing it. We also view it as a way for us to mitigate a tenant and line of trade concentration as we acquire large portfolios and so gain on sale is a piece of the equation, but it is not the sole motivation for us selling properties either in the T.R.S. or obviously in our core portfolio.

You said half of it is development. It's all completed development at this point?

Two-thirds of that half is completed.

So you still have funding for the remaining?

Yes, modest. I mean, we've got about $13 million under construction, which will take another $4 million to complete. So in terms of dollars committed to complete development it's a very nominal number.

So what would you say the yield on cost right now is 9%?

I think in total it's closer to where we acquired -- what we have in our core portfolio.

Which is?

Well, mid eights to high eights.

Okay. And then is there any sort of concentration sector-wise or tenant-wise within that $205 million?

Not material, no.

You feel really comfortable with potential to continue to have at least gains on the $205 million?

We think we will comfortably meet our guidance of $10 million to $10.5 million of gains on that entity this year. We think the first quarter obviously was half of that. So we have good visibility on meeting that guidance. We think the marketplace remains reasonably attractive to sell properties. We sold $72 million worth of properties out of that entity. We've, as I mentioned, got another $50 million with good line-of-sight. So we are very comfortable with the inventory that we hold there and our ability to sell that in the coming quarters.

I think Ambika has some questions, also.

Hi, on your tenant exposure, you mentioned that there are four tenants in bankruptcy and one you're still waiting to here from on the lease rejection. Just in general for the rest of your portfolio, could you consider what tenants would you say are at risk and what percentage of the portfolio does that represent, either because of their corporate credits or on a cash flow coverage basis?

No, let me just clarify one thing. There's four properties that were in bankruptcy. Two different tenants representing a total of four properties. Three of the four properties have post-petition have been affirmed by the tenant, so we are left with one property that's still at risk of being rejected. So that's less than 0.1% of our base rent. So it's a very, all that to say it's a very small number. Internally, I mean, we do create what we call a credit watchlist. We don't publish it. It's a report that we produce regularly and monitor on a quarterly basis, including with our board. The composition of that credit watchlist is not materially different than it was a year ago and the size of that list. Historically, and you know it's all art as to what tenant gets on that list and how soon one decides to put it on that list. My inclination is always better to put it on there sooner rather than later. If you look at that over time, historically we've had 4% to 6% of our base rent generally on that list as a tenant that we are just going to pay extra close attention to and try to deal with and right now that list falls within that range of normal credit watch profile.

What has been like the historical loss rate of that 4% to 6%?

It's been nil. I mean, tenants either get better over time so they can get off the list. Just for an example, Office Max was on that list a few years ago. It's not on there today. But what we do is when it's on the list, obviously, we have a heightened portfolio management urgency around that evaluating the real estate and so we will proactively, some of the properties we will actually sell and so the Good Guys as an example, four or five years ago was a 5% tenants of us. It was on our credit watchlist. And we proactively sought to reduce that exposure and sold properties and a couple of occasions we actually terminated the lease and put in new tenants. And for the properties we had left over we just loved the real estate and had no fear of the tenant vacating. And so that's the kind of attention that it would get and we try to proactively deal with that.

Another example would be Linens 'n Things where we had some exposure but in the last three to four years we sold those properties. We now have zero exposure to Linens 'n Things.

And there's a number of examples like that as we've talked about over the --- Steak and Ale was in a portfolio we bought in 2001 and the Cab Tech merger and we own one property today, down from, we own owned several of those before. We try to proactively deal with it. We try to put it on this list early so maybe we can sell properties before the marketplace has a good sense that maybe there is trouble with a particular tenant.

Thanks. And then your theater exposure has grown in the past year and also I think about 2% in the last quarter. Can you talk about the tenant of these properties and also what the coverages are and cap rate?

Ambika, we have purchased theaters in two different transactions in the past 12 months. The operator is one of the top ten largest operators in the U.S. The cap rate is very consistent with what we've been acquiring properties at. Last year our weighted-average was 8.4%. This year we are, first quarter was just over 8.9%. The cap rates in both of those transactions were similar to our averages for the year. The tenant that we purchased properties from in the current quarter, in the first quarter, is a company that we are very pleased to see likes operating with no debt. Obviously that gives us a lot of comfort. They've been around a long time. They are a particularly good operator and range coverages are in the 2.0 range.

Thank you.

Thank you. Our next question is from [Simet Peret] with Banc of America Securities. Please proceed with your question.

Good afternoon, guys, it is actually Dustin here with Simet. Just a follow-up on Ambika's question on the tenants. What's the average coverage right now of the companies that are on that watchlist? The average rent coverage, that is.

Dustin, to stay with it for a second, as Kevin mentioned some of the names of these tenants but if it's a company like, for example, Pier One. Pier One doesn't disclose its store level financial performance to anybody, including National Retail Properties. So that data is not available. We have a four or five different Blockbusters that are on that list. And by the way, Blockbuster has been on this credit watchlist since I've been at the Company, which is over four years.

And just to maybe reiterate or make sure it's clear, the composition of this list, like I said, is consistent with, frankly, where it was two and three years ago when everybody thought everything was great. I guess what I'm trying to communicate, at the moment we don't have any particular tenants where we feel particularly exposed at at the moment. I understand, we obviously understand the world can change and performance of tenants can change quickly. We understand that. But at the moment it's in relatively good shape overall.

Okay. And I guess, I guess if you're not getting the store level financials from a number of these tenants, I mean, how do you then really get comfortable with where they stand, either on a ongoing viability type of basis or just from a coverage perspective?

Well, two things, I guess. One, and your first line of defense in credit underwriting is tenant entity level underwriting, which obviously for example in the case of Pier One, there's lots of that data and so you can do your analysis like any credit analysis in which you're evaluating that credit profile for that company. And so some of our top ten large tenants fall in that category. A Best Buy, a Barnes & Noble, a CVS, where we are not getting store level data and, as Craig mentioned, no one else is. And so you're looking at tenant level credit underwriting, which gives you some level of comfort. And frankly if the tenant never files for bankruptcy, just be clear, you never get the store level credit. So that's an important level of credit underwriting you do. Secondly, you are also re-evaluating the quality of the real estate you have and you are looking at what the marketplace and what market rents might be. And so that's the other way you would evaluate your risk as it relates to a particular property.

Okay. And then just looking at the transaction markets, when you're looking at new deals that may come to committee, obviously it's going to vary on a deal by deal basis, but what sort of threshold, yield threshold are you looking at now on new deals and are there any industries as well that you just won't even consider at this point?

Dustin, our threshold in this environment is the quality of the deal. Just as a reminder, we are in the real estate business. We are not a bank that's focused on financial parameters. We are paying a lot of attention to the specific real estate attributes of the property; what's the access, what's the visibility? What is -- how does rent compare with comparable rents in that marketplace? Who might we re-lease that store to if we ever have to do it? Now, that's the first thing. And in this environment where there are more transactions than there is money to buy them, we are focused on selectively underwriting properties that make sense for us to hold for the long duration of the lease. In addition to acquiring good real estate, we want to be adequately compensated for it.

Our yield in the first quarter was very high, 8.9% on average. I think we will be hard pressed to accomplish that going forward. But we are obviously trying to get the best yields we can. Even with tenants that we've done deals with for the last couple of years, we are pushing yields higher. Our cost of capital has gone up. There are less people in the marketplace so we can get better yields. But a high yield doesn't compensate you adequately for weak real estate.

Okay. So then I guess just following up on that more generally, I mean, where would you say cap rates generally are in the marketplace today, since it sounds like you don't think you are necessarily going to be able to reach that 8.9 again as we look out through the rest of this year? Would you say that they are in the low eight range or have they continued to move higher, or lower, frankly?

Well, it depends on the specific attributes of the properties. But just as a reminder, we are buying these properties at wholesale in structured transactions and then frequently turning around and reselling properties at very low cap rate. Thus far this year we've been selling properties at an average cap rate of around 6.25%. So when -- to be sure there is pressure on cap rates, but we are still getting excellent pricing when we are selling our properties one by one. On the acquisition side, we have been pushing yields up and I think illustrative cap rates depending on the quality of the tenants, the quality of the real estate are in the mid 8% range. Just as a reminder, a very high cap rate doesn't make poor real estate a good deal.

Our next question comes from Charlie Place with Ferris Baker Watts. Please proceed with your question.

Thank you. Craig and Kevin, could you comment a little bit on your C Store JV with Trammell. It looked like you didn't really have much activity in the first quarter on that? Can you give give a little bit more color on kind of the activity there and what we should think about when we are looking at ramping up that?

Yes, I think in the first quarter we did participate in a number of transactions outside the convenience store sector. I think there are going to be convenience store transactions, some of which will go into our own portfolio, some of which will be presented to our joint venture with Crow. The joint venture is going well. It's, from a financial standpoint, it is a small part of our business.

Yes. Well, and I guess kind of a related question is what type of properties did you buy in the first quarter? Where was the -- what kind of retail segment were we involved in?

Just staying with that for a second, Charlie, there is some information in the back of our press release and we'll talk about it in a moment. But getting back to a question that I know you've asked off-line and Dustin asked a moment ago, restaurants are a category that we have been cautious about for the last period of time. There are -- the restaurant sector, both casual dining and fast food is a huge category in net lease. And there are always plenty of those transactions in the market. In that particular area our underwriting has been very rigorous for the last period of time and as a result many of these deals haven't passed muster internally. We did in the first quarter do some theater deals, which we just talked about a moment ago. We did some deals in the broad automotive parts section. And then there are always lots of little deals.

Okay. Thank you.

Our next question is from David Fick with Stifel Nicolaus. Please proceed with your question.

Good afternoon. You've answered most of my questions so I guess I will ask a generic analyst question. Restaurants, where are you considering the ongoing weakness in their numbers? Would you be in or out. Same for gas stations, convenience stores? And then geographically speaking with 30% of your rents coming out of Florida and Texas, are you worried about any of your geography?

Just staying with that last question first, our biggest concentrations are in the broadly the sun belt states where the population continues to grow. We do have a big exposure in Texas and fortunately the commodities boom is benefiting Texas. Retail sales in Texas is still very good. The price of oil is high. And also agriculture is doing well in that state. So Texas, is fine. Florida is clearly adversely impacted by the glut of housing and retailers in Florida are not doing as well in 2008 as they did the past several years. That is not going to turn in the next couple of months. But ultimately, retail sales in Florida are going to continue to grow faster than the nation. Like everybody else, we are doing what we can to avoid states like Michigan. On the restaurant side we are being very, very cautious, Dave. It's hard to underwrite where sales will stabilize for a restaurant operator when they are having declining same store sales. In addition, the increases in commodity pricing is putting terrific pressure on the cost structure of restaurants and they are having a hard time passing that through to their guests.

So restaurants for us are a difficult transaction to underwrite and our activity in that sector reflects our caution. Convenience stores, we've got a vast deal flow. Enormous presence in that category. Some of the big oil companies have announced that they are going to be selling convenience stores. So there's more deal flow to follow. And I think we are going to get our share of that. To be sure for the last two quarters C. store operators have struggled to pass through the high price or the increase in the price of oil at the pump. In the event the price of oil stabilizes, or lo and behold it should even turnover and the price of oil moderate a little bit, C. store operators margins on gas will improve. Just as a sort of point of reference on that, most people know that our two biggest tenants are Pantry and [Sasa], both of them have pre-released the first quarter. Sasa, in particular, pre-released very, very strong numbers, Texas is doing very well. Their comp store sales were excellent.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question is from Jeff Donnelly with Wachovia. Please proceed with your question.

Good afternoon, guys. Just a few questions. Kevin, if I could ask one last one on that credit watchlist you're discussing. I'm curious, do you guys tend to watch by location as an individual stores or do you just watch by overall credit of the tenant itself?

That one is directed totally at the tenant credit and so all stores related to that tenant are on our list, if you will, and so, yes, it's tenant specific. And then, like I say, part of our portfolio management would be to sort through that and say, look, we have got these stores that are exceptional locations and rents that are excellent and these two over here are marginal and so let's sell the two that are marginal or approach the tenant and work something out. Any way, it's by tenant.

It's cost at that level. But then we have to get to the store level real estate fundamentals. What's the rent the tenant is paying in that space and how does it compare with market.

And then, Craig, I guess, a question for you. I think you're -- I suspect you are a big fan of the convenience store business given its fragmentation. Where do you think you might, looking forward, take your concentration in that business as a percentage of your portfolio or do you think where we are at today is kind of where it will be in the future?

Jeff, it certainly has run up considerably in the last four years. One of the criteria which we as management and our board of directors pay a lot of attention to is risk adjusted returns. We continue to feel that the convenience store category provides us very good risk adjusted returns. We are buying corner locations that could be re-leased to any of a number of tenants, where the land as a percentage of the value of the land and building is in the 45% type range. So our down side is very protected. The real estate is high quality. And the good news is we've established relationships with some of the leading operators in the C-store business. And I do think that slowly it might grow a little bit from our current level. I mean, in fact in this second quarter we are in the process of reviewing a number of C-store transactions. In the first quarter we did review several and I think in general we've passed on them.

And again, for context a little bit as it relates to C. stores in concentration and lines of trade, those of you out there who have followed the Company for a long periods of time recall that we were very heavy in restaurants at one point in time and we were very heavy in drug stores at one point in time. At one point in time I think book stores were 18%, 19% of our portfolio and they are 4% today, drug stores are 4% today. And Craig's point about risk adjusted return, at times there's up seasons of opportunity to get attractive risk adjusted returns in particular sectors and those seasons pass and so it might not be as clairvoyant as we might like to be on precisely where convenience stores will be in the future. We are focused on risk adjusted returns and quality of that return and that's really what's going to drive a good chunk of the equation. Over the time, we've seen all these different categories that have spiked in concentration moderate as the opportunities have diminished.

If I could stay with your portfolio, I guess, Craig, it seems that a lot of the assets you've been selling, I guess, have been more tertiary market locations in that you have been buying consistently. I guess my sense is that you've been sort of slowly repositioning your portfolio, I don't want to say to urban meaning downtown locations, but just call it more close in markets, if you will. Is that true and I guess is there a way that to measure that or to quantify that shift in your portfolio that you guys maybe would monitor?

Jeff, let's just make sure we all understand the context. Our average lease is 13 years. So even if we have a great urban location, we are not going to get the opportunity to re-lease that space until the primary term 13 years is over and the option periods are over. But the virtues of good real estate locations are important. When we are underwriting properties to keep in the investment portfolio, we are paying a lot of attention to whether this individual property is at or close to the retail hub in that community. And we've done a great job of selling real estate and we have, in many instances, when we purchase a portfolio we are carving out some of the weaker properties from that portfolio, for example, we bought ten properties in one particular transaction, we calibrate and rent these, we took the bottom three under a variety of different metrics and we are marketing and we've marketed those in our 1031 platform. So what we have done, Jeff, is we have done a very good job of qualitatively improving the portfolio.

Just to be clear, I guess I wasn't implying that I thought you guys would sort of wait until the lease is over and then redevelop the site to something else, it's more that -- it feels like you're getting away from the drug stores that are $20, $34 a square foot in rent in Kentucky, whatever pick a state, and moving more towards the major MSA's where, I guess, I'm thinking about it more from a standpoint of security of or consistency of tenancy or occupancy. Just one last question if I could and maybe I'm asking you to look too far into your crystal ball, but as you look out to 2009, do you guys have a sense, or do you have a sense, Craig, about how you think about where pricing on assets will be by that time, I mean in terms of -- I'm sure you might have a view on kind of where credit markets are going and you know what sort of supply and demand like is, I guess, in the investor market. Do you think cap rates in '09 are going to be stable with where they are today, do you think you will see continued expansion? Do you have a sense?

No, I think that it's yet early in the cycle for what the appetite of credit markets are going to be to advancing credit to real estate. But I think the worse is behind us. Those markets are slowly beginning to stabilize. And 12 months from today I think you are going to see a little bit more lending to real estate, which is going to mean that the number of participants in the market is going to increase and leverage yields will still be more than satisfactory, which means that cap rates are not going to be higher in 12 months time. I think that right now is a very unusual window of opportunity and our activity in the first quarter reflects how we took advantage of it. I think cap rates 12 months from today are going to be at or lower than this level, 8.5%.

Thanks, guys.

(OPERATOR INSTRUCTIONS)

Many thanks very much, just to repeat, folks, we are very, very pleased with the way we are positioned right now. Our portfolio is in great shape. And our balance sheet gives us plenty of capacity to take advantage of opportunities. Thanks very much and we will be talking to you all soon. Good afternoon.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your line at this time. Thank you for your participation.