Site Centers Corp (SITC) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Developers Diversified Realty second-quarter conference call. At this time all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. Should anyone require assistance during the conference please press star then 0 on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host of today's session, Miss Michelle Mahue Dawson Dawson. Ma'am you may begin.

Michelle Mahue Dawson Dawson: Thank you, operator. And good morning, ladies and gentlemen. Welcome to our second-quarter conference call. I am Michelle Mahue Dawson, Vice President of Investor Relations for Developers Diversified. With me in Cleveland are Scott Wolstein, Chairman and Chief Executive Officer, David Jacobstein, President and Chief Operating Officer, Dan Hurwitz, Executive Vice President, and Bill Schafer, Senior Vice President and Chief Financial Officer. Before we begin, I need to alert you that certain of our statements today may be forward-looking. For example, statements that are not historical in nature or that concern future earnings, results, or estimates, or that reflect expectations or beliefs are forward-looking statements. Although we believe that such statements are based upon reasonable assumptions, you should understand that those statements are subject to risks and uncertainties and that actual results may differ materially from the forward-looking statement. Additional information about such factors and uncertainties that could cause actual results to differ may be found in the management's discussion and analysis portion of our form 10-K for the year ended December 31, 2003 and filed with the SEC. At this time, I'd like to introduce Scott Wolstein, our Chairman and CEO.

Good morning. I am pleased to announce our second-quarter results. We have exceeded consensus estimates by 2 cents despite over 5 cents of dilution created by our early May equity issuance of approximately 15 million shares which generated $492 million in proceeds. When we provided guidance on our first-quarter conference call, we assumed that we would issue equity sometime around the end of the second quarter; however, we issued the equity approximately 60 days earlier than we had budgeted. Our portfolio continues to generate strong and consistent cash flow, and we continue to structure and execute transactions that will create substantial long-term shareholder value. With respect to our 15 million share offering, we were very pleased with the execution of this transaction and the strong market demand for our equity. Although a $500 million bridge loan was available to us, we pursued the stock issuance in order to fully eliminate any equity overhang. We issued the equity at a price in excess of the share price that existed at the that time we underwrote the Benderson acquisition. And accretion at the pricing remains highly compelling. The market rapidly absorbed the new shares with no real correction in stock price, vis-a-vis the performance of our peers. I am also pleased to announce that we have agreements with Koi Financial Center to joint venture a $210 million neighborhood grocery anchored portfolio and with Prudential real estate investors to joint venture an additional $157 million grocery anchored portfolio.

Although these joint ventures which are expected to close during the third quarter, it will be approximately 5 cent dilutive to our 2004 results unless we reinvest these funds in other opportunities. They are very important to us in several ways. For example, these transaction will significantly reduce our exposure to the neighborhood grocery anchored property type thereby sharpening our focus on community centered products and better aligning the assets acquired from Benderson with our core product focus. The original $2.3 billion Benderson acquisition was comprised of approximately 80% community shopping centers and 20% neighborhood grocery anchored centers. After the joint venture transaction, the remaining Benderson portfolio will be comprised of less than 12% neighborhood grocery anchored centers and more than 88% community shopping centers. In our total portfolio after the joint ventures, we will have fewer than 40 neighborhood grocery anchored centers which will represent less than 4% of our total portfolio. The joint ventures are also important because they will significantly reduce our annualized rent exposure to Royal A Hold parent of top supermarkets by approximately $8.8 million or by approximately150 basis points as a percent of total portfolio rents.

In addition, these transaction will strengthen our balance sheet, enhance our financial flexibility, and our ability to pursue future high-yielding accretive transactions. The portfolio to be transferred to the KFC joint venture includes 13 properties totaling approximately 1.7 million square feet. Ten of those properties were previously owned by Benderson and three were previously owned by JDM. KFC will acquire an 80% interest in these properties at a 7.75 cap rate. Although this cap rate is slightly higher than we would have typically accepted, the overall structure of the transaction is highly profitable. We will earn a 50% promote above a 11.5% leverage internal rate of return. This compares favorably to our first joint venture with KFC which was priced at an 8.9% cap rate in which we earned a 20% promote above a 12% leverage return. We will also earn a deferred asset management fee of 6.5% of net operating income, which is 100 basis points higher than we were paid on our first joint venture. In addition to property management, leasing and redevelopment fees.

The PREI portfolio is comprised of 14 properties totaling approximately 1.3 million square feet. Eight of those properties were previously owned by Benderson and six were previously owned by JDM. PREI will acquire a 90% interest in these properties and a 7.75% cap rate. Developers Diversified will earn property management, leasing, and redevelopment fee. I would also like to summarize where we are with the Benderson closing. As you know, we closed on the Benderson assets in two large trenchant (ph). The first trench was closed May 14, included 31 properties acquired by DDR and 14 properties acquired by our MDT joint venture. As part of that transaction, MDT also purchased nine properties from our existing portfolio. We also acquired a second trench of 53 Benderson properties on May 21. Including the four properties that we closed since then, we have acquired 102 assets, aggregating 18 million square feet for a total acquisition price of approximately $2.2 billion. We will close on the remaining properties in the acquisition portfolio as various closing conditions such as letter consent relating to loan assumptions and partner approvals are satisfied.

I am also pleased to announce that we have recently exercised our accordion option on our senior unsecured revolving credit facility increasing our maximum capacity to $1 billion. This increased facility coupled with our joint venture sales significantly enhances our financial flexibility, and we are gratified by the tremendous support we received from our line of credit banks. I would now like to turn the floor over to Bill Schafer.

Thank you, Scott. For the second-quarter 2004, DDR reported FFO of 84 cents per share on a diluted basis. These figures reflect a per share increase of 31.3% over the adjusted second-quarter 2003 results. As indicated in our press release, we revised our 2003 FFO to include an impairment charge of 2.6 million which was added back to FFO in the second-quarter of 2003 similar to losses on sales of operating properties. This adjustment was done in response to a recent comment letter received from the SEC. Excluding the effect of this impairment charge, the per share increase was 25.4%. The Company earned total FFO of 94.1 million in the second quarter of 2004, which is 40% higher than the 67.2 million earned in the second quarter of 2003.

In addition to the increase in same-store NOI of 1.3% which aggregated over 800,000, and as I discussed last quarter in our conference call, the increase in FFO is largely attributable to the sale of existing DDR assets to MDT, which generated approximately 9.9 million of merchant building gains, which were included in FFO. These gains were associated with the sale of a second phase of Riverdale village in Coon Rapids, Minnesota, Erie Marketplace in Erie, Pennsylvania and Steel Crossing in Riverdale, Arkansas. Riverdale village is a wholly owned DDR development and the Erie market place and Steel crossings were developments that we assumed from JDN. We recognized approximately 2.5 million of landfill gains in our second-quarter FFO. As result of our sale of wholly-owned assets to MDT, we recognized additional gains of approximately $28 million, of which approximately 75% or 21 million represents pure economic gains, which is reflective of our ability to create shareholder value. These gains were not included in the second-quarter FFO. Also as part of the sale of assets to MDT, we earned acquisition fees and financing fees, aggregating approximately 3.5 million, which were also included in our second-quarter FFO. Although the majority of of the Benderson assets were acquired between the 14, and 21, of May, the per share FFO impact attributable to the operatng results associated with this acquisition during the second quarter was flat-to-slightly dilutive since the majority of the financing was put in place prior to the acquisition date. Therefore the dilutive impact associated with the common shares, preferred shares, and long-term unsecured debt that were issued prior to the acquisition more than offset the FFO contribution of the Benderson assets during the second quarter. As referenced in our quarterly financial supplement for the six-month period ending June 30, our financial ratios remain strong with interest coverage at 4 times, debt service coverage at 3.5 times, and fixed charge coverage at over 2.5 times. I would now like to turn the call over to Dan Hurwitz.

Thanks, Bill, and good morning. I am very pleased to report that our second-quarter leasing results continue to exhibit the robust tenant demand that currently exists for quality assets in an open-air environment. Specifically during the quarter, our leasing team executed 109 new leases representing 753,520 square feet at an average rental increase of 17.5%. In addition, we executed 146 renewals, representing 798,000 square feet and an average rental rate -- increase of 7.6%. The combined production of 1.55 million square feet produced a blended rental increase of 10.7%. At the conclusion of Q2, the portfolio occupancy rate, excluding the Benderson portfolio remained at 95% leased and 94.4% occupied, which represents a 70 basis-point increase in leased rate and 60-basis increase in occupancy over the same period in 2003. It's also of interest to note that approximately 75% of our 2004 renewals have been negotiated and our retention rate is running in the 95% range.

Also in regard to leasing matters, I am sure most of you are aware of the recently announced transaction between K-Mart and Sears to help facilitate the expansion of the Sears grand concept in markets where barriers to entry are high and the Sears customers may not currently be conveniently served. Within our portfolio, we have two locations that were included in that transaction. One in Rochester, New York, recently acquired through the Benderson transaction, and another in San Ysidro, California that part of our Coventry/RVIP joint venture. We are currently working with Sears to assist in the facilitation of that assignment. Upon completion, our total number of K-Marts will aggregate 13, representing less than .5% of annual base rental revenues. Regarding development activity for the quarter, I am pleased to announce significant progress on a number of different fronts. We celebrated the grand opening of South Town Center in St. Louis, Missouri, the 97,000-square-foot project that was a reuse of a location previously leased but not occupied by K-Mart and is anchored by Office Max, PetSmart, Walgreen's and 39,000 square feet of small shops including Starbucks and EB games. In addition we broke ground in South Florida for the shops in midtown Miami. This project is comprised of 600,000 square feet of retail space coupled with over 3,000 residential units that are being developed by others. Mid town has enjoyed unprecedented tenant interest with over 81% of the space either committee approved or being actively negotiated through letters of intent. I mentioned that the interest is unprecedented as it is very unusual for tenant demand to reach this level of interest, a full two years prior to the scheduled opening.

Later this fall, we are scheduled to open Centerton square in Mount Laurel, New Jersey. This 720,000 square-foot project is anchored by Target, Wegmans, Costco, Bed, Bath & Beyond, TJ Maxx, PetSmart and over 65,000 square feet of small shops that include, Bombay, Justice, Panera bread, Hallmark and many others. This project compliments a group of existing assets spanning from Atlantic City to Princeton, New Jersey, that firmly entrenches Developers Diversified as the dominant owner of this asset class in the Philadelphia metropolitan area. Overall, Centerton square is currently 99% leased. Also later this fall stores will commence opening at Beaver Creek commons in Apex, North Carolina. This 425,000-square-foot center is initially comprised of Super Target, Lowe's, Office Max, Linens and Things, PetSmart and additional small shops. This phase is currently 98% leased. It should also be noted that during the second quarter we received zoning approval for the next phase of this project to be anchored by Kohl's, Michael's, Bed, Bath & Beyond, Ross, Peer One, True Carnival and Dress Barn. The 250,000 square foot phase will commence construction after site plan approval is obtained. Anticipated currently for the spring of 2005 for a spring 2006 opening. In addition, a third phase of this project has demonstrated continued strong tenant interest and will represent an additional 350,000 square feet of retail tentatively scheduled for fall 2006 opening. Upon completion, this project will represent over 1 million square feet of retailers.

I am also pleased to report continued progress at the Pike at Rainbow Harbor in Long Beach, California. Currently we have 66% of the leaseable space open and occupied with tenants such as Cinemark, PF Chang's, Bubba Gump Shrimp Company, Gameworks and California Pizza Kitchen. All tenants are doing well and specifically restaurants are reporting sales far in excess of their projections. In addition there is another 10% of the square footage out for signature and another 20% in active negotiations. During the second quarter, we executed a letter of intent for a 15,000-square-foot pad to house a 90,000-square-foot Siera Suites hotel. Overall, the tenants are open -- the tenants that are open and operating are performing well, which is creating additional interest from retailers who heretofore have been difficult to attract. Finally I am pleased to announce that during Q2 in conjunction with our Coventry II joint venture, Developers Diversified entered into a development partnership with Dave Berndt Interests to develop a new community center in San Antonio, Texas called Westover Marketplace. This will be our fourth such project with David Berndt Interests and will involve the development of 600,000 square feet of retail space anchored by Target, Lowe's and a number of medium-sized boxes. The project is scheduled to open by late 2005. With that, I will turn it over to David.

Thanks, Dan. During the second quarter DDR's acquisition and disposition volumes were substantially enhanced by the Company's transactions with Benderson and MDT, including the property sold to MDT, DDR has sold assets with a gross value of over $340 million on a year-to-date basis. During the same period, DDR has acquired approximately $2.3 billion of shopping center assets including the 102 properties acquired from Benderson. In addition we are negotiating sales on several assets through our RVIP joint venture. One of these pending sales relates to the so-called international school site at Long Beach City Place, which includes Albertson's, Save-on Drugs,and 12,500 square feet of small shops. This transaction is scheduled to close in the third quarter generating proceeds of approximately $16.6 million at a 6.2% cap rate. In addition through our RVIP joint venture we are in discussions to sell approximately $70 million in assets purchased from Bernum Pacific at a weighted average cap rate approximately 300 basis points lower than our original acquisition.

We have also made progress on three redevelopment projects previously acquired by the DDR Coventry II joint venture. At Phoenix spectrum in Arizona, we recently purchased Dillard's 163,000-square-foot building which we intend to demolish. We are currently in discussions with several potential anchor tenants that could locate on this site. In addition we are moving forward and are relocating the Harken's theatre which will be rebuilt from the ground up as a state-of-the-art stadium-style theatre. At Ward Parkway in Kansas city, we are currently relocating five small shop tenants in order to demolish and redevise the lower level enclosed mall and food court. We have an approved deal and are in lease negotiations with PetSmart and have several LOIs with other mid-sized tenants that will allow us to retenant the shopping center in an open-air format. These tenants will join the existing Target, Dillards, and AMC theatre anchors. The Totum Lake malls in Suburban Seattle, which is also a demoing project, we will pursue the relocation of several mid-sized tenants over the next 12 to 36 months.

This redevelopment is strongly supported by the local community which recently granted a rezoning to allow multiple story construction. The new zoning allows a parking deck to be constructed that will serve the shopping center, the adjacent hospital and a future transit station that will provide access to downtown Seattle. We continue to see numerous value-added opportunities cross our desks and are evaluating several redeveloping projects and forward commitments. On a related note, at the end of June, the RVIP joint venture bought out David Berndt Interests in the shops at Tech Ridge, in Austin, Texas for $5.6 million pursuant to the joint venture agreement between RVIP and Berndt. The buyout was made at a 9.5% cap rate which compares very favorably to the property's cap rate of approximately 7% based on current market value. This $31 million project was delivered at a 14.2% return on cost and after the buyout of Berndt, the project yielded a return of 11.6% to DDR. I would also like to spend a moment highlighting the integration of the Benderson portfolio. During the period leading up to the Benderson acquisition, we spent a great deal of time with our department heads discussing the human capital needed to handle the increased number of assets in the new territory in upstate New York.

In our first-quarter conference call I indicated that we intended to hire approximately 70 new employees primarily in leasing, property management, tenant coordination, property accounting, and legal. I am pleased to report that we have hired 55 employees to date against the reforecasted 73 new positions. At present we are slightly under budget with respect to anticipated head-count-related expenses. In conjunction with the Benderson acquisition, we have opened field offices in Buffalo and Rochester. In Buffalo we have two leasing agents, a Senior Regional Operations Manager, two Regional Operation Managers and administrative support. And in Rochester we have a leasing agent and two Regional Operations Managers. We have also added a Regional Operations Manager in New Jersey to supplement our existing field staff in the mid-Atlantic region. In the first-quarter conference call, I noted that we expected to incur approximately $5 million in annual incremental G&A associated with the Benderson transaction of which most is personnel related. Although total G&A will increase as a result of the significant increase in the size of our portfolio, there will be efficiencies created by the transaction which should drive G&A as a percent of revenues down to approximately 4.8% by year end, 2004. As of the end of the second quarter our G&A as a percent of revenues aas 4.9%. At this time I will turn it back to Scott to discuss earnings guidance.

Thank you, David. We are reducing our 2004 guidance to $2.95, which is consistent with our previous guidance of approximately $3. Adjusted downward by the 10 cents of dilution from our early equity issuance -- early issuance of equity in the sale of the joint venture interest in the grocery anchored portfolio and adjusted upward by 5 cents for better than expected operating results. Importantly our guidance does not reflect any additional acquisition activity in 2004. I would now like to open the phone lines to receive questions.

Operator, we can receive questions at this point.

Ladies and gentlemen, if you have a question at this time, please press the 1 key on your touch-tone telephone. If your question has been answered and you wish to remove yourself from the queue, please press the pound key. One moment while we wait for questions. Our first question comes from Matt Ostrower from Morgan Stanley.

Good morning. Can you -- Scott, can you just address the variable rate exposure as it stands now, and what your plans for that going forward will be. Will you be paying down debt? is effectively your intention to pay down debt using the JV proceeds?

Yeah, we will, and that will all be applied initially to reduce variable debt. Bill Schafer can give you better specifics on the metrics.

Yeah, currently we have probably about 27% to 28% in floating rate debt, and we will probably generate net proceeds to us in -- close to $340 million, which will be actually applied to repay variable rate debt at that point in time. We also have some maturities of fixed rate debt of approximately $90 million that will be paid off. So it will probably bring the overall floating rate debt down to a 22 to 23%.

Okay. And, Scott, it sounded like, you know, you were open to the idea of sort of, you know, using the proceeds as well to buy additional assets. Would that sort of, in your mind, serve to bring your variable debt back up again? And could you just address, you know, sort of where you see the ideal variable exposure being over the course of the next year or two?

Yeah, Matt, I mean we have consistently said that we think a variable rate should be about 15 to 25% of our total debt, which, you know, is fairly consistent with where we are right now or where we will be after these transactions. The -- you know, -- if we make further acquisitions, it really depends, you know, what types of transactions they are. If they are core acquisitions that are acquired in a joint venture, it's highly unlikely they will be financed primarily with a fixed rate debt, which would not increase our available rate debt exposures. So, you know, that's certainly possible, but I wouldn't -- I wouldn't imply that any acquisition activity that we enter into is going to have a dramatic impact on that ratio.

Okay. And without committing yourself to anything as it relates to acquisitions, could you just sort of give us a sense -- it sounds like you are being appropriately conservative lowering guidance. You don't want to get yourself in a box for acquisitions, but what is the probability of something happening this year? Are you working on a lot of things right now that make it likely you will actually be able to buy something?

We are in active discussions in a variety of areas, and something could happen late this year, early next year. We also have a partner in Australia that has a very good appetite to put out additional capital. So, you know, I wouldn't be at all surprised, but, you know, as I said in the guidance, I am reluctant to -- to project anything that isn't currently under contract.

Okay, great. And then, I guess just finally. Could you update your sort of guidance or view on additional gains that would be included in FFO and additional fees that would occur going forward? In particular, will there there be fees from the creation of these JVs that we need to put in the model for 2004.

Again on the 2004, there isn't significant gains on the grocery anchor joint ventures because those properties are not merchant building. There will be significant economic gains and they will be reflected in that income but we won't include them in FFO. Where there may be a positive surprise in terms of promotes or gains, you know would come primarily from our Coventry activities where we are in active negotiations to sell certain assets primarily from the Bernum Pacific portfolio that will generate significant gains that might trigger promotes.

Okay. Any fees? Like acquisition-type fees that you will be getting?

Nothing really significant unless, again, we -- we enter into new acquisitions with MDT, which always -- unless they come from our portfolio, we do earn acquisition fees in connection with those transactions.

But the Kuwait and Prudential funds themselves don't create the fees?

No, they don't.

Okay, Great. Thank you.

Our next question comes from Carey Callaghan from Goldman Sachs.

Yeah, good morning. Make you can just help me on the Benderson-implied yield, and this is kind of simplistic math, but you indicated in your supplemental about 16 million of NOI contribution. And given that it was about mid-quarter, if you multiply that by two and then multiply that by four to annualize it, it is about 128 million. And on a base of a billion nine, you know, taking out the stuff you transferred to MDT, it implies about a 6.7% yield rather than the 8 that you talked about. Is that -- is the math overly simplistic or maybe you can reconcile the difference.

Well one of the -- you know I am not -- without looking at the numbers that you are reflecting, you know, I could speak in part to that. I mean, there is -- in terms of in the Benderson portfolio, there were a lot of properties that were in redevelopment by Benderson prior to the acquisition. So it is dangerous to try to take a snapshot and extrapolate from that what the actual stabilized yield is, and many of those are under vaster lease from Benderson which is not reflected even though we earn the income, it isn't reflected in our FFO because it is related to the acquisition. So the economic cap rate on a stabilized basis after the joint venture sales is actually about 8.12%. If you adjust for the master release and the fully stabilized redevelopment activities, that Benderson has completed -- is completed.

Okay. All right. So -- okay. Away from that, on the -- you mentioned a number of demolling projects. And I'm wondering if you can just share with us your thoughts on how many demolling projects do you have in the portfolio right now and how do the returns there compared relative to Greenfield.

The returns are comparable to Greenfield. You know, we would not enter into a demolling project if we didn't see, you know, unleveraged returns in the, you know, north of 11%. And how many of them do we have? I think we pretty much describe them in the script there. I think there are three of them that are currently under construction. And there are quite a few of them that come across our desk. They are difficult deals because oftentimes there is anchors in place that have to remain in place who have significant site plan control, and they also become difficult if the mall in question is only suffering but not quite dead. Because it can be very expensive to -- to move tenants out of the way to facilitate the redevelopment, that creates leverage on their behalf. Having, you know, we also recently completed a demolling opportunity in Long Beach which you probably are aware of which was a perfect example of a successful project in which the unleveraged return on cost was well north of 12.

Scott, this is Michael Villerman. Maybe just a question for Dan. You know, you guys have talked about that it was one of best conventions that you've had. You already have a very high occupancy in the Core at 95. Where will most of that leasing effect, you know, are we still going to, are we going to see a potential bump here the second half of the year and maybe you can talk a little bit about the pre-leasing within your large development pipeline.

Sure, Mike. I mean, yeah, Vegas was pretty active and it is pretty clear that the deals have emerged as a result of that convention. A lot of those deals that we're talking to people about obviously are 2005 transactions, and a lot of that attention is in the development pipeline. You know, it is -- it really is unusual to have the level of enthusiasm for 2006 openings that we are finding for Miami, Phase III of Apex, and a few other projects that are in the pre-development pipeline. Like I mentioned Centerton square, Mount Laurel is 99% leased and hasn't opened yet. Apex, Phase I is 98% leased, it hasn't opened up yet either. So there is no question that the appetites for new development projects is out there and we are being very selective obviously in what we pursue because we are following the lead of our tenant interest. In regard to the core and the interest from Vegas, you know, we are running right now about 30 basis points ahead of our budgeted number for occupancy for the year. And we thought that occupancy would be by the end of the year about 95%, and -- and for second quarter, we budgeted 94.1, so we're running a little bit above that and I would expect that trend to continue.

Thank you so much.

Thank you.

Our next question comes from Michael Mueller from JP Morgan.

Hi, question for Bill, probably. Just wondering how much debt is associated with the two grocery anchor portfolios that are going in the JCs and if there is debt on it, what's the rate?

There will be debt in the KFC joint venture of approximately $150 million.

Are you talking existing debt today or are you talking about debt on the--

Existing debt today.

Existing debt today?

Yes.

What are the projects currently encumbered by --

In the joint ventures.

The projects with the transfer joint ventures. Are they -- ventures. Are they encumbered?

No, they are not encumbered. I am sorry.

Okay. And with respect to the timing, I know you said Q3. Is it likely to be middle of the quarter, back-end loaded? And just any more color on that?

On the --

Yeah, the formation.

It would be late -- late in the quarter.

Okay. Thanks.

Again, ladies and gentlemen, if you have a question at this time, please press the 1 key on your touch-tone telephone. Our next question comes from Jeff Donnelly from Wachovia Securities.

Good morning, folks. Dan, I recognize it's early on but what progress, if any, has been made on leasing of the vacant space underlying the master lease with Benderson?

Well, at 3/31/04 when the original master lease exhibit was assembled, there were 97 spaces on the master lease. At the closing, there were 78 on the list. So between 3/31/04 and the closing 25 tenants or 100,000 square feet had opened and commenced paying rent. Currently there are 47 additional master lease spaces that have executed leases and that are under construction. But they are not open or paying rent. The majority of those will open in Q4, and some will spill over into Q1 of '05. So of the original 97, total executed leases were 72 or 557,000 square feet. That leaves us with 25 from the original list. 16 have active proposals and 9 are relatively inactive at this time.

Can you tell us roughly what the square footage of those 16. Is it significant?

363,000 feet of the 16 that are active and of the inactive ones, is about 143,000 square feet.

Okay. And -- out of curiosity. Is the redemption of Benderson's 2% equity interest in the venture tied to the success or failure of their performance under the master lease?

No.

No.

And as far as when you refer to the "joint ventures," their interest is reflected as "operating partnership units" versus, you know, a joint venture that we would typically account for on an equity basis.

Right. And then Scott, there was a transaction out last evening obviously from Mervyn's, and just because of your knowledge of some of the involved parties, can you share with us maybe what you believe their intentions to be and maybe remind us of what DDR's exposure is to Mervyn's and perhaps is there an opportunity for you to participate in their entity or what they are doing there.

We don't expect to participate in what they are doing. I think we have a store in Minneapolis that's owned by Mervyn's that is being -- that was acquired by Sears --

May's.

Or I mean by May's in the recent Marshal Field's acquisition.

We have one in Portland and we have one in Salt Lake.

Right. And, you know, the transaction itself I don't have the details other than, you know, we were involved in looking at the Company, and at least initially, the Company will have to be operated as a retail enterprise, and that really spooked us in terms of, you know, the opportunity. We think that there's, you know, our mission as a real estate company does not expand to operating a retail business with 29,000 employees.

Okay. Thank you, have a good day

Our next question comes from Jim Sullivan from Prudential Equity.

Good morning. Starting first with same-store growth. In the quarter, we estimate about .9% for the quarter, for the same-store portfolio. I know last time we talked about this, and at the time I think there was kind of confirmation. You thought you were on track to do 3% same-store for the year. Occupancy trends are positive. I guess spreads are also, you know, relatively healthy. I wonder if you could address whether you are still comfortable with 3% for the year.

Well, again, Jim, you know, same-store NOI is sort of in many cases in the eye of the beholder and how it's calculated different ways by different people. We did have some unexpected tips to same-store NOI as a result of bankruptcies that were not originally budgeted in for '04, particularly in Zaney Brainy and Just for Feet, and that did have a negative impact overall on the portfolio, the releasing of those spaces has been very positive but the occupancy has not yet occurred. So I think the same-store NOI trend will be consistent in the last six months as it was for the first six months.

All right, it will be consistent in the -- in the second half of the year with what it was in the first half? Or it will be -- it will offset the weakness in the first half.

I think it will be consistent with what we saw in the first half.

So does that suggest that the releasing of the vacant boxes that you are talking about are really not going to contribute until next year?

A lot of those that will open will open -- if they open this year at all, they will open late in the year and a lot of those will be first-quarter '05.

Okay. Shifting gears, in terms of the -- the assets that you talked about that are being transferred, Scott, I just wonder, you had talked previously about MDT having a right of first offer on several assets. Are any of the assets which are being transferred ones that they otherwise have the right of first offer?

No. MDT right of first offer relates to a list assets that are large community shopping centers. MDT investment protocol does not allow for the acquisition of neighborhood grocery anchored properties. They have another entity called Macquarie Countrywide that invest in that product which precludes, you know, the deal we made with Macquarie is Countrywide cannot buy community shopping centers and MDT cannot buy neighborhood centers. So -- which is largely why we pursued joint ventures with other capital providers on this grocery anchored portfolio.

Can you update us in terms of the MDT, that list, that right of first offer list? I think we talked about this also before, possibly being a source of, you know, additional transactional revenue in '05. Any indications -- any update on whether there is likely to be some transactions with them in '05.

They have done due diligence on group of assets and it's certainly possible for us to pull the trigger any time we think it's appropriate to do so. You know, there are assets on the right of first offer list that would trigger significant merchant building gains, which we -- you know we've elected not to -- to accelerate into 2004, so, you know, it is certainly possible that they could occur in 2005. As we complete our budgets for 2005 in October, you know, we will make a determination of how that all fits into our capital strategy for 2005. You know, as you know, the beauty of the MDT relationship and the elegance of it, is that we do have the flexibility to time those types of transactions wherever they best, you know, help us with our strategies. So we'll be really honing in on that in the next couple of months as we refine our budget.

And from the standpoint of MDT and the decision process that they have to go through, to complete additional transactions, is it -- would it be contemplated that they would simply lever the assets they have or would they have to go back to the equity market in Australia?

It's not likely that we would significantly increase leverage on an interim basis, but there is -- there are ways to acquire assets without doing that. One is that we have a very active dividend reinvestment plan in that company that has over 60% participation. So every time there is a dividend distribution there is an equity raised automatically of significant dollars. In addition, the cap rates on the assets that MDT owns has compressed probably at least 50 basis points in many cases, and there is always the possibility over there that we could do a revaluation of the existing portfolio that would, in turn, cause the existing leverage as a percentage of market value to decline, and would give us an opportunity to lever up. Having said that, you know, we think that the appetite for our equity over there is very strong, and, you know, we could access that market whenever we choose to under current circumstances.

And just a quick general question on your development and redevelopment pipeline. The -- on other calls with other REITs this quarter we have been hearing a lot about increases in construction costs. Is there -- are your yields on cost consistent with what they have been historically for the existing pipeline?

The answer is, yes, for the projects that are under construction and have been for about the last eight to ten months. Going forward, however, we are seeing the exact same thing. In fact, we just bid on a job where we saw about a 40% increase in steel costs beyond where a similar project was bid only two years ago. So we are -- we are dealing with the same issues. A lot of our pricing for the existing construction was locked in prior to those increases, but we are dealing with them going forward.

But, Jim, I would say to that in terms of pursuing new opportunities, that -- those types of increases in costs more often burden the land over than the developer, because the yields we have to receive aren't going to change and all that's going to change is what we can afford to pay for the land, and we can't afford to pay any different amount than anybody else can. So somebody who thought their land might have been worth $400,000 an acre might have to accept $350,000 an acre if the construction costs rise. It doesn't have a direct impact on yields at least the way we do business.

The yields should be consistent with what they have been?

Yes.

And this is also kind of a related question, but there's been a lot of -- you know a lot written over the last couple of months as to the valuation of real estate owned by retailers and there's been speculation, that a number of large retailers -- we've seen some transactions, we heard about, there's been speculation regarding Home Depot, sort of monetizing the value that they have doing a large sale leaseback transaction. Have you been in any active discussions with any of the large retailers about such transactions? Do you think they make sense for DDR to participate given the kind of yields you get on your development?

It doesn't make sense for us to be extending capital to large retailers at the yield that they would be willing to offer. Frankly -- the discussions that we have been having have been the opposite. We have been in active discussions with Wal-Mart and Target, who have a strong appetite to buy buildings in our portfolio at cap rates South of 6%. So if we are going to enter into any kind of transaction -- Home Depot, if they are going to divest real estate would be an outlier in terms of current thinking. Most of the retailers today are going the other direction and want to own because their cost-to-capital is so low that they can reduce their costs by financing it, you know, on their balance sheet. So, you know, it's an interesting dichotomy, you know, that we are involved in now where we can significantly enhance yields on a development because a tenant is willing to pay us a much higher price to own their box than the yield they are willing to pay us on a ground lease or on a build-to-suit.

Just Scott's point, Jim, we are actually seeing some mid-sized boxes for the first time in -- in memory talking about a desire to own their boxes as well as opposed to lease.

Interesting --

Frankly, I think that that's one of the most interesting aspects of that is what are the implications it has for the net asset value of our company and our peers because, you know, we have, you know, probably, I would guess, 40, $50 million of revenue from A credits or better that we can sell at 20 times the income on those leases. And that clearly is not being reflected in anybody's net asset value, asset analysis for Developers Diversified.

Certainly. Final question for me, a quick one. In connection with the Palisade Park project in Colorado. I understand you have decided not to participate. Is there likely to be any broken-deal cost in the third quarter on that?

No, there is not likely to be broken-deal costs, and if they are -- and there's -- maybe some. But it will be immaterial. It will be nominal. We really didn't put a lot of money into that project, Jim. We marketed that project actively at ICSC and through our national tenant account program and quite frankly, the retailer reaction was not as robust where we would have liked to get the returns that we need in order to proceed. So we had the option to withdraw and get our refunded capital back and we did.

Okay, very good, thank you.

Our next question comes from Alexander Goldfarb from Lehman Brothers.

Good morning. Just going back to what you were saying on the A credit. You said $40 to $50 million in NOI?

I'm sorry, revenue.

Oh, revenue.

Breaking out the leases. For instance, you know, if we chose to, Alex, we could break out, you know 20 Wal-Mart, Target, Lowe's, Home Depot stores and sell them, you know, at probably 20 times the rent or Kohl's or any of those stores. That's what I was really speaking to.

Okay. Okay. Following the big box theme. Have you seen any movement on Wal-Mart and their 99 format?

Yeah. I mean they are actively pursuing opportunities, and I think you are going to see particularly out in California, they are going to be extremely active. And I also expect them to be active in looking at K-Mart boxes, you know, and maybe some of the Mervyn's boxes, you know, in the future with that prototype.

But with you guys, are you guys currently in discussion for any?

We are not in current discussions on any at the present time, but I am sure we will be.

Okay. If -- what was the -- you just filed a billion dollar shelf, what was available under your prior shelf?

A bucus (ph) (LAUGHTER).

Okay. It was--

No, we, yeah, we pretty much utilized our prior shelf with the last preferred offerings that we had done prior to the Benderson acquisition and we had maybe 30 million, $40 million or so that was remaining on it.

Okay. Just wanted to make certain of that. Going to the -- to the pending grocery deals. First is -- are you intending to keep the balance of the grocery stores or ultimately will see, you know, further JV's to entirely eliminate your grocery exposure.

I don't think we will ever see it entirely eliminated, but one of the reasons that there weren't more assets in either of these joint ventures is because several of them are encumbered, and the joint ventures that we form on these are really very sensitive to the cost of debt. And we weren't willing to, you know, mark-to-market for the debt. So, you know, that's always going to have an impact in terms of your, you know, disposition strategy. There's just -- it is not always the right time. There's also assets, you know, that are grocery anchored that we consider, you know, fortress assets that really aren't threatened by, you know, the competition from Wal-Mart and others that are in great locations where we think the growth rate, you know, may be equivalent or greater than the growth rate in our overall portfolio. And so we wouldn't necessarily sell them unless we were getting spectacular pricing. So, you know, I think, that here is always going to be some percentage. I think it's right now the neighborhood shopping center exposure in the portfolio is really comparable to our industrial exposure in the portfolio. It's really not that material, but it does exist.

Okay. And getting to the returns that you had mentioned. I think you mentioned the 50% on the Kuwaiti one, 50% promote above an 11 or 11.5.

11.5% IRR.

Okay. 11.5%. And based on some of your previous comments in terms of some of the fee structure, there's still the 4% property fee and then the 6.5% asset fee?

Yes.

Okay. How will those fees be booked because my understanding is that the asset management fee is only booked after the return is achieved.

That's right. That's why we've -- yeah, we mentioned in the script that that was a deferred asset management fee, and we are going to earn it currently, but we are subject to a clawback in the event that we don't achieve the 11.5% IRR. Because until that clawback is eliminated by a sale, that fee will remain deferred on our books.

Okay. So -- the time frame is, what, like five years or something like that?

Probably seven.

Seven years.

Yeah.

And then what would happen. You would recognize the fee all at once?

That's correct.

Okay. And it's an IRR based or it's a preferred equity based return.

An IRR base.

IRR base, okay.

Interestingly enough -- I mean, if these assets have no growth and are sold at the end of seven years, at a cap rate that would be available today in the market, we would probably earn that asset management fee. You know, the, the reason that we that it is subject to a clawback is because the Kuwaiti finance center wanted to be protected in the event that there was a significant increase in cap rates between now and disposition.

Okay, and the -- and the Prudential deal it has a similar structure.

No. The Prudential deal does not have a promote, the assets into the Prudential joint venture are a little less quality than the assets in the KFC joint venture. So we earned that promote in the pricing if you will. You know, they were more in tertiary markets and smaller grocery stores and so forth.

Okay, so it's just the 4% property management fee.

Yeah. 4% property management fees and leasing fees and any redevelopment fees and so forth.

Okay. Looking bigger picture, a few of the mall companies have been talking about ways to assess their value. Outside of some of the traditional metrics. One of your main competitors seems to be going off bulking up in -- in the financing or preferred equity and then also looking, you know, both south of the board and continuing to increase in Canada. What is your view for the future of DDR in terms of growth. I mean the bigger -- you are talking about potentially acquiring more at the end of the year. Obviously the bigger your asset base gets the harder it is to generate the returns. So where do you see the future of returns and how do you balance the asset base to continue to generate the types of returns that we have been experiencing so far?

Well, first of all, you know, this -- I am not sure that I agree with the premise that the size of the Company makes it difficult to move the dial. It only makes it difficult to move the dial if your growth is financed by issuance of new equity. If what you are doing is growing internally and supplementing that with the reinvestment of retained capital and the retained capital is a percentage of your company remains consistent, then the -- getting bigger doesn't necessarily adversely impact your growth rate. And really, what we have been doing and what we probably will continue to do is effectively recycle capital. You know, yes, we do a lot of big acquisitions. We also do a lot of big dispositions, and I think that that will be a hallmark of what you will be seeing from us from a capital market perspective, you know, selling interest and assets at sub A cap rates and reinvesting it in redevelopment opportunities, development opportunities, et cetera, at much higher returns. So I expect we will always continue to be active on both sides of the equation in buying and selling, and there are times where it is beneficial, you know, to grow by issuing equity, and there have been times we have done that. There has also been times where it is beneficial to shrink a company and buy back equity and we have also done that. So from our perspective, we look at our capital strategy as whatever will generate the highest, you know, growth and earnings for the shareholders and that isn't necessarily a mission to just get better, it's a mission to get bigger when it makes sense to get bigger and we also sometimes, there's a mission to get smaller when it makes sense to get smaller. You know, a few years ago, you know, we bought back about $400 million of equity at a time where we felt that was our best use of capital and we sold assets in order to fund that, and, you know, that is entirely possible if we see circumstances, you know present that opportunity.

Okay. But would you consider expanding into, let's say Mexico or getting into the mezzanine business or preferred equity business.

We would consider expanding anywhere where we think we can get the, you know, appropriate returns on our capital. And I think that that's most likely to be in this hemisphere. You know going north or south because the returns, at least in western Europe that we have experienced, you know, are much lower than they are here. And there is enough opportunities here that we don't see a reason to cross the pond to reduce our returns. There are opportunities in North and South America that we will probably look at in the future where we can, you know, see the kinds of yields that we would want to expect. In terms of preferred equity, you know, it's certainly something that we have looked at from time to time with Coventry and away from Coventry. It could happen but, you know, it's not. We are not really a finance company, you know, we are really much more interested in the real estate. So the way we would look at any of those, you know, financing transactions is what would happen if we end up owning the assets, you know, for the amount of capital we have advanced, and is that an investment opportunity that we would pursue.

Okay. Thanks.

If you have a question at this time, please press the 1 key on your touch-tone telephone. We have a follow-up question from Michael Mueller from JP Morgan.

Hi, Scott. I know you said would you comment on budgeting and guidance on the next call, but I was just wondering, given some of the large fees that are incorporated in this year's 295 estimate and the implied second half of the year run-rate, I was just wondering if you have any preliminary thoughts on the '05 consensus which is into the 330s for next year.

I really don't have any specific preliminary thoughts. You are right, any time there is one-time items in your earnings that always presents a challenge, you know, to replicate that in the following year; however, there are also some very important additions, you know, to our run rate going into next year that will offset a lot of that. We have a lot of developments that will be coming on line at very high yields that drop right to the bottom line in terms of our run rate, you know, as well as, you know, the full-year impact of Benderson, which we won't have in this year's number, which will help as well. So, you know, we -- at the end of the day, you know, my guess is that consensus is probably not far off, but we will be, we will have a much better idea about that, you know, after we complete the budgeting process.

Okay. That's helpful. Thanks.

Again, if you have a question at this time, please press the 1 key on your touch-tone telephone. And this question comes from Rich Moore from Key Bank Capital.

Hi. Good morning, guys. The two Sears brand are those going into operating K-Mart boxes?

They are going into operating K-Mart boxes. K-Mart will operate through the spring of '05, they'll shut it down, and Sears will open in the fall of '05.

Okay. And then staying on leasing, Dan, when I look at the metrics, base rents were a little bit softer this quarter than in the first quarter. Spreads were down somewhat even though they are still good. They were down from the first quarter. Is that Benderson kind of muddying that up or is there something else going there?

Well the spreads didn't include the Benderson portfolio. I think if you look, you know, historically, Rich, the spreads are really in line. The average between our renewals and our and our new deals has been pretty consistent for the last about 12 quarters actually. So, you know, from time to time, this fluctuation is based on the type of deals that are done, the size of the deals, the average size of the box, things of that nature, but we are still very optimistic about what we are seeing in the market and we don't think there is any softness going forward.

Okay, great, thanks, and then -- you know the mall guys in their conference calls have all been talking about pretty incredible tenant demand. Are you seeing -- I mean given that there is only so much mall space out there. I mean, what are you seeing from mall-based tenants. Is that, you know, is there a pretty strong interest coming across to your sector as well?

It increases every day. It really is amazing what is going on because as we've said before, a lot of the mall tenants just aren't able to satisfy their demand because there is no new product out there. So we -- our roster of tenants is expanding on a consistent basis and our tenant base is changing quite frankly, I mean, you know, Sears is becoming just as aggressive as a lot of other people. Bombay is becoming just as aggressive as General Nutrition used to be in our asset class. So we really are seeing a lot of those tenants coming across the line and they are giving us better merchandise mix in some cases and some pricing power on space.

Okay, great, wonderful, thanks. And the last thing from me is, other income was a little bit higher, Bill, this quarter. And I know part of that is -- is lease termination fees. Anything else in there?

Well, we did have the acquisition and financing fees that we earned from the MDT transaction in there, and that's detailed out in our -- in our supplement and actually in our earnings release, you know, following the table of income.

Great, terrific, thanks.

Again, if you have a question at this time, please press the 1 key on your touch-tone telephone. Ladies and gentlemen, this concludes the program. Thank you for your participation. You may all disconnect. Have a wonderful day.