Site Centers Corp (SITC) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Second Quarter Developers Diversified Realty 2006 Earnings Conference Call. My name is Onika and I will be your Operator for today. [OPERATOR INSTRUCTIONS] At this time, I would now like to turn the call over to Ms. Michelle Dawson. Please proceed, ma’am.

Thanks, Onika. Good morning. I am Michelle Dawson, Vice President of Investor Relations for Developers Diversified. We are pleased to have you join us for this quarter’s conference call. On the call this morning you’ll hear from Scott Wolstein, Chairman and Chief Executive Officer, David Jacobstein, President and Chief Operating Officer, Dan Hurwitz, Senior Executive Vice President and Chief Investment Officer and Bill Schafer, Executive Vice President and Chief Financial Officer.

Before we begin, let me 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 statements. Additional information about risk 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, 2005 and filed with the SEC.

Now I’d like to introduce Scott Wolstein our Chairman and CEO.

Good morning everybody. I am pleased to report this quarter’s results and activities. We reported FFO per share of $0.99 which reflects an increase of nearly 18% over the prior year. Excluding the merchant build and land sales gains for the comparable periods and holding interest rates constant, our FFO per share grew by over 10%.

As you will hear during the call, we continue to improve the performance and productivity of our properties and our overall corporate platform. Our sale of assets to MDT reflects value creation through development and capital recycling while our acquisitions through our Coventry Joint Venture reflect important opportunities for future growth.

I’m proud of the progress we’ve made to improve our balance sheet and gratified that Moody’s recognized our position by upgrading our credit rating. We continue to look for ways to improve. To that end we continue to focus on the efficiency of our operations and providing our employees with the best organization and infrastructure to support their efforts.

From an industry perspective we are mindful of the fact that some analysts and investors have discussed potential sector rotation from the retail sector to the office sector because of perceived pricing power in office during a short-term supply and demand imbalance favoring landlords. However, despite this potential short-term growth opportunity in the office sector, we believe that retail continues to offer the best long-term opportunity for stable growth for two reasons. First, underlying tenant demand for space continues to be strong and re-leasing is further compelling. Second, retail development opportunities continue to offer retail real estate the best opportunity for value creation. The profit margins on new developments ranged from 50 to 100%, the largest in the history of our business and the largest in the entire real estate industry. Company’s like Developers Diversified that have a strong development capability will provide very strong growth and funds from operation and net asset value over the next several years from their development initiatives.

While many pundits continue to speculate on the demise of the consumer, historical results prove that the consumer will continue to support growth in retail sales if population and incomes continue to grow throughout the nation. Moreover, the more successful retailers will continue to perform well in their existing stores and continue to demand locations for new stores primarily because of their ability to win market share at the expense of weaker competitors rather than from their ability to earn their fair share of sales generated by any significant growth in consumer spending.

To give a brief overview on the industry, I’d like to turn the floor to Bill Schafer to discuss our financial results in greater detail.

Thank you, Scott. If you take a closer look at this quarter's financial results, same store NOI growth contributed a little over $0.04 per share in FFO growth. This increase was offset by an increase in interest costs resulting in an FFO per share reduction of nearly $0.07 as compared to the prior year.

At June 30, 2006, the Company’s weighted average effective interest rate approximated 5.8% which compares to 5.25% in June 30, 2005. Moreover, the Company’s floating rate debt at quarter end was approximately 19.7% of total debt compared to 31.7% a year ago. Excluding construction-related debt, our variable rate debt drops to approximately 11% of total debt.

I’m pleased with where we are from a balance sheet position. As you’ve heard me say on many conference calls, our active balance sheet management has substantially improved our credit profile and our financial efficiency. For example, following the credit rating upgrade that Scott mentioned earlier, we amended our two senior unsecured credit facilities. We made improvements in four key areas. First, we reduced pricing to LIBOR plus 60 basis points. Second, we increased capacity. Third, we modified our covenants to provide greater flexibility; and fourth, we extended the term to 2010. These changes will not only affect our bottom line but will have a meaningful impact on our operating flexibility and efficiency.

As Moody’s recognized, our capital market activities over the last several quarters have made a positive difference to our credit profile. We continue to maintain one of the lowest costs of total debt within our industry sector and our unhedged variable rate debt is at less than 20% of total consolidated debt. We’ve addressed our largest near-term maturities and we’ve improved our flexibility through increased corporate liquidity and debt capacity as well as more favorable debt covenants.

Now I’ll turn the call over to Dan for his comments on leasing and development.

Thank you, Bill, and good morning. I’m pleased to report the health of the retail industry continues to be strong supporting our leasing efforts in our core portfolio and creating new opportunities within our development properties.

Coming off a successful ICSC leasing convention in Las Vegas where retailers reinforced their enthusiasm for 2007 and 2008 open to buys and some actually had additional 2006 capacity, we are confident in the continued growth aspirations of our core retail partners. This positive outlook may seem inconsistent with some predictions of current and future market conditions giving concerns regarding energy prices, interest rates and consumer’s disposable income levels. However, it’s important to understand that retailer’s growth plans are largely unaffected by these issues unless they have a direct, material and most importantly unplanned effect on overall sales and margin. Quality retail companies have seen these market issues before and know how to operate efficiently in this environment.

As a result, to date, we haven’t seen the predicted negative impact. Where markets may be tightening, retailers are factoring this impact into overall sales and inventory plans which permit margins to be maintained in the face of modest same-store sales growth. However, high employment levels, wage growth and a dose of modest inflation are strong signals to retailers that consumer demand will support future store growth.

As Scott mentioned, we are mindful that many credible pundits have been predicting the demise of the consumer for a number of years. And I assume if you continue to make such predictions, over time, they may become reality due to the cyclical nature of our business. However, to date, that does not seem to be a supportable trend.

It’s also important to recognize that from a credit perspective the retail industry overall continues to exhibit strength. This is true even with the increased activity of private equity firms investing in retailers which corporate structure may obscure operational transparency. While we monitor the activity of these firms very carefully and, as mentioned last quarter, are also monitoring near-term leverage levels, the focus on the current results and infusion of significant equity commitments serves as an important function in the retail market.

Private ownership can make rapid and significant improvements to business strategy that would have otherwise been very difficult to achieve as a public entity particularly outside of bankruptcy. Today, retailers’ balance sheets are solid and our credit watch list is relatively short.

We can see these positive industry trends in our quarterly results which reflect brisk leasing activity throughout the portfolio. We leased over 1.7 million square feet during the quarter including new deals with Wal-Mart, Target, JC Penney, Kohl’s, Sportsman’s Warehouse, Best Buy, PetSmart, Bed Bath and Beyond, Ross, DSW, Michael’s Ulta Cosmetics and four new locations to [Justice]. In Puerto Rico we signed new leases with Children’s Place and Foot Action which are expanding their presence on the island. In addition, we also brought Aldo Shoes to Puerto Rico for their first store and are continuing the dialogue with numerous other tenants for entree as well. Our core portfolio lease rate increased 40 basis points over the second quarter of ’05 to 96%. In our overall leasing spreads 12.9% were strong which spreads our new leases up 21%.

Leasing activity within our development portfolio also continues at a brisk pace giving us good visibility on 2006 and 2007 openings. At our midtown Miami project we have tenant commitments on 90% of available space in the north block. Tenants in this first phase will begin opening in the fourth quarter of this year including Target, Ross, Dress for Less, Linens and Things, Circuit City, Marshalls and PetSmart.

The first phase of our McHenry, Illinois project will also open in late 2006 with Dick’s, Best Buy, Bed Bath and Beyond, Office Max and PetSmart. We also expect substantial completion of Phase I at Beaver Creek Crossings in Suburban Raleigh with Marshalls Super Center, Dick’s, Old Navy, Circuit City and Borders opening in the fourth quarter. Mount Nebo Pointe in Pittsburgh will also be substantially completed later this year. Hallmark, GameStop, Quizno’s and Payless will open before Christmas joining Target, Sam’s, Sportsman’s Warehouse and Sally Beauty which are already open.

With respect to our 2007 deliveries we are under construction at our hybrid center in San Antonio. The community center portion of the center will be anchored by Target plus several junior anchors including Hobby Lobby, DSW, World Market, Office Max and TJ Maxx. The lifestyle portion will feature Chico’s, Soma, Cold Water Creek, Talbot’s, White House/Black Market, Victoria Secret, [inaudible] and many other comparable retailers and restaurants.

We continue to see opportunities to develop hybrid centers where lifestyle tenants and community center tenants are located in the same project. During the quarter we announced a new development in conjunction with our Coventry Joint Venture in suburban Dallas. Watter’s Creek will be a 350,000 square foot retail development that will service the town center to a 500 acre master planned mixed use community. This site has already received anchor commitments from Market Street United, a local specialty grocer and Borders as well as a variety of high-end specialty merchants and restaurants.

Given the continued strong demand by anchors and junior anchors for new product, ICSC was also highly productive for our site selection team. As an active self developer, we received a strong reception from many landowners and our site acquisition team in Cleveland, San Jose, and now South Florida, continue to evaluate the leads we identified at the convention.

Now I’d like to turn the call over to David for his overview of transactions and operations.

As you heard earlier in the call, our sale of six assets to MDT during the quarter reflects significant value creation through development and capital recycling. The portfolio was priced at $123 million which equates to a 6.6% cap rate. The portfolio was owned through a preferred equity structure that differs from our typical asset sale to MDT. We like this structure because it provides us with a continuing interest in a high quality retail portfolio plus an accretive fee stream and the ability to recognize promotes through additional value creation. Although we do not expect to receive significant income during the initial years, we are confident in the upside potential of these assets through additional leasing and future rent increases.

We received upfront fees for debt placement and structuring of approximately $500,000. In addition, we expect to receive annual property management fees of $400,000, and annual base asset management fees of approximately $250,000. Consistent with previous sales to MDT, it was important for us to maintain an ownership interest in these assets, maintain day-to-day control and benefit from an accretive fee stream.

Although we view the current acquisition environment judiciously, we identified a handful of strategic investments during the quarter that represent opportunities for us to leverage our core competencies to create shareholder value. For example, we acquired three properties in Ohio, Michigan and Texas through our Coventry II Joint Venture. These properties which were purchased based on an aggregate price of approximately $225 million reflect the diverse opportunities that Coventry sources for us as value add investments.

Tri-County Mall is the dominant regional mall in Cincinnati’s primary retail corridor. We will focus on the redevelopment of a 160,000 square foot former JC Penney box with in-line retail and restaurant usage.

Fairplain Plaza in Benton Harbor, Michigan is a 325,000 square foot community center anchored by Target, Office Depot and TJ Maxx. The Center which is 69% occupied was partially redeveloped in 2001. We expect to complete the redevelopment, we tenant the existing retail space and develop the adjacent land parcels. Kohl’s is currently under construction at the Center and we have received strong interest from several other community center tenants.

The Watters’s Creek Development at Montgomery Farm in suburban Dallas which Dan already described is the third Coventry investment we acquired during the second quarter. Coventry will also be buying an 80% ownership interest in the remaining service merchandise portfolio. By recapitalizing the service merchandise assets in this way, we will maximize returns from lease up and control an orderly liquidation rather than a portfolio sale as was pursued by the prior joint ventures. We expect this transaction to close during the third quarter. The total purchase price for these assets is $185 million and the overall cap rate in the portfolio including straight line rents is approximately 7.8%. This cap rate reflects a diversity of assets and ownership interests. The portfolio includes 42 leased and stabilized assets, 27 of which are fee interest or ground leases and 15 of which are lease-holds. These assets are well located in strong markets and under long-term leases to tenants such as Bed Bath and Beyond, Best Buy, Circuit City, Michael’s and PetSmart. Of the 10 remaining partially leased or vacant assets, two are expected to be sold in the near-term and two have tenant commitments leaving approximately 300,000 square feet to be leased.

I’d like to give you a few statistics on the overall performance of our Service Merchandise investment which has been very profitable for us. Since the joint venture’s 2002 inception and through our pending acquisition, we have earned a leveraged IRR of 23% on our equity investment. This return was driven by the fees and revenues we received as well as proceeds from the sale of assets at profitable spreads over cost. We anticipate that we will recognize an FFO gain of approximately $0.03 per quarter, excuse me, $0.03 per share next quarter as a result of the recapitalization of the joint venture.

Going forward, we expect additional upside through the [one-up] disposition of the stabilized assets, an additional lease-up and redevelopment of the partially leased and vacant assets including the Service Merchandise transaction, our Coventry II Joint Venture has invested in projects representing over $900 million in anticipated project costs.

Changing gears a bit, I’d like to talk about some operational changes that we’ve recently made and will have an important impact on the efficiency and profitability of our platform in Puerto Rico. As you may recall, at the time we acquired the 15 center portfolio in January of ’05, we expected to use PMI, a third party, to provide on-site management and local leasing services for our portfolio in Puerto Rico. Our relationship with PMI provided us with an opportunity to become acquainted with the local markets, tenants, vendors and on-site staff. In fact, we ramped up our knowledge base a great deal sooner than we had originally anticipated.

Now, 18 months later, we have determined that it makes good business sense to manage and lease these centers in-house rather than relying on a third party. Consistent with these objectives, we will assume full management of leasing responsibilities during the third quarter. We’ve opened a regional office in Ft. Lauderdale which will house a new leasing manager for our Puerto Rico portfolio and a new development manager who will source land for us in Florida. The economics behind these changes is compelling. We will eliminate fees paid for leasing commissions plus annual management fees and personnel expenses while providing these services in-house at a much lower cost. Moreover, we expect to recognize better operating efficiencies by controlling all leasing and management functions. These operational savings will result in lower reimbursable operational costs for tenants which will at least in theory provide for additional opportunities to increase base rent on expiring leases.

Lastly, I’m very proud to report that with respect to our 2005 Annual Report, we received NAREITs Gold Award in the management discussion and analysis category for large cap REITs. This is the fourth year in a row that we have won this award. It is gratifying that our commitment to having the best disclosure has been repeatedly recognized at an industry level.

At this point, I’d like to turn the floor back to Scott for his concluding remarks.

Thank you, David. At this juncture I’d like to comment on our earnings guidance for the balance of 2006. I’d like to tighten our year-end FFO guidance from a range of 336 to 346 per share to a range of 338 to 344 a share as we gain greater visibility for the second half of this year.

Due to the timing of certain transactions, however, analyst consensus estimates for the third quarter may be a couple of cents too high at this point.

Now I’d like to open the line to receive your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Jonathan Litt with Citigroup. Please proceed.

Hi. This is [inaudible]. My first question is this quarter there is a positive income tax benefit in the TRS. Could you walk through what caused this to be positive?

Yes. I’ll take a shot. It’s a little complicated. First the benefit that’s reflected in that particular line item is somewhat offset by the tax expense that is netted against the gains down below. It should be noted that a lot of the assets have triggered what we refer to as the merchant building gains, came to us from JDN and we assumed the tax basis from JDN which was higher than what was allocated to us from a financial perspective due to our purchase price allocation.

However, just given the increase in the total gain income, we are able to then deduct a greater amount of inter-company interest costs, you know, essentially a higher tax rate because the gains down below are generally at capital gains rates versus ordinary rates and, again, the higher interest deductions that we can get will provide us a future benefit through reduced tax payments, primarily going forward.

Okay. And the next question is, for your operating margin it dipped a little. Was that more related to revenues or expenses and do you see that trend going forward?

I don’t know that it dipped that much. I think if you take a look at the numbers in our same-store NOI, we had a positive number there. The percentage is probably slightly down; I that’s more just due to the mix of assets in the portfolio which are a little bit different now than they were a year ago.

All right. And that will improve once you bring in the management leasing for Puerto Rico. Correct?

Yes. Those will all have positive benefits. Correct.

Okay. Thank you.

Your next question comes from the line of Christeen Kim with Deutsche Bank. Please proceed.

Hi. Good morning. Scott, again, I appreciate your commentary on how the retailers are fairing in this consumer market, but I was just curious how much an impact is -- concern about the consumer impact -- your discussions with tenants in terms of renewals and new leases. I just noticed your lease spreads have been very robust over the past 5 quarters. I’m just wondering how sustainable that is over the 10% levels?

Well, I think it’s very sustainable because it’s basically in line with historical trends now for several years. When you really look at it to what it means, you’ve got to basically understand that most of these leases that are rolling over are about 5 years old. So when you see a re-leasing spread of 20%, it’s really sort of a 4% compounded growth number in tenant sales, if you’re getting your same percentage of tenant sales in terms of occupancy cost. So it sounds like a big number but it really is a number that’s been pretty consistent and it’s not much greater than the rate of inflation. You should expect to at least achieve rate of inflation in your re0leasing spreads which would be, as you know, about 2½% to 3½% right now in terms of compounded annual sales growth. But the sales growth also comes in other ways because new stores take awhile to ramp up to maturity and their sales tend to do a little bit better than inflation and therefore the leasing spreads are a little bit better.

One of the things that I think there is a lot of confusion about with respect to how tenants view the world, you hear a lot of commentary about, “Gee, we have rising gas prices. How does that affect the consumer and what’s a tenant going to do in light of that?” Most tenants who make new store decisions and make commitments on new leases are basically doing research based on their estimates of third year sales after they sign the new lease. It’s not based on what’s going to happen yesterday or even today or tomorrow. It’s what’s going to happen three years in the future. They can’t really project those kinds of near-term cyclical costs and benefits in the economy of things like energy prices. What they can do is they can make a pretty good estimate of how much retail sales are going to be available in the market place where that store is going to exist and what their fair share of those sales are going to be. And that’s really what determines their sales.

And what I was trying to say in my comments is that far more than the health of the consumer is the available sales in the market and what they think they can gain in terms of share of those sales. And if you look at that on a sort of – taking Wal-Mart as a primary example – Wal-Mart opens about 350 new stores in the United States every year. Each store averages about 150 to 200,000 feet and they expect to do $60 to $100 million in sales in each of those stores. If they were basing that on growth and consumer sales, they’d have to get all the growth and consumer sales in the nation. They are not basing it on that. They are basing it on their ability to compete as a retailer, go into markets where they are not maximizing their share of retail sales and get their fair share of sales from weaker competition. And what people need to understand is there’s a lot of sales to be had because there’s been considerable consolidation in retail and lots of retailers have left the landscape. Half of the department stores don’t exist anymore that existed a few years ago. All of them were doing business and that business has to go some place. And a lot of that business is really going to a lot of the tenants that occupy space in our shopping centers and that’s where they are going to get their share from people like May Company from people like Montgomery Wards, from store closings by people like Kmart and Sears and so on and so forth. All of that puts new sales in play.

Generally, when you have hundreds of grocery stores closing which we’ve seen the last few years, those sales have to go somewhere and they are available to people like Whole Foods that enter new markets or Wegman’s that build new stores or Wal-Mart Supercenters who are going to basically capture all of those sales that become available because of the dynamic nature of our business. So I do think that we spend a lot of time agonizing over what the consumer sales are going to be month-to-month and people really ought to spend more time kind of looking at long-term consumer sales trends over a longer period of time like retailers do and really look at what kind of retail sales are in play and who is going to get their share of those sales; and which landlords are going to have an opportunity to lease space to those stores.

I agree with you on those points. I was just looking back to some of your historical leasing spreads on a blended basis and it seems like you went from a range of 7% to 8% in ’04, early ’05, to a solid double-digit number from the beginning of ’05 and into ’06. I was just wondering --

That’s a good observation but if you really study that that’s almost entirely on the renewal side. The re-leasing spreads on the new leases have basically held steady in the low 20% range. What has changed a little bit is the initiative of the Company to try to minimize the below market renewal options that tenants have and what used to give us a blended leasing spread in the high single digits is a much lower re-leasing spread on renewals.

Okay.

21% re-leasing spreads in this quarter are really not out of line. It’s the renewals that I think have come up a bit.

Okay. Great. And my next question was just if you could remind us what you were estimating or including in your guidance for G&A?

The G&A will continue to run at a rate of about $15.4 million a quarter as opposed to what has been previous which has been in the mid-14s. And that’s what you should continue to use.

And the pick up from last year, that’s mainly attributable to --?

No. The principal reason for that is some out-performance plans which have been put into place for 11 members of senior management. There are some challenging metrics that must be met including one that requires us to outperform our peers. The measurement period is over an extended period of time. Nothing has been paid to date. The accounting rules require us to start accruing even though nothing has been earned and nothing has been paid. That’s just what the rules require. So we have started the accrual and it will be running at a rate that will require us to have higher G&A for the foreseeable future.

Great. Thank you.

Your next question comes from the line of Matt Ostrower with Morgan Stanley. Please proceed.

Hey, good morning. It’s Mick Cheng here. We have a question regarding the new Macquarie Preferred JV and we would like to understand how you can get to 9% preferred return if the initial cap rates are sub-7 and the borrowing costs are over 6%?

I’m sorry. How you can get to -- you get to it from growth in NOI over time is how you get there.

Okay.

It doesn’t necessarily have to be earned in year one. There are bumps in leases throughout the portfolio that generate incremental NOI over the holding period of the assets and there’s also continued NOI growth. The way those transactions were structured was to give the priority return to the MDT shareholders and then to give a lion’s share of the growth opportunity to DDR because we’re going to be responsible for generating that growth.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Scott Crowe with UBS. Please proceed, sir.

Good morning. I’ve just got a follow-up to that last question. I think what the previous caller may have been trying to ask was the latest DDR Preferred JV looked a little near-term dilutive.

I’m sorry. Which JV are you talking about?

The Six Crossings for 122 million.

The sale to Macquarie?

Yes. It looked a little bit near-term dilutive and I think you sort of are eluding to you’re going to catch that up in the growth; but as a rather broader question stemming from that is, can you comment on the competitiveness of the Macquarie capital going forward in the current pricing environment.

It’s very challenging right now for the Macquarie capital in the current environment. And that’s largely occasions that need to be a little more creative in terms of structure in order to enable us to effect a transaction. The general mood over in Australia right now is to favor internally managed vehicles with development capabilities and the higher growth opportunity. And the externally managed passive vehicles like MDT right now that are invested in the United States are trading at lower multiples than the Australian-based LPTs with assets in Australia that are internally managed. We actually had a strategy call with our partners at Macquarie yesterday to talk about how to address that and some of the new initiatives we might pursue in MDT to achieve a more competitive cost of capital over there.

As you know, these things are cyclical. Sometimes the race today isn’t the race tomorrow; but right now, to be quite candid, MDT is trading at probably 20% to 25% discount NAV which means its cost of capital is higher currently than our cost of capital domestically.

Okay. Thanks, Scott. Just a follow-up to that. I mean if you look at [inaudible] they seem to have moved away, I suppose, from their Australian trust. Are you thinking about, perhaps, other capital sources that may be more competitive perhaps here in the U.S. on the unlisted side for argument’s sake?

Well, yes, there won’t be anything new, Scott. We have already been basically doing that over time. Over the last few years we’ve sold assets to Prudential; we’ve sold assets to our joint venture with the Kuwaiti’s. We’ve sold assets with DRA and we will continue to pursue domestic-based private equities because right now I think it’s very compelling. That is, I think, a strong core competency of our Company is our ability to access capital from a variety of sources and to continue to find the best priced capital.

Having said that, we continue to be committed to the Macquarie vehicle; it’s been a very good vehicle for us and has enabled us to maintain ownership of our development assets while we’ve been able to harvest merchant building gains and we do think that over time we will be able to be more competitive over there in terms of the capital markets and reduce our cost of capital so they can be a more important player. But we’re never going to sell assets to MDT at a price lower than we would be able to sell them to anybody else anywhere in the world. So unless they are able to pay a competitive price, then we’re absolutely going to have to pursue other capital sources and we are in very earnest discussions on a variety of opportunities to do that.

Thank you very much.

Your next question comes from the line of Stephanie Liu with Lehman Brothers. Please proceed.

Hi. This is Stephanie Lau with Steven Rodriguez at Lehman Brothers. Just have a few questions and I’m wondering if you can give some color on your line items. For ancillary income I notice that you previously gave guidance on a 10% growth a year, are you still holding on that? And the second question is on lease term fees. I notice that year-to-date it’s 6.5 million and previously you’ve given guidance on 10.5 million. Are you still holding to that previous guidance that was given? And can you give a little bit of color on TIs? How are they going forward? Just those three line items. Thank you.

Well, certainly in regard to the ancillary income we are holding the line on 10% annual growth and we actually have a few initiatives in place that we think might be able to exceed that line; but for budgeting purposes and for modeling purposes 10% is a number that we’re using.

Okay.

The lease termination number -- the $10 million number we’re probably maybe looking closer to $9 million-ish in that area at this point in time. And the last question was or the last part was --?

On TIs?

TIs, I believe we do disclose that in our supplemental?

Yes. Stephanie, in Sections 3 and 5 we disclose recurring capital expenditures and those total $20 million for 2006.

Okay. Great. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Rich Moore with RBC Capital Markets. Please proceed.

Hi. Good morning, guys. Scott, you asked most of my favorite retailer questions but I have one more for you that keeps popping up. You guys are at 96% leased, do you have room to add more tenants?

Well, sure. We have more room to add more tenants but I don’t think we have room to increase overall occupancy much. You really don’t want to. When you get to 96% to 97% you really are much more interested in driving higher re-leasing spreads than higher occupancy. You’re always going to have structural vacancy of 3% to 4% in your portfolio. So I think what you can look for when we get to this kind of occupancy level is maybe higher spreads rather than higher occupancy.

Okay. Is it safe to assume that you’ll actually get higher quality tenants, as well, since you have the opportunity to get rid of some of these guys?

Well, obviously you always look for a tenant who can pay more rent because he’s going to be able to do more in sales. And the other thing that I think people really need to understand is we really actively asset manage our portfolio. We sell the lower 10% in quality of the portfolio at all times as quickly as we can; so some of the occupancy gains don’t have to come from leasing. It just has to come from off-loading some of the less occupied and less desirable assets in the portfolio which in the market that we’ve been in for the last couple of years there’s been a great opportunity and we’ve sold some assets at 7 and 8 cap rates that years ago we wouldn’t have been able to get us up over a 13 cap.

Okay. I got you. Thanks. And then you exclude Mervyns from the occupancy number. Right? Is there a reason for that?

It’s 100% leased.

That’s okay.

It would be helpful to the number but I think it would be a little distortive of sort of the facts. We sort of view those single purpose buildings that are 100% leased as not the core, if you will.

I got you. Thanks, Dan. That’s fair. I just thought, you know, it’s a major tenant and obviously major property so in my mind it would be fine. Did you say how much the new preferred MDT joint venture, the capacity of that is? You maybe did and I missed it.

No. There’s no limit to the capacity. It’s just the limit from time-to-time as to the appetite. This transaction, frankly, was funded without raising any equity. So that is one way to look at capacity. How much can you borrow without violating your leverage protocols and how much can you raise just from the DRIP proceeds that you receive; and that was basically the constraint that determined the available funds for this transaction because I don’t think at the current cost of capital we would be anxious to go and do an offering to support an acquisition of MDT. But we have -- we continue -- in every country but the United States as you know, where you have these real estate vehicles, you do periodic reappraisals to determine the value of the portfolio to support your metrics vis-à-vis financing and so forth. And obviously at MDT we’ve seen a very significant appreciation in the value of the assets which has enabled MDT to buy more assets at cap rates that would be lower than they would be able to buy if they had to fund them with new equity. We probably have some room to do an additional revaluation. For instance, the Mervyns participation that MDT has was valued at an 8/6 cap rate going in. I think based on some positive operating numbers at Mervyns that that cap rate is probably 100 basis points too high today which means those assets are actually going to value at a higher value which means they’ll be able to borrow more without increasing leverage or what they call gearing above the current levels and that will enable them to do more transactions with us.

Okay. Very good. Thank you. And then on the service merchandise, why do you guys get to book $3 million of gain? Is it because you are moving from 25% ownership to 20% ownership basically when you sell the Coventry? I’m a little confused why you would be able to buy from one entity and turn right around and sell for a gain.

We’re not recognizing any gain on our share. We’re only recognizing the gain on --

That’s correct. Basically it’s a transaction – we’re acquiring the assets and then basically we’re reselling them and there is a gain component based on the price of this being resold at from what our original basis was in those assets.

So you’re able to buy and turn around the next day and actually sell it at a higher price?

Well, again, it’s not so much --

[Inaudible] between our purchase price and the sale; it’s our original investment --

Our original – yes, exactly; original basis in those assets.

Okay. I think I’ve got you. Maybe I’ll follow-up with you on that. Great. Thank you, guys.

[OPERATOR INSTRUCTIONS] Your next question is a follow-up question from the line of Scott Crowe with UBS. Please proceed, sir.

This is a quick follow-up on the Macquarie DDR. Given that they are sort of trading at a 25% discount to NAV, it looks challenging for them to raise equity. But you did mention the DRIP program which is a potential source of funding. How large is that?

There’s about a 75% participation, Scott, in the DRIP for MDT. So if you basically take the dividend over there – I think right now is probably about 8½% yield on an equity of about a billion 1, billion 2, I’m just guessing. So if you basically look at that on a quarterly and divide it by four on a quarterly basis, the DRIP is about 75% of that.

Okay. Thank you.

Your next question comes from the line of Eric Rothman with Wachovia. Please proceed.

Good morning. I was curious, relative to many of your peers your joint ventures are fairly mature. Is it fair to say that we should expect to see accelerating volume of promoted interest in equity kickers over the next few years or are we kind of between, so to speak, waves of that activity?

That’s a good question. I think probably it’s going to be fairly steady. In terms of the Coventry I Joint Venture, there are some assets left in that venture that have a significant promote embedded. However, our partners, the pension funds advised by PREI that are co-invested in those assets with us, are pretty happy with them. So it might take awhile before we can encourage them to allow us to harvest those promotes. But they are there and they are very significant. With respect to Coventry II, that is a fairly young venture and we’re probably at least a couple years away from harvesting any significant promotes from that venture. However, I do think we probably have a significant opportunity to harvest or promote from one of our Kuwaiti joint ventures in the next year or so.

It’s a mixed bag. I think it’s going to be fairly steady but it’s also going to be growing because the numbers of transactions that are subject to the promotes continue to grow every year and we will have more and more in joint ventures. So it’s going to be a steady number and it’s going to be a growing number.

Thank you very much.

Your next question comes from the line of Greg Andrews with Green Street Advisors. Please proceed.

Good morning. Did you give guidance again for the total merchant building gains for the full year?

I don’t know if we did, Greg; but I could give it to you now if we didn’t.

In the call, I think, last quarter you were talking about a number in the range of 59 million for the full year.

I think we said something about 61 and I think we’re probably slightly above that, probably about 63.

Great. Thank you.

That includes land sales and stuff.

Yes. That’s not just merchant building.

Okay. Great. That’s right. Thanks.

At this time there are no questions in the queue. I would now like to thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Thank you and have a good day.