Jul 30, 2008
Executives
Barbara Pooley – VP, Finance and IR Mike Pappagallo – EVP and CFO Dave Henry – Vice Chairman and Chief Investment Officer Milton Cooper – Chairman and CEO David Lukes – EVP Mike Melson – General Manager and Managing Director, Latin America Jerry Friedman – President, Development, Kimco Developers, Inc.
Analysts
Paul Morgan – FBR Christine McElroy – Banc of America Michael Mueller – J.P. Morgan Steve Sakwa – Merrill Lynch Jeff Donnelly – Wachovia Securities Lou Taylor – Deutsche Bank Michael Bilerman – Citi J.
Habermann – Goldman Sachs Rich Moore – RBC Capital Markets
Operator
Good morning, ladies and gentlemen, and welcome to Kimco’s second quarter earnings conference call. Please be aware that today’s conference is being recorded.
As a reminder, all lines will be muted to prevent background noise. After the speakers’ remarks, there will be a formal question-and-answer session.
(Operator instructions) At this time, it is my pleasure to introduce your speaker today, Barbara Pooley. Please proceed, Ms.
Pooley.
Barbara Pooley
Thank you, Dana. Thank you all for joining the second quarter 2008 Kimco earnings call.
With me on the call this morning are Milton Cooper, Chairman and CEO; Dave Henry, Chief Investment Officer; Mike Flynn, Vice Chairman and President; Mike Pappagallo, Chief Financial Officer; and David Lukes, Executive Vice President. Other key executives are also available to take your questions at the conclusion of our prepared remarks.
As a reminder, statements made during the course of this call represent the company and management’s hope, intentions, beliefs, expectations, or projections of the future, which are forward-looking statements. It’s important to note that the company’s actual results could differ materially from those projected in such forward-looking statements.
Information concerning factors that could cause actual results to differ materially from those forward-looking statements is contained in the company’s SEC filing. During this presentation, management may make reference to certain non-GAAP financial measures that we believe help investors better understand Kimco’s operating results.
Examples include but are not limited to funds from operations and net operating income. Reconciliations of these non-GAAP financial measures are available on our website.
And finally, during the Q&A portion of the call, we request that you respect a limit of one question with one appropriate follow-up so that all of our callers have an opportunity to speak with management. Feel free to return to the queue if you have additional questions.
I’ll now turn the call over to Mike Pappagallo.
Mike Pappagallo
Thanks, Barbara, and good morning. Welcome to our second quarter conference call.
And for the next hour you have the opportunity if you so choose to not watch your monitor and get seasick watching stock prices swinging wildly, or to be told how billions of dollars in write-offs showed good thing because there are a few billion left than everyone thought. The first order of business this week was the Board’s decision to increase our quarterly dividend rate to $0.44, representing a 10% increase from current level.
The new rate will commence with the October dividend. Notwithstanding the fluctuations in annual earnings, we’ve been able to keep our dividend increases at a solid level of between 8% to 11% over the past four years, primarily as a consequence of our longstanding practice of keeping FFO and AFFO payout ratios low and operating under a conservative debt policy.
Additionally, investors should be comforted by the fact that the dividend level is supported by our operating cash flows without regard to achievement of transactional income. FFO per share this quarter was $0.66, which was $0.02 above the first quarter level.
Year-over-year FFO per share was $0.05 lower, which was exclusively due to the level of transactional activity in the comparable periods. Last year’s second quarter included more significant gains from the Kimco Capital Services or KCS businesses, including the liquidation of a preferred equity position in self storage in Canada and a New York mixed use building.
We also generated a significant promote last year from our investment management business in the disposition of properties and our joint venture with GE. On the other side of the ledger, we experienced higher merchant building profits this quarter, primarily from the sale of our interest in the Woodlands Project in Houston, and more importantly, an increase in operating cash flow from shopping center holdings and recurring flows from those KCS businesses.
And while we are pleased that our merchant building’s earnings are up, I think it is once again important to emphasize that development gains are not a critical component of our earnings base, contrary to some recently published research. Since the advent of our program in 2001, these profits have ranged between 2.7% to 4.9% of reported FFO.
Timing and extent of the transaction side of this business will always wreak havoc with quarterly comparisons and against the consensus numbers. We exceeded the most recent First Call numbers by $0.01, which is not surprising since our quarterly results have not matched First Call numbers in about two years.
And we continue to encourage the research community to focus less on these quarterly comparisons than more on the annual results in overall business strategies. That said, the composition of our second quarter earnings statement was reflective of the underlying business trends.
First, our US based shopping center assets are holding up well despite the stress on retailers as consumer wallets are being affected by gas and food prices, and as their confidence continues to vain. Occupancy dropped slightly from the March quarter end declining only 30 basis points to a level of 95.7%.
Compared to the year ago June level, it was also a modest drop of 20 basis points. Same-store NOI did decelerate to a quarterly level of 2.4%.
Leasing spreads are holding up with new leases at over 12% and renewals at almost 10%, but the internal growth numbers were impacted by the slightly lower occupancies and higher write-offs. There is no question that the current economic environment has and will continue to put some pressure on portfolio metrics in the short-term.
But we are confident that our portfolio will be able to withstand the recessionary environment and sustain its cash flows due to the strength of the portfolio and the lack of concentration in the tenant base. The second trend is the absolute lower number of transactions, reflecting fewer buyers and sellers and a continued difficult financing market.
Cap rates yet have not moved sufficiently to entice core investors get the greatly anticipated avalanche of distressed opportunities in hard assets, not paper, is yet to arrive. As a consequence, the aggregate level of gains, promotes, and other transactions was about half the level from 2007.
The third area, the appetite to invest outside the US continues in earnest and our investment capital continues to flow into the Mexico development program. In addition, we were able to rekindle some acquisition activity in Canada with our old friends at RioCan jointly acquiring a ten-property shopping center portfolio from H&R REIT in June as well as our first transaction in Brazil and Peru.
Dave will follow with more color on our investment strategies. Liquidity remains healthy with about $1 billion available, but in this environment we will continually look for every opportunity to increase it at a reasonable price.
And with limited debt maturities over the next 18 months, we can afford to be strategic in accessing the capital markets. I again affirm the full year FFO guidance for the year at a range of between 270 to 278, but unbiased towards the low end of the range.
Hitting the numbers, as you would expect, is dependent on achieving the planned transactions in the Kimco Capital Services business as well as continuing to bring our Mexico development pipeline online. The components of the guidance are once again included in the earnings press release.
Finally there is no question that REIT landed in a different place. The real estate cycle does exist and it is unreasonable to assume that fundamentals will be negative as the prospects for an extended recession with stagflation are real.
How will the REIT model flair, I’m not going to generalize. But at Kimco, we recognize that we have to focus on riding through this rough patch upon us and to continue to cultivate a long range strategy focused on shopping centers, investment management, non-US expansion and our opportunity business.
Milton will give you his take on this approach in a few moment. Now I’d like to turn over to my esteemed colleague, Mr.
Henry.
Dave Henry
Thank you, Mike. Using one of Milton’s favorite words, the perturbations of the real estate market and the stormy economic seas continued unabated in the second quarter.
Shopping center sales activity in the US has declined dramatically in 2008, and accordingly our US new business transaction activity has been limited. Institutional investors and lenders of all types continue to largely sit on the side lines, as they wait for the market to stabilize and cap rates to settle.
On the pharmacy side, we are happy to report the closing yesterday of our Kimco Income Fund II, KIF II, with an initial set of institutional investors including Zurich Insurance, Knights of Columbus and CNL. KIF II is the $345 million leverage portfolio of 14 existing retail properties purchased by Kimco over the past 18 months.
The properties have long-term fixed rate debt, averaging 65% of cost, and the projects were selected to achieve diversity, low leverage and strong current cash yield to the investors. KIF II helps us continue to grow our funds under management and our relationships with high quality domestic and international institutional investors.
Also in the US, and as mentioned on our last call, we are planning to introduce a New York urban fund, which will target redevelopment and acquisition opportunities in the New York Metro area where Kimco has decades of experience and where retails are still looking for expansion opportunities, because of the region’s density and lack of many national big box retailers. Outside of the US, Kimco continues to grow its portfolio in Canada, Mexico and South America.
In Canada, we were very pleased to form our second joint venture with RioCan, Canada’s largest REIT and a valued partner for the past six years. Our new venture, creatively called RioKim II, has been seeded with a large portfolio of ten retail properties comprising 1.1 million square feet purchased in June from another large Canadian REIT, H&R.
The portfolio of seasoned properties is 98% leased and 90% of the portfolio contains strong national and regional tenants such as Walmart, Canadian Tire, Zellers, Metro, Shoppers Drug, and Price Chopper. Kimco and Riocan both can grow RioKim too in the future with additional opportunistic acquisitions.
Also in Canada, Kimco acquired additional stock in Plazacorp, a public regional shopping center owner and developer specializing in Quebec and the Maritime Province. Kimco now owns 14.3% of the company and we also had a successful joint venture with Plazacorp on a 458,000 square foot shopping center in St.
John's Newfoundland. We very much look forward to exploring additional joint venture opportunities with Plazacorp.
Looking at Latin America, Kimco continues to expand in a number of focused areas. In Mexico, we closed on 3 new development projects during the quarter and added 2 new land parcels to our Mexico retail land farm.
The new projects and land sites are located in Mexico City, Cancun, Rio Bravo, Torreon, and Mazatlan. In addition, we added one net leased industrial property Monterrey, Mexico, to our American Industries joint venture, which now contains 72 net leased industrial buildings.
During the quarter, we also sold our equity interest in G. Accion's to AMB, the largest shareholder of G.
Accion. In South America, we achieved 2 important milestones, closing our first transactions in both Peru and Brazil.
In Peru, our local partner is Penta Realty, which is headquartered in Lima and controls a portfolio of 23 projects. In Brazil, our development partner is REP, Real Estate Partners, a local firm based in Sao Paulo specializing in small neighborhood and community shopping centers.
We have a strong pipeline of pending development projects with both of these partners in their respective markets. In Chile, we continued to grow our portfolio and relationships by forming a new partnership with D&S, Chile’s largest grocery store retailer, for the development of a new 250,000 square foot shopping center anchored by D&S’s large leader format and home center, Sodimac, a major home improvement store.
As an overview and to give you some perspective of our growing activities in Latin America as a whole, we have approved 23 new deals today in 2008 totalling $308 million, 16 projects in Mexico and 7 in South America. Our pipeline of transactions in various stages of underwriting is very strong and totals approximately $900 million, 29 projects in Mexico and 16 in South America.
All of this compares very favorably with 2007 totals at this point last year. As previously announced, we continue to market a new $500 million commingled fund for South America, which will be seeded with all of our existing investments in pipeline for South America.
Similar to our existing Mexico retail land fund, our South America real estate fund will be our exclusive vehicle to invest in retail acquisitions and development opportunities in South America. Investor interest has been strong and we hope to close the fund late this year.
Overall, we continue to be very optimistic about retail development in Latin America, particularly in the countries we are concentrating on, Mexico, Chile, Peru, and Brazil. All of these countries have strong economies, rich natural resources, a growing middle class, expanding trade, and excellent demographics.
As the US wrestles with its significant housing and economic issues we believe that both Canada and Latin America offer excellent investment opportunities. Now, I would like to the turn to Milton for his thoughts.
Milton Cooper
Thank you, Dave. We have been through many cycles in our five-decade history and each time there is a downturn, we can never be sure how prolonged or how severe it will be.
All indications are that this downturn will punish the consumer, which in turn will hurt most retailers and has to negatively affect shopping center occupancy. There are, however, four constants that are essential for a company during a difficult period and they all start with the letter L, loan leverage, loan payout ratios, lots of liquidity, and finally, level-headed talent.
And loan leverage is safety net and a combination of low leverage and a low payout ratio ensures that our dividend is sacrosanct. We have always maintained the store’s balance sheet and we are committed to continue to do so.
Invariably, downturns bring up and through these company’s liquidity and a talented team that can evaluate and seize the opportunities. And in times of stress, intuitional investors should have retail property investments managed by companies experienced in working through problems having close relationships with retailers and having cash to be co-investor.
A skillful manager with skill in the game becomes of paramount importance. Now, we have always had a long history of specializing in situations involving distressed retailers and distressed properties.
The income in this business should increase with the growing turmoil in the retail sector. Nonetheless, we should not hit ourselves, notwithstanding our relative strength and some shock absorbers we will not be exempt from retail problems and occupancy issues, but well located shopping centers are a wonderful long-term investment and while there will be periods when cash flows may decrease because of tenant bankruptcies, those periods passing over time the rental streams increase.
With hints of inflation and an emphasis on quality real estate, we are confident that our portfolio will perform well for our shareholders over the coming years. Our business model is good one.
We had liquidity and level-headed talent and we will continue to deliver the goods for all of our constituencies and with that all of us will be delighted to answer any questions you may have. Okay, David, thanks we are ready to take questions.
Operator
(Operator instructions) We will go first to Paul Morgan with FBR.
Paul Morgan – FBR
Good morning. Just a couple of things on the transactional side, you know, first on the Woodlands, you listed in your supplemental as having sold for $17.8 million and that does not seem right [ph], maybe you could just give a little bit of detail on that sale and maybe the cap rates on that sale and maybe the cap rates.
And then looking ahead, you know, I assume that there is some number in the second half guidance for Albertson’s transactions and if you could give any sense of what you think that number might be right now given the deals that took place in the second quarter?
Milton Cooper
With respect to the Woodlands, we sold our equity interest in Woodlands. We have a 50% interest in Woodlands net of the existing debt on the property.
Although, the number you are looking is the value of our 50% equity interest.
Paul Morgan – FBR
So, is that true – and that is true for of the dispositions that you list there and none of them are sort of aggregate values?
Barbara Pooley
Paul, if you will cover that with me later we will go through that, I will go through the detail with you.
Paul Morgan – FBR
Okay.
Milton Cooper
With respect to your question for the second half of the year, as the guidance indicated Paul that we are expecting between $100 and $125 million of various transactional activities. We have identified currently about 80% of that number and are pursuing a series of other transactions as well.
Albertson’s certainly is a transaction and its sale of its certain assets to public within the marketplace and it is being considered as one of the elements of that aggregate bogie, but at this point it is too premature to give the specific estimate for that particular transaction.
Mike Pappagallo
Paul, I did not mean to ignore your other question on cap rate, but it is effectively is low 6s.
Paul Morgan – FBR
The 80%, so that does include your estimate of the gains from Albertson’s?
Mike Pappagallo
Yes.
Paul Morgan – FBR
Okay, thanks.
Operator
We will go next to Christine McElroy with Banc of America.
Christine McElroy – Banc of America
Hi, good morning, Mike, in guiding towards the low end of your FFO guidance ranges, your more conservative stance from 3 months ago, primarily the results of slower core growth, and how should we expect occupancy to trend in the back half of the year?
Mike Pappagallo
I would say that the primary reason for my bias towards the low end is more geared towards the transactions than it is core growth activity, although with respect to the guidance ranges we did trend down the ranges for same store growth. And really that is a consequence of the second quarter results and just a more conservative perspective.
But I think in the aggregate that is not to have as much as a driver effect in terms of going to 270 to a 278 level. On occupancy, it is pretty much our custom, we are not going to kind of go out and predict the specific level, but I think, you have heard in the various comments that we are very sensitive to increasing stress on some of our retailers and that it would be not unreasonable to expect the continued downward trend in occupancy.
We don’t see anything draconian at this point and that is simply a consequence of a very diverse tenant concentration base and not reliance significantly on any one particular tenant, but we do indicate that there will be continued pressure on occupancies.
Christine McElroy – Banc of America
Okay, and then my followup is, I guess you know if you are thinking about how you envision your FFO growth looking like over the next few years, can you kind of walk us through how much of that growth you expect to come from kind of core property level income from development and acquisitions and from your more kind of opportunistic investments in transaction income?
Mike Pappagallo
I think it is certainly too premature to talk about the component in to 2009 and beyond. I think, we have always, if you look at the framework of our business though that our core business be it US and now increasingly in Latin America has always been a mid-to-high single digit return and then which generally has brought us to the 10% plus level.
It has been the range of transactional activity that is available in the market place. And to Milton’s point earlier about as distress continues and that we may find ourselves with more opportunity on the distressed retailer and bankruptcy side, the weight and degree of transactional activities may move from say development and merchant development and promoted interests on portfolios to more the opportunistic place on the distress.
So, longer term the composition that you have seen in the last few years will be probably the same but it will have different stripes.
Christine McElroy – Banc of America
Thank you.
Operator
We will go next to Michael Mueller of J.P. Morgan.
Michael Mueller – J.P. Morgan
Yes, hi, this is kind of a followup to the prior question. But when you look across the different buckets, how do you think about capital allocation when you go from preferred equity to retailer services development today.
I guess – where you are seeing the most opportunities and where you are seeing the better returns?
Dave Henry
Well, I think, every Monday we take a look at the potential transactions in our investment community, and it is all about risk reward. I mean, in today’s time, it is fair to say we are looking for higher returns and given our cost of capital in general we are looking for things that will return mid-teens or better IRRs on our shareholders capital over time.
Now, as the risk of the transactions goes up for instance, merchant development building opportunities we are looking for higher returns in Brazil, we are looking for higher returns than we would perhaps see in stabilized portfolio shopping centers in Canada which we just acquired with RioKim which would be a lower IRR, but it is all about risk reward these days. It is all about liquidity issues out there, it is about us trying to take advantage of things.
We have not seen property prices fall dramatically and as a result we haven’t been aggressively buying either for ourselves or our investors. However, we are beginning to see the pick up in preferred equity opportunities.
We are continuing to grow internationally and we will just see how it comes. Retailer services we also expect to pick up some activity as retailers have other struggles.
84 Lumber is a transaction that was right in our strike zone because it was a very well secured loan on our real estate base. If more opportunities like that come along we want to jump on it.
Michael Mueller – J.P. Morgan
And a followup, what is the range of the cap rates for what you bought and are looking at in Brazil?
Dave Henry
Well, this is Mike, excellent opportunities have introduced Mike Melson, who is the General Manager and Managing Director of all of our Latin America effort and somebody who I feel tremendous envy for, because he speaks both Spanish and Portuguese as well as English. So, Mike with that introduction what don’t jump in on cap rates.
Mike Melson
Thanks, Dave. I will respond in English.
Most of our investments in Brazil would be development deals. The acquisition has gotten a bit frothy we think.
So, I think, we will focus on developments and we see yield there of between 13% and 16% on investment.
Michael Mueller – J.P. Morgan
Okay. Thank you.
Mike Melson
Those are unleveraged returns on cost. But Mike, you might comment on what type of cap rates you are seeing on existing properties there?
They’ve gotten very well.
Mike Pappagallo
They have. Some recent large transactions have been done at 7, 8% cap rates.
Again, those acquirers are betting on significant growth in NOI and in some cases an expansion of the assets going forward.
Operator
We’ll go next to Jeff Donnelly with Wachovia Securities. Well, we’ll go next to Steve Sakwa with Merrill Lynch.
Steve Sakwa – Merrill Lynch
Good morning. Milton, I guess over the last several years you’ve been very successful in taking advantage of these distressed retail businesses whether it was the Montgomery Wards or K-Mart bankruptcy.
But clearly that was done in a very different retail environment. I’m just wondering, you’ve talked about distressed opportunities potentially coming up, but certainly the appetite from other retails is not as great.
I mean, how do you think about those opportunities today, how would you think about underwriting and how would you think about return hurdles today versus the returns that you got over the last five to seven years?
Milton Cooper
Steve, I couldn’t more with really the indications that helps. It will be tougher.
First of all, Steve, we have much more competition of funds who really want to be in it so that – we didn’t have a competition early on. Secondly, there aren’t that many uses.
So the distressed business that we see will be creative uses and creative seizing an awful lot in the debt – on mezzanine debt and other instruments. But I can [ph] tell you I think it’s going to be tougher.
I do think we are going to get a share and we’ll be able to because of long-term relationships with some of the other players who play with us in the distress field. But I am really optimistic we’re going to get our share and the returns will be juicy.
Steve Sakwa – Merrill Lynch
Okay. Just as a follow-up, I don’t know who wants to handle this.
It relates to development, but when you compare your development schedule this quarter to last quarter, a number of projects have either slipped out of the merchant building bucket and some have gone back into land. A number of dates have been pushed out, which isn’t terribly surprising.
And some of the committed space figures have come down. Can you just maybe talk about the developments, what you are seeing from the retailers and how you think about those returns and kind of KBI gains going forward?
Mike Pappagallo
Steve, I will answer the specific questions about what’s on the page and then I’ll let one of the other – someone else answer the general aspect of development. We took a fresh look at the development page, I noticed a couple of things.
First, there were a few smaller projects on that list. It’s really what you call are Kimco Capital Services assets, more arbitrage placed on smaller tracks of landhold, a variety of urban based projects that were in the 30,000 to 40,000 square foot mode.
And those are really almost single tenant arbitrage plate. So we just simply took them off the list because they really weren’t reflective of the longer-term shopping development on that page.
In a couple of other instances, we did take a look, and the original underwriting there is a couple of specific examples where there was an LOI for super target now working with a preferred developer, the targeted opening was 2010, 2011. So we had circled the land, but from a realistic point of view, the development even in our base case underwriting really wasn’t going to start for a few years.
So we thought it prudent to separate the development, active development program with those assets that were really more akin to landholding that had more outside dates from a standpoint of when the development would start or alternatively a thought process of just selling the land as we riddle down our development exposure. So those are the specifics.
I don’t know if anyone here want to make a comment about general development trends.
Dave Henry
I’ll let Jerry give you some more specifics, but in general, we like most of our peers are seeing a lot pure, viable new development transactions. As retailers have cut back on their expansion plans, as rents have softened, as costs have increased, as debt has gotten more difficult to achieve, our joint venture partners in the development business have found many fewer potential transactions that seems to be viable.
Jerry, you may want to comment on what you see as well
Jerry Friedman
Okay. Yes.
Basically we are being very conservative in looking at the basic elements of development as we’ve done in the past and trying to scrutinize and be realistic. So we have not really done only one new development that we were proposing this in the last recent period.
And we will continue to look, we expect to see a break in – as we feel those are going to need sites, the big box retailers in the coming years. But for the foreseeable future, it’s going to be a tough call.
Steve Sakwa – Merrill Lynch
Can you just comment on the yield expectation–?
Milton Cooper
Steve, let me just say this. Really to be as realistically, developments in retailers when the want sites, they got to see rooftops, they got to see growth.
You don’t have any housing growth in so many markets and consequently the development isn’t going to make sense in most of America. There will be some pockets that are of exceptions.
Houston is like Dubai now. But other than that, I think it’s unrealistic to think of a strong development market when you don’t have a strong housing market.
That is the reason why there is such an appetite in Mexico because Mexico has a housing board. And we have retailers who say, no, no, no, in the United States, but please, please, please, in Mexico.
So I guess the heart of it is, there won’t be development, there won’t be demand until there is a resurgence of housing and I suspect that’s a long, long way off.
Steve Sakwa – Merrill Lynch
Right. Well, I guess that’s fine in terms of the new starts, but you still got maybe 20 projects here in the US that are in various – 20 projects in various stages.
And I just wonder to what extent are those returns coming down.
Dave Henry
We actually took a hard look at the whole inventory about a week ago. Luckily most of our existing products on the list are near the tail end in terms of construction completion and lease-up.
And one of the reasons we recharacterize a few, a few of the other projects where we closed – closed on the land, we have not broken ground yet. And it will probably be several years before the entitlements are all achieved and so forth.
So at least with respect to our inventory of projects, they largely fall into the tail end of their construction completion cycle. And as Jerry pointed out, we really haven’t started anything new in the past year or so.
So we have very few projects that are in the very initial stages of going forward. But we feel pretty good.
Yes, the tail end leasing is getting a little tougher in terms of some of the local spaces and selling out these projects, but in general we think the portfolio is in reasonable shape.
Steve Sakwa – Merrill Lynch
Okay, thanks a lot.
Operator
We’ll go next to Jeff Donnelly with Wachovia Securities.
Jeff Donnelly – Wachovia Securities
Hi guys. Milton, I’d like to put a finer point on your outlook for the retail real estate business, just given your experience on what you are hearing from retailers.
Would it, for instance, surprise you if the business sees negative absorption in space through, say, 2010 before we get a return retailer demand? And put differently, at what point do you think retailers will begin to want to boosting the square footage growth?
Milton Cooper
I think – it’s hard to generalize. Let me just say this about retailer demand and absorption.
Two general rules. One, retailers need inflation.
They have to have. Where this inflation in the retailer products you are going to see growth and more growth?
Where do you see that? Food, supermarkets.
Supermarkets are doing quite well today because of inflation (inaudible) trading down. They are doing very well.
They are not buying Heinz ketchup, but they are buying private labels and their margins are higher. They are selling prepared food.
You are going to see expansion in supermarkets. You are going to see the desire to expand when tenants cater to trading down.
Wal-Mart, warehouse clubs are doing well. TJ Maxx is doing well, Ross, they cater.
Outside of that, it will be very difficult. I suspect when you get all done, I think it will be a wash.
I don’t think it will be negative, but I’m not sure. But that’s the trend that’s happening within it.
Jeff Donnelly – Wachovia Securities
Okay. And then the second question is for you Dave.
Fund-raising activity out there certainly scares. These institutions seem to be sitting on the sidelines, and you guys are out there looking at the New York City fund.
Can you use that to talk about what sort of returns unlevered or levered investors are seeking from investments maybe versus a year ago and how is the fee structure for partners such as yourself change, now that we are in such a hot market?
Dave Henry
Well, two things. A trend is definitely continuing where funds or problematic joint ventures would emphasize core properties with core returns are simply not very marketable today.
Our Kimco Income Fund II, which is a wonderful portfolio of 14 seasoned properties, is giving a day one leverage yield to the investors in the seven [ph] is the tough sell today, because people are afraid of where cap rates are going to go for something that’s existing. By the same token, when we offer interim and international product like our Mexico land fund or our new South American fund or this new urban redevelopment fund, all of which are targeting net returns to the investors of 15% to 20% depending on very strong demand on the investors.
And I suspect it because most of these continue to have money allocated for real estate. And they are simply saying, I’m going to stay in the real estate business in these uncertain times, I want to have a higher return, and I’m willing to invest with a wonderful operator like Kimco but I want higher returns.
And that’s what’s going on. Even the international investors who you would say, boy, America is a very wonderful time to buy a stabilized property because our currency is so weak and theirs is so strong.
Even those guys are saying, but what if the currency keeps going down and what if the cap rate goes up. So it’s an interesting time, but we continue to grow the relationships with our investor base and the new wonderful new investors like Zurich who just joined our Kimco Income Fund.
And so we believe our future is tight as the money management business and we will grow it and we will introduce products that the investors want. And it will be a while, of course, the cap rates settle and investors that come back into the existing stable properties.
But we think we got the products that will meet the need and we’ll keep growing.
Operator
We’ll go next to Lou Taylor with Deutsche Bank.
Lou Taylor – Deutsche Bank
Thanks, good morning. Milton, can you make a comment with regard to the new bankruptcy rules that retailers are going to operate under this year?
And do you think it’s going to change you to the pace or the timing of retailer bankruptcies?
Milton Cooper
The new retailer rules take away some of the new bankruptcy rules with a time to extend or reject. What has happened as a practical manner in some cases, the retailers are saying, fellas, if you don’t give us the time, we just going to reject.
So they get it indirectly. It makes the designation rights a little less valuable in the bankruptcy proceeding.
So that – but on balance, retailers will take advantage of bankruptcy when they have no other choice. And I think that business will continue.
It has changed a little, but not that much.
Lou Taylor – Deutsche Bank
Okay. And the second question just for Dave, in terms of South American fund, are you going to seed that with some of recent acquisitions/developments that you referenced earlier today?
Dave Henry
Are we going to see debt?
Lou Taylor – Deutsche Bank
Are you going to seed the fund with–?
Dave Henry
Yes, South America is, for instance, everything we’ve done and we started closing transactions probably 12 months ago with an existing portfolio of four shopping centers in Santiago. Everything we have done in our whole pipeline, we will go into the South American fund at cost.
We will not mark these things up. And that will be our vehicle for South America.
And that’s different in Mexico. Mexico, we have a fund per land, but then Kimco together occasionally with partners like GE does the development itself.
Lou Taylor – Deutsche Bank
Great. Thank you.
Operator
We will go next to Michael Bilerman with Citi.
Michael Bilerman – Citi
Good morning. Ambika Goel is here with me as well.
I’m not sure if it was Dave or Mike where you talked about that you are not expecting the draconian scenario in occupancy. But maybe you can just delve into a little bit more with becoming more conservative on your same-store guidance with occupancy ticking down in the quarter.
What are you sort of seeing, what’s surprising out there? And clearly with given Barry’s goodies, Mervyn’s and Milan’s [ph], I’m not sure if your exposure is more or less relative to others and sort of where you think things are going to fall out?
Mike Pappagallo
Michael, I’m going to let David Lukes answer that. He probably has the best perspective in terms of portfolio and trend.
David?
David Lukes
Michael, it’s probably not a lot of change from what we said last quarter. But to give you a little bit of insight, to date there has been a lot of churn.
If you look at the vacates and the new leases in the last two quarters, there has been a lot of vacates and there has been a lot of new leasing. In fact, the second quarter this year was a very high numbers for new leasing.
So, it is not – it is hard to draw immediate conclusions. I can give some anecdotes that could probably help justify what we said last quarter, which is the housing markets that seemed to be doing worse are correlating fairly well with the retail markets.
They are having a lot of vacates. Of all of the vacates in the second quarter, almost half of them were in the Western region.
Ironically, of all of the new leasing in the second quarter, half of them were in the Western region. So, you end up with a lot of tenants leaving and a lot of tenants coming in which doesn’t necessarily coincide with the general newspaper trend that you know, retailers are going bankrupt and leaving.
There seems to be still a healthy demand, and when I look at the same store leasing spreads of that Western region, which is, you know, half of the driver this quarter, you are still looking at 7% to 8% to 9% increase in same store rent. So, I think that the trend that we can draw and I was going to look exactly who vacated and who signed the leases.
The trend that we are drawing is that some types of tenants like movie rentals; cell phone operators, their franchisees; small beauty supply chains. Those – their discretionary items are tending to be the ones that are vacating at a higher percentage, and the tenants that are coming in tend to be more consumer staples.
So, that is not inconsistent when a change in the economy happens, but is just changes consumer spending habits, it will reflect itself on which tenants are coming and going out. The markets just like last quarter they don’t have the same, you know, 50 leave and 50 come in or probably still you know, the Phoenix markets, Florida, and certainly Las Vegas where there is a little bit more leakage.
The Midwest tends to be very strong right now. You know, we are up there; we are up in the Northeast.
So, it is hard to draw national conclusions. With respect to your question about our risk level and tenant bankruptcies, the going forward occupancy I don’t think is going to be impacted heavily by the shops because we are seeing a lot of movement out and in.
I think the real question will be what happens to the major categories with the larger retailers, and we do have a very diversified portfolio both in terms of square footage and annualized based rent, but you know, certain tenants have higher average rents than others and a lot in the future is just simply going to depend on those senior anchors do.
Michael Bilerman – Citi
Good ahead, sorry.
Dave Henry
Might be the consequence of all of those thoughts from David and then translating into financial numbers, because of that churn and the fact that with some of the churn comes increased pressure on write-offs of non selective account, that is why I tempered the same-store growth when you look at it over 3 month period this time and while pulled back to those numbers a little bit.
Michael Bilerman – Citi
Does your pace of leasing going into 2009, has that shifted relatively to where you were at this point last year for ’08?
Dave Henry
Tell it again, Michael?
Michael Bilerman – Citi
I was wondering, if you know think about your 2009 expiries which you are obviously in negotiations already on. Has the tone changed and has – are you further ahead or you behind relative to where you were leasing for 2008?
Dave Henry
When you are looking at, part of the vacates is the contractual end of the lease term and the other part of the vacate is just tenants that just walk out. If you look at the number of vacates it is fairly steady every year in terms of the percentage of portfolio that rolls and you know, a year in advance is a good time to start having discussions with the retailer, but you are really not getting to deal terms until you are within 6 months of the end of that base term.
So, it is a little bit early to probably be able to answer that with honesty. I can say that in the markets where the supply is higher than what it was maybe a couple of years ago, the question comes down to, you know, will you renew me at the same rent.
The markets that don’t really have a supply issue like, you know, a lot of the higher density markets, you’re really still looking at the market rent and then you are looking at whether the tenant with get TIs on a renewal and if you look at our numbers to date, you will know that we are pretty conservative on TIs and almost nonexistent on renewals, but that is one indicator that things will change. If we start seeing a higher request for TIs for either new deals or renewals, but if I look ahead at the next quarter and the year ahead as to how it is going with conversations with retailers, we still feel pretty good about the general tone of the conversation and I would say it is more even than it is one sided, but like I said, what will change that really is whether we see some larger scale tenants go away because that will put pressure on how many different categories are looking at the same box.
Michael Bilerman – Citi
And just one follow up on the marketable securities and the preferred, you know, you include your marketable securities almost $400 million in sort of capital availability. Maybe Mike you can just review the concentration of any large positions, how liquid those marketable securities are and then on the preferred side, again, I know, it is pretty diverse in terms of number of investment, but is there any risk if some of those investments mature that given the refinancing that financing market that there maybe risk to some of your principal?
Mike Pappagallo
On the marketables, as you know Mike, we generally not disclose all of our positions, but all of the instruments there are liquid and actively traded. So, for us to recycle those assets is not a problem based on preferred equity.
Dave Henry
On the preferred equity portfolio, it is a wonderful diversified portfolio of relatively small investments many of which or most of were originated over a long period of time and the debt is reasonably conservative an in many cases, they’re amortized down and the values of those properties have grown significantly. So, at this point after a pretty through portfolio review, we really don’t see any significant problems in that portfolio from either an occupancy or NOI basis or maturing debt.
The portfolio is in very, very good shape.
Operator
We will go next to J. Habermann with Goldman Sachs.
J. Habermann – Goldman Sachs
Hi, good morning, here with Tom as well. Just following up on that last question on page 36 of the supplemental with Kimco Capital services and also the details in the preferred equity, retailer services.
Give us some sense for the timing of the harvesting of those embedded gains. Should we see more of that you think in 2009 given that that core business continues to hold up well and you have been able to realize transactional income this year?
Mike Pappagallo
Clearly, the preferred equity does have substantial upside and as we continually evaluate the opportunities to harvest them with our partners there are a variety of assets that we will consider moving forward in harvesting in both 2009 and 2010. Clearly, the financing markets have an indication on the absolute ability to sell products, properties in given point in time, but we are very focused in working with those operating partners in the preferred equity space to methodically harvest them as the market conditions exist and as the opportunities exist.
Dave Henry
We try to add on the size of doing what our partners want to do. So, in many cases our partners want to hold these assets longer term and we try to work with them on that.
In some cases, they are able to refinance both the underlying first and our position and we sit together for a long period of time. So, in general we try not to push value customers to selling the properties or somehow liquidating, but to Mike’s point, we also work with them as best we can to harvest these positions which in many cases have substantial embedded value in those, and we work together with JoAnn Carpenter that runs this business and Mike and the rest of us, and we set the target for each year and sometimes on a quarterly target of things to try to make happen, but generally we do try to listen to our customers and what they want to do on these things.
J. Habermann – Goldman Sachs
Okay, then on the transactions markets, I know, you mentioned institutional capital still on the sidelines, but have your views changed at all with regard to how much cap rates you need to adjust in order to see a greater space of transaction volumes?
Dave Henry
Just speaking for myself, it is not a question of adjustment, it needs to stabilize. It needs to settle in at a number.
It either needs to return to the old cap rates in the low 6s if you will, or stabilize at 7 or 7.5. It just needs a period of time when it is more or less settled.
The most scary thing to institutional investors is turmoil and change, one way or another, it makes them very nervous and nobody wants to buy something today and then have to explain to his boss or his board a month later that he is underwater or have to take a mark-to-market to loss because it has moved so quickly on. So, in many cases they just don’t want to run that risk and they will sit on the sideway or they will invest for higher return opportunities in a fund type investment vehicle and it is going to be a long period of time before the final verdict is in.
Operator
We will go next to Rich Moore with RBC Capital Markets?
Rich Moore – RBC Capital Markets
Hi, good morning guys. Clearly the US has got some tenant issues and I noticed that the occupancy in Mexico dipped a little bit.
I am wondering is the US the only place with the tenant issues and the rest of the world is sort of (inaudible) or there other places where you are seeing possibly some tenant problems as well around the world?
Dave Henry
Well, it is interesting. If you look at the markets where we are, I mean, Canada is still exceptionally strong if you read RioCan’s press release, I think, from yesterday quarterly announcement.
They are virtually no delinquencies in their portfolio or our portfolio together and most of our partners in Canada see no signs of slowdown or weakness. In Mexico, I think it is fair to say that there is a beginning of some softening.
I think you have all read the remittences are way down for Mexicans living in the United States. So, I think most of the retailers, they are 100% honest with us are beginning to see a little bit of softening, not to be confused at all with what is going on in US, and it is still night and day down there, and people like Home Depot and Walmart are as aggressive as they have ever been in terms of expanding in Mexico as opposed to pulling their horns in the US.
So, these retailers still feel very confident about Mexico, and then looking at Brazil, Walmart, Mike correct me if I am wrong, 14 different formats they want to expand and Brazil is one of their very highest priorities to take advantage of that country being the tenth largest economy in the world. So, there is a night and day difference in these markets, but in fairness, I think, there is just the whip of some soft softening in Eastern Mexico.
Milton Cooper
And Rich, I think I shot myself on the foot on the occupancy because one of the projects that we had acquired which had a high occupancy; we initiated a phase 2 of the project. I don’t remember the exact project name and we have some good preleasing going on, but because it was only x percent occupied we just incorporated both phases, so it is theoretically a drop in both of them, but in effect it actually was no occupancy issue in terms of existing tenants, recycling out.
Rich Moore – RBC Capital Markets
You throw the curve balls every so often with these different schedules?
Milton Cooper
I think [ph] one of the 25,000 pieces of data in the supplementals. You will have to give me a break.
Dave Henry
I am very comfortable with the leasing and the rents in our retailers and Mexico and we continue to run at this window of opportunity as fast as we can.
Mike Pappagallo
The only other comment we will make is we are starting to see actually a lot of interest from our US tenant base, as they see continued expansion, as they coming to us asking how can we grow into Mexico. So, we do still see very strong demand for all Mexico assets.
Rich Moore – RBC Capital Markets
Okay, very good thanks guys.
Operator
At this time, there are no further questions; I would like to turn conference back over to Barbara Pooley for any additional or closing remarks?
Barbara Pooley
Everybody as a remainder, our supplemental is in our website at www.kimcorealty.com. Thanks everybody for participating today.
Operator
That does conclude today’s presentation. We thank you for your participation and you may now disconnect.