SITC

Business Context and Reporting Period

Company: Developers Diversified Realty Corporation (DDR)

Filing Type: Form 10-Q (Unaudited Quarterly Report)

Period Ended: September 30, 2004

Business Overview: DDR is a real estate investment trust (REIT) engaged in acquiring, developing, owning, and operating shopping centers and business centers. The reporting period was significantly impacted by the substantial acquisition of assets from Benderson Development Company, Inc., the consolidation of certain joint ventures under FIN 46, and various financing activities to fund growth.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 35.1% ($42.9 million) for the three months and 27.1% ($93.2 million) for the nine months compared to the prior year periods. This growth is primarily attributed to the acquisition of Benderson assets, the JDN merger, and the consolidation of joint ventures.
• Net Income: Net income increased 5.5% ($2.3 million) for the quarter and 22.3% ($33.1 million) for the nine months. The nine-month increase was driven by higher operating revenues and gains on real estate dispositions, partially offset by increased interest and depreciation expenses.
• Debt Levels: Total indebtedness rose significantly from $2.08 billion at December 31, 2003, to $3.28 billion at September 30, 2004, reflecting new borrowings and assumed debt related to the Benderson transaction.
• Occupancy: Aggregate occupancy for the shopping center portfolio was 94.6% at September 30, 2004, compared to 94.0% in the prior year. Average annualized base rent per occupied square foot decreased slightly to $10.69 due to the inclusion of lower-rent Benderson assets.

Guidance, Outlook, and Risks

• Strategic Transactions: The company completed the acquisition of 104 properties from Benderson (with 4 more expected in November 2004). It also entered into an agreement to purchase 15 Puerto Rican retail assets for approximately $1.15 billion, expected to close in Q1 2005.
• Joint Ventures: DDR completed two significant joint venture transactions in late 2004: a $128 million deal with Prudential Real Estate Investors and a $204 million deal with Kuwait Financial Centre-Markaz, retaining management roles and equity interests in both.
• Dividends: The Board increased the quarterly common share dividend to $0.51 per share in July 2004. The payout ratio for the first nine months of 2004 was approximately 64.2% of FFO.
• Accounting Changes: The adoption of FIN 46 resulted in the consolidation of five entities, including a $3.0 million charge related to cumulative losses in a Martinsville, Virginia joint venture.
• Risks: Key risks include interest rate volatility (mitigated by swaps), the ability to integrate the Benderson portfolio, tenant bankruptcies, and the need to maintain REIT qualification. The company faces potential exposure in unconsolidated joint ventures, with a maximum estimated loss of $89.3 million in the MDT Joint Venture and $24.3 million in the Service Merchandise Joint Venture.

Investor Verification Checklist

• Benderson Integration: Verify the performance and lease-up status of the newly acquired Benderson portfolio, which represents a significant portion of current revenue but has lower average rents.
• Debt Structure: Review the maturity profile of the $3.28 billion debt load, noting that 33.2% is variable rate (though partially hedged), and assess refinancing risks.
• FFO vs. Net Income: Analyze the reconciliation between Net Income and Funds From Operations (FFO), particularly the impact of depreciation and gains on dispositions, as FFO is the primary metric for REIT valuation.
• Joint Venture Exposure: Confirm the financial health of major unconsolidated joint ventures (MDT, Service Merchandise) and the status of any guarantees or master lease obligations.
• Legal Contingencies: Monitor the resolution of the Regal Cinemas litigation, for which a $9.2 million liability was accrued and largely settled in 2004.