ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2011
Business Overview: Agree Realty is a fully-integrated, self-administered REIT focused on the ownership, development, and management of retail properties net-leased to national tenants. As of March 31, 2011, the portfolio consisted of 80 properties (68 freestanding, 12 community shopping centers) totaling approximately 3.8 million square feet of gross leasable area (GLA). The portfolio was 95.7% leased with a weighted average lease term of approximately 12 years remaining.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 14.1% to $10.2 million, driven by a 15% increase in minimum rents ($9.1M vs $7.9M) due to new developments (Walgreens, Dick's Sporting Goods) and acquisitions (CVS, PNC, Lowe's, Kohl's, AT&T).
• Net Income Decline: Net income decreased 53% to $4.7 million. This decline is primarily attributable to the absence of a $5.3 million gain on the sale of a Borders property in Santa Barbara, California, which occurred in Q1 2010.
• Expense Increases: Operating expenses rose to $4.3 million from $3.6 million. Notable increases included real estate taxes (+26%), land lease payments (+135%), and general and administrative expenses (+15%).
• Discontinued Operations: Income from discontinued operations dropped to $92,000 from $507,000, reflecting the completion of the sale of two Borders stores in Tulsa, Oklahoma, in January 2011 with no gain or loss recognized.

Outlook, Risks, and Contingencies

Borders Bankruptcy Impact

The most significant risk factor is the Chapter 11 bankruptcy filing of major tenant Borders Group, Inc. in February 2011. Borders rejected leases at five locations leased by Agree Realty, representing approximately $2.6 million in annualized base rent. Additionally, Borders proposed rent reductions at other locations.

Debt Defaults and Cross-Defaults

Due to the Borders bankruptcy and lease rejections, Agree Realty is facing potential defaults on six non-recourse mortgage loans totaling approximately $17.4 million:

• Two Loans in Default: A $2.3 million loan (Lawrence, KS) and a $5.7 million loan (Ann Arbor, MI) are currently in default. The lender for the Ann Arbor loan has accelerated obligations.
• Four Cross-Defaulted Loans: Four loans totaling $9.4 million are cross-collateralized and cross-defaulted. While not yet in direct default, the company missed a $36,410 debt service payment due May 2, 2011, related to the Oklahoma City store closure. The company anticipates the lender may declare these loans in default and accelerate obligations.

Management is negotiating with lenders but provided no assurance of favorable outcomes. Failure to restructure could result in foreclosure and loss of the mortgaged properties.

Liquidity and Capital Resources

The company maintains a $55 million Credit Facility (matures Nov 2011) with $29.6 million remaining capacity and a $5 million Line of Credit (matures Nov 2011). The company intends to maintain a debt-to-market capitalization ratio of 65% or less; the ratio was approximately 42% as of March 31, 2011.

Investor Verification Checklist

• Borders Lease Status: Verify the final outcome of lease rejections and rent reduction proposals for remaining Borders locations.
• Debt Restructuring: Monitor the status of negotiations with lenders regarding the six non-recourse loans and the risk of foreclosure on the $17.4 million in debt.
• Credit Facility Renewal: Confirm the extension or replacement of the $55 million Credit Facility and $5 million Line of Credit, both maturing in November 2011.
• FFO vs. Net Income: Note the divergence between Net Income (down 53%) and FFO (up 4.3%), driven by the one-time gain in the prior year.
• Tenant Concentration: Assess the impact of the top three tenants (Walgreens 33%, Borders 14%, Kmart 11%) on future cash flows, particularly given the Borders situation.