ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-K
Period Ended: December 31, 2007
Business Model: Fully-integrated, self-administered REIT focused on developing, acquiring, and managing retail properties net-leased to national tenants. The portfolio consists of 64 properties (52 freestanding, 12 community shopping centers) totaling approximately 3.4 million square feet across 16 states, with significant concentration in Michigan (36 properties).
Tenant Concentration: As of December 31, 2007, approximately 66% of annualized base rent was derived from three major tenants: Borders Group (31%), Walgreen Co. (23%), and Kmart Corporation (12%).

Key Financial Metrics

Debt Composition: Total debt of approximately $82.6 million consisted of $45.8 million in fixed-rate debt (weighted average 6.64%) and $36.8 million in floating-rate debt (weighted average 5.65%). The ratio of indebtedness to market capitalization was approximately 32.5%.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 4.7% to $34.5 million, driven by a 6% increase in minimum rental income ($31.6 million) due to new developments (Walgreen stores in Livonia, MI and Barnesville, GA) and acquisitions.
• Expense Increases: General and administrative expenses rose 11% to $4.5 million, primarily due to increased compensation ($595,000) and development investigation costs. Interest expense increased 6% to $4.9 million due to higher borrowings and interest rates.
• Net Income: Net income increased 10.8% to $15.5 million. This was bolstered by a one-time gain of $1.04 million from the sale of land contracts (net of deferred taxes), whereas 2006 had no such gains.
• Portfolio Expansion: The company completed the development of four properties and acquired two land parcels in 2007, increasing the total property count to 64.

Guidance, Outlook, Risks, and Contingencies

Outlook and Strategy: Management intends to continue growing the asset base through pre-leased development of retail properties. The company maintains a policy to keep total indebtedness to market capitalization at 65% or less. Four development projects were under construction as of year-end, expected to be completed in 2008.

Material Risks:

• Tenant Concentration: Heavy reliance on Borders, Walgreen, and Kmart (66% of rent). The bankruptcy or default of any major tenant would have a material adverse effect.
• Geographic Concentration: 36 of 64 properties are located in Michigan; a regional economic downturn could significantly impact operations.
• Internal Control Weakness: The company disclosed a material weakness in internal control over financial reporting. The Chief Financial Officer is the sole employee with significant GAAP knowledge and controls the general ledger, reconciliations, and financial statement preparation without adequate segregation of duties. The auditor issued an adverse opinion on internal controls.
• Financing Risk: Reliance on credit facilities for development financing exposes the company to interest rate volatility and refinancing risk.

Investor Verification Checklist

• Internal Controls: Verify the status of remediation efforts regarding the material weakness in financial reporting and segregation of duties.
• Tenant Solvency: Monitor the financial health of Borders Group, Walgreen, and Kmart, given their combined 66% contribution to base rent.
• Debt Maturity: Review the $36.8 million in floating-rate debt and the $50 million credit facility maturing in November 2009 for refinancing terms and covenants.
• Development Pipeline: Confirm the completion and leasing status of the four projects under construction (Macomb, Ypsilanti, Marion County, Shelby Township) scheduled for 2008.
• REIT Status: Ensure continued compliance with REIT distribution requirements (90% of taxable income) to maintain tax-exempt status.