ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Reporting Period: Fiscal Year Ended December 31, 2002
Business Overview: Agree Realty is a self-administered REIT that develops, acquires, and operates retail properties leased primarily to national and regional retailers under net leases. As of December 31, 2002, the portfolio consisted of 48 properties (14 shopping centers, 33 free-standing, 1 land lease) totaling approximately 3.7 million square feet across 13 states. The portfolio was 99% leased, with 95% of base rental income derived from national and regional tenants.

Key Financial Metrics

Debt Structure: Total indebtedness included $71.6 million in fixed-rate mortgages, $5.6 million in construction loans, and $38.1 million in variable-rate notes payable (lines of credit). The ratio of indebtedness to market capitalization was approximately 57%.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 4.9% to $25.8 million. Minimum rental income rose 5.1% to $22.8 million, driven by new developments and the acquisition of joint venture partner interests. However, percentage rental income declined 40% to $248,000 due to lease restructuring and lower sales-based rents from Kmart.
• Expense Increases: Property operating expenses increased 22% to $1.75 million, primarily due to higher snow removal and maintenance costs. General and administrative expenses rose 15% to $2.01 million due to compensation increases.
• Interest Expense: Interest expense decreased 7.8% to $6.2 million, attributed to lower interest rates on variable-rate notes.
• Portfolio Expansion: The Company completed one free-standing development (14,490 sq. ft.) and acquired 100% ownership of three joint venture properties in Oklahoma City, Omaha, and Indianapolis during 2002.

Outlook, Risks, and Management Commentary

Kmart Bankruptcy Risk: A significant portion of the Company's revenue (20% of base rent) is derived from Kmart, which filed for Chapter 11 reorganization in January 2002. Kmart announced plans to close 610 stores. One of the Company's Kmart stores (Lakeland, FL) was identified for closure in Q1 2003, resulting in an estimated loss of $480,000 in annual rent and $110,000 in operating cost reimbursements. Additionally, the Company agreed to $300,000 in annual rent reductions on two other Kmart leases.

Tenant Concentration: As of year-end, three tenants (Borders, Kmart, and Walgreen) collectively accounted for approximately 65% of base rental income. Borders represented 28%, Kmart 20%, and Walgreen 17%.

Liquidity and Capital Strategy: The Company maintains a $50 million credit facility (maturity August 2003) and a $5 million line of credit. Management intends to maintain a debt-to-market capitalization ratio of 65% or less, with a target of 50% or less after refinancing short-term construction debt with long-term financing.

Subsequent Events: In February 2003, the Company acquired the remaining interest in a joint venture property in Ann Arbor, MI (Borders headquarters) for approximately $7.7 million, financed with a fixed-rate mortgage.

Investor Verification Checklist

• Kmart Exposure: Verify the status of the Lakeland, FL store closure and the impact of co-tenancy clauses on other tenants in that shopping center.
• Debt Maturities: Review the $30.8 million mortgage balloon payment due in 2005 and the refinancing strategy for the $50 million credit facility maturing in August 2003.
• Tenant Concentration: Assess the financial health of Borders and Walgreen, which together represent 45% of base rental income.
• Lease Expirations: Monitor the 19 leases expiring in 2003 (7.1% of GLA) and the Company's ability to renew or re-lease these spaces at market rates.
• Construction Pipeline: Confirm the completion and leasing status of the development project under construction as of Q1 2003.