ADC

Business Context and Reporting Period

Company: Agree Realty Corporation (REIT)
Reporting Period: Year ended December 31, 1996
Business Overview: Agree Realty is a self-administered REIT specializing in developing, acquiring, and operating retail properties leased primarily to national and regional retailers under net leases. As of December 31, 1996, the portfolio consisted of 32 properties (13 shopping centers and 19 free-standing) totaling approximately 3.1 million square feet of gross leasable area (GLA) across 12 states. The portfolio was 98% leased, with 92% of base rental income derived from national and regional tenants.

Key Financial Metrics

Debt Composition: Total debt includes $53.7 million in mortgages, $10.6 million in construction loans, and $23.6 million in notes payable (primarily credit facilities). The debt-to-market capitalization ratio was 54% as of year-end.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 19% to $16.3 million, driven by a 21% increase in rental income ($14.5 million) due to the development and acquisition of five new properties in 1996 and three in late 1995.
• Profitability: Net income rose 15% to $3.7 million. FFO increased 11% to $7.1 million.
• Expense Increases: Interest expense surged 41% to $6.1 million due to financing for new developments. General and administrative expenses increased 14% to $1.1 million, though as a percentage of rental income, they decreased from 8.1% to 7.6%.
• Portfolio Expansion: The number of properties grew from 20 to 32, and total square footage increased from 2.47 million to 3.07 million.
• Joint Ventures: The company formed seven joint ventures with Borders Group, Inc., owning economic interests ranging from 8% to 20% in these properties.

Outlook, Risks, and Management Commentary

Guidance and Strategy: 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 debt or equity. The company plans to continue developing pre-leased properties and acquiring assets to increase FFO per share.

Risks and Contingencies:

• Tenant Concentration: The top four tenants (Kmart, Borders, Roundy's, and Fashion Bug) collectively represent approximately 70% of base rental income. Kmart alone accounts for 31% of annual base rent.
• Environmental Liability: While Phase I environmental studies have not revealed hazardous substances, the company carries no insurance for environmental risks and faces potential strict liability.
• Lease Expirations: Approximately 26.75% of the portfolio's GLA and 25.72% of annualized base rent are scheduled to expire within the next 10 years (excluding renewal options).
• Joint Venture Terms: Leases for the seven Borders joint venture properties expire in November 2000 unless refinanced or extended, at which point terms may adjust.

Investor Verification Checklist

• Tenant Financial Health: Verify the financial stability of Kmart and Borders, which together comprise 57% of rental income.
• Debt Refinancing: Monitor the company's ability to refinance $10.6 million in construction loans and $23.6 million in credit facility debt into long-term fixed-rate mortgages to meet the 50% debt-to-capitalization target.
• Lease Renewals: Track renewal rates for the 26.75% of GLA expiring over the next decade, particularly the 1997-2001 window.
• Joint Venture Control: Review the terms of the Borders joint ventures, specifically the conditions under which Borders may purchase the properties or refinance, potentially altering the company's equity interest.
• Dividend Sustainability: Confirm that FFO growth supports the current $1.80 per share annual dividend payout required for REIT status.