Business Context and Reporting Period
Company: Agree Realty Corporation (REIT)
Filing Type: Form 10-K
Period Ended: December 31, 2008
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 December 31, 2008, the portfolio consisted of 68 properties (56 freestanding, 12 community shopping centers) totaling approximately 3.4 million square feet across 16 states, primarily in Michigan. The portfolio was 99.2% leased with a weighted average lease term of 10.6 years.
Key Financial Metrics
| Metric | 2008 | 2007 |
|---|---|---|
| Total Revenue | $35,654,000 | $34,468,000 |
| Net Income | $15,017,000 | $15,482,000 |
| Funds from Operations (FFO) | $21,598,000 | $20,739,000 |
| Diluted EPS | $1.95 | $2.01 |
| Cash Dividends Declared | $2.00 per share | $1.97 per share |
| Total Debt | $100,600,000 | $82,900,000 |
| Cash and Equivalents | $669,000 | $545,000 |
| Debt-to-Market Cap Ratio | 65.4% | 32.5% |
Note: Debt-to-Market Cap ratio increased significantly due to a decline in the market price of common stock, not solely due to increased borrowing.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 3.4% to $35.65 million, driven by new developments (primarily Walgreen locations) adding approximately $2.01 million in revenue. This was partially offset by a reduction in rental income from a Circuit City store and redevelopment activities.
- Net Income Decline: Net income decreased 3% to $15.02 million. This was primarily due to a $1.04 million gain on the sale of assets in 2007 which did not recur in 2008, and increased interest expense ($5.18 million vs. $4.90 million) resulting from higher borrowings to fund development.
- Expense Trends: General and administrative expenses decreased 2% to $4.36 million. Depreciation and amortization increased 7% to $5.38 million due to new property additions.
- Debt Structure: Total debt increased to approximately $100.6 million. The portfolio consists of $43.0 million in fixed-rate debt (avg. 6.64%) and $66.6 million in floating-rate debt (credit facilities and one mortgage).
Guidance, Outlook, Risks, and Contingencies
Management Commentary and Outlook
Management expects to continue growing the asset base through the development of pre-leased retail properties. However, the company notes that current market conditions have severely limited the availability of new financing sources, which may impact the ability to obtain construction financing for planned projects in the near term. The company intends to maintain a debt-to-market capitalization ratio of 65% or less, though it currently sits at 65.4%.
Risk Factors
- Tenant Concentration: Approximately 68% of annualized base rent is derived from three tenants: Borders (30%), Walgreen (26%), and Kmart (12%). The bankruptcy or insolvency of any of these tenants would have a material adverse effect.
- Bankruptcy Risk: Circuit City, a tenant occupying one location, filed for bankruptcy in December 2008 and is in liquidation. The company expects this tenant to terminate its lease in 2009.
- Geographic Concentration: 39 of 68 properties are located in Michigan, creating exposure to regional economic difficulties.
- Interest Rate Risk: A significant portion of debt is floating rate. A 100 basis point increase in interest rates would increase interest expense by approximately $576,000. (Note: An interest rate swap was entered into in February 2009 to hedge a $24.6 million floating rate mortgage).
- Internal Control Weakness: The company identified a material weakness in internal controls over financial reporting due to a lack of segregation of duties in the period-end financial reporting process. The CFO and Director of Finance are the only employees with significant GAAP knowledge.
Investor Verification Checklist
- Tenant Solvency: Verify the current financial status of Borders Group, Inc., given its 30% contribution to base rent and the retail sector's distress in 2008.
- Circuit City Exposure: Confirm the timeline and financial impact of the Circuit City lease termination expected in 2009.
- Financing Availability: Assess the company's ability to refinance floating-rate debt and secure construction loans given the tight credit markets described in the filing.
- Internal Controls: Review the remediation plan for the material weakness in internal controls regarding segregation of duties.
- Dividend Sustainability: Monitor Funds from Operations (FFO) relative to the $2.00 per share dividend requirement to maintain REIT status.