Net Lease Forum

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NLF: How has the transition gone, and can you give usan update on our investment activities?

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Fleischer: That's one of the benefits of beingprivate. We're thrilled with our new partners. We were takenprivate by a private equity consortium with Macquarie Bank Ltd. inthe lead. Our thought process, on the equity side, is to bringglobal pension and global institutional capital to the US net-leasemarket, which is a model that would be new for the US. There arefirms that have a retail investment strategy, and there are firmsthat have a US institutional strategy, and so the different twisthere is to find the most efficient pockets of global equity capitaland direct it to the market here. We're excited about it.

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It's similar to how Macquarie has funded their infrastructuregroups and their other investments in North America, so we'rebasically looking at that style of investment and we're activelycalling on investors in the US, Australia, Europe and elsewhere toset up a fund so that long-term, we've got a callable vehicle tofund the market here. In the interim we've got great partners. Whenwe're funding transactions today we just fund them on a call basis,and all our partners have participated in our calls since we'vegone private, and everybody has stepped up and written checks tofund our growth. Our growth, through the end of last year, waspretty similar to what you saw when we were public, so there hasn'tbeen a big change there, although obviously the debt dynamics havechanged pretty dramatically, and that's translated into thepurchase price where you can buy assets and that's translated toincreased cap rates in the marketplace.

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NLF: In terms of bringing global capital to the USnet-lease market, how would you characterize interest?

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Fleischer: Long-term it's an excellent model.Short-term, the market presents certain challenges in the next sixmonths. Whenever you launch a new fund, the idea is to get aninitial investor who's a lead, and then have other investors whoroll in. We'll see how that turns out. We haven't actually launchedthe fund, but we're preparing for that. Long-term it's going to bea lot more efficient than, for example, going back to the sameinstitutional investors in the US.

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The calls we've made so far have been very successful. I thinkwe have a long track record going back to Franchise Finance Corp.of America, which we sold to GE Capital, and to Spirit, where weshowed investors how we underwrite credits and look at cash flow ona store-by-store basis and use underwriting techniques to tranchenon-investment grade credits. We're basically standing at the frontof the line so that when we have issues, have economic downturns,your recovery rates tend to be very good. And it's still a veryefficient financing tool.

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NLF: Can you give us an example of a recent dealyou've closed on?

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Fleischer: We funded an $82-million restauranttransaction on Dec. 31 for Sun Capital, which acquired the SmokeyBones restaurant chain from Darden Restaurants. We helped with thesale-leaseback and a small piece of senior financing. We've fundeda number of distribution and industrial transactions in Q1, one inthe $20-million range, one in the $52-million range, with cap ratesaround 9%. Those have not yet closed so I probably shouldn't giveyou the specific names.

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NLF: The debt market has changed quite a bit sincelast August. How are the broader market conditions impactingbusiness?

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Fleischer: We've been doing this since 1980.There's probably not a direct comparison to any of the previousdislocations. I think there was an expectation last year thatpeople would come back and renew allocations come the New Year andput fresh capital in the market, and actually the reverse hashappened. We've seen an increase in fear and we've seen the FederalReserve lower rates a few times, and the effect has been thatspreads have widened dramatically, in the conduit markets, whichhave been the most dramatically impacted; in CMBS or theasset-backed conduit markets; and then in the REIT universe.Investment-grade REITs have probably gapped out from borrowing at250 over to today, and if you look at BBB REITs, their financing isabout 450 over. And so the best estimate, where last summer, thecost of debt was in the high 5s/low 6s, to today it's easily in the7s. And in some recent quotes you're looking at a cost of debt of 8to 8.5. For most of the customers on the other side, the businessescan't afford that kind of pass-through. If people are continuing tofund transactions at the same cap rate levels as last year, thenobviously there's a significant decrease in the equity returns. Butrealistically, we're seeing a lot of transactions being pulled fromthe marketplace. So we're looking more aggressively to alternativesources of debt and seeing if transactions can be funded on ashorter-term basis, and in some cases bridging the debt execution,albeit at higher cap rates.

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NLF: Are you seeing results?

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Fleischer: We saw results at the end of the year,and I think as we're going into this year, one of the benefits ofbeing private is that we're not really forced to make acquisitionson any regular schedule. So if you find yourself in a circumstancewhere you don't have a lot of clarity on the liability side, andyou don' think that you're going to get the appropriate return onthe equity, then you can just pass. We have that flexibility now,although on average when we were public we were clearing around8.40 or 8.50. I would say that the cap rates through Q4 and earlyinto this year have been in the 8.75-to-9.50 range. As you startpushing up into 10 or 11, I don't think there's much of a marketthere. Either that or you're getting so far out on the creditspectrum that it just doesn't make underwriting sense.

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NLF: So how do you see the prospects for acquisitionopportunities this year?

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Fleischer: What's happened is good news and badnews--you're moving from an auction market a year ago when therewas tons of capital chasing deals to where there are companies thatmay not have considered using sale-leasebacks as a viable financingtool. They're calling us back and saying, "What can you do to helpus? Our banks are pulling back and we need to find alternativesources of liquidity."

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There is a stack of deals on my desk right now that's aboutthree feet high. We've typically funded 5% to 10% of what we lookat. So you do tend to look at a lot of opportunities, and there area lot of things out there. There's a $1-trillion market of justsingle-tenant net-lease retail and industrial assets in the USalone, and probably less than 5% of that has already beensecuritized or institutionally held. So there's no lack of product.What the market is telling us today--and its way overblown in ouropinion--is that in the short-term asset values are going to falland that essentially you can earn an equity risk for holding a debtasset.

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NLF: Any market trends or shifts you're keeping an eyeon?

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Fleischer: Broadly, sellers are getting morerealistic as to what assets should be valued at and wherebusinesses should be valued. So where we saw retail businessestrade at nine, 10, 11 multiples, we're now seeing transactions thatare more at historic levels of five, six or seven times. And thattranslates into an ability to buy real estate for asset prices thatmake more sense. There has been a bit of a gap in time for CEOs andCFOs of retail companies who don't necessarily live in the capitalmarkets all day, between their current expectations in terms ofseeing where their businesses were valued a year ago versus thekind of capital that's available today. That's going to continuefor a while.

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In our view, this is probably systemic this time and not anisolated problem. It will last Whether you're talking about modellines or how much room banks have for commercial mortgages or aboutsovereign funds coming in, our view is that we're probably lookingat next year before things start to return to they were in2007.

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