| AGREE REALTY CORP ITEM 1A RISK FACTORS General We rely significantly on three major tenants |
| As of December 31, 2005, we derived approximately 67prca of our annualized base rent from three major tenants, Borders, Walgreen and Kmart |
| In the event of a default by any of these tenants under their leases, we may experience delays in enforcing our rights as lessor and may incur substantial costs in protecting our investment |
| The bankruptcy or insolvency of any of the major tenants would likely have a 6 _________________________________________________________________ [57]Table of Contents material adverse effect on the properties affected and the income produced by those properties and correspondingly our ability to make distributions |
| In the event that certain tenants cease to occupy a property, although under most circumstances such a tenant would remain liable for its lease payments, such an action may result in certain other tenants having the right to terminate their leases at the affected property, which could adversely affect the future income from that property |
| As of December 31, 2005, 12 of our properties had tenants with those provisions in their leases |
| We could be adversely affected by a tenant’s bankruptcy |
| We may not be able to evict a tenant solely because of its bankruptcy |
| On the other hand, a bankruptcy court might authorize the tenant to terminate its leases with us |
| If that happens, our claim against the bankrupt tenant for unpaid future rent would be subject to statutory limitations that might be substantially less than the remaining rent we are owed under the leases |
| In addition, any claim we have for unpaid past rent would likely not be paid in full |
| Risks involved in single tenant leases |
| We focus our development activities on net leased real estate or interests therein |
| Because our properties are generally leased to single tenants, the financial failure of or other default by a tenant resulting in the termination of a lease is likely to cause a significant reduction in our operating cash flow and might decrease the value of the property leased to such tenant |
| Risks associated with borrowing, including loss of properties in the event of a foreclosure |
| At December 31, 2005, our ratio of indebtedness to market capitalization was approximately 22dtta3prca |
| The use of leverage presents an additional element of risk in the event that (1) the cash flow from lease payments on our properties is insufficient to meet debt obligations, (2) we are unable to refinance our debt obligations as necessary or on as favorable terms or (3) there is an increase in interest rates |
| If a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, the property could be foreclosed upon with a consequent loss of income and asset value to us |
| Under the “cross-default” provisions contained in mortgages encumbering some of our properties, our default under a mortgage with a lender would result in our default under mortgages held by the same lender on other properties resulting in multiple foreclosures |
| Risks associated with our development and acquisition activities |
| We intend to continue development of new properties and to consider possible acquisitions of existing properties |
| New project development is subject to a number of risks, including risks of construction delays or cost overruns that may increase project costs, risks that the properties will not achieve anticipated occupancy levels or sustain anticipated rent levels, and new project commencement risks such as receipt of zoning, occupancy and other required governmental permits and authorizations and the incurrence of development costs in connection with projects that are not pursued to completion |
| In addition, we anticipate that our new development will be financed under lines of credit or other forms of construction financing that will result in a risk that permanent financing on newly developed projects might not be available or would be available only on disadvantageous terms |
| In addition, the fact that we must distribute 90prca of our taxable income in order to maintain our qualification as a REIT will limit our ability to rely upon income from operations or cash flow from operations to finance new development or acquisitions |
| As a result, if permanent debt or equity financing was not available on acceptable terms to refinance new development or acquisitions undertaken without permanent financing, further development activities or acquisitions might be curtailed or cash available for distribution might be adversely affected |
| Acquisitions entail risks that investments will fail to perform in accordance with expectations and that judgments with respect to the costs of improvements to bring an acquired property up to standards established for the market position intended for that property will prove inaccurate, as well as general investment risks associated with any new real estate investment |
| Our portfolio has limited geographic diversification |
| Our properties are located primarily in the Midwestern United States and Florida |
| The concentration of our properties in a limited number of geographic regions creates the risk that, should these regions experience an economic downturn, our operations may be adversely affected |
| Thirty-three of our properties are located in Michigan |
| Should Michigan experience an economic downturn, our operations and our rentals from our Michigan properties could be adversely affected |
| Dependence on key personnel |
| We are dependent on the efforts of our executive officers |
| The loss of one or more of our executive officers would likely have a material adverse effect on our future development or 7 _________________________________________________________________ [58]Table of Contents acquisition operations, which could adversely affect the market price of our common stock |
| We do not presently have key-man life insurance for any of our employees |
| We are not limited by our organization documents as to the amount of debt we may incur |
| We intend to maintain a ratio of total indebtedness (including construction or acquisition financing) to market capitalization of 65prca or less |
| Nevertheless, we may operate with debt levels which are in excess of 65prca of market capitalization for extended periods of time |
| Our organization documents contain no limitation on the amount or percentage of indebtedness which we may incur |
| Therefore, our board of directors, without a vote of the stockholders, could alter the general policy on borrowings at any time |
| If our debt capitalization policy were changed, we could become more highly leveraged, resulting in an increase in debt service that could adversely affect our operating cash flow and our ability to make expected distributions to stockholders, and could result in an increased risk of default on our obligations |
| We can change our investment and financing policies without stockholder approval |
| Our investment and financing policies, and our policies with respect to certain other activities, including our growth, debt capitalization, distributions, REIT status and investment and operating policies, are determined by our board of directors |
| Although we have no present intention to do so, these policies may be amended or revised from time to time at the discretion of our board of directors without a vote of our stockholders |
| We face competition in seeking properties for acquisition and tenants who will lease space in these properties from insurance companies, credit companies, pension funds, private individuals, investment companies and other REITs, many of which have greater financial and other resources than we do |
| There can be no assurance that the Company will be able to successfully compete with such entities in its development, acquisition and leasing activities in the future |
| Risks Associated With Investment In Real Estate There are risks associated with owning and leasing real estate |
| Although our lease terms obligate the tenants to bear substantially all of the costs of operating our properties, investing in real estate involves a number of risks, including: • The risk that tenants will not perform under their leases, reducing our income from the leases or requiring us to assume the cost of performing obligations (such as taxes, insurance and maintenance) that are the tenant’s responsibility under the lease |
| • The risk that changes in economic conditions or real estate markets may adversely affect the value of our properties |
| • The risk that local conditions (such as oversupply of similar properties) could adversely affect the value of our properties |
| • The risk that we may not always be able to lease properties at favorable rental rates |
| • The risk of changes in tax, zoning or other laws could make properties less attractive or less profitable |
| If a tenant fails to perform on its lease covenants, that would not excuse us from meeting any mortgage debt obligation secured by the property and could require us to fund reserves in favor of our mortgage lenders, thereby reducing funds available for payment of dividends on our shares of common stock |
| We cannot be assured that tenants will elect to renew their leases when the terms expire |
| If a tenant does not renew its lease or if a tenant defaults on its lease obligations, there is no assurance we could obtain a substitute tenant on acceptable terms |
| If we 8 _________________________________________________________________ [59]Table of Contents cannot obtain another tenant with comparable structural needs, we may be required to modify the property for a different use, which may involve a significant capital expenditure and a delay in re-leasing the property |
| Uncertainties relating to lease renewals and re-letting of space |
| We are subject to the risks that, upon expiration of leases for space located in our properties, the premises may not be re-let or the terms of re-letting (including the cost of concessions to tenants) may be less favorable than current lease terms |
| If we are unable to re-let promptly all or a substantial portion of our retailers or if the rental rates upon such re-letting were significantly lower than expected rates, our net income and ability to make expected distributions to stockholders would be adversely affected |
| There can be no assurance that we will be able to retain tenants in any of our properties upon the expiration of their leases |
| Some potential losses are not covered by insurance |
| Our leases require the tenants to carry comprehensive liability, casualty, workers’ compensation, extended coverage and rental loss insurance on our properties |
| However, there are some types of losses, such as terrorist acts or catastrophic acts of nature, for which we or our tenants cannot obtain insurance at an acceptable cost |
| If there is an uninsured loss or a loss in excess of insurance limits, we could lose both the revenues generated by the affected property and the capital we have invested in the property |
| We believe the required coverage is of the type, and amount, customarily obtained by an owner of similar properties |
| We believe all of our properties are adequately insured |
| We would, however, remain obligated to repay any mortgage indebtedness or other obligations related to the property |
| Potential liability for environmental contamination could result in substantial costs |
| Under federal, state and local environmental laws, we may be required to investigate and clean up any release of hazardous or toxic substances or petroleum products at our properties, regardless of our knowledge or actual responsibility, simply because of our current or past ownership of the real estate |
| If unidentified environmental problems arise, we may have to make substantial payments, which could adversely affect our cash flow and our ability to make distributions to our stockholders |
| This potential liability results from the fact that: • As owner we may have to pay for property damage and for investigation and clean-up costs incurred in connection with the contamination |
| • The law may impose clean-up responsibility and liability regardless of whether the owner or operator knew of or caused the contamination |
| • Even if more than one person is responsible for the contamination, each person who shares legal liability under environmental laws may be held responsible for all of the clean-up costs |
| • Governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs |
| These costs could be substantial and in extreme cases could exceed the value of the contaminated property |
| The presence of hazardous substances or petroleum products or the failure to properly remediate contamination may adversely affect our ability to borrow against, sell or lease an affected property |
| In addition, some environmental laws create liens on contaminated sites in favor of the government for damages and costs it incurs in connection with a contamination |
| Our leases require our tenants to operate the properties in compliance with environmental laws and to indemnify us against environmental liability arising from the operation of the properties |
| However, we could be subject to strict liability under environmental laws because we own the properties |
| There is also a risk that tenants may not satisfy their environmental compliance and indemnification obligations under the leases |
| Any of these events could substantially increase our cost of operations, require us to fund environmental indemnities in favor of our secured lenders and reduce our ability to service our secured debt and pay dividends to stockholders and any debt security interest payments |
| Environmental problems at any properties could also put us in default under loans secured by those properties, as well as loans secured by unaffected properties |
| 9 _________________________________________________________________ [60]Table of Contents Real estate investments are relatively illiquid |
| We may desire to sell a property in the future because of changes in market conditions or poor tenant performance or to avail ourselves of other opportunities |
| We may also be required to sell a property in the future to meet secured debt obligations or to avoid a secured debt loan default |
| Real estate projects cannot always be sold quickly, and we cannot assure you that we could always obtain a favorable price |
| We may be required to invest in the restoration or modification of a property before we can sell it |
| Tax Risks We will be subject to increased taxation if we fail to qualify as a REIT for federal income tax purposes |
| A REIT generally is not taxed at the corporate level on income it distributes to its stockholders, as long as it distributes annually at least 90prca of its taxable income to its stockholders |
| We have not requested and do not plan to request, a ruling from the Internal Revenue Service that we qualify as a REIT If we fail to qualify as a REIT, we will face tax consequences that will substantially reduce the funds available for payment of dividends: • We would not be allowed a deduction for dividends paid to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates |
| • We could be subject to the federal alternative minimum tax and possibly increased state and local taxes |
| • Unless we are entitled to relief under statutory provisions, we could not elect to be treated as a REIT for four taxable years following the year in which we were disqualified |
| In addition, if we fail to qualify as a REIT, we will no longer be required to pay dividends (other than any mandatory dividends on any preferred shares we may offer) |
| As a result of these factors, our failure to qualify as a REIT could adversely effect the market price for our common stock |
| Excessive non-real estate asset values may jeopardize our REIT status |
| In order to qualify as a REIT, at least 75prca of the value of our assets must consist of investments in real estate, investments in other REITs, cash and cash equivalents, and government securities |
| Therefore, the value of any property that is not considered a real estate asset for federal income tax purposes must represent in the aggregate less than 25prca of our total assets |
| In addition, under federal income tax law, we may not own securities in any one company (other than a REIT, a qualified REIT subsidiary or a taxable REIT subsidiary) which represent in excess of 10prca of the voting securities or 10prca of the value of all securities of any one company, or which have, in the aggregate, a value in excess of 5prca of our total assets, and we may not own securities of one or more taxable REIT subsidiaries which have, in the aggregate, a value in excess of 20prca of our total assets |
| We may invest in securities of another REIT, and our investment may represent in excess of 10prca of the voting securities or 10prca of the value of the securities of the other REIT If the other REIT were to lose its REIT status during a taxable year in which our investment represented in excess of 10prca of the voting securities or 10prca of the value of the securities of the other REIT as of the close of a calendar quarter, we will lose our REIT status |
| If we fail to meet any such test at the end of any calendar quarter, we will cease to qualify as a REIT We may have to borrow funds or sell assets to meet our distribution requirements |
| Subject to some adjustments that are unique to REITs, a REIT generally must distribute 90prca of its taxable income |
| In addition, we may be required not to accrue as expenses for tax purposes some items which actually have been paid, including, for example, payments of principal on our debt, or some of our deductions might be disallowed by the Internal Revenue Service |
| As a result, we could have taxable income in excess of cash available for distribution |
| If this occurs, we may have to borrow funds or liquidate some of our assets in order to meet the distribution requirement applicable to a REIT 10 _________________________________________________________________ [61]Table of Contents We may be subject to other tax liabilities |
| Even if we qualify as a REIT, we may be subject to some federal, state and local taxes on our income and property that could reduce operating cash flow |
| Changes in tax laws may prevent us from qualifying as a REIT As we have previously described, we intend to qualify as a REIT for federal income tax purposes |
| However, this intended qualification is based on the tax laws that are currently in effect |
| We are unable to predict any future changes in the tax laws that would adversely affect our status as a REIT If there is a change in the tax laws that prevents us from qualifying as a REIT or that requires REITs generally to pay corporate level income taxes, we may not be able to make the same level of distributions to our stockholders |