UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2004

OR

For the transition period from __________ to __________

Commission File Number 1-12928

Agree Realty Corporation

Registrant’s telephone number, included area code: (248) 737-4190

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

6,466,971 Shares of Common Stock, $.0001 par value, were outstanding as of May 5, 2004

Agree Realty Corporation

Form 10-Q

Index

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Agree Realty Corporation

Consolidated Balance Sheets (Unaudited)

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Balance Sheets (Unaudited)

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statements of Income (Unaudited)

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statement of Stockholders’ Equity (Unaudited)

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Consolidated Statements of Cash Flows (Unaudited)

See accompanying notes to consolidated financial statements.

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Agree Realty Corporation

Notes to Consolidated Financial Statements

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Agree Realty Corporation

Part I

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OEPRATIONS

Forward-Looking Statements

Management has included herein certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. When used, statements which are not historical in nature, including the words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” and similar expressions, are intended to identify forward-looking statements. Such statements are, by their nature, subject to certain risks and uncertainties. Risks and other factors that might cause future results to differ from the statements include, but are not limited to, the effect of economic and market conditions; risks that the Company’s acquisition and development projects will fail to perform as expected; financing risks, such as the inability to obtain debt or equity financing on favorable terms; the level and volatility of interest rates; loss or bankruptcy of one or more of the Company’s major retail tenants; and failure of the Company’s properties to generate additional income to offset increases in operating expenses.

Overview

We were established to continue to operate and expand the retail property business of our predecessor. We commenced our operations in April 1994. Our assets are held by, and all operations are conducted through, Agree Limited Partnership (the Operating Partnership), of which Agree Realty Corporation is the sole general partner and held a 90.57% interest as of March 31, 2004. We are operating so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes.

On August 4, 2003, we completed an offering of 1,700,000 shares of common stock at $23.50 per share; on August 12, 2003 the underwriters exercised their over allotment option for an additional 255,000 shares at the same per share price (collectively, the “2003 Offering”). The net proceeds from the 2003 Offering of approximately $43.2 million were used to repay amounts outstanding under our credit facility.

We have fourteen (14) leases with Kmart Corporation. Eleven (11) of the Kmart stores are currently anchors in our community shopping centers and three (3) Kmart stores are freestanding net leased properties. The Kmart stores in our portfolio provided 16.8% of our annual base rent as of March 31, 2004. Four of the Kmart stores paid percentage rent in addition to their minimum rent during 2003. As of March 31, 2004, all of our Kmart stores were open and operating as Kmart discount stores.

In May 2003 Kmart emerged from the bankruptcy proceeding which it had initiated in January 2002. Pursuant to the confirmed plan of reorganization, Kmart closed approximately 600 of its stores, including one located in our center in Lakeland, Florida. Kmart vacated the premises in Lakeland, Florida in April 2003, and we have actively marketed the space formerly occupied by Kmart. Kmart’s annual rent on this property was approximately $480,000 and their annual contribution under the lease for real estate taxes, insurance and common area maintenance was approximately $110,000. Certain tenants in the Lakeland, Florida community shopping center have co-tenancy clauses in their leases which provide either for modification of their rent to be based on gross sales or an option to terminate their lease when the Kmart store closed, and we are unable to obtain a replacement anchor tenant. As of April 30, 2004, none of these tenants has indicated that they will exercise their option to terminate their leases with us. In addition, we have agreed to a rent

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Part I

reduction of $150,000 per year under a Kmart lease for a store in Perrysburg, Ohio. The rent reduction is for a 5-year period.

We have entered into a lease with a department store to lease the entire vacant Kmart space. The terms of the lease are similar to the terms under the previous Kmart lease. We expect the tenant to commence paying rent and other chares in October 2004. In connection with re-letting the Kmart location, we have agreed to make capital expenditures of approximately $600,000 with respect to the property.

During October, 2003 we sold a community shopping center that was located in Winter Garden, Florida and was anchored by Kmart. The Company developed the 233,512 square foot shopping center in 1988. The property was sold to a private investor for approximately $8.5 million. We recognized a gain of approximately $835,000 on the sale.

The following should be read in conjunction with the Consolidated Financial Statements of Agree Realty Corporation, including the respective notes thereto, which are included elsewhere in this Form 10-Q.

Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”). The objective of SFAS 150 is to establish standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In November 2003, the FASB indefinitely delayed the effective date of SFAS 150 with respect to certain mandatory redeemable non-controlling interests in consolidated financial statements. Adoption of SFAS 150 did not have an impact on the results of operations or financial position of the Company.

Critical Accounting Policies

In the course of developing and evaluating accounting policies and procedures, we use estimates, assumptions and judgments to determine the most appropriate methods to be applied. Such processes are used in determining capitalization of costs related to real estate investments, potential impairment of real estate investments, operating cost reimbursements, and taxable income.

Real estate assets are stated at cost less accumulated depreciation. All costs related to planning, development and construction of buildings prior to the date they become operational, including interest and real estate taxes during the construction period, are capitalized for financial reporting purposes and recorded as property under development until construction has been completed. Subsequent to completion of construction, expenditures for property maintenance are charged to operations as incurred, while significant renovations are capitalized. Depreciation of the buildings is recorded on the straight-line method using an estimated useful life of forty years.

In determining the fair value of real estate investments, we consider future cash flow projections on a property by property basis, current interest rates and current market conditions of the geographical location of each property.

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Part I

Substantially all of our leases contain provisions requiring tenants to pay as additional rent a proportionate share of operating expenses (Operating Cost Reimbursements) such as real estate taxes, repairs and maintenance, insurance, etc. The related revenue from tenant billings is recognized in the same period the expense is recorded.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), commencing with our 1994 tax year. As a result, we are not subject to federal income taxes to the extent that we distribute annually at least 90% of our taxable income to our stockholders and satisfy certain other requirements defined in the Code. Accordingly, no provision was made for federal income taxes in the accompanying consolidated financial statements.

Comparison of Three Months Ended March 31, 2004 to Three Months Ended March 31, 2003

Minimum rental income increased $439,000, or 7%, to $6,370,000 in 2004, compared to $5,931,000 in 2003. The increase was the result of an increase of $264,000 due to additional rent resulting from the acquisition of our joint venture partner’s interest in two joint venture properties in 2003; an increase of $231,000 from the development and acquisition of three properties in 2003 and two properties in 2004; and rental decreases of ($56,000) from existing properties.

Percentage rental income decreased $16,000, or 41%, to $25,000 in 2004, compared to $41,000 in 2003. The decrease was the result of a decrease in percentage rent received from tenants.

Operating cost reimbursements increased $132,000, or 18%, to $851,000 in 2004, compared to $719,000 in 2003. Operating cost reimbursement increased due to the increase in the reimbursable property operating expenses as explained below and an adjustment to the bad debt reserve of $50,000.

Other income remained constant at $2,000 in 2004 and 2003.

Real estate taxes decreased $16,000, or 3%, to $452,000 in 2004 compared to $468,000 in 2003. The decrease is the result of general assessment adjustments.

Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) increased $84,000, or 14%, to $689,000 in 2004 compared to $605,000 in 2003. The increase was the result of reduced shopping center maintenance of ($27,000); increased snow removal costs of $93,000; an increase in utility costs of $1,000; and an increase in insurance costs of $17,000 in 2004 versus 2003.

Land lease payments remained constant at $185,000 for 2004 and 2003.

General and administrative expenses increased $76,000, or 14%, to $633,000 in 2004 compared to $557,000 in 2003. The increase was the result of increased compensation related expenses of $56,000 and increased general state taxes of $20,000. General and administrative expenses as a percentage of rental income increased from 9.3% for 2003 to 9.9% for 2004.

Depreciation and amortization increased $77,000, or 7%, to $1,083,000 in 2004 compared to $1,006,000 in 2003. The increase was the result of the development of two properties in 2003 and one property in 2004; the acquisition of one property in 2003 and one property in 2004; and the acquisition of the joint venture partner’s interest in two joint venture properties in 2003.

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Interest expense decreased $480,000, or 30%, to $1,104,000 in 2004, from $1,584,000 in 2003. The decrease in interest expense was the result of decreased borrowings as a result of the reduction in outstanding indebtedness with the net proceeds from the issuance of additional common stock.

Equity in net income of unconsolidated entities decreased $22,000, or 18%, to $97,000 in 2004 compared to $119,000 in 2003 as a result of the acquisition of our joint venture partner’s interest in two joint venture properties in 2003.

The Company’s income before minority interest and discontinued operations increased $789,000, or 33%, to $3,197,000 in 2004, from $2,408,000 in 2003 as a result of the foregoing factors.

Liquidity and Capital Resources

Our principal demands for liquidity are distributions to our shareholders, debt service, development of new properties and future property acquisitions.

During the quarter ended March 31, 2004, we declared a quarterly dividend of $.485 per share. The dividend was paid on April 15, 2004 to holders of record on March 31, 2004.

As of March 31, 2004, we had total mortgage indebtedness of $55,440,958 with a weighted average interest rate of 6.63%. Future scheduled annual maturities of mortgages payable for the years ending March 31 are as follows: 2005 - $2,084,016; 2006 - $2,336,447; 2007 - $2,495,525; 2008 - $2,660,733; 2009 - $2,827,257. The mortgage debt is all fixed rate, self-amortizing debt.

In addition, the Operating Partnership has in place a $50 million credit facility with Standard Federal Bank, as the agent (Credit Facility), which is guaranteed by the Company. The Credit Facility matures in November 2006 and can be extended for an additional three years. During the three year extension period we will have no further ability to borrow under this facility and will be required to repay a portion of the unpaid principal on a quarterly basis. Advances under the Credit Facility bear interest within a range of one-month to six-month LIBOR plus 150 basis points to 213 basis points or the lender’s prime rate, at the our option, based on certain factors such as debt to property value and debt service coverage. The Credit Facility is used to fund property acquisitions and development activities and is secured by most of the properties which are not otherwise encumbered and properties to be acquired or developed. As of March 31, 2004, $24,000,000 was outstanding under the Credit Facility bearing a weighted average interest rate of 2.74%.

We also have in place a $5 million line of credit (Line of Credit), which matures on June 30, 2004, and which the Company expects to renew for an additional 12 month period. The Line of Credit bears interest at the lender’s prime rate less 50 basis points or 175 basis points in excess of the one-month LIBOR rate, at our option. The purpose of the Line of Credit is to provide working capital and fund land options and start-up costs associated with new projects. As of March 31, 2004, $2,900,000 was outstanding under the Line of Credit bearing a weighted average interest rate of 3.50%.

We have received funding from an unaffiliated third party for the construction of one of our properties. Advances under this arrangement bear no interest. The advances are secured by the specific land and buildings being developed. As of March 31, 2004, $1,569,000 was outstanding under this arrangement.

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Agree Realty Corporation

Part I

The following table outlines our contractual obligations (in thousands) as of March 31, 2004.

We have one development project under construction that will add an additional 13,650 square feet of GLA to our portfolio. The project is expected to be completed during the fourth quarter of 2004. Additional funding required for this project is estimated to be $2,200,000 and will come from the Credit Facility.

We intend to meet our short-term liquidity requirements, including capital expenditures related to the leasing and improvement of the properties, through cash flow provided by operations and the Line of Credit. We believe that adequate cash flow will be available to fund our operations and pay dividends in accordance with REIT requirements. We may obtain additional funds for future development or acquisitions through other borrowings or the issuance of additional shares of common stock. We intend to incur additional debt in a manner consistent with our policy of maintaining a ratio of total debt (including construction and acquisition financing) to total market capitalization of 65% or less. We believe that these financing sources will enable us to generate funds sufficient to meet both our short-term and long-term capital needs.

We plan to begin construction of additional pre-leased developments and may acquire additional properties, which will initially be financed by the Credit Facility and Line of Credit. We will periodically refinance short-term construction and acquisition financing with long-term debt and / or equity. Upon completion of refinancing, we intend to lower the ratio of total debt to market capitalization to 50% or less. Nevertheless, we may operate with debt levels or rations, which are in excess of 50% for extended periods of time prior to such refinancing.

Inflation

The Company’s leases generally contain provisions designed to mitigate the adverse impact of inflation on net income. These provisions include clauses enabling the Company to pass through to tenants certain operating costs, including real estate taxes, common area maintenance, utilities and insurance, thereby reducing the Company’s exposure to increases in costs and operating expenses resulting from inflation. Certain of the Company’s leases contain clauses enabling the Company to receive percentage rents based on tenants’ gross sales, which generally increase as prices rise, and, in certain cases, escalation clauses, which generally increase rental rates during the terms of the leases. In addition, expiring tenant leases permit the Company to seek increased rents upon re-lease at market rates if rents are below the then existing market rates.

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Agree Realty Corporation

Part I

Funds from Operations

We consider Funds from Operations (“FFO”) to be a useful supplemental measure to evaluate our operating performance because, by excluding gains or losses on dispositions and excluding depreciation, FFO can help one compare the operating performance of our real estate between periods or compare such performance to that of different companies. FFO is defined by the National Association of Real Estate Investment Trusts, Inc. (NAREIT) to mean net income computed in accordance with generally accepted accounting principles (GAAP), excluding gains (or losses) from sales of property, plus real estate related depreciation and amortization. FFO should not be considered as an alternative to net income as the primary indicator of our operating performance or as an alternative to cash flow as a measure of liquidity. While we adhere to the NAREIT definition of FFO in making our calculation, our method of calculating FFO may not be comparable to the methods used by other REITs and accordingly may be different from similarly titled measures reported by other companies.

The following tables illustrate the calculation of FFO for the three months ended March 31, 2004 and 2003:

ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to interest rate risk primarily through its borrowing activities. There is inherent roll over risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and the Company’s’ future financing requirements.

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The Company’s interest rate risk is monitored using a variety of techniques. The table below presents the principal payments (in thousands) and the weighted average interest rates on remaining debt, by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.

The fair value (in thousands) is estimated at $56,000, $1,569 and $26,900 for fixed rate debt, construction loans and variable rate debt, respectively.

The table above incorporates those exposures that exist as of March 31, 2004; it does not consider those exposures or positions, which could arise after that date. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period and interest rates.

The Company does not enter into financial instruments transactions for trading or other speculative purposes or to manage interest rate exposure.

A 10% adverse change in interest rates on the portion of the Company’s debt bearing interest at variable rates would result in an increase in interest expense of approximately $75,000.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Vice-President-Finance have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Vice-President-Finance have concluded that our current disclosure controls and procedures are effective and timely, providing them with material information relating to us required to be disclosed in the reports we file or submit under the Exchange Act.

Changes in Internal Controls

There have not been any significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. We are not aware of any significant deficiencies or material weaknesses, therefore, no corrective actions were taken.

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Part II

Other Information

Item 1. Legal Proceedings

None

Item 2. Changes in Securities

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

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Part II

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

3.1		Articles of Incorporation and Articles of Amendment of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-11 (Registration Statement No. 33-73858, as amended (“Agree S-11”))
3.2		Bylaws of the Company (incorporated by reference to Exhibit 3.3 to Agree S-11)
31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Richard Agree, Chief Executive Officer
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Kenneth R. Howe, Chief Financial Officer
32.1		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Richard Agree, Chief Executive Officer
32.2		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Kenneth R. Howe, Chief Financial Officer

(b)		Reports on Form 8-K
		On April 23, 2004, the Company furnished an 8-K disclosing its first quarter 2004 results of operations and financial condition.

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Part II

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has fully caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Agree Realty Corporation

Date: May 6, 2004

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EXHIBIT INDEX