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, directly or indirectly, Agree Limited Partnership (Operating Partnership), of which Agree Realty Corporation is the sole general partner and held a 92.85% interest as of December 31, 2008. We are operating so as to qualify as a real estate investment trust (REIT) for federal income tax purposes.

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-K.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157. "Fair Value Measurements" ("SFAS No. 157"). This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies to accounting pronouncements that require or permit fair value measurements, except for share-based compensation transactions under FASB Statement No. 123 (Revised) "Share Based Payment." This Statement was effective for financial statements issued for fiscal years beginning after November 15, 2007, except for non-financial assets and liabilities for which this Statement will be effective for years beginning after November 15, 2008. The deferral to this Statement applies to all nonfinancial assets and nonfinancial liabilities including but not limited to initial measurements of fair value of: nonfinancial assets and nonfinancial liabilities in a business combination or other new basis event, asset retirement obligations, and nonfinancial liabilities for exit or disposal activities, as well as impairment assessments of nonfinancial long lived assets and goodwill. This Statement does not require any new fair value measurements or remeasurements of previously reported fair values. The Company will account for nonfinancial assets and nonfinancial liabilities under SFAS No. 157 beginning on January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS No. 160"), an amendment to Accounting Research Board No. 51. SFAS No. 160's objective is to improve the relevance, comparability and transparency of financial information that a reporting entity provides in its consolidated financial statements. The key aspects of SFAS No. 160 are (i) the minority interests in subsidiaries should be presented in the consolidated balance sheet within equity of the consolidated group, separate from the parent's shareholders' equity, (ii) acquisitions or dispositions of noncontrolling interests in a subsidiary that do not result in a change of control should be accounted for as equity transactions, (iii) a parent recognizes a gain or loss in net income when a subsidiary is deconsolidated, measured using the fair value of the non-controlling equity investment, (iv) the acquirer should attribute net income and each component of other comprehensive income between controlling and noncontrolling interests based on any contractual arrangements or relative ownership interests, and (v) a reconciliation of beginning to ending total equity is required for both controlling and noncontrolling interests. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008 and should be applied prospectively. We expect SFAS No. 160 will require the disclosure of minority interest as a separate item in the equity section of our balance sheet, once adopted. We do not expect SFAS No. 160 to have a material effect on our financial statements. The Company will account for minority interest under SFAS No.160 beginning on January 1, 2009. In March 2008, the SEC announced revisions to Topic No. D-98 "Classification and Measurement of Redeemable Securities" that provide interpretive guidance on the interaction on the interaction between Topic D-98 and Statement No. 160.

In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations" ("SFAS No. 141"). SFAS No. 141(R) will significantly change the accounting for business combinations. Under SFAS No. 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141(R) will change the accounting treatment for certain specific acquisition related items including: (1) expensing acquisition related costs as incurred;
(2) valuing noncontrolling interests at fair value at the acquisition date; and
(3) expensing restructuring costs associated with an acquired business. SFAS No. 141(R) also includes a substantial number of new disclosure requirements. SFAS No. 141(R) is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The Company will account for business combinations under this Statement beginning on January 1, 2009.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS No. 161"). SFAS No. 161 requires enhanced disclosures about an entity's derivative and hedging activities. It clarifies (a) how and why an entity uses derivative instruments,
(b) how derivative instruments and related hedged items are accounted for under SFAS No.133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company will disclose hedging activities under SFAS No. 161 beginning on January 1, 2009 and do not expect SFAS No. 161 to have a material effect on our financial statements since it pertains to disclosure only.

In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles," ("SFAS No. 162"). The current hierarchy of generally accepted accounting principles is set forth in the American Institute of Certified Accountants (AICPA) Statement of Auditing Standards (SAS) No. 69, "The meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework or hierarchy for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. This Statement is effective November 15, 2008. The Company will adopt this Statement effective January 1, 2009 but does not anticipate that the Statement will have a material effect on the Company's results of operations or financial position, as the Statement does not directly impact the accounting principles applied in the preparation of the Company's financial statements.

In June 2008, the FASB ratified FASB Staff Position No. EITF 03-6-01 "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities" ("FSP EITF 03-6-01"). FSP EITF 03-6-01 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share ("EPS") under the two-class method of SFAS 128. It clarifies that unvested share-based payment awards that contain nonforfeitable right to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. FSP EITF 03-6-01 is effective for fiscal years beginning after December 15, 2008. The Company will account for instruments granted in share-based payment transactions under this Statement beginning on January 1, 2009, however we do not expect FSP EITF 06-6-01 to have a material impact on our computation of EPS.

In November 2008, the FASB ratified Emerging Issue Task Force Issue No. 08-6, "Equity Method Investment Accounting Considerations." EITF 08-6 addresses certain issues that arise from a company's application of the equity method under Opinion 18 due to a change in accounting for business combinations and consolidated subsidiaries resulting from the issuance of Statement 141(R) and Statement 160. EITF 08-6 addresses issues regarding the initial carrying value of an equity method investment, tests of impairment performed by the investor over an investee's underlying assets, changes in ownership resulting from the issuance of shares by an investee, and changes in an investment from the equity method to the cost method. This Issue is effective and will be applied on a prospective basis in fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years, consistent with the effective dates of Statement 141(R) and Statement 160. The Company will adopt this Statement effective January 1, 2009, however we do not expect Issue No. 08-6 to have a material impact on our financial statements.

Critical Accounting Policies

Critical accounting policies are those that are both significant to the overall presentation of our financial condition and results of operations and require management to make difficult, complex or subjective judgments. For example, significant estimates and assumptions have been made with respect to revenue recognition, capitalization of costs related to real estate investments, potential impairment of real estate investments, operating cost reimbursements, and taxable income.

Minimum rental income attributable to leases is recorded when due from tenants. Certain leases provide for additional percentage rents based on tenants' sales volumes. These percentage rents are recognized when determinable by us. In addition, leases for certain tenants contain rent escalations and/or free rent during the first several months of the lease term; however such amounts are not material.

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. The viability of all projects under construction or development are regularly evaluated under applicable accounting requirements, including requirements relating to abandonment of assets or changes in use. To the extent a project, or individual components of the project, are no longer considered to have value, the related capitalized costs are charged against operations. 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.

We evaluate real estate for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value and such excess carrying value is charged to income. The expected cash flows of a project are dependent on estimates and other factors subject to change, including (1) changes in the national, regional, and/or local economic climates, (2) competition from other shopping centers, stores, clubs, mailings, and the internet, (3) increases in operating costs, (4) bankruptcy and/or other changes in the condition of third parties, including tenants, (5) expected holding period, and (6) availability of credit. These factors could cause our expected future cash flows from a project to change, and, as a result, an impairment could be considered to have occurred.

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 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 lease 90% of our taxable income to our shareholders and satisfy certain other requirements defined in the Code.

In October 2007, we established a taxable REIT subsidiary pursuant to the provisions of the REIT Modernization Act. Our TRS is able to engage in activities resulting in income that previously would have been disqualified from being eligible REIT income under the federal income tax regulations. As a result, certain activities of the Company which occur within its TRS entity are subject to federal and state income taxes. As of December 31, 2008 the Company had accrued a deferred income tax amount of $705,000 which was netted against the gain on sale.

Comparison of Year Ended December 31, 2008 to Year Ended December 31, 2007

Minimum rental income increased $1,214,000, or 4%, to $32,850,000 in 2008, compared to $31,636,000 in 2007. The increase was the result of the development of a Walgreen drug store in Livonia, Michigan in June 2007, the development of a Walgreen drug store in Barnesville, Georgia in October 2007, the development of a parcel of land located in East Lansing, Michigan in November 2007, the development of a parcel of land located in Plainfield, Indiana in November 2007, the development of a Walgreens drug store and a bank land lease in Macomb Township, Michigan in March 2008, the development of a Walgreens drug store located in Ypsilanti, Michigan in May 2008, the development of a Walgreens drug store in Ocala, Florida in June 2008 and the development of a Walgreens drug store in Shelby Township, Michigan in July 2008. Our revenue increases from these developments amounted to $2,010,000. Our increase in rental income was partially offset by a lease termination payment related to our Big Rapids, Michigan shopping center that was received in 2007 of ($608,000), a reduction in rental of income related to our redevelopment of our Big Rapids, Michigan shopping center of ($143,000) and a reduction of rent at our only Circuit City store of ($56,000).

Percentage rents decreased $22,000, or 59%, to $15,000 in 2008, compared to $37,000 in 2007. The decrease was primarily the result of decreased tenant sales.

Operating cost reimbursements increased $25,000, or 1%, to $2,784,000 in 2008, compared to $2,759,000 in 2007. Operating cost reimbursements increased due to the increase in property operating expenses as explained below.

Other income decreased $31,000 to $4,000 in 2008, compared to $35,000 in 2007.

Real estate taxes increased $18,000, or 1%, to $1,867,000 in 2008 compared to $1,849,000 in 2007. The increase is the result of general assessment increases on the properties.

Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) increased $28,000, or 2%, to $1,813,000 in 2008 compared to $1,785,000 in 2007. The increase was the result of a decrease in shopping center maintenance expenses of ($64,000); increased snow removal costs of $68,000; increased utility costs of $29,000; and decreased insurance costs of ($5,000) in 2008 versus 2007.

Land lease payments increased $91,000, or 14%, to $767,000 in 2008 compared to $676,000 for 2007. The increase is the result of our leasing of land for our Shelby Township, Michigan development.

General and administrative expenses decreased $101,000, or 2%, to $4,361,000 in 2008 compared to $4,462,000 in 2007. The decrease was the result of an increase in compensation related expenses of $58,000; decreased contracted services to investigate development opportunities of ($165,000) and increased property management related expenses of $6,000. General and administrative expenses as a percentage of rental income decreased from 14.1% for 2007 to 13.3% for 2008.

Depreciation and amortization increased $368,000, or 7%, to $5,385,000 in 2008 compared to $5,017,000 in 2007. The increase was the result the development and acquisition of four properties in 2008 and four properties in 2007.

Interest expense increased $283,000, or 6%, to $5,179,000 in 2008, from $4,896,000 in 2007. The increase in interest expense was the result of increased borrowings to fund the development and acquisition of four properties in 2008 and four properties in 2007.

In October 2007, we completed the sale of our interest in two contracts to acquire a 14.9 acre parcel of land to a national home improvement superstore. The transaction resulted in a gain of $1,044,000 net of deferred income taxes of $705,000. We established a taxable REIT subsidiary to facilitate this transaction. We elected to defer the recognition of the gain from the transaction for income tax purposes by making an election under Section 1031 of the Code. There were no gains from property sales in 2008.

The Company's income before minority interest decreased $545,000, or 3%, to $16,282,000 in 2008, from $16,827,000 in 2007 as a result of the foregoing factors.

Comparison of Year Ended December 31, 2007 to Year Ended December 31, 2006

Minimum rental income increased $1,673,000, or 6%, to $31,636,000 in 2007, compared to $29,963,000 in 2006. The increase was the result of the development of a Walgreen drug store at our Capital Plaza shopping center in December 2006, the acquisition of a Rite Aid drug store in Summit Township, Michigan in September 2006, the development of a Walgreen drug store in Livonia, Michigan in June 2007, the development of a Walgreen drug store in Barnesville, Georgia in October 2007, the development of a parcel of land located in East Lansing, Michigan and the development of a parcel of land located in Plainfield, Indiana in November 2007. Our revenue increase from these acquisitions and developments amounted to $850,000. In addition we received a lease termination payment related to our Big Rapids, Michigan shopping center of $608,000 and increased revenue from existing tenants of $215,000.

Percentage rents decreased $17,000, or 31%, to $37,000 in 2007, compared to $54,000 in 2006. The decrease was primarily the result of decreased tenant sales.

Operating cost reimbursements decreased $88,000, or 3%, to $2,759,000 in 2007, compared to $2,847,000 in 2006. Operating cost reimbursements increased $62,000 due to the increase in property operating expenses as explained below, however this increase was offset by an adjustment for insurance billed to one of our tenants in the amount of $150,000.

Other income decreased $9,000 to $35,000 in 2007, compared to $44,000 in 2006.

Real estate taxes increased $28,000, or 2%, to $1,849,000 in 2007 compared to $1,821,000 in 2006. The increase is the result of general assessment increases on the properties.

Property operating expenses (shopping center maintenance, snow removal, insurance and utilities) increased $148,000, or 9%, to $1,785,000 in 2007 compared to $1,637,000 in 2006. The increase was the result of an increase in shopping center maintenance expenses of $30,000; increased snow removal costs of $129,000; increased utility costs of $11,000; and decreased insurance costs of ($22,000) in 2007 versus 2006.

Land lease payments decreased $84,000, or 11%, to $676,000 in 2007 compared to $760,000 for 2006. The decrease is the result of our purchase of the fee interest in the land located at our Lawrence, Kansas property previously leased.

General and administrative expenses increased $443,000, or 11%, to $4,462,000 in 2007 compared to $4,019,000 in 2006. The increase was the result of an increase in compensation related expenses of $595,000; increased contracted services to investigate development opportunities of $86,000 and increased property management related expenses of $27,000. These increases were offset by a decrease in general business taxes of $90,000 and decreased professional fees of $175,000. General and administrative expenses as a percentage of rental income increased from 13.4% for 2006 to 14.1% for 2007. The increase in compensation related expenses was primarily the result of employee bonus payments of $346,000 and the hiring of two additional employees in 2007.

Depreciation and amortization increased $166,000, or 3%, to $5,017,000 in 2007 compared to $4,851,000 in 2006. The increase was the result the development and acquisition of four properties in 2007 and two properties in 2006.

Interest expense increased $271,000, or 6%, to $4,896,000 in 2007, from $4,625,000 in 2006. The increase in interest expense was the result of increased borrowings to fund the development and acquisition of four properties in 2007 and two properties in 2006, as well as overall interest rate increases.

In October 2007, we completed the sale of our interest in two contracts to acquire a 14.9 acre parcel of land to a national home improvement superstore. The transaction resulted in a gain of $1,044,000 net of deferred income taxes of $705,000. We established a taxable REIT subsidiary to facilitate this transaction. We expect to elect to defer the recognition of the gain from the transaction for income tax purposes by making an election under Section 1031 of the Code. There were no gains from property sales in 2006.

The Company's income before minority interest and discontinued operations increased $1,633,000, or 11%, to $16,827,000 in 2007, from $15,194,000 in 2006 as a result of the foregoing factors.

Liquidity and Capital Resources

Our principal demands for liquidity are operations, distributions to our stockholders, debt repayment, development of new properties, redevelopment of existing properties and future property acquisitions. 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 and the Credit Facility. We believe that adequate cash flow will be available to fund our operations and pay dividends in accordance with REIT requirements for at least the next 12 months. We may obtain additional funds for future development or acquisitions through other borrowings or the issuance of additional shares of common stock, although current market conditions have severely limited the availability of new sources of financing and capital, which will likely have an impact on our ability to obtain construction financing for planned new development projects in the near term. 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. As of December 31, 2008, our ratio of indebtedness to market capitalization was approximately 65.4%. We believe that these financing sources will enable us to generate funds sufficient to meet both our short-term and long-term capital needs.

During the quarter ended December 31, 2008, we declared a quarterly dividend of $.50 per share. The cash dividend was paid on January 6, 2009 to holders of record on December 22, 2008.

Our cash flows from operations increased $293,000 to $21,930,000 in 2008, compared to $21,637,000 in 2007. Cash used in investing activities increased $3,411,000 to $21,419,000 in 2008, compared to $18,008,000 in 2007. Cash used in financing activities decreased $3,162,000 to $387,000 in 2008, compared to $3,549,000 in 2007. Our cash and cash equivalents increased by $124,000 to $669,000 as of December 31, 2008 as a result of the foregoing factors.

As of December 31, 2008, we had total mortgage indebtedness of $67,623,697. Of this total mortgage indebtedness, $43,010,397 is fixed rate, self-amortizing debt with a weighted average interest rate of 6.64% and the remaining mortgage debt of $24,613,300 has a maturity date of July 14, 2013, can be extended at our option for two additional years and bears interest at 150 basis points over LIBOR (or 2.695% as of December 31, 2008). The proceeds from this mortgage loan were used to reduce amounts outstanding under our Credit Facility. In February 2009 the Company entered into an interest rate swap agreement that will fix the interest rate during the initial term of the mortgage at 3.744%.

In addition, the Operating Partnership has in place a $55 million credit facility (the "Credit Facility") with Bank of America, as the agent, which is guaranteed by the Company. The Credit Facility matures in November 2011. Advances under the Credit Facility bear interest within a range of one-month to twelve-month LIBOR plus 100 basis points to 150 basis points or the lender's prime rate, at our option, based on certain factors such as the ratio of our indebtedness to the capital value of our properties. The Credit Facility generally is used to fund property acquisitions and development activities. As of February 16, 2009, $34,500,000 was outstanding under the Credit Facility bearing a weighted average interest rate of 1.46%.

We also have in place a $5 million line of credit (the "Line of Credit"), which matures in November 2009, and can be extended at our option subject to specified conditions for two additional one year periods. The Line of Credit bears interest at the lender's prime rate less 75 basis points or 150 basis points in excess of the one-month to twelve month LIBOR rate, at our option. The purpose of the Line of Credit is to generally provide working capital and fund land options and start-up costs associated with new projects. As of February 16, 2009, $300,000 was outstanding under the Line of Credit bearing a weighted average interest rate of 2.50%.

The following table outlines our contractual obligations (in thousands) as of December 31, 2008:

                                    Total         Yr 1         2-3 Yrs       4-5 Yrs       Over 5 Yrs
Mortgages Payable                 $  67,624     $   3,397     $   7,493     $  30,554     $     26,180
Notes Payable                        32,945         2,445        30,500             -                -
Land Lease Obligations               13,928           859         1,797         1,813            9,459
Other Long-Term Liabilities               -             -             -             -                -
Estimated Interest Payments on
Mortgages and Notes Payable          21,843         3,854         6,878         5,287            5,824

Total                             $ 136,340     $  10,555        46,668     $  37,654     $     41,463

We have four development projects under construction that will add an additional 57,570 square feet to our portfolio. The projects are expected to be completed during the first three quarters of 2009. Additional funding required to complete the projects is estimated to be $4,555,000, which is not reflected in the table above, and is expected to be provided by the Credit Facility.

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, medium term debt and/or equity.

Off-Balance Sheet Arrangements

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