UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to ______

 

Commission File Number 001-15663

 

 

 

AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Nevada 75-2847135

(State or Other Jurisdiction of
Incorporation or Organization)

(I.R.S. Employer

Identification No.)

 

1603 Lyndon B. Johnson Freeway, Suite 800, Dallas, Texas 75234

(Address of principal executive offices)

(Zip Code)

 

(469) 522-4200 

(Registrant’s telephone number, including area code)

 

 

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.  ☒ Yes  ☐ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)  ☒ Yes  ☐ No.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,”  and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer ☐ Accelerated filer
Non-accelerated filer   ☐  (Do not check if a smaller reporting company) Smaller reporting company
Emerging growth company  ☐    

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes  ☒  No.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, $.01 par value 15,997,076
(Class) (Outstanding at August 14, 2018)

 

 

 

 

 

 

AMERICAN REALTY INVESTORS, INC.

FORM 10-Q

TABLE OF CONTENTS

 

    PAGE
PART I. FINANCIAL INFORMATION  
   
Item 1. Financial Statements  
     
  Consolidated Balance Sheets at June 30, 2018 (unaudited) and December 31, 2017 3
     
  Consolidated Statements of Operations for the three and six months ended June 30, 2018 and 2017 (unaudited) 4
     
  Consolidated Statement of Shareholders’ Equity for the six months ended June 30, 2018 (unaudited) 5
     
  Consolidated Statements of Comprehensive Income for the six months ended June 30, 2018 and 2017 (unaudited) 6
     
  Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and 2017 (unaudited) 7
     
  Notes to Consolidated Financial Statements 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
     
Item 3. Quantitative and Qualitative Disclosures About Market Risks 29
     
Item 4. Controls and Procedures 29
     
PART II. OTHER INFORMATION  
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
     
Item 6. Exhibits 30
     
SIGNATURES 31

 

2  

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

AMERICAN REALTY INVESTORS, INC. 

CONSOLIDATED BALANCE SHEETS 

 

 

    June 30,
2018
    December 31,
2017
 
    (unaudited)     (audited)  
Assets   (dollars in thousands, except share and par value amounts)  
Real estate, at cost   $ 1,147,612     $ 1,117,429  
Real estate subject to sales contracts at cost     46,262       48,234  
Less accumulated depreciation     (183,630 )     (177,546 )
Total real estate     1,010,244       988,117  
               
Notes and interest receivable (including $104,665 in 2018 and $99,410 in 2017 from related parties)     142,277       127,865  
Less allowance for estimated losses (including $14,269 in 2018 and 2017 from related parties)     (15,770 )     (15,770 )
Total notes and interest receivable     126,507       112,095  
                 
Cash and cash equivalents     28,116       42,920  
Restricted cash     64,652       45,618  
Investments in unconsolidated joint ventures and investees     6,993       6,396  
Receivable from related party     55,987       38,311  
Other assets     56,605       63,263  
Total assets   $ 1,349,104     $ 1,296,720  
                 
Liabilities and Shareholders’ Equity                
Liabilities:                
Notes and interest payable   $ 921,461     $ 898,750  
Notes related to real estate held for sale     376       376  
Notes related to real estate subject to sales contracts           1,957  
Bond and interest payable     143,897       113,049  
Deferred revenue (including $57,289 in 2018 and $56,887 in 2017 to related parties)     78,548       77,332  
Accounts payable and other liabilities (including $9,764 in 2018 and $11,893 in 2017 to related parties)     31,655       39,373  
Total liabilities     1,175,937       1,130,837  
                 
Shareholders’ equity:                
Preferred stock, Series A: $2.00 par value, authorized 15,000,000 shares, issued and outstanding 1,800,614 and 2,000,614 shares in 2018 and 2017 (liquidation preference $10 per share), including 900,000 shares in 2018 and 2017 held by ARL.     1,805       2,205  
Common stock, $0.01 par value, 100,000,000 shares authorized; 16,412,861 shares issued and 15,997,076 outstanding as of  2018 and 15,930,145 shares issued and 15,514,360 outstanding as of  2017, including 140,000 shares held by TCI (consolidated) in 2018 and 2017.     164       159  
Treasury stock at cost; 415,785 shares in 2018 and 2017, and 140,000 shares held by TCI (consolidated) as of 2018 and 2017     (6,395 )     (6,395 )
Paid-in capital     111,907       110,138  
Retained earnings     11,161       5,967  
Total American Realty Investors, Inc. shareholders’ equity     118,642       112,074  
Non-controlling interest     54,525       53,809  
Total shareholders’ equity     173,167       165,883  
Total liabilities and shareholders’ equity   $ 1,349,104     $ 1,296,720  

 

The accompanying notes are an integral part of these consolidated financial statements. 

 

3  

 

 

AMERICAN REALTY INVESTORS, INC. 

CONSOLIDATED STATEMENTS OF OPERATIONS 

(unaudited)

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2018     2017     2018     2017  
  (dollars in thousands, except per share amounts)
Revenues:                      
Rental and other property revenues (including $208 and $199 for the three months and $415 and $389 for the six months ended 2018 and 2017, respectively, from related parties)   $ 31,607     $ 31,587     $ 62,690     $ 63,409  
                                 
Expenses:                                
Property operating expenses (including $231 and $239 for the three months and $458 and 476 for the six months ended 2018 and 2017, respectively, from related parties)     15,550       15,429       29,974       31,693  
Depreciation and amortization     6,504       6,409       12,895       12,739  
General and administrative (including $297 and $552 for the three months and $2,437 and $1,295 for the six months ended 2018 and 2017, respectively, from related parties)     2,954       1,995       5,295       4,026  
Net income fee to related party     53       77       106       137  
Advisory fee to related party     2,929       2,849       5,885       5,508  
       Total operating expenses     27,990       26,759       54,155       54,103  
Net operating income     3,617       4,828       8,535       9,306  
                                 
Other income (expenses):                                
Interest income (including $4,832 and $4,972 for the three months and $9,311 and $9,092 for the six months ended 2018 and 2017, respectively, from related parties)     4,882       5,059       9,991       9,852  
Other income     7,537       (116 )     9,438       1,327  
Mortgage and loan interest (including $1,909 and $1,683 for the three months and $3,708 and $3,195 for the six months ended 2018 and 2017, respectively, from related parties)     (15,907 )     (17,347 )     (31,631 )     (34,143 )
Foreign currency transaction gain (loss)     5,889       (3,425 )     7,645       (3,747 )
Earnings from unconsolidated subsidiaries and investees     277       153       597       208  
        Total other income (expenses)     2,678       (15,676 )     (3,960 )     (26,503 )
                                 
Income (loss) before gain on land sales, non-controlling interest, and taxes     6,295       (10,848 )     4,575       (17,197 )
Gain (loss) on land sales           (476 )     1,335       (31 )
Net income (loss) from continuing operations before taxes     6,295       (11,324 )     5,910       (17,228 )
Net income (loss) from continuing operations     6,295       (11,324 )     5,910       (17,228 )
Net income (loss)     6,295       (11,324 )     5,910       (17,228 )
Net (income) loss attributable to non-controlling interest     (441 )     435       (716 )     628  
Net income (loss) attributable to American Realty Investors, Inc.     5,854       (10,889 )     5,194       (16,600 )
Preferred dividend requirement     (225 )     (275 )     (450 )     (550 )
Net income (loss) applicable to common shares   $ 5,629     $ (11,164 )   $ 4,744     $ (17,150 )
                                 
Earnings per share - basic:                                
Net loss from continuing operations   $ 0.35     $ (0.72 )   $ 0.30     $ (1.11 )
                                 
Earnings per share - diluted:                                
Net income (loss) from continuing operations   $ 0.35     $ (0.72 )   $ 0.30     $ (1.11 )
                                 
Weighted average common shares used in computing earnings per share     15,997,076       15,514,360       15,967,740       15,514,360  
Weighted average common shares used in computing diluted earnings per share     15,997,076       15,514,360       15,967,740       15,514,360  
                                 
Amounts attributable to American Realty Investors, Inc.:                                
Net income (loss) from continuing operations   $ 5,854     $ (10,889 )   $ 5,194     $ (16,600 )
Net income (loss) applicable to American Realty Investors, Inc.   $ 5,854     $ (10,889 )   $ 5,194     $ (16,600 )

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4  

 

 

AMERICAN REALTY INVESTORS, INC. 

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY 

For the Six Months Ended June 30, 2018

(unaudited, dollars in thousands, except share amounts)

 

    Total     Comprehensive     Preferred     Common Stock     Treasury     Paid-in     Retained     Non-controlling  
    Equity     Income (Loss)     Stock     Shares     Amount     Stock     Capital     Earnings     Interest  
Balance, December 31, 2017   $ 165,883     $ (67,613 )   $ 2,205       15,930,145     $ 159     $ (6,395 )   $ 110,138     $ 5,967     $ 53,809  
Net income     5,910       5,194                                     5,194       716  
Conversion of Series A preferred stock into common stock     1,824             (400 )     482,716       5             2,219              
Series A preferred stock dividend ($1.00 per share)     (450 )                                   (450 )            
Balance, June 30, 2018   $ 173,167     $ (62,419 )   $ 1,805       16,412,861     $ 164     $ (6,395 )   $ 111,907     $ 11,161     $ 54,525  

 

The accompanying notes are an integral part of these consolidated financial statements. 

 

5  

 

 

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 

(unaudited)

 

    Six Months Ended June 30,  
    2018     2017  
    (dollars in thousands)  
Net income (loss)   $ 5,910     $ (17,228 )
Total comprehensive income (loss)     5,910       (17,228 )
Comprehensive (income) loss attributable to non-controlling interest     (716 )     628  
Comprehensive income (loss) attributable to American Realty Investors, Inc.   $ 5,194     $ (16,600 )

 

The accompanying notes are an integral part of these consolidated financial statements. 

 

6  

 

 

AMERICAN REALTY INVESTORS, INC. 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

    Six Months Ended  
    June 30,  
    2018     2017  
    (dollars in thousands)  
Cash Flow From Operating Activities:                
Net income (loss)   $ 5,910     $ (17,228 )
Adjustments to reconcile net income (loss) applicable to common shares to net cash provided by (used in) operating activities:                
                   (Gain) loss on sale of land     (1,335 )     31  
                   Depreciation and amortization     12,895       12,739  
                   Amortization of deferred borrowing costs     1,394       2,131  
                   Amortization of bond issuance costs     728       462  
                   Earnings from unconsolidated subsidiaries and investees     (597 )     (207 )
      (Increase) decrease in assets:                
                   Accrued interest receivable     (1,154 )     4,053  
                   Other assets     4,791     (477 )
                   Prepaid expense     1,597       (4,195 )
                   Rent receivables     269       (1,669 )
                   Related party receivables     (18,070 )     (4,930 )
      Increase (decrease) in liabilities:                
                   Accrued interest payable     (1,040 )     141  
                   Other liabilities     (2,442 )     6,781  
                              Net cash provided by (used in) operating activities     2,946       (2,368 )
                 
Cash Flow From Investing Activities:                
      Proceeds from notes receivables     6,541       19,753  
      Origination of notes receivables     (14,557 )     (4,116 )
      Acquisition of land held for development           (11,440 )
      Proceeds from sale of income producing properties     2,706        
      Proceeds from sale of land     3,649       1,596  
      Improvement of land held for development           (585 )
      Improvement of income producing properties     (2,725 )     (1,895 )
      Construction and development of new properties     (47,452 )     (26,708 )
                              Net cash used in investing activities     (51,838 )     (23,395 )
                 
Cash Flow From Financing Activities:                
      Proceeds from bonds     39,399       102,364  
      Bond issuance costs     (2,022 )     6,253  
      Proceeds from notes payable     44,707       82,865  
      Recurring payment of principal on notes payable     (11,762 )     (12,083 )
      Payments on maturing notes payable     (16,750 )     (113,838 )
      Deferred financing costs           676  
      Preferred stock dividends - Series A     (450 )     (550 )
                              Net cash provided by financing activities     53,122       65,687  
                 
Net increase in cash and cash equivalents     4,230       39,924  
Cash and cash equivalents, beginning of period     88,538       55,921  
Cash and cash equivalents, end of period   $ 92,768     $ 95,845  
                 
Supplemental disclosures of cash flow information:                
Cash paid for interest   $ 31,029     $ 28,065  
                 
Schedule of noncash investing and financing activities:                
     Notes receivable received from sale of income-producing properties   $ 1,735     $  
     Seller financing note - acquisition of income-producing properties   $ 1,895     $  
     Notes payable issued on acquisition of income-producing properties   $ 8,605     $  

 

The accompanying notes are an integral part of these consolidated financial statements. 

 

7  

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

 

As used herein, the terms “ARL”, “the Company”, “we”, “our” or “us” refer to American Realty Investors, Inc., a Nevada corporation, which was formed in 1999. The Company is headquartered in Dallas, Texas and its common stock trades on the New York Stock Exchange (“NYSE”) under the symbol (“ARL”). Over 80% of ARL’s stock is owned by related party entities.

 

ARL and a subsidiary own approximately 78% of the outstanding shares of common stock of Transcontinental Realty Investors, Inc. (“TCI”), a Nevada corporation, whose common stock is traded on the NYSE under the symbol (“TCI”). TCI, a subsidiary of ARL, owns approximately 81.25% of the common stock of Income Opportunity Realty Investors, Inc. (“IOR”). Effective July 17, 2009, IOR’s financial results were consolidated with those of ARL and TCI and their subsidiaries. IOR’s common stock is traded on the NYSE American under the symbol (“IOR”).

 

ARL’s Board of Directors is responsible for directing the overall affairs of ARL and for setting the strategic policies that guide the Company. As of April 30, 2011, the Board of Directors delegated the day-to-day management of the Company to Pillar Income Asset Management, Inc. (“Pillar”), a Nevada corporation, under a written Advisory Agreement that is reviewed annually by ARL’s Board of Directors. The directors of ARL are also directors of TCI and IOR. The Chairman of the Board of Directors of ARL also serves as the Chairman of the Board of Directors of TCI and IOR. The officers of ARL also serve as officers of TCI, IOR and Pillar.

 

ARL invests in real estate through direct ownership, leases and partnerships and also invests in mortgage loans on real estate. Pillar Income Asset Management, Inc. (“Pillar”) is the Company’s external Advisor and Cash Manager. Although the Board of Directors is directly responsible for managing the affairs of ARL, and for setting the policies which guide it, the day-to-day operations of ARL are performed by Pillar, as the contractual Advisor, under the supervision of the Board. Pillar’s duties include, but are not limited to: locating, evaluating and recommending real estate and real estate-related investment opportunities and arranging debt and equity financing for the Company with third party lenders and investors. Additionally, Pillar serves as a consultant to the Board with regard to their decisions in connection with ARL’s business plan and investment policy. Pillar also serves as an Advisor and Cash Manager to TCI and IOR.

 

Regis Realty Prime, LLC (“Regis”) manages our commercial properties and provides brokerage services. ARL engages third-party companies to lease and manage its apartment properties.

 

Properties

 

We own or had interests in a total property portfolio of fifty three income-producing properties as of June 30, 2018. The properties consisted of:

 

Seven commercial properties consisting of five office buildings and two retail centers comprising in aggregate approximately 1.7 million rentable square feet;
     
Forty-six apartment communities totaling 8,195 units, excluding apartments being developed; and
     
3,492 acres of developed and undeveloped land.

 

We join with various third-party development companies to construct residential apartment communities. We are in the predevelopment process on several residential apartment communities that have not yet begun construction. At June 30, 2018, we had ten apartment projects in development. The third-party developer typically holds a general partner interest in a limited partnership formed for the purpose of building a single property, we generally are a majority of the limited partner interests in the limited partnership. We may contribute land to the partnership as part of our equity contribution or we may contribute the necessary funds to the partnership to acquire the land. We are required to fund all necessary equity contributions while the third-party developer is responsible for obtaining construction financing, hiring a general contractor and for the overall management, successful completion and delivery of the project. We generally bear all the economic risks and rewards of ownership in these partnerships and therefore include these partnerships in our Consolidated Financial Statements. The third-party developer is paid a developer fee typically equal to a percentage of the construction costs. When the project reaches stabilized occupancy, we acquire the third-party developer’s partnership interests in exchange for any remaining unpaid developer fees. 

 

8

 

 

Basis of Presentation

 

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted in accordance with such rules and regulations, although management believes the disclosures are adequate to prevent the information presented from being misleading. In the opinion of management, all adjustments (consisting of normal recurring matters) considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2018, are not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year.

 

The year-end Consolidated Balance Sheet at December 31, 2017 was derived from the audited Consolidated Financial Statements at that date, but does not include all of the information and disclosures required by U.S. GAAP for complete financial statements. For further information, refer to the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Certain 2017 Consolidated Financial Statement amounts have been reclassified to conform to the 2018 presentation.

 

Principles of Consolidation

 

The accompanying Consolidated Financial Statements include the accounts of the Company, its subsidiaries, generally all of which are wholly-owned, and all entities in which we have a controlling interest. Arrangements that are not controlled through voting or similar rights are accounted for as a Variable Interest Entity (“VIE”), in accordance with the provisions and guidance of ASC Topic 810, “Consolidation”, whereby we have determined that we are a primary beneficiary of the VIE and meet certain criteria of a sole general partner or managing member as identified in accordance with Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership when the Investor is the Sole General Partner and the Limited Partners have Certain Rights (“EITF 04-5”). VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders as a group lack adequate decision making ability, the obligation to absorb expected losses or residual returns of the entity, or have voting rights that are not proportional to their economic interests. The primary beneficiary is generally the entity that provides financial support and bears a majority of the financial risks, authorizes certain capital transactions, or makes operating decisions that materially affect the entity’s financial results. All significant intercompany balances and transactions have been eliminated in consolidation.

 

In determining whether we are the primary beneficiary of a VIE, we consider qualitative and quantitative factors, including, but not limited to: the amount and characteristics of our investment; the obligation or likelihood for us or other investors to provide financial support; our and the other investors’ ability to control or significantly influence key decisions for the VIE; and the similarity with and significance to the business activities of us and the other investors. Significant judgments related to these determinations include estimates about the current future fair values and performance of real estate held by these VIEs and general market conditions.

 

For entities in which we have less than a controlling financial interest or entities where we are not deemed to be the primary beneficiary, the entities are accounted for using the equity method of accounting. Accordingly, our share of the net earnings or losses of these entities is included in consolidated net income. Our investment in Gruppa Florentina, LLC is accounted for under the equity method.

 

Real Estate, Depreciation and Impairment

 

Real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired. Major replacements and betterments are capitalized and depreciated over their estimated useful lives. Depreciation is computed on a straight-line basis over the useful lives of the properties (buildings and improvements: 10-40 years; furniture, fixtures and equipment: 5-10 years). The Company continually evaluates the recoverability of the carrying value of its real estate assets using the methodology prescribed in ASC Topic 360 (“ASC 360”), “Property, Plant and Equipment”. Factors considered by management in evaluating impairment of its existing real estate assets held for investment include significant declines in property operating profits, annually recurring property operating losses and other significant adverse changes in general market conditions that are considered permanent in nature. Under ASC 360, a real estate asset held for investment is not considered impaired if the undiscounted, estimated future cash flows of an asset (both the annual estimated cash flow from future operations and the estimated cash flow from the theoretical sale of the asset) over its estimated holding period are in excess of the asset’s net book value at the balance sheet date. If any real estate asset held for investment is considered impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value.

 

Real Estate Held For Sale

 

We periodically classify real estate assets as “held for sale.” An asset is classified as held for sale after the approval of our Board of Directors, after an active program to sell the asset has commenced and if the sale is probable. One of the deciding factors in determining whether a sale is probable is whether the firm purchase commitment is obtained and whether the sale is probable within the year. Upon the classification of a real estate asset as held for sale, the carrying value of the asset is reduced to the lower of its net book value or its estimated fair value, less costs to sell the asset. Subsequent to the classification of assets as held for sale, no further depreciation expense is recorded. Real estate assets held for sale are stated separately on the accompanying Consolidated Balance Sheets. Upon a decision that the sale is no longer probable, the asset is classified as an operating asset and depreciation expense is reinstated.

 

9

 

 

Prior to January 1, 2015, the operating results of real estate assets held for sale and sold were reported as discontinued operations in the accompanying Consolidated Statements of Operations. Income from discontinued operations includes the revenues and expenses, including depreciation and interest expense, associated with the assets. Effective January 1, 2015, Accounting Standards Update 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”) substantially changed the criteria for determining whether a disposition qualifies for discontinued operations presentation. Since the Company adopted ASU 2014-08, effective January 1, 2015, we have had no dispositions that met the discontinued operations criteria.

 

Cost Capitalization

 

Costs related to planning, developing, leasing and constructing a property are capitalized and classified as Real Estate in the Consolidated Balance Sheets. We capitalize interest to qualifying assets under development based on average accumulated expenditures outstanding during the period. In capitalizing interest to qualifying assets, we first use the interest incurred on specific project debt, if any, and next use the weighted average interest rate of non-project specific debt. We capitalize interest, real estate taxes and certain operating expenses until building construction is substantially complete and the building is ready for its intended use, but no later than one year from the cessation of major construction activity.

 

We capitalize leasing costs which include commissions paid to outside brokers, legal costs incurred to negotiate and document a lease agreement and any internal costs that may be applicable. We allocate these costs to individual tenant leases and amortize them over the related lease term.

 

Fair Value Measurement

 

We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures”, to the valuation of real estate assets. These provisions define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date, establish a hierarchy that prioritizes the information used in developing fair value estimates and require disclosure of fair value measurements by level within the fair value hierarchy. The hierarchy gives the highest priority to quoted prices in active markets (Level 1 measurements) and the lowest priority to unobservable data (Level 3 measurements), such as the reporting entity’s own data.

 

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and includes three levels defined as follows:

 

  Level 1 – Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets.
     
  Level 2 – Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
     
  Level 3 – Unobservable inputs that are significant to the fair value measurement.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Deferred Costs

 

Costs relating to the financing of properties are deferred and amortized over the life of the related financing agreement. Amortization is reflected as interest expense in the Consolidated Statements of Operations, with remaining terms ranging from 6 months to 40 years. Unamortized financing costs are written off when the financing agreement is extinguished before the maturity date.

 

Related Parties

 

We apply ASC Topic 805, “Business Combinations”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.

 

10

 

 

Newly Issued Accounting Standards

 

In May 2014, Accounting Standards Update (“ASU”) No. 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers,” was issued. This new guidance established a new single comprehensive revenue recognition model and provides for enhanced disclosures. Under the new policy, the nature, timing and amount of revenue recognized for certain transactions could differ from those recognized under existing accounting guidance. This new standard does not affect revenue recognized under lease contracts. ASU 2014-09 is effective for reporting periods beginning after December 15, 2017. The Company does not believe the adoption of this guidance had a material impact on its financial statements.

 

In February 2016, FASB issued ASU 2016-02 (“ASU 2016-02”), Leases. This guidance establishes a new model for accounting for leases and provides for enhanced disclosures. ASU 2016-02 is effective for reporting periods beginning after December 15, 2018. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its financial position and results of operations, if any.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years; however, early adoption is permitted. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively if retrospective application would be impracticable. The Company adopted this standard effective on January 1, 2018. ASU 2016-15 will impact our presentation of operating, investing and financing activities related to certain cash receipts and payments on our consolidated statements of cash flows.  

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which clarifies guidance on the classification and presentation of changes in restricted cash. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted, and will be applied retrospectively to all periods presented. Upon adoption, restricted cash balances will be included along with cash and cash equivalents as of the end of the period and beginning period, respectively, in the Company’s consolidated statement of cash flows for all periods presented. Upon adoption, separate line items showing changes in restricted cash balances will be eliminated from the Company’s consolidated statement of cash flows. The Company adopted this guidance effective on January 1, 2018. ASU 2016-18 will impact our presentation of operating, investing and financing activities related to restricted cash on our consolidated statements of cash flows.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company expects that acquisitions of real estate or in-substance real estate will not meet the revised definition of a business and thus will be treated as asset acquisitions. Acquisition costs for those acquisitions that are not businesses will be capitalized rather than expensed. The Company adopted this guidance effective January 1, 2018. The Company does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

 

In February 2017, the FASB issued ASU 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Topic 610-20), which requires that all entities account for the derecognition of a business in accordance with ASC 810, including instances in which the business is considered in-substance real estate. The ASU requires the Company to measure at fair value any retained interest in a partial sale of real estate. The ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2017. The Company adopted ASU 2017-05 effective January 1, 2018. The Company does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

 

11

 

 

NOTE 2. REAL ESTATE ACTIVITY

 

Below is a summary of the real estate owned as of June 30, 2018 (dollars in thousands):

 

Apartments   $ 730,045  
Apartments under construction     152,943  
Commercial properties     202,367  
Land held for development     62,257  
Real estate subject to sales contract     46,262  
Total real estate   $ 1,193,874  
Less accumulated depreciation     (183,630 )
Total real estate, net of depreciation   $ 1,010,244  

 

The highlights of our significant real estate transactions for the six months ended June 30, 2018 are listed below:

 

Purchases

 

During the six months ended June 30, 2018, the Company purchased through one of its subsidiaries, an 80 unit residential apartment community located in Baton Rouge, LA for a total purchase price of $12 million, paid through a seller’s financing note of $1.9 million, issuance of a note payable of $8.6 million, and by exercising an option to purchase of $1.5 million paid in the previous year.

 

Sales

 

During the six months ended June 30, 2018, ARL sold 112.2 acres of land to an independent third party for a total sales price of $7.2 million. We recorded an aggregate gain of $1.3 million from the land sale. Also, for the quarter just ended, the Company sold a golf course comprising approximately 96.09 acres for an aggregate sales price of $2.3 million, out of which, $0.6 million was received in cash and $1.7 million in note receivables. In addition, during the first quarter we sold six income-producing properties to a related party for an aggregate purchase price of $8.5 million, out of which, $2.1 million was received in cash and $6.4 million in note receivables. No gain or loss was recorded from the sale of income-producing properties.

 

As of June 30, 2018, the Company has approximately 91 acres of land, at various locations that were sold to related parties in multiple transactions. These transactions are treated as “subject to sales contract” on the Consolidated Balance Sheets. Due to the related party nature of the transactions, TCI has deferred the recording of the sales in accordance with ASC 360-20.

 

We continue to invest in the development of apartment projects. During the six months ended June 30, 2018, we have invested $47.5 million related to the construction or predevelopment of various apartment complexes and capitalized $3.5 million of interest costs.

 

NOTE 3. SUPPLEMENTAL CASH FLOW INFORMATION

 

For the six months ended June 30, 2018 and 2017, the Company paid interest expense of $31.0 million and $28.1 million, respectively.

 

Cash and cash equivalents, and restricted cash for the six months ended June 30, 2018 and 2017 was $92.8 million and $95.8 million, respectively. The following is a reconciliation of the Company’s cash and cash equivalents, and restricted cash to the total presented in the consolidated statement of cash flows:

 

    June 30,  
    2018     2017  
Cash and cash equivalents   $ 28,116     $ 58,260  
Restricted cash (cash held in escrow)     49,760       33,448  
Restricted cash (certificate of deposits)     9,162       -  
Restricted cash (held with Trustee)     5,730       4,137  
    $ 92,768     $ 95,845  

 

Amounts included in restricted cash represent funds required to be set aside to meet contractual obligations with certain financial institutions for the payment of reserve replacement and tax and insurance escrow. In addition, restricted cash includes funds with the Bond’s Trustee for payment of interest.

 

12

 

 

NOTE 4. NOTES AND INTEREST RECEIVABLE

 

A portion of our assets are invested in mortgage notes receivable, principally secured by real estate. We may originate mortgage loans in conjunction with providing purchase money financing of property sales. Notes receivable are generally collateralized by real estate or interests in real estate and guarantees, unless noted otherwise, are so secured. Management intends to service and hold for investment the mortgage notes in our portfolio. A majority of the notes receivable provide for principal to be paid at maturity.

 

Below is a summary of our notes receivable as of June 30, 2018 (dollars in thousands):

 

Borrower   Maturity Date   Interest Rate   Amount     Security
Performing loans:                      
H198, LLC (Las Vegas Land)   01/20     12.00%   $ 5,907     Secured
Leman Development, Ltd (2)   N/A     0.00%     1,500     Unsecured
Oulan-Chikh Family Trust   03/21     8.00%     174     Secured
H198, LLC (McKinney Ranch Land)   09/18     6.00%     4,554     Secured
2818 Ventures LLC (Forest Pines)   11/18     5.00%     2,223     Secured
ABC Land & Development (Mandahl Bay)   05/38     6.00%     1,735     Secured
Unified Housing Foundation, Inc. (Echo Station) (1)   12/32     12.00%     1,481     Secured
Unified Housing Foundation, Inc. (Inwood on the Park) (1)   12/32     12.00%     3,639     Secured
Unified Housing Foundation, Inc. (Kensington Park) (1)   12/32     12.00%     3,933     Secured
Unified Housing Foundation, Inc. (Lakeshore Villas) (1)   12/32     12.00%     2,000     Secured
Unified Housing Foundation, Inc. (Lakeshore Villas) (1)   12/32     12.00%     9,101     Secured
Unified Housing Foundation, Inc. (Limestone Ranch) (1)   12/32     12.00%     1,953     Secured
Unified Housing Foundation, Inc. (Limestone Ranch) (1)   12/32     12.00%     6,000     Secured
Unified Housing Foundation, Inc. (Reserve at White Rock Phase I) (1)   12/32     12.00%     2,485     Secured
Unified Housing Foundation, Inc. (Reserve at White Rock Phase II) (1)   12/32     12.00%     2,555     Secured
Unified Housing Foundation, Inc. (Timbers of Terrell) (1)   12/32     12.00%     1,323     Secured
Unified Housing Foundation, Inc. (Tivoli) (1)   12/32     12.00%     7,965     Secured
Unified Housing Foundation, Inc. (Trails at White Rock) (1)   12/32     12.00%     3,815     Secured
Unified Housing Foundation, Inc. (1)   12/18     12.00%     3,994     Unsecured
Unified Housing Foundation, Inc. (1)   12/18     12.00%     6,407     Unsecured
Unified Housing Foundation, Inc. (1)   06/20     12.00%     5,760     Unsecured
Unified Housing Foundation, Inc. (1)   03/21     12.00%     5,314     Unsecured
One Realco Corporation (1,2)   01/20     3.00%     7,000     Unsecured
Realty Advisors Management, Inc. (1)   12/19     2.28%     20,387     Unsecured
Other related party notes   Various     Various     1,349     Various secured interests
Other related party notes   Various     Various     510     Various unsecured interests
Other non-related party notes   Various     Various     3,466     Various secured interests
Other non-related party notes   Various     Various     14,639     Various unsecured interests
Accrued interest               11,108      
Total Performing             $ 142,277      
Allowance for estimated losses               (15,770 )    
                       
Total             $ 126,507      

 

(1) Related party notes

(2) An allowance was taken for estimated losses at full value of note.

 

We invest in mortgage loans, secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and guarantees.

 

At June 30, 2018, we had mortgage loans and accrued interest receivable from related parties, net of allowances, totaling $104.7 million. We recognized interest income of $4.9 million related to these notes receivables.

 

The Company has various notes receivable from Unified Housing Foundation, Inc. (“UHF”) and Foundation for Better Housing, Inc. (“FBH”). UHF and FBH are determined to be related parties due to our reliance upon the performance of the collateral secured under the notes receivable. Payments are due from surplus cash flow of operations of the properties. A sale or refinance of any of the properties underlying these notes will be used to repay outstanding interest and principal for the remaining notes for the specific borrower. These notes are cross-collateralized for the specific borrower, but to the extent cash is received from a specific UHF or FBH property, it is applied first against any outstanding interest for the related-property note. The allowance on the UHF notes was a purchase allowance that was netted against the notes when acquired.

 

13

 

 

NOTE 5. INVESTMENT IN UNCONSOLIDATED INVESTEES

 

Investments in unconsolidated investees in which we have a 20% to 50% interest or otherwise exercise significant influence are carried at cost and adjusted for the Company’s proportionate share of their undistributed earnings or losses under the equity method of accounting.

 

Investments in unconsolidated investees consist of the following:

 

    Percentage ownership as of  
    June 30, 2018     June 30, 2017  
Gruppa Florentina, LLC     20.00 %     20.00 %

 

Gruppa Florentina, LLC is the sole shareholder of Milano Restaurants International Corporation, (“Milano”) which operates 33 pizza parlors under the trade name “Me-N-Ed’s Pizza Parlors” and four pizza parlors operating under the trade name “Blast 825 Pizza”, located primarily in Central and Northern California. Milano has a 100% ownership interest in Siena Corp, which operates two grills under the trade names “Me-N-Ed’s Victory Grill” and “Me-N-Ed’s Coney Island Grill”. Milano has a 100% ownership interest in Piazza del Pane, Inc., which operates two restaurants located in Central California. Milano also has 23 franchised locations, including two operating, under the trade name Angelo & Vito’s Pizzerias.

 

The following is a summary of the financial position and results of operations from our investees (dollars in thousands):

 

As of June 30,   2018     2017  
Real estate, net of accumulated depreciation   $ 13,485     $ 13,578  
Notes receivable     10,918       9,969  
Other assets     32,290       30,188  
Notes payable     (10,745 )     (9,514 )
Other liabilities     (7,775 )     (7,821 )
Shareholders’ equity     (38,173 )     (36,400 )

 

For the Six Months Ended June 30,   2018     2017  
Revenue   $ 27,195     $ 27,458  
Depreciation     (728 )     (575 )
Operating expenses     (25,630 )     (25,533 )
Interest expense     (340 )     (353 )
Income from continuing operations     497       497  
Net income   $ 497     $ 997  
                 
Company’s proportionate share of earnings   $ 99     $ 199  

 

14

 

 

NOTE 6. NOTES PAYABLE

 

Below is a summary of our notes and interest payable as of June 30, 2018 (dollars in thousands):

 

    Notes Payable     Accrued Interest     Total Debt  
Apartments   $ 568,449     $ 1,585     $ 570,034  
Apartments under Construction     118,665       31       118,696  
Commercial     125,807       616       126,423  
Land     21,734       197       21,931  
Real estate subject to sales contract     376             376  
Mezzanine financing     93,422       509       93,931  
Other     8,882       (593 )     8,289  
Total   $ 937,335     $ 2,345     $ 939,680  
Unamortized deferred borrowing costs     (17,843 )           (17,843 )
    $ 919,492     $ 2,345     $ 921,837  

 

The segment labeled as “Other” consists of unsecured or stock-secured notes payable.

 

There are various land mortgages, secured by the property, that are in the process of a modification or extension to the original note due to expiration of the loan. We are in constant contact with these lenders, working together in order to modify the terms of these loans and we anticipate a timely resolution that is similar to the existing agreement or subsequent modification.

 

In conjunction with the development of various apartment projects and other developments, we drew down $44.7 million in construction loans during the six months ended June 30, 2018.

 

The properties that we have sold to a related party and have deferred the recognition of the sale are treated as “subject to sales contract” on the Consolidated Balance Sheets. These properties were sold to a related party in order to help facilitate an appropriate debt or organizational restructure and may or may not be transferred back to the seller upon resolution. These properties have mortgages that are secured by the property and many have corporate guarantees. According to the loan documents, the maker is currently in default on these mortgages primarily due to lack of payment and is actively involved in discussions with every lender in order to settle or cure the default situation. We have reviewed each asset and taken impairment to the extent we feel the value of the property was less than our current basis.

 

NOTE 7. BONDS PAYABLE

 

In August 2016 Southern Properties Capital LTD (“Southern”), a British Virgin Islands corporation was incorporated for the purpose of raising funds by issuing Bonds to be traded on the Tel Aviv Stock Exchange (“TASE”).  TCI transferred certain residential and commercial properties located in the United States to Southern, its wholly owned subsidiary. 

 

On February 13, 2017, Southern filed a final prospectus with the TASE for an offering and sale of nonconvertible Series A Bonds to be issued by Southern. The bonds are obligations of Southern.  During the year ended December 31, 2017 on three separate occasions Southern issued nonconvertible Series A Bonds with a total value of approximately NIS400 million New Israeli Shekels (“NIS”) or approximately $115 million dollars.  The Series A Bonds have a stated interest rate of 7.3%.  At March 31, 2018 the effective interest rate is 9.17%. The bonds require semi-annual equal installments on January 31 and July 31 of each year from 2019 to 2023 (inclusive). The interest will be repaid on January 31 and July 31 of each of the years 2018 to 2023 (inclusive), with the first payment commencing on July 31, 2017.

 

On January 25, 2018, interest payment of approximately NIS 14.6 million (or approximately $4.3 million) was paid to the Series A bondholders.

 

On February 15, 2018, Southern issued Series B bonds in the amount of NIS 137.7 million par value (approximately $39.2 million as of February 15, 2018). The Series B bonds are registered on the TASE. The bonds are reported in NIS and bear annual interest rate of 6.8%. Interest shall be repaid January 31 and July 31 of each of the years 2019 to 2023 (inclusive), first payment commencing on July 31, 2018. The principal shall be repaid in ten equal installments on January 31 and July 31 of each of the years from 2021 to 2025 (inclusive). The total bond issuance cost of $1.4 million was incurred. The effective interest rate is 7.99%.

 

On July 26, 2018, interest payment of approximately NIS 18.9 million (or approximately $5.2 million) was paid to the Series A and B bondholders.

 

15

 

 

The outstanding balance of these Bonds at June 30, 2018 is as follows:

 

    June 30,
2018
    December 31, 2017  
Bonds (Series A)   $ 109,552     $ 115,336  
Bonds (Series B)     37,726        
Less: deferred issuance expense, net     (7,210 )     (5,916 )
Accrued Interest     3,829       3,629  
    $ 143,897     $ 113,049  

 

The aggregate maturity of the bonds are as follows:

 

Year        
2018     $  
2019       23,067  
2020       23,067  
2021       23,067  
2022       30,903  
Thereafter       47,174  
      $ 147,278  

 

The funds were used primarily for the acquisition and development of additional real estate operations in the United States. The funds were raised and will be repaid in NIS, however the funds raised have been converted to US dollars. The Company records unrealized gains or losses each quarter based upon the relative exchange values of the US dollar and the NIS; however, no gain or loss will be realized until a conversion from US dollars to NIS actually occurs in the future. The recorded unrealized gain or loss is reflected as a separate line item to highlight the fact that it is a non-cash transaction until such time as actual payment of principal and interest on the bonds is made. For the six months ended June 30, 2018, the Company recorded a gain on foreign currency transaction of approximately $7.6 million.

 

NOTE 8. RELATED PARTY TRANSACTIONS

 

The following table reflects the reconciliation of the beginning and ending balances of accounts receivable from and (accounts payable) to related parties as of June 30, 2018 (dollars in thousands):

 

    Pillar  
Related party receivable, December 31, 2017   $ 38,311  
Cash transfers     26,033  
Advisory fees     (5,884 )
Net income fee     (106 )
Cost reimbursements     (2,346 )
Interest income     1,347  
Notes receivable purchased     (5,315 )
Fees and commissions     (162 )
Expenses (paid) received by Advisor     4,845  
Financing (mortgage payments)     (169 )
Sales/purchases transactions     (567 )
Related party receivable, June 30, 2018   $ 55,987  

 

During the ordinary course of business, we have related party transactions that include, but are not limited to, rental income, interest income, interest expense, general and administrative costs, commissions, management fees, and property expenses. In addition, we have assets and liabilities that include related party amounts. The related party amounts included in assets and liabilities, and the related party revenues and expenses received and paid are shown on the face of the Consolidated Financial Statements.

 

16

 

 

NOTE 9. OPERATING SEGMENTS

 

Our segments are based on our method of internal reporting which classifies our operations by property type. Our property types are grouped into commercial properties, apartments, land and other operating segments. Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative and other expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow.

 

Items of income that are not reflected in the segments are interest, other income, gain on debt extinguishment, gain on condemnation award, equity in partnerships and gains on sale of real estate. Expenses that are not reflected in the segments are provision for losses, advisory, net income and incentive fees, general and administrative, non-controlling interests and net loss from discontinued operations before gains on sale of real estate.

 

The segment labeled as “Other” consists of revenue and operating expenses related to the notes receivable and corporate debt.

 

Presented below is our reportable segments’ operating income for the three months ended June 30, 2018 and 2017, including segment assets and expenditures (dollars in thousands):

 

For the Three Months Ended June 30, 2018   Commercial
Properties
    Apartments     Land     Other     Total  
Rental and other property revenues   $ 7,404     $ 24,201     $     $ 2     $ 31,607  
Property operating expenses     (4,238 )     (11,199 )     (135 )     22       (15,550 )
Depreciation     (2,323 )     (4,195 )           14       (6,504 )
Mortgage and loan interest     (1,893 )     (5,342 )     65       (8,737 )     (15,907 )
Interest income                       4,882       4,882  
Segment operating (loss) income   $ (1,050 )   $ 3,465     $ (70 )   $ (3,817 )   $ (1,472 )
                                         
Balance Sheet Data                                        
Capital expenditures   $ 2,092     $     $     $     $ 2,092  

 

 

                                       
Property Sales                                        
Sales price   $ 2,313     $     $     $     $ 2,313  
Cost of sale     (2,313 )                       (2,313 )
Gain (loss) on sale   $     $     $     $     $  

 

For the Three Months Ended June 30, 2017   Commercial
Properties
    Apartments     Land     Other     Total  
Rental and other property revenues   $ 8,553     $ 23,030     $     $ 4     $ 31,587  
Property operating expenses     (4,900 )     (10,211 )     (168 )     (150 )     (15,429 )
Depreciation     (2,397 )     (4,030 )           18       (6,409 )
Mortgage and loan interest     (2,121 )     (5,028 )     (389 )     (9,809 )     (17,347 )
Interest income                       5,059       5,059  
Loss on land sales                 (476 )           (476 )
Segment operating (loss) income   $ (865 )   $ 3,761     $ (1,033 )   $ (4,878 )   $ (3,015 )
                                         
Balance Sheet Data                                        
Capital expenditures   $ 557     $     $ 186     $     $ 743  
                                         
Property Sales                                        
Sales price   $     $     $ 507     $     $ 507  
Cost of sale                 (983 )           (983 )
Loss on sale   $     $     $ (476 )   $     $ (476 )

 

17

 

 

The table below presents the reconciliation of segment information to the corresponding amounts in the Consolidated Statements of Operations for the three months ended June 30, 2018 and 2017 (dollars in thousands):

 

    Three Months Ended June 30,  
    2018     2017  
Segment operating loss   $ (1,472 )   $ (3,015 )
Other non-segment items of income (expense)                
General and administrative     (2,954 )     (1,995 )
Net income fee to related party     (53 )     (77 )
Advisory fee to related party     (2,929 )     (2,849 )
Other income     13,426       (3,541 )
Earnings from unconsolidated investees     277       153  
Net income (loss) from continuing operations   $ 6,295     $ (11,324 )

 

Presented below is our reportable segments’ operating income for the six months ended June 30, 2018 and 2017, including segment assets and expenditures (dollars in thousands):

 

For the Six Months Ended June 30, 2018   Commercial
Properties
    Apartments     Land     Other     Total  
Rental and other property revenues   $ 14,959     $ 47,726     $ 1     $ 4     $ 62,690  
Property operating expenses     (7,986 )     (21,782 )     (134 )     (72 )     (29,974 )
Depreciation     (4,616 )     (8,344 )           65       (12,895 )
Mortgage and loan interest     (3,742 )     (10,798 )     (130 )     (16,961 )     (31,631 )
Interest income                       9,991       9,991  
Gain on land sales                 1,335             1,335  
Segment operating (loss) income   $ (1,385 )   $ 6,802     $ 1,072     $ (6,973 )   $ (484 )
                                         
Balance Sheet Data                                        
Capital expenditures   $ 2,725     $     $     $     $ 2,725  
Real estate assets   $ 135,288     $ 762,410     $ 111,899     $ 647     $ 1,010,244  
                                         
Property Sales                                        
Sales price   $ 2,313     $ 8,512     $ 7,239     $     $ 18,064  
Cost of sale     (2,313 )     (8,512 )     (5,904 )           (16,729 )
Gain on land sales   $     $     $ 1,335     $     $ 1,335  

 

For the Six Months Ended June 30, 2017   Commercial
Properties
    Apartments     Land     Other     Total  
Rental and other property revenues   $ 17,711     $ 45,691     $     $ 7     $ 63,409  
Property operating expenses     (9,839 )     (20,956 )     (447 )     (451 )     (31,693 )
Depreciation     (4,699 )     (8,076 )           36       (12,739 )
Mortgage and loan interest     (3,727 )     (11,787 )     (1,083 )     (17,546 )     (34,143 )
Interest income                       9,852       9,852  
Loss on land sales                 (31 )           (31 )
Segment operating (loss) income   $ (554 )   $ 4,872     $ (1,561 )   $ (8,102 )   $ (5,345 )
                                         
Balance Sheet Data                                        
Capital expenditures   $ 1,932     $ 585     $     $     $ 2,517  
Real estate assets   $ 148,718     $ 654,119     $ 127,810     $     $ 930,647  
                                         
Property Sales                                        
Sales price   $     $     $ 1,596     $     $ 1,596  
Cost of sale                 (1,627 )           (1,627 )
Loss on land sales   $     $     $ (31 )   $     $ (31 )

 

18

 

 

The table below presents the reconciliation of segment information to the corresponding amounts in the Consolidated Statements of Operations for the six months ended June 30, 2018 and 2017 (dollars in thousands):

 

    For the Six Months Ended  
    June 30,  
    2018     2017  
Segment operating income (loss)   $ (484 )   $ (5,345 )
Other non-segment items of income (expense)                
General and administrative     (5,295 )     (4,026 )
Net income fee to related party     (106 )     (137 )
Advisory fee to related party     (5,885 )     (5,508 )
Other income     17,083       (2,420 )
Earnings from unconsolidated investees     597       208  
Net income (loss) from continuing operations   $ 5,910     $ (17,228 )

 

The following table reconciles segment information to the corresponding amounts in the Consolidated Balance Sheets (dollars in thousands):

 

    As of June 30,  
    2018     2017  
Segment assets   $ 1,010,244     $ 930,647  
Investments in unconsolidated investees     6,993       6,294  
Notes and interest receivable     126,507       106,874  
Other assets     205,360       188,921  
Total assets   $ 1,349,104     $ 1,232,736  

 

NOTE 10. COMMITMENTS, CONTINGENCIES, AND LIQUIDITY

 

Liquidity.     Management believes that ARL will generate excess cash flow from property operations in 2018; such excess, however, will not be sufficient to discharge all of ARL’s obligations as they became due. Management intends to sell land and income-producing real estate, refinance real estate and obtain additional borrowings primarily secured by real estate to meet its liquidity requirements.

 

Partnership Buyouts .    ARL is the limited partner in various partnerships related to the construction of residential properties. As permitted in the respective partnership agreements, ARL intends to purchase the interests of the general and any other limited partners in these partnerships subsequent to the completion of these projects. The amounts paid to buy out the non-affiliated partners are limited to development fees earned by the non-affiliated partners and are outlined in the respective partnership agreements.

 

Litigation.     The ownership of property and provision of services to the public as tenants entails an inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, in the opinion of management, the outcome of such litigation will not have a material adverse impact upon the Company’s financial condition, results of operation or liquidity, unless otherwise noted below.

 

Guarantees. The Company is the primary guarantor on a $39.1 million mezzanine loan between UHF and a lender. In addition, ARI and an officer of the Company are limited recourse guarantors of the loan. As of June 30, 2018 UHF was in compliance with the covenants to the loan agreement.

 

ART and ART Midwest, Inc.

 

While the Company and all entities in which the Company has a direct or indirect equity interest are not parties to or obligated in any way for the outcome, a formerly owned entity (American Realty Trust, Inc.) and its former subsidiary (ART Midwest, Inc.) have been engaged since 1999 in litigation with Mr. David Clapper and entities related to Mr. Clapper (collectively, the “Clapper Parties”). The matter originally involved a transaction in 1998 in which ART Midwest, Inc. was to acquire eight residential apartment complexes from the Clapper Parties. Through the years, a number of rulings, both for and against American Realty Trust, Inc. “ART” and ART Midwest, Inc., were issued. In October 2011, a ruling was issued under which the Clapper Parties received a judgment for approximately $74 million, including $26 million in actual damages and $48 million interest. The ruling was against ART and ART Midwest, Inc., but no other entity. During February 2014, the Court of Appeals affirmed a portion of the judgment in favor of the Clapper Parties, but also ruled that a double counting of a significant portion of the damages had occurred and remanded the case back to the trial court to recalculate the damage award, as well as pre- and post-judgment interest thereon. Subsequently, the trial court recalculated the damage award, reducing it to approximately $59 million, inclusive of actual damages and then current interest. ART was also a significant owner of a partnership interest in the partnership that was awarded the initial damages in this matter.

 

19

 

 

The Clapper Parties subsequently filed a new lawsuit against ARI, its subsidiary EQK Holdings, Inc. “EQK”, and ART. The Clapper Parties seek damages from ARL for payment by ART to ARL of ART’s stock in EQK in exchange for a release of the Antecedent Debt owed by ART to ARI. In February 2018 the court determined that this legal matter should not have been filed in federal court and therefore granted motions to dismiss on jurisdictional grounds. In June 2018, the court overruled its own grant of motions to dismiss and reinstated the case.  We continue to vigorously defend the case and management believes it has defenses to the claims.

 

In 2005, ART filed suit against a major national law firm over the initial transaction. That action was initially abated while the principal case with the Clapper Parties was pending, but the abatement was recently lifted.  The trial court subsequently dismissed the case on procedural grounds, but ART has filed a notice of appeal. The appeal was heard in February 2018 and we are awaiting a ruling by the appeals court. In January 2012, the Company sold all of the issued and outstanding stock of ART to an unrelated party for a promissory note in the amount of $10 million. At December 31, 2012, the Company fully reserved and valued such note at zero.

 

Dynex Capital, Inc.

 

On July 20, 2015, the 68 th  Judicial District Court in Dallas County, Texas issued its Final Judgment in Cause No. DC-03-00675, styled Basic Capital Management, Inc., American Realty Trust, Inc., Transcontinental Realty Investors, Inc., Continental Poydras Corp., Continental Common, Inc. and Continental Baronne, Inc. v. Dynex Commercial, Inc. The case, which was litigated for more than a decade, had its origin with Dynex Commercial making loans to Continental Poydras Corp., Continental Common, Inc. and Continental Baronne, Inc. (subsidiaries of Continental Mortgage & Equity Trust (“CMET”), an entity which merged into TCI in 1999 after the original suit was filed). Under the original loan commitment, $160 million in loans were to be made to the entities. The loans were conditioned on the execution of a commitment between Dynex Commercial and Basic Capital Management, Inc. (“Basic”).

 

An original trial in 2004, which also included Dynex Capital, Inc. as a defendant, resulted in a jury awarding damages in favor of Basic for “lost opportunity,” as well as damages in favor of ART and in favor of TCI and its subsidiaries for “increased costs” and “lost opportunity.” The original Trial Court judge ignored the jury’s findings, however, and entered a “Judgment Notwithstanding the Verdict” (“JNOV”) in favor of the Dynex entities (the judge held the Plaintiffs were not entitled to any damages from the Dynex entities). After numerous appeals by all parties, Dynex Capital, Inc. was ultimately dismissed from the case and the remaining claims against Dynex Commercial were remanded to the Trial Court for a new judgment consistent with the jury’s findings. The Court entered the new Final Judgment against Dynex Commercial, Inc. on July 20, 2015. 

 

The Final Judgment entered against Dynex Commercial, Inc. on July 20, 2015 awarded Basic was $0.256 million in damages, plus pre-judgment interest of $0.192 million for a total amount of $0.448 million. The Judgment awarded ART was $14.2 million in damages, plus pre-judgment interest of $10.6 million for a total amount of $24.8 million. The Judgment awarded TCI was $11.1 million, plus pre-judgment interest of $8.4 million for a total amount of $19.5 million. The Judgment also awarded Basic, ART, and TCI post-judgment interest at the rate of 5% per annum from April 25, 2014 until the date their respective damages were paid. Lastly, the Judgement awarded Basic, ART, and TCI was $1.6 million collectively in attorneys’ fees from Dynex Commercial, Inc. 

 

TCI is working with counsel to identify assets and collect on the Final Judgment against Dynex Commercial, Inc., as well as explore possible additional claims, if any, against Dynex Capital, Inc. 

 

NOTE 11. EARNINGS PER SHARE

 

Earnings Per Share (“EPS”) have been computed pursuant to the provisions of ASC Topic 260, “Earnings Per Share”. The computation of basic EPS is calculated by dividing net income available to common shareholders from continuing operations, adjusted for preferred dividends, by the weighted-average number of common shares outstanding during the period. Shares issued during the period shall be weighted for the portion of the period that they were outstanding.

 

As of June 30, 2018, we have 1,800,614 shares of Series A 10.0% cumulative convertible preferred stock, which are outstanding. These shares may be converted into common stock at 90% of the average daily closing price of the common stock for the prior 20 trading days. These are considered in the computation of diluted earnings per share if the effect of applying the if-converted method is dilutive. Of the outstanding 1,800,614 shares of Series A 10.0% cumulative convertible preferred stock, 900,000 shares are held by ARL. Dividends are not paid on the shares owned by ARL subsidiaries.

 

Prior to January 12, 2018, RAI owned 1,100,000 shares of the outstanding Series A 10.0% convertible preferred stock and had accrued dividends unpaid of $10.5 million. On January 12, 2018, RAI converted 200,000 shares, including $1.8 million in accumulated dividends unpaid for these shares, into the requisite number of shares of common stock. This conversion resulted in the issuance of 482,716 new shares of ARL common stock. As of June 30, 2018 RAI owns 900,000 shares of the outstanding Series A 10.0% convertible preferred stock and has accrued dividends unpaid of $9.2 million.

 

20

 

 

NOTE 12. SUBSEQUENT EVENTS

 

On July 19, 2018, Southern closed a private placement offering of its Series B bonds in the amount of NIS 72.3 million (or approximately $19.8 million). The bonds are reported in NIS, are registered on the TASE, bear an annual interest rate of 6.8% and have an effective interest rate of 9.60%. Interest will be paid on January 31 and July 31 of each of the years 2019 to 2023 (inclusive). The principal will be repaid in ten equal installments on January 31 and July 31 of each of the years from 2021 to 2025 (inclusive). The Company incurred bond issuance costs of approximately $1.9 million.

 

21

 

 

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

 

The following discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto appearing elsewhere in this report.

 

This Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, principally, but not only, under the captions “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. We caution investors that any forward-looking statements in this report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions made by, and information currently available to, management. When used, the words “anticipate”, “believe”, “expect”, “intend”, “may”, “might”, “plan”, “estimate”, “project”, “should”, “will”, “result” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements. These statements are subject to risks, uncertainties, and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution you that, while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update our forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

 

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

 

general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, dependence on tenants’ financial condition, and competition from other developers, owners and operators of real estate);

 

risks associated with the availability and terms of construction and mortgage financing and the use of debt to fund acquisitions and developments;

 

demand for apartments and commercial properties in the Company’s markets and the effect on occupancy and rental rates;

 

the Company’s ability to obtain financing, enter into joint venture arrangements in relation to or self-fund the development or acquisition of properties;

 

risks associated with the timing and amount of property sales and the resulting gains/losses associated with such sales;

 

failure to manage effectively our growth and expansion into new markets or to integrate acquisitions successfully;

 

risks and uncertainties affecting property development and construction (including, without limitation, construction delays, cost overruns, inability to obtain necessary permits and public opposition to such activities);

 

risks associated with downturns in the national and local economies, increases in interest rates, and volatility in the securities markets;

 

costs of compliance with the Americans with Disabilities Act and other similar laws and regulations;

 

potential liability for uninsured losses and environmental contamination;

 

risks associated with our dependence on key personnel whose continued service is not guaranteed; and

 

the other risk factors identified in this Form 10-Q, including those described under the caption “Risk Factors.”

 

The risks included here are not exhaustive. Some of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those expressed or implied by forward-looking statements, include among others, the factors listed and described at Part I, Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K, which investors should review. There have been no changes from the risk factors previously described in the Company’s Form 10-K for the fiscal year ended December 31, 2017.

 

Other sections of this report may also include suggested factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time-to-time and it is not possible for management to predict all such matters; nor can we assess the impact of all such matters on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and to other materials we may furnish to the public from time-to-time through Forms 8-K or otherwise as we file them with the SEC.

 

22

 

 

Overview

 

We are an externally advised and managed real estate investment company that owns a diverse portfolio of income-producing properties and land held for development. Our portfolio of income-producing properties includes residential apartment communities, office buildings and other commercial properties. Our investment strategy includes acquiring existing income-producing properties, as well as developing new properties on land already owned or acquired for a specific development project. We acquire land primarily in urban in-fill locations or high-growth suburban markets. We are an active buyer and seller of real estate. During the six months ended June 30, 2018, we sold 112.2 acres of land for a total sales price of $7.2 million, a golf course comprising approximately 96 acres for $2.3 million and sold six income-producing properties for an aggregate purchase price of $8.5 million, out of which, $2.1 million was received in cash and $6.4 million in note receivables. In addition, during the quarter just ended, we purchased an 80 unit residential apartment community in Baton Rouge, LA for a total purchase price of $12 million, paid through a seller’s financing note of $1.9 million, issuance of a note payable of $8.6 million, and by exercising an option to purchase of $1.5 million paid in the previous year.

 

As of June 30, 2018, we owned 8,195 units in forty-six residential apartment communities, and seven commercial properties comprising approximately 1.7 million rentable square feet. In addition, we own approximately 3,492 acres of land held for development. The Company currently owns income-producing properties and land in ten states.

 

We finance our acquisitions primarily through operating cash flow, proceeds from the sale of land and income-producing properties and debt financing primarily in the form of property-specific first-lien mortgage loans from commercial banks and institutional lenders. We finance our development projects principally with variable interest rate construction loans that are converted to long-term, fixed rate amortizing mortgages when the development project is completed and occupancy has been stabilized. We will, from time to time, also enter into partnerships with various investors to acquire income-producing properties or land and to sell interests in certain of our wholly owned properties. When we sell assets, we may carry a portion of the sales price generally in the form of a short-term, interest bearing seller-financed note receivable. We generate operating revenues primarily by leasing apartment units to residents and leasing office, retail and industrial space to commercial tenants. We have no employees.

 

We have historically engaged in and may continue to engage in certain business transactions with related parties, including, but not limited to, asset acquisition and dispositions. Transactions involving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in our best interest.

 

Pillar Income Asset Management, Inc. (“Pillar”) is the Company’s external Advisor and Cash Manager. Although the Board of Directors is directly responsible for managing the affairs of ARL, and for setting the policies which guide it, the day-to-day operations of ARL are performed by Pillar, as the contractual Advisor, under the supervision of the Board. Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities and arranging debt and equity financing for the Company with third party lenders and investors. Additionally, Pillar serves as a consultant to the Board with regard to their decisions in connection with ARL’s business plan and investment policy. Pillar also serves as an Advisor and Cash Manager to TCI and IOR.

 

Regis Realty Prime, LLC (“Regis”) manages our commercial properties and provides brokerage services. ARL engages third-party companies to lease and manage its apartment properties.

 

Critical Accounting Policies

 

We present our Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The FASB Accounting Standards Codification (“ASC”) is the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP.

 

The accompanying Consolidated Financial Statements include our accounts, our subsidiaries, generally all of which are wholly-owned, and all entities in which we have a controlling interest. Arrangements that are not controlled through voting or similar rights are accounted for as a Variable Interest Entity (“VIE”), in accordance with the provisions and guidance of ASC Topic 810 “Consolidation”, whereby we have determined that we are a primary beneficiary of the VIE and meet certain criteria of a sole general partner or managing member as identified in accordance with Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership when the Investor is the Sole General Partner and the Limited Partners have Certain Rights (“EITF 04-5”). VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders as a group lack adequate decision making ability, the obligation to absorb expected losses or residual returns of the entity, or have voting rights that are not proportional to their economic interests. The primary beneficiary generally is the entity that provides financial support and bears a majority of the financial risks, authorizes certain capital transactions, or makes operating decisions that materially affect the entity’s financial results. All significant intercompany balances and transactions have been eliminated in consolidation.

 

23

 

 

In determining whether we are the primary beneficiary of a VIE, we consider qualitative and quantitative factors, including, but not limited to: the amount and characteristics of our investment; the obligation or likelihood for us or other investors to provide financial support; our and the other investors’ ability to control or significantly influence key decisions for the VIE; and the similarity with and significance to the business activities of us and the other investors. Significant judgments related to these determinations include estimates about the current future fair values and performance of real estate held by these VIEs and general market conditions.

 

For entities in which we have less than a controlling financial interest or entities where we are not deemed to be the primary beneficiary, the entities are accounted for using the equity method of accounting. Accordingly, our share of the net earnings or losses of these entities are included in consolidated net income. Our investment in Gruppa Florentina, LLC is accounted for under the equity method.

 

Real Estate

 

Upon acquisitions of real estate, we assess the fair value of acquired tangible and intangible assets, including land, buildings, tenant improvements, “above-market” and “below-market” leases, origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities in accordance with ASC Topic 805 “Business Combinations”, and allocate the purchase price to the acquired assets and assumed liabilities, including land at appraised value and buildings at replacement cost.

 

We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, as well as available market information. Estimates of future cash flows are based on a number of factors including, the historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant. We also consider an allocation of purchase price of other acquired intangibles, including acquired in-place leases that may have a customer relationship intangible value, including (but not limited to) the nature and extent of the existing relationship with the tenants, the tenants’ credit quality and expectations of lease renewals. Based on our acquisitions to date, our allocation to customer relationship intangible assets has been immaterial.

 

A variety of costs are incurred in the acquisition, development and leasing of properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. Our capitalization policy on development properties is guided by ASC Topic 835-20 “Interest – Capitalization of Interest” and ASC Topic 970 “Real Estate - General”. The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We cease capitalization when a building is considered substantially complete and ready for its intended use, but no later than one year from the cessation of major construction activity.

 

Depreciation and Impairment

 

Real estate is stated at depreciated cost. The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition costs. Costs directly related to the development of properties are capitalized. Capitalized development costs include interest, property taxes, insurance, and other project costs incurred during the period of development.

 

Management reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates impairment in value. An impairment loss is recognized if the carrying amount of its assets is not recoverable and exceeds its fair value. If such impairment is present, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods.

 

Investments in Unconsolidated Real Estate Ventures

 

Except for ownership interests in variable interest entities, we account for our investments in unconsolidated real estate ventures under the equity method of accounting because we exercise significant influence over, but do not control, these entities. These investments are recorded initially at cost, as investments in unconsolidated real estate ventures, and subsequently adjusted for equity in earnings and cash contributions and distributions. Any difference between the carrying amount of these investments on our balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in earnings of unconsolidated real estate ventures over the life of the related asset. Under the equity method of accounting, our net equity is reflected within the Consolidated Balance Sheets, and our share of net income or loss from the joint ventures is included within the Consolidated Statements of Operations. The joint venture agreements may designate different percentage allocations among investors for profits and losses; however, our recognition of joint venture income or loss generally follows the joint venture’s distribution priorities, which may change upon the achievement of certain investment return thresholds. For ownership interests in variable interest entities, we consolidate those in which we are the primary beneficiary.

 

Recognition of Rental Income

 

Rental income for commercial property leases is recognized on a straight-line basis over the respective lease terms. On our Consolidated Balance Sheets, we include as a receivable the excess of rental income recognized over rental payments actually received pursuant to the terms of the individual commercial lease agreements.

 

24

 

 

Reimbursements of operating costs, as allowed under most of our commercial tenant leases, consist of amounts due from tenants for common area maintenance, real estate taxes and other recoverable costs, and are recognized as revenue in the period in which the recoverable expenses are incurred. We record these reimbursements on a “gross” basis, since we generally are the primary obligor with respect to purchasing goods and services from third-party suppliers, have discretion in selecting the supplier and have the credit risk with respect to paying the supplier.

 

Rental income for residential property leases is recorded when due from residents and is recognized monthly as earned, which is not materially different than on a straight-line basis as lease terms are generally for periods of one year or less. An allowance for doubtful accounts is recorded for all past due rents and operating expense reimbursements considered to be uncollectible.

 

Revenue Recognition on the Sale of Real Estate

 

Sales and the associated gains or losses of real estate are recognized in accordance with the provisions of ASC Topic 360-20, “Property, Plant and Equipment – Real Estate Sale”. The specific timing of a sale is measured against various criteria in ASC 360-20 related to the terms of the transaction and any continuing involvement in the form of management or financial assistance associated with the properties. If the sales criteria for the full accrual method are not met, we defer some or all of the gain recognition and account for the continued operations of the property by applying the finance, leasing, deposit, installment or cost recovery methods, as appropriate, until the sales criteria are met.

 

Non-Performing Notes Receivable

 

We consider a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower is not making interest payments in accordance with the terms of the agreement.

 

Interest Recognition on Notes Receivable

 

We record interest income as earned in accordance with the terms of the related loan agreements.

 

Allowance for Estimated Losses

 

We assess the collectability of notes receivable on a periodic basis, of which the assessment consists primarily of an evaluation of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment. See Note 3 “Notes and Interest Receivable” for details on our notes receivable.

 

Fair Value of Financial Instruments

 

We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures”, to the valuation of real estate assets. These provisions define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date, establish a hierarchy that prioritizes the information used in developing fair value estimates and require disclosure of fair value measurements by level within the fair value hierarchy. The hierarchy gives the highest priority to quoted prices in active markets (Level 1 measurements) and the lowest priority to unobservable data (Level 3 measurements), such as the reporting entity’s own data.

 

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and includes three levels defined as follows:

 

  Level 1 – Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets.
  Level 2 – Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
  Level 3 – Unobservable inputs that are significant to the fair value measurement.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Related Parties

 

We apply ASC Topic 805, “Business Combinations”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.

 

25

 

 

Results of Operations

 

The discussion of our results of operations is based on management’s review of operations, which is based on our operating segments. Our operating segments consist of apartments, commercial properties, hotels, land and other. For discussion purposes, we break these segments down into the following sub-categories; same property portfolio, acquired properties and developed properties in the lease-up phase. The same property portfolio consists of properties that were held by us for the entire period for both years being compared. The acquired property portfolio consists of properties that we acquired but have not been held for the entire period for both periods being compared. Developed properties in the lease-up phase consist of completed projects that are being leased up. As we complete each phase of the project, we lease-up that phase and include those revenues in our continuing operations. Once a developed property becomes leased up and is held the entire period for both periods under comparison, it is considered to be included in the same property portfolio.

 

Prior to January 1, 2015, the operating results of real estate assets held for sale and sold were reported as discontinued operations in the accompanying Consolidated Statements of Operations. Income from discontinued operations includes the revenues and expenses, including depreciation and interest expense, associated with the assets. The Company adopted ASU 2014-08, effective January 1, 2015, which substantially changed the criteria for determining whether a disposition qualifies for discontinued operations presentation. As a result, we had no dispositions that met the criteria for discontinued operations during the six months ending June 30, 2018.

 

The following discussion is based on our Consolidated Statements of Operations for the three and six months ended June 30, 2018 and 2017, as included in Part I, Item 1. “Financial Statements” of this report. At June 30, 2018 and 2017, we owned or had interests in a portfolio of fifty three and fifty nine income-producing properties, respectively.

 

Comparison of the three months ended June 30, 2018 to the same period ended 2017:

 

For the three months ended June 30, 2018, we reported net income applicable to common shares of $5.6 million or $0.35 income per diluted share, as compared to net loss applicable to common shares of $11.2 million or $0.72 earnings per diluted share for the same period in 2017.

 

Revenues

 

Rental and other property revenues were $31.6 million for the three months ended June 30, 2018 and 2017. The change by segment was an increase in revenues the apartment portfolio of approximately $1.2 million, offset by a decrease in revenues in the commercial portfolio of $1.2 million.

 

Expense

 

Property operating expenses were $15.5 million for the three months ended June 30, 2018 . This represents an increase of $0.1 million compared to the prior period operating expenses of $15.4 million. This increase is driven primarily by an increase in property operating expenses in the apartment portfolio of $1.0 million offset by a decrease in operating expenses from our commercial portfolio of $0.7 million and $0.2 million from other portfolio.

 

Depreciation and amortization expense was $6.5 million for the three months ended June 30, 2018, as compared to $6.4 million in the same period of 2017. This increase was due primarily to the growth in our apartment portfolio which resulted in a $0.1 million increase in the expense year over year.

 

General and Administrative expenses was $2.9 million for the three months ended June 30, 2018. This represents an increase of $1.0 million compared to the prior period expense of $1.9 million. The increase is due to an increase in expense reimbursements paid to our advisor of approximately $0.7 million and professional fees for consulting, audit and tax services of approximately $0.3 million.

 

Other income (expense)

 

Mortgage and loan interest expense was $15.9 million for the three months ended June 30, 2018. This represents a decrease of $1.4 million compared to the prior period expense of $17.3 million. The change by segment represents a decrease in the other portfolio of $1.0 million, $0.5 million in the land portfolio and $0.2 million in the commercial portfolio offset by an increase of $0.3 million in the apartment portfolio. Within the other portfolio the decrease is primarily due to $1.2 million of interest expense savings related to maturing notes payable paid during the first quarter of 2018.

 

Other income was $7.5 million for the three months ended June 30, 2018. This represents an increase of $7.6 million as compared to prior period other expense of $0.1 million. The increase is the result of insurance proceeds of approximately $6.6 million received subsequent to the "as is" sale of a property damaged by a hurricane, and other miscellaneous income of approximately $1.0 million.

 

26

 

 

Foreign currency transaction was a gain of $5.9 million for the three months ended June 30, 2018. This represents an increase of $9.3 million compared to prior period foreign currency transaction loss of $3.4 million. The increase is the result of a gain in foreign currency exchange as a result of the favorable exchange rate between the Israel Shekels and the U.S. Dollar related to our Bond program.

 

For the three months ended June 30, 2018, we sold a golf course for a total sales price of $2.3 million and recorded no gain or loss on the sale. For the same period in 2017, the Company recorded a loss of approximately $0.5 million from the sale of 8.3 acres of land for a sales price of $0.5 million.

 

Comparison of the six months ended June 30, 2018 to the same period ended 2017:

 

For the six months ended June 30, 2017, we reported net income applicable to common shares of $4.7 million or $.30 income per diluted share compared to net loss applicable to common shares of $17.2 million or $1.11 loss per diluted share for the same period in 2017.

 

Revenues

 

Rental and other property revenues were $62.7 million for the six months ended June 30, 2018. This represents a decrease of approximately $0.7 million compared to the prior period revenues of $63.4 million. The change by segment is due to a decrease in revenues of $2.7 million in the commercial portfolio, offset by an increase in revenues of $2.0 million in the apartment portfolio.

 

Expense

 

Property operating expenses were $30.0 million for the six months ended June 30, 2018. This represents a decrease of $1.7 million compared to the prior period operating expenses of $31.7 million. This decrease is due to decreases in property operating expenses of $1.9 million in our commercial portfolio, and $0.3 million and $0.4 million in our land and other portfolio operating segments, respectively, offset by an increase of $0.9 million in our apartment portfolio operating segment.

 

Depreciation and amortization expense was $12.9 million for the six months ended June 30, 2018, an increase of $0.2 million, as compared to the prior period expense of $12.7 million. This increase was due primarily to the growth in our apartment portfolio which resulted in a $0.3 million increase in the expense year over year, offset by a decrease in depreciation and amortization expense of $0.1 million from the commercial portfolio segment.

 

General and Administrative expenses was $5.3 million for the six months ended June 30, 2018. This represents an increase of $1.3 million compared to the prior period expense of $4.0 million. The increase is due to an increase in expense reimbursements paid to our advisor of approximately $1.1 million and professional fees for consulting, audit and tax services of approximately $0.2 million.

 

Other income (expense)

 

Mortgage and loan interest expense was $31.6 million for the six months ended June 30, 2018. This represents a decrease of approximately $2.5 million compared to the prior period expense of $34.1 million. The change by segment was a decrease in the apartment and land portfolios of $1.0 million each, and $0.5 million in the other portfolio.

 

Other income was $9.4 million for the six months ended June 30, 2018. This represents an increase of $8.1 million as compared to prior period other income of $1.3 million. The increase is due to insurance proceeds of approximately $6.6 million received subsequent to the "as is" sale of a property damaged by a hurricane, and other miscellaneous income of approximately $1.5 million.

 

Foreign currency transaction was a gain of $7.6 million for the six months ended June 30, 2018. This represents an increase of $11.3 million compared to prior period foreign currency transaction loss of $3.7 million. The increase is the result of a gain in foreign currency exchange as a result of the favorable exchange rate between the Israel Shekels and the U.S. Dollar related to our Bond program.

 

Gain on land sales increased for the six months ended June 30, 2018, compared to the prior period. For the six months ended June 30, 2018 we sold 112 acres of land for a sales price of $7.2 million and recorded a gain of $1.3 million.  In addition, we sold six income-producing properties and a golf course for total sales price of approximately $10.8 million and recorded no gain or loss on the sale. For the same period in 2017, we sold 10.8 acres of land for a sales price of $1.6 million and recorded a loss on sale of approximately $31.0 thousand.

 

Liquidity and Capital Resources

 

Our principal liquidity needs are:

 

fund normal recurring expenses;

 

meet debt service and principal repayment obligations including balloon payments on maturing debt;

 

fund capital expenditures, including tenant improvements and leasing costs;

 

fund development costs not covered under construction loans; and

 

fund possible property acquisitions.

 

Our principal sources of cash have been and will continue to be:

 

property operations;

 

proceeds from land and income-producing property sales;

 

collection of mortgage notes receivable;

 

27

 

 

collection of receivables from related party companies;

 

refinancing of existing debt; and

 

additional borrowing, including mortgage notes, mezzanine financing and lines of credit.

 

We draw on multiple financing sources to fund our long-term capital needs. We generally fund our development projects with construction loans. Management anticipates that our available cash from property operations may not be sufficient to meet all of our cash requirements. Management intends to selectively sell land and income-producing assets, refinance or extend real estate debt and seek additional borrowing secured by real estate to meet its liquidity requirements. Although the past cannot predict the future, historically, management has been successful at extending a portion of our current maturity obligations and selling assets as necessary to meet current obligations.

 

Cash Flow Summary

 

The following summary discussion of our cash flows is based on the statements of cash flows as presented in Part I Item 1. “Financial Statements” and is not meant to be an all-inclusive discussion of the changes in our cash flow (dollars in thousands):

 

    June 30,        
    2018     2017     Variance  
                   
Net cash provided by (used in) operating activities   $ 2,946     $ (2,368 )   $ 5,314  
Net cash used in investing activities   $ (51,838 )   $ (23,395 )   $ (28,443 )
Net cash provided by financing activities   $ 53,122     $ 65,687     $ (12,565 )

 

Our primary use of cash for operations is daily operating costs, general and administrative expenses, advisory fees, and land holding costs. Our primary source of cash from operating activities is from rental income on properties. In addition, we have a related party account in which excess cash is transferred to or from.

 

Our primary cash outlays for investing activities are for construction and development, acquisition of land and income-producing properties, and capital improvements to existing properties. During the six months ended June 30, 2018, we advanced $14.6 million toward various notes receivable and $47.4 million for development of new properties. For the same period a year ago we advanced $4.1 million in notes receivable, and invested $26.7 million in construction and development of new properties.

 

Our primary sources of cash from investing activities are from the proceeds on the sale of land and income-producing properties. During the six months ended June 30, 2018, we received aggregate sales proceeds of $3.7 million from the sale of 112.2 acres of land with recorded total gain of $1.3 million from the sale. In addition, we received aggregate sale proceeds of $2.7 million from the sale of six income producing properties and a golf course. During the six months ended June 30, 2017, we sold 10.7 acres of land for a total sales price of $1.6 million and recorded a net loss on the sale of approximately $31 thousand.

 

Our primary sources of cash from financing activities are from proceeds on notes payables either through refinancing our existing loans or by obtaining new financing. Our primary cash outlays are for recurring debt payments and payments on maturing notes payable. The increase in cash flow from financing activities is primarily due to $39.4 million of proceeds received from the sale of nonconvertible Series B Bonds by Southern Properties Capital LTD, a British Virgin Islands corporation (“Southern”), which is an indirect subsidiary of TCI.

 

Environmental Matters

 

Under various federal, state and local environmental laws, ordinances and regulations, we may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.

 

Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on our business, assets or results of operations.

 

Inflation

 

The effects of inflation on our operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in real estate costs. Fluctuations in the rate of inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new financings as well as the cost of variable interest rate debt will be affected.

 

28

 

 

Tax Matters

 

ARL is a member of the May Realty Holdings, Inc., (“MRHI”) consolidated group for federal income tax reporting. There is a tax sharing and compensating agreement between ARL, Income Opportunities Realty Investors, Inc. (“IOR”), and Transcontinental Realty Investors, Inc. (“TCI”).

 

Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARL had taxable income for federal income tax purposes for the first six months of 2018, and taxable losses in 2017 and 2016; due to the uncertainty over whether ARL will have taxable income for the entire year, it recorded no provision for income taxes.

 

At June 30, 2018, ARL had a net deferred tax asset of approximately $38 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax assets, a 100% valuation allowance has been established.

 

ITEM 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

 

We may be exposed to interest rate changes primarily as a result of long-term debt used to acquire properties and make loans and other permitted investments. Our management’s objectives, with regard to interest rate risks, are to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve these objectives, we will borrow primarily at fixed rates or variable rates with the lowest margins available and in some cases, with the ability to convert variable rates to fixed rates. Of our $921.8 million in notes payable at June 30, 2018, $65.3 million represented debt subject to variable interest rates. If our variable interest rates increased 100 basis points, we estimate that total annual interest cost, including interest expensed and interest capitalized, would increase by $0.65 million, and would result in an increase of $0.04 in our loss per share.

 

At June 30, 2018, the Company's weighted average borrowing rate was 6.87%.  Our variable rate exposure is mitigated through the ability to secure long-term fixed rate HUD financing on the residential apartment complexes.

 

ITEM 4.        CONTROLS AND PROCEDURES

 

Based on an evaluation by our management (with the participation of our Principal Executive Officer and Principal Financial Officer), as of the end of the period covered by this report, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosures.

 

There has been no change in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 2.         UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

On September 1, 2000, the Board of Directors approved a share repurchase program authorizing the repurchase of up to a total of 1,000,000 shares of ARL common stock. This repurchase program has no termination date. In August 2010, the Board of Directors approved an increase in the share repurchase program for up to an additional 250,000 shares of Common Stock which results in a total authorization under the repurchase program for up to 1,250,000 shares. There were no shares purchased under this program during the six months ended June 30, 2018. As of June 30, 2018, 986,750 shares have been purchased and 263,250 shares may be purchased under the program.

 

29

 

 

ITEM 6.         EXHIBITS

 

The following exhibits are filed herewith or incorporated by reference as indicated below:

 

Exhibit
Number

 

Description of Exhibit

3.0   Certificate of Restatement of Articles of Incorporation of American Realty Investors, Inc. dated August 3, 2000 (incorporated by reference to Exhibit 3.0 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2000).
     
3.1   Certificate of Correction of Restated Articles of Incorporation of American Realty Investors, Inc. dated August 29, 2000 (incorporated by reference to Exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q dated September 30, 2000).
     
3.2   Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series B Cumulative Convertible Preferred Stock dated August 23, 2003 (incorporated by reference to Exhibit 3.3 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).
     
3.3   Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc., decreasing the number of authorized shares of and eliminating Series I Cumulative Preferred Stock dated October 1, 2003 (incorporated by reference to Exhibit 3.4 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).
     
3.4   Bylaws of American Realty Investors, Inc. (incorporated by reference to Exhibit 3.2 to Registrant’s Registration Statement on Form S-4 filed December 30, 1999).
     
4.1   Certificate of Designations, Preferences and Relative Participating or Optional or Other Special Rights, and Qualifications, Limitations or Restrictions Thereof of Series F Redeemable Preferred Stock of American Realty Investors, Inc., dated June 11, 2001 (incorporated by reference to Exhibit 4.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001).
     
4.2   Certificate of Withdrawal of Preferred Stock, Decreasing the Number of Authorized Shares of and Eliminating Series F Redeemable Preferred Stock, dated June 18, 2002 (incorporated by reference to Exhibit 3.0 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
     
4.3   Certificate of Designation, Preferences and Rights of the Series I Cumulative Preferred Stock of American Realty Investors, Inc., dated February 3, 2003 (incorporated by reference to Exhibit 4.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002).
     
4.4   Certificate of Designation for Nevada Profit Corporations designating the Series J 8% Cumulative Convertible Preferred Stock as filed with the Secretary of State of Nevada on March 16, 2006 (incorporated by reference to Registrant’s current report on Form 8-K for event of March 16, 2006).
     
4.5  

Certificate of Designation for Nevada Profit Corporation designating the Series K Convertible Preferred Stock as filed with the Secretary of State of Nevada on May 6, 2013 (incorporated by reference to Registrant’s current report on form 8-K for event of May 7, 2013).

 

10.1   Advisory Agreement between American Realty Investors, Inc. and Pillar Income Asset Management, Inc., dated April 30, 2011 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, dated May 2, 2011).
     
10.2   Second Amendment to Modification of Stipulation of Settlement dated October 17, 2001 (incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-4, dated February 24, 2002).
     
31.1*   Certification by the Principal Executive Officer pursuant to Rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended.
     
31.2*   Certification by the Principal Financial Officer pursuant to Rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended.
     
32.1*   Certification pursuant to 18 U.S.C. 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

 

*     Filed herewith

 

30

 

 

SIGNATURE PAGE

 

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

 

  AMERICAN REALTY INVESTORS, INC.
     
Date: August 14, 2018 By: /s/ Daniel J. Moos
    Daniel J. Moos
   

President and Chief Executive Officer

(Principal Executive Officer)

     
Date: August 14, 2018 By: /s/ Gene S. Bertcher
    Gene S. Bertcher
   

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

 

31

American Realty Investors (NYSE:ARL)
Historical Stock Chart
From Feb 2024 to Mar 2024 Click Here for more American Realty Investors Charts.
American Realty Investors (NYSE:ARL)
Historical Stock Chart
From Mar 2023 to Mar 2024 Click Here for more American Realty Investors Charts.