CSR

Business Context and Reporting Period

Company: Investors Real Estate Trust (IRET), a self-advised equity REIT.

Reporting Period: Second quarter of fiscal year 2009, ended October 31, 2008.

Portfolio Overview: As of October 31, 2008, IRET owned 77 multi-family residential properties (9,564 units) and 165 commercial properties (11.6 million sq. ft.) including office, medical, industrial, and retail assets. Operations are concentrated in North Dakota and Minnesota, with additional holdings in nine other states.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 10.0% ($5.4 million) for the quarter and 9.8% ($10.6 million) for the six months compared to the prior year, driven primarily by acquisitions in fiscal years 2008 and 2009.
• Net Income Decline: Despite revenue growth, Net Income Available to Common Shareholders decreased 14.0% for the quarter and 20.2% for the six months. This was caused by increased interest expense, higher depreciation/amortization on new assets, and rising operating costs.
• Expense Increases:
  • Interest Expense: Increased 10.4% for the quarter and 10.9% for the six months due to new debt on acquired properties.
  • Maintenance & Utilities: Maintenance expenses rose 9.4% (quarter) and 12.9% (six months); utility expenses rose 7.2% (quarter) and 9.7% (six months), partly due to higher fuel costs and new properties.
  • Property Management: Increased significantly (23.3% for the quarter) largely due to a higher bad debt provision in the commercial medical segment.
• Occupancy Trends: Economic occupancy on stabilized properties declined in Commercial Office (88.5% vs 92.9%) and Commercial Industrial (96.5% vs 98.4%) segments, while Multi-Family and Medical segments remained stable or improved slightly.

Outlook, Risks, and Contingencies

• Market Conditions: Management cites worsening economic conditions and credit market turmoil as restraints on demand for commercial space. Expectations include continued occupancy declines in commercial segments and increased credit stress on tenants.
• Tenant Credit Risk:
  • Sunwest Management: Significant past due balances exist at two senior housing facilities (Fox River and Stevens Point, WI). IRET has written off $417,000 in receivables and is pursuing collection on guarantees. IRET is receiving partial cash flow from Stevens Point but no payments from Fox River.
  • Berman's the Leather Experts: A major industrial tenant declared bankruptcy and rejected its lease. A sub-tenant currently occupies the space at approximately 85% of the previous rent.
• Financing Environment: While IRET has successfully placed debt recently, the conservatorship of Fannie Mae and Freddie Mac presents heightened risk for refinancing multi-family debt, potentially leading to higher loan costs.
• Development: The IRET Corporate Plaza project in Minot, ND, is approximately 82% complete with an estimated total cost of $20.7 million.

Investor Verification Checklist

• Sunwest Exposure: Verify the status of collection efforts and potential asset recovery for the Fox River and Stevens Point properties leased to Sunwest affiliates.
• Refinancing Strategy: Assess the impact of Fannie Mae/Freddie Mac conservatorship on the company's ability to refinance maturing multi-family debt at current rates.
• Commercial Occupancy: Monitor vacancy trends in the Commercial Office and Industrial segments, which showed year-over-year declines in economic occupancy.
• Debt Maturities: Review the schedule of debt maturities, noting that $16.9 million in principal is due in the remainder of fiscal 2009.
• FFO vs. Net Income: Note the divergence where FFO increased (5.6% for the quarter) while GAAP Net Income decreased, driven by non-cash depreciation and amortization charges on new acquisitions.