CSR

Business Context and Reporting Period

Company: Investors Real Estate Trust (IRET), a self-advised equity REIT focused on multi-family residential and commercial properties (office, medical, industrial, retail) primarily in the upper Midwest.

Reporting Period: Third quarter of fiscal year 2006, ended January 31, 2006.

Portfolio Overview: As of January 31, 2006, the portfolio consisted of 66 multi-family properties (8,648 units) and 159 commercial properties (8.6 million square feet).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 13.0% ($5.0 million) for the quarter and 11.5% ($13.2 million) for the nine-month period compared to the prior year, driven primarily by acquisitions in fiscal years 2005 and 2006.
• Net Income Decline: Despite revenue growth, Net Income decreased 28.3% for the quarter and 48.1% for the nine-month period. This was largely due to the absence of significant gains from discontinued operations in the current period (which contributed $1.8 million and $6.3 million in the prior year's respective periods) and increased operating expenses.
• Expense Increases:
  • Maintenance: Increased 27.1% for the quarter and 20% for the nine months, attributed to new acquisitions and higher costs on existing properties.
  • Utilities: Increased 19.2% for the quarter and 24.9% for the nine months, driven by sharp rises in natural gas and heating oil prices.
  • Interest: Mortgage interest expense increased 9.8% for the quarter and 9.9% for the nine months due to increased debt levels ($774 million vs. $708.6 million).
• Occupancy: Economic occupancy rates improved across most segments (Multi-family: 92.3%, Office: 91.7%, Medical: 94.7%) compared to the prior year, though retail occupancy dipped slightly to 88.7%.

Outlook, Risks, and Management Commentary

• Acquisitions and Dispositions: The company acquired approximately $67.4 million in properties during the nine months ended January 31, 2006, including assisted living facilities and office buildings. Subsequent to the period end, agreements were signed to acquire an office complex for $18.8 million and sell several retail properties totaling approximately $5.65 million.
• Liquidity: The company maintains three unsecured lines of credit totaling $24.4 million, with no outstanding borrowings as of January 31, 2006. Management believes cash flow from operations is adequate to meet distribution requirements and operating needs.
• Risks and Contingencies:
  • Market Risk: Approximately 3.4% of debt is variable rate; a 1% increase in rates would increase annual interest expense by $262,000.
  • Environmental: Potential liability for remediation of hazardous substances at properties, though no violations are currently known.
  • Restrictions: Approximately $542.1 million of property value is subject to restrictions on taxable dispositions.
• Dividends: On February 15, 2006, the Board declared a distribution of $0.1640 per common share/unit and $0.5156 per preferred share.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the extent to which the decline in Net Income is driven by the lack of one-time gains from property sales in the prior year versus ongoing operational performance.
• Expense Run-Rate: Assess whether the 27% increase in maintenance and 25% increase in utility costs are sustainable or temporary anomalies driven by specific weather conditions or new asset integration.
• Debt Maturity Profile: Review the schedule of debt maturities to ensure refinancing risk is manageable given the current interest rate environment.
• Retail Segment Performance: Investigate the decline in retail segment operating profit (down 38% for the quarter) and the slight increase in retail vacancy rates.
• Pending Transactions: Monitor the closing of the $18.8 million office acquisition and the $5.65 million in retail dispositions announced in February 2006.