CSR

Business Context and Reporting Period

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

Reporting Period: First quarter of fiscal year 2006, ended July 31, 2005.

Portfolio Overview: As of July 31, 2005, the portfolio consisted of 66 multi-family properties (8,646 units) and 150 commercial properties (8.2 million sq. ft.).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 8.6% to $41.75 million, driven by acquisitions in fiscal 2005 and 2006. However, stabilized property revenue declined slightly due to vacancy and concessions.
• Net Income Decline: Net income dropped significantly ($3.8 million decrease) primarily due to the absence of a $2.62 million gain from property sales and an $850,000 lease termination payment recorded in the prior year.
• Expense Increases:
  • Maintenance expenses rose 19.8% ($842,000 increase), attributed to new acquisitions and higher costs on existing assets.
  • Utility expenses increased 10.8% ($280,000 increase) due to new properties and rising energy prices.
  • Administrative expenses increased 37.2% ($328,000 increase) due to hiring and Sarbanes-Oxley compliance costs.
• Segment Performance:
  • Multi-Family: Operating profit turned negative ($-40k) from $825k due to increased vacancy and rent concessions.
  • Commercial Office: Operating profit increased 38.0% to $1.21 million.
  • Commercial Retail: Operating profit declined 52.7% to $865k due to higher vacancy.
• Debt: Mortgage debt increased by $25.4 million to fund acquisitions.

Outlook, Risks, and Management Commentary

• Market Conditions: Management notes that while multi-family and medical vacancy improved slightly, commercial vacancy (office, industrial, retail) increased. Demand for commercial space remains weak.
• Rent Concessions: Tenant concessions increased, reducing operating revenues by approximately $1.3 million in the quarter. Management does not expect significant occupancy improvements or reduced concessions in the remainder of fiscal 2006.
• Energy Costs: Utility expenses are expected to rise further due to Hurricane Katrina impacts and forecasts of higher natural gas and heating oil prices.
• Acquisitions: The company closed on five office/industrial properties in Omaha, NE ($7.25 million) and four assisted living facilities ($40.4 million) in September 2005, shortly after the reporting period.
• Liquidity: The company maintains three unsecured lines of credit totaling $24.4 million (none drawn as of period end) and expects operating cash flow to meet short-term needs.

Investor Verification Checklist

• Stabilized Property Trends: Verify the trend in economic vacancy rates for commercial segments, which are currently rising despite revenue growth from new acquisitions.
• One-Time Items: Confirm the exclusion of the $2.62 million property sale gain and $850,000 lease termination payment from the current quarter to understand the true operating performance decline.
• Debt Maturities: Review the schedule of fixed vs. variable rate debt maturities, noting that 96% of debt is fixed, limiting immediate interest rate risk.
• Subsequent Acquisitions: Assess the impact of the $47.6 million in acquisitions closed in September 2005 on future leverage and cash flow.
• FFO vs. Net Income: Monitor Funds From Operations (FFO) as the primary performance metric, as GAAP net income is heavily distorted by depreciation and non-recurring gains/losses.