NEW ENGLAND REALTY ASSOCIATES LIMITED PARTNERSHIP quarterly report, Q3 FY2018

New England Realty Associates Limited Partnership — Q3 2018 Form 10-Q

Business context and period. The unaudited report covers the three and nine months ended September 30, 2018. NERA owns 27 properties and holds 40%–50% interests in eight unconsolidated joint ventures, primarily in Eastern Massachusetts and Southern New Hampshire. Its portfolio includes 2,711 apartment units, 19 condominium units and 108,043 square feet of commercial space in owned properties.

Key financial metrics

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Total revenue	$14.55 million	$13.42 million	$43.23 million	$38.95 million
Income before other income (expense)	$3.22 million	$2.93 million	$10.85 million	$10.64 million
Net income	$0.66 million	$0.87 million	$2.59 million	$5.25 million
Net income per unit	$5.31	$7.01	$20.84	$42.20
Operating cash flow	Not separately provided	Not separately provided	$20.82 million	$16.93 million

Nine-month operating expenses were $32.39 million, up 14.4%; depreciation and amortization rose 19.7% to $11.55 million. Interest expense increased 15.0% to $9.33 million.
At September 30, assets were $250.0 million, including $9.23 million of cash. Mortgage notes payable were $252.78 million and the revolving credit line balance was $5.0 million. Total liabilities were $286.06 million; partners’ capital was negative $36.08 million.
Nine-month investing cash use was $2.03 million and financing cash use was $16.79 million. Cash increased $2.00 million to $9.23 million. The Partnership distributed $3.36 million to partners.
Mortgage rates ranged from 3.76% to 5.81%, with a weighted-average rate of 4.59%. Scheduled mortgage maturities include approximately $80.04 million in 2023. The filing reports $71.25 million as NERA’s proportionate share of unconsolidated joint venture debt.

Material changes versus the prior period

Nine-month revenue rose 11.0%, including contributions from acquisitions. Management reported 4.8% revenue growth excluding acquisitions, with expenses up 2.3% and income before other income and expense up 11.4% on that basis.
Nine-month net income fell 50.6%, principally reflecting lower income from joint ventures. NERA’s joint-venture income declined to $1.07 million from $2.72 million, including its approximately $1.53 million share of a defeasance charge on the Dexter Park refinancing. Joint-venture unit-sale gains also declined year over year.
NERA acquired the 79-unit Webster Green Apartments in March for $34.5 million, funded with approximately $13.0 million cash and assumed mortgage debt of $21.5 million. It also acquired Woodland Park in 2017, affecting period-to-period comparisons.
Dexter Park refinanced with a $125 million, 10-year, fixed-rate mortgage at 3.99%. Its distribution to NERA was approximately $16.5 million; NERA used refinancing proceeds to reduce its credit line. The line stood at $5 million at quarter-end and was reduced to $2 million after quarter-end.

Outlook, commentary, risks and unusual items

Management reported strong core-portfolio revenue gains and high occupancy, with residential new-lease and renewal increases of approximately 4.1%. It expected rents to continue rising through the rest of 2018 and operating expenses to increase with inflation. No formal earnings guidance was provided.
Management said cash from operations and interest-bearing accounts should be sufficient for current operations, distributions, required debt payments and planned improvements. It planned approximately $378,000 of additional capital improvements in 2018.
Residential vacancy was 3.3% on November 1, 2018, versus 2.6% a year earlier; commercial vacancy was 1.3%, versus none reported a year earlier. These are post-quarter occupancy figures.
Interest-rate exposure is material: the Partnership, subsidiaries and joint ventures reported $55.9 million of variable-rate debt. A 100-basis-point rate change would alter annual interest costs by approximately $559,000, assuming rate caps are not effective. Management also estimated an approximately $21 million change in fixed-rate debt fair value for that rate shift.
Key risks include local real-estate and rental-market conditions, tenant collections and retention, operating and utility costs, refinancing availability, competition, property and environmental liabilities, insurance availability and interest-rate changes. The filing identifies a new tax risk: IRS adjustments for tax years beginning after 2017 could result in taxes, penalties and interest being collected directly from the Partnership, reducing cash available for distributions.
The $3.83 million Dexter Park defeasance charge was an unusual item affecting joint-venture income. The Partnership has guaranteed the new Dexter Park mortgage, although it reports no general legal obligation to fund operating deficits at several joint ventures whose carrying values are below zero.
Management reported effective disclosure controls, no material third-quarter change in internal control over financial reporting, and no material pending legal proceedings. Related-party management, professional and property-service arrangements are disclosed; Harold Brown controls the general partner and has significant ownership and management ties.

Most important facts for investors to verify

Whether core rental growth and occupancy remain strong after separating acquisition effects, and whether expense growth continues to outpace comparable revenue growth.
The nature and potential obligations of NERA’s Dexter Park mortgage guarantee, joint-venture commitments and negative investment balances.
The timing and refinancing plans for large mortgage maturities, particularly the approximately $80.04 million scheduled for 2023, and compliance with credit-line covenants.
How much reported earnings are affected by joint-venture unit sales and refinancing charges versus recurring property operations.
The terms, oversight and economic effects of related-party management and service arrangements, and any potential impact of future tax audits on partner distributions.