Business context and reporting period
Transcontinental Realty Investors, Inc. (TCI) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. TCI invests in apartments, commercial real estate, development land, and mortgage notes; it is externally advised by Pillar Income Asset Management and has no employees. At quarter-end, its portfolio included 48 apartment communities with 8,494 units, seven commercial properties, and 3,218 acres of land.
Financial performance and condition
- Revenue: Rental and other property revenue was $33.5 million for Q3, up 6.4% from $31.5 million; nine-month revenue was $96.2 million, up 2.0% from $94.3 million.
- Operating results: Net operating income was $5.8 million for Q3, essentially unchanged from $5.8 million; for nine months it was $15.6 million, down from $16.8 million. Net operating income as a share of rental revenue was approximately 17.2% for Q3 and 16.2% for nine months, versus 18.3% and 17.8%, respectively, in 2017.
- Net income and EPS: Q3 net income was $23.1 million, or $2.52 per diluted share, versus $7.2 million, or $0.79, a year earlier. Nine-month net income was $30.4 million, or $3.27 per diluted share, compared with a $8.1 million net loss, or $1.05 per share, in 2017.
- Cash flow: The cash flow statement reports nine-month operating cash used of $20.3 million, investing cash used of $62.6 million, and financing cash provided of $91.0 million. Cash, cash equivalents, and restricted cash totaled $96.5 million at period-end, including $23.8 million in cash and cash equivalents.
- Debt and liquidity: Balance-sheet notes and interest payable were $314.2 million, debt related to real estate held for sale was $651.0 million, and bonds payable were $161.0 million. Total liabilities were $1.185 billion; total equity was $238.0 million. Restricted cash was $72.7 million. Management said property-operation cash would not be sufficient to meet all obligations as due and expects to rely on asset sales, refinancing, and additional real-estate-secured borrowing.
- Interest-rate exposure: TCI reported a 5.96% weighted-average borrowing rate and $65.1 million of variable-rate debt. A 100-basis-point rate increase was estimated to add $0.65 million to annual interest cost and reduce EPS by $0.07.
Material changes versus the prior comparable period
- Nine-month results turned positive, chiefly alongside a $17.6 million deferred-income recognition associated with asset sales, $13.6 million of land-sale gains, and a $6.4 million foreign-currency gain. The filing describes the currency gain as unrealized.
- Rental revenue increased, principally from apartments, while commercial revenue declined. Nine-month operating expenses fell slightly, but general and administrative expense rose to $6.2 million from $4.7 million, including higher advisor reimbursements and transaction costs.
- Q3 foreign-currency results shifted to a $1.3 million loss from a $1.9 million gain in Q3 2017. Nine-month mortgage and loan interest expense declined to $43.8 million from $45.2 million.
- Total assets increased to $1.423 billion from $1.313 billion at year-end 2017. TCI classified $760.5 million of real estate as held for sale, including $727.6 million associated with a proposed Macquarie joint venture.
Outlook, risks, contingencies, and unusual items
- TCI and Macquarie agreed to form a venture expected to close in Q4 2018, with anticipated 49% ownership each and 2% for TCI’s CEO. The filing states each company would have a 50% voting interest. The proposed transfer of the portfolio remains subject to closing.
- TCI invested $81.4 million in apartment construction or predevelopment during the first nine months and had ten apartment projects in development. It purchased three apartment communities for approximately $45.0 million during the period.
- Some properties sold to a related party remain classified as subject to sales contracts, with sales recognition deferred. The filing says mortgages on those properties are in default, primarily for nonpayment, and discussions with lenders are ongoing; impairments were recorded where management judged property value below carrying basis.
- Management disclosed that some land mortgages are being modified or extended. TCI is also seeking to collect a court judgment against Dynex Commercial; collection is not assured. TCI is primary guarantor on a $39.1 million mezzanine loan to Unified Housing Foundation, which was reported compliant with loan covenants at quarter-end.
- Management cited real-estate demand, financing availability and cost, interest rates, construction delays and cost overruns, property-sale timing, and related-party dealings as risks. It reported no material change to the risk factors in its 2017 Form 10-K.
Important facts for investors to verify
- Confirm whether the proposed Macquarie venture closed and the final assets, debt, ownership, and proceeds transferred.
- Assess the status and potential recovery of defaulted mortgages, loan extensions, related-party receivables, and the Dynex judgment.
- Review the company’s ability to meet obligations given management’s stated liquidity shortfall and reliance on sales, refinancing, and new borrowing.
- Reconcile cash-flow figures: the cash flow statement reports investing outflows of $62.6 million and financing inflows of $91.0 million, while the MD&A cash-flow summary reports $49.8 million and $90.2 million, respectively.
- Check the bond disclosures and schedules against the underlying filing: the text contains apparent date errors in Series B payment and principal-installment descriptions.