AMERICAN REALTY INVESTORS INC annual report, FY2017

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American Realty Investors, Inc. — 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017. The company is an externally advised real estate owner and developer; its consolidated results include its majority-owned subsidiaries TCI and IOR. Figures below are in U.S. dollars; financial-statement amounts are generally in millions unless noted.

Business context and portfolio

At year-end, the portfolio included 51 apartment communities with 8,427 units, seven commercial properties totaling about 1.70 million square feet, a golf course, and approximately 3,613 acres of land. Apartment occupancy was 95.18%; commercial occupancy varied by property. The company reported 14 apartment projects in development, with $89.1 million of costs to date against projected total costs of $495.8 million.

Financial performance and liquidity

  • Revenue: Rental and other property revenue was $126.2 million, up 5.5% from $119.7 million in 2016. Apartment revenue increased $6.2 million, primarily reflecting acquired properties.
  • Profit and margins: Operating income rose to $17.4 million from $14.6 million; operating margin was approximately 13.8%, versus 12.2% in 2016. Net loss attributable to common shares widened to $9.5 million, or $0.61 per diluted share, from $3.8 million, or $0.25 per share. The 2017 result included $16.7 million of gains on income-producing property sales and $4.9 million of land-sale gains.
  • Key costs: Property operating expenses were $64.1 million; depreciation and amortization, $25.7 million; advisory fees to related-party advisor Pillar, $11.1 million; and mortgage and loan interest expense, $66.2 million, up from $59.4 million.
  • Cash flow: Operating activities used $37.3 million, compared with $17.4 million provided in 2016. Investing activities used $90.0 million; financing activities provided $152.8 million. Year-end cash was $42.9 million, with an additional $45.6 million of restricted cash.
  • Assets and equity: Total assets were $1.297 billion, including net real estate of $988.1 million. Total equity was $165.9 million, and book value per share was $10.69, down from $11.35.
  • Debt: Notes and interest payable had a net carrying amount of $901.1 million; bonds and interest payable added $113.0 million. The filing also cites approximately $901.1 million of indebtedness in its risk discussion, apparently excluding the separately reported bonds. The mortgage debt portfolio was predominantly fixed-rate; approximately $39.8 million was variable-rate. Total contractual debt obligations, including scheduled interest, were $1.816 billion.
  • Debt service and liquidity: Contractual principal payments on notes payable were $86.3 million in 2018 and $101.1 million in 2019. The auditor included an emphasis of liquidity, and management said operating cash flow alone would not cover all obligations as due; it expects to rely on property sales, refinancing, extensions, and additional secured borrowing.

Material changes versus 2016

  • Revenue increased, but common-share net loss widened. Higher interest expense, a $4.5 million non-cash foreign-currency translation loss related to bonds, and other expenses weighed on results.
  • Operating cash flow swung from positive $17.4 million to negative $37.3 million. The company continued substantial development spending, reporting $69.8 million for construction or predevelopment and $2.4 million of capitalized interest.
  • Debt and bond financing increased. Southern Properties Capital issued approximately $115.3 million of nonconvertible Series A bonds in 2017, denominated in Israeli shekels, at a stated 7.3% rate and an effective rate of 9.17% at year-end.
  • Gains on income-producing property sales included $14.0 million of previously deferred gains recognized in 2017. The company reported $4.9 million of land-sale gains, versus $3.1 million in 2016.

Outlook, risks, contingencies, and unusual items

  • Outlook: Management expects excess cash flow from property operations in 2018 but acknowledges it will not be enough to discharge all obligations as they come due. It plans selective property sales, debt refinancing or extensions, and further secured borrowing. No earnings or revenue guidance was provided.
  • Principal risks: High leverage, refinancing and maturity risk, variable interest rates, limited real-estate liquidity, construction cost overruns and delays, occupancy and tenant risks, regional economic concentration, and access to capital. The company states substantially all assets are pledged to secure debt.
  • Related parties: More than 80% of ARL stock was reported as owned by related parties. Pillar advises the company and related entities; ARL paid Pillar $11.1 million in advisory fees and reported other related-party fees and reimbursements. UHF is a related-party borrower, and a substantial portion of notes receivable is due from related parties. Management cautions such transactions may not be arm’s length.
  • Guarantees and litigation: TCI is primary guarantor on a $39.1 million UHF mezzanine loan; ARL and an officer are limited-recourse guarantors. UHF was reported covenant-compliant at year-end. The company is pursuing collection of a judgment against Dynex Commercial, including a $19.5 million award to TCI; collection is uncertain. Separate Clapper-related litigation involved former entities and a dismissed lawsuit against ARL, with possible refiling not ruled out.
  • Subsequent events: Southern issued approximately $39.4 million of Series B bonds in February 2018. In March 2018, the company announced a proposed multifamily joint venture with Macquarie, subject to regulatory approval.
  • Other: Common dividends were not paid in 2015–2017. The 2017 income-tax provision reflects remeasurement of deferred tax items following the U.S. corporate tax-rate reduction. The auditor gave an unqualified opinion on the financial statements and included an emphasis of liquidity; it did not attest to internal-control effectiveness.

Investor verification priorities

  1. Confirm near-term maturities, covenant headroom, refinancing progress, and the assets available to support borrowing; reconcile debt totals that exclude or include Southern’s bonds.
  2. Assess whether operating cash flow can improve and whether property sales or refinancing can fund the 2018 liquidity gap without distressed dispositions.
  3. Review related-party receivable collectability, especially UHF exposure, non-performing related-party balances, and the $38.3 million receivable from Pillar.
  4. Verify development budgets, completion and lease-up schedules, remaining funding requirements, and exposure to cost overruns across the 14 projects.
  5. Track the foreign-exchange and repayment risk on shekel-denominated bonds, the Series B issuance terms, and completion conditions for the proposed Macquarie joint venture.