Business context and reporting period
Transcontinental Realty Investors, Inc. (NYSE: TCI) filed its Form 10-K for the fiscal year ended December 31, 2013. TCI is an externally advised real estate company and a C corporation, not a REIT. At year-end, its portfolio included 36 apartment communities with 6,078 units, nine commercial properties totaling about 2.3 million square feet, and 4,100 acres of land. ARL subsidiaries owned approximately 83.8% of TCI; TCI owned 81.1% of IOT and consolidates IOT.
Financial performance and position
| Metric | 2013 | 2012 |
|---|---|---|
| Rental and other property revenue | $86.2 million | $86.6 million |
| Operating income (loss) | $(2.1) million | $11.6 million |
| Net income (loss) attributable to TCI | $58.5 million | $(8.3) million |
| Net income (loss) applicable to common shares | $57.4 million; $6.82 per diluted share | $(9.4) million; $(1.12) per diluted share |
| Net cash used in operating activities | $(66.7) million | $(24.7) million |
| Net cash provided by investing activities | $269.0 million | $67.8 million |
| Net cash used in financing activities | $(199.3) million | $(50.1) million |
| Total assets | $897.7 million | $1,045.3 million |
| Total notes and interest payable | $602.8 million | $808.0 million |
| Shareholders’ equity | $191.6 million | $133.1 million |
Operating margin was approximately negative 2.4% in 2013, versus positive 13.4% in 2012, based on reported operating income and property revenue. Year-end cash and cash equivalents were $16.1 million, with $31.8 million of restricted cash. Apartment occupancy averaged 95.7%; commercial occupancy was uneven, including 47.0% at 1010 Common, 56.1% at Browning Place, and 69.1% at 600 Las Colinas.
Debt interest rates ranged from 1.0% to 12.5%; the reported year-end weighted-average rate was 5.65%, up from 5.20%. The company reported approximately $518.3 million of fixed-rate and $81.4 million of variable-rate debt in its market-risk discussion. A 100-basis-point increase in variable rates was estimated to reduce 2014 net income by $0.8 million. Scheduled principal payments were $134.5 million in 2014; the separate contractual-obligations table shows $157.2 million due in 2014, including interest and other obligations.
Material changes versus the prior comparable period
- Common-share earnings swung to $57.4 million from a $9.4 million loss, but the improvement chiefly reflected $97.4 million of gains on property sales reported in discontinued operations and a $40.5 million income-tax benefit. Continuing operations still reported a $1.3 million net loss.
- TCI sold nine apartment communities for $189.6 million in December, with buyers assuming $115.1 million of secured debt; the reported gain was $73.5 million. The year included other property dispositions as well; cash proceeds from sales of income-producing properties totaled $261.5 million.
- Rental and other property revenue decreased $0.4 million. Apartment revenue increased $3.5 million, while commercial revenue fell $3.9 million, principally as larger tenants downsized or left.
- Impairment provisions rose to $11.3 million from $2.3 million, including $9.6 million on a Dallas commercial building and $1.5 million on land. Litigation settlement expense increased to $20.3 million from $0.2 million.
- Cash used in operations increased by $42.0 million, while investing cash inflows rose substantially due mainly to property sales. Debt fell year over year, reflecting repayments and dispositions.
Outlook, risks, contingencies and unusual items
- Liquidity: Management said anticipated 2014 property cash generation would not be sufficient to meet all obligations. Its plans included selective property sales, refinancing or extending debt, and additional real-estate-secured borrowing. The auditor’s report also highlighted management’s liquidity plans.
- Debt and property risk: Substantially all assets were pledged to secure debt. The company identified refinancing, balloon maturities, variable rates, covenant compliance, tenant vacancies, operating costs, and the illiquidity of real estate as key risks.
- Related-party exposure: TCI reported $66.4 million of notes and interest receivable from related parties and recognized $12.2 million of related-party interest income. Related-party advisor Pillar received $8.5 million in advisory fees and $4.1 million in net-income fees; Regis received $4.5 million in property-management and brokerage-related fees. TCI disclosed that related-party transactions may not be on arm’s-length terms.
- Deferred related-party sales and defaults: At year-end, one apartment complex, one commercial building, and 212 acres remained classified as subject to sales contracts because TCI retained continuing involvement. Related mortgages were reported in default, and settlement or cure discussions with lenders were ongoing.
- Contingencies: Management estimated potential aggregate exposure from lender deficiency claims at no more than approximately $20 million, if any, with outcomes potentially occurring in future years. A favorable appellate ruling in the long-running Dynex case remained subject to further challenges and trial-court proceedings.
- Subsequent events: In February 2014, TCI sold Pecan Pointe for $23.1 million and reported a $5.8 million gain; it also settled the Petra/Amoco obligations for $1.2 million, with $3.5 million forgiven. In March 2014, TCI secured a $40 million loan at 12% interest, secured by equity interests in apartments. TCI declared no common dividends in 2011–2013.
- Reporting and governance: The auditor issued an unqualified opinion on the financial statements but did not attest to internal-control effectiveness. Management concluded disclosure controls and internal control over financial reporting were effective at year-end. TCI has no employees and depends on its external advisor; common control and overlapping directors and officers with ARL and IOT create potential conflicts.
Most important facts for investors to verify
- How much of 2013’s reported profit was attributable to recurring property operations versus disposition gains and tax benefits; continuing operations remained loss-making.
- The sources and timing of liquidity for 2014 maturities, covenant compliance, and the terms and use of the subsequent $40 million, 12% secured financing.
- Whether operating cash flow can improve after substantial asset sales and related-party payable reductions, and how property sales affect future rental income.
- The status and recoverability of related-party notes, deferred related-party property transfers, defaulted mortgages, and the estimated deficiency-claim exposure.
- The sustainability of occupancy and rents, particularly in commercial properties, and any additional impairments or costs associated with vacancies, refinancing, and litigation.