American Realty Investors, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; financial statements are unaudited. Amounts are in U.S. dollars unless noted. The company is an externally advised real estate owner and lender, with substantial related-party ownership and transactions.
Business context and financial results
- ARL and its consolidated affiliates reported interests in 59 income-producing properties: 50 apartment communities with 8,226 units, eight commercial properties, and a golf course. The portfolio also included development land and seven apartment projects in development.
- Q3 revenue: Rental and other property revenue was $31.8 million, up from $30.1 million a year earlier. Net operating income was $5.4 million versus $3.8 million.
- Q3 earnings: Net income attributable to common shares was $9.1 million, or $0.59 per diluted share, compared with a $4.0 million loss, or $0.26 per share, in Q3 2016. The 2017 result included $12.8 million of gain recognized on prior-year sales of two apartment properties and $1.1 million of land-sale gains.
- Nine-month results: Revenue was $95.2 million versus $90.1 million; net operating income was $14.7 million versus $11.7 million. ARL reported a common-share loss of $8.1 million, or $0.52 per share, compared with a $5.3 million loss, or $0.34 per share, in 2016.
- Expenses and margins: Nine-month operating expenses were $80.5 million, including $47.1 million of property operating costs and $19.1 million of depreciation and amortization. Mortgage and loan interest expense rose to $49.9 million from $43.6 million. The filing does not present a standardized operating margin.
- Balance sheet at September 30: Total assets were $1.233 billion and shareholders’ equity was $167.8 million. Cash and cash equivalents were $58.0 million, with another $43.0 million in restricted cash. Notes and interest receivable, net of allowance, were $102.6 million, including $90.6 million from related parties.
- Debt: The balance sheet reported $832.8 million of notes and interest payable and $107.9 million of bonds payable. A debt note separately reports $837.1 million of notes payable after deferred borrowing costs, including accrued interest; debt classifications and totals should be reconciled across the filing.
Changes, cash flow, and financing
- For the first nine months, operating activities used $23.9 million of cash, versus providing $28.5 million in 2016. Investing activities used $33.6 million, compared with $62.4 million used in 2016. Financing activities provided $97.9 million, versus $26.0 million.
- Cash increased by $40.5 million to $58.0 million, primarily reflecting financing proceeds. The company reported $106.6 million of proceeds from Series A bonds issued by an indirect subsidiary; the bonds are denominated in Israeli shekels, carry a 7.3% stated rate and a 9.25% effective yield, and mature through 2023.
- ARL acquired three land parcels for $11.4 million and spent about $41.4 million on apartment construction or predevelopment during the nine months. It refinanced three loans with $80.1 million of principal and drew $25.7 million on construction loans.
- Nine-month interest income fell to $14.1 million from $15.8 million, while interest expense increased. The company recorded an unrealized foreign-currency loss of $1.8 million for the nine months; Q3 included an unrealized gain of $1.9 million.
Outlook, risks, and unusual items
- Liquidity: Management expected excess cash flow from property operations in 2017, but stated it would not be sufficient to discharge all obligations as they come due. Planned sources include asset sales, refinancing or extending debt, and additional real-estate-secured borrowing.
- Some land mortgages were being modified or extended. The filing also says mortgages on properties previously sold to a related party are in default, primarily for nonpayment, and that the borrower is discussing resolution with lenders.
- ARL is the primary guarantor on a $39.1 million mezzanine loan to Unified Housing Foundation. It also guaranteed a loan with an outstanding balance of $19.7 million related to a formerly sold entity.
- Related-party exposure is significant: more than 80% of ARL’s stock is held by related-party entities, and Pillar, its external adviser and cash manager, also advises affiliates. The filing cautions that related-party transactions may not be on arm’s-length terms.
- Litigation disclosures include a claim against ARL related to alleged transfers of assets of former entities; management says it believes ARL has no liability. A separate lawsuit filed in 2017 against Dynex entities alleges fraudulent transfer and alter ego. Management describes ordinary-course litigation as not expected to have a material adverse effect, subject to disclosed matters.
- Management reported no changes to the risk factors in its 2016 Form 10-K. Key risks include financing availability and maturities, property demand and occupancy, development delays or cost overruns, interest rates, property sales, and environmental or uninsured liabilities. No specific earnings guidance was provided.
Important facts for investors to verify
- Reconcile reported debt balances and maturities, including the separate notes-payable and bond disclosures, and assess refinancing capacity.
- Evaluate cash generation: operating cash flow was negative despite higher rental revenue, and management acknowledged a funding shortfall against obligations.
- Separate recurring operating performance from Q3 earnings driven by recognition of $12.8 million in previously deferred gains.
- Review collectability and terms of related-party notes and receivables, the $31.0 million related-party receivable, and deferred related-party property sales.
- Confirm status of defaulted mortgages, loan modifications, guarantees, and material litigation exposure.