CSR

Business Context and Reporting Period

Company: Investors Real Estate Trust (IRET), a self-advised equity REIT focused on multi-family residential and commercial properties (office, medical, industrial, retail) primarily in the upper Midwest.

Reporting Period: Second Quarter of Fiscal Year 2006, ended October 31, 2005.

Portfolio Overview: As of October 31, 2005, the portfolio consisted of 66 multi-family properties (8,648 units) and 159 commercial properties (8.5 million sq. ft.).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 12.9% ($5.0 million) for the quarter and 10.7% ($8.3 million) for the six months compared to the prior year, driven primarily by acquisitions in fiscal years 2005 and 2006.
• Net Income Decline: Net income decreased significantly year-over-year (35% for the quarter, 55% for six months). This decline is largely attributed to a reduction in gains from discontinued operations (sales of properties) in the current period compared to the prior year.
• FFO Increase: Funds From Operations (FFO) increased 20.0% for the quarter and 6.1% for the six months, reflecting improved operational performance excluding non-recurring gains/losses.
• Expense Increases:
  • Interest Expense: Increased 10.2% (quarter) and 8.9% (six months) due to new debt on acquired properties.
  • Utilities: Increased 47.7% (quarter) and 28.2% (six months) due to new acquisitions and rising energy prices.
  • Maintenance: Increased 13.5% (quarter) and 16.7% (six months), with 91.4% of the six-month increase attributable to existing properties.
• Occupancy: Economic occupancy rates improved across most segments, with Multi-Family rising to 93.1% (quarter) and Commercial-Medical to 94.2%.

Outlook, Risks, and Management Commentary

• Acquisitions: During the six months ended October 31, 2005, the company acquired four assisted living facilities, five office properties, and two medical office buildings for approximately $67.4 million, plus one completed apartment complex.
• Dispositions: Sold one retail property and undeveloped land for approximately $450,000.
• Market Risks:
  • Interest Rates: Approximately 97% of mortgage debt is fixed-rate, limiting exposure. However, $26.5 million remains in variable-rate debt; a 1% increase would raise annual interest expense by $265,000.
  • Vacancy and Concessions: While physical vacancy decreased, tenant concessions increased to maintain occupancy, negatively impacting revenue by an estimated $1.4 million (quarter) and $2.6 million (six months).
  • Energy Costs: Management expects utility expenses to continue rising due to general increases in natural gas and heating oil prices.
• Liquidity: The company maintains three unsecured lines of credit totaling $24.4 million, with no outstanding borrowings as of the period end. Cash flow from operations is deemed sufficient to meet distribution requirements.
• Subsequent Event: On November 16, 2005, the Board declared a preferred share distribution of $0.5156 per share, payable January 2, 2006.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the extent to which the decline in GAAP Net Income is driven by the absence of property sale gains compared to the prior year, rather than operational deterioration.
• FFO vs. Net Income: Confirm that the 20% increase in FFO accurately reflects the core operating performance of the stabilized portfolio.
• Utility and Maintenance Trends: Assess whether the sharp increases in utility and maintenance costs are sustainable or indicative of specific property issues that may require capital expenditures.
• Debt Maturities: Review the schedule of fixed-rate debt maturities to ensure refinancing risk is manageable given current interest rate environments.
• Concession Levels: Monitor future quarters to see if increased tenant concessions continue to erode rental revenue growth despite improved physical occupancy.