Business context and reporting period
Transcontinental Realty Investors, Inc. (TCI) filed this Form 10-K for the fiscal year ended December 31, 2015. TCI acquires, develops and operates residential and commercial real estate and land; it is externally managed, has no employees, and subsidiaries of American Realty Investors, Inc. (ARL) own approximately 80.9% of its common stock. At year-end, the portfolio included 48 apartment communities with 7,983 units, eight commercial properties totaling about 1.9 million square feet, a golf course and approximately 3,665 acres of land.
Key financial results and metrics
- Revenue: Rental and other property revenue was $102.2 million, up $26.3 million (about 35%) from $75.9 million in 2014, primarily reflecting acquisitions.
- Operating results: Operating income was $9.3 million, versus $0.8 million in 2014; operating margin was approximately 9.1%, compared with 1.0%. Property operating expenses rose to $52.3 million from $39.5 million, and depreciation and amortization increased to $21.3 million from $17.4 million.
- Profit and per-share results: Net loss attributable to common shares was $8.5 million, or $0.98 per diluted share, compared with income of $40.6 million, or $4.74 per diluted share, in 2014. The 2015 result included $18.9 million of land-sale gains and $0.9 million of discontinued-operations income; 2014 included $37.9 million of discontinued-operations income, largely reflecting property-sale gains.
- Cash flow: Net cash used in operating activities was $50.9 million, compared with $29.4 million used in 2014. Investing activities used $139.8 million, while financing activities provided $193.7 million. Year-end cash and cash equivalents were $15.2 million; restricted cash was $44.1 million.
- Debt and interest: Gross principal debt was approximately $796.8 million; the filing separately reports $799.4 million including accrued interest and $779.4 million net of unamortized borrowing costs. Approximately $758.7 million was fixed-rate and $38.1 million variable-rate. The weighted-average rate was 4.54%. Mortgage and loan interest expense rose to $41.6 million from $30.9 million. Scheduled principal payments were $79.5 million in 2016.
- Balance sheet and liquidity: Total assets were $1.110 billion and stockholders’ equity was $225.1 million. Gross principal debt equaled about 72% of total assets. Management said anticipated 2016 operating cash would not cover all obligations and that it intended to sell assets, refinance or extend debt, and seek additional real-estate-secured borrowing.
- Portfolio operations: Average apartment occupancy was 94.39%. Management reported commercial occupancy above 86% for 2015. A $5.3 million impairment reduced the carrying value of the U.S. Virgin Islands golf course and related assets.
Material changes versus the prior comparable period
- Revenue growth reflected additions to the portfolio, including 12 apartment communities and one commercial office building acquired during 2015. Disclosed purchase prices included $82.9 million for five third-party apartment communities, $30.4 million for seven related-party communities and $16.8 million for an office building.
- Land sales generated $18.9 million of reported gains; TCI also sold approximately 579 acres in Texas for $102.9 million. The filing describes a separate U.S. Virgin Islands land sale for $33.9 million cash and cites a gain of about $12 million, but the relationship of that stated gain to reported land-sale gains is not clear from the filing text.
- Interest expense increased by $10.7 million, including higher costs associated with new mezzanine debt. The company also incurred $5.0 million in loan charges and prepayment penalties, versus $2.8 million in 2014.
- Operating cash use worsened, while financing cash flow turned positive, mainly because of new borrowings. TCI refinanced or modified ten loans totaling $136 million, which management said lowered rates and monthly payments.
- Adoption of updated discontinued-operations accounting meant fewer property dispositions qualified for that presentation. Consequently, 2015 results are not directly comparable with 2014, which included substantial discontinued-operations gains.
Outlook, risks, contingencies and unusual items
- Outlook and liquidity: No quantitative earnings or revenue guidance was provided. Management plans to continue acquisitions and selected apartment development, while selling properties where it believes value has been maximized. It cautioned that 2016 operating cash would not be sufficient for all obligations and depends on asset sales, refinancing, extensions and additional borrowing. The auditor’s report also draws attention to management’s liquidity plans.
- Debt and development risks: Substantial leverage, balloon maturities, covenant requirements, variable-rate exposure and reliance on refinancing create liquidity and default risks. Management identified construction delays, cost overruns, permitting and lease-up as development risks. A 100-basis-point increase in variable borrowing rates was estimated to reduce 2016 net income by $0.4 million.
- Related-party exposure and governance: TCI has overlapping directors and officers with ARL and IOT, and its external advisor Pillar also serves those entities. TCI reported $90.5 million receivable from ARL, $62.4 million of notes receivable due from related entities (primarily UHF), and a $60.35 million mezzanine-loan guarantee involving UHF. Related-party transactions are not necessarily arm’s length.
- Sales and accounting items: The Mercer Crossing land transaction had total consideration of $75 million, including a $50 million subordinated seller note held by TCI. Because the buyer’s down payment was considered inadequate and seller financing substantial, TCI used deposit-method accounting and recognized no sale revenue; the land remained on the books. Approximately 91 acres sold to related parties were also still treated as subject to sales contracts, with sales recognition deferred.
- Litigation: TCI obtained a July 2015 judgment against Dynex Commercial awarding it $19.5 million, plus post-judgment interest; collection and next steps were under review. A separate suit naming TCI, its directors and officers was dismissed as to TCI and IOT by a January 2016 court order. Management said other ordinary-course litigation was not expected to materially affect the company.
- Capital allocation: No common dividends were declared in 2013, 2014 or 2015. Future distributions are subject to the board’s assessment of financial condition, prospects and financing restrictions.
- Audit and controls: The auditor issued an unqualified opinion on the financial statements. Management assessed disclosure controls and internal control over financial reporting as effective; the auditor did not attest to internal-control effectiveness.
Important facts for investors to verify
- How TCI will meet 2016 liquidity needs, including the actual maturity schedule, covenant headroom and progress on refinancing, extensions and planned asset sales.
- Whether the reported negative operating cash flow is recurring, and how cash available for debt service compares with property-level operating performance.
- The collection prospects and collateral coverage for related-party receivables, particularly UHF notes, and the potential exposure under the $60.35 million mezzanine-loan guarantee.
- The final accounting, proceeds allocation and collection status for the Mercer Crossing transaction and other land sales, including the U.S. Virgin Islands gain figures, which are not clearly reconciled in the filing text.
- Commercial-property occupancy and lease expirations, including the concentration of 2016 expirations and lower occupancy at certain office buildings.
- The terms and economics of related-party acquisitions, advisory and brokerage fees, and how investment opportunities are allocated among TCI, ARL and IOT.