AMERICAN REALTY INVESTORS INC annual report, FY2019

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American Realty Investors, Inc. — 2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019. The company is an externally advised real estate owner and developer; its consolidated results include Transcontinental Realty Investors, Inc. (TCI) and Income Opportunity Realty Investors, Inc. (IOR). ARL has no employees and is managed by related-party advisor Pillar.

Business context and portfolio

At year-end, ARL directly owned 10 apartment communities with 1,657 units, seven commercial properties totaling about 1.7 million square feet, and about 1,951 acres of land. It also held a 50% interest in Victory Abode Apartments (VAA), whose portfolio comprised 51 apartment communities and 9,888 units. Five ARL/TCI apartment projects and one VAA project were in development; reported project costs and scope vary by entity in the filing.

Financial performance and position

  • Revenue: Rental and other property revenue was $48.0 million, down from $121.0 million in 2018. The principal reason was the November 2018 contribution of apartment properties to VAA: those properties were deconsolidated, and ARL’s share of VAA results is now recorded under the equity method.
  • Profit and margins: Operating loss was $11.4 million versus operating income of $13.9 million in 2018. Net loss attributable to ARL was $16.0 million; net loss applicable to common shares was $16.0 million, or $1.00 diluted loss per share. By comparison, 2018 common-share income was $172.8 million, including a $154.1 million gain on forming VAA. 2019 included $15.3 million in land-sale gains.
  • Notable expense and income items: Interest income was $26.0 million; mortgage and loan interest expense was $39.9 million. Foreign-currency transaction loss was $15.1 million, compared with a $12.4 million gain in 2018. Debt extinguishment costs were $5.2 million, including a prepayment penalty, after repayment of $41.5 million of commercial mortgage debt.
  • Cash flow: Operating activities used $40.6 million, investing activities used $3.7 million, and financing activities provided $21.0 million. Cash and cash equivalents were $51.2 million; restricted cash was $32.1 million. The cash-flow statement reports $83.3 million of cash, cash equivalents and restricted cash combined.
  • Assets and equity: Total assets were $830.6 million and total shareholders’ equity was $296.5 million. Net real estate was $387.8 million; notes and interest receivable, net, were $156.2 million. Book value was $18.54 per share.
  • Debt and liquidity: Notes payable were $261.4 million gross, and bonds payable were $233.0 million gross; balance-sheet carrying amounts, including accrued interest and net of issuance costs, were $254.9 million and $229.7 million, respectively. Management cited approximately $501.7 million of total indebtedness. Contractual notes and bond obligations, including interest, totaled $619.5 million, with $82.7 million scheduled for 2020 and $162.3 million for 2023. Most notes had fixed rates; the weighted-average rate on notes payable was 5.04% at year-end.
  • Distributions: No common dividends were declared in 2019, 2018 or 2017.

Material changes versus 2018

  • Revenue fell largely because the prior-year comparison included the apartment properties later contributed to VAA. Property operating expenses and depreciation also declined for the same reason.
  • 2018’s reported profit was unusually high because of the VAA formation gain; 2019 instead reported a loss, including currency losses and debt-extinguishment costs.
  • Land-sale proceeds were about $30.0 million in 2019, versus $43.3 million in 2018; reported land-sale gains were $15.3 million and $17.4 million, respectively.
  • Gross bonds outstanding rose to $233.0 million from $162.7 million, including the 2019 Series C issuance of approximately $78.1 million. The company used part of the proceeds to repay a $41.5 million mortgage.

Outlook, risks and contingencies

  • Management said cash on hand and anticipated 2020 receipts from notes and interest receivable were expected to meet cash requirements, while also planning selective property sales, debt refinancing or extensions, and additional real-estate-secured borrowing. The auditor highlighted this liquidity plan. Management acknowledged that cash generated by TCI’s property operations might not cover all obligations as due.
  • COVID-19 was identified as a subsequent-event risk; the filing said the effect on the company and economy was uncertain and could be materially adverse. No quantified COVID-19 impact or numerical earnings guidance was provided.
  • Key risks include substantial leverage, refinancing and covenant risk, property illiquidity, development delays and cost overruns, tenant and occupancy risks, regional market concentration, and exposure to variable-rate debt and foreign-exchange movements. The company stated substantially all assets were pledged to secure debt.
  • Related-party exposure is significant: ARL reported $86.0 million due from Pillar and substantial notes receivable from related parties, including UHF. ARL also guaranteed, on a primary basis, a $25 million UHF mezzanine loan; UHF was reported in covenant compliance at year-end. Related-party transactions may not be on arm’s-length terms.
  • Legal matters include the Berger shareholder action alleging breaches of fiduciary duty in transactions involving ARL, TCI, IOR and related parties; dismissal motions remained pending. The filing also describes the Clapper litigation involving a former entity and claims against ARL, and a Dynex judgment for TCI and others that TCI was pursuing collection on. Management said ordinary-course litigation was not expected to materially affect ARL, but outcomes remain uncertain.
  • The auditor issued an unqualified opinion on the financial statements and emphasized liquidity. The auditor did not attest to internal control over financial reporting; management concluded disclosure controls and internal controls were effective.

Important facts for investors to verify

  • Near-term maturities, covenant compliance, and the availability and terms of refinancing or extensions, particularly the 2020 and 2023 obligations.
  • Whether cash generation, property sales, and collection of notes receivable can support liquidity; distinguish unrestricted cash from restricted cash.
  • Credit quality, collateral, collectability, and repayment timing of related-party receivables, including amounts involving UHF and Pillar.
  • VAA’s operating performance, distributions, debt, and the economic value of ARL’s 50% interest; VAA reported a 2019 net loss of $50.4 million.
  • Occupancy and lease rollover exposure, including weak occupancy at certain properties; the Bridgeview Plaza retail center was 37.25% occupied at year-end.
  • Effects of COVID-19, foreign-exchange changes on shekel-denominated bonds, and outcomes of material legal claims.
  • Related-party governance, fees, guarantees, and reported ownership concentration; more than 80% of ARL shares were held by related parties.