American Realty Investors, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. ARL is an externally advised real estate company; its consolidated results include majority-owned Transcontinental Realty Investors (TCI) and Income Opportunity Realty Investors (IOR). ARL has no employees and is majority-owned by related parties.
Business context and portfolio
ARL invests in apartments, commercial properties, land and related real estate interests. At year-end, it owned nine apartment communities with 1,489 units and seven commercial properties totaling about 1.7 million square feet, plus land holdings. Its 50%-owned Victory Abode Apartments (VAA) joint venture held 49 apartment communities with 9,192 units.
Key financial results
| Metric | 2018 | 2017 |
|---|---|---|
| Rental and other property revenue | $121.0 million | $126.2 million |
| Operating income | $13.9 million | $17.4 million |
| Net income (loss) applicable to common shares | $172.8 million | $(9.5) million |
| Diluted earnings (loss) per share | $10.81 | $(0.61) |
| Cash from (used in) operating activities | $(172.3) million | $(30.1) million |
| Total assets | $826.1 million | $1,296.7 million |
| Total shareholders’ equity | $321.1 million | $165.9 million |
Revenue decreased about 4% year over year, primarily reflecting the November contribution of properties to VAA. Operating income also declined. Reported 2018 net income was largely transaction-driven: it included a $154.1 million gain on the VAA disposition and $17.4 million of land-sale gains. The filing reports no impairment charges in 2018.
ARL reported $36.4 million of cash and cash equivalents and $70.2 million of restricted cash at year-end. The cash-flow statement’s $106.6 million ending balance includes restricted cash. Debt on the balance sheet was approximately $445.5 million, comprising $287.0 million of notes and interest payable and $158.6 million of bonds and interest payable. The contractual-obligations schedule, including interest, totaled $613.9 million, with $93.4 million scheduled for 2019. The filing identifies $41.9 million of variable-rate notes; its reported overall weighted-average interest rate was 7.29%, versus 4.91% in 2017.
Material changes and unusual items
- In November 2018, TCI and its subsidiary contributed 49 apartment properties and three development projects to VAA, received approximately $236.8 million in cash, and recognized a $154.1 million gain. VAA assumed property liabilities, including HUD mortgage debt. ARL accounts for VAA using the equity method after the transaction.
- Revenue and property operating expenses fell following the VAA contribution. General and administrative expense rose to $12.7 million from $7.7 million, including costs associated with forming the joint venture and higher advisory, legal and professional fees.
- Other income included approximately $17.6 million of recognized deferred income and $7.6 million of insurance proceeds. A $12.4 million foreign-currency transaction gain related to Southern’s Israeli-shekel-denominated bonds was also recorded; the filing characterizes such exchange effects as unrealized until settlement.
- Mercer Crossing sales and related accounting contributed to land-sale gains. The company reacquired unsold portions of an earlier land transaction in August 2018; certain sales to related parties remained deferred and recorded as subject to sales contracts.
- Common dividends were not declared in 2018, 2017 or 2016. The filing reports an acquisition by TCI of 900,000 Series A preferred shares for about $9 million, with approximately $9.9 million of accrued dividends, and consolidation eliminations.
Liquidity, outlook, risks and contingencies
Management said it expected excess cash flow from property operations in 2019, but also stated that operating cash flow alone would not cover all obligations as due. Its stated liquidity plan depends on property and land sales, refinancing or extending debt, and additional real-estate-secured borrowing. Elsewhere, management says year-end cash and expected 2019 collections on notes and interest receivable should meet cash requirements. The auditor’s report includes an emphasis of liquidity referencing the planned asset sales and debt refinancing or extensions.
Liquidity and refinancing are key risks: substantially all assets are pledged, debt covenants can permit acceleration, and the company notes that balloon maturities may exceed available cash. A 100-basis-point increase in variable borrowing rates was estimated to reduce net income by about $0.4 million. Other material risks include tenant vacancies or defaults, market and construction risks, real-estate illiquidity, geographic concentration, and related-party conflicts. The company reported approximately $97.5 million of mortgage notes receivable exposure to related parties in one disclosure; Pillar owed ARL approximately $70.6 million at year-end. Transactions and management arrangements with affiliates are extensive and may not be on arm’s-length terms.
Contingencies include ARL’s limited-recourse guarantee, alongside TCI’s primary guarantee, on a $39.1 million UHF mezzanine loan; UHF was reported in covenant compliance. The filing also describes a February 2019 shareholder lawsuit alleging fiduciary-duty breaches involving transactions with IOR. The company denies the allegations and intends to defend the action. Financial statements received an unqualified audit opinion; the auditor did not attest to internal-control effectiveness, while management concluded controls were effective.
Most important facts for investors to verify
- Whether the 2019 liquidity plan—particularly asset dispositions, note collections and debt extensions/refinancing—can meet scheduled maturities and covenant requirements.
- The quality, collectability, collateral and terms of related-party receivables, including the reported balances due from UHF and Pillar; related disclosures do not present a fully consistent picture.
- The VAA transaction’s final ownership, profit-allocation and cash true-up terms. The filing describes 50% voting rights, 49% profit participation for each principal Class A member and a 2% executive profit interest; verify the agreement and final adjustments.
- The sustainability of earnings excluding the VAA gain, land-sale gains, deferred income, insurance proceeds and foreign-exchange gains.
- The status and potential exposure of disclosed litigation. The Clapper litigation discussion is inconsistent within the filing regarding dismissal and reinstatement; clarify the current status, and monitor the post-year-end Berger case.