Business context and reporting period
American Realty Investors, Inc. (ARL) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. ARL is an externally advised real estate investor with apartment, commercial, land-development and mortgage-loan activities. At quarter-end, it reported 48 apartment communities with 8,494 units, seven commercial properties totaling about 1.7 million rentable square feet, 3,218 acres of land and ten apartment projects in development. The filing also gives differing portfolio counts in different sections; see investor verification items below.
Unless otherwise stated, financial amounts below are in millions of dollars. ARL reported 15,997,076 common shares outstanding as of November 13, 2018.
Financial performance and position
| Metric | Three months ended Sept. 30 | Nine months ended Sept. 30 |
|---|---|---|
| Rental and other property revenue | 2018: $33.4; 2017: $31.8 | 2018: $96.1; 2017: $95.2 |
| Net operating income | 2018: $5.2; 2017: $5.4 | 2018: $13.7; 2017: $14.7 |
| Net income (loss) attributable to ARL | 2018: $20.4; 2017: $9.4 | 2018: $25.5; 2017: $(7.2) |
| Net income (loss) applicable to common shares | 2018: $20.1; 2017: $9.1 | 2018: $24.9; 2017: $(8.1) |
| Diluted EPS | 2018: $1.26; 2017: $0.59 | 2018: $1.56; 2017: $(0.52) |
For the first nine months, operating cash flow was negative $11.2 million, investing cash flow was negative $71.9 million and financing cash flow was positive $91.0 million. The cash-flow statement reports $96.4 million of ending cash and restricted cash combined; the balance sheet separates this into $23.8 million of cash and equivalents and $72.7 million of restricted cash. Cash paid for interest was $45.7 million.
At September 30, total assets were $1.402 billion, total liabilities $1.209 billion and total shareholders’ equity $193.3 million. Notes payable, net of deferred borrowing costs, were about $971.4 million; bonds payable were reported at $161.0 million. These balances include debt associated with real estate held for sale. The company reported a 6.63% weighted-average borrowing rate and $65.1 million of variable-rate debt; management estimated a 100-basis-point rate increase would add about $0.65 million to annual interest cost.
Material changes versus the prior comparable period
- Nine-month common-share earnings improved from an $8.1 million loss in 2017 to $24.9 million of income in 2018. The increase was substantially affected by non-routine gains and accounting recognition, rather than stronger property operating income: nine-month NOI declined to $13.7 million from $14.7 million.
- Other income included approximately $17.6 million of deferred income recognized in September following IOR’s sale of land, and the company recorded a $6.4 million nine-month foreign-currency transaction gain related to its shekel-denominated bonds. The currency gain is described as unrealized. Nine-month land-sale gains were $13.6 million, versus $1.0 million in 2017.
- Property revenue rose modestly, driven by apartment revenue growth, while commercial revenue declined. Nine-month property operating expenses decreased, but general and administrative expense rose to $7.4 million from $5.8 million; management cited increased advisor reimbursements and transaction costs.
- Investing cash outflow increased to $71.9 million from $33.6 million, principally reflecting $66.6 million for construction and development. Operating cash outflow improved from the prior year but remained negative.
- ARL converted 200,000 Series A preferred shares into 482,716 common shares in January 2018. Preferred shares outstanding declined to 1,800,614 from 2,000,614 at year-end 2017.
Outlook, risks, contingencies and unusual items
- Liquidity: Management expects excess cash flow from property operations in 2018 but states it will not be sufficient to meet all obligations as they come due. The company plans to sell land and income-producing properties, refinance or extend debt and seek additional real-estate-secured borrowings. No specific earnings guidance is provided.
- Potential joint venture: A TCI agreement with Macquarie concerns a portfolio of Class A multifamily properties, including ARL assets. The filing says $726.6 million of assets were classified as held for sale for the proposed venture and that closing was expected in the fourth quarter of 2018. The anticipated ownership was 49% each for TCI and Macquarie and 2% for TCI’s president and CEO; completion and final terms were not yet established in this filing.
- Debt and defaults: Certain mortgages on properties transferred to related parties and classified as subject to sales contracts were in default, primarily for lack of payment. The company said discussions with lenders were ongoing and that it had assessed impairment. Some land mortgages were also being modified or extended.
- Related parties: More than 80% of ARL stock is owned by related-party entities. Pillar, the external advisor and cash manager, is shared with affiliated companies; ARL reported a $62.5 million receivable from a related party. Management cautions that related-party transactions may not be on arm’s-length terms.
- Other exposures: ARL is the primary guarantor on a $39.1 million mezzanine loan to UHF; UHF was reported in covenant compliance. The filing describes ongoing Clapper-related litigation, including a reinstated claim naming ARL, which the company says it is vigorously defending. Management believes ordinary-course litigation will not materially affect the company, subject to the matters described.
- Management identifies real-estate market and tenant risks, financing availability and interest rates, development delays and cost overruns, property-sale timing, environmental exposure and potential uninsured losses. It reported no changes to the risk factors in its 2017 Form 10-K.
Most important facts for investors to verify
- Whether the proposed multifamily joint venture closed, which ARL assets and debt transferred, and the resulting proceeds, ownership and control arrangements.
- Near-term debt maturities, covenant status and lender outcomes for mortgages described as in default or under modification, alongside management’s stated liquidity shortfall.
- Cash available for general use: distinguish the $23.8 million of cash and equivalents from $72.7 million of restricted cash.
- The sustainability of earnings excluding the $17.6 million deferred-income recognition, land-sale gains and unrealized currency effects; compare recurring property NOI and operating cash flow.
- Related-party receivable and loan collectability, transaction terms, advisor fees and the $39.1 million UHF guarantee.
- Portfolio-count reconciliation: the organization note reports 55 income-producing properties at September 30, while MD&A reports 58 for 2018; also verify asset and debt amounts classified as held for sale.