Business Context and Reporting Period
Investors Real Estate Trust (NYSE: IRET) is a self-advised equity REIT operating through an UPREIT structure. It owns and operates multifamily residential and commercial properties, including office, healthcare, industrial and retail assets, primarily in Minnesota and North Dakota. The filing is a Form 10-K for the fiscal year ended April 30, 2015; the requested “2014 Q4” period does not match the filing’s reporting period.
- Portfolio at April 30, 2015: 100 multifamily properties with 11,844 units and 149 commercial properties totaling approximately 9.6 million square feet.
- Minnesota and North Dakota generated approximately 69.5% of fiscal 2015 gross revenue.
- Management shifted its strategy in January 2015 toward multifamily and healthcare acquisitions and began exploring the sale of substantially all office and retail properties.
Financial Metrics
| Metric | Fiscal 2015 | Fiscal 2014 | Change |
|---|---|---|---|
| Total revenue | $283.2 million | $267.1 million | Up 6.0% |
| Real estate rentals | $235.9 million | $219.9 million | Up 7.2% |
| Net income | $28.7 million | $(16.9) million | Improved $45.6 million |
| Net income available to common shareholders | $12.6 million | $(24.7) million | Improved $37.3 million |
| Basic and diluted EPS | $0.11 | $(0.23) | Improved $0.34 |
| Funds from operations applicable to common shares and units | $86.6 million; $0.64 per share/unit | $79.9 million; $0.63 per share/unit | Up 8.3% in dollars |
| Net cash provided by operating activities | $114.2 million | $92.5 million | Up $21.7 million |
| Net cash used in investing activities | $(176.4) million | $(121.8) million | Higher investment spending |
| Cash and cash equivalents | $49.0 million | $47.3 million | Up $1.7 million |
| NOI | $168.7 million | $159.5 million | Up 5.8% |
Operating income was $78.7 million, compared with $33.4 million in fiscal 2014. The improvement primarily reflected lower impairment charges and higher property revenue. Interest expense was broadly stable at $59.0 million. The filing does not provide a consolidated GAAP operating margin; based on reported figures, operating income was approximately 27.8% of revenue versus 12.5% in fiscal 2014.
Balance Sheet, Debt and Liquidity
- Total assets were $2.0 billion and total liabilities were $1.25 billion at April 30, 2015.
- Real estate investments increased to $1.83 billion from $1.70 billion.
- Mortgage debt was $974.8 million, down from $997.7 million; the weighted-average mortgage rate declined to 5.16% from 5.37%.
- Construction debt and other debt increased to $144.1 million from $63.2 million, reflecting development activity.
- The secured revolving line of credit had a $90.0 million commitment and $60.5 million outstanding, with maturity in September 2017 and a 4.75% rate at year-end.
- Approximately 92.8% of mortgage debt was fixed-rate. Approximately $70.0 million of mortgage debt was variable-rate.
- Total indebtedness was 64.1% of total real estate investments and 97.8% of net assets as calculated under the company’s bylaws.
- Mortgage principal due in fiscal 2016 was $121.9 million, with approximately $48.3 million of related interest payments scheduled.
- Management stated that it expected sufficient liquidity for the next twelve months, including estimated capital expenditures of $22.6 million, but noted dependence on operating cash flow, refinancing, asset sales and new borrowings.
Operations and Property Metrics
- Same-store multifamily revenue increased 3.4%, and same-store multifamily occupancy rose to 94.7% from 93.4%. All-property multifamily occupancy was 92.0%.
- Same-store commercial occupancy declined to 89.7% from 90.1%; all-property occupancy was 83.2% for office, 95.8% for healthcare, 83.4% for industrial and 83.4% for retail.
- Segment NOI was $67.4 million for multifamily, $38.5 million for office, $49.1 million for healthcare, $5.0 million for industrial and $8.8 million for retail.
- Capital expenditures, tenant improvements and other capital spending totaled approximately $31.7 million during fiscal 2015.
- Distributions to common shareholders and operating partnership unitholders remained $0.13 per quarter, or $0.52 per share/unit for the year.
Material Changes Versus the Prior Comparable Period
- Revenue increased 6.0%, driven by acquisitions, development projects placed in service and same-store rent growth.
- Net income available to common shareholders changed from a $24.7 million loss to $12.6 million of income, primarily because fiscal 2014 included $42.6 million of real estate impairment charges versus $6.1 million in fiscal 2015.
- FFO increased to $86.6 million from $79.9 million, while FFO per share/unit rose to $0.64 from $0.63.
- Operating cash flow increased to $114.2 million from $92.5 million.
- The company placed approximately $124.5 million of development projects in service, compared with $53.5 million in fiscal 2014, and acquired approximately $56.3 million of properties.
- The multifamily investment allocation increased to 45.1% of property owned cost from 37.7%; office declined to 22.9% from 27.3%.
- Common shares outstanding increased to approximately 124.5 million from 109.0 million, while operating partnership units declined to approximately 14.0 million from 21.1 million.
Outlook, Risks, Contingencies and Unusual Items
- Material loan default: A subsidiary received a default notice concerning a $122.6 million non-recourse loan after a missed April 2015 payment. The estimated fair value of the collateral was below the loan balance. The loan matures in October 2016, and the outcome of discussions with the special servicer was uncertain.
- Strategic asset sales: Subsequent to year-end, IRET signed agreements to sell 34 office properties for $250.0 million, five additional office properties through a joint venture for $40.0 million and 17 retail properties plus land for $81.5 million. These transactions were expected in the second or third quarter of fiscal 2016 but remained subject to conditions.
- Development exposure: Projects in progress had anticipated total costs of approximately $292.8 million, with $209.0 million incurred at year-end. Completion timing and final costs were subject to contingencies.
- Market commentary: Management reported improving multifamily conditions, strong demand for new apartment units and stable healthcare markets. Office demand remained weak, particularly for suburban Class B properties, while retail and industrial conditions were improving unevenly.
- Energy-market exposure: Williston, North Dakota properties faced increased vacancy and price competition as lower oil prices reduced demand associated with the Bakken region.
- Impairments: Fiscal 2015 included $6.1 million of non-cash impairments on four commercial properties and two parcels of unimproved land, compared with $44.4 million in fiscal 2014.
- Lease and occupancy risk: Approximately 12.9% of commercial square footage and 8.0% of apartment units were vacant at April 30, 2015. Significant commercial lease expirations occur in fiscal 2016 and 2017.
- Other contingencies: A tenant exercised an option to purchase Nebraska Orthopaedic Hospital; the purchase price was subject to arbitration and completion was not assured. The company also had $7.2 million of tenant-improvement commitments expected within approximately 12 months.
- REIT and interest-rate risks: Failure to maintain REIT qualification, reduced availability of Fannie Mae or Freddie Mac financing, refinancing risk, higher interest rates, tenant credit deterioration and uninsured property losses could adversely affect distributions and liquidity.
Investor Verification Points
- Verify the status, collateral value, covenant compliance and potential remedies related to the $122.6 million defaulted loan.
- Confirm whether the announced office and retail dispositions closed, at what prices and how proceeds were allocated between debt reduction, development and acquisitions.
- Reconcile FFO and NOI to GAAP results and assess the effects of impairment charges, property sales and noncontrolling interests.
- Review upcoming mortgage maturities, refinancing assumptions and the availability of the revolving and construction facilities.
- Monitor multifamily occupancy, rent growth and new supply, particularly in North Dakota and the Williston market.
- Assess the execution risk, remaining funding requirements and lease-up progress of development projects.
- Review the potential impact of commercial vacancies and lease expirations on future cash flow and distributions.