Business Context and Reporting Period
New England Realty Associates Limited Partnership (NERA) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. NERA owns and operates residential, mixed-use and commercial properties in Eastern Massachusetts and Southern New Hampshire, and holds 40%–50% interests in nine unconsolidated joint ventures. At quarter-end, its consolidated portfolio included 2,412 apartments, 19 condominium units and approximately 110,949 square feet of commercial space.
Financial Results and Key Metrics
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $9.968 million | $8.759 million | $27.990 million | $26.184 million |
| Income before other income and discontinued operations | $2.484 million | $3.117 million | $8.412 million | $9.396 million |
| Income (loss) from continuing operations | $(32,220) | $772,871 | $1.640 million | $2.403 million |
| Net income | $(32,874) | $774,454 | $5.338 million | $2.449 million |
| Net cash from operating activities | Not stated for quarter | Not stated for quarter | $6.713 million | $8.444 million |
Revenue and operating performance: Nine-month rental income increased 6.9% to $27.688 million. Management cited higher rents and the July acquisition of Hamilton Green, which contributed approximately $891,000 of rental income in the quarter. Nine-month operating expenses rose 16.6% to $19.578 million, outpacing revenue growth; increases included depreciation and amortization, operating costs, repairs, taxes and insurance, and administrative expenses. The implied income-before-other-income margin was approximately 30.0% for the nine months, versus 35.9% in 2012; for Q3 it was approximately 24.9%, versus 35.6%.
Profit and unusual items: Nine-month net income more than doubled, principally because of a $3.679 million gain on the May sale of Nashoba Apartments. Continuing-operations income fell 31.7% to $1.640 million. Q3 net loss compared with prior-year net income; management attributed the pressure primarily to Hamilton Green’s acquisition-period expenses, including depreciation and amortization.
Cash flow and distributions: Nine-month operating cash flow was $6.713 million, down from $8.444 million. Investing activities used $59.822 million, largely reflecting $64.285 million of rental-property acquisitions and improvements. Financing activities provided $51.386 million, including $95.0 million of mortgage proceeds and $39.081 million of mortgage payoffs and principal payments. Cash declined $1.723 million to $5.259 million. NERA paid distributions of $7.50 per unit, or $0.25 per depositary receipt, in each of the first three quarters ($0.75 per receipt for the period).
Balance sheet, debt and liquidity: Total assets were $177.631 million, including rental properties of $154.265 million; mortgage notes payable were $191.974 million, total liabilities were $198.753 million, and partners’ capital was negative $21.122 million. Mortgage rates ranged from 2.44% to 7.07%, with a 4.84% weighted average rate for NERA’s consolidated mortgages. NERA also reported approximately $61.057 million as its proportionate share of non-recourse joint-venture debt. Cash and cash equivalents were $5.259 million; security deposits and escrow balances include restricted cash. Management said operating cash and interest-bearing accounts should cover operations, distributions, required debt payments and current improvements. It also reported approximately $3.609 million of property improvements completed during the nine months and planned a further $200,000 for the rest of 2013.
Material Changes Versus Prior Period
- Hamilton Green, a 193-unit Andover apartment complex, was acquired in July for $62.5 million. The acquisition drove growth in rental-property assets, depreciation and debt, and contributed to Q3 expenses.
- Nashoba Apartments was sold for $4.3 million; NERA recorded a $3.679 million book gain and used approximately $2.1 million of net proceeds in a Section 1031 exchange toward Hamilton Green.
- Mortgage debt rose to $191.974 million from $138.056 million at December 31, 2012. NERA refinanced School Street and 62 Boylston Street during the period; subsequent refinancing of Westgate is described below.
- Nine-month revenue grew 6.9%, while operating expenses rose 16.6%. Same-store rental revenue increased 3.4% for the nine months, according to management.
- Cash from operations fell year over year, while the acquisition substantially increased investing cash outflows. The Partnership repurchased units and depositary receipts for $1.022 million during the nine months.
Outlook, Commentary, Risks and Contingencies
Management expected 2013 net operating income (income before depreciation, amortization and interest) to exceed 2012. It forecast overall revenue growth of 3%–4% in 2014, while anticipating slower growth, increased leasing time and resistance in suburban markets. Management noted that housing demand was consistent with the prior leasing season but had weakened early in Q4, and that additional Eastern Massachusetts housing supply could temper rent growth.
NERA expected to close the $38.5 million Hamilton Green mortgage in Q4 at a fixed 4.67% rate for 15 years, with two years of interest-only payments and amortization thereafter. The filing said this refinancing would require an additional $1.5 million of Partnership capital. Westgate was refinanced on October 1, 2013 with a $15.7 million mortgage at 4.65%, interest-only for 10 years, maturing in September 2023. Management stated that the refinancing of Westgate and 62 Boylston would increase annual debt service to approximately $3.0 million once amortization begins, versus approximately $2.0 million previously.
Risks include local real-estate and leasing conditions, vacancies and tenant credit, rising operating and utility costs, competition, access to refinancing, interest-rate changes, property acquisition and leverage risks, and environmental or insurance exposures. Management reported no material environmental liabilities known to it, no material pending legal proceedings, and no material change to the risk factors in the 2012 Form 10-K. Related-party exposure merits attention: the properties are managed by an entity owned by the General Partner’s majority shareholder, and the Partnership also transacts with that manager and invests in joint ventures with its principals and employees. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the Hamilton Green refinancing closed as expected, on what final terms, and how the stated additional capital requirement affected liquidity.
- Occupancy and leasing trends: at November 1, residential vacancy was 4.2% versus 3.0% a year earlier, and commercial vacancy was 8.7% versus 4.9%.
- Whether rental growth can offset operating-cost inflation, higher depreciation and debt service; assess the 2014 growth outlook against actual leasing performance.
- Debt maturities, refinancing requirements, fixed versus variable exposure, prepayment provisions, and joint-venture obligations; confirm the relationship between consolidated and proportionate joint-venture debt.
- The quality and sustainability of reported earnings, separating recurring operations from the Nashoba sale gain, and the effect of acquisitions and refinancing costs.
- Related-party management fees, professional-service charges and joint-venture transactions, including governance and conflict-of-interest oversight.
- Liquidity after acquisition spending, distributions, unit repurchases, planned capital improvements and subsequent financing; the filing reports negative partners’ capital and mortgage debt exceeding consolidated assets.