CSR

Business Context and Reporting Period

Company: Investors Real Estate Trust (IRET), a self-advised equity REIT focused on multi-family residential and commercial properties (office, industrial, retail, medical) primarily in the upper Midwest.

Reporting Period: Third quarter of fiscal year 2005, ended January 31, 2005.

Portfolio Overview: As of January 31, 2005, the portfolio consisted of 66 multi-family properties (8,505 units) and 145 commercial properties (7.8 million square feet).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 13.6% for the quarter and 18.9% for the nine-month period compared to the prior year, driven primarily by acquisitions in fiscal 2004 and 2005.
• Net Income: Net income increased 30% for the quarter and 58% for the nine-month period. However, net income available to common shareholders was impacted by preferred dividends ($1.8 million for the nine months).
• Discontinued Operations: Significant gains were recognized from the sale of properties classified as discontinued operations ($2.3 million gain in the quarter; $8.2 million gain for the nine months).
• Expense Increases:
  • Maintenance: Increased 10% (quarter) and 21% (nine months), largely due to new acquisitions.
  • Utilities: Increased 22% (quarter) and 25% (nine months) due to new properties and general rate increases.
  • Interest Expense: Increased 9% (mortgage debt balance) and 16% (quarterly expense) due to new debt financing acquisitions.
  • Administrative Expenses: Increased 43% (quarter) due to hiring and Sarbanes-Oxley compliance costs.
• Occupancy: Economic vacancy for stabilized commercial properties increased to 11.46% (quarter) from 8.32% in the prior year. Multi-family stabilized vacancy decreased slightly to 9.60%.

Guidance, Outlook, and Risks

• Market Outlook: Management expects demand for both commercial space and apartments to remain weak through the fourth quarter of fiscal 2005. Seasonal reductions in demand are anticipated during winter months.
• Concessions: Tenant concessions (rent reductions) are increasing to maintain occupancy, estimated to have lowered operating revenues by $0.8 million in the quarter and $2.8 million for the nine months.
• Capital Resources: The company maintains three unsecured lines of credit totaling $24.4 million with no outstanding balances. Liquidity is supported by operating cash flows and potential equity issuances.
• Pending Transactions: As of January 31, 2005, the company had agreements to acquire properties totaling approximately $17.9 million and sell properties for approximately $2.6 million. A subsequent acquisition of a 140-unit apartment complex for $7.1 million closed in March 2005.
• Risks:
  • Interest Rate Risk: While 95% of debt is fixed, the company has $36.0 million in variable rate debt. A 1% increase in rates would increase annual interest expense by $360,000.
  • Environmental Liability: Potential costs for remediation of hazardous substances at properties.
  • Internal Controls: The company is in the process of remediating deficiencies identified during Sarbanes-Oxley Section 404 compliance testing.

Investor Verification Checklist

• Occupancy Trends: Verify the impact of rising commercial vacancy rates (11.46%) and increased rent concessions on future cash flows.
• Discontinued Operations: Assess the sustainability of net income given the significant one-time gains ($8.2 million) from property sales in the nine-month period.
• Debt Maturities: Review the schedule of mortgage debt maturities, noting the weighted average interest rate of 6.09% and the mix of fixed vs. variable rates.
• Acquisition Pipeline: Confirm the closing of pending acquisitions ($17.9 million) and the subsequent Olympik Village Apartments purchase ($7.1 million) to evaluate portfolio growth.
• Sarbanes-Oxley Compliance: Monitor the company's progress in remediating internal control deficiencies to ensure timely compliance with Section 404 by the April 30, 2005 deadline.