American Realty Investors, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited. Amounts below are in millions of dollars unless noted. ARL is an externally advised real estate owner and lender; its consolidated reporting includes TCI and its subsidiaries.
Business context and portfolio
At September 30, the company reported 49 apartment communities with 8,128 units, eight commercial properties totaling approximately 2.0 million rentable square feet, a golf course, and 3,754 acres of land. It also had eight apartment projects in development. During the first nine months, it acquired apartment communities and development land, sold land and income-producing properties, and continued apartment construction and predevelopment.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Rental and other property revenue | $30.1 | $27.8 | $90.1 | $75.2 |
| Net operating income | $3.8 | $2.1 | $11.7 | $7.9 |
| Net loss attributable to common shares | $(4.0) | $(5.4) | $(5.3) | $(1.6) |
| Diluted loss per share | $(0.26) | $(0.35) | $(0.34) | $(0.11) |
| Operating cash flow | Not presented quarterly | $28.5 | $(28.2) |
Net operating income is calculated here as property revenue less property operating expenses and depreciation and amortization; on that basis, NOI margin was approximately 12.6% in Q3 2016 versus 7.5% in Q3 2015, and 13.0% for the first nine months versus 10.6%.
- Balance sheet: Total assets were $1,139.4, versus $1,117.4 at December 31, 2015. Net real estate was $909.7; shareholders’ equity was $170.7.
- Debt: The notes-payable disclosure reports $834.0 of debt after unamortized borrowing costs, including accrued interest. The balance sheet separately reports $827.8 of notes and interest payable, plus $6.2 related to assets held for sale and sales contracts. Debt increased from $798.0 of balance-sheet notes and interest payable at year-end.
- Cash: Cash and equivalents fell to $7.3 from $15.2; restricted cash was $33.6, which should not be assumed to be freely available.
- Cash flows: Nine-month investing outflow was $62.4 and financing inflow was $26.0. Management attributed the operating cash-flow improvement primarily to changes in related-party receivables. Cash interest paid was $31.9, compared with $9.2 in 2015.
- Related-party lending: Net mortgage loans and accrued interest receivable from related parties totaled $112.4; the company recognized $14.5 of related-party note interest income in the first nine months.
Material changes versus the prior comparable periods
- Revenue increased 8% in Q3 and 20% year to date, primarily with apartment portfolio growth and, year to date, a commercial property acquisition. Property operating expenses also rose, by $1.2 in Q3 and $8.6 year to date.
- Q3 common-share loss narrowed, while the nine-month common-share loss widened. Year-to-date mortgage and loan interest expense increased $7.1 to $43.6; gains on land sales declined to $3.9 from $7.9, partly offset by $4.9 of gains on income-producing property sales versus $0.7 in 2015.
- Year-to-date segment operating income was $7.4 versus $7.2, but higher general and administrative and advisory expenses, among other non-segment items, contributed to a larger continuing-operations loss.
- The company refinanced or modified two loans totaling $67.9, obtained a $15.0 mezzanine loan, and drew $16.5 of construction loans. Debt repayments and new borrowing remained significant financing activities.
Outlook, risks, contingencies, and unusual items
- Liquidity outlook: Management expected excess property operating cash flow in 2016, but explicitly said it would not be sufficient to meet all obligations as due. Its plans included property and land sales, refinancing or extensions, and additional real-estate-secured borrowing. No quantified earnings or revenue guidance was provided.
- Debt and property-sale risks: Some land mortgages were being modified or extended. The filing says mortgages on properties subject to sales contracts to a related party were in default, primarily for nonpayment, and the maker was negotiating with lenders. The company reported impairment assessments but did not provide a clear quantified estimate of potential additional losses.
- Seller-financed sale: The Mercer Crossing land transaction had $75 of total consideration and included a $50 subordinated buyer note held by TCI. Because of the down payment and seller financing, it was accounted for under the deposit method; no sale revenue was recognized, and the land remained on the books pending satisfaction of recognition criteria.
- Guarantees and litigation: ARL guaranteed a $22.1 outstanding loan for LK-Four Hickory despite having sold its investment. ARL was also the primary guarantor of a $60.35 mezzanine loan to UHF; UHF was reported in covenant compliance. The filing describes ongoing Clapper-related litigation naming ARL and a subsidiary, which management said it was vigorously defending. The company was also pursuing collection of a Dynex judgment awarded to related entities; collection remained uncertain.
- Interest-rate exposure: Of $834.0 of notes payable, $40.1 was variable-rate debt. Management estimated a 100-basis-point increase would add $0.4 to annual interest cost. It cited a 3.83% weighted-average borrowing rate for long-term fixed-rate HUD financing on apartment properties.
- Other stated risks include real estate market and occupancy conditions, financing availability and rates, development delays or cost overruns, property-sale timing, environmental matters, and related-party transactions. Related parties owned approximately 86.7% of ARL stock; the company had no employees and relied on its external advisor for day-to-day operations.
Most important facts for investors to verify
- Near-term debt maturities, extensions and refinancing progress, particularly land loans in modification and mortgages associated with defaulted sales-contract properties.
- Cash available for obligations, restrictions on the $33.6 of restricted cash, and the sustainability of operating cash flow given its reliance on changes in related-party receivables.
- Collectability and concentration of the $112.4 in net related-party mortgage notes and interest receivable, including UHF/FBH collateral and payment sources.
- Status and accounting treatment of the Mercer Crossing transaction and other related-party land sales; confirm when, if ever, proceeds and gains can be recognized.
- Potential cash exposure from guarantees and litigation, and the likelihood and timing of collecting the Dynex-related judgment proceeds.
- Reconcile acquisition disclosures: the filing describes two apartment communities purchased for $40.0 in the real estate note, while MD&A gives other purchase counts and the cash-flow statement reports $41.75 of property acquisitions.