Transcontinental Realty Investors, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; balance-sheet comparisons are against December 31, 2016. Amounts below are in U.S. dollars. The company owns and develops apartments, commercial properties and land, and also holds mortgage loans. At quarter-end, its portfolio included 50 apartment communities with 8,226 units, seven commercial properties, a golf course and 3,505 acres of land.
Financial performance and position
- Third-quarter revenue and earnings: Rental and other property revenue was $31.5 million, up 5.8% from $29.8 million. Net operating income was $5.8 million versus $4.3 million. Net income applicable to common shares was $6.9 million, or $0.79 per diluted share, compared with a loss of $4.8 million, or $0.55 per share.
- Nine-month results: Revenue was $94.3 million, up 5.7% from $89.2 million; net operating income was $16.8 million versus $14.2 million. The company reported a net loss applicable to common shares of $9.1 million, or $1.05 per diluted share, compared with a $4.1 million loss, or $0.47 per share.
- Drivers and margins: Revenue growth reflected apartment acquisitions and higher commercial occupancy. Third-quarter earnings included a $9.8 million recognition of deferred gain on prior-year sales of two apartment properties to a related party, plus a $1.9 million unrealized foreign-currency gain. Nine-month results included the same $9.8 million deferred gain, but also a $1.8 million unrealized currency loss. Mortgage and loan interest expense rose to $45.2 million for nine months from $38.8 million. NOI margin, calculated as reported NOI divided by property revenue, was approximately 18.3% for the quarter and 17.8% for nine months.
- Cash flow: Nine-month operating cash flow was negative $18.3 million, versus positive $17.1 million in 2016. Investing used $40.4 million, compared with $65.2 million used in 2016; financing provided $99.2 million, compared with $40.2 million. Cash and cash equivalents rose to $58.0 million from $17.5 million; restricted cash was $42.8 million. Cash paid for interest was $36.4 million.
- Assets, debt and equity: Total assets were $1.251 billion, up from $1.186 billion at year-end; total liabilities were $1.035 billion, up from $961.4 million. The balance sheet reported $826.1 million of notes and interest payable, $107.9 million of bond and bond interest payable, and $3.9 million of notes related to real estate subject to sales contracts. A separate debt note reports $830.4 million of notes payable and accrued interest net of deferred borrowing costs; classifications differ across the filing. Shareholders’ equity was $215.7 million, down from $224.5 million.
- Debt and liquidity indicators: A subsidiary issued Series A bonds with approximately $106.6 million of proceeds; the bonds carry a 7.3% stated rate and 9.25% effective yield, are payable in Israeli shekels, and mature through 2023. Of approximately $830.3 million of notes payable cited in the market-risk discussion, $34.4 million was variable-rate debt. Management estimated a 100-basis-point rate increase would add about $0.4 million in annual interest cost. The company also held $107.7 million in receivables from related parties.
Material changes versus the prior comparable period
- Quarterly common-share earnings turned positive, principally reflecting the $9.8 million deferred property-sale gain; nine-month common-share loss more than doubled, from $4.1 million to $9.1 million.
- Nine-month property revenue increased $5.1 million, while interest expense increased $6.4 million and interest income declined $1.1 million.
- Operating cash flow deteriorated by $35.4 million year over year. Financing cash flow increased, largely due to the Series A bond issuance.
- Real estate net of depreciation rose to $928.9 million from $891.2 million. The company spent $41.4 million on apartment construction or predevelopment and acquired three development land parcels for $11.4 million.
Outlook, risks and unusual items
- Liquidity outlook: Management expects excess cash from property operations in 2017 but says it will not be sufficient to meet all obligations as they fall due. Its planned sources include property and land sales, refinancing or extending debt, and additional real-estate-secured borrowings. No quantified earnings or revenue guidance was provided.
- Debt and development risks: Certain land mortgages were being modified or extended. Mortgages on properties sold to a related party but still classified as subject to sales contracts were in default, primarily for nonpayment; the borrower was discussing resolution with lenders. Seven apartment projects were in development, exposing the company to construction, funding and completion risks.
- Related parties: Related-party dealings include property sales, financing, management and advisory fees. The company recognized deferred gains on prior related-party property sales and reported a substantial related-party receivable, making collectability and transaction terms important considerations.
- Contingencies: The company is the primary guarantor on a $60.4 million mezzanine loan to Unified Housing Foundation; the borrower was reported in covenant compliance. Plaintiffs filed a $50 million lawsuit in April 2017 against Dynex Capital and Dynex Commercial alleging, among other matters, fraudulent transfer and alter ego. Management said ordinary-course litigation was not expected to materially adversely affect the company.
- Other risks: Management cited real-estate demand and occupancy, financing availability and interest rates, property sales timing, development delays or cost overruns, environmental and uninsured liabilities, and dependence on key personnel. It reported no change in previously disclosed risk factors, and stated disclosure controls were effective with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Near-term debt maturities, lender modifications, defaults tied to properties subject to sales contracts, and the feasibility of planned refinancing and asset sales.
- Cash conversion and liquidity: why operating cash flow was negative $18.3 million, and how much of the reported cash is available after restrictions and commitments.
- Collectability and concentration of the $107.7 million related-party receivable, as well as the terms and status of related-party property transactions and deferred gains.
- Development funding requirements, completion schedules and potential cost overruns across the seven apartment projects.
- Exposure to Israeli-shekel exchange movements and the Series A bonds’ effective financing cost and repayment obligations.
- The status and potential financial effect of the Dynex litigation and the $60.4 million mezzanine-loan guarantee.