Business context and reporting period
Transcontinental Realty Investors, Inc. (TCI) filed this Form 10-K for the fiscal year ended December 31, 2014. TCI is an externally advised real estate company and a taxable C corporation, not a REIT. Its portfolio included 37 apartment communities (6,024 units), eight commercial properties, and approximately 4,087 acres of land. Subsidiaries of American Realty Investors, Inc. (ARL) owned about 80.9% of TCI; TCI owned 81.1% of Income Opportunity Realty Investors, Inc. (IOT).
Financial performance and position
| Metric | 2014 | 2013 |
|---|---|---|
| Operating revenues | $75.9 million | $77.4 million |
| Operating income (loss) | $0.8 million | $(5.4) million |
| Net income (loss) applicable to common shares | $40.6 million; $4.74 per diluted share | $57.4 million; $6.83 per diluted share |
| Cash flow from operations | $(29.4) million | $(66.7) million |
| Cash flow from investing | $28.9 million | $269.0 million |
| Cash flow from financing | $(3.4) million | $(199.3) million |
| Cash and cash equivalents at year-end | $12.2 million | $16.1 million |
| Total assets | $930.4 million | $897.7 million |
| Total shareholders’ equity | $233.4 million | $191.6 million |
Operating income was approximately 1.0% of revenue in 2014, versus an operating loss in 2013. However, 2014 common-share earnings were driven principally by discontinued operations: $37.9 million of discontinued income, including $61.9 million of property-sale gains, compared with $61.6 million of discontinued income in 2013. Continuing operations produced $4.1 million of net income before non-controlling interests and preferred dividends; the filing does not provide a comparable consolidated FFO measure.
- Rental and other property revenue fell 1.9% to $75.9 million: apartment revenue rose $2.4 million, while commercial revenue declined $3.8 million, partly reflecting a prior-year lease termination fee.
- Property operating expenses rose to $39.5 million from $36.7 million; depreciation and amortization increased to $17.4 million from $15.8 million. No impairment provision was recorded in 2014, compared with $11.3 million in 2013.
- Mortgage and loan interest expense decreased to $28.4 million from $29.7 million. The weighted-average debt rate was 4.72%, down from 5.65%.
- At year-end, debt principal was $605.6 million ($608.9 million including accrued interest); $542.6 million was fixed-rate and $63.0 million variable-rate. Approximately $103.8 million of principal was scheduled for 2015 and $45.8 million for 2016.
- Restricted cash was $48.2 million, in addition to $12.2 million of cash and cash equivalents. Apartment occupancy averaged 94.36%; office occupancy varied materially, including 48.57% at Stanford Center and 60.50% at Browning Place.
- TCI paid no common dividends in 2012–2014. Series C preferred shares were converted into 304,298 common shares in July 2014.
Material changes and significant transactions
TCI sold properties and land for approximately $142.5 million and acquired approximately $45.4 million during 2014, while cash-flow statement proceeds and acquisition totals reflect accounting classifications and may differ from these transaction summaries. Major dispositions included Blue Ridge for $52.8 million, Sunset Lodge and adjacent land for $40.6 million, Pecan Pointe for $23.1 million, and 1010 Common for $16.6 million. TCI acquired three apartment communities by exchanging notes receivable and acquired Mahogany Run Golf Course for approximately $13.1 million, including $6.6 million of seller financing.
The company refinanced several apartment mortgages at rates of 3.50%–3.75%. It also obtained a $40 million five-year loan at 12%, secured by equity interests in residential apartments. A $28 million Stanford Center refinancing carries a floating rate of 5.50% above 30-day LIBOR, subject to a 5.75% floor, and matures in January 2017.
Outlook, risks and unusual items
- Liquidity: Management said cash and expected 2015 property operating cash flows may not cover all cash requirements. It plans selective property sales, refinancing or extensions, and additional real-estate-secured borrowing. The auditor highlighted this liquidity plan while issuing an unqualified opinion on the financial statements.
- Cash generation: Operating cash flow remained negative in 2014. The company depends on asset-sale proceeds, financing and collections of notes and related-party receivables; real estate may not be readily saleable on acceptable terms.
- Debt and refinancing: Substantially all assets were pledged as debt collateral. Maturities, balloon payments, covenant compliance and variable-rate exposure present risks. Management estimated that a 100-basis-point increase in variable borrowing rates would reduce annual net income by about $0.6 million.
- Related parties and governance: Pillar, a related-party external advisor that also advises ARL and IOT, received $7.4 million in advisory fees and $3.7 million in net-income fees in 2014, among other fees and reimbursements. About $73.2 million, or 91.1%, of mortgage notes receivable was due from related entities; TCI also reported $58.4 million due to ARL. The shared management and ownership structure creates potential conflicts of interest.
- Deferred sales and defaults: Certain property transfers were not recognized as sales because TCI retained continuing involvement. Mortgages on properties subject to sales contracts were reported in default, principally for nonpayment, with negotiations ongoing. The related assets and obligations remain on TCI’s books.
- Litigation: The long-running Dynex matter remains unresolved; an appellate ruling favored TCI, including stated damages of approximately $12.1 million plus further interest and attorney-fee determinations, but further challenges were expected. Separate deficiency claims could expose TCI and subsidiaries to up to approximately $20 million in aggregate, according to management. A 2014 complaint named TCI, directors and officers; management intended to defend it. The approximately $74 million Clapper judgment described in the filing was against ART and ART Midwest, not TCI.
- Management outlook: Management cited strong apartment occupancy and expected benefits from commercial re-leasing over the next twelve months. It gave no numerical earnings or revenue guidance and cautioned that forward-looking results are uncertain.
Important facts for investors to verify
- How management expects to cover the 2015 liquidity shortfall and scheduled debt payments, and the status of refinancing, extensions and planned asset sales.
- The quality, collectability, collateral and repayment timing of the concentrated related-party notes receivable, especially UHF balances.
- Current status of mortgage defaults, guarantees, properties subject to sales contracts, and potential deficiency claims.
- Whether property-sale gains and discontinued operations are recurring or provide a misleading picture of continuing earnings and operating cash generation.
- Commercial leasing progress, particularly upcoming lease expirations and low-occupancy properties, and the effects of any leasing costs or tenant improvements.
- Terms and outcomes of related-party transactions, advisor fees, and any material developments in the Dynex or other litigation.