American Realty Investors, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. Amounts below are U.S. dollars; financial statement amounts are generally in millions unless stated otherwise. The filing consolidates ARL with subsidiaries including Transcontinental Realty Investors and Income Opportunity Realty Investors.
Business context and portfolio
ARL invests in, develops, and operates apartments, commercial real estate, and land. At year-end it reported 50 apartment communities, eight commercial properties totaling about 2.0 million square feet, a golf course, and approximately 3,666 acres of land held for development or sale. Its operating portfolio is geographically diversified across multiple U.S. states and the U.S. Virgin Islands, with substantial exposure to Texas and the southwestern United States.
During 2016, the Company acquired four apartment properties for $79.7 million and acquired land for $12.5 million. It sold land for $29.1 million, two apartment communities for a combined $20.4 million, and an industrial warehouse. Three apartment projects, totaling 1,085 planned units, were under development; reported projected costs were $162.8 million.
Financial performance and position
| Metric | FY2016 | FY2015 |
|---|---|---|
| Rental and other property revenue | $119.7 million | $104.2 million |
| Operating expenses | $105.0 million | $97.9 million |
| Operating income | $14.6 million | $6.3 million |
| Net loss applicable to common shares | $3.8 million; $(0.25) per share | $3.2 million; $(0.21) per share |
| Cash from operating activities | $17.4 million | $(34.5) million |
| Cash used in investing activities | $(61.1) million | $(130.3) million |
| Cash from financing activities | $45.9 million | $167.8 million |
| Cash and cash equivalents at year-end | $17.5 million | $15.2 million |
| Total assets | $1,174.9 million | $1,117.4 million |
| Shareholders’ equity | $176.1 million | $176.9 million |
Operating margin, calculated as operating income divided by rental and other property revenue, was approximately 12.2% in 2016 versus 6.1% in 2015. The Company nevertheless remained loss-making at the common-share level, in part reflecting interest costs and advisory and corporate expenses. It recorded $16.2 million of gains on income-producing property sales and $3.1 million of land-sale gains in 2016; 2015 land-sale gains were $21.6 million and included $2.7 million of deferred gains recognized from prior transactions.
At December 31, 2016, gross notes payable were $867.7 million, including $119.9 million of mezzanine financing; the balance sheet reported notes and interest payable of $851.1 million after unamortized borrowing costs and including specified related balances. Approximately $827.9 million was fixed-rate debt and $39.8 million variable-rate debt. The weighted-average interest rate was 4.91%, compared with 4.66% in 2015. The filing states substantially all assets are pledged to secure debt. Scheduled principal payments were $140.1 million in 2017; aggregate contractual debt obligations including stated future interest were $1.33 billion.
Cash and cash equivalents were $17.5 million, while restricted cash was $38.4 million. Management said expected 2017 operating cash flow would not cover all obligations coming due. Its planned responses include asset sales, refinancing or extending debt, and additional real-estate-secured borrowings. No common dividends were declared for 2014–2016. Series A preferred stock remained outstanding and carries a 10% cumulative dividend when declared.
Material changes versus the prior comparable period
- Revenue rose $15.5 million, mainly from apartment acquisitions and a commercial acquisition. Property operating expenses rose $9.0 million and depreciation and amortization rose $2.4 million, also principally reflecting portfolio growth.
- Operating income increased to $14.6 million from $6.3 million. Common-share net loss widened to $3.8 million from $3.2 million.
- Mortgage and loan interest expense increased to $59.4 million from $52.5 million, partly due to new mezzanine debt and acquired properties. Five loans with $78.9 million of principal were refinanced or modified at lower rates during 2016.
- Operating cash flow improved to positive $17.4 million from negative $34.5 million. Investing outflows and financing inflows both declined substantially from 2015.
- Property-sale gains of $16.2 million were recorded in 2016; there were no such gains in 2015. Land-sale gains fell to $3.1 million from $21.6 million.
Outlook, risks, contingencies, and unusual items
- Liquidity and refinancing: Management warned that cash and anticipated operating cash flow may be insufficient for all 2017 requirements. The filing highlights refinancing and balloon-payment risk, covenant restrictions, limited real-estate liquidity, and possible difficulty obtaining capital on acceptable terms.
- Debt and guarantees: TCI is the primary guarantor of a $60.4 million UHF mezzanine loan; ARL and an officer are limited-recourse guarantors. The filing also reports ARL remains a guarantor on $20.9 million of debt for an entity whose investment it sold in 2012. UHF was reported in compliance with its loan covenants at year-end.
- Related-party exposure and governance: More than 80% of ARL stock is held by related parties, and Pillar, the external advisor, also advises affiliated companies. ARL reported $125.8 million of performing notes receivable from related parties before allowances, including substantial UHF exposure; $118.4 million, or 88.2% of the mortgage-note portfolio, was due from related parties. The filing also reports a $24.7 million receivable from Pillar. Management cautions that related-party transactions may not be arm’s length.
- Land sale accounting: About 91 acres sold to related parties remained recorded as “subject to sales contract,” with sale recognition deferred. The balance sheet reported $48.9 million of real estate subject to sales contracts and $5.6 million of related notes payable.
- Legal matters: The Clapper litigation principally concerns formerly owned ART and ART Midwest; ARL states it is not otherwise obligated for that judgment, though a separate lawsuit names ARL and its subsidiary. The Company is also seeking to collect on a Dynex Commercial judgment awarded among Basic, ART, and TCI; collection is not assured. Management stated ordinary-course litigation was not expected to materially affect ARL, while outcomes of the described matters remain uncertain.
- Operations and development: Risks include tenant defaults, vacancies, operating-cost increases, construction delays and overruns, and adverse local market conditions. Reported occupancy was notably low at Browning Place (66.6%) and Cross County Mall (56.3%). A 100-basis-point increase in variable borrowing rates was estimated to reduce annual net income by about $0.4 million.
- Other items: A $5.3 million impairment of the U.S. Virgin Islands golf course was recorded in 2015, with no real-estate impairment provision in 2016. In February 2017, an indirect subsidiary accepted orders for approximately $73.7 million of unsecured Israeli-shekel-denominated bonds at an average annual interest rate of about 7.38%.
The independent auditor issued an unqualified opinion on the consolidated financial statements. Management concluded disclosure controls and internal control over financial reporting were effective at year-end; the auditor did not provide an internal-control attestation.
Important facts for investors to verify
- Reconcile portfolio and acquisition disclosures: the filing variously reports 8,226 and 8,266 apartment units, and the narrative says 723 units were added in 2016 while a financial-statement note says 422.
- Confirm the timing and sources for 2017 debt maturities, including the $140.1 million scheduled principal and the larger contractual-obligation figure that includes future interest and operating leases; assess covenant compliance and refinancing progress.
- Evaluate liquidity plans and the availability, pricing, and execution of planned property sales and secured borrowing, given management’s warning that expected operating cash flow is insufficient for all obligations.
- Assess collectability and collateral support for related-party notes, particularly UHF balances, and the Pillar receivable; verify the status and terms of the related-party land sales and guarantees.
- Review the development budgets, project financing, lease-up assumptions, and weaker commercial-property occupancy, alongside the concentration of assets in regional real-estate markets.
- Verify the collectability and status of the Dynex judgment and developments in litigation naming ARL, as well as the actual cost and debt implications of the subsequent bond offering.