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: First quarter of fiscal year 2005, ended July 31, 2004.

Portfolio Overview: As of July 31, 2004, the portfolio consisted of 65 multi-family properties (8,671 units) and 148 commercial properties (7.7 million sq. ft.). The company operates through a consolidated operating partnership (UPREIT structure).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 22.5% ($7.2 million) year-over-year, driven primarily by acquisitions made in fiscal 2004 and 2005.
• Discontinued Operations: Net income was significantly boosted by a $3.1 million gain on the sale of discontinued operations (properties sold), compared to only $97,000 in the prior year.
• Expense Increases:
  • Maintenance: Increased 26.9% ($923,000), partly due to new acquisitions and higher costs on existing assets.
  • Utilities: Increased 44% ($815,000) due to new properties and general rate increases.
  • Interest: Mortgage interest expense rose 15.5% ($1.5 million) due to increased debt levels ($57.3 million increase in mortgage debt).
• Occupancy Trends: Economic vacancy for stabilized commercial properties increased to 9.4% from 5.6% in the prior year. Stabilized apartment vacancy decreased slightly to 9.2%, though concessions increased by 59.7%.

Outlook, Risks, and Management Commentary

• Market Conditions: Management expects weak demand for both apartments and commercial space to continue through the second quarter of fiscal 2005. Occupancy levels are not expected to improve significantly, and rent concessions are likely to remain elevated.
• Acquisitions & Dispositions:
  • Acquisitions: Acquired 8 commercial properties (medical, office, industrial) totaling $61.3 million in cost during the quarter.
  • Dispositions: Sold 3 commercial properties and 4 apartment complexes, generating a $3.1 million gain.
  • Pending: Signed an agreement to purchase an 185,000 sq. ft. office building in Minneapolis for ~$22.0 million, contingent on the seller purchasing a 62,000 sq. ft. building from IRET for ~$5.8 million.
• Liquidity: The company maintains three unsecured lines of credit totaling $24.4 million (none drawn as of July 31, 2004). A $25 million bridge loan used for acquisitions was repaid in July 2004 with mortgage proceeds.
• Risks:
  • Interest Rate Risk: 94% of mortgage debt is fixed-rate; however, $41.2 million is variable-rate. A 1% increase in rates would increase annual interest expense by $412,000.
  • Environmental: Potential liability for remediation of hazardous substances at properties.
  • Concentration: No single tenant accounts for more than 10% of commercial rental income.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of net income growth, as a significant portion ($3.1 million) is derived from one-time gains on property sales rather than core operations.
• Commercial Vacancy: Monitor the trend of increasing commercial vacancy (9.4%) and the ability to re-lease space without further rent concessions.
• Debt Maturities: Review the schedule of fixed-rate debt maturities to assess refinancing risks, particularly given the 6.71% weighted average interest rate.
• Pending Transactions: Confirm the closing of the Minneapolis office building swap transaction, which is subject to customary conditions.
• FFO vs. Net Income: Note that FFO ($12.0 million) is significantly higher than Net Income ($5.5 million) due to the exclusion of depreciation and gains on sales, which is standard for REIT analysis but requires careful interpretation.