NOTE 4 — OPERATING PROPERTIES AND REAL ESTATE HELD FOR DEVELOPMENT OR SALE

Operating properties and REO assets consist primarily of properties acquired as a result of foreclosure or purchase and are reported at the lower of cost or fair value, less estimated costs to sell the property. Under GAAP, the foreclosure of a loan and the recording of REO assets are deemed to be a conversion of a monetary asset to a long-lived asset. Further, such assets are valued at fair value at the foreclosure date and this fair value becomes the new basis for financial reporting purposes. REO assets are reported as either operating properties, held for development or held for sale, depending on whether we plan to hold and operate them, develop such assets prior to selling them or instead sell them immediately.

At December 31, 2013, we held total operating properties and REO assets of $202.5 million, of which $12.3 million were held for development, $86.6 million were held for sale, and $103.7 million were held as operating properties. At December 31, 2012, we held total REO assets of $119.0 million, of which $43.0 million was held for development, $54.1 million was held for sale, and $21.9 million was held as operating properties. A summary of operating properties and REO assets owned as of December 31, 2013 and 2012, respectively, by state, is as follows (dollars in thousands):



	December 31, 2013
	Operating Properties			Held For Development			Held For Sale
State	# of Projects	Aggregate Net Carrying Value		# of Projects	Aggregate Net Carrying Value		# of Projects	Aggregate Net Carrying Value
California	—	$	—	—	$	—	3	$	8,596
Texas	1	18,642		1	1,153		4	15,897
Arizona	3	85,041		6	11,109		19	48,226
Minnesota	—	—		—	—		2	6,899
New Mexico	—	—		—	—		2	3,144
Hawaii	—	—		—	—		1	3,800
Total	4	$	103,683	7	$	12,262	31	$	86,562



	December 31, 2012
	Operating Properties			Held For Development			Held for Sale
State	# of Projects	Aggregate Net Carrying Value		# of Projects	Aggregate Net Carrying Value		# of Projects	Aggregate Net Carrying Value
California	—	$	—	1	$	900	3	$	9,141
Texas	1	19,613		4	14,089		1	2,865
Arizona	1	2,302		9	18,609		16	33,866
Minnesota	—	—		2	7,339		—	—
Nevada	—	—		—	—		—	—
New Mexico	—	—		1	2,069		1	1,075
Idaho	—	—		—	—		2	7,103
Total	2	$	21,915	17	$	43,006	23	$	54,050

Following is a roll-forward of REO activity for the years ended December 31, 2013 and 2012 (dollars in thousands):



	Operating Properties			# of Projects	Held for Development			# of Projects		Held for Sale			# of Projects		Total Net Carrying Value
Balances at December 31, 2011	$	19,611		1	$	47,252		16		$	34,644		24		$	101,507

Additions:
Net principal carrying value of loans foreclosed	1,792			1	3,028			1		25,095			6		29,915
Other receivables transferred	93			—	53			—		111			—		257
Property taxes assumed on loans foreclosed	660			—	1,456			—		978			—		3,094
Capital costs additions	1,511			—	645			—		53			—		2,209

Reductions:
Cost of Properties Sold	—			—	(83		)	—		(16,095		)	(7	)	(16,178		)
Recoveries	(94		)	—	(15		)	—		(66		)	—		(175		)
Depreciation	(1,658		)	—	—			—		—			—		(1,658		)
Impairment	—			—	—			—		—			—		—
Transfers, net	—			—	(9,330		)	—		9,330			—		—

Balances at December 31, 2012	21,915			2	43,006			17		54,050			23		118,971

Additions:
Net principal carrying value of loans foreclosed	52,395			2	7,730			1		—			—		60,125
Fair value adjustment of assets acquired through foreclosure (1)	30,739			—	—			—		—			—		30,739
Other receivables transferred	493			—	—			—		4,075			2		4,568
Property taxes assumed on loans foreclosed	—			—	27			—		—			—		27
Capital costs additions	990			—	1,614			—		339			—		2,943

Reductions :
Cost of Properties Sold	—			—	(1,089		)	—		(9,825		)	(5	)	(10,914		)
Impairment	—			—	—			—		(1,103		)	—		(1,103		)
Depreciation	(2,849		)	—	—			—		—			—		(2,849		)
Transfers, net	—			—	(39,026		)	(11	)	39,026			11		—
Balances at December 31, 2013	$	103,683		4	$	12,262		7		$	86,562		31		$	202,507

(1)

Amount represents the step-up in basis to the estimated fair value of the assets received as of the date of acquisition based on appraisals received for such assets. The stepped up basis reflects the approximate balances of certain liabilities assumed upon foreclosure including a mortgage note payable of approximately $24.7 million, a capital lease obligation of approximately $1.3 million, and accounts payable and accrued liabilities of $3.4 million at the date of acquisition. The appraised values of such assets were equal to or in excess of the new assets recorded.

Operating properties includes depreciable building and improvements, furniture, fixtures and equipment, and tenant improvements with balances totaling $67.3 million, net of accumulated depreciation and amortization of $7.6 million.

On May 14, 2013, the Company, through various subsidiaries, completed the acquisition of certain assets and assumption of certain related liabilities (the “Sedona Assets”), pursuant to an agreement dated March 28, 2013, as amended and restated (the “Sedona Agreement”), with one of the Company's borrowers and certain subsidiaries and affiliates (collectively, the “Borrowers”) in full satisfaction of certain mortgage loans held by the Company with a net carrying value of approximately $60.2 million as of December 31, 2012, and for the purpose of releasing the Borrowers from further liability under the loans and guarantees, subject to certain post-closing conditions and limitations. The primary Sedona Assets include the following:


•	certain real property, including all improvements thereon, including two operating hotels located in Sedona, Arizona, subject to a pre-existing primary first mortgage lien and capital lease obligation, which totaled approximately $24.7 million and $1.3 million, respectively, as of May 14, 2013 (date of acquisition);


•	various leasehold and other interests in multiple leases relating primarily to the operations of the hotels; and


•	a 28-lot residential subdivision located in Sedona, Arizona.

In connection with the recording of the deed-in-lieu of foreclosure, we recorded the assets and liabilities on a gross basis at their estimated fair values based on appraisals received for such assets, but not in excess of our net basis in the loans. This included property, plant and equipment with a carrying value at the date of acquisition of approximately $91.4 million, as well as a mortgage note payable of approximately $24.7 million, a capital lease obligation of approximately $1.3 million, and accounts payable and accrued liabilities of $3.4 million. The appraised values of such assets were equal to or in excess of the new assets recorded.

Of the assets acquired in the transaction, the operating hotels are classified as operating properties in our hospitality and entertainment segment, while the 28-lot residential subdivision is classified as real estate held for development.

The Sedona Assets contributed approximately $13.0 million to hospitality and entertainment revenue and $0.2 million to pre-tax net loss (inclusive of $2.0 million of project-specific interest expense) for the period from May 14, 2013 (the date of acquisition) through December 31, 2013. The following table presents estimated unaudited pro forma information during the years ended December 31, 2013 and 2012, including debt service amounts for long-term debt and capital leases other than interest attributable to loans payable to us, as if the acquisitions had been consummated on January 1, 2012.



	Year Ended December 31, 2013						Year Ended December 31, 2012
(Amounts in thousands)	Actual			Proforma			Actual			Proforma
Revenue	$	23,326		$	30,452		$	4,764		$	24,278
Net income (loss)	$	(26,205	)	$	(26,531	)	$	(32,192	)	$	(32,918	)

In addition, during the year ended December 31, we acquired two single-family residences in connection with a guarantor settlement with a combined gross estimated fair value of approximately $4.1 million.

Other than the assets described above, we did not foreclose on any other loans during the year ended December 31, 2013. During the year ended December 31, 2012, we foreclosed on 9 loans (resulting in 8 property additions) and took title to the underlying collateral with net carrying values totaling $29.9 million.

The number of REO property additions does not necessarily correspond directly to the number of loan foreclosures as some loans have multiple collateral pieces that are viewed as distinct REO projects or, alternatively, we may have foreclosed on multiple loans to one borrower relating to the same REO project.

REO Sales

We are periodically approached on an unsolicited basis by third parties expressing an interest in purchasing certain REO assets. However, except for those assets designated for sale, management had not developed or adopted any formal plan to dispose of these assets or such assets do not meet one or more of the GAAP criteria as being classified as held for sale (for example, the anticipated disposition period may extend beyond one year).

During the year ended December 31, 2013, we sold seven REO assets (or portions thereof) for $12.4 million (net of selling costs), of which we financed $1.1 million, resulting in a net gain of approximately $1.4 million. During the year ended December 31, 2012, we sold eight REO assets or portions thereof for $17.2 million (net of selling costs), for a gain of $1.0 million. During the year ended December 31, 2011, we sold seven REO assets or portions thereof for $9.4 million (net of selling costs), of which we financed $0.2 million, resulting in a gain on disposal of real estate of $0.3 million.

REO Planned Development

Costs related to the development or improvements of the real estate assets are generally capitalized and costs relating to holding the assets are generally charged to expense. Cash outlays for capitalized development costs totaled $2.9 million, $1.4 million and $0.8 million during the years ended December 31, 2013, 2012 and 2011, respectively. In addition, costs and expenses related to operating, holding and maintaining such properties (including property taxes), which are expensed and included in property taxes and other operating expenses for REO assets in the accompanying consolidated statement of operations, totaled approximately $16.6 million, $7.4 million and $6.2 million for the years ended December 31, 2013, 2012 and 2011, respectively.

We are continuing to evaluate our use and disposition options with respect to our REO projects. REO assets that are classified as held for sale are measured at the lower of carrying amount or fair value, less estimated cost to sell and are subject to quarterly fair value analysis. REO assets that are classified as held for development or as operating properties are considered “held and used” and are evaluated for impairment when circumstances indicate that the carrying amount exceeds the sum of the undiscounted net cash flows expected to result from the development and eventual disposition of the asset. During the year ended December 31, 2013, we transferred 11 properties with a carrying value of $39.0 million previously held for development to held for sale based on a formal plan to dispose of such assets adopted by management. Similarly, during the year ended December 31, 2012, we transferred certain properties with a carrying value of $9.3 million previously held for development to held for sale based on a formal plan to dispose of such assets adopted by management.

Certain projects are expected to have minimal development activity, but rather are expected to require maintenance activity only until a decision is made to sell the asset. The undiscounted cash flow from these projects is based on current comparable sales for the asset in its current condition, less costs to sell, and less holding costs, which are generally minimal for a relatively short holding period. Other projects are expected to be developed more extensively to maximize the proceeds from the disposition of such assets. The undiscounted cash flow from these projects is based on a build-out scenario that considers both the cash inflows and the cash outflows over the duration of the project, which often includes an estimate for required financing.

In the absence of available financing, our estimates of undiscounted cash flows assume that we will pay development costs from the disposition of current assets or the raising of additional capital. However, the level of planned development for our individual properties is dependent on several factors, including the current entitlement status of such properties, the cost to develop such properties, our financial resources, the ability to recover development costs, competitive conditions and other factors. Generally, vacant, unentitled land is being held for future sale to an investor or developer with no planned development expenditures by us. Such land is not planned for further development unless or until we locate a suitable developer with whom we can possibly develop the project under a joint venture arrangement. Alternatively, we may choose to further develop fully or partially entitled land to maximize interest to developers and our return on investment.

Based on our assessment of impairment of REO held for development or operating properties, we recorded impairment charges of $1.1 million, $0.0 million and $1.5 million during the years ended December 31, 2013, 2012 and 2011, respectively. In 2013, the impairment charges were primarily to adjust the fair value of our REO held for sale. The impairment charges in 2011 were primarily a result of a change in management’s disposition strategy for selected REO assets from a development approach to a disposal approach based on recent values consistent with the change in business strategy resulting from the Conversion Transactions.