PREFERRED EQUITY INVESTMENT AND DERIVATIVE INVESTMENT RECEIVABLE

Preferred Equity Investment

During the nine months ended September 30, 2013, we entered into a limited liability agreement to form a joint venture with unrelated parties for the purpose of acquiring a multi-family portfolio comprised of 14 apartment communities across six states, which is being managed by a third party, national firm, specializing in multi-family assets. Under the terms of the joint venture agreement, we contributed $15 million through one of our wholly-owned subsidiaries that holds the status of a preferred member. Another of our wholly-owned subsidiaries contributed no capital, but serves as a limited guarantor member on the senior indebtedness of the joint venture that is secured by the acquired operating properties. No other capital contributions are required by us. A non-IMHFC member will serve as the managing member of the joint venture. Our preferred member interest is secured by the other non-IMHFC members’ interest in each of the single member LLC’s that hold title to real property owned by each respective LLC.

Under the terms of the joint venture agreement, the joint venture is required to redeem our preferred membership interest for the redemption price (as defined in the joint venture agreement) on or before the second anniversary of the closing date, or the redemption date may be extended at the joint venture’s option for one additional year for a fee to the Company of $0.3 million. We are also entitled to a 15% annualized return on our $15 million preferred equity investment, and we are further entitled t o an exit fee equal to the greater of 4% of our original investment or 1.5% of the fair market value of the portfolio assets of the joint venture at the two year preferred equity redemption date, as described further below.

Additionally, we are entitled to retain a 15% carried interest in the profits of the entire investment portfolio, after payment of the preferred returns to us and similar preferred returns of non-IMHFC members. In addition, we are entitled to effectively receive all available cash flow of the joint venture until we receive the entirety of our preferred equity investment and any accrued and unpaid preferred return amounts. The non-IMHFC members are obligated to fund any shortfalls in our preferred return.

A summary of unaudited financial statement data for the joint venture as of and for the period from inception (February 28, 2013) through September 30, 2013 follows (amounts in thousands):



Balance Sheet Data	As of September 30, 2013
Assets:	(unaudited)
Investment in real estate, net	$	130,035
Cash, cash equivalents and restricted cash	6,953
Receivables and other assets	3,330

Total assets	$	140,318

Liabilities:
Mortgage payable to bank	$	119,946
IMHFC Preferred Member Interest recognized as a liability	13,704
Derivative exit fee liability	2,250
Accounts payable, accrued and other liabilities	6,654

Total liabilities	142,554

Members' Equity	(2,236		)

Total liabilities and members' equity	$	140,318



Statement of Operations Data	Period Ended September 30, 2013
Revenue:	(unaudited)
Total rents and other income	$	16,545

Expenses:
Acquisition costs	17,207
Total operating expenses	9,564
Depreciation and amortization	1,791
Interest Expense - Primary Lender	3,420
Interest Expense - IMHFC Preferred Member Interest	1,962
Total expenses	33,944
Net loss	$	(17,399	)

Accounting for Preferred Equity Investment

As a result of the passive nature of this investment by us, the mandatory redemption feature of the investment, the defined preferred return, and other repayment and security features of the investment, the investment is being accounted for as a debt security investment held to maturity, whereby we are recording the 15% annual preferred return over the term of the investment period using the effective interest method. Similarly, the deferred origination fees, net of direct costs are being amortized over the term of the investment using the effective interest method as an adjustment to yield.

In addition, as described above, we are further entitled to an exit fee equal to the greater of 4% of our original investment or 1.5% of the fair market value of the portfolio assets of the joint venture at the two year preferred equity redemption date. At the date of execution of the agreement, we estimated that the fair market value of the underlying assets to be approximately $190 million at the redemption date. We then discounted the computed exit fee using a discount rate of 12%. Accordingly, we recorded the exit fee as a derivative investment receivable in the accompanying condensed consolidated balance sheet as of September 30, 2013 in the amount of $2.25 million. The offsetting amount was treated as a discount on the investment which is being amortized as an adjustment to investment income over the term of the investment using the effective interest method.

During the three and nine months ended September 30, 2013 we recognized approximately $0.8 million and $2.0 million, respectively, in investment income from this investment.

A reconciliation of the preferred equity investment as of September 30, 2013 follows (in thousands):



Preferred Equity Investment	$	15,000
Less: exit fee discount	(2,250		)
Accrued preferred return	205
Amortization of exit fee discount	749
Preferred Member Interest per joint venture	13,704
Add: additional investment basis (1)	66
Total preferred equity investment	$	13,770


(1)	Amount represents unamortized costs incurred and paid directly by us relating to our investment in the preferred equity investment.

Derivative Investment Receivable

As described above, we recorded a derivative asset resulting from this transaction in the amount of $2.25 million at the origination date based on the estimated gross fair value as of the derivative investment. As of September 30, 2013, we applied a similar methodology to estimate the fair market value of the portfolio assets and recorded no gain or loss on the fair value of the derivative investment. This is our only derivative investment and we do not anticipate the volume of our derivative investments to be significant.

As described in note 12, subsequent to September 30, 2013, we sold our preferred equity position in the joint venture to an unrelated party for $19.0 million which exceeded the collective carrying value of our preferred equity investment and derivative investment receivable. No gain on the sale was recognized during the nine months ended September 30, 2013.