S-11 1 ds11.htm FORM S-11 Form S-11
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As filed with the Securities and Exchange Commission on January 22, 2010

Registration No. 333-            

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-11

FOR REGISTRATION UNDER THE SECURITIES ACT OF 1933 OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES

Verde Realty

(Exact Name of Registrant as Specified in its Governing Instruments)

 

 

201 East Main Drive El Paso, Texas 79901 (915) 225-3200

(Address, Including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

 

 

C. Ronald Blankenship

President and Chief Executive Officer

201 East Main Drive El Paso, Texas 79901 (915) 225-3200

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

 

Copies to:

 

Benjamin R. Weber, Esq.

William G. Farrar, Esq.

Sullivan & Cromwell LLP

125 Broad Street

New York, NY 10004

(212) 558-4000

 

Steven A. Seidman, Esq.

Laura L. Delanoy, Esq.

Willkie Farr & Gallagher LLP

787 Seventh Avenue

New York, NY 10019

(212) 728-8000

 

 

Approximate date of commencement of proposed sale to the public:    As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨   Accelerated filer  ¨    Non-accelerated filer  x   Smaller reporting company  ¨

(Do not check if a smaller reporting company)

CALCULATION OF REGISTRATION FEE

 

 

 

Title of each class of

securities to be registered

  Proposed maximum
aggregate offering price(1)
  Amount of
registration fee

Common shares of beneficial interest, par value $0.01 per share

  $300,000,000   $21,390
 
 
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to completion. Dated January 22, 2010.

 

PROSPECTUS

     Shares

Verde Realty

Common Shares

 

 

Verde Realty is a fully integrated, self-administered and self-managed real estate investment trust, or REIT, that specializes in the ownership, acquisition and management of institutional-quality multifamily rental properties and industrial distribution facilities. We intend to continue to operate as a REIT for U.S. federal income tax purposes.

This is the initial public offering of our common shares of beneficial interest, par value $0.01 per share, or common shares. All of the common shares being sold in this offering are being sold by us. Prior to this offering, there has been no public market for our common shares. We expect the public offering price of our common shares to be between $             and $             per share. We intend to apply to list our common shares on the New York Stock Exchange, or NYSE, under the symbol “VRE.”

 

 

Investing in our common shares involves risks. See “Risk Factors” beginning on page 20 of this prospectus for certain risks relevant to an investment in our common shares, including:

 

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Risks associated with the ownership of real property, or changes in economic, demographic or real estate market conditions, may adversely affect our results of operations. The concentration of our portfolio makes us particularly susceptible to adverse economic developments in those markets.

 

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Continued disruptions in the financial markets and deteriorating or unimproved economic conditions could adversely affect our ability to secure debt financing on attractive terms and the values of investments we make.

 

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Our long-term growth will depend upon future acquisitions of properties, and we may be unable to consummate acquisitions on advantageous terms or acquisitions may not perform as we expect.

 

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Prior to this offering, there has been no public trading market for our common shares, and as a result it may be difficult for you to sell your shares. If you sell your common shares, it may be at a substantial discount to the price you paid for your shares.

 

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We have a history of losses, and we may be unsuccessful in meeting our investment objectives.

 

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The timing and amount of our cash distributions, if any, may vary over time.

 

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There are limits on the percentage of our outstanding shares that any holder may own. See “Description of Securities—Restrictions on Ownership and Transfer.”

 

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We may fail to qualify or remain qualified as a REIT and may be required to pay income taxes at corporate rates.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share    Total

Initial public offering price

   $                 $             

Underwriting discount

   $                 $             

Proceeds, before expenses, to Verde Realty

   $                 $             

To the extent that the underwriters sell more than              common shares, the underwriters have the option to purchase up to an additional              shares from us at the initial public offering price less the underwriting discount.

The underwriters expect to deliver the common shares against payment in New York, New York on                     , 2010.

 

Goldman, Sachs & Co.   BofA Merrill Lynch   Wells Fargo Securities

 

 

Prospectus dated                      , 2010.


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TABLE OF CONTENTS

 

     Page

PROSPECTUS SUMMARY

   1

RISK FACTORS

   20

FORWARD-LOOKING STATEMENTS

   47

USE OF PROCEEDS

   49

CAPITALIZATION

   50

DISTRIBUTION POLICY

   51

DILUTION

   53

SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

   54

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   56

INDUSTRY OVERVIEW

   80

BUSINESS AND PROPERTIES

   92

MANAGEMENT

   116

COMPENSATION DISCUSSION AND ANALYSIS

   123

PRINCIPAL SHAREHOLDERS

   137

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   139

POLICIES WITH RESPECT TO CERTAIN ACTIVITIES

   140

DESCRIPTION OF THE OPERATING PARTNERSHIP

   144

DESCRIPTION OF SECURITIES

   158

MATERIAL PROVISIONS OF MARYLAND LAW AND OF OUR DECLARATION OF TRUST AND BYLAWS

   162

SHARES ELIGIBLE FOR FUTURE SALE

   168

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

   170

ERISA CONSIDERATIONS

   185

UNDERWRITING

   188

VALIDITY OF THE COMMON SHARES

   193

EXPERTS

   193

WHERE YOU CAN FIND MORE INFORMATION

   193

INDEX TO FINANCIAL STATEMENTS

   F-1

 

 

Dealer Prospectus Delivery Obligation

Through and including                     , 2010 (the 25th day after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.


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PROSPECTUS SUMMARY

This summary highlights some of the information in this prospectus. This summary does not contain all of the information that you should consider before investing in our common shares. You should read carefully the more detailed information set forth under the heading “Risk Factors” and the other information included in this prospectus. Except where the context suggests otherwise, the terms “our company,” “we,” “us” and “our” refer to Verde Realty, a Maryland REIT, together with its consolidated subsidiaries. Our operations are carried on through Verde Realty Operating Partnership, L.P., a Delaware limited partnership, which we refer to in this prospectus as our “operating partnership.” Unless otherwise indicated, the information in this prospectus assumes that the underwriters’ option to purchase additional shares is not exercised and that the common shares to be sold in this offering are sold at $             per share, the mid-point of the range indicated on the cover page of this prospectus. Market and industry data and forecasts used in this prospectus have been obtained from Reis, Inc. (“Reis”), AXIOMETRICS Inc. (“AXIOMETRICS”), CoStar Group, Inc. (“CoStar”), the U.S. Census Bureau and other industry sources where specifically noted. We have not independently verified the data obtained from these sources and we cannot assure you of the accuracy or completeness of the data. Any forecasts prepared by Reis, AXIOMETRICS, CoStar and other sources are based on data (including third-party data), models and experience of various professionals, and are based on various assumptions, all of which are subject to change without notice. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and uncertainties as the other forward-looking statements contained in this prospectus.

Overview

We are a fully integrated, self-administered and self-managed real estate investment trust, or REIT, that specializes in the ownership, acquisition and management of institutional-quality multifamily rental properties and industrial distribution facilities. Our existing operating portfolio is composed primarily of recently constructed multifamily rental properties in the southwestern United States and industrial distribution facilities in the southwestern United States and northern Mexico. C. Ronald Blankenship, our president and chief executive officer, and William Sanders, our chairman, founded the company and have a combined 75 years of experience in the real estate industry. We intend to capitalize on the experience and track record of Mr. Blankenship and the other members of our management team in successfully growing and managing public real estate companies. We also intend to utilize a significant portion of the proceeds of this offering to expand our existing asset base through the acquisition of multifamily rental properties and industrial distribution facilities focused in select high-growth markets in the western and southwestern United States.

As of November 30, 2009, our multifamily rental portfolio consisted of 14 properties totaling 4,790 units, representing an investment at cost of $363.4 million. The weighted average age of the properties in our multifamily rental portfolio is 1.1 years (excluding one property that is still in service but was acquired for future development). Our management team developed 13 of these properties since 2006, representing 4,363 units. Our multifamily rental portfolio was 94.8% physically occupied as of November 30, 2009, excluding four properties that are currently still in lease-up. Inclusive of these lease-up properties, our combined physical occupancy was 89.8% as of November 30, 2009.

As of November 30, 2009, our industrial distribution portfolio consisted of 87 properties, comprised of 52 properties in the United States and 35 in Mexico, totaling 12.0 million rentable square feet. The weighted average age of the properties in our industrial portfolio is 4.9 years (measured from the later of major renovation or the completion of construction). Our management team developed 29 of these properties since 2005, representing 4.6 million square feet. Our industrial portfolio was 83.6%

 

 

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leased as of November 30, 2009. Our industrial tenant base is broad and diversified. As of November 30, 2009, we had approximately 117 tenants in our industrial portfolio, with no single tenant accounting for more than 5.0% of our annualized rents and our 10 largest tenants comprising 28.7% of our rentable square feet and providing 33.9% of our annualized rent.

As of November 30, 2009, we owned approximately 86.8 acres of land suitable for construction of multifamily rental properties, which we refer to as “multifamily land,” and approximately 1,895.6 acres of land suitable for construction of industrial distribution facilities, which we refer to as “industrial land.” See “Business and Properties—Our Existing Portfolio.” By “suitable for construction,” we mean that the land generally has access to roads, utilities and other relevant entitlements (but excluding subdivision approvals, building permits and similar items) that would be conditions precedent to such construction. This multifamily land and industrial land had, as of November 30, 2009, an aggregate book value of approximately $39.4 million and $133.4 million, respectively (including our proportionate share of industrial land owned in joint ventures). We do not use mortgage debt to finance acquisitions of land. However, approximately 10.0 acres of our multifamily land are pledged to secure mortgage debt on one of our multifamily rental properties, Cypress Creek, and approximately 166.9 acres of our industrial land are included in property pledged to secure mortgage debt on certain properties in our industrial distribution portfolio. We generally acquired this land for its construction potential, but we do not believe market conditions warrant such activity at this time. We intend to hold this land in inventory for disposition and/or future development, including build-to-suit opportunities, as and when appropriate opportunities arise.

As of November 30, 2009, we also owned approximately 23,968.8 acres of land in Doña Ana County, New Mexico, which we refer to as Santa Teresa and that we acquired with a view toward developing as a mixed-use project. We no longer intend to pursue large-scale development of this land. In addition, we own approximately 9,560.1 acres of land relating to a low-density residential lot development business we previously conducted in central New Mexico, which we refer to as Heritage Preserve. We have completed all intended land development relating to Heritage Preserve. None of the Santa Teresa land or the land in our Heritage Preserve business is mortgaged.

In 2009, the aggregate land holding cost of our multifamily land, industrial land, the Santa Teresa land and our Heritage Preserve land was approximately $2.1 million and consisted primarily of real estate taxes and some maintenance expense. We do not expect these costs to increase significantly in 2010.

We believe that our senior management team has a successful track record of creating, growing, operating and monetizing public real estate companies. This public company experience is in addition to management’s substantial experience in all aspects of multifamily and industrial real estate. Management’s extensive experience includes, during the period from 1991 to 2002:

 

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Selected financing activity:

 

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initial public offerings of ProLogis, Security Capital Atlantic, Security Capital Group Incorporated (“Security Capital”) and Homestead Village Incorporated;

 

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strategic equity investments in Regency Centers Corporation, CarrAmerica Realty Corporation and Storage USA; and

 

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numerous follow-on equity offerings and unsecured and secured debt transactions.

 

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Selected merger and acquisition activity:

 

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public-to-public corporate mergers of Security Capital Atlantic with Security Capital Pacific to form Archstone Communities Trust, the predecessor of Archstone-Smith Trust, Security Capital U.S. Realty with Security Capital, and Storage USA with Security Capital; and

 

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sale of Security Capital to General Electric Capital and the merger of Pacific Retail Trust with Regency Centers Corporation.

 

 

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We intend to capitalize on this experience to grow, develop and operate our business.

Each of the four senior members of our management team has been a chief executive officer, chief operating officer, chief investment officer or chief financial officer of a NYSE-listed real estate company. Before forming Verde, Mr. Blankenship worked with our chairman, Mr. Sanders, for 12 years at Security Capital, a company that built or provided strategic assistance in the growth of 18 real estate companies, including successful, publicly traded REITs such as ProLogis, Archstone-Smith Trust, Regency Centers Corporation and CarrAmerica Realty Corporation. David C. Dressler, Jr., our executive vice president and chief investment officer, Richard Moore, our executive vice president and chief financial officer, and James C. Potts, our executive vice president for multifamily, all worked with Mr. Blankenship and Mr. Sanders at Security Capital. See “Management” for additional information regarding our board and management.

Our operating partnership was formed in 2003 and has owned and managed multifamily rental properties and industrial distribution facilities since 2004. We were formed in 2006 to serve as the general partner of our operating partnership. Through our operating partnership, we have four operating divisions, consisting of our multifamily rental business, our industrial distribution facilities business, the Santa Teresa mixed-use project and the Heritage Preserve residential lot development business.

Our Competitive Strengths

Successful track record in running public real estate companies

Our senior management team has a successful track record in creating, growing, operating and monetizing public real estate companies and has strategically supported the growth of some of the most well-known public real estate companies in the United States. Mr. Blankenship was the chief operating officer of Security Capital, which founded ProLogis, purchased and refocused Property Trust of America, which became Archstone-Smith Trust, and provided strategic guidance in the growth of companies such as CarrAmerica Realty Corporation and Regency Centers Corporation. See “Management.”

Senior management possesses a depth of real estate experience working together as a cohesive team

Our four-member senior management team has a combined 120 years of experience in the multifamily and industrial real estate sectors and brings deep national, regional and local industry relationships that it will utilize to grow and develop our business. Our senior management has substantial experience in all aspects of multifamily and industrial real estate acquisitions, dispositions, management, leasing, financing, developing and redeveloping across multiple real estate cycles. Mr. Blankenship has worked with our chairman, Mr. Sanders, for a total of 19 years. Each member of our senior management team worked at Security Capital for between five and 12 years. Ronald Blankenship, David C. Dressler, Jr. and James C. Potts also worked together at Trammell Crow Residential prior to their tenure at Security Capital.

Deep multidisciplinary management expertise across various real estate sectors

Based on their real estate experience, including their years at Security Capital and at Verde, our senior management possesses significant expertise in investing and operating multifamily and

 

 

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industrial real estate at the same time. In addition to their multisector experience, senior management has a multidisciplinary track record of successfully deploying capital through acquisitions, development and redevelopment.

Fully integrated multifamily and industrial distribution operating platform scaled for growth

We have a fully established and integrated multifamily and industrial real estate operating platform that is scaled for significant growth with minimal incremental overhead. We possess in-house expertise in all facets of owning, acquiring, developing, redeveloping and managing multifamily rental properties and industrial real estate assets. As of December 31, 2009, we employed approximately 246 employees and, in addition to our principal executive office in El Paso, Texas, we have 13 regional and market offices in the southwestern United States and northern Mexico, which enables us to perform a continual monitoring of market dynamics and opportunities in these high-growth markets. Our goal is to build on our existing operating, management and industry strengths as we seek to expand our platform in select high-growth markets in the western and southwestern United States.

Existing portfolio of high-quality operating properties, including recently developed institutional-quality multifamily rental properties and industrial distribution facilities

As of November 30, 2009, the weighted average age of our multifamily rental properties was 1.1 years (excluding one property that is still in service but was acquired for future development) and the weighted average age of our industrial distribution facilities was 4.9 years (measured from the later of major renovation or completion of construction). This relatively young portfolio has the potential to serve as a foundation for organic growth and expansion of market share in our key markets. Our property-level focus is on customer satisfaction and continuous refinement of operating efficiencies aimed at maximizing performance of our assets. See “Business and Properties—Existing Portfolio.”

Balance sheet positioned to facilitate future growth

Following this offering, we will have cash and other liquid assets of approximately $            , approximately $             million of outstanding indebtedness and a debt to cost ratio of approximately     %. As of September 30, 2009, our mortgage debt had a weighted average interest rate of 6.00%, which we believe is significantly below the cost of new secured indebtedness available to us at similar leverage levels in the current market. In addition, our operating partnership had outstanding $69.6 million of convertible debentures as of September 30, 2009, with a weighted average interest rate of 4.75%, which we also believe is below the cost currently available for new indebtedness. Further, after giving effect to the application of the net proceeds of this offering as described in “Use of Proceeds” and assuming we complete our anticipated conversion of our construction loans into permanent financing, as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Financing Activities,” we will have no significant near-term maturities and no debt maturing before 2013. We intend to enter into a line of credit in the near term in order to increase the flexibility of our balance sheet.

Near-term visible growth due to the stabilization of recently completed multifamily rental properties

Almost all of our multifamily rental properties are recently developed and four are still in the process of being fully leased. We developed 13 of the 14 multifamily rental properties in our portfolio. Seven of these properties achieved stabilized occupancy levels during 2009; therefore, 2010 will be their first full year of stabilized operations. We completed development of one property during the third quarter of 2009, two during the fourth quarter of 2009, and one during the first quarter of 2010, all of which are currently pre-stabilized and had a weighted average physical occupancy of 77.3% as of November 30,

 

 

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2009. It is expected that these four properties will achieve stabilized occupancy levels during 2010. Two of the pre-stabilized properties are expected to achieve stabilization in the third quarter of 2010, with the remaining two properties expected to reach stabilization in the fourth quarter of 2010. As a result, we believe that higher average occupancy levels for our multifamily rental portfolio, as well as effective rental rates consistent with other stabilized properties (rather than properties in lease up), will result in more robust near-term growth rates in net operating income than most of our competitors.

Strong alignment of interest between management and shareholders

Our executive officers and members of our board of trustees own a significant amount of our equity, representing over 19% of our common shares and common units of our operating partnership on an as-converted basis immediately prior to this offering and     % of our common shares and common units of our operating partnership on an as-converted basis upon completion of the offering. See “Principal Shareholders.” We intend to put in place a long-term incentive compensation plan to incentivize management through the awarding of options and equity-based compensation.

Commitment to strong corporate governance

We are committed to strong corporate governance, as demonstrated by the following:

 

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following completion of this offering, all members of our board of trustees will serve annual terms;

 

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we have opted out of two Maryland anti-takeover provisions; and

 

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we do not have a shareholder rights plan, and we do not intend to adopt a shareholder rights plan in the future unless our shareholders approve in advance the adoption of a plan, or, if adopted by our board of trustees, we submit the shareholder rights plan to our shareholders for ratification within 12 months of adoption or the plan will terminate.

Our Business Strategy

Capitalize on an attractive acquisition environment to expand our portfolio into key high-growth markets in the western and southwestern United States

We believe the next several years will present an attractive acquisition environment as a result of the current economic environment and its effect on the commercial real estate sector. We intend to capitalize on these opportunities by acquiring existing multifamily rental properties and industrial distribution facilities using a significant portion of the net proceeds of this offering. We will target markets with significant potential for job growth that have been impacted by current economic conditions yet offer excellent prospects for recovery and property-level cash flow growth. We believe that there are near-term growth prospects in the western and southwestern United States, although we will maintain flexibility for acquisitions in high-growth markets in other regions. We expect to benefit from the operational capabilities and market insight that our existing, established platform provides. We believe any successful acquisitions should meaningfully drive shareholder returns, especially in the short term, because our targeted acquisition volumes are significant relative to the size of our existing asset base.

Take advantage of positive fundamentals for multifamily and industrial real estate assets and maximize cash flow at our properties through internal growth

We believe that multifamily and industrial real estate assets are well positioned to outperform the general economy as the economy recovers and as tenant demand reasserts itself in response to improving economic conditions and in response to demographic trends. Accordingly, we intend to grow our operations in these asset classes through acquisitions. From an internal growth perspective, we

 

 

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believe that our strong in-house leasing and property management capabilities, including our practice of having a local presence in each of our markets, will help us achieve results that are superior to those companies who rely on unaffiliated third-party service providers. In addition, for our industrial distribution facilities, our market officers provide significant local marketing and tenant-relationship support.

Achieve growth through acquisitions of operating properties, while pursuing the sale of undeveloped land parcels

In the near term, we anticipate that our growth will come primarily through acquisitions of multifamily and industrial operating properties and thus we do not currently intend to expend significant resources or management time and attention on development activities. Our objective with respect to land held in inventory is to maximize value within a reasonable period of time, taking into account general economic conditions, supply and demand for real estate in the markets in which the land is located and prospective alternative investment opportunities that would be facilitated by a sale of the land. In this regard, we may consider the following alternatives: sales of land to third parties, construction on industrial land in connection with build-to-suit opportunities that may arise in the future and, potentially, construction of industrial and/or multifamily properties for our own portfolio if, at some point in the future, we determine that market rents and other related conditions justify development of new properties. Our strategy with regard to each tract of land will depend on economic conditions in the relevant market, supply and demand conditions impacting the values of developed industrial and multifamily properties within the relevant market, the land holding cost and the strategic value of the site, when compared to other competitive sites within the relevant market.

Maintain a flexible capital allocation strategy

We believe that our ability to be flexible in the allocation of capital, combined with our in-house research capabilities, allows us to take advantage of evolving industry dynamics to seize the best opportunities to grow property-level cash flow based on our operating expertise. We intend to allocate capital between multifamily rental properties and industrial distribution segments based on the potential for value creation between each asset type. We will also strategically re-deploy capital, generally from certain stabilized assets to higher growth opportunities as we broaden the scope of our target markets. Although we will initially focus on acquisitions, we will also utilize our expertise to develop and redevelop assets as markets rebound. Because of our established capabilities in property and asset management, we will consider lease-up and value-added assets in addition to stabilized assets.

Geographic focus in western and southwestern United States in key growth markets

Our geographic focus on acquisitions in the western and southwestern United States has positioned us to take advantage of strong growth fundamentals in markets within these regions as and when their economies strengthen, which we generally expect to commence in late 2010 and 2011. In both of our segments—multifamily rental properties and industrial distribution facilities—we intend to acquire properties in markets with strong job and population growth. In this regard, according to AXIOMETRICS, the four major Texas markets in which we currently operate are projected to be among the top U.S. metropolitan areas as measured by job growth over the period from 2010 to 2014. We expect the growth in these four markets to be driven by their diversified industrial base, business-friendly government environment, low cost of living and trade-oriented economies.

Market Opportunities

We believe that the extent of our opportunities to acquire desirable multifamily rental properties and industrial distribution facilities will be a function, in part, of the previous financial excesses in the commercial real estate sector, the current economic downturn and our ability to allocate capital consistent with desirable structural and economic growth trends.

 

 

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The credit crisis and economic downturn that began in late 2007 brought, among other things, substantial volatility and reductions in equity and asset values worldwide, which has caused a significant reduction in the amount of equity capital and available financing in the real estate sector. This dramatic reduction in available liquidity, combined with weakening underlying market fundamentals, reflected in a significant decline in market occupancies and rents, has significantly reduced property values. We believe that these conditions have created opportunities in select markets to acquire well-located, current-generation distressed assets at below our estimated replacement cost. We expect that these opportunities will begin to appear slowly in early 2010 and will increase in volume through 2011. As we acquire our target assets at attractive prices and seek to improve their operating performance, we believe that we will be positioned to provide investors with attractive risk-adjusted returns.

Delinquency rates are rising sharply for construction loans, mezzanine loans, permanent mortgage debt and commercial mortgage-backed securities, or CMBS. We believe there will be strong pressure on financial institutions and CMBS portfolios over the next several years, especially for loans originated during 2006 and 2007 at the peak of investment activity and lending excess. We believe that refinancing needs will be confronted by an environment of constrained liquidity and tougher underwriting standards. This comes against a backdrop of high unemployment that has put significant pressure on property fundamentals.

We believe that multifamily rental properties represent an attractive investment opportunity due to favorable demographics, lease characteristics and macroeconomic factors such as improving employment trends, population growth and the historically low levels of multifamily supply. In addition, we believe that a strong, high-quality management team can lead to stronger rent growth, higher resident retention and better expense control and risk management, which in turn, can significantly increase the operating performance and value of investments in multifamily rental properties. Further, mortgage financing is currently available for multifamily rental properties through Fannie Mae and Freddie Mac at attractive rates, which we believe provides us with the potential to actively manage our capital structure as we make acquisitions.

We believe that industrial distribution facilities represent an attractive investment opportunity due to, among other things, structural trends in distribution activity, minimal asset capital expenditure requirements, market cycle predictability, the ability to create customer relationships, low tenant turnover and the ability to pass on a significant portion of operating expenses to the tenants of such properties. Although the U.S. industrial real estate market is currently experiencing a downturn as a result of sharp declines in demand for industrial space, we believe that as the U.S. economy recovers, economic growth will lead to greater demand for industrial real estate, thus creating growth opportunities for owners of high-quality, well-positioned industrial real estate.

Through our internal market research expertise, we identify and prioritize markets, submarkets and assets where we believe cash flow growth can drive increased asset value. We are committed to measured growth using the analytics and research that we employ in our portfolio today.

 

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At a market level, we examine job growth and its sustainability, population growth, and the financial impact of governmental regulation (as it translates to property taxes, utility and insurance cost) and liquidity (such as institutional demand).

 

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At a submarket level, we consider the supply and construction pipeline, land availability and ease of entitlements, job locations, transportation infrastructure and lifestyle attributes.

 

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At a property level, we study competitive product pricing and service, product design, physical characteristics, condition, availability of financing (if applicable), replacement costs, visibility and location and specific opportunities to leverage our property management abilities.

We evaluate market, submarket and property opportunities using a standardized template and investment analysis. Any investment is subject to our thorough due diligence and investment committee process.

 

 

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Historically, Verde has been focused on major southern and U.S.-Mexico border markets. As we seek to deploy capital that we raise in this offering, we intend to leverage our senior management team’s broad geographic experience and focus on multifamily rental properties and industrial opportunities within our existing U.S. and Mexican markets, as well as select targeted markets in the western and southwestern United States, which may include: Los Angeles, California; Las Vegas, Nevada; Phoenix, Arizona; Riverside-San Bernardino, California; San Francisco, California; Seattle, Washington; and Denver, Colorado.

Multifamily Real Estate Industry

We believe that favorable opportunities will be found in the acquisition of existing Class A and B+ properties in our targeted markets and submarkets at significantly below our estimates of replacement cost. During market recoveries, we believe there is a “flight to quality” whereby renters tend to move up to better apartments (which are initially relatively favorably priced). Class A apartments will typically benefit from a “flight to quality” earlier and more substantially during the market recovery phase.

Multifamily Investment Opportunities

The U.S. multifamily real estate market has experienced a decline in rental rates and increase in concessions as economic conditions have triggered a broad decline in market fundamentals. Job losses, decreased migration and population growth and ongoing additions to new supply have weakened real property market performance, leading to a decline in market occupancies, rents and property values. Despite these difficulties, we believe that the following characteristics make multifamily real estate an attractive asset class for investment:

 

  Ÿ  

Market cycle.     We believe that multifamily real estate fundamentals in our target markets will be favorably impacted by observable macroeconomic factors, including improving employment trends, population growth and a fall-off in the supply pipeline. In particular, as the markets recover, new supply delivery will be at historically low levels.

 

  Ÿ  

Demographic trends.    According to the U.S. Census Bureau, renters represent 60% of households headed by persons under the age of 35. We believe that national and regional demographic trends will support multifamily fundamentals over the next few years as the prime rental market population, adults aged 20 to 34, significantly increases with the children of the “baby boom” generation reaching adulthood.

 

  Ÿ  

Attractive lease characteristics.    Multifamily leases are typically six months to one year in duration and thus allow lease rates to adjust frequently in response to changes in the market. Lease expirations can be managed to occur in a predictable fashion. New leases are not generally sourced through a broker, thus avoiding the need to factor broker or finder fees into the investment analysis, although some of our tenants come to us through apartment locator services that charge fees generally ranging from 50% to 100% of one month’s rent depending on the market and demand for apartments.

We believe our experienced management team can find additional investment advantages and add value as a result of:

 

  Ÿ  

Positive impact of strong internal property management.    We believe that multifamily real estate performance can be particularly impacted by the quality of the property management team. We believe that strong internal property management can drive increases in rent growth, resident retention, expense control and risk management.

 

  Ÿ  

Targeting.    Multifamily investments can be targeted to meet broad or narrow segments of renter demand. Garden-style apartments, for example, have very different cost and expense characteristics, and often very different renter profiles, than elevator high-rise units. In our opinion, targeting to meet desirable demand characteristics can lead to enhanced investment returns.

 

 

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Our Existing Multifamily Markets

Although distress in the housing, financial and labor markets has been experienced nationwide, performance of particular multifamily markets has differed and will vary depending on the strength of local economic conditions, key industries, job growth, population growth and inventory additions, including the level of shadow supply. Our multifamily rental portfolio currently consists of properties located in each of the following Texas markets: Austin, Dallas, Houston and San Antonio.

Industrial Real Estate Industry

The U.S. industrial real estate market consisted of approximately 14.3 billion square feet for the quarter ended September 30, 2009, according to CoStar. Of this total, approximately 12.6 billion square feet is industrial space, which consists of bulk distribution and light manufacturing facilities, and approximately 1.7 billion is flex space.

Warehouse properties, which represent the substantial majority of our assets, are characterized by their simple design and are generally leased to regional or national distribution tenants or tenants engaged in light manufacturing activities. In contrast, flex space typically has been designed or configured to a specialized use such as research and development, with comparatively higher re-tenanting costs as compared to warehouse properties due to higher build-out specifications. Industrial distribution facilities are typically leased on a triple-net basis.

Industrial Investment Opportunities

We believe that the current opportunity to acquire industrial distribution facilities and generate returns will be a function of both the severe economic downturn and the financial excesses in the commercial real estate sector. While distress is not as high in the industrial real estate market as it is for other property types, it is widespread and growing. We believe that distress in this sector will continue to rise well into 2010 and into early 2011 and that we are in the initial stages of what is anticipated to be a very negative cycle for commercial real estate. Accordingly, we believe that we will be able to acquire properties at attractive prices that will experience increasing rental and occupancy growth when the market recovers.

We believe that distressed acquisition opportunities of well-located, current-generation properties should be available at attractive prices beginning slowly in 2010 and increasing into 2011 and beyond. In addition, we believe that lower levels of new supply will characterize the U.S. industrial market for several years given the environment of reduced capital availability and speculative activity. With limited new supply entering the market during the early years of projected recovery, increasing demand for industrial space should lead to gains in occupancy and rents.

Industrial real estate, especially industrial distribution space, our preferred type of industrial real estate, as an asset class has investment characteristics that are distinct from other real estate asset classes. We believe that industrial real estate is an attractive asset class for investment because of:

 

  Ÿ  

Triple net leases.    Industrial leases are typically triple net, meaning that the majority of operating expenses, including real estate taxes, insurance and utilities, are passed on to the tenant. Although we are sensitive to tenant concerns about occupancy costs, this structure helps to mitigate our risk with respect to unforeseen increases in operating expenses.

 

  Ÿ  

Low annual tenant turnover.    In our experience, on a portfolio-wide basis, average annual customer turnover among the typical larger industrial tenants is generally low, primarily due to

 

 

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longer lease terms and the high relocation costs of changes to tenants’ existing supply-chain infrastructure. Tenant retention can serve to reduce volatility in earnings and minimize re-tenanting capital costs.

 

  Ÿ  

Minimal capital expenditures.    Industrial distribution facilities typically have a low level of interior finish, contributing to lower initial configuration and ongoing capital costs.

 

  Ÿ  

Corporate outsourcing.    A structural trend in the U.S. market toward corporate outsourcing of non-core business functions, particularly logistics activity, to third-party logistics providers should lead to increased demand for industrial distribution space.

 

  Ÿ  

Market cycle predictability.    We believe that economic factors influence growth in the demand for industrial space in a predictable and observable fashion. We believe that key drivers of demand include population growth, increasing global trade, growth in the number of products (such as an increase in SKUs), an increase in demand for regional facilities and overall GDP growth and consumer demand.

Our Existing Industrial Markets

The properties in our current industrial portfolio are located in markets that are important centers of production and trade between the United States and Mexico. Dramatic increases in trade between Mexico and the United States occurred as a result of the implementation of the North American Free Trade Agreement (“NAFTA”) in January 1994. According to the U.S. Census Bureau, the total value of NAFTA goods that are imported into the United States has more than tripled from 1994 to 2008 and, although sharp declines from 2008 levels occurred in 2009, continued growth is expected in the long term.

Summary Risk Factors

An investment in our common shares involves various risks. You should consider carefully the risks discussed below and under the heading “Risk Factors” beginning on page 20 of this prospectus before purchasing our common shares. If any of these risks occur, our business, financial condition, liquidity, results of operations and prospects could be materially and adversely affected. In that case, the trading price of our common shares could decline, and you may lose some or all of your investment.

 

  Ÿ  

Risks associated with the ownership of real property, or changes in economic, demographic or real estate market conditions, may adversely affect our results of operations and returns to our shareholders.

 

  Ÿ  

Declining real estate valuations and impairment charges could adversely affect our earnings and financial condition.

 

  Ÿ  

The geographic and market concentration of our portfolio makes us susceptible to adverse economic developments in those markets.

 

  Ÿ  

Continued disruptions in the financial markets and economic conditions that either deteriorate or fail to improve could adversely affect our ability to secure debt financing on attractive terms and the values of investments we may make. The current downturn and any economic conditions that either deteriorate or fail to improve may also impact our tenants and their business operations directly, reducing their ability to pay rent when due and thereby adversely affecting our operating results.

 

  Ÿ  

Delays we encounter in the selection, acquisition, development, redevelopment and/or renovation of real properties could adversely affect our results of operations and returns to our shareholders.

 

 

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  Ÿ  

Our long-term growth will depend upon future acquisitions of properties, and we may be unable to consummate acquisitions on advantageous terms or acquisitions may not perform as we expect.

 

  Ÿ  

Demand for land is subject to a number of risks that could reduce our ability to realize value from our land assets.

 

  Ÿ  

Real estate development activities are subject to a number of risks and uncertainties that could reduce our profitability.

 

  Ÿ  

We have a history of losses, and we may be unsuccessful in meeting our investment objectives.

 

  Ÿ  

Real properties are illiquid investments, and we may be unable to adjust our portfolio in response to changes in economic or other conditions or sell a property if or when we decide to do so.

 

  Ÿ  

We depend on tenants for revenue, and vacancies, tenant defaults, exercise of termination options by tenants or capital improvements may adversely affect our operations and cause the value of your investment to decline.

 

  Ÿ  

Uninsured losses or premiums for insurance coverage relating to real property may adversely affect your returns.

 

  Ÿ  

Our real property is subject to property taxes that may increase in the future, which could reduce our cash flow and results of operations.

 

  Ÿ  

Liability for environmentally hazardous conditions may adversely affect our operating results.

 

  Ÿ  

Our board of trustees may change significant corporate policies, including policies regarding acquisitions, dispositions, financing, growth, debt capitalization, REIT qualifications and distributions, without shareholder approval.

 

  Ÿ  

Certain aspects of our organizational documents and Maryland law may discourage a takeover or business combination that may benefit our shareholders, including ownership and transfer limits that prohibit any person from directly or indirectly owning more than 9.9% in number or value of our outstanding shares of beneficial interest.

 

  Ÿ  

Our organizational documents contain no limitation on the amount of debt we may incur. As a result, we may become highly leveraged in the future. Following this offering, we will have approximately $             million of outstanding indebtedness. The use of debt to finance our acquisitions and developments could restrict our operations, inhibit our ability to grow and adversely affect our cash flows.

 

  Ÿ  

Prior to this offering, there has been no public trading market for our common shares, and as a result it may be difficult for you to sell your shares. If you sell your common shares, it may be at a substantial discount to the price you paid for your shares. The market price and trading volume of our shares may be volatile and could decline following the offering, resulting in a substantial or complete loss on your investment.

 

  Ÿ  

Fluctuations in interest rates could increase our expenses, require us to sell investments or make it more difficult to make attractive investments and effectively pursue an acquisition strategy.

 

  Ÿ  

The timing and amount of our cash distributions, if any, may vary over time.

 

  Ÿ  

If we fail to remain qualified as a REIT, we could not deduct distributions to our shareholders in computing our taxable income and would have to pay federal income tax on our taxable income

 

 

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at regular corporate rates. As a result, cash available for distribution to our shareholders would be reduced and we may be required to borrow additional funds or sell some of our assets in order to meet our obligations.

Property Overview

The breakdown of our multifamily rental portfolio as of November 30, 2009, was as follows:

 

    Multifamily Rental Properties

Market

  Number of
Properties
  Number
of Units
  Physical
Occupancy(1)
    Average Monthly
Rent Per
Occupied Unit(2)

Austin, Texas

  3   1,104   94.1   $ 812

Dallas, Texas

  2   895   83.0        971

Houston, Texas

  7   2,263   92.7        878

San Antonio, Texas

  2   528   79.7        859
           

Total/Weighted Average

  14   4,790   89.8   $ 880
                   

 

(1) We define physical occupancy as the number of leased units in a multifamily community divided by total units.
(2) We define average monthly rent per occupied unit as the average effective rent revenue (contractual rent less concessions) from signed leases in place divided by the total number of occupied units.

The breakdown of our industrial distribution portfolio as of November 30, 2009, was as follows:

 

    Industrial Distribution Facilities

Market

  Number of
Properties
  Net Rentable Area
(Square Feet)
  Percent
Leased(1)
    Annualized
Cash Rent
  Annualized
Rent Per
Leased

Square
Foot(2)

Austin, Texas

  2   244,800   93.5   $ 1,282,224   $ 5.60

El Paso, Texas

  18   1,537,119   87.4        5,145,624     3.83

Houston, Texas

  2   257,848   75.0        837,960     4.33

Laredo, Texas

  8   1,339,725   67.9        3,577,455     3.93

McAllen, Texas

  11   1,647,927   76.2        5,189,507     4.13

San Antonio, Texas(3)

  5   588,027   81.0        2,113,443     4.44

Santa Teresa, New Mexico

  6   740,267   95.1        2,412,728     3.43
                 

United States

  52   6,355,713   80.4        20,558,941     4.02

Chihuahua, Chihuahua

  4   484,450   100.0        1,780,048     3.67

Juarez, Chihuahua

  15   2,852,772   88.2        11,398,738     4.53

Monterrey, Nuevo Leon

  1   120,994   0.0        0     0.00

Reynosa, Tamaulipas(3)

  8   982,142   84.4        5,087,831     6.14

Tijuana, Baja California(3)

  7   1,241,610   90.8        5,943,325     5.27
                 

Mexico

  35   5,681,968   87.3        24,209,942     4.88

Total/Weighted Average

  87   12,037,681   83.6   $ 44,768,883   $ 4.45
                         

 

(1) We define percent leased as leased square feet divided by net rentable square feet.
(2) Represents annualized cash rent divided by leased square feet.
(3) Includes one or more properties held in a joint venture.

 

 

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Our Corporate Structure

We are structured as an umbrella partnership REIT, or UPREIT. We hold substantially all of our assets in, and conduct substantially all of our operations through, our operating partnership and its subsidiaries. We control our operating partnership as the sole general partner and will own approximately             % of the aggregate partnership interests, after giving effect to this offering. We will own a total number of common units in our operating partnership equal to the total number of common shares that we will have outstanding after the completion of this offering.

Beginning on the first anniversary of the completion of this offering, limited partners of our operating partnership (other than us) may redeem each operating partnership unit they hold in exchange for cash in an amount equal to the market value of one common share or, if we elect to assume and satisfy the redemption obligation directly, either that same amount of cash or one common share, adjusted as specified in the partnership agreement of our operating partnership. We will have the sole discretion to elect whether the redemption right will be satisfied by us in cash or our common shares or a combination of cash and our common shares. See “Description of the Operating Partnership—Redemption of Common Units for Cash or Common Shares.”

 

 

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The following chart shows our structure after giving effect to this offering, assuming no exercise by the underwriters of their option to purchase additional shares.

LOGO

 

(1) Our operating partnership has outstanding several classes and series of convertible preferred units, which we refer to as “CPUs,” and convertible subordinated debentures. See “Description of the Operating Partnership—Capitalization.” If all of the CPUs and convertible debentures were converted into common units of the operating partnership, then, after giving effect to this offering, our ownership of the operating partnership would be reduced from 90.3% to     %, the ownership of the other current limited partners would be reduced from 9.7% to     %, the current CPU holders would own     % of the operating partnership’s common units, and the current debenture holders would own     % of the common units. In addition, each common unit of the operating partnership is generally redeemable for cash by the holder in an amount equal to the value of one common share, subject to certain adjustments. We may elect to satisfy the operating partnership’s redemption obligation by delivering our common shares or cash, or a combination of both cash and our common shares in our sole discretion. See “Description of the Operating Partnership—Redemption of Common Units for Cash or Common Shares.” Upon completion of this offering, we intend to convert approximately 68% of the outstanding CPUs into their common unit equivalent.

 

 

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Distribution Policy

In order to maintain our status as a REIT, we must make annual distributions to our shareholders of at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains. We intend to pay quarterly cash dividends to holders of our common shares out of funds legally available therefor. We intend to pay a pro rata dividend with respect to the period commencing on the completion of this offering and ending                     , 2010. On an annualized basis, this would be $              per share, or an annual dividend rate of approximately     % based on an initial public offering price of $              per share, which is the mid-point of the range indicated on the cover page of this prospectus. We intend to maintain our initial dividend rate for the 12-month period following completion of this offering unless actual results of operations, economic conditions or other factors differ materially from the assumptions used in our estimate.

In considering the amount of cash available for distribution to our shareholders, management considers adjusted funds from operations, or AFFO, which is FFO as calculated by us and described under “Summary Selected Historical Financial and Operating Data,” as adjusted to exclude the non-cash effect of such items as non-real estate depreciation, amortization or impairments, stock-based compensation expense, amortization of deferred financing costs, amortization of debt discount, amortization of above or below market leases and straight line rents, and deducting the expenditures of recurring capital maintenance and principal amortization of indebtedness.

We cannot assure you as to when we will begin to generate sufficient cash flow to make distributions to our shareholders or as to our ability to sustain those distributions. Dividends paid by us will be authorized and determined by our board of trustees in its sole discretion out of funds legally available therefor and will be dependent upon a number of factors, including restrictions under applicable law and our capital requirements. We do not intend to reduce the expected dividend per share if the underwriters’ option to purchase additional shares is exercised.

Our Tax Status

We have elected to be taxed as a REIT as provided in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, or the Code, since our inception in 2006, and we intend to maintain our status as a REIT following this offering. We believe that our organization and proposed method of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT for federal income tax purposes. To maintain REIT status, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute at least 90% of our REIT taxable income to our shareholders, excluding net capital gains. As a REIT, we generally will not be subject to federal income tax on REIT taxable income that we distribute to our shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to some federal, state and local taxes on our income or property. See “Material U.S. Federal Income Tax Considerations.”

Transfer Restrictions

Our executive officers, trustees and each holder of     % or more of our common shares and securities convertible or exchangeable into common shares (including units in our operating partnership) have agreed with the underwriters, subject to certain exceptions, not to sell or otherwise transfer or encumber any of our common shares or securities convertible into or exchangeable for our common shares during the period from the date of this prospectus continuing through the     th day after the date of this prospectus, except with the prior written consent of the representatives of the underwriters. This agreement does not apply to any shares or units issued pursuant to existing employee benefit plans. In addition, pursuant to the terms of the partnership agreement of our

 

 

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operating partnership, holders of units in our operating partnership do not have redemption rights and may not otherwise transfer their units, except under certain limited circumstances, for a period of 12 months after the completion of this offering.

Corporate Information

Our principal executive office is located at 201 East Main Drive, El Paso, Texas 79901, and our telephone number is (915) 225-3200. We maintain an internet site at www.verderealty.com. The information included or referenced on, or otherwise accessible through, our website is not intended to form a part of or be incorporated by reference into this prospectus.

 

 

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THE OFFERING

 

Common shares offered by us

             shares (plus up to an additional              common shares that we may issue and sell upon the exercise of the underwriters’ option to purchase additional shares)

 

Common shares outstanding after this offering

             shares(1) (plus up to an additional              common shares that we may issue and sell upon the exercise of the underwriters’ option to purchase additional shares)

Common shares and common units in our operating partnership outstanding after this offering

             shares/units(2) (plus up to an additional              common shares that we may issue and sell upon the exercise of the underwriters’ option to purchase additional shares)

 

Use of proceeds

We intend to use the net proceeds of this offering to repay existing indebtedness of approximately $             million, to fund future property acquisitions and for general corporate purposes. After this repayment, we expect to have approximately $             million of outstanding indebtedness. Prior to such use of the net offering proceeds, we intend initially to invest the net proceeds in interest-bearing short-term investment grade securities or money-market accounts which are consistent with our intention to qualify as a REIT, although we may also hold a portion of the net proceeds in an interest- or non-interest-bearing deposit account. These initial investments are expected to provide a lower net return than we will seek to achieve from investments in real properties or other real estate-related interests. See “Use of Proceeds.”

 

Ownership restrictions

Due to limitations on the concentration of ownership of REIT shares imposed by the Code, our declaration of trust generally prohibits any person from actually or constructively owning more than 9.9% of our outstanding shares of beneficial interest. Our declaration of trust, however, does permit exceptions to be made for shareholders in the sole discretion of our board of trustees.

 

Risk factors

Investing in our common shares involves risks. You should carefully read and consider the information set forth under “Risk Factors” and all other information in this prospectus before investing in our common shares.

 

Proposed NYSE symbol

We intend to apply for our common shares to be listed on the NYSE under the symbol “VRE.”

 

(1) Includes 21,852,435 shares owned by our continuing investors. See “Principal Shareholders.”
(2) Includes 2,340,837 operating partnership units not owned by us and that may, subject to certain limitations and adjustments, be exchanged for cash or, at our option, common shares on a one-for-one basis. Does not include common units issuable upon the conversion of the convertible preferred units or subordinated convertible debentures of our operating partnership. See “Description of the Operating Partnership—Capitalization.”

 

 

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SUMMARY SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

We derived the summary selected consolidated statements of income data for the nine months ended September 30, 2009, and the years ended December 31, 2008, 2007 and 2006, and the summary selected consolidated balance sheet data as of September 30, 2009, and December 31, 2008 and 2007, from our audited consolidated financial statements included elsewhere in this prospectus. We derived the summary selected consolidated statements of income data for the years ended December 31, 2005 and 2004, and the summary selected consolidated balance sheet data as of December 31, 2006, 2005 and 2004, from our audited consolidated financial statements that are not included in this prospectus. We derived the summary selected consolidated statements of income data for the nine months ended September 30, 2008, from our unaudited consolidated interim financial statements included elsewhere in this prospectus. We derived the summary selected consolidated balance sheet data as of September 30, 2008, from our unaudited consolidated financial statements that are not included in this prospectus.

Prior to July 1, 2006, Verde Group, L.L.C., or Group, was the majority owner of both us and our operating partnership. Effective July 1, 2006, in a series of merger and restructuring transactions, Group merged with and into our operating partnership. As the general partner of our operating partnership, we succeeded to the operations of Group and our operating partnership. Accordingly, amounts presented in our summary selected consolidated historical financial and operating data prior to the merger date are derived from Group’s consolidated financial statements.

The results for any interim period are not necessarily indicative of the results that may be expected for the full year. Additionally, our historical results are not necessarily indicative of the results expected for any future period. You should read the selected historical financial data together with the consolidated financial statements and related notes appearing elsewhere in this prospectus, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the other financial information included elsewhere in this prospectus.

 

    Nine months ended
September 30
    Year ended December 31,  
    2009     2008(1)     2008     2007     2006     2005     2004  
    (In thousands, except per-share data)  

Balance Sheet Data (end of period):

             

Real estate, net

  $ 1,044,605      $ 1,036,044      $ 1,045,940      $ 977,537      $ 620,335      $ 406,104      $ 172,526   

Total assets

    1,228,903        1,278,819        1,238,858        1,221,479        731,127        555,347        261,226   

Total liabilities

    660,054        646,415        636,033        562,508        349,356        274,938        123,220   

Total shareholders’ equity

    482,994        539,727        512,741        563,014        325,847        176,291        118,057   

Noncontrolling interests

    85,855        92,677        90,084        95,957        55,924        104,118        19,949   
                                                       

Total equity

    568,849        632,404        602,825        658,971        381,771        280,409        138,006   

Statement of Operations Data:

             

Total revenues

    73,869        53,909        77,461        61,690        47,752        25,177        4,381   

Total expenses

    85,124        72,784        117,044        89,377        67,428        38,977        10,252   

Operating loss

    (11,255     (18,875     (39,583     (27,687     (19,676     (13,800     (5,871

Net loss attributable to common shareholders

    (31,608     (27,303     (55,623     (40,874     (21,136     (18,836     (8,315

Cash Flow Data:

             

Net cash provided by (used in) operating activities

    (967     (11,968     (15,751     5,656        (27,615     (16,186     (16,201

Net cash used in investing activities

    (65,133     (117,853     (147,772     (333,682     (194,656     (229,959     (140,411

Net cash provided by financing activities

    38,286        100,497        119,483        443,714        176,800        272,334        208,639   

 

(1) Restated, see Note 1 to our consolidated financial statements included herein.

 

 

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Funds from operations, or FFO, is computed in accordance with guidance promulgated by the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT defines FFO as net income or loss determined in accordance with generally accepted accounting principles (“GAAP”), excluding gains or losses from sales of previously depreciated operating real estate assets, plus real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures. In addition, we exclude deferred income tax expense or benefit and changes in fair value of derivatives. Gains or losses on land and investment real estate are included in FFO; investment real estate is defined as real estate assets for which our original intent was that the assets would not be included in the operating portfolio on a long-term basis. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cash Flows” for reconciliation of net loss to funds from operation, before minority interest.

Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income by itself as the primary measure of our operating performance. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself. There can be no assurance that FFO presented by us is comparable to similarly titled measures of other REITs.

FFO should not be considered as an alternative to net income or other measurements under GAAP as an indicator of our operating performance or to cash flows from operating, investing or financing activities as a measure of liquidity. FFO does not reflect working capital changes, cash expenditures for capital improvements or principal payments on indebtedness.

Our FFO is as follows (in thousands):

 

     Nine Months Ended
September 30,
    Year Ended
December 31,
 
      2009     2008     2008     2007  

Funds used in operations attributable to Verde Realty

   $ (11,029   $ (8,437   $ (23,326   $ (13,592
                                

 

 

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RISK FACTORS

Investing in our common shares involves risk. In addition to other information contained in this prospectus, you should carefully consider the following factors before acquiring the common shares offered by this prospectus. If any of the risks discussed in this prospectus occur, our business, prospects, financial condition, results of operations and our ability to make cash distributions to our shareholders could be materially and adversely affected, the trading price of our common shares could decline significantly and you could lose part or all of your investment. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. Please refer to “Forward-Looking Statements” for additional information.

Risks Related to Our Business

Risks associated with the ownership of real property, or changes in economic, demographic or real estate market conditions, may adversely affect our results of operations and returns to our shareholders.

We are subject to risks generally attributable to the ownership of real property, including:

 

  Ÿ  

the illiquid nature of real estate compared to other financial assets;

 

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changes in international, national, regional or local economic, demographic or real estate market conditions;

 

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changes in supply of or demand for multifamily rental properties and industrial distribution facilities in an area;

 

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competition for real property investments targeted by our investment strategy;

 

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vacancies, tenant bankruptcies, changes in market rental rates, changes in consumer trends and preferences that affect tenant demand, lease terminations and the need periodically to repair, renovate and re-let our properties;

 

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changes in interest rates and the availability of financing;

 

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environmental risks related to the presence of hazardous or toxic substances or materials at or in the vicinity of our properties;

 

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changes in government rules, regulations and fiscal policies, including those governing real estate usage and tax; and

 

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catastrophic events that may result in uninsured or underinsured loss.

We are unable accurately to predict future changes in international, national, regional or local economic, demographic or real estate market conditions. For example, a continued recession or rise in interest rates could make it more difficult for us to lease real properties, may require us to lease the real properties we acquire at lower rental rates than projected and may lead to an increase in tenant defaults. In addition, these conditions may also lead to a decline in the value of our properties and make it more difficult for us to dispose of these properties at an attractive price. These conditions, or others we cannot predict, could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

We have not identified any of the properties that we will purchase with the net proceeds of this offering, which makes your investment more speculative.

We will seek to invest a significant portion of the net proceeds of this offering in real estate, primarily in the multifamily rental and industrial distribution real estate sectors. We have established criteria for evaluating multifamily rental properties and industrial distribution facilities. See “Policies with

 

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Respect to Certain Activities.” However, you will be unable to evaluate the transaction terms, location or financial or operational data concerning any of the properties that we will purchase with the net proceeds of this offering.

Declining real estate valuations and impairment charges could adversely affect our earnings and the market price of our common shares.

We intend to review the carrying value of our properties when circumstances, such as adverse market conditions (including conditions resulting from the current economic downturn), indicate potential impairment may exist. We intend to base our review on an estimate of the future cash flows (excluding interest charges) expected to result from the investment’s use and eventual disposition. We intend to consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our evaluation indicates that we may be unable to recover the carrying value of a real estate investment, an impairment loss will be recorded to the extent that the carrying value exceeds the estimated fair value of the property. Land is particularly susceptible to declining real estate valuations. These losses would have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. A worsening real estate market may cause us to reevaluate the assumptions used in our impairment analysis. Impairment charges could adversely affect our results of operations and the market price of our common shares.

The concentration of our portfolio may make us particularly susceptible to adverse economic developments in those markets.

In addition to regional, national and international economic conditions, our operating performance will be impacted by the economic conditions of the specific markets in which we have concentrations of properties. We currently own properties in states along the U.S.-Mexico border. As a result of the concentration of our real estate investment portfolio in this geographic area, our operating results and ability to make distributions are likely to be impacted by economic changes affecting the real estate markets in these markets, including oversupply of, or reduced demand for, industrial space and multifamily housing. Your investment will therefore be subject to greater risk because we lack a geographically diversified portfolio. Our investments in these markets are susceptible to developments which may adversely affect these markets’ competitiveness as a production zone, including increased competition from China and other developing countries and other low-cost producer nations and adverse changes in laws or regulations that govern trade between Mexico and the United States. These economies may also be negatively impacted by other factors, including a downturn in the U.S. or world economy that reduces demand for goods produced in these markets. If there is a downturn in the economy in any of these markets, our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares could be materially adversely affected.

In addition, our investments will be concentrated in industrial distribution facilities and multifamily rental properties. This concentration may expose us to the risk of economic downturns in these sectors to a greater extent than if our business activities included a more significant portion of other sectors of the real estate industry.

 

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Continued disruptions in the financial markets and deteriorating economic conditions could adversely affect our ability to secure debt financing on attractive terms, the values of investments we make and our ability to make distributions.

Recent events in the financial markets have had an adverse impact on the credit markets and, as a result, credit has become significantly more expensive and difficult to obtain, if available at all. We expect to finance our investments in part with debt. If adverse conditions in the credit markets—particularly with respect to real estate—materially deteriorate or fail to materially improve, our business could be materially and adversely affected. Market conditions may make it difficult to obtain financing, and we cannot assure you that we will be able to obtain additional debt or equity financing or that we will be able to obtain it on favorable terms. Our long-term ability to acquire real properties and to expand our operations will be limited if we cannot obtain additional financing on favorable terms. If we cannot establish reserves out of cash flow generated by our investments or out of net sale proceeds in non-liquidating sale transactions, or obtain debt or equity financing on acceptable terms, we will be less likely to achieve our investment objectives, which may negatively impact our results of operations and reduce our ability to make distributions to our shareholders.

In addition, the turmoil in the capital markets has constrained equity and debt capital available for investment in commercial real estate, resulting in fewer buyers seeking to acquire commercial properties and consequent reductions in property values. As a consequence, we may be unable to sell our properties at an attractive price. Furthermore, the current state of the economy, and the implications of future potential weakening may negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our current portfolio. The current downturn and any further worsening of economic conditions may impact our tenants and their business operations directly, reducing their ability to pay rent or other charges due to us.

To the extent that the economic downturn is prolonged or becomes more severe, our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares could be materially adversely affected.

Our long-term growth will depend upon future acquisitions of properties, and we may be unable to consummate acquisitions on advantageous terms or acquisitions may not perform as we expect.

We intend to manage our existing properties and acquire additional properties in the multifamily rental and industrial distribution real estate sectors. The acquisition of properties entails various risks, including the risks that our investments may not perform as we expect, that we may be unable quickly and efficiently to integrate our new acquisitions into our existing operations and that our cost estimates for bringing an acquired property up to market standards may prove inaccurate. Further, we face significant competition for attractive investment opportunities from other investors. This competition increases as investment in real estate becomes increasingly attractive relative to other forms of investment. As a result of competition, we may be unable to acquire properties as we desire or the purchase price may be significantly elevated. Although we expect to finance future acquisitions through a combination of long-term debt, common equity capital and retained cash flow, these sources of funds may not be available at all or on advantageous terms, which could adversely affect our cash flows. Any of the above risks could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Demand for land is subject to a number of risks that could reduce our ability to realize value from our land assets.

A portion of our business involves the ownership and potential sale of developed and undeveloped land. The value of such land may be adversely affected by changes in the overall

 

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demand for homes, home sites, commercial sites or other real estate in the regions in which our land is located. In particular, reductions in demand could result from higher interest rates, reductions in consumer confidence, increases in costs of materials and labor necessary for construction, the unavailability of acquisition financing for potential purchasers, inflation, recession or other economic conditions that could reduce the demand for housing or commercial space, any of which, in turn, could reduce the demand for our land. Any increase in interest rates or lack of recovery in the national economy or in the economy of the areas in which our land is located could affect our profitability with respect to this land.

If we determine to develop any of our multifamily land or industrial land sites, our real estate development strategies may not be successful.

If we decide to build properties on any of our multifamily land or industrial land sites, we will be subject to risks associated with our development activities that could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common stock, including, but not limited to the risk that:

 

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we might elect to abandon projects after we commence construction and might be required to record an impairment in connection therewith;

 

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we may not be able to obtain, or may experience delays in obtaining, necessary construction, occupancy and other governmental permits and authorizations;

 

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we may not be able to obtain financing for development projects on favorable terms;

 

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construction costs of a project may exceed the original estimates or that construction may not be concluded on schedule, making the project less profitable than originally estimated or not profitable at all (including the possibility of contract default, the effects of local weather conditions, the possibility of local or national strikes and the possibility of shortages in materials, building supplies or energy and fuel for equipment);

 

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upon completion of construction, we may not be able to obtain, or obtain on advantageous terms, permanent financing for activities that we have financed through construction loans; and

 

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occupancy levels and the rents that can be charged for a completed project do not meet forecasted occupancy or rent levels and result in a lower return than was anticipated.

Moreover, substantial development activities, regardless of their ultimate success, typically require a significant amount of management’s time and attention, diverting their attention from our other operations.

Delays in the acquisition, development and construction of real properties may have adverse effects on our results of operations and returns to our shareholders.

Delays we encounter in the selection, acquisition, development, redevelopment or renovation of real properties could adversely affect our results of operations and returns to our shareholders. We may experience delays in making investments due to delays or difficulties in locating suitable investments, negotiating or obtaining the necessary purchase documentation, obtaining financing or complying with regulatory requirements. We may also incur greater costs than projected in connection with the construction, development or redevelopment projects that we elect to pursue. Each of those factors could result in increased costs of a project or loss of our investment. In addition, we will be subject to normal lease-up risks relating to newly constructed projects. Further, the price we pay for real property investments will be based on our projections of rental income and expenses upon completion of construction. If our projections are inaccurate, we may overpay for a property.

 

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We expect to invest the proceeds we receive from this offering in short-term, highly liquid investments until we use such funds for the purposes described under “Use of Proceeds.” We expect that the income we earn on these temporary investments will not be substantial, as these investments, although liquid, generate little yield. Therefore, delays in investing proceeds we raise from this offering could impact our ability to generate cash flow for distributions.

We have a history of losses.

We were formed in 2006 to invest in real-estate related assets. Our operating partnership, Verde Realty Operating Partnership, L.P., through which we hold our investments, has owned and managed multifamily rental properties and industrial distribution facilities since 2004. The results of our operations will depend on many factors, including the availability of opportunities to acquire properties, the level and volatility of interest rates, readily accessible short- and long-term funding, alternative conditions in the financial markets and general economic conditions. We cannot assure you that we will be able successfully to operate or comply with regulations applicable to our company as a publicly traded REIT, including the requirements to timely meet disclosure requirements and comply with the Sarbanes-Oxley Act of 2002.

We depend on key personnel.

Our success depends to a significant degree upon the contributions of certain key personnel including, but not limited to, our president and chief executive officer, each of whom would be difficult to replace. If any of our key personnel were to cease employment with us, our operating results could suffer. Our ability to retain our senior management group or to attract suitable replacements should any members of the senior management group leave is dependent on the competitive nature of the employment market. The loss of services from key members of the management group or a limitation in their availability could adversely impact our financial condition and cash flows. Further, such a loss could be negatively perceived in the capital markets. We have not obtained and do not expect to obtain key man life insurance on any of our key personnel.

We also believe that, as we expand, our future success depends, in large part, upon our ability to hire and retain highly skilled managerial, investment, financing, operational and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such skilled personnel or that such competition will not result in increased labor costs.

We compete with numerous other parties for real property investments and tenants and may not compete successfully.

We compete with many other persons and entities seeking to buy real property or to attract tenants to properties they own. There are numerous financial institutions, real estate funds and investment companies, pension funds, real estate developers and public and private U.S. and non-U.S. investors that compete with us in seeking investments and tenants. Many of these entities have significant financial and other resources, including operating experience, allowing them to compete effectively with us. In particular, many of our competitors are larger public REITs, which have greater name recognition, resources and access to capital than we do.

The apartment community industry in particular is a highly competitive market. This competition could reduce occupancy levels and revenues at our multifamily rental properties, which would adversely affect our operations. We face competition from many sources, including from multifamily rental communities both in the immediate vicinity and in the larger geographic market where our multifamily rental properties are located. Overbuilding of multifamily rental properties may occur. If so,

 

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this will increase the number of apartment units available and may decrease occupancy and apartment rental rates. As of November 30, 2009, our multifamily rental portfolio was 94.8% physically occupied, excluding four properties that are currently still in lease-up. Inclusive of these lease-up properties, our combined physical occupancy was 89.8% as of November 30, 2009.

There is no assurance that we will be able to acquire properties or attract tenants on favorable terms, if at all. Our competitors may be willing to offer space at rental rates below our rates, causing us to lose existing or potential tenants and pressuring us to reduce our rental rates or provide tenant inducement packages to retain existing tenants or convince new tenants to lease space at our properties. Each of these factors could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Our acquisition activities may pose integration and other risks that could harm our business.

We intend to acquire additional properties and, as a result of these acquisitions, we may be required to incur debt and expenditures and issue additional common shares or units of our operating partnership to pay for the acquired properties. These acquisitions may dilute our shareholders’ ownership interest, delay or prevent our profitability and may also expose us to risks such as:

 

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the possibility that we may not be able successfully to integrate acquired properties into our existing portfolio or achieve the level of quality with respect to such properties to which tenants of our existing properties are accustomed;

 

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the possibility that senior management may be required to spend considerable time negotiating agreements and integrating acquired properties, diverting their attention from our other objectives;

 

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the possible loss or reduction in value of acquired properties; and

 

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the possibility of pre-existing undisclosed liabilities regarding acquired properties, including environmental or asbestos liability, for which our insurance may be insufficient or for which we may be unable to secure insurance coverage.

We cannot assure you that the price for any future acquisitions will be similar to prior acquisitions. If our revenue does not keep pace with these potential acquisition and expansion costs, we may incur net losses. There is no assurance that we will successfully overcome these risks or other problems encountered with acquisitions.

We may be unable successfully to expand our current operations into new markets.

As the opportunities arise, we intend to explore acquisitions of properties in markets other than the markets in which we currently operate. Each of the risks applicable to our ability to acquire and successfully integrate and operate properties in our current multifamily and industrial real estate markets in the southwestern United States are also applicable to our ability to acquire and successfully acquire and operate properties in other markets. In addition to these risks, we will not possess the same level of familiarity with the dynamics and market conditions of any new markets that we may enter, which could adversely affect our ability to expand into those markets. We may be unable to build a significant market share or achieve a desired return on our investments in new markets. If we are unsuccessful in expanding into new markets, it could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

 

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We may make expedited decisions on whether to invest in certain properties prior to receipt of detailed information on the property.

We may be required to make expedited decisions in order to effectively compete for the acquisition of properties. Additionally, we may be required to make substantial non-refundable deposits prior to the completion of our analysis and due diligence on property acquisitions, and the time period during which we will be allowed to conduct due diligence may be limited. In such cases, the information available to us at the time of making any particular investment decision, including the decision to pay any non-refundable deposit and the decision to consummate an acquisition, may be limited, and we may not have access to detailed information regarding an investment property, such as physical characteristics, environmental matters (including the presence of materials that could require remediation), zoning regulations or other local conditions affecting the property.

Therefore, no assurance can be given that we will have knowledge of all circumstances that may adversely affect an investment. In addition, we expect to rely upon independent consultants in connection with their evaluation of proposed investment properties, and no assurance can be given as to the accuracy or completeness of the information provided by such independent consultants.

Our business could be adversely impacted if we have deficiencies in our disclosure controls and procedures or internal control over financial reporting.

Our disclosure controls and procedures and internal control over financial reporting may not prevent all errors, misstatements or misrepresentations. Although management will review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, there can be no guarantee that our internal control over financial reporting will be effective in accomplishing all control objectives all of the time. Deficiencies, including any material weakness, in our internal control over financial reporting that may occur in the future could result in misstatements of our results of operations, restatements of our financial statements, a decline in our share price, or otherwise adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

We may become subject to litigation or threatened litigation that may divert management time and attention, require us to pay damages and expenses or restrict the operation of our business.

We may become subject to disputes with parties with whom we have commercial or other relationships. Any such dispute could result in litigation between us and the other party. Whether or not any dispute actually proceeds to litigation, we may be required to devote significant management time and attention to its successful resolution (through litigation, settlement or otherwise), which would detract from our management’s ability to focus on our business. Any such resolution could involve the payment of damages or expenses by us, which may be significant, or involve our agreement with terms that restrict the operation of our business.

Some of our trustees and executive officers are involved in other real estate activities and investments and, therefore, may have conflicts of interest with us.

Certain of our executive officers and trustees may own interests in other real estate-related businesses and investments, including equity securities of public and private real estate companies. Our executive officers’ involvement in other real estate-related activities could divert their attention from our day-to-day operations. State law may limit our ability to enforce any non-compete agreements. We will not acquire any properties from our executive officers, trustees or their affiliates unless the transaction is approved by a majority of the disinterested and independent members (as defined by the rules of the NYSE) of our board of trustees with respect to that transaction. See “Policies with Respect to Certain Activities—Conflict of Interest Policies.”

 

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There are risks inherent in conducting business in Mexico.

Certain of our industrial distribution facilities and industrial land are located in Chihuahua, Juarez, Monterrey, Reynosa, and Tijuana, Mexico. There are numerous risks inherent in conducting business in Mexico, including the potential for high crime rates (including crime related to drug activity) and inflation. An increased incidence of crime along the U.S.-Mexico border could adversely affect the Mexican economy, which, in turn, could have a material adverse effect on our business, financial condition and results of operation.

Under Mexican constitutional law, foreign companies are not permitted to hold direct fee simple title to real estate located within 100 kilometers from the U.S.-Mexico border. Instead, title to property located within this area must be held through a trust authorized under Mexico’s foreign investments laws, which grants the foreign company beneficial ownership rights to its property and provides it with all benefits and burdens of ownership. We have 42 industrial distribution facilities and 517.0 acres of industrial land located within this zone that are held in trust in accordance with Mexican law. Under the Mexican constitution, the protection of the government of the United States of America is not available should any dispute regarding the properties arise.

The Mexican constitution also permits federal, state and municipal governments to expropriate private property, so long as eminent domain can be ascertained and provided that the rightful owner of the property expropriated is paid fair compensation for the same. The NAFTA requires fair market value be paid by any property expropriated by the applicable Mexican government via eminent domain, and all legal remedies are available to property owners contesting any exercise of Mexican eminent domain claim.

In addition, the U.S. Foreign Corrupt Practices Act prohibits U.S. companies and their representatives from offering or making payments to non-U.S. officials for the purpose of obtaining or retaining business. Failure to comply with U.S. or non-U.S. laws could result in various adverse consequences, including an adverse effect on our reputation or the imposition of significant fines, injunctions or civil or criminal sanctions against us and our officers or employees.

Our participation in joint ventures creates additional risk.

We participate in joint ventures and may purchase properties jointly with other entities, including limited partnerships and limited liability companies, some of which may be unaffiliated with us. There are additional risks involved in these types of transactions, including but not limited to:

 

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that our joint venture partner in an investment might become bankrupt, which would mean that we and any other remaining members would bear an unexpectedly large portion of the economic responsibilities associated with the joint venture;

 

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that our joint venture partner may at any time have economic or business interests or goals which are or which become inconsistent with our business interests or goals;

 

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that our joint venture partner may take action contrary to our instructions, our policies or our objectives, including our policy with respect to maintaining our qualification as a REIT;

 

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that joint venture agreements may restrict our ability to transfer the interest when we desire or on advantageous terms;

 

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that our joint venture partner may exercise buy-sell, put-call and other similar liquidity mechanisms that could require us to fund additional capital to buy out our joint venture partner’s interests or sell our interest to our joint venture partner at a price that we would consider to be less than optimal; and

 

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that we may in certain circumstances be liable for the actions of our joint venture partners.

 

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In addition, we may owe a fiduciary obligation to our partner in a joint venture transaction, which may make it more difficult to enforce our rights. We generally will seek to maintain sufficient control of our joint venture partnerships to permit us to achieve our business objectives; however, we may not be able to do so. Any of the above risks could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

If we invest in a limited partnership as a general partner, we could be responsible for all liabilities of such partnership.

In some joint ventures or other investments we may make, if the entity in which we invest is a limited partnership, we may acquire all or a portion of our interest in such partnership as a general partner. As a general partner, we could be liable for all the liabilities of the partnership. Additionally, we may be required to take our interests in other investments as a non-managing general partner. Consequently, we would be potentially liable for all such liabilities without having the same rights of management or control over the operation of the partnership as the managing general partner or partners may have. Therefore, we may be held responsible for all of the liabilities of an entity in which we do not have full management rights or control, and our liability may far exceed the amount or value of the investment we initially made in the partnership.

We may rely on third-party property management companies to operate our properties.

Although our properties are self-managed, we have one multifamily community (Chateaux Dijon) that previously was managed by a third party and we may employ third-party managers to operate our industrial or residential properties pursuant to management agreements. Our cash flow may be adversely affected if our managers fail to provide quality services. In addition, our managers or their affiliates may manage, and in some cases may own, invest in or provide credit support or operating guarantees to properties that compete with properties that we acquire, which may result in conflicts of interest and decisions regarding the operation of our properties that are not in our best interests.

Risks Related to the Real Estate Industry Generally

Real estate investments are relatively illiquid, and we may be unable to adjust our portfolio in response to changes in economic or other conditions or sell a property if or when we decide to do so.

Real estate investments are relatively illiquid. We will have a limited ability to vary our portfolio in response to changes in economic or other conditions. We will also have a limited ability to sell assets in order to fund working capital and similar capital needs. Land is generally less liquid than other types of real estate investments. Therefore, we are particularly subject to the risks related to the illiquidity of real estate assets with respect to our land assets. We expect generally to hold real estate investments for the long term. When we sell any of our real estate investments, we may not realize a gain on such sale, or the amount of our taxable gain could exceed the cash proceeds we receive from such sale. We may not distribute any proceeds from the sale of real estate investments to our shareholders; for example, we may use such proceeds to:

 

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acquire additional real estate investments;

 

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repay debt;

 

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buy out interests of any partners in any joint venture in which we are a party;

 

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create working capital reserves; or

 

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make repairs, maintenance, tenant improvements or other capital improvements or expenditures on our other properties.

 

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Our ability to sell our properties may also be limited by our need to avoid a 100% penalty tax that is imposed on gain recognized by a REIT from the sale of property characterized as dealer property. See “Material U.S. Federal Income Tax Considerations.” In order to avoid such characterization and to take advantage of certain safe harbors under the Code, we may determine to hold our properties for a minimum period of time, generally two years.

We depend on tenants for revenue, and vacancies, tenant defaults, lease terminations or capital improvements may adversely affect our operations and cause the value of your investment to decline.

The success of our investments depends upon the occupancy levels, rental income and operating expenses of our properties and our company. With respect to our multifamily rental portfolio, our revenues may be adversely affected by the general or local economic climate; local real estate considerations (such as over-supply of or reduced demand for apartments); the perception by prospective residents of the safety, convenience and attractiveness of the communities or neighborhoods in which our properties are located and the quality of local schools and other amenities; and increased operating costs (including real estate taxes and utilities). Our industrial distribution portfolio and tenants are similarly affected by general and local economic conditions. A significant portion (nearly 50%) of our industrial tenants operate in three industries—third-party logistics, automotive and transportation and electronic components—and may therefore be particularly susceptible to economic changes in these industries. In addition, certain of our industrial leases contain early termination options, which may enable a tenant to terminate its payment obligations sooner than we expect.

The underlying value of our properties and our ability to make distributions to you depend upon our ability to lease our available multifamily rental units and industrial distribution facilities and the ability of our tenants to generate enough income to pay their rents in a timely manner. Our tenants’ inability to pay rents may be impacted by employment and other constraints on their personal finances, including debts, purchases and other factors. Upon a tenant default, we will attempt to remove the tenant from the premises and re-lease the property as promptly as possible. Our ability and the time required to evict a tenant, however, will depend on applicable law and, in the case of our industrial properties located in Mexico, may require us to institute formal court proceedings and take a year or more to complete. Virtually all of our multifamily leases are short-term leases (generally, six months to one year), and our industrial lease terms generally range from three to seven years. To the extent we are unable to renew leases, or re-lease apartment units as leases expire, it will decrease our cash flow and harm our operating results. Increased competition may also require us to make capital improvements that we would not otherwise have made, particularly with respect to our multifamily rental properties, in order to keep pace with changing market demands. Any unbudgeted capital improvements we undertake may divert cash that otherwise would be available for distribution to shareholders.

We face potential adverse effects from the bankruptcies or insolvencies of tenants.

The bankruptcy or insolvency of our tenants may adversely affect the income produced by our properties. Our tenants could file for bankruptcy protection or become insolvent. Under bankruptcy law, a tenant cannot be evicted solely because of its bankruptcy. On the other hand, a bankrupt tenant may reject and terminate its lease with us. In such case, our claim against the bankrupt tenant for unpaid and future rent would be subject to a statutory cap that might be substantially less than the remaining rent owed under the lease, and, even so, our claim for unpaid rent would likely not be paid in full. This shortfall could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

 

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Long-term leases may not result in fair market lease rates over time. As a result, our income and our distributions to our shareholders could be lower than if we did not enter into long-term leases.

We may enter into long-term leases with tenants of certain of our properties. Long-term leases may provide for rent increases over time. However, if we do not accurately judge the potential for increases in market rental rates, we may set the rental rates of these long-term leases at levels such that even after contractual rental increases, the resulting rental rates are less than then-current market rental rates. Further, we may have no ability to terminate those leases or to adjust the rent to then-prevailing market rates. As a result, our income and distributions to our shareholders could be lower than if we did not enter into long-term leases.

Our operating expenses may increase in the future, and to the extent such increases cannot be passed on to tenants, our cash flow and our operating results could decrease.

Operating expenses, such as expenses for fuel, utilities, labor and insurance, are not fixed and may increase in the future. There is no guarantee that we will be able to pass such increases on to tenants. To the extent such increases cannot be passed on to tenants, any such increase would cause our cash flow and our operating results to decrease.

Our real estate investments may include special-use properties that may be difficult to sell or re-lease upon tenant defaults or early lease terminations.

We intend to focus a portion of our investments on industrial distribution facilities, which may include special-use properties. Certain of these types of properties (such as highly improved or unusually large properties) can be relatively illiquid compared to other types of real estate and financial assets. This illiquidity will limit our ability to respond quickly to changes in economic or other conditions. In addition, in the event we are forced to sell the property, we may have difficulty selling it quickly, if at all, or we may sell the property at a loss. These and other limitations may affect our ability to sell or re-lease properties and adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

We may not have funding for future tenant improvements.

When a tenant at one of our properties does not renew its lease or otherwise vacates its space, it is likely that, in order to attract one or more new tenants, we will be required to expend funds for improvements in the vacated space. If we do not establish sufficient reserves for working capital or obtain adequate financing to supply necessary funds for capital improvements or similar expenses, we may be required to defer necessary or desirable improvements to our real properties. Deferral of such improvements may cause the applicable properties to decline in value, and it may be more difficult for us to attract or retain tenants at such properties, or the amount of rent we can charge at such properties may decrease. Although we intend to manage our cash position or to seek financing to pay for any improvements required for re-leasing, we cannot assure our shareholders that we will have adequate sources of funding available to us for such purposes in the future.

Uninsured losses or premiums for insurance coverage relating to real property may adversely affect your returns.

Our business operations are susceptible to, and could be significantly affected by, adverse weather conditions and natural disasters such as earthquakes, hurricanes, wind, floods, landslides, drought and fires. These adverse weather conditions and natural disasters could cause significant damage to the properties in our portfolio, the risk of which is exacerbated by virtue of the concentration of our properties’ locations and the potential for global climate change that may increase severe

 

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weather patterns. In addition, we may be subject to losses as a result of other catastrophic events, such as war or acts of terrorism, or pollution or environmental matters (including the presence of asbestos or other hazardous building materials) that are uninsurable or not economically insurable.

We maintain general commercial liability insurance on all of our properties and will attempt adequately to insure all of our real properties against casualty and other losses. However, these policies may not be available at a reasonable cost, if at all, which could inhibit our ability to finance or refinance our real properties. Insurance proceeds may not be adequate to cover business interruption or losses resulting from adverse weather or other catastrophic disasters or to restore our economic position with respect to the affected property. In such instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. Changes in the cost or availability of insurance could expose us to uninsured casualty losses. In the event that any of our real properties incurs a casualty loss which is not fully covered by insurance and we must pay unexpectedly large amounts for insurance, we could suffer reduced earnings and reductions in the value of our assets that could result in lower distributions to shareholders.

Our real property is subject to property taxes that may increase in the future, which could reduce our cash flow and results of operations.

Our real properties are subject to real and personal property taxes in the United States and Mexico that may increase as tax rates change and as the real properties are assessed or reassessed by taxing authorities. If we fail to pay any such taxes, the applicable taxing authority may place a lien on the property and the property may be subject to a tax sale. In addition, we will generally be responsible for real property taxes related to any vacant space. Consequently, any tax increase may adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Liability for environmentally hazardous conditions may adversely affect our operating results.

Under various U.S. federal, state and local environmental laws (and similar laws of other countries in which we operate), a current or previous owner or operator of real property may be liable for the cost of removing or remediating hazardous or toxic substances on such property. In the case of contamination of one of our properties, we may face liability under such laws regardless of:

 

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our knowledge of the contamination;

 

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the timing of the contamination;

 

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the cause of the contamination; or

 

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the party responsibility for the contamination.

Even if more than one person may have been responsible for the contamination, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred. In addition, third parties may sue the owner or operator of a site for damages based on personal injury, natural resources or property damage or other costs, including investigation and clean-up costs, resulting from the environmental contamination. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated. A property owner who violates environmental laws may be subject to sanctions which may be enforced by governmental agencies or, in certain circumstances, private parties.

Environmental laws in the United States and Mexico also require that owners or operators of buildings containing asbestos properly manage and maintain the asbestos, adequately inform or train those who may come into contact with asbestos and undertake special precautions, including removal

 

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or other abatement, in the event that asbestos is disturbed during building renovation or demolition. These laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos. Properties we now own or acquire in the future may also contain asbestos.

We currently own and intend to continue to invest in properties previously and presently used for industrial purposes. Dumping of debris and other waste products may have occurred on some of our properties. These operations create a potential for the release of hazardous or toxic substances. In addition, some of our properties may be adjacent to or near other properties upon which others, including former owners or tenants of our properties, may have engaged, or may in the future engage, in activities that may release hazardous or toxic substances. In addition, the presence of asbestos or other hazardous building materials in our buildings may require increased capital expenditures associated with ongoing maintenance and asset retirement obligations at the end of the useful life of a structure.

If environmental contamination exists on any of our properties, we could be subject to strict, joint and several liability for the contamination by virtue of our ownership interest. The presence of hazardous or toxic substances on one of our properties, or the failure to properly remediate a contaminated property, could give rise to a lien in favor of the government for costs it may incur to address the contamination, or otherwise adversely affect our ability to sell or lease the property or borrow using the property as collateral. In addition, we could be subject to strict liability by virtue of our ownership interest. Therefore, the discovery of environmental liabilities attached to properties, and costs of defending against environmental claims, of compliance with environmental regulatory requirements or of remediating any contaminated property could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Many of our properties have limited environmental insurance subject to deductibles, exclusions and policy conditions. Environmental liabilities may not be covered, proceeds from any such insurance policy may be insufficient to address any particular environmental situation or we may be unable to continue to obtain insurance for environmental matters, at a reasonable cost or at all, in the future.

All of our currently owned properties have been subject to a Phase I or similar environmental assessment by independent environmental consultants at the time of acquisition, and we intend to subject any additional industrial acquisitions to similar assessment. Phase I assessments are intended to discover and evaluate information regarding the environmental condition of the surveyed property and surrounding properties with respect to releases or potential releases of hazardous substances. Phase I assessments generally include a historical review, a public records review, an investigation of the surveyed site and surrounding properties, and preparation and issuance of a written report, but do not include soil sampling or subsurface investigations and typically do not include an asbestos survey or verification of compliance with environmental or permitting requirements. Even if none of our environmental assessments of our properties reveal an environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations taken as a whole, we cannot give any assurance that such conditions do not exist or may not arise or be discovered in the future. Material environmental conditions, liabilities or compliance concerns may arise after the environmental assessment has been completed. Moreover, (1) future laws, ordinances or regulations, or changes to current laws, ordinances or regulations, may impose material environmental liability and (2) the environmental condition of our properties may be affected by tenants, by the condition of land or operations in the vicinity of our properties (such as releases from underground storage tanks), by third parties unrelated to us, or by catastrophic events such as severe weather, fire or earthquakes.

 

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Costs of complying with governmental laws and regulations may adversely affect our income and the cash available for any distributions.

All real property and the operations conducted on real property are subject to federal, state and local laws and regulations (including those of other countries in which we operate) relating to environmental protection and human health and safety. Tenants’ ability to operate and to generate income to pay their lease obligations may be affected by permitting and compliance obligations arising under such laws and regulations. Leasing properties to tenants that engage in industrial, manufacturing, and commercial activities will cause us to be subject to the risk of liabilities under environmental laws and regulations, as detailed above. In addition, there are various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply and which may subject us to liability in the form of fines or damages for non-compliance. Any material expenditures, fines or damages we must pay will reduce our ability to make distributions and may reduce the value of our common shares. In addition, changes in these laws and governmental regulations or their interpretation by agencies or the courts, or the creation of new laws or regulations such as with respect to greenhouse gas emissions or climate change regulation, could occur.

We may obtain only limited warranties when we purchase a property.

The seller of a property will often sell such property in its “as is” condition on a “where is” basis and “with all faults,” without any warranties of merchantability or fitness for a particular use or purpose. In addition, purchase agreements may contain only limited warranties, representations and indemnifications that will only survive for a limited period after the closing. Also, many sellers of real estate are single-purpose entities without any other significant assets. The purchase of properties with limited warranties or from undercapitalized sellers increases the risk that we may lose some or all of our invested capital in the property as well as the loss of rental income from such property.

Risks Related to Our Operating Structure

Our board of trustees may change significant corporate policies without shareholder approval.

Our board of trustees determines our major policies, including our policies regarding acquisitions, dispositions, financing, growth, debt capitalization, REIT qualification and distributions. These policies may be amended or revised at any time and from time to time at the discretion of our board of trustees without a vote of our shareholders. Our board of trustees’ broad discretion in setting policies and your inability to exert control over those policies increases the uncertainty and risks you face, especially if our board of trustees and you disagree as to what course of action is in your best interests. A change in our policies may not have the anticipated effects and could have an adverse effect on our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Limits in our declaration of trust on the percentage of our securities that a person may own may discourage a takeover or business combination that may benefit our shareholders.

In order for us to qualify as a REIT, no more than 50% of our outstanding shares may be beneficially owned, directly or indirectly, by five or fewer individuals (including certain types of entities) at any time during the last half of each taxable year. Our declaration of trust restricts direct or indirect ownership by one person, corporation or other entity to no more than 9.9% in number or value, whichever is more restrictive, of our outstanding shares of beneficial interest unless exempted by our board of trustees. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including in an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all our assets) that might provide a premium price to our shareholders. In addition to discouraging potential takeover transactions, these provisions may also decrease your ability to sell your common shares. See “Description of Securities—Restrictions on Ownership and Transfer.”

 

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Our shareholders have only limited voting rights, and will be bound by the majority vote on matters on which our shareholders are entitled to vote.

In accordance with our declaration of trust, you may vote only on certain matters at an annual or special meeting of shareholders, including the election and removal of trustees, amendments to the declaration of trust, termination of our company, any merger or consolidation or sale or disposition of substantially all of our assets, any matters that are required to be approved by our shareholders under applicable law or the rules of any exchange on which our common shares are listed or traded, and any other matters that our board of trustees directs to be submitted to our shareholders. Outside these limited areas, the board of trustees may take actions without a vote of the shareholders. In addition, except with respect to the removal of trustees, you will be bound by the majority vote on matters requiring approval of the shareholders even if you do not vote with the majority on any such matter. A trustee may be removed only for cause (as defined in the declaration of trust) and by the affirmative vote of holders of two-thirds of the outstanding common shares.

Your interest in us will be diluted by our issuance of additional shares in this offering or otherwise.

Existing shareholders and potential investors in this offering do not have preemptive rights to any shares issued by us in the future. Our declaration of trust provides that we may issue up to 300 million shares of beneficial interest, of which 250 million shares are designated as common shares and 50 million shares are designated as preferred shares. All of such shares may be issued in the discretion of our board of trustees. Our board of trustees may increase the number of authorized shares of beneficial interest, increase or decrease the number of shares of any class or series of shares designated, or reclassify any unissued shares without obtaining shareholder approval.

Existing shareholders and investors purchasing common shares in this offering will also experience dilution of their equity investment in us in the event that we:

 

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issue common shares in the future;

 

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issue securities that are convertible into common shares;

 

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issue common shares in a private offering;

 

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issue common shares upon the exercise of the options granted to our independent trustees, employees or others; or

 

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issue common shares to sellers of properties acquired by us in connection with a redemption of common units of our operating partnership.

Depending on the terms of such transactions, most notably the price per share, which may be less than the price paid per share in this offering, and the value of our properties, investors in this offering may experience a dilution in the book value per share of their common shares. Issuances of a substantial amount of our common shares in the public market, or the perception that such issuances might occur, could also adversely affect the market price of our common shares.

We may issue debt securities, preferred shares or separate classes or series of common shares, which could be senior to your common shares in liquidation or for the purpose of distributions, and which may adversely affect the value of common shares issued pursuant to this offering.

We may attempt to increase our capital resources by issuing, without shareholder approval, debt securities, preferred shares or a class or series of common shares with rights that could adversely affect the holders of the common shares issued in this offering. Upon the affirmative vote of a majority

 

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of our trustees, our declaration of trust authorizes our board of trustees (without any further action by our shareholders) to issue preferred shares or common shares in one or more classes or series, and to set, subject to the express terms of any class or series of shares outstanding at the time, the terms, preferences, conversion rights, voting powers or other rights, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption for such class or series of shares. Additional equity offerings may dilute the holdings of our existing shareholders and reduce the value of your common shares.

If we create and issue preferred shares with a distribution preference over common shares, payment of any preferred distribution on our preferred shares would reduce the amount of funds available for the payment of distributions on our common shares. Holders of any debt securities or preferred shares with a liquidation preference, as well as lenders with respect to any other borrowings we have, will be entitled to receive priority distributions in the event we liquidate, dissolve or wind up before any payment is made to the common shareholders, likely reducing the amount common shareholders would otherwise receive upon such an occurrence. We could also designate and issue shares in a class or series of common shares with rights and preferences senior to our common shares to be issued in this offering. Our decision and ability to issue debt securities or preferred shares in any future offering will depend on market conditions and other factors beyond our control; as a result, no prediction of the estimated amount, pricing, time or nature of future offerings can be made. Thus, you bear the risk that future offerings may reduce the value of your common shares and dilute your ownership in us.

In addition, under certain circumstances, the issuance of preferred shares or a separate class or series of common shares may render more difficult or tend to discourage a merger, tender offer or proxy contest, the acquisition of control by a holder of a large block of our securities, and the removal of incumbent management.

Our rights and the rights of our shareholders to take action against our trustees and officers are limited.

Our declaration of trust limits the liability of our present and former trustees and officers to us and our shareholders for money damages, to the maximum extent permitted by Maryland law. In addition, pursuant to our declaration of trust and bylaws, we have obligated our company to indemnify our trustees and officers for actions taken by them in those capacities and to pay or reimburse reasonable expenses in advance of a final disposition of a proceeding against such persons, to the maximum extent permitted by Maryland law. As a result, we and our shareholders may have more limited rights against our trustees and officers than might otherwise exist absent the provisions in our declaration of trust and bylaws, which could limit your recourse in the event of actions not in your interest.

Our UPREIT structure may result in potential conflicts of interest with limited partners in our operating partnership whose interests may not be aligned with those of our shareholders.

Limited partners in our operating partnership have the right to vote on certain amendments to the operating partnership agreement, as well as on certain other matters. Persons holding such voting rights may exercise them in a manner that conflicts with the interests of our shareholders. As the general partner of our operating partnership, we have fiduciary duties to the limited partners of our operating partnership. Circumstances may arise in the future when the interests of limited partners in our operating partnership may conflict with the interests of our shareholders. These conflicts may be resolved in a manner shareholders do not believe are in their best interest.

In addition, the holders of convertible preferred units issued by our operating partnership may be entitled to a one-time payment in conjunction with a transaction as a result of which all or substantially

 

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all of the common units of the operating partnership are converted into the right to receive cash, securities or other assets. This potential obligation to make payments to the holders of the convertible preferred units could have an adverse effect on our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

We depend on dividends and distributions from our operating partnership and our indirect subsidiaries.

We hold substantially all of our assets in, and conduct substantially all of our operations through, our operating partnership, which in turn holds substantially all of its properties and assets through subsidiaries. Our operating partnership’s cash flow is dependent on cash distributions to it by its subsidiaries, and, in turn, substantially all of our cash flow is dependent on cash distributions to us by the operating partnership. The creditors of our direct and indirect subsidiaries are entitled to payment of that subsidiary’s obligations to them, when due and payable, before distributions may be made by that subsidiary to its equity holders. Thus, our operating partnership’s ability to make distributions to holders of its units, including us, depends on its subsidiaries’ ability first to satisfy their obligations to their creditors and then to make distributions to our operating partnership. The holders of preferred units of the operating partnership are entitled to receive preferred distributions before payment of distributions to holders of common units of the operating partnership, including us.

Therefore, our ability to make distributions to our shareholders and satisfy our debt obligations depends on the operating partnership’s ability first to satisfy its obligations to its creditors and make distributions payable to holders of its preferred units, and then to make distributions to us. The total liquidation value of outstanding convertible preferred units of the operating partnership with preference over our common units that will be outstanding upon completion of this offering is $             million. In addition, our participation in any distribution of the assets of any of our direct or indirect subsidiaries upon their liquidation, reorganization or insolvency is only after the claims of its creditors, including trade creditors and preferred security holders, are satisfied.

The Maryland General Corporation Law contains provisions that may reduce the likelihood of certain takeover transactions.

Under the Maryland General Corporation Law, as amended, which we refer to as the “MGCL,” as applicable to REITs, certain “business combinations,” including certain mergers, consolidations, share exchanges and asset transfers and certain issuances and reclassifications of equity securities, between a Maryland REIT and any person who beneficially owns 10% or more of the voting power of the trust’s outstanding voting shares or an affiliate or an associate, as defined in the MGCL, of the trust who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then-outstanding shares of beneficial interest of the trust, which we refer to as an “interested shareholder,” or an affiliate of the interested shareholder, are prohibited for five years after the most recent date on which the interested shareholder becomes an interested shareholder. After that five-year period, any such business combination must be recommended by the board of trustees of the trust and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding voting shares of beneficial interest of the trust and (2) two-thirds of the votes entitled to be cast by holders of voting shares of the trust other than shares held by the interested shareholder with whom, or with whose affiliate, the business combination is to be effected or held by an affiliate or associate of the interested shareholder, unless, among other conditions, the trust’s common shareholders receive a minimum price, as defined in the MGCL, for their shares and the consideration is received in cash or in the same form as previously paid by the interested shareholder for its common shares.

These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by the board of trustees of the trust before the interested shareholder becomes an

 

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interested shareholder, and a person is not an interested shareholder if the board of trustees approved in advance the transaction by which the person otherwise would have become an interested shareholder. In approving a transaction, our board of trustees may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board. Our board of trustees has by resolution exempted from the provisions of the business combination statute any “business combination” involving us. However, this resolution may be altered or repealed at any time, in whole or in part, by our board of trustees.

The MGCL also provides that “control shares” of our company (defined as voting shares that, when aggregated with all other shares owned by the acquirer or in respect of which the acquirer is entitled to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquirer to exercise one of three increasing ranges of voting power in electing trustees) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our shareholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding shares owned by the acquirer, by our officers or by our employees who are also trustees of our company. We have opted out of the control share provisions of the MGCL pursuant to a provision of our bylaws. However, in the future, and only upon the approval of our stockholders, our board of trustees may by amendment to our bylaws opt in to the control share provisions of the MGCL at any time, in whole or in part.

Becoming subject to, or the potential to become subject to, these provisions of the MGCL could inhibit, delay or prevent a transaction or a change of control of our company that might involve a premium price for our shareholders or otherwise be in our or their best interest. In addition, the provisions of our declaration of trust on removal of trustees and the advance notice provisions of our bylaws could have a similar effect.

See “Material Provisions of Maryland Law and Our Declaration of Trust and Bylaws” for additional information.

Risks Related to Our Indebtedness and Future Debt Financing

The use of debt to finance acquisitions or developments could restrict operations, inhibit our ability to grow our business and revenues, and adversely affect cash flow.

Some of our property acquisitions or developments have been, and may in the future be, made by borrowing a portion of the purchase price or development cost of the properties and securing the loan with a mortgage on the property. As of September 30, 2009, we had approximately $601.2 million of outstanding indebtedness. We also intend to incur additional debt in connection with future acquisitions, developments and redevelopments of our properties. Most of our borrowings to acquire properties will be secured by mortgages on our properties. If cash flow from our properties is insufficient to service the mortgage debt, we may be required to use cash flow from other sources, if any is available, to service our mortgage debt. If we default on our secured indebtedness, the lender may foreclose and we could lose our entire investment in the properties securing such loan, which could adversely affect the value of our company and any distributions to our shareholders.

Other than financing for the construction of a property, historically we have borrowed on a non-recourse basis (with exceptions relating to so-called “bad boy” or non-recourse carveout guarantees) to limit our exposure on any property to the amount of the equity invested in the property. Some of our loan documents contain (and in the future may contain) restrictive covenants, such as net worth requirements, liquidity and leverage ratios and other financial covenants. In addition, our loan documents with respect to certain of our Mexican properties provide the lender with a right of first offer if we decide to obtain additional financing with respect to such properties that requires us to offer to borrow from such lender before we may obtain financing from a third party. As a result of restrictive

 

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financial and other covenants and limitations in our loan documents, our operating flexibility may be limited, which may cause us to forego investment opportunities or to finance investments in a less efficient manner than if we were not subject to such covenants. Subject to various financial covenants and terms imposed by some of our existing mortgage loan documents, however, there is no limitation on the amount we can borrow on a single property or the aggregate amount of our borrowings, and we can change this policy at any time without the approval of the shareholders.

Additionally, we may borrow funds when necessary to satisfy the requirement that we distribute to shareholders at least 90% of our annual REIT taxable income, or otherwise as is necessary or advisable, to ensure that we maintain our qualification as a REIT for federal income tax purposes or otherwise avoid paying taxes that can be eliminated through distributions to our shareholders.

Our organizational documents contain no limitation on the amount of debt we may incur. As a result, we may become highly leveraged in the future.

Our organizational documents contain no limitations on the amount of indebtedness that we or our operating partnership may incur. Subject to certain limitations under our existing loan documents, such as restrictive financial covenants, we could alter the balance between our total outstanding indebtedness and the value of our assets at any time. If we become more highly leveraged, then the resulting increase in debt service could adversely affect our ability to make payments on our outstanding indebtedness and to pay our anticipated distributions or the distributions required to maintain our REIT status, and could harm our financial condition.

Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to you.

When providing financing, a lender may impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt. Some of our existing loan documents, and loan documents that we may enter into in the future, may contain covenants that limit our ability to incur additional indebtedness or further mortgage our properties. These provisions could restrict our ability to pursue business initiatives or acquisition transactions that may be in our best interests. In addition, failure to meet any of the covenants could cause an event of default under or acceleration of some or all of the indebtedness or imposition of cash management controls by our lenders, any of which would have an adverse effect on our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Cross-collateralization and cross-default provisions in our loan documents may increase the risk of loss, as defaults under these documents may cause us to lose the properties securing the loans.

In addition to the general foreclosure risk associated with mortgage financing, some of our secured loan documents contain cross-collateralization or cross-default provisions. These provisions create the risk that a default on a single property could affect multiple properties, including by triggering foreclosure against multiple properties to satisfy the loan obligation. If any of our properties are foreclosed upon due to a default, it would have an adverse effect on our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

Fluctuations in interest rates could increase our expenses, require us to sell investments or make it more difficult to make attractive investments.

High debt levels would cause us to incur higher interest charges, would result in higher debt service payments, and could be accompanied by restrictive covenants. Interest we pay would reduce cash available for distribution to our shareholders and other purposes. Interest rates are currently low relative to historical levels and may increase significantly in the future. Unless we have hedged

 

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effectively against interest rate changes, if we incur variable-rate debt, increases in interest rates would increase our interest costs, which would reduce our cash flow and our ability to make distributions to you. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments for lower returns than anticipated and could result in a loss. Further, increases in interest rates may make investments in other entities more attractive than an investment in us. Conversely, decreases in interest rates may cause the price of real property investments and real estate-related investments to increase, thus making it more difficult for us to make otherwise attractive investments. Any of these risks could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

To hedge against exchange rate and interest rate fluctuations, we may use derivative financial instruments that may not be successful in mitigating our risks associated and may reduce the overall returns on your investment.

As of September 30, 2009, out of our $601.2 million aggregate indebtedness outstanding, we had $123.2 million in indebtedness that bears interest at a floating rate. As of September 30, 2009, we had outstanding approximately $120.9 million notional amount of interest rate swaps to minimize our exposure to interest rate fluctuations on substantially all of the floating rate debt. We may use derivative financial instruments to hedge exposures to exchange rate and interest rate fluctuations on loans secured by our assets. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions will be determined in light of the facts and circumstances existing at the time of the hedge and may differ from time to time.

To the extent that we use derivative financial instruments to hedge against exchange rate and interest rate fluctuations, we will be exposed to credit, basis risk and legal enforceability risks. In this context, credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. We intend to manage credit risk by dealing only with major financial institutions that have high credit ratings at the time we enter into the instruments. Basis risk occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. We intend to manage basis risk by matching, to a reasonable extent, the contract index to the index upon which the hedged asset or liability is based. Finally, legal enforceability risks encompass general contractual risks, including the risk that the counterparty will breach the terms of, or fail to perform its obligations under, the derivative contract. We intend to manage legal enforceability risks by ensuring, to the best of our ability, that we contract with reputable counterparties and that each counterparty complies with the terms and conditions of the derivative contract. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest and exchange rate volatility or that our hedging transactions will not result in losses. If we are unable to manage these risks effectively, our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares may be adversely affected.

Balloon payment obligations may adversely affect our financial condition.

Some of our financing arrangements may require us to make a lump-sum or “balloon” payment at maturity. See “Policies with Respect to Certain Activities—Our Financing Policies.” Our ability to make balloon payments is uncertain and may depend on our ability to obtain replacement or additional financing or to sell the property. At the time payment is due, we may or may not be able to refinance the payment on terms as favorable as the original loan or sell the property at a price sufficient to make the payment, if at all, which could require us to incur debt on unfavorable terms or divert funds from other sources to make the balloon payment. As a result, financing with balloon payments could result in increased costs and reduce our liquidity. If the payment is refinanced at a higher rate, it would

 

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reduce or eliminate any income from the property. If we fail to sell the property, it may cause a default on the loan, which may trigger cross-defaults on other then-outstanding indebtedness. Any of these results would have a significant, negative impact on our financial condition and your investment in us.

Risks Related to this Offering

Prior to this offering, there has been no public trading market for our shares, and as a result it may be difficult for you to sell your common shares.

There is no current public market for our common shares and there is no assurance that an active trading market will ever develop or be sustained for our common shares. There can be no assurance that our common shares will not trade below the initial public offering price following the completion of this offering. The market value of our common shares could be substantially affected by general market conditions, including the extent to which a secondary market develops for our common shares following the completion of this offering, the extent of institutional investor interest in us, the general reputation of REITs and the attractiveness of their equity securities as compared to other equity securities (including securities issued by other real estate-related companies), our financial performance and general stock and bond market conditions.

In addition, our declaration of trust contains restrictions on the ownership and transfer of our shares, and these restrictions may limit your ability to sell your common shares. Our declaration of trust prevents any one person, corporation or other entity from owning more than 9.9% in number or value, whichever is more restrictive, of our outstanding shares of beneficial interest unless exempted by our board of trustees.

As a result, it may be difficult for you to sell your common shares promptly or at all, and you may only be able to sell your common shares at a substantial discount from the price you paid. You should consider your common shares as illiquid and a long-term investment, and you should be prepared to hold your common shares for an indefinite period of time.

The market price and trading volume of our common shares may be volatile and could decline following the offering, resulting in a substantial or complete loss on your investment.

At times, stock markets, including the NYSE, on which we intend to apply to list our common shares, experience significant price and volume fluctuations. As a result, the market price of our common shares may be similarly volatile, and the trading volume in our common shares may fluctuate and cause significant price variations to occur. As an investor in our common shares, you may experience a decrease in the value of your common shares, including decreases unrelated to our operating performance or prospects. The market price of our common shares may fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common shares include:

 

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our operating performance and the performance of similar companies;

 

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general disruptions in the capital markets;

 

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market perception of our growth potential and actual or anticipated variations in our quarterly operating results or distributions;

 

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changes in our funds from operations or earnings estimates;

 

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the public’s reaction to our public announcements and our filings with the SEC;

 

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changes in market valuations of companies similar to us;

 

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changes in the market for REIT securities generally and the attractiveness of REIT securities as compared to the securities of other companies;

 

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publication of research reports about us or the real estate industry by securities analysts;

 

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changes in market interest rates, including increased market rates that could lead investors to demand a higher yield and therefore cause the market price of our shares to decline;

 

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strategic decisions by us or our competitors, such as acquisitions, divestments, spin-offs, joint ventures, strategic investments or changes in business strategy;

 

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changes in the value of our real estate assets;

 

  Ÿ  

adverse market reaction to any debt we incur in the future;

 

  Ÿ  

additions or departures of key personnel;

 

  Ÿ  

actions by institutional shareholders;

 

  Ÿ  

speculation in the press or investment community;

 

  Ÿ  

the passage of legislation or other regulatory developments that adversely affects us or our industry, including changes in accounting principles;

 

  Ÿ  

the realization of any of the other risk factors presented in this prospectus; and

 

  Ÿ  

general market and economic conditions.

The timing and amount of our cash distributions, if any, may fluctuate over time.

One of our primary investment objectives is to pay regular cash distributions to shareholders. The actual amount and timing of distributions will be determined by our board of trustees based on its analysis of our earnings, cash flow, anticipated cash flow, capital expenditure requirements, tax considerations (including qualification as a REIT for federal income tax purposes) and general financial condition. Our ability to buy, and earn positive yields on, real estate assets, the yields on our investments, our operating expense levels, and many other variables may affect the availability and timing of our cash distributions. As a result, our distribution rate and payment frequency may vary. Our long-term strategy is to fund the payment of quarterly distributions to our shareholders entirely from our funds from operations. However, in the near term we may need to borrow funds, issue new securities, sell assets, or, to the extent necessary, utilize offering proceeds in order to make cash distributions. We have not established a cap on the amount of proceeds from this offering that may be used to fund distributions. Accordingly, the amount of distributions paid at any given time may not reflect current cash flow from operations. See “Distribution Policy.”

If we pay distributions from sources other than our cash flow from operations, we will have less funds available for the acquisition of properties, and your overall return may be reduced.

Our organizational documents permit us to make distributions from any source, and we may choose to pay distributions when we do not have sufficient cash flow from operations to fund such distributions. In addition, to the extent we make distributions to shareholders with sources other than funds from operations, the amount of cash that is distributed from such sources will limit the amount of investments that we can make, which will in turn negatively impact our ability to achieve our investment objectives and limit our ability to make future distributions. Distributions that exceed cash flows from operations or the cash flow generated by investing activities will likely not be sustainable for a significant period of time. Further, to the extent distributions exceed cash flow from operations, a shareholder’s basis in our common shares will be reduced and, to the extent distributions exceed a shareholder’s basis, the shareholder may recognize capital gain.

 

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The offering price of our common shares was determined by our board of trustees and may not be indicative of the price you would receive for the common shares in the open market.

This is a fixed-price offering, which means that the offering price for our common shares in this offering is fixed and will not vary based on the underlying value of our assets at any time. Our board of trustees determined the offering price in negotiation with the underwriters, based on a variety of factors.

The offering price of our common shares was not based on appraisals of any assets we own and bears no relationship to our book or asset value or to any other established criteria for valuing stock. Because the offering price is not based upon any independent valuation, the value of your investment may be substantially less than what you pay and may not be indicative of the proceeds that you would receive upon liquidation.

Your investment will be subject to additional risks from our investments in Mexico, including foreign currency fluctuations.

We currently have industrial real estate investments in Mexico and may pursue growth opportunities in Mexico in the future, where the U.S. dollar is not the national currency. Although some of our expenses (primarily taxes) relating to these properties are paid in the Mexican peso, we collect rent on leases in U.S. dollars (or the equivalent amount in Mexican pesos at the then-prevailing exchange rate). As a result of our investments in real estate assets located in Mexico, in addition to risks inherent in U.S. real estate investments, we are subject to fluctuations in foreign currency exchange rates and the uncertainty of non-U.S. laws and markets including, but not limited to, unexpected changes in regulatory requirements, land use and zoning laws, currency exchange controls, potentially adverse tax laws, additional accounting and control expenses, the administrative burden associated with complying with a wide variety of non-U.S. laws and difficulties in managing international operations generally. We do not currently mitigate foreign currency risk. We may be unable to obtain debt financing at favorable rates in Mexico. Non-recourse debt financing is generally less available in Mexico than it is in the United States, and to the extent such financing is available, it may be at rates less favorable than those that we could obtain in the United States. Any of these risks could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common shares.

If you invest in this offering, you will experience immediate and substantial dilution.

We expect the initial public offering price of our common shares to be higher than the book value per share of our outstanding common shares. Accordingly, if you purchase common shares in this offering, you will experience immediate dilution of approximately $             in the book value per common share. This means that investors who purchase common shares will pay a price per share that exceeds the book value of our assets after subtracting our liabilities. Moreover, to the extent that outstanding options or warrants to purchase our common shares are exercised, or options reserved for issuance are issued and exercised, each person purchasing common shares in this offering will experience further dilution.

The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and make additional investments.

Through 2013, the Federal Deposit Insurance Corporation, or “FDIC,” will only insure amounts up to $250,000 per depositor per insured bank; on and after January 1, 2014, the FDIC will only insure up to $100,000 per depositor per bank. We expect that we will have cash and cash equivalents and restricted cash deposited in certain financial institutions in excess of federally insured levels. If any of

 

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the banking institutions in which we have deposited funds fail, we may lose any amount of our deposits over the federally insured amount. The loss of our deposits would reduce the amount of cash we have available to distribute or invest and could result in a decline in the value of our shares.

Risks Related to Taxation

We may fail to qualify or remain qualified as a REIT and may be required to pay income taxes at corporate rates.

Although we believe that we will remain organized and will continue to operate so as to qualify as a REIT for federal income tax purposes, we may fail to remain qualified in this way. Qualification as a REIT for federal income tax purposes is governed by highly technical and complex provisions of the Code for which there are only limited judicial or administrative interpretations. Our qualification as a REIT also depends on various facts and circumstances that are not entirely within our control. In addition, legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws with respect to the requirements for qualification as a REIT or the federal income tax consequences of qualifying as a REIT.

Our qualification as a REIT could also depend on our operating partnership’s treatment for federal income tax purposes as a partnership and not as an association or a publicly traded partnership taxable as a corporation. We believe that our operating partnership will be treated as a partnership for federal income tax purposes. If the IRS were successfully to determine that our operating partnership were properly treated as a corporation, we could fail to qualify as a REIT.

If, with respect to any taxable year, we fail to maintain our qualification as a REIT and do not qualify under statutory relief provisions, we could not deduct distributions to shareholders in computing our taxable income and would have to pay federal income tax on our taxable income at regular corporate rates. The federal income tax payable would include any applicable alternative minimum tax. If we had to pay federal income tax, the amount of money available to distribute to shareholders and pay our indebtedness would be reduced for the year or years involved, and we would no longer be required to make distributions to shareholders. In addition, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost, unless we were entitled to relief under the relevant statutory provisions. Although we currently intend to operate in a manner designed to allow us to qualify as a REIT, future economic, market, legal, tax or other considerations may cause us to revoke the REIT election or fail to qualify as a REIT. See “Policies with Respect to Certain Activities—Investments in Securities and Interests in Entities Primarily Engaged in Real Estate Activities and Other Issuers.”

We encourage you to read “Material U.S. Federal Income Tax Considerations” in this prospectus for further discussion of the tax issues related to this offering.

Notwithstanding our status as a REIT, we may be subject to tax in certain circumstances, which would reduce our cash available to pay shareholder distributions.

Even if we maintain our status as a REIT, we may be required to pay certain federal, state or local taxes on our income and property. For example, net income from a “prohibited transaction” will be subject to a 100% tax. We may not be able to make sufficient distributions to avoid paying federal income tax or the 4% excise tax that generally applies to income retained by a REIT. We may also decide to retain income we earn from the sale or other disposition of our real estate assets and pay income tax directly on such income. In that event, our shareholders would be treated as if they earned that income and paid the tax on it directly, and would be allowed a credit or a refund, as the case may be, for the tax they are deemed to have paid.

 

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In addition, any net taxable income earned directly by our taxable REIT subsidiaries will be subject to federal and state corporate income tax. We have a number of existing taxable REIT subsidiaries, and we may elect to treat other subsidiaries as taxable REIT subsidiaries in the future. In this regard, several provisions of the laws applicable to REITs and their subsidiaries ensure that a taxable REIT subsidiary will be subject to an appropriate level of federal income taxation. For example, a taxable REIT subsidiary is limited in its ability to deduct certain interest payments made to an affiliated REIT. In addition, the REIT has to pay a 100% penalty tax on some payments that it receives or on some deductions taken by the taxable REIT subsidiaries if the economic arrangements between the REIT, the REIT’s customers, and the taxable REIT subsidiary are not comparable to similar arrangements between unrelated parties.

Moreover, not all states and localities follow the federal income tax treatment of REITs. We may also be subject to state and local taxes on our income or property, either directly or at the level of the companies through which we indirectly own our assets. In addition, notwithstanding our status as a REIT, entities through which we hold investments in assets located outside the United States (such as our investments in Mexico) will, in most cases, be subject to income taxation by jurisdictions in which such assets are located. To the extent that we and our affiliates are required to pay federal, state and local taxes, or non-U.S. taxes, we will have less cash available for distributions to our shareholders.

REIT distribution requirements could adversely affect our liquidity or cause us to distribute amounts that would otherwise be used in our operations.

To qualify as a REIT, we generally must distribute at least 90% of our net taxable income (determined before the deduction for dividends paid and excluding any net capital gains) each year to our shareholders, and we generally expect to make distributions in excess of such amount. As a result, our ability to retain earnings to fund acquisitions, development and redevelopment, if any, or other capital expenditures will be limited. We intend to use the net proceeds of this offering to repay existing indebtedness, fund future property acquisitions and for general corporate purposes. In the event that we develop a need for additional capital in the future for investments, the improvement of our real properties or for any other reason, sources of funding may not be available to us. If we cannot obtain debt or equity financing on acceptable terms, our ability to acquire further properties and expand our operations will be adversely affected.

In addition, we will be subject to corporate income tax to the extent that we distribute less than 100% of our net taxable income including any net capital gain, and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years.

We intend to make distributions to our shareholders to comply with the requirements of the Code for REITs and to minimize or eliminate our corporate income tax obligation. However, we may have insufficient cash or other liquid assets to meet these distribution requirements as a result of competing demands for funds or differences in timing between the recognition of taxable income and the actual receipt of cash. As a result, we may be required to (1) sell assets in adverse market conditions, (2) borrow on unfavorable terms or (3) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, or to fund our operations, in order to comply with REIT distribution requirements.

Except in certain circumstances, if we fail to make a required distribution, we would cease to qualify as a REIT for federal income tax purposes. If we fail to make a required distribution as a result of an adjustment to our tax return by the IRS, we may be able to retroactively cure the failure by paying a “deficiency dividend,” plus applicable penalties and interest, within a specified period.

 

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Complying with the REIT requirements may cause us to forego otherwise attractive opportunities.

To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our shareholders and the ownership of our common shares. We may be required to make distributions to shareholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of your investment. See “Material U.S. Federal Income Tax Considerations—Requirements for Qualification as a REIT.”

Complying with the REIT requirements may cause us to liquidate otherwise attractive opportunities.

U.S. federal income tax rules require, as of the end of each calendar quarter, that at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets in order to ensure our qualification as a REIT. The remainder of our investments (other than governmental securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total securities can be represented by securities of one or more taxable REIT subsidiaries. See “Material U.S. Federal Income Tax Considerations—Operational Requirements—Asset Tests.” If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments, which, in the case of non-U.S. shareholders, may impose withholding tax obligations on us.

Distributions payable by REITs do not qualify for the reduced tax rates applicable to other corporate distributions and may make REIT investments comparatively less attractive.

Under current law, qualifying corporate distributions payable to individuals are subject to tax at a maximum rate of 15% through 2010. Distributions payable by REITs, however, generally continue to be taxed at the normal rate applicable to the individual recipient, rather than the 15% preferential rate. Although this legislation does not adversely affect the taxation of REITs or distributions paid by REITs, the more favorable rates applicable to regular corporate distributions could cause individual investors to perceive investments in a non-REIT corporations as more attractive relative to an investment in the stock of REITs, which could reduce the value of the stock of REITs, including our shares.

Legislative or regulatory action could adversely affect investors.

In recent years, numerous legislative, judicial and administrative changes have been made to the U.S. federal income tax laws applicable to investments in REITs and similar entities. Additional changes to tax laws are likely to continue to occur in the future, and we cannot assure you that any such changes will not adversely affect the taxation of a shareholder. Any such changes could have an adverse effect on an investment in our common shares. We urge you to consult with your own tax advisor with respect to the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our common shares.

 

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Recharacterization of sale-leaseback transactions may cause us to lose our REIT status.

We may purchase real properties and lease them back to the sellers of such properties. While we will use our best efforts to structure any sale-leaseback transaction such that the lease will be characterized as a “true lease,” thereby allowing us to be treated as the owner of the property for federal income tax purposes, we cannot assure you that the IRS will not challenge such characterization. In the event that a sale-leaseback transaction is challenged and recharacterized as a financing transaction or loan for federal income tax purposes, deductions for depreciation and cost recovery relating to such property would be disallowed. If a sale-leaseback transaction were so recharacterized, we might fail to satisfy the REIT qualification “asset tests” or the “income tests” and, consequently, lose our REIT status effective with the year of recharacterization. Alternatively, the amount of our REIT taxable income could be recalculated which might also cause us to fail to meet the distribution requirement for a taxable year. See “—Risks Related to Taxation—We may fail to qualify or remain qualified as a REIT and may be required to pay income taxes at corporate rates.”

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements within the meaning of the federal securities laws. We caution investors that forward-looking statements are based on management’s beliefs and on assumptions made by, and information currently available to, management. This prospectus also contains forward-looking statements by third parties relating to market and industry data and forecasts; forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and uncertainties as the other forward-looking statements contained in this prospectus. When used, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “result,” “should,” “will” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements.

These statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially and adversely from those anticipated, estimated or projected. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

 

  Ÿ  

the factors included in this prospectus, including those set forth under headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business and Properties”;

 

  Ÿ  

adverse economic or real estate conditions or developments in the industrial or multifamily real estate sector and/or in the markets in which we acquire properties;

 

  Ÿ  

decreases in real estate values;

 

  Ÿ  

decreased rental rates or increased tenant incentives or vacancy rates;

 

  Ÿ  

defaults on, early terminations of or non-renewal of leases by tenants;

 

  Ÿ  

tenant bankruptcies;

 

  Ÿ  

our failure to identify and complete acquisitions or properties on terms favorable to us;

 

  Ÿ  

our failure successfully to operate acquired properties;

 

  Ÿ  

our failure to generate sufficient cash flows to service our outstanding indebtedness and make distributions to our shareholders;

 

  Ÿ  

increased interest rates or operating costs;

 

  Ÿ  

our inability to manage growth effectively;

 

  Ÿ  

our inability to comply with the laws and regulations applicable to companies, particularly public companies;

 

  Ÿ  

changes in real estate or zoning laws and regulations or increases in real property tax rates;

 

  Ÿ  

estimates related to our ability to make distributions to shareholders;

 

  Ÿ  

our dependence on key personnel;

 

  Ÿ  

conflicts of interest with our officers and trustees;

 

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  Ÿ  

our failure to obtain necessary outside financing;

 

  Ÿ  

potential losses from environmental uncertainties or natural disasters;

 

  Ÿ  

uninsured or underinsured losses relating to our properties;

 

  Ÿ  

any future terrorist attacks;

 

  Ÿ  

general volatility of the capital markets and the market price of our common shares; and

 

  Ÿ  

our failure to maintain our status as a REIT.

You should not place undue reliance on any forward-looking statements, which are based only on information currently available to us. We undertake no obligation to update or publicly release any revisions to such forward-looking statements to reflect events or circumstances after the date of this prospectus, except as required by applicable law.

 

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USE OF PROCEEDS

We estimate that the net proceeds of this offering will be approximately $             million after deducting the underwriting discount and other estimated offering expenses. If the underwriters’ option to purchase additional shares is exercised in full, we estimate that the net proceeds will be approximately $             million. Of the net proceeds of this offering, we intend to use approximately $             million to repay existing indebtedness and the remainder to fund future property acquisitions and for general corporate purposes. Of the existing indebtedness we intend to repay from the net proceeds of this offering, $             bears interest at a rate of     % and has a maturity date of                     . After this repayment, we expect to have approximately $             million of outstanding indebtedness. Prior to such use of the net offering proceeds, we intend initially to invest the net proceeds in interest-bearing short-term investment grade securities or money-market accounts which are consistent with our intention to qualify as a REIT, although we may also hold a portion of the net proceeds in an interest- or non-interest-bearing deposit account. These initial investments are expected to provide a lower net return than we will seek to achieve from investments in real properties or other real estate-related interests.

 

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CAPITALIZATION

The following table sets forth (1) our actual capitalization as of September 30, 2009, and (2) our pro forma capitalization as adjusted to give effect to this offering, the application of the net proceeds as described in “Use of Proceeds” and the repayment by us of a portion of our construction debt, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Financing Activities,” and the conversion of a portion of our operating partnership’s outstanding CPUs into common units, as described in “Business and Properties—Our Corporate Structure.” This table should be read in conjunction with the sections captioned “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as our audited consolidated financial statements included elsewhere in this prospectus.

 

     As of September 30, 2009
(in thousands)
     Actual     Pro Forma As
Adjusted(1)

Cash and cash equivalents

   $ 85,007      $             
              

Debt:

    

Notes payable

     525,493     

Revenue bond obligations

     6,058     

Convertible debentures

     69,650     
              

Total debt

   $ 601,201      $  
              

Shareholders’ equity:

    

Common shares of beneficial interest, par value $0.01 per share, 250,000,000 shares authorized, 21,368,000 shares issued and outstanding, actual and            shares issued and outstanding, as adjusted

     214     

Preferred shares of beneficial interest, par value $0.01 per share, 50,000,000 shares authorized, 0 shares issued and outstanding, actual and 0 shares issued and outstanding, as adjusted

     —       

Additional paid-in-capital

     658,497     

Accumulated deficit

     (175,717  
              

Total shareholders’ equity

     482,994     
              

Noncontrolling interests:

    

Verde Realty Operating Partnership common units

     47,186     

Verde Realty Operating Partnership convertible preferred units

     34,222     

Other

     4,447     
              

Total noncontrolling interests

     85,855     
              

Total equity

     568,849     
              

Total capitalization

   $ 1,170,050      $             
              

 

(1) Assumes no exercise of the underwriters’ option to purchase up to an additional             common shares in this offering.

 

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DISTRIBUTION POLICY

To qualify as a REIT so that U.S. federal income tax generally does not apply to our earnings to the extent distributed to shareholders, we must, in addition to meeting other requirements, annually distribute to our shareholders an amount at least equal to:

 

  (i) 90% of our REIT taxable income (determined before the deduction for dividends paid and excluding any net capital gain); plus

 

  (ii) 90% of the excess of our after-tax net income, if any, from foreclosure property over the tax imposed on such income by the Code; less

 

  (iii) the sum of certain items of non-cash income.

See “Material U.S. Federal Income Tax Considerations.”

We intend over time to make regular quarterly distributions to holders of our common shares. We intend to pay a pro rata dividend with respect to the period commencing on the completion of this offering and ending                     , 2010. On an annualized basis, this would be $             per share, or an annual dividend rate of approximately     % based on an initial public offering price of $             per share, which is the mid-point of the range indicated on the cover page of this prospectus. We intend to maintain our initial dividend rate for the 12-month period following completion of this offering unless actual results of operations, economic conditions or other factors differ materially from the assumptions used in our estimate.

We did not declare any distributions with respect to the fiscal years ended 2007, 2008 or 2009.

In considering the amount of cash available for distribution to our shareholders, management considers adjusted funds from operations, or AFFO, which is FFO as calculated by us and described under “Prospectus Summary—Summary Selected Historical Financial and Operating Data,” as adjusted to exclude the non-cash effect of such items as non-real estate depreciation, amortization or impairments, stock-based compensation expense, amortization of deferred financing costs, amortization of debt discount, amortization of above- or below-market leases and straight-line rents, and deducting the expenditures of recurring capital maintenance and recurring principal amortization of indebtedness. To the extent that, in respect of any calendar year, cash available for distribution is less than our REIT taxable income, we could be required to sell assets or borrow funds to make cash distributions or make a portion of the required distribution in the form of a taxable share distribution or distribution of debt securities. In addition, before we fully invest the net proceeds of this offering, we may fund our quarterly distributions out of such net proceeds. The use of our net proceeds for distributions could be dilutive to our financial results. In addition, funding our distributions from our net proceeds may constitute a return of capital to our investors, which would have the effect of reducing each shareholder’s basis in its common shares. We will generally not be required to make distributions with respect to activities conducted through any domestic taxable REIT subsidiary that we form following the completion of this offering. See “Material U.S. Federal Income Tax Considerations—Taxable REIT Subsidiaries.” Income as computed for purposes of the foregoing tax rules will not necessarily correspond to our income as determined for financial reporting purposes.

We cannot assure you that we will be able to pay or maintain cash distributions or that distributions will increase over time. Our ability to pay distributions to our shareholders will depend on a variety of factors, including:

 

  Ÿ  

our actual and projected results of operations;

 

  Ÿ  

our actual and projected financial condition, cash flows and liquidity;

 

  Ÿ  

the timing of the investment of the net proceeds of this offering;

 

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  Ÿ  

our debt service requirements;

 

  Ÿ  

capital expenditure requirements for our properties;

 

  Ÿ  

restrictions under Maryland law;

 

  Ÿ  

our taxable income;

 

  Ÿ  

the annual distribution requirement under the REIT provisions of the Code;

 

  Ÿ  

our operating expenses; and

 

  Ÿ  

other factors that our board of trustees may deem relevant.

Our ability to pay distributions to our shareholders will depend, in part, upon receipt of rent payments from our lessees and the management of our properties by us and any third-party management companies that we may engage. We anticipate that distributions to our shareholders generally will be taxable as ordinary income to our non-exempt shareholders, although a portion of such distributions may be designated by us as long-term capital gain or qualified dividend income or may constitute a return of capital. To the extent that we decide to make distributions in excess of taxable income, such excess distributions generally will be considered a return of capital. To the extent not inconsistent with maintaining our qualification as a REIT, we may retain any earnings that accumulate in our taxable REIT subsidiaries. For a discussion of the U.S. federal income tax treatment of distributions by us, see “Material U.S. Federal Income Tax Considerations—Taxation of Holders of Common Shares.”

 

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DILUTION

Purchasers of our common shares offered in this prospectus will experience an immediate and substantial dilution of the net tangible book value of our common shares from the initial public offering price. Dilution in net tangible book value per share represents the difference between the amount per share paid by purchasers of our common shares in this offering and the net tangible book value per common share immediately after this offering. Net tangible book value per share represents the amount of total tangible assets less total liabilities, divided by the number of outstanding common shares and common units of our operating partnership. As of September 30, 2009, our net tangible book value was approximately $512.0 million, or $21.60 per common share held by existing investors prior to this offering, assuming the redemption of common units in our operating partnership into common shares on a one-for-one basis. After giving effect to the sale of the common shares offered hereby and the application of the aggregate net proceeds from the offering, our pro forma net tangible book value as of September 30, 2009, would have been $            , or $             per common share. This amount represents an immediate increase in net tangible book value of $             per share to existing investors prior to this offering and an immediate dilution in pro forma net tangible book value of $             per share to new public investors. See “Risk Factors—Risks Related to This Offering—If you invest in this offering, you will experience immediate and substantial dilution.” The following table illustrates this per-share dilution:

 

Assumed initial public offering price per share

   $             

Net tangible book value per share before this offering

  

Net increase in pro forma net tangible book value per share attributable to this offering

  

Pro forma net tangible book value per share after this offering(1)

  

Dilution in pro forma net tangible book value per share to new investors(2)

   $             

 

(1) Based on pro forma net tangible book value of approximately $             divided by the sum of              common shares and common units of our operating partnership to be outstanding after this offering.
(2) Dilution is determined by subtracting pro forma net tangible book value per share of our common shares after giving effect to this offering from the initial public offering price paid by a new investor for a common share.

 

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SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

We derived the selected consolidated statements of income data for the nine months ended September 30, 2009, and the years ended December 31, 2008, 2007 and 2006, and the selected consolidated balance sheet data as of September 30, 2009, and December 31, 2008 and 2007, from our audited consolidated financial statements included elsewhere in this prospectus. We derived the selected consolidated statements of income data for the years ended December 31, 2005 and 2004, and the selected consolidated balance sheet data as of December 31, 2006, 2005 and 2004, from our audited consolidated financial statements that are not included in this prospectus. We derived the selected consolidated statements of income data for the nine months ended September 30, 2008, from our unaudited consolidated interim financial statements included elsewhere in this prospectus. We derived the summary selected consolidated balance sheet data as of September 30, 2008, from our unaudited consolidated financial statements that are not included in this prospectus.

Prior to July 1, 2006, Verde Group, L.L.C., or Group, was the majority owner of both us and our operating partnership. Effective July 1, 2006, in a series of merger and restructuring transactions, Group merged with and into our operating partnership. As the general partner of our operating partnership, we succeeded to the operations of Group and our operating partnership. Accordingly, amounts presented in our selected consolidated historical financial and operating data prior to the merger date are derived from Group’s consolidated financial statements.

 

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The results for any interim period are not necessarily indicative of the results that may be expected for the full year. Additionally, our historical results are not necessarily indicative of the results expected for any future period. You should read the selected historical financial data together with the consolidated financial statements and related notes appearing elsewhere in this prospectus, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the other financial information included elsewhere in this prospectus.

 

    Nine months ended
September 30,
    Year ended December 31,  
    2009     2008(1)     2008     2007     2006     2005     2004  
                (In thousands, except per-share/unit data)        

Balance Sheet Data (end of period):

             

Real estate, net

  $ 1,044,605      $ 1,036,044      $ 1,045,940      $ 977,537      $ 620,335      $ 406,104      $ 172,526   

Cash and cash equivalents

    85,007        127,280        112,821        156,861        41,173        82,566        60,455   

Total assets

    1,228,903        1,278,819        1,238,858        1,221,479        731,127        555,347        261,226   

Notes payable

    525,493        463,834        472,553        410,346        150,038        118,460        51,414   

Revenue bond obligations

    6,058        10,420        10,165        10,759        11,464        12,152        11,835   

Convertible debentures

    69,650        69,650        69,650        69,650        69,650        69,650        53,550   

Total liabilities

    660,054        646,615        636,033        562,508        349,356        274,938        123,220   

Common shares and additional paid-in capital

    658,711        655,517        656,850        651,500        373,459        204,802 (2)      127,732 (2) 

Accumulated deficit

    (175,717     (115,789     (144,109     (88,486     (47,612     (28,511     (9,675
                                                       

Total common shareholders’ equity

    482,994        539,728        512,741        563,014        325,847        176,291        118,057   

Noncontrolling interests

    85,855        92,677        90,084        95,957        55,924        104,118        19,949   
                                                       

Total equity

    568,849        632,405        602,825        658,971        381,771        280,409        138,006   

Statement of Operations Data:

             

Rental revenues

  $ 72,484      $ 51,953      $ 73,072      $ 52,092      $ 34,700      $ 17,200      $ 4,123   

Total revenues

    73,869        53,909        77,461        61,690        47,752        25,177        4,381   

Property expenses

    25,547        19,121        26,987        16,772        11,887        5,837        1,498   

Payroll and related

    17,799        20,874        27,067        25,243        17,395        10,419        3,342   

General and administrative expenses

    4,901        7,487        10,098        10,126        9,388        5,685        1,093   

Depreciation and amortization

    22,762        19,468        26,900        19,000        13,354        8,373        2,193   

Total expenses

    85,124        72,784        117,044        89,377        67,428        38,977        10,252   

Operating loss

    (11,255     (18,875     (39,583     (27,687     (19,676     (13,800     (5,871

Interest expense

    (24,478     (14,861     (21,820     (9,965     (11,607     (7,321     (2,117

Loss from continuing operations, net of tax

    (36,185     (35,911     (67,002     (47,800     (28,475     (18,999     (7,650

Income (loss) from discontinued operations

    348        (292     33        459        1,336        163        (665

Gain on disposition of discontinued operations

    —          5,620        5,473        1,631        3,029        —          —     

Net loss attributable to common shareholders

    (31,608     (27,303     (55,623     (40,874     (21,136     (18,836     (8,315

Loss from continuing operations per common share attributable to common shareholders—basic and diluted

  $ (1.49   $ (1.50   $ (2.83   $ (2.25   $ (2.42   $ (2.82 )(2)    $ (3.39 )(2) 

Net earnings (loss) per common share attributable to common shareholders-basic and diluted

    (1.48     (1.28     (2.60     (2.15     (2.02     (2.85 )(2)      (3.70 )(2) 

Weighted average number of common shares outstanding—basic and diluted

    21,378        21,361        21,362        19,043        10,442        6,603 (2)      2,247 (2) 

Cash Flow Data:

             

Net cash provided by (used in) operating activities

  $ (967   $ (11,968   $ (15,751   $ 5,656      $ (27,615   $ (16,186   $ (16,201

Net cash used in investing activities

    (65,133     (117,853     (147,772     (333,682     (194,656     (229,959     (140,411

Net cash provided by financing activities

    38,286        100,497        119,483        443,714        176,800        272,334        208,639   

 

(1) Restated, see Note 1 to our consolidated financial statements included herein.
(2) Represents common units outstanding.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with the sections of this prospectus entitled “Selected Historical Financial and Operating Data,” “Risk Factors,” “Forward-Looking Statements,” “Business” and our consolidated financial statements and the notes thereto included elsewhere in this prospectus. This discussion contains forward-looking statements reflecting current expectations that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the section entitled “Risk Factors” and elsewhere in this prospectus.

Overview

We are a fully integrated, self-administered and self-managed real estate investment trust, or REIT, that specializes in the ownership, acquisition and management of institutional-quality multifamily rental properties and industrial distribution facilities. Our existing operating portfolio is composed primarily of recently constructed multifamily rental properties in the southwestern United States and industrial distribution facilities in the southwestern United States and northern Mexico. C. Ronald Blankenship, our president and chief executive officer, and William Sanders, our chairman, founded the company and have a combined 75 years of experience in the real estate industry. We intend to capitalize on the experience and track record of Mr. Blankenship and the other members of our management team in growing and managing public real estate companies and utilize the proceeds of this offering to expand our existing asset base through the acquisition of multifamily rental properties and industrial distribution facilities focused in select high-growth markets in the western and southwestern United States.

As of November 30, 2009, our industrial distribution portfolio consisted of 87 properties, comprised of 52 properties in the United States and 35 in Mexico, totaling 12.0 million rentable square feet. The weighted average age of the properties in our industrial distribution portfolio is 4.9 years (measured from the later of major renovation or the completion of construction). Our management team developed 29 of these properties since 2005, representing 4.6 million square feet. Our industrial distribution portfolio was 83.6% leased as of November 30, 2009. Our industrial tenant base is broad and diversified, with no single tenant accounting for more than 5.0% of our annualized rents and our 10 largest tenants comprising 28.7% of our rentable square feet and providing 33.9% of our annualized rent.

As of November 30, 2009, our multifamily rental portfolio consisted of 14 properties totaling 4,790 units, representing an investment at cost of $363.4 million. The weighted average age of the properties in our multifamily rental portfolio is 1.1 years (excluding one property that is still in service but was acquired for future development). Our management team developed 13 of these properties since 2006, representing 4,363 units. Our multifamily rental portfolio was 94.8% physically occupied as of November 30, 2009, excluding four properties that are currently still in lease-up. Inclusive of these lease-up properties, our combined physical occupancy was 89.8% as of November 30, 2009.

As of November 30, 2009, we owned approximately 86.8 acres of land suitable for construction of multifamily rental properties, which we refer to as “multifamily land,” and approximately 1,895.6 acres of land suitable for construction of industrial distribution facilities, which we refer to as “industrial land.” See “Business and Properties—Our Existing Portfolio.” By “suitable for construction,” we mean that the land generally has access to roads, utilities and other relevant entitlements (but excluding subdivision approvals, building permits and similar items) that would be conditions precedent to such construction. This multifamily land and industrial land had, as of November 30, 2009, an aggregate book value of approximately $39.4 and $133.4, respectively (including our proportionate share of industrial land

 

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owned in joint ventures). We do not use mortgage debt to finance acquisitions of land. However, approximately 10.0 acres of our multifamily land is pledged to secure mortgage debt on one of our multifamily rental properties, Cypress Creek, and approximately 166.9 acres of our industrial land is included in property pledged to secure mortgage debt on certain properties in our industrial distribution portfolio. We generally acquired this land for its construction potential, but we do not believe market conditions warrant such activity at this time. We intend to hold this land in inventory for disposition and/or future development, including build-to-suit opportunities, as and when appropriate opportunities arise.

As of November 30, 2009, we also owned approximately 23,968.8 acres of land in Doña Ana County, New Mexico, which we refer to as Santa Teresa and that we acquired with a view toward developing as a mixed-use project. We no longer intend to pursue large-scale development of this land. In addition, we own approximately 9,560.1 acres of land relating to a low-density residential lot development business we previously conducted in central New Mexico, which we refer to as Heritage Preserve. We have completed all intended land development relating to Heritage Preserve. None of the Santa Teresa land or the land in our Heritage Preserve business is mortgaged.

In assessing the performance of our properties, management carefully tracks the occupancy of our portfolio. Our industrial occupancy grew from 82.7% at December 31, 2007, to 85.5% at December 31, 2008, and our multifamily occupancy declined from 92.8% at December 31, 2007, to 82.3% at December 31, 2008, due to the completion of additional properties that were in lease-up at the end of 2008. Another important indicator of performance is our ability to re-lease properties at the end of a lease term and maintain high occupancy rates. We completed 70 new industrial leases or renewals during 2008 totaling 3.3 million square feet, increasing rental rates an average of 2.1% on a cash basis.

We are structured as an umbrella partnership REIT, or UPREIT. We were formed in 2006 and have elected to be taxed as a REIT for federal tax purposes since our inception. Substantially all of our assets are held by, and our operations conducted through, our operating partnership, which was formed in 2003, and its subsidiaries. We control our operating partnership as the sole general partner and as the owner of approximately 90.3% of the aggregate partnership interests.

Prior to June 30, 2006, Verde Group, L.L.C., or Group, was the majority owner of both us and Verde Realty Master Limited Partnership, the former name of our operating partnership. Effective July 1, 2006, Group merged with and into the operating partnership in a series of merger and restructuring transactions, pursuant to which one common partnership unit was issued for each outstanding Group member unit. Most unitholders exercised an election to exchange their common partnership units for our common shares, resulting in us owning a majority of the operating partnership’s common units. Amounts presented in our consolidated financial statements and accompanying notes prior to the merger date represent Group’s consolidated financial statements. The acquired minority interests were carried over at their historical book value.

Critical Accounting Policies

Set forth below is a summary of the accounting policies that management believes are critical to the preparation of the consolidated financial statements included in this prospectus. Certain of the accounting policies used in the preparation of these consolidated financial statements are particularly important for an understanding of the financial position and results of operations presented in the historical consolidated and combined financial statements included in this prospectus. We have also provided a summary of significant accounting policies in note 1 of the notes to our consolidated financial statements. These policies require the application of judgment and assumptions by

 

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management and, as a result, are subject to a degree of uncertainty. Due to this uncertainty, actual results could differ from estimates calculated and utilized by management.

Basis of Presentation

Our discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Our consolidated financial statements include the accounts of our operating partnership and its subsidiaries controlled through voting interests, as well as the accounts of variable interest entities in which our operating partnership holds a variable interest and is the primary beneficiary and the related amounts of minority interest and joint ventures or partnerships that meet the guidelines for consolidation. All intercompany balances and transactions have been eliminated in consolidation.

Property

Our operating real estate properties are stated at cost, and improvements and replacements are capitalized when they extend the useful life or improve the efficiency of the asset. Acquisitions of properties are accounted for using the acquisition method of accounting by recording the purchase of identifiable assets acquired and liabilities assumed at their acquisition date fair values and any goodwill or gain on purchase. The costs of repairs and maintenance are expensed as incurred. We compute depreciation using the straight-line method, generally over estimated useful lives of approximately 40 years for buildings and improvements, three to five years for equipment and fixtures and, the shorter of the useful life or the remaining lease term, which includes periods covered by bargain renewal options, if any, for tenant improvements and leasehold interests.

Property held for future development is stated at cost. Costs directly related to land acquisition, and development or renovations of real estate, are capitalized. These costs generally include cash paid, development costs, cost of debt assumed and other transaction costs. Management considers whether partial carryover basis or fair value should be applied in circumstances where real estate is acquired in exchange for an equity interest. In the opinion of management, each property held for future development is stated at an amount not in excess of the individual property’s estimated undiscounted future cash flows, including estimated proceeds from disposition.

Properties under development are stated at cost. Development expenditures, including indirect project costs directly related to the project, interest and real estate taxes, are capitalized. During the land development and construction periods of qualifying projects, interest costs are capitalized as provided under Accounting Standards Codification (“ASC”) 835, “Interest.” The capitalization of such costs ceases when the property is substantially complete and ready for its intended use.

 

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Impairment

We review our properties for impairment if events or changes in circumstances indicate that the carrying amount of the property may not be recoverable. In such an event, we compare either the current and projected operating cash flows of each such property in the foreseeable future on an undiscounted basis or the estimated net sales price to the carrying amount of such property. If impairment is indicated, we reduce the carrying amount to either estimated fair value to reflect any impairment in the value of the assets to be held and used or estimated fair value less cost to sell for assets held for sale.

Revenue Recognition

We lease properties to tenants under agreements that are classified as operating leases and recognize the total minimum lease payments under the leases on a straight-line basis over the lease term, including rent holidays and bargain renewal options, if any. An allowance for possible loss is made if the collection of a receivable balance is considered to be doubtful. Under the terms of the leases, some or all of our operating expenses are recovered from our tenants. We reflect amounts recovered from tenants as a component of rental income in the period the related expense is incurred.

Revenues from real estate sales of residential home sites and land sales are recognized upon closing of sales contracts and lapsing of any applicable rescission period in accordance with ASC 605, “Revenue Recognition.” A portion of real estate inventory and estimates for costs to complete are allocated to each parcel based on the relative sales value of each unit as compared to the sales value of the total project.

Acquisition of Real Property

Acquisitions of properties are accounted for utilizing the acquisition method of accounting as set forth in ASC 805, “Business Combinations,” and, accordingly, the results of operations are included in our results of operations from the respective dates of acquisition. We have used estimates of future cash flows and other valuation techniques to allocate the purchase price of acquired property among land, buildings on an “as if vacant” basis, tenant improvements, and other identifiable intangibles which include the effect of out-of-the-market leases, the value of having leases in place and tenant relationships.

Income Taxes

We have elected REIT status for U.S. federal income tax purposes. No provision has been made in our financial statements for U.S. federal income taxes because REITs are generally not required to pay federal income taxes if they distribute 90% of their taxable income and meet certain income, asset and shareholder tests. We did not have taxable income for the nine months ended September 30, 2009 or 2008, or the years ended December 31, 2008 or 2007, or the period from July 1, 2006 to December 31, 2006.

The Tax Relief Extension Act of 1999 gave REITs the ability to conduct activities that a REIT was previously precluded from engaging in provided that such activities are performed in entities that have elected to be treated as taxable REIT subsidiaries under the IRS code. These activities include buying or developing properties with the express purpose of selling them. We conduct certain of these activities in taxable REIT subsidiaries that we have created. We calculate and record income taxes in our consolidated financial statements based on the activities in those entities. We also record deferred taxes for the temporary tax differences that have resulted from those activities as required under ASC 740, “Income Taxes.” We use estimates in preparing our deferred tax amounts, and if revised, these estimates could impact our results of operations.

 

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Foreign Currency Risks

We own and operate industrial distribution facilities in Mexico and pay some local expenses in Mexican pesos. We collect rent on leases in U.S. dollars, which is the functional currency. We do not currently mitigate foreign currency risk, but monitor the exchange rate of the Mexican peso to the U.S. dollar to determine whether to mitigate the risk from foreign currency fluctuations.

Results of Operations

During the nine months ended September 30, 2009 and 2008, and for the years ended December 31, 2008, 2007 and 2006 we operated in four reportable segments: industrial distribution facilities, multifamily rental property, Santa Teresa and Heritage Preserve. Our industrial distribution segment acquires, develops and manages industrial warehouse and distribution facilities. Our multifamily rental segment acquires, develops and manages multifamily apartment communities. Santa Teresa is engaged in the development and sale of land for industrial parks, residential, mixed-use development and rail trans-load facilities in Santa Teresa, New Mexico. Heritage Preserve is the developer of rural low-density residential lots in conservation preserves located in New Mexico. Following the discussion of our consolidated results for each reporting period is a discussion of the results of each of our reportable segments for such period. Additional financial information regarding our reportable segments is included in note 14 to our consolidated financial statements included elsewhere in this prospectus.

Comparison of nine months ended September 30, 2009, and nine months ended September 30, 2008

Leased occupancy in our industrial and physical occupancy in our multifamily rental portfolios were:

 

     September 30,  
     2009     2008  

Industrial

   85.1 %*    86.0

Multifamily

   84.8   71.2

 

* After adjustment for April 2009 fire in Juarez, Mexico.

Revenues

Total revenues.    Total revenues consist of rental revenues from industrial distribution facilities and multifamily rental properties as well residential lot sales and land sales. Total revenues for the nine months ended September 30, 2009, increased to $73.9 million from $53.9 million for the nine months ended September 30, 2008, an increase of $20.0 million or 37.0%. The increase in total revenues was primarily due to new property development activity in our industrial distribution and multifamily rental segments.

Industrial distribution revenues.    Industrial distribution revenues for the nine months ended September 30, 2009, increased to $44.3 million from $39.4 million for the nine months ended September 30, 2008, an increase of $4.9 million or 12.4%. New property development activity contributed $4.4 million of the rental income increase. We had approximately 12.0 million square feet of industrial operating properties at September 30, 2009, compared to 11.9 million square feet at September 30, 2008. At September 30, 2009, the average annual rate of in-place leases was $4.58 per square foot compared to $4.50 per square foot at September 30, 2008. In addition, we received a lease termination fee of $2.5 million.

Multifamily rental revenues.    Multifamily rental revenues for the nine months ended September 30, 2009, increased to $28.2 million from $12.6 million for the nine months ended September 30, 2008, an increase of $15.6 million or 124.4%. Substantially all of the increase was due to new property development activity, including properties that commenced operating during 2009 as

 

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Multifamily rental revenues.    Multifamily rental revenues for the nine months ended September 30, 2009, increased to $28.2 million from $12.6 million for the nine months ended September 30, 2008, an increase of $15.6 million or 124.4%. Substantially all of the increase was due to new property development activity, including properties that commenced operating during 2009 as well as properties that commenced in 2008 that had activity through all of the nine months ended September 30, 2009. We had 14 multifamily rental properties with 4,790 units substantially completed and operating at September 30, 2009, compared to 10 properties with 3,250 units at September 30, 2008. At September 30, 2009, the average monthly rate of in-place leases was $738 per unit compared to $593 per unit at September 30, 2008.

Residential lot sales.    During the nine months ended September 30, 2009, we sold six residential lots in our Heritage Preserve business compared to 15 residential lot sales during the nine months ended September 30, 2008. Residential lot sales decreased during the period to $0.6 million from $1.9 million. At September 30, 2009, Heritage Preserve owned approximately 9,560.1 acres in New Mexico with a carrying value of $9.6 million.

Land sales.    During the nine months ended September 30, 2009, we sold in a single transaction approximately 5,100 acres of land in our Heritage Preserve business for $0.8 million. During the nine months ended September 30, 2008, we sold 51 acres of land in our Heritage Preserve business for $0.1 million.

Operating Expenses

Total operating expenses.    Total operating expenses consist primarily of industrial distribution facility and multifamily rental property expenses, cost of residential lot sales, cost of land sales, payroll and related expenses, depreciation and amortization and other operating expenses. Other operating expenses consist of professional fees, property taxes, terminated pursuit costs, and general and administrative expenses. Total operating expenses for the nine months ended September 30, 2009, increased to $85.1 million from $72.8 million for the nine months ended September 30, 2008, an increase of $12.3 million or 17.0%. The increase in total operating expenses was primarily due to increased property operating expenses and an impairment charge recognized in 2009.

Industrial distribution operating expenses.    Industrial distribution operating expenses for the nine months ended September 30, 2009, decreased to $8.3 million from $9.7 million for the nine months ended September 30, 2008, a decrease of $1.4 million or 14.3%. During 2008, we internalized our property management function and reduced the amount of property management fees paid to third parties. For the nine months ended September 30, 2009, this reduction in property management fees was $1.8 million compared to $0.8 million for the nine months ended September 30, 2008, representing a change of $1.0 million. In addition, operating expenses related to a property in Juarez, Mexico that was damaged by fire in April 2009 decreased by $0.5 million. The remainder of our operating properties had consistent expense levels for the nine months ended September 30, 2009, compared to the same period in 2008.

Multifamily rental operating expenses.    Multifamily rental operating expenses for the nine months ended September 30, 2009, increased to $17.3 million from $9.4 million for the nine months ended September 30, 2008, an increase of $7.8 million or 82.7%. The increase in operating expenses was due primarily to operating expenses relating to new property development since December 31, 2008, as well as from properties with nine full months of operations in 2009.

Cost of residential lot sales.    Cost of residential lot sales, including commissions and other costs, decreased during the period to $0.6 million from $1.3 million due primarily to selling fewer lots during the nine months ended September 30, 2009, compared to the same period in 2008.

Cost of land sales.    Cost of land sales increased during the period to $0.7 million from $0.1 million. The increase is due to the value of land sold during the nine months ended September 30, 2009, compared to the same period in 2008.

 

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Payroll and related.    Payroll and related expenses decreased $3.1 million or 14.7% during the period to $17.8 million from $20.9 million due primarily to reductions made in our staffing as we minimized our development activity.

General and administrative expenses.    General and administrative expenses decreased $2.6 million or 34.5% during the period to $4.9 million from $7.5 million. During the nine months ended September 30, 2009, we reduced our advertising spending in our Heritage Preserve business approximately $1.3 million compared to the nine months ended September 30, 2008. For the nine months ended September 30, 2008, we established a reserve of approximately $1.0 million related to a receivable from a lender for foreign income tax withholding, which did not recur during the nine months ended September 30, 2009.

Depreciation and amortization.    Depreciation and amortization increased $3.3 million or 16.9% during the period to $22.8 million from $19.5 million due primarily to the increased number of operating properties during the year compared to 2008. Depreciation of our operating properties and tenant improvements was $20.0 million for the nine months ended September 30, 2009, compared to $15.5 million for the same period in 2008 due primarily to the higher number of industrial distribution facilities and multifamily rental properties in operation. Amortization of lease valuation, which is established when an operating property is acquired, decreased to $1.6 million for the nine months ended September 30, 2009, compared to $2.6 million for the same period in 2008. The amortization of lease valuation is over the same period as the in-places leases on acquired properties. Non-real estate depreciation totaled $1.1 million and $1.3 million, respectively, for the nine months ended September 30, 2009 and 2008.

Impairment of long-lived assets and inventory valuation adjustments.    During the nine months ended September 30, 2009, we recognized impairments and inventory valuation adjustments of $8.2 million. At September 30, 2009, the carrying value of the Heritage Preserve properties was written down by $2.8 million to fair value of $9.6 million. In addition, a parcel of land for future multifamily development was placed under contract to sell in October 2009 for $4.9 million less than its carrying value. The remaining impairment of approximately $0.5 million was recognized as land for future development of industrial distribution facilities which was sold during the year. There were no impairments recognized during the nine months ended September 30, 2008.

Operating Loss

As a result of the above factors, our operating loss during the period decreased to $11.3 million from $18.9 million, a decrease of $7.6 million or 40.4%.

Non-Operating Income and Expenses

Net interest expense.    Interest income decreased during the period by $2.3 million or 79.2% from $2.9 million to $0.6 million. Our cash balances decreased from $156.9 million at December 31, 2007, to $85.0 million at September 30, 2009, and interest rates decreased substantially. Interest expense increased during the period by $9.6 million or 64.7% from $14.9 million to $24.5 million. This increase is due primarily to the increase in our outstanding indebtedness. At December 31, 2007, we had $490.8 million of outstanding notes, bonds and convertible debentures compared to $552.4 million outstanding at December 31, 2008, and $601.2 million at September 30, 2009. During the nine months ended September 30, 2009, we incurred an additional $40.0 million (proceeds, net of repayments) of indebtedness compared to $102.1 million for the same period in 2008. Debt incurred during the nine months ended September 30, 2009 carried lower interest rates than the debt incurred during the nine months ended September 30, 2008.

 

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Change in fair value of derivatives.    Due to interest rate fluctuations in 2008 and 2009, we recognized income related to the change in the fair value of our interest rate swap agreements of $1.2 million for the nine months ended September 30, 2009, compared to expense of $1.6 million for the same period in 2008.

Income taxes.    We recognized $2.4 million of income tax expense for the nine months ended September 30, 2009, compared to $4.4 million of income tax for the same period in 2008, a decrease of $2.0 million or 45.2%. The income taxes are primarily Mexican income taxes, which are affected by both foreign currency exchange rate fluctuations and Mexican inflation rates. During the nine months ended September 30, 2008, the U.S. dollar to Mexican peso exchange rate decreased by approximately 7%, creating additional income subject to Mexican income taxes, while for the same period in 2009 the exchange rate decreased by only 2%.

Noncontrolling interest.    The loss attributable to noncontrolling interests increased $0.9 million during the period, or 28.9%, to $4.2 million from $3.3 million. Loss attributable to noncontrolling interests represents the amount of the loss allocated to third-party owners of consolidated subsidiaries. The increase in loss attributable to noncontrolling interests was due to higher losses at our operating partnership, of which we owned approximately 90.1% as of September 30, 2009.

Discontinued operations.    During the nine months ended September 30, 2009, we entered into contracts to sell 10 industrial distribution facilities and classified these operations into discontinued operations. The operating results of these properties are shown as discontinued operations. For the nine months ended September 30, 2009, the combined income from discontinued operations was approximately $0.3 million, which includes an impairment loss of $1.3 million, compared to a loss for the same period in 2008 of $0.3 million.

Segment reporting.

We view our industrial distribution, multifamily rental, Santa Teresa and Heritage Preserve operations as business segments and evaluate their operating performance based on Adjusted EBITDA, or adjusted earnings before interest, taxes, depreciation and amortization, general and administration expenses and other non-cash expenses. Management does not consider the effect of gains or losses from the sale of property in evaluating segment operations. Management considers Adjusted EBITDA a supplemental measure for making decisions and assessing the un-levered performance of its segments. Adjusted EBITDA should not be considered a substitute for net income. Adjusted EBITDA may not be comparable to similarly titled measures employed by other companies.

Industrial distribution.    The Adjusted EBITDA of the industrial distribution segment was $29.0 million for the nine months ended September 30, 2009, compared to $23.6 million for the same period in 2008, an increase of $5.4 million or 23.1%. The differences are primarily related to the increases in industrial distribution revenues and the decrease in industrial distribution operating expenses discussed above.

Multifamily rental.    The Adjusted EBITDA of the multifamily rental segment was $4.8 million for the nine months ended September 30, 2009, compared to a loss of $1.8 million for the same period in 2008, an increase of $6.6 million. The increase in Adjusted EBITDA is due primarily to increased multifamily rental property revenue due to the completion of additional developments.

Santa Teresa.    The Adjusted EBITDA of the Santa Teresa segment was a loss of $0.9 million for the nine months ended September 30, 2009, compared to a loss of $1.0 million for the same period in 2008. There were no significant transactions during those periods.

 

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Heritage Preserve.    The Adjusted EBITDA of the Heritage Preserve sales segment was a loss of $0.8 million for the nine months ended September 30, 2009, compared to a loss of $3.1 million for the same period in 2008, a decrease of $2.3 million or 73.2%. In 2008, in response to worsening economic conditions, we reduced our marketing activity and reduced our staff in this business.

Reconciliation of Segment Adjusted EBITDA to Net Loss:

 

     Nine Months Ended
September 30,
 
     2009     2008  
     (in thousands)  

Adjusted EBITDA of the industrial distribution segment

   $ 29,030      $ 23,592   

Adjusted EBITDA of the multifamily rental segment

     4,837        (1,786

Adjusted EBITDA of the Santa Teresa segment

     (916     (1,049

Adjusted EBITDA of the Heritage Preserve segment

     (838     (3,131

Adjusted EBITDA of other segments

     —          1,843   
                

Total

     32,113        19,469   

Interest expense

     (24,596     (17,202

Depreciation and amortization

     (25,003     (22,778

General and administrative expenses

     (7,789     (10,512

Provision for income taxes

     (2,745     (4,537

Gains (losses) on real estate sold or under contract

     (1,325     5,007   

Impairment loss and inventory valuation adjustment

     (8,229     —     

Change in fair value of derivatives

     1,179        (1,557

Loss allocated to noncontrolling interests

     4,702        3,334   

Interest and other income

     85        1,473   
                

Net loss

   $ (31,608   $ (27,303
                

Comparison of year ended December 31, 2008, to year ended December 31, 2007

Leased occupancy in our industrial and physical occupancy in our multifamily portfolios compared to the prior year were:

 

     December 31,  
     2008     2007  

Industrial

   85.5     82.7

Multifamily

   79.8     94.5

Revenues

Total revenues.    Total revenues consist of rental revenues from industrial distribution facilities and multifamily rental properties as well residential lot sales and land sales. Total revenues for the year ended December 31, 2008, increased to $77.5 million from $61.7 million for the year ended December 31, 2007, an increase of $15.8 million or 25.6%. The increase in total revenues and property expenses was primarily due to new property development activity in our industrial distribution facilities and multifamily rental segments.

Industrial distribution revenues.    Industrial distribution revenues for the year ended December 31, 2008, increased to $53.3 million from $42.9 million for the year ended December 31, 2007, an increase of $10.5 million or 24.4%. New property development activity since December 31, 2007, contributed $4.3 million of the rental income increase and the remainder of the increase came

 

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from properties with a full year of operations in 2008. We had approximately 12.3 million square feet of industrial operating properties at December 31, 2008, compared to 11.0 million square feet at December 31, 2007. At December 31, 2008, the average annual rate of in-place leases was $4.53 per square foot compared to $4.40 per square foot at December 31, 2007.

Multifamily rental revenues.    Multifamily rental revenues for the year ended December 31, 2008, increased to $19.7 million from $9.2 million for the year ended December 31, 2007, an increase of $10.5 million or 114.3%. Substantially all of the increase was due to new property development activity, including properties that commenced operating during 2008 as well as properties that commenced in 2007 that had activity through all of the year ended December 31, 2008. We had 10 multifamily rental properties with 3,498 units substantially completed and operating at December 31, 2008, compared to four properties with 1,110 units at December 31, 2007. At December 31, 2008, the average monthly rate of in-place leases was $655 per unit compared to $795 per unit at December 31, 2007.

Residential lot sales.    During the year ended December 31, 2008, we sold 16 residential lots in our Heritage Preserve business compared to 64 residential lot sales during the year ended December 31, 2007. Residential lot sales decreased during the period to $1.9 million from $9.6 million.

Land sales.    During the year ended December 31, 2008, we sold 18 acres of land in Santa Teresa for $2.4 million. There were no land sales during the year ended December 31, 2007.

Operating Expenses

Total operating expenses.    Total operating expenses consist primarily of industrial distribution facility and multifamily rental property expenses, cost of residential lot sales, cost of land sales, payroll and related expenses, depreciation and amortization and other operating expenses. Other operating expenses consist of professional fees, property taxes, terminated pursuit costs, and general and administrative expenses. Total operating expenses for the year ended December 31, 2008, increased to $117.0 million from $89.4 million for the year ended December 31, 2007, an increase of $27.7 million or 31.0%. This increase was primarily attributable to increased property operating expenses, real estate depreciation and amortization and impairment losses.

Industrial distribution operating expenses.    Industrial distribution operating expenses for the year ended December 31, 2008, increased to $12.3 million from $11.9 million for the year ended December 31, 2007, an increase of $440,000 or 3.7%. The increase in operating expenses was due primarily to acquisitions and new property development since December 31, 2007, and from properties with a full year of operations in 2007.

Multifamily rental operating expenses.    Multifamily rental operating expenses for the year ended December 31, 2008, increased to $14.7 million from $4.9 million for the year ended December 31, 2007, an increase of $9.7 million or 198.8%. The increase in operating expenses was due primarily to new property development since December 31, 2007, as well as from properties with a full year of operations in 2008.

Cost of residential lot sales.    Cost of residential lot sales decreased during the period to $1.4 million from $5.8 million due primarily to selling fewer lots during the year ended December 31, 2008, compared to the same period in 2007.

Cost of land sales.    Cost of land sales during the year ended December 31, 2008 was $1.9 million. There were no land sales in 2007.

Payroll and related.    Payroll and related expenses increased $1.8 million or 7.2% during the period to $27.1 million from $25.2 million, due primarily to incremental hiring.

 

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General and administrative.    General and administrative expenses of $10.1 million were approximately the same for the years ended December 31, 2008 and 2007.

Terminated pursuit costs.    Terminated pursuit costs decreased during the year ended December 31, 2008, to $2.8 million from $7.1 million for the year ended December 31, 2007. In 2007, $5.0 million of pursuit costs and earnest money was written off related to a transaction that was no longer considered probable. Effective January 1, 2009, pursuit costs are charged to expense as incurred.

Depreciation and amortization.    Depreciation and amortization increased $7.9 million, or 41.6%, during the period to $26.9 million from $19.0 million due primarily to the increased number of operating properties compared to 2007. Depreciation of our operating properties and tenant improvements was $21.4 million for the year ended December 31, 2008, compared to $12.9 million for the same period in 2007 due primarily to the higher number of industrial distribution facilities and multifamily rental properties in operation. Amortization of lease valuation decreased to $3.7 million for the year ended December 31, 2008, compared to $4.5 million for same period in 2007. Non-real estate depreciation totaled $1.8 million and $1.6 million, respectively, for the years ended December 31, 2008, and 2007.

Inventory valuation adjustment.    During the year ended December 31, 2008, we recognized an impairment of properties in our Heritage Preserve segment of $14.5 million to reduce the basis to fair value.

Operating Loss

As a result of the above factors, our operating loss during the period increased $11.9 million, or 43.0%, to $39.6 million from $27.7 million.

Non-Operating Income and Expenses

Net interest expense.    Interest income decreased during the period by $0.9 million or 21.2%, from $4.3 million to $3.4 million. Our cash balances decreased from $156.9 million at December 31, 2007, to $112.8 million at December 31, 2008, and interest rates decreased slightly. Interest expense increased during the period by $11.9 million, or 119.0%, from $10.0 million to $21.8 million. This increase is due primarily to the increase in our debt. At December 31, 2007, we had $490.8 million of outstanding notes, bonds and convertible debentures compared to $552.4 million outstanding at December 31, 2008. During the year ended December 31, 2008, we entered into an additional $121.1 million (proceeds, net of repayments) of indebtedness and $135.7 million for the same period in 2007. Debt incurred during 2008 carried lower interest rates than the debt incurred during 2007.

Other income (expense).    We recognized $0.6 million of other income (net) during the year ended December 31, 2008, compared to $0.6 million of other expense (net) during the same period in 2007.

Noncontrolling interest.    The loss attributable to noncontrolling interests increased $1.1 million during the year, or 21.4%, to $5.9 million from $4.8 million. Loss attributable to noncontrolling interests represents the amount of the loss allocated to third-party owners of consolidated subsidiaries. The increase in loss attributable to noncontrolling interests was due to higher losses at our operating partnership, of which we owned approximately 90.1% as of September 30, 2009.

Change in fair value of derivatives.    Due to a decrease in interest rates during 2008, we recognized an expense related to the change in the fair value of our interest rate swap agreements of $8.0 million for the year ended December 31, 2008. There was no significant change for the year ended December 31, 2007.

 

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Income taxes.    We recognized $1.6 million of income tax expense for the year ended December 31, 2008, compared to $14.0 million of income tax expense for the same period in 2007, a decrease of $12.4 million or 88.4%. In 2007, the Mexican government enacted an additional tax regime. The transition provisions of this regime eliminated a substantial portion of the tax basis of our properties in Mexico, if we were to sell them. We recognized a deferred tax liability of $11.6 million related to this change.

Discontinued operations.    Discontinued operations for the year ending December 31, 2008, includes the results of the industrial distribution portfolio placed under contract in 2009 and the 2008 sale of two retail properties and one multifamily rental property. For the year ended December 31, 2008, the combined income and gain from sale of discontinued operations was $5.5 million compared to a gain of $2.1 million for the same period in 2007.

Segment Reporting

We view our industrial distribution, multifamily rental, Santa Teresa and Heritage Preserve operations as business segments and evaluate their operating performance based on Adjusted EBITDA, or adjusted earnings before interest, taxes, depreciation and amortization, general and administration expenses and other non-cash expenses. Management does not consider the effect of gains or losses from the sale of property in evaluating segment operations. Management considers Adjusted EBITDA a supplemental measure for making decisions and assessing the un-levered performance of its segments. Adjusted EBITDA should not be considered a substitute for net income. Adjusted EBITDA may not be comparable to similarly titled measures employed by other companies.

Industrial distribution.    The Adjusted EBITDA of the industrial distribution segment was $30.9 million for the year ended December 31, 2008, compared to $21.1 million for the same period in 2008, an increase of $9.8 million or 46.4%. The increase in Adjusted EBITDA is primarily related to the increases in industrial distribution revenues discussed above.

Multifamily rental.    The Adjusted EBITDA of the multifamily rental segment was a loss of $2.8 million for the year ended December 31, 2008, compared to a loss of $2.0 million for the same period in 2007, an increase of $0.8 million or 38.2%. The increase in the loss is due primarily to the costs of expanding our multifamily rental property business in addition to the costs associated with our preparation to commence operations at properties that were nearing development completion at the end of 2007.

Santa Teresa.    The Adjusted EBITDA of the Santa Teresa segment was a loss of $1.3 million for the year ended December 31, 2008, compared to a loss of $0.9 million for the same period in 2007. The loss increased by $0.4 million due to an increase in general and administrative costs.

Heritage Preserve.    The Adjusted EBITDA of the Heritage Preserve segment was a loss of $3.6 million for the year ended December 31, 2008, compared to a loss of $1.5 million for the same period in 2007, an increase of $2.1 million. The loss increased due to a substantial decline in sales while the overhead remained approximately the same.

 

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Reconciliation of Segment Adjusted EBITDA to Net Loss:

 

     Year Ended
December 31,
 
     2008     2007  
     (in thousands)  

Adjusted EBITDA of the industrial distribution segment

   $ 30,882      $ 21,089   

Adjusted EBITDA of the multifamily rental segment

     (2,768     (2,003

Adjusted EBITDA of the Santa Teresa segment

     (1,276     (856

Adjusted EBITDA of the Heritage Preserve segment

     (3,600     (1,513

Adjusted EBITDA of other segments

     2,139        1,334   
                

Total

     25,377        18,051   

Interest expense

     (24,548     (12,281

Depreciation and amortization

     (31,108     (23,322

General and administrative expenses

     (14,282     (18,103

Provision for income taxes

     (1,957     (14,157

Gains (losses) on real estate sold or under contract

     5,331        1,640   

Inventory valuation adjustment

     (14,496     —     

Change in fair value of derivatives

     (8,003     247   

Loss allocated to noncontrolling interests

     6,561        4,825   

Interest and other income

     1,502        2,226   
                

Net loss

   $ (55,623   $ (40,874
                

Comparison of year ended December 31, 2007, to year ended December 31, 2006

Leased occupancy in our industrial and physical occupancy multifamily rental portfolios compared to the prior year were:

 

     December 31,  
     2007     2006  

Industrial

   82.7   82.6

Multifamily

   94.5   90.0

Revenues

Total revenues.    Total revenues consist of rental revenues from industrial distribution facilities and multifamily rental properties as well residential lot sales and land sales. Total revenues for the year ended December 31, 2007, increased to $61.7 million from $47.8 million for the year ended December 31, 2006, an increase of $13.9 million or 29.2%. The increase in total revenues and property expenses was primarily due to new property development activity in our industrial distribution and multifamily rental segments.

Industrial distribution revenues.    Industrial distribution revenues for the year ended December 31, 2007, increased to $42.9 million from $31.1 million for the year ended December 31, 2006, an increase of $11.7 million or 37.7%. Acquisitions and new property development since December 31, 2006, contributed $5.0 million of the rental revenue increase and the remainder of the increase came from properties with a full year of operations in 2007. We had approximately 11.0 million square feet of industrial operating properties at December 31, 2007, compared to 9.1 million square feet at December 31, 2006. At December 31, 2007, the average annual rate of in-place leases was $4.40 per square foot compared to $4.34 per square foot at December 31, 2006.

Multifamily rental revenues.    Multifamily rental revenues for the year ended December 31, 2007, increased to $9.2 million from $3.6 million for the year ended December 31, 2006, an increase of $5.7

 

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million or 159.0%. Substantially all of the increase was due to new property development activity, including properties that commenced operating during 2007 as well as properties that commenced in 2006 that had activity through all of the year ended December 31, 2007. We had four multifamily rental properties with 1,110 units substantially completed and operating at December 31, 2007, compared to two properties with 550 units at December 31, 2006. At December 31, 2007, the average monthly rate of in-place leases was $795 per unit compared to $839 per unit at December 31, 2006.

Residential lot sales.    During the year ended December 31, 2007, we sold 64 residential lots in our Heritage Preserve business compared to the sale of 63 residential lots for the year ended December 31, 2006. Residential lot sales increased during the period to $9.6 million from $9.5 million.

Land sales.    We did not sell any land during the year ended December 31, 2007. In 2006, we sold 90 acres of land in Santa Teresa, New Mexico, and 96 residential lots in Sunland Park, New Mexico for $3.5 million.

Operating Expenses

Total operating expenses.    Total operating expenses consist primarily of industrial distribution facility and multifamily rental property expenses, cost of residential lot sales, cost of land sales, payroll and related expenses, depreciation and amortization and other operating expenses. Other operating expenses consist of professional fees, property taxes, terminated pursuit costs, and general and administrative expenses. Total operating expenses for the year ended December 31, 2007, increased to $89.4 million from $67.4 million for the year ended December 31, 2006, an increase of $22.0 million or 32.6%. This increase was primarily attributable to higher property expenses and depreciation because of an increase in operating properties, additional payroll and the write-off of pursuit costs related to acquisitions that were no longer considered probable.

Industrial distribution operating expenses.    Industrial distribution operating expenses for the year ended December 31, 2007, increased to $11.9 million from $9.5 million for the year ended December 31, 2006, an increase of $2.4 million or 25.3%. Acquisitions and new property development since December 31, 2006, contributed $1.7 million of the expense increase and the remainder of the increase came from properties with a full year of operations in 2007.

Multifamily rental operating expenses.    Multifamily rental operating expenses for the year ended December 31, 2007, increased to $4.9 million from $2.4 million for the year ended December 31, 2006, an increase of $2.5 million or 102.5%. New property development since December 31, 2006, contributed $2.0 million of the expense increase and the remainder of the increase came from properties with a full year of operations in 2007.

Cost of residential lot sales.    Cost of residential lot sales was $5.8 million during each of 2007 and 2006. We sold approximately the same number of lots in 2007 and 2006.

Cost of land sales.    Cost of land sales were $2.4 million during 2006. We did not sell any land in 2007.

Payroll and related.    Payroll and related expenses increased $7.8 million, or 45.1%, during the period to $25.2 million from $17.4 million due primarily to additional hiring related to our growth.

Terminated pursuit costs.    During 2007, we wrote off $7.2 million of pursuit costs and earnest money deposits for transactions that we no longer considered probable. Effective January 1, 2009, pursuit costs are charged to expense as incurred.

 

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General and administrative.    General and administrative expenses increased to $10.1 million for the year ended December 31, 2007, from $9.4 million, an increase of $0.7 million or 7.9%. The increase was due to the growth in our industrial and multifamily portfolios and the related increase in staffing and staffing support costs.

Depreciation and amortization.    Depreciation and amortization increased $5.6 million, or 42.3%, during the period to $19.0 million from $13.4 million due primarily to the increased number of operating properties during the year compared to 2006. Depreciation of our operating properties and tenant improvements was $12.9 million for the year ended December 31, 2007, compared to $8.3 million for the same period in 2006 due primarily to the higher number of industrial distribution facilities and multifamily rental properties in operation. Amortization of lease valuation increased to $4.5 million for the year ended December 31, 2007, compared to $3.7 million for same period in 2006 due to the acquisition of operating industrial distribution facilities during 2006 and 2007. Non-real estate depreciation totaled $1.6 million and $1.2 million, respectively, for the years ended December 31, 2007 and 2006.

Operating loss

As a result of the above factors, our operating loss during the period increased $8.0 million, or 40.7%, to $27.7 million from $19.7 million.

Non-operating income and expenses

Net interest expense.    Interest income increased during the period by $1.0 million, or 30.3%, from $3.3 million to $4.3 million. Our cash balances increased from $41.2 million at December 31, 2006, to $156.9 million at December 31, 2007, due primarily to $312.3 million of proceeds from equity offerings during 2007. Interest expense decreased during the period $1.6 million, or 14.1%, from $11.6 million to $10.0 million. This decrease is due to a decrease in our average balance of debt which was reduced during the period using some of the equity proceeds raised in 2006. At December 31, 2006, we had $311.2 million of outstanding notes, bonds and convertible debentures compared to $490.8 million outstanding at December 31, 2007. During the year ended December 31, 2007, we incurred an additional $135.7 million (proceeds, net of repayments) of indebtedness compared to $63.6 million for the same period in 2006.

Noncontrolling interest.    The loss attributable to noncontrolling interests increased $1.8 million or 62.6%, during the year to $4.8 million from $3.0 million. Loss attributable to noncontrolling interests represents the amount of the loss allocated to third-party owners of consolidated subsidiaries. The increase in loss attributable to noncontrolling interests was due to higher losses at our operating partnership, of which we owned approximately 90.1% and September 30, 2009.

Income taxes.    We recognized $14.0 million of income taxes for the year ended December 31, 2007, compared to $1.0 million of income taxes for the same period in 2006, a increase of $13.0 million or 1,355%. In 2007, the Mexican government enacted an additional tax regime. The transition provisions of this regime eliminated a substantial portion of the tax basis of our properties in Mexico, if we were to sell them. We recognized a deferred tax liability of $11.6 million in 2007 related to this change in tax regime.

Discontinued operations.    Discontinued operations for the year ending December 31, 2007, includes the results of the industrial distribution portfolio placed under contract in 2009, the 2008 sales of two retail properties and one multifamily rental property and the 2007 sale of an industrial building. For the year ended December 31, 2007, the combined income and gain from sale of discontinued operations was $2.1 million compared to a gain of $4.4 million for the same period in 2006. In 2006, we sold industrial land and properties for a gain of $3.0 million.

 

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Segment reporting

We view our industrial distribution, multifamily rental, Santa Teresa and Heritage Preserve operations as business segments and evaluate their operating performance based on Adjusted EBITDA, or adjusted earnings before interest, taxes, depreciation and amortization, general and administration expenses and other non-cash expenses. Management does not consider the effect of gains or losses from the sale of property in evaluating segment operations. Management considers Adjusted EBITDA a supplemental measure for making decisions and assessing the un-levered performance of its segments. Adjusted EBITDA should not be considered a substitute for net income. Adjusted EBITDA may not be comparable to similarly titled measures employed by other companies.

Industrial distribution.    The Adjusted EBITDA of the industrial distribution segment was $21.1 million for the year ended December 31, 2007, compared to $20.4 million for the same period in 2006, an increase of $0.7 million, or 3.3%. The increase in Adjusted EBITDA is primarily related to the increases in industrial distribution revenues discussed above, offset by additional staffing to expand our industrial business.

Multifamily rental.    The Adjusted EBITDA of the multifamily rental segment was a loss of $2.0 million for the year ended December 31, 2007, compared to a loss of $1.3 million for the same period in 2006, an increase of $0.7 million. The increase in the loss is due primarily to the costs of expanding our multifamily rental property business in addition to the costs associated with our preparation to commence operations at properties that were nearing development completion at the end of 2006.

Santa Teresa.    The Adjusted EBITDA of the Santa Teresa segment was a loss of $0.9 million for the year ended December 31, 2007, compared to a loss of $0.7 million for the same period in 2006. There were no significant transactions or differences in 2007 compared to 2006.

Heritage Preserve.    The Adjusted EBITDA of the Heritage Preserve segment was a loss of $1.5 million for the year ended December 31, 2007, compared to a loss of $0.4 million for the same period in 2006, an increase of $1.1 million due primarily to an increase in personnel and related costs.

Reconciliation of Segment Adjusted EBITDA to Net Loss:

 

    Year Ended
December 31,
 
    2007     2006  
    (in thousands)  

Adjusted EBITDA of the industrial distribution segment

  $ 21,089      $ 20,422   

Adjusted EBITDA of the multifamily rental segment

    (2,003     (1,298

Adjusted EBITDA of the Santa Teresa segment

    (856     (727

Adjusted EBITDA of the Heritage Preserve segment

    (1,513     (427

Adjusted EBITDA of other segments

    1,334        (881
               

Total

    18,051        17,089   

Interest expense

    (12,281     (11,680

Depreciation and amortization

    (23,322     (15,506

General and administrative expenses

    (18,103     (18,078

Provision for income taxes

    (14,157     (1,345

Gains (losses) on real estate sold or under contract

    1,640        2,280   

Change in fair value of derivatives

    247        —     

Loss allocated to noncontrolling interests

    4,825        2,976   

Interest and other income

    2,226        3,128   
               

Net loss

  $ (40,874   $ (21,136
               

 

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Funds from Operations

FFO is computed in accordance with guidance promulgated by NAREIT. NAREIT defines FFO as net income or loss determined in accordance with GAAP, excluding gains or losses from sales of previously depreciated operating real estate assets, plus real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures. In addition, we exclude deferred income tax expense or benefit and change in fair value of derivatives. Gains or losses on land and investment real estate are included in FFO; investment real estate is defined as real estate assets for which Verde’s original intent was that the assets would not be included in the operating portfolio on a long-term basis.

Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income by itself as the primary measure of our operating performance. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself. There can be no assurance that FFO presented by us is comparable to similarly titled measures of other REITs.

FFO should not be considered as an alternative to net income or other measurements under GAAP as an indicator of our operating performance or to cash flows from operating, investing or financing activities as a measure of liquidity. FFO does not reflect working capital changes, cash expenditures for capital improvements or principal payments on indebtedness.

FFO is calculated as follows (in thousands):

     Nine Months Ended
September 30,
    Year Ended
December 31,
 
     2009     2008     2008     2007  

Net loss

   $ (35,837   $ (30,583   $ (61,496   $ (45,710

Adjustments:

        

Real estate depreciation and amortization

     22,191        20,256        27,662        20,633   

(Gains) losses on sales of depreciable real estate

     1,105        (645     (528     (1,631

Change in fair value of derivatives

     (1,179     1,557        8,003        (247

Deferred foreign income taxes

     946        121        745        11,556   

Noncontrolling interest share of funds from operations and other

     537        (67     (268     437   
                                

Funds from operations attributable to the operating partnership

     (12,237     (9,361     (25,882     (14,962

Operating partnership limited partners’ share of funds from operations

     1,208        924        2,556        1,370   
                                

Funds from operations attributable to Verde Realty

   $ (11,029   $ (8,437   $ (23,326   $ (13,592
                                

Cash Flows

Comparison of nine months ended September 30, 2009, and nine months ended September 30, 2008

Net cash used in operations during the nine months ended September 30, 2009, was approximately $1.0 million, compared to cash used in operations of $15.9 million during the same

 

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period in 2008. The decrease in cash used in operations was due primarily to an increase in cash from the operation of rental real estate and an increase in accounts and notes receivable, partially offset by an increase in interest expense.

Net cash used in investing activities decreased from $117.9 million for the nine months ended September 30, 2008, to $65.2 million for the nine months ended September 30, 2009, due primarily to a reduction in real estate development in 2009 compared to 2008. Industrial property development for the nine months ended September 30, 2009, was $36.5 million less than the same period in 2008, and Multifamily development was $18.3 million less during the nine months ended September 30, 2009, compared to September 30, 2008. We sold $6.7 million of properties during the nine months ended September 30, 2008, compared to $18.0 million for the same period in 2008.

Net cash provided by financing activities decreased from $100.5 million for the nine months ended September 30, 2008, to $38.3 million for the nine months ended September 30, 2009, a decrease of $62.2 million, or 61.9%. This decrease was primarily attributable to a reduced amount of mortgage debt incurred in 2009, corresponding to the reduced amount of real estate development during the period.

Comparison of year ended December 31, 2008, to year ended December 31, 2007

Net cash used in operations in 2008 was approximately $15.8 million compared to $5.7 million provided by operations in 2007. The increase in cash used in operations was due primarily to a $13.5 million increase in interest expense related to the 2007 increase in mortgages and a decrease of $4.6 million in proceeds from Heritage Preserve lot sales. This decrease in cash, in addition to a decrease of $12.4 million from changes in operating assets and liabilities, was partially offset by additional cash from the operation of rental real estate.

Net cash used in investing activities decreased from $333.7 million for the year ended December 31, 2007, to $147.8 million for the year ended December 31, 2008. This decrease was primarily attributable to a decrease of $71.7 million of investment in multifamily rental properties, a decrease of $57.8 million in investment in industrial distribution facilities, and an increase of $19.0 million in proceeds from dispositions of property and real estate joint venture.

Net cash provided by financing activities decreased from $443.7 million for the year ended December 31, 2007, to $119.5 million for the year ended December 31, 2008, a decrease of $324.2 million, or 73.1%. This decrease was primarily attributable to incurring only $161.3 million of mortgages in 2008, compared to $270.4 million in 2007 (partially offset by an $80 million net decrease in line of credit borrowings), and raising no equity in 2008 as compared to over $310 million in 2007.

Comparison of year ended December 31, 2007, to year ended December 31, 2006

Net cash provided by operations in 2007 was approximately $5.7 million compared to $27.6 million used by operations in 2006. The increase in net cash provided by operations was due primarily to an increase in the number of operating properties during 2007 and an increase of $18.9 million from changes in operating assets and liabilities. Originations, net of repayments, of the loan portfolio at Verde Mortgage LLC were $0.3 million for the year ended December 31, 2007, compared to $(3.9) million for the year ended December 31, 2006. In 2006, we sold the Verde Mortgage loan portfolio and operations for approximately $22.3 million.

Net cash used in investing activities increased from $194.7 million for the year ended December 31, 2006, to $333.7 million for the year ended December 31, 2007. This increase was primarily attributable to an increase of $111.4 million of investment in multifamily rental properties and a decrease of $22.3 million from the 2006 sale of builders’ finance loans.

 

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Net cash provided by financing activities increased from $176.8 million for the year ended December 31, 2006, to $443.7 million for the year ended December 31, 2007, an increase of $266.9 million, or 151.0%. This increase was primarily attributable to incurring $230.0 million of additional mortgage financing in 2007 and $193.9 million of additional proceeds from the issuance of equity in 2007. During 2007, we paid off our line of credit with a balance of $80.0 million at December 31, 2006, with equity proceeds.

Liquidity and Capital Resources

Short-Term Liquidity Requirements

Our short-term liquidity requirements consist primarily of funds necessary to pay for operating expenses and other expenditures associated with the acquisition and development of our properties. Historically, we have had deficiencies in cash flows from operations that have been funded through debt and equity offerings. We believe that our existing working capital, borrowing capacity and the net proceeds of this offering will continue to be sufficient to meet our short-term liquidity requirements for the next 12 months. In addition, we intend to enter into a line of credit in the near-term in order to increase the flexibility of our balance sheet. However, we have not yet initiated discussions with lenders and there can be no assurance that we will be able to obtain such financing on favorable terms or at all.

Under the terms of our industrial leases, the tenant is responsible for substantially all expenses associated with operation of the related property, such as insurance, utilities, routine maintenance and capital improvements. As a result of these arrangements, we do not anticipate incurring substantial unreimbursed expenses in connection with these properties during the terms of the leases. We expect to incur capital expenditures, such as tenant improvement allowances and leasing commissions, in connection with the leasing of space in our non-stabilized properties. We believe that our existing working capital, borrowing capacity and the net proceeds of this offering will continue to be sufficient for these expenditures.

Long-Term Liquidity Requirements

Our long-term liquidity requirements consist primarily of funds necessary to pay for the costs associated with the acquisition of additional properties, development of land associated with our existing operating properties, scheduled debt maturities, renovations, expansions and other non-recurring capital expenditures that need to be made periodically with respect to our properties. In the future, we expect to satisfy our long-term liquidity requirements through various sources of capital, including our existing working capital, cash provided by operations and long-term property mortgage financing.

We expect to acquire properties in the next 12 months and to fund the equity portion of such acquisitions with available cash, including the net proceeds of this offering. We have a target maximum leverage ratio of no more than 50%. Subject to various financial covenants and terms imposed by some of our existing mortgage loan documents, however, there is no limitation on the amount we can borrow on a single property or the aggregate amount of our borrowings, and we can change this policy at any time without the approval of our shareholders.

Financing Activities

Indebtedness.    Our aggregate indebtedness increased from $490.8 million at December 31, 2007, to $552.4 million at December 31, 2008. From December 31, 2008, to September 30, 2009, our

 

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aggregate indebtedness increased by $48.8 million to $601.2 million. Details of the indebtedness we incurred in 2008 and the first nine months of 2009 are described below:

 

  Ÿ  

Industrial distribution

 

  Ÿ  

During 2008, we originated mortgage loans totaling $46.5 million on certain of our operating properties in Mexico and we made scheduled principal repayments of $6.7 million. Total mortgage debt related to industrial distribution facilities was $282.8 million at December 31, 2008. Total revenue bond obligations related to industrial land and industrial distribution facilities in Santa Teresa, New Mexico was $6.1 million at December 31, 2008, including a fair value adjustment of $1.6 million that is being amortized over the life of the bond.

 

  Ÿ  

During the first nine months of 2009, we made scheduled principal payments of $4.9 million and paid off $3.8 million of mortgage loans. Total mortgage debt related to our industrial distribution facilities was $274.1 million at September 30, 2009. Total revenue bond obligations related to industrial land and industrial distribution facilities in Santa Teresa, New Mexico was $6.1 million at September 30, 2009, including a fair value adjustment of $1.6 million that is being amortized over the life of the bond.

 

  Ÿ  

Multifamily rental

 

  Ÿ  

During 2008, we borrowed $85.4 million under existing construction loans. Construction loans with balances of $26.6 million were converted into fixed-rate permanent mortgage loans of $33.0 million. In connection with the sale of an operating property, we paid off the mortgage on such property with a balance of $18.8 million. We transferred a mortgage loan with a balance of $11.3 million to liabilities from discontinued operations. The property securing the mortgage was placed under contract to sell at December 31, 2008. Total debt related to our multifamily rental properties was $188.7 million at December 31, 2008.

 

  Ÿ  

During the first nine months of 2009, we borrowed $55.6 million under existing construction loans. Construction loans with balances of $32.1 million were converted into fixed-rate permanent mortgage loans of $28.0 million. We transferred the aforementioned loan with a balance of $11.3 million into continuing operations when the sales contract was cancelled. We paid $40,000 in regularly scheduled principal payments. Total debt related to the multifamily rental properties was $251.4 million at September 30, 2009.

 

  Ÿ  

Santa Teresa

 

  Ÿ  

During 2008, we made a regularly scheduled principal payment of $0.5 million on a mortgage loan. Also during 2008, we paid $0.6 million of principal reductions on revenue bond obligations. Total debt related to Santa Teresa was $5.0 million at December 31, 2008, consisting of $4.0 million in revenue bond obligations and $1.0 million of mortgage debt.

 

  Ÿ  

During the first nine months of 2009, we paid the remaining $1.0 million on a mortgage loan. A revenue bond obligation with a carrying balance of $4.0 million was defeased. As of September 30, 2009, we had no outstanding debt related to Santa Teresa.

 

  Ÿ  

Retail

 

  Ÿ  

During 2008, in connection with the sale of an operating property, we paid off a mortgage with a balance of $32.4 million. We exited the retail business during 2008.

 

  Ÿ  

Convertible Debentures

 

  Ÿ  

The outstanding balance on our convertible debentures was $69.6 million at December 31, 2008 and September 30, 2009.

 

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The following table sets forth certain information with respect to our indebtedness outstanding as of September 30, 2009.

 

Indebtedness

  Principal
Balance
  Fixed/Floating
Interest Rate at
September 30,
2009
  Effective
Annual
Interest
Rate
    Maturity Date
(without
extensions)
  Swap Maturity
Date
    (Dollars in thousands)

CONSTRUCTION LOANS:

         

Verde Panther Creek Apartments LP

  $ 17,705   Libor + 1.60% (1.846%)   1.862   March 27, 2011   March 27, 2011

Verde Cypress Creek Ranch Apartments LP

    19,597   Libor + 1.60% (1.846%)   1.862      March 31, 2011   March 31, 2011

Verde Westover Hills Apartments LP

    12,883   Libor + 2.50% (2.8125%)   2.849      April 17, 2011   April 1, 2011

Verde Northpointe Apartments LP

    21,547   Libor + 1.25% (1.570%)   1.581      October 30, 2010   October 26, 2010

Verde Brushy Creek Apartments LP

    15,259   Libor + 1.25% (1.570%)   1.581      November 2, 2010   October 26, 2010

Wells Branch Apartments LP (operating as Oak Park)

    20,270   Libor + 1.25% (1.570%)   1.581      January 11, 2011   December 1, 2010

Verde Woodland Hills Apartments LP

    15,929   Libor + 1.65% (1.97%)   1.988      May 5, 2011   May 1, 2011

PERMANENT LOANS:

         

Verde 5700 International Parkway

    3,249   4.01%   4.08      August 31, 2013   n/a

Verde Lakemont Apartments LP

    18,000   5.77   5.93      July 1, 2015   n/a

MX Industrial Loan #2

    45,618   6.64   6.85      July 5, 2015   n/a

Verde Riverwalk Apartments LP II

    42,245   5.99   6.16      October 1, 2016   n/a

Verde Alamar S. de R.L. de C.V.(1)

    16,389   8.00   8.00      March 8, 2017   n/a

Verde Braun Station Apartments LP

    11,300   6.14   6.32      August 9, 2017   n/a

MX Industrial Loan #1

    90,270   6.89   7.11      November 5, 2017   n/a

Verde Shadow Brook Apartments LP I & II

    28,675   6.13   6.31      April 1, 2018   n/a

Verde 420 Pan American LP

    1,913   7.00   7.23      February 1, 2019   n/a

Woodson Park Apartment Financing LP

    13,859   5.68   5.83      June 1, 2019   n/a

Verde Katy Grand Harbor Apartment Financing LP

    14,085   5.91   6.07      October 1, 2019   n/a

US Industrial Loan

    58,850   6.74   6.95      December 5, 2019   n/a

US Industrial Loan

    32,482   5.57   5.71      January 5, 2025   n/a

US Industrial Loan

    7,769   5.77   5.93      January 5, 2025   n/a

US Industrial Loan

    17,599   5.61   5.76      January 5, 2025   n/a

REVENUE BOND OBLIGATIONS:

         

Verde Border Industrial Park LLC

    4,976   8.88   9.07      January 1, 2021   n/a

Verde 100 Lindbergh LLC

    89   8.38   8.55      January 1, 2021   n/a

Verde 2800 Airport Road LLC

    272   8.38   8.55      January 1, 2021   n/a

Verde Border One and Two

    479   8.88   9.07      January 1, 2021   n/a

Verde 401 Avenida Ascencion LLC

    242   8.88   9.07      January 1, 2021   n/a

CONVERTIBLE DEBENTURES:

         

Series 2018

    53,550   4.75   4.81      December 31, 2018   n/a

Series 2020

    12,880   4.75   4.81      December 31, 2020   n/a

Series 2020 (MLP)

    3,220   4.75   4.81      December 31, 2020   n/a
             

Total

  $ 601,201        
             

 

(1) The borrower under this loan, Verde Alamar S. de R.L. de C.V., is a joint venture vehicle held through a Mexican business trust, of which we own approximately 54.8% of the beneficial interests.

The construction loans can be extended if certain criteria are met. Verde Westover Hills, Verde Panther Creek and Verde Cypress Creek can be extended by one year; Verde Brushy Creek, Verde Northpointe, Wells Branch and Verde Woodland Hills have two one-year extensions available.

We have interest rate swap agreements on our construction loans. As of September 30, 2009, the weighted average fixed rate of the swap agreements was 4.66%.

Each of these construction loans, as well as our MX Industrial Loan #1 and MX Industrial Loan #2, has customary restrictions on the transfer or encumbrance of mortgaged facilities. Other than the documents governing our construction loans and our MX Industrial Loan #1 and MX Industrial Loan #2, our debt agreements generally do not impose restrictive financial covenants on us, and we believe we were in full compliance with all our covenants as of September 30, 2009.

 

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Prior to completion of this offering, we intend to prepay approximately $             of these construction loans, having an average interest rate of     %, and to convert the remaining balance to term loans with maturities of seven to 10 years and a combination of fixed and floating interest rates to be determined. We also intend to obtain the right to prepay approximately $             of the remaining balance prior to maturity without premium or penalty, and expect to exercise that prepayment right and satisfy the payment from the proceeds of this offering.

Contractual Obligations.    Our debt obligations primarily consist of mortgage loans, bond obligations and convertible debentures. The following table sets forth our principal obligations and commitments, including periodic interest payments, as of September 30, 2009:

 

     Payment due by period (in thousands)

Contractual Obligations

   Total    Less than
1 year
   1-3
years
   3-5
years
   More than
5 years

Long-term debt obligations(1)

   $ 843,392    $ 43,786    $ 200,818    $ 74,496    $ 524,292

Minimum lease payments

     1,583      195      1,024      296      68

Purchase commitments related to capital expenditures associated with tenant improvements and repositioning and other purchase obligations

     3,664      3,664      —        —        —  

Joint venture funding obligations

     1,515      1,515      —        —        —  
                                  

Total

   $ 850,154    $ 49,160    $ 201,842    $ 74,792    $ 524,360
                                  

 

(1) Includes principal and interest on variable-rate debt calculated using rates as of September 30, 2009 including the effect of interest rate swaps.

Off-Balance Sheet Arrangements

We do not currently have any off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on our financial condition, liquidity, capital expenditures or capital resources.

Derivative Financial Instruments

We have interest rate swaps in place to minimize interest rate fluctuation exposure on our variable rate construction loans. Changes in fair value during the period are reflected in determining the results of operations. For the nine months ended September 30, 2009, we recognized a gain of $1.2 million. For the year ended December 31, 2008, we recognized a loss of $8.0 million. For the years ended December 31, 2007 and 2006, no gain or loss was recognized.

Under the terms of certain CPUs of our operating partnership, there is a distribution feature that is tied to triggering events relating primarily to future real estate transactions or to the eventual sales prices of the land. These distribution features are accounted for as embedded derivatives of the CPUs and are classified as derivative liabilities. The eventual settlement amount of these derivative liabilities will depend on the underlying real estate transactions. Future changes in fair value are reflected in determining net income. For the nine months ended September 30, 2009, and for the year ended December 31, 2008, no gain or loss was recognized. For the years ended December 31, 2007 and 2006, we recognized a gain of $0.2 million and $0.1 million, respectively, as the change in fair value.

After the completion of this offering, the conversion option in our convertible debentures will be accounted for separately as a derivative liability, with changes in the fair value of the derivative reflected in determining the results of operations.

 

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Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Our future income, cash flows and fair values relevant to financial instruments depend upon prevailing interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates.

As of September 30, 2009, we had approximately $478.0 million of fixed rate debt outstanding (representing 79.5% of our total debt outstanding as of such date). A change in interest rates on fixed rate debt generally impacts the fair market value of our debt but has no impact on interest incurred or cash flow. A 100 basis point increase in interest rates would result in a decrease in the fair value of this fixed rate debt of approximately $28.4 million at September 30, 2009. A 100 basis point decrease in interest rates would result in an increase in the fair value of our fixed rate debt of approximately $30.8 million at September 30, 2009.

As of September 30, 2009, we had approximately $123.2 million of variable debt outstanding (representing 20.5% of our total debt outstanding as of such date). Based upon the balances outstanding on our variable rate debt at September 30, 2009, a 100 basis point increase or decrease in interest rates on our variable rate debt would increase or decrease our future interest expense by approximately $1.2 million annually. We have interest rate swaps with a notional value of $120.9 million that reduce our exposure to changes in interest rates. The weighted average fixed interest rate on these derivatives is 4.66%.

Foreign Currency Risk

Our exposure to foreign currency exchange rates relates to transactions in Mexican pesos. To mitigate our foreign currency exchange exposure, our development activities in Mexico are generally U.S. dollar denominated and our operating leases in Mexico are all in U.S. dollars. We also keep a minimal amount in Mexican peso cash accounts. Value-added tax is required to be paid before requesting reimbursement, and we do have foreign currency risk between the time of payment and being reimbursed. See “Risk Factors—Risks Related to this Offering—Your investment will be subject to additional risks from our investments in Mexico, including foreign currency fluctuations.”

Newly Issued Accounting Standards

In December 2007, the FASB issued an update to ASC 805, “Business Combinations.” The update expands the original guidance’s definition of a business. It broadens the fair value measurement and recognition to all assets acquired, liabilities assumed and interests transferred as a result of business combinations. The revision requires expanded disclosures to improve the ability to evaluate the nature and financial effects of business combinations. The update is effective for business combinations made on or after January 1, 2009. The update adoption did not have a significant impact on our financial statements for the nine months ended September 30, 2009, since acquisition activity was not significant during the period, but we expect that this update will have a material impact in future periods to the extent that real estate acquisitions are significant.

In December 2007, the FASB issued an update to ASC 810, “Consolidation.” The update established requirements for ownership interest in subsidiaries held by parties other than us to be clearly identified, presented, and disclosed in the consolidated statement of financial position within equity, but separate from the parent’s equity. All changes in the parent’s ownership interests are required to be accounted for consistently as equity transactions and any noncontrolling equity investments in deconsolidated subsidiaries must be measured initially at fair value. We adopted this update effective January 1, 2009. The adoption of this update resulted in an increase to equity in our

 

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consolidated balance sheet as of December 31, 2008 and 2007 of $90.1 million and $96.0 million, respectively for the reclassification of minority interest to equity for noncontrolling interest in consolidated entities.

In March 2008, the FASB issued an update to ASC 815, “Derivatives and Hedging.” The update requires enhanced disclosures about an entity’s derivative and hedging activities such as: (1) how and why they are used, (2) how they are accounted for and (3) how they affect an entity’s financial statements. This update is effective for fiscal years beginning after November 15, 2008. Implementation has resulted in certain additional disclosures.

In April 2009, the FASB updated ASC 825, “Financial Instruments,” to require annual disclosures to be made also during interim reporting periods. Implementation has resulted in certain additional disclosures included in the footnotes to the financial statements.

In May 2009, the FASB issued an update to ASC 855, “Subsequent Events,” which establishes general standards of accounting and disclosure for events that occur subsequent to the balance sheet date but before financial statements are issued or are available to be issued. This update requires disclosure of the date through which we have evaluated our subsequent events and the basis for that date. Implementation has resulted in an additional disclosure included in the footnotes to the financial statements.

In June 2009, the FASB issued SFAS No. 167 (“SFAS 167”), “Amendments to FASB Interpretation No. 46(R),” which is not yet included in the ASC. SFAS 167 was intended to improve an organization’s variable interest entity reporting. SFAS 167 will require an analysis to determine whether an entity is the primary beneficiary in a variable interest entity (“VIE”). The holder of the variable interest will be defined as the primary beneficiary if it has both the power to direct matters which most significantly impact the activities of the VIE and has the obligation to absorb losses, or the right to receive benefits, of the VIE which could potentially be significant to the VIE. This statement was effective for us January 1, 2010. We are currently evaluating the impact that the adoption of SFAS 167 will have on our consolidated financial statements.

Inflation

Many of our multifamily rental properties are rented subject to short-term leases, which provide us the ability to increase rental rates as each lease expires, thereby enabling us to seek to mitigate our exposure to increased costs and expenses resulting from inflation. However, there is no assurance that the market will accept rental increases.

Most of our industrial distribution facilities are rented subject to leases that provide for each tenant to pay its proportionate share of operating expenses, including any increases in operating expenses, thereby enabling us to mitigate our exposure to increased cost and expenses. There is no assurance that any tenant will be able to pay its contractual obligation.

 

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INDUSTRY OVERVIEW

Market and industry data and forecasts used in this section have been obtained from Reis, AXIOMETRICS, CoStar, the U.S. Census Bureau and other industry sources where specifically noted. We have not independently verified the data obtained from these sources and we cannot assure you of the accuracy or completeness of the data. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and uncertainties as the other forward-looking statements contained in this prospectus.

Multifamily

Multifamily Real Estate Industry

The U.S. multifamily real estate market consisted of approximately 9.6 million units as of September 30, 2009, according to Reis. Reis collects market data on properties with more than 40 units (primarily on Class A and B properties) and does not report figures for rent controlled, stabilized, low-income, tax credit or co-operative properties. Multifamily communities typically have a combination of studio and one-, two- and three-bedroom apartment units and can be classified based on condition and location. We believe that favorable opportunities will be found in the acquisition of existing Class A and B+ properties in our targeted markets and submarkets at significantly below our estimates of replacement cost. During market recoveries, we believe there is a “flight to quality” whereby renters tend to move up to better apartments (which are initially relatively favorably priced). Class A apartments will typically benefit from a “flight to quality” earlier and more substantially during the market recovery phase.

Multifamily Investment Opportunities

The U.S. multifamily real estate market has experienced a decline in rental rates and increase in concessions as economic conditions have triggered a broad decline in market fundamentals. Job losses, decreased migration and population growth and ongoing additions to new supply have weakened real property market performance, leading to a decline in market occupancies, rents and property values. Despite these difficulties, we believe that the following characteristics make multifamily real estate an attractive asset class for investment:

 

  Ÿ  

Market cycle.    We believe that multifamily real estate fundamentals in our target markets will be favorably impacted by observable macroeconomic factors including improving employment trends, population growth, and a fall-off in the supply pipeline. In particular, as the markets recover, new supply delivery will be at historically low levels.

 

  Ÿ  

Demographic trends.    According to the U.S. Census Bureau, for the third quarter of 2009 renters represented 60% of households headed by persons under the age of 35. We believe that national and regional demographic trends will support multifamily fundamentals over the next few years as the prime rental market population, adults aged 20 to 34, significantly increases with the children of the “baby boom” generation reaching adulthood.

 

  Ÿ  

Attractive lease characteristics.    Multifamily leases are typically six months to one year in duration and thus allow lease rates to adjust frequently in response to changes in the market. Lease expirations can be managed to occur in a predictable fashion. New leases are not generally sourced through a broker, thus avoiding the need to factor broker or finder fees into the investment analysis, although some of our tenants come to us through apartment locator services that charge fees generally ranging from 50% to 100% of one month’s rent depending on the market and demand for apartments.

We believe our experienced management team can find additional investment advantages and add value as a result of:

 

  Ÿ  

Positive impact of strong internal property management.    We believe that multifamily real estate performance can be particularly impacted by the quality of the property management

 

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team. We believe that strong internal property management can drive increases in rent growth, resident retention, expense control and risk management.

 

  Ÿ  

Targeting.    Multifamily investments can be targeted to meet broad or narrow segments of renter demand. Garden-style apartments, for example, have very different cost and expense characteristics, and often very different renter profiles, than elevator high-rise units. In our opinion, targeting to meet desirable demand characteristics can lead to enhanced investment returns.

The table below summarizes national multifamily historical and projected performance through the key measures of new supply, occupancy, net absorption and effective rent change. Reis projects a return to positive demand (net absorption) in 2010, as well as low levels of new supply. As a result, occupancy is expected to stabilize in 2010 and experience modest gains through at least 2013. Growth in effective rent is expected to resume in 2011. Both rental growth and occupancy increases are expected to drive increases in net absorption in the near-term.

National Multifamily Data

 

Year

   Change in
Supply(1)
    Occupancy(2)     Net Absorption
(Units)(1)
    Effective
Rent(2)

2000

   2.2   96.8   242,437      $ 843

2001

   1.8      95.3      17,280        853

2002

   1.5      93.7      (8,338     845

2003

   1.2      93.1      44,054        849

2004

   0.3      93.3      47,644        867

2005

   -0.7      94.3      28,646        892

2006

   0.0      94.2      (8,731     932

2007

   1.0      94.3      97,612        975

2008

   1.1      93.3      4,550        995

2009(3)

   1.1      92.0      (29,409     963

2010(3)

   0.8      91.7      40,153        962

2011(3)

   0.6      92.1      98,856        973

2012(3)

   0.7      92.6      105,834        992

2013(3)

   0.7      93.0      105,911        1,021

Source: Reis, as of Third Quarter 2009.

 

(1) For the year ended December 31 of the applicable year.
(2) For the quarter ended December 31 of the applicable year.
(3) Forecasted data.

Internal Property Management

One of the significant strengths of our multifamily operating platform is our internal property management. Our property management employees are highly focused on positioning each of our properties within its own specific market and optimizing operating performance consistent with the operating strategy for our multifamily rental portfolio. We believe our ability to internally manage our properties enables us to quickly and efficiently respond to subtle market changes and maintain above-average occupancies in our submarkets. As of the third quarter of 2009, Reis estimated that the U.S. multifamily occupancy level was 92.0%, approximately 1.3 percentage points below the fourth-quarter 2008 level and 2.3 percentage points below occupancy levels as of the fourth-quarter of 2007. Reis predicts that occupancy will reach a low point in 2010 and recover by a modest 0.5 percentage points per year from 2011 to 2013.

 

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LOGO

In the face of declining occupancy levels, we began to execute an occupancy strategy in the second quarter of 2009 that utilizes a “soft rent” approach to pricing, with the primary objective of sustaining full occupancies and stabilization of our existing portfolio. One of our key reasons for adopting this approach was our belief that we can be most effective in managing rental growth in recovering markets if we begin with a strong base of existing residents. Our internal property management team is critical in executing this strategy of aggressive rental rate management and is focused on achieving and maintaining full occupancy levels to allow us to maximize attainable operating potential as we look forward to cyclical improvement in economic and market conditions in the near term as the economy recovers.

Our Existing Multifamily Markets

Although distress in the housing, financial and labor markets has been experienced nationwide, performance of particular multifamily markets has differed and will vary depending on the strength of local economic conditions, key industries, job growth, population growth and inventory additions, including the level of shadow supply. Our multifamily rental portfolio currently consists of properties located in each of the following Texas markets: Austin, Dallas, Houston and San Antonio.

 

  Ÿ  

Austin.    Austin, the capital of Texas, is home to many well-known companies in the technology industry and is emerging as a hub for the pharmaceutical and biotechnology industries. With a current population of over 1.65 million, Austin has been one of fastest growing cities in Texas and in the United States in terms of general economic expansion, employment growth and population growth over the past few decades. Although it experienced a dramatic slowdown in 2008 and modest contraction in 2009, Austin’s economy is presently performing better than most cities in the United States.

 

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  Ÿ  

Dallas.    Dallas’s economy is primarily based on banking, commerce, telecommunications, computer technology, energy and transportation. Dallas is the main economic center of the 12-county, 6.3 million Dallas-Fort Worth metropolitan area and is one of the fastest-growing metropolitan areas in the United States in terms of population. The Dallas-Fort Worth metropolitan area experienced economic growth in 2008, but experienced moderate contraction in 2009 as the national recession reached the region. We believe the current outlook for the metropolitan area suggests that economic stabilization will occur in 2010 and that the region should experience strong recovery thereafter.

 

  Ÿ  

Houston.    Houston’s economy is based on energy (oil and natural gas), international trade (especially via the Port of Houston), medical research, healthcare (with the world-renowned Texas Medical Center) and other industries. Through the mid-2000s, Houston had one of the most dynamic economies in the United States and despite slowed economic growth in 2008, Houston still led the United States in job creation. Although Houston is currently experiencing economic contraction, such contraction has been less severe than on the national level.

 

  Ÿ  

San Antonio.    San Antonio’s economy is based on diverse industries, including military, aerospace, biotechnology and medical research. San Antonio has one of the fastest growing populations in the United States and is expected to continue to be a leader in demographic and economic growth. San Antonio’s economy expanded at robust rates from 2004 through 2007 and although it contracted slightly in 2008 and 2009, we believe the long-term outlook for its economy is strong.

Multifamily Markets Data

The following tables summarize, for each market indicated, historical and projected data from Reis regarding change in supply, occupancy, net absorption and effective rent. According to Reis, in each of these markets occupancy rates and effective rents are projected to experience moderate increases beginning in 2011.

Austin, Texas

 

Year

   Change in
Supply(1)
    Occupancy(2)     Net Absorption
(Units)(1)
   Effective
Rent(2)

2000

   5.9   97.5   8,176    $ 768

2001

   7.9      90.5      128      767

2002

   5.2      88.4      3,094      712

2003

   3.4      88.5      4,081      686

2004

   1.5      89.8      3,643      669

2005

   0.2      92.4      3,796      685

2006

   1.2      92.8      2,059      710

2007

   3.0      93.3      4,699      754

2008

   3.1      92.3      2,654      784

2009(3)

   6.0      89.1      3,077      769

2010(3)

   1.6      89.5      2,895      766

2011(3)

   0.7      90.2      2,118      774

2012(3)

   0.9      90.6      2,055      791

2013(3)

   0.8      91.4      2,423      817

Source: Reis, as of Third Quarter 2009

 

(1) For the year ended December 31 of the applicable year.
(2) For the quarter ended December 31 of the applicable year.
(3) Forecasted data.

 

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San Antonio, Texas

 

Year

   Change in
Supply(1)
    Occupancy(2)     Net Absorption
(Units)(1)
    Effective
Rent(2)

2000

   3.6   94.6   4,890      $ 576

2001

   2.5      93.0      842        569

2002

   1.3      93.4      2,063        577

2003

   1.8      93.3      1,914        586

2004

   0.9      92.4      60        593

2005

   2.4      93.9      4,814        602

2006

   2.4      92.6      1,281        620

2007

   2.3      93.4      3,966        646

2008

   1.2      91.0      (1,767     661

2009(3)

   2.1      89.5      422        654

2010(3)

   1.9      89.7      2,847        653

2011(3)

   0.8      90.3      1,831        661

2012(3)

   1.0      91.0      2,452        673

2013(3)

   0.7      92.0      2,480        696

Source: Reis, as of Third Quarter 2009

 

(1) For the year ended December 31 of the applicable year.
(2) For the quarter ended December 31 of the applicable year.
(3) Forecasted data.

Dallas, Texas

 

Year

   Change in
Supply(1)
    Occupancy(2)     Net Absorption
(Units)(1)
    Effective
Rent(2)

2000

   3.8   96.0   16,045      $ 694

2001

   1.6      93.1      (5,032     704

2002

   1.4      91.5      (1,083     684

2003

   1.2      90.3      (508     665

2004

   1.1      89.6      1,164        661

2005

   0.8      91.8      10,887        672

2006

   1.2      91.7      3,745        687

2007

   0.8      92.9      7,456        719

2008

   1.4      91.9      1,271        740

2009(3)

   2.3      90.0      810        729

2010(3)

   1.8      89.2      2,869        732

2011(3)

   0.8      89.5      4,198        740

2012(3)

   0.8      90.0      5,372        753

2013(3)

   0.6      90.8      5,311        774

Source: Reis, as of Third Quarter 2009

 

(1) For the year ended December 31 of the applicable year.
(2) For the quarter ended December 31 of the applicable year.
(3) Forecasted data.

 

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Houston, Texas

 

Year

   Change in
Supply(1)
    Occupancy(2)     Net Absorption
(Units)(1)
    Effective
Rent(2)

2000

   2.5   95.0   11,291      $ 611

2001

   1.8      95.4      8,865        629

2002

   1.1      93.0      (6,105     636

2003

   1.7      90.5      (3,735     630

2004

   2.5      89.4      4,851        637

2005

   1.4      93.8      25,168        644

2006

   1.0      92.9      11        663

2007

   1.7      91.2      (925     685

2008

   2.7      89.9      5,249        715

2009(3)

   2.5      88.1      2,076        704

2010(3)

   1.2      87.8      3,728        705

2011(3)

   0.5      88.7      6,192        712

2012(3)

   0.5      89.4      5,842        724

2013(3)

   0.5      90.2      6,289        739

Source: Reis, as of Third Quarter 2009

 

(1) For the year ended December 31 of the applicable year.
(2) For the quarter ended December 31 of the applicable year.
(3) Forecasted data.

Industrial Real Estate Industry

The U.S. industrial real estate market consisted of approximately 14.3 billion square feet for the quarter ended September 30, 2009, according to CoStar. Of this total, approximately 12.6 billion square feet is industrial space, which consists of bulk distribution and light manufacturing properties, and approximately 1.7 billion is flex space.

Warehouse properties, which represent the substantial majority of our industrial portfolio, are characterized by their simple design and are generally leased to regional or national distribution tenants or tenants engaged in light manufacturing activities. In contrast, flex space typically has been designed or configured to a specialized use such as research and development, with comparatively higher re-tenanting costs as compared to warehouse properties due to higher build-out specifications. Industrial distribution facilities are typically leased on a triple-net basis.

Industrial Investment Opportunities

We believe that the current opportunity to acquire industrial distribution facilities and generate returns will be a function of both the severe economic downturn and the financial excesses in the commercial real estate sector. While distress is not as high in the industrial real estate market as it is for other property types, it is widespread and growing. We believe that distress in this sector will continue to rise well into 2010 and into early 2011 and that we are in the initial stages of what is anticipated to be a very negative cycle for commercial real estate. Accordingly, we believe that we will be able to acquire properties at attractive prices that will experience increasing rental and occupancy growth when the market recovers.

We believe that distressed acquisition opportunities of well-located, current-generation properties should be available at attractive prices beginning slowly in 2010 and increasing into 2011 and beyond. In addition, we believe that lower levels of new supply will characterize the U.S. industrial market for

 

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several years given the environment of reduced capital availability and speculative activity. With limited new supply entering the market during the initial years of projected recovery, increasing demand for industrial space should lead to gains in occupancy and rents.

Industrial real estate, especially industrial distribution space, our preferred type of industrial real estate, as an asset class has investment characteristics that are distinct from other real estate asset classes. We believe that industrial real estate is an attractive asset class for investment because of:

 

  Ÿ  

Triple net leases.    Industrial leases are typically triple net, meaning that the majority of operating expenses, including real estate taxes, insurance and utilities, are passed on to the tenant. Although we are sensitive to tenant concerns about occupancy costs, this structure helps to mitigate our risk with respect to unforeseen increases in operating expenses.

 

  Ÿ  

Low annual tenant turnover.    In our experience, on a portfolio-wide basis, average annual customer turnover among the typical larger industrial tenants is generally low, primarily due to longer lease terms and the high relocation costs of changes to tenants’ existing supply-chain infrastructure. Tenant retention can serve to reduce volatility in earnings and minimize re-tenanting capital costs.

 

  Ÿ  

Minimal capital expenditures.    Industrial distribution facilities typically have a low level of interior finish, contributing to lower initial configuration and ongoing capital costs.

 

  Ÿ  

Corporate outsourcing.    A structural trend in the U.S. market toward corporate outsourcing of non-core business functions, particularly logistics activity, to third-party logistic providers should lead to increased demand for industrial distribution space.

 

  Ÿ  

Market cycle predictability.    We believe that economic factors influence growth in the demand for industrial space in a predictable and observable fashion. We believe that key drivers of demand include population growth, increasing global trade, growth in the number of products (such as an increase in SKUs), an increase in demand for regional facilities and overall GDP growth and consumer demand.

U.S. Industrial Market Overview

The U.S. industrial real estate market is currently experiencing a downturn as a result of sharp declines in demand for industrial space, which we believe is the result of the U.S. and global recession and overall decline in global trade. The downturn presents both an attractive acquisition environment and an opportunity for significant value accretion to owners of high-quality, well-positioned industrial real estate over the next several years.

As the U.S. economy recovers from this economic downturn, economic growth should lead to greater demand for industrial real estate. We believe that this increased demand, combined with forecasted declines in the development of industrial space, should lead to significant value accretion to owners of high-quality, well-positioned industrial real estate over the next several years. Reis forecasts that demand for industrial space, based on net absorption, will turn positive in 2011, and forecasted new industrial supply is expected to remain at historically low levels. According to Reis, after the recession in 2001 and 2002, industrial occupancy grew from 89% to 91% at its peak in 2006. Reis predicts that industrial occupancy will reach its lowest level in 2010 at 88%, with a recovery commencing in 2011. According to Reis, industrial rents enjoyed three years of above-average increases during the last expansion phase of the industrial market, from 2005 to 2007. Reis forecasts a 2.5% decline is 2010 and effectively flat rental growth in 2011. Reis forecasts above-average rental growth of 2.5-3% in 2012 and 2013. Based on these occupancy and rental changes, Reis forecasts industrial property revenue to decline by approximately 2% in 2010, with a modest recovery in 2011 and improved revenue growth in 2012 and 2013.

 

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National Industrial Data

The following table summarizes U.S. industrial historical and projected data from Reis regarding change in supply, occupancy, net absorption and effective rent. According to Reis, occupancy is expected to stabilize in 2010 to 2011 with modest growth in 2012 to 2013. Effective rent is expected to increase slowly beginning in 2011.

 

Year

   Change in
Supply(1)
    Occupancy(2)     Net Absorption
(Units)(1)
    Effective
Rent(2)

2000

   1.5   92.0   100,332      $ 4.50

2001

   1.6      90.0      (36,642     4.37

2002

   0.9      89.2      (3,722     4.32

2003

   0.6      89.0      29,629        4.27

2004

   0.9      89.3      85,404        4.29

2005

   0.9      90.2      137,750        4.42

2006

   1.0      90.6      108,769        4.55

2007

   1.0      90.5      62,827        4.70

2008

   0.8      89.8      (1,740     4.65

2009(3)

   0.4      88.5      (71,887     4.44

2010(3)

   0.4      88.0      (11,726     4.33

2011(3)

   0.3      88.2      33,858        4.34

2012(3)

   0.4      88.5      60,597        4.44

2013(3)

   0.6      88.9      82,273        4.57

Source: Reis, as of Third Quarter 2009

 

(1) For the year ended December 31 of the applicable year.
(2) For the quarter ended December 31 of the applicable year.
(3) Forecasted.

Mexican Industrial Market Overview

The Mexican industrial real estate market is also currently experiencing a downturn, particularly due to decreased U.S. consumer demand. Other factors such as lower oil production, declining remittances, reduced tourism and swine flu are hurting the economy as well.

 

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The properties in our current industrial portfolio are located in markets that are important centers of production and trade between the United States and Mexico. Dramatic increases in trade between Mexico and the United States occurred as a result of the implementation of NAFTA in January 1994. According to the U.S. Census Bureau, the total value of NAFTA goods that are imported into the United States has more than tripled from 1994 to 2008 and, although sharp declines from 2008 levels occurred in 2009, continued growth is expected in the long term. The following chart indicates the historical amount of NAFTA goods imported into the United States from Mexico from 1994 to 2009.

LOGO

In addition to comprising a large portion of the NAFTA trade, Mexico represents a large portion of U.S. trade in general, accounting for 11% of total U.S. trade as of September 30, 2009. As of September 30, 2009, and for the year-to-date, Mexico was the second-largest U.S. trading partner in exports and the third largest U.S. trading partner in imports, according to U.S. Census Bureau data.

Commercial activity along the U.S.-Mexico border is particularly robust. Commercial truck crossings from the U.S. into Mexico increased by 70% from 1995 to 2008. In addition, U.S.-Mexico trade has historically been concentrated in a handful of states, especially Texas, which accounted for 41% of all U.S. exports to Mexico in 2008. Although trade between the United States and Mexico remained robust throughout most of 2008, truck traffic at principal border ports and train transportation from Mexico to the United States declined beginning in the latter half of 2008 and significantly the first three quarters of 2009. Activity is expected to rise modestly in 2010 and recover more fully in 2011. The following charts indicate the top ranked truck and rail ports for year-to-date 2009.

 

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LOGO

LOGO

 

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Our Existing Industrial Markets

Our industrial portfolio currently consists of properties located in the U.S.-Mexico trade corridor: Austin, El Paso, Houston, Laredo, McAllen, San Antonio, Santa Teresa and northern Mexico. In general, the economic trends and drivers for industrial distribution facilities in Austin, Houston and San Antonio are similar to those discussed above under “—Multifamily Real Estate—Our Existing Markets,” including job creation and population growth.

 

  Ÿ  

El Paso.    El Paso is one of the most important centers for twin-plant production (with its sister city, Ciudad Juarez) in the U.S.-Mexico border region. Despite facing minor economic contraction as a result of the recession in the United States and Mexico, El Paso continues to perform better than most other cities. Recent declines in the performance of the industrial market in El Paso have been mitigated by the fact that supply levels have remained level due to a lack of new construction projects in recent years.

 

  Ÿ  

Laredo.    Laredo’s principal economic driver is border trade. According to the U.S. Census Bureau, Laredo is the most important crossing for both truck and rail on the U.S.-Mexico border: 32% of all inbound truck traffic (1.6 million trucks) and 34% of trains entered the United States at Laredo in 2009 (measured as of July 2009). Laredo’s economic activity has slowed significantly in 2009, but its economy remains healthier than most U.S. and Texas metropolitan areas.

 

  Ÿ  

McAllen.    McAllen’s economy is largely based on the twin-plant operations of the McAllen-Reynosa region. McAllen’s industrial market continued to have favorable leasing activity toward the end of 2008, but recent occupancy levels have declined as a result of demand being outpaced by construction levels. Although experiencing a dramatic slowdown, McAllen’s economy continues to outpace Texas and the broader United States and experience modest but positive industrial demand in 2009.

 

  Ÿ  

Santa Teresa.    Santa Teresa is located in southern New Mexico (near El Paso) and contains a U.S.-Mexico border crossing that has generated significant activity and industrial demand. Most of the industrial space in Santa Teresa consists of distribution/logistics centers.

 

  Ÿ  

Northern Mexico.    Our industrial distribution facilities in northern Mexico are located in Chihuahua, Juarez, Monterrey, Reynosa and Tijuana.

 

  Ÿ  

Chihuahua.    Located 230 miles south of El Paso, Chihuahua has been a growing center for industrial production and it is an emerging center for the aerospace industry. Chihuahua experienced healthy rates of economic expansion through the mid-2000s and despite a slowing economy in recent times, Chihuahua performed better than most Mexican cities in 2009.

 

  Ÿ  

Juarez.    Juarez is Mexico’s fifth-largest metropolitan area and the largest center for twin-plant production. It is also one of Mexico’s most important industrial centers in general. Major sectors include appliances, electronics, automotive and medical products. Despite experiencing significant economic and industrial expansion from 2004 through 2007, economic expansion slowed considerably in 2008 and 2009.

 

  Ÿ  

Monterrey.    Monterrey is Mexico’s third-largest metropolitan area in terms of population and the second most important industrial center. Monterrey has been a major industrial hub for over 100 years and manufacturing, information technology and regional services are its major economic drivers. Despite experiencing very strong demand for industrial space in the mid-2000s, construction outpaced demand in 2007 and 2008, and weakening economic conditions have caused demand to weaken considerably.

 

  Ÿ  

Reynosa.    Reynosa is one of Mexico’s principal centers for twin-plant production operations and its major drivers for industrial space include manufacturing, remanufacturing, warranty

 

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repair, logistics and speed-to-market. Reynosa is home to major manufacturing companies and has experienced significant expansion through the mid-2000s. Reynosa is currently experiencing economic contraction that we believe will likely continue into 2010.

 

  Ÿ  

Tijuana.    Tijuana is Mexico’s sixth-largest metropolitan area and has experienced very high rates of economic and population growth. In 2008, Tijuana’s economy slowed considerably and is not likely to return until the second half of 2010. Still, we believe Tijuana’s economy is positioned to experience one of the most robust growth rates in Mexico.

 

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BUSINESS AND PROPERTIES

Overview

We are a fully integrated, self-administered and self-managed real estate investment trust, or a REIT, that specializes in the ownership, acquisition and management of institutional-quality multifamily rental properties and industrial distribution facilities. Our existing operating portfolio is composed primarily of recently constructed multifamily rental properties in the southwestern United States and industrial distribution facilities in the southwestern United States and northern Mexico. C. Ronald Blankenship, our president and chief executive officer, and William Sanders, our chairman, founded the company and have a combined 75 years of experience in the real estate industry. We intend to capitalize on the experience and track record of Mr. Blankenship and the other members of our management team in growing and managing public real estate companies. We also intend to utilize a significant portion of the proceeds of this offering to expand our existing asset base through the acquisition of multifamily rental properties and industrial distribution properties focused in select high-growth markets in the western and southwestern United States.

We believe that our senior management team has a successful track record of creating, growing, operating and monetizing public real estate companies. This public company experience is combined with senior management’s substantial experience in all aspects of multifamily rental properties and industrial distribution industry, including during the period from 1991 to 2002:

 

  Ÿ  

Selected financing activity:

 

  Ÿ  

initial public offerings of ProLogis, Security Capital Atlantic, Security Capital and Homestead Village Incorporated;

 

  Ÿ  

strategic equity investments in Regency Centers Corporation, CarrAmerica Realty Corporation and Storage USA; and

 

  Ÿ  

numerous follow-on equity offerings and unsecured and secured debt transactions.

 

  Ÿ  

Selected merger and acquisition activity:

 

  Ÿ  

public-to-public corporate mergers of Security Capital Atlantic with Security Capital Pacific to form Archstone Communities Trust, the predecessor of Archstone-Smith Trust, Security Capital U.S. Realty with Security Capital, and Storage USA with Security Capital; and

 

  Ÿ  

sale of Security Capital to General Electric Capital and the merger of Pacific Retail Trust with Regency Centers Corporation.

We intend to capitalize on this experience to grow, develop and operate our business.

Each of the four senior members of our management team has been a chief executive officer, chief operating officer, chief investment officer or chief financial officer of a NYSE-listed real estate company. Before forming Verde, Mr. Blankenship worked with our chairman, Mr. Sanders, for 12 years at Security Capital, a company that built or provided strategic assistance in the growth of 18 real estate companies, including successful, publicly traded REITs such as ProLogis, Archstone-Smith Trust, Regency Centers Corporation and CarrAmerica Realty Corporation. David C. Dressler, Jr., our executive vice president and chief investment officer, Richard Moore, our executive vice president and chief financial officer, and James C. Potts, our executive vice president for multifamily, all worked with Mr. Blankenship and Mr. Sanders at Security Capital. See “Management” for additional information regarding our board and management.

 

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Our operating partnership was formed in 2003 and has owned and managed multifamily rental properties and industrial distribution facilities since 2004. We were formed in 2006 to serve as the general partner of our operating partnership. Through our operating partnership, we have four operating divisions, consisting of our multifamily rental business, our industrial distribution facilities business, the Santa Teresa mixed-use project and the Heritage Preserve residential lot development business.

Our Competitive Strengths

Successful track record in running public real estate companies

Our senior management team has a successful track record in creating, growing, operating and monetizing public real estate companies and has strategically supported the growth of some of the most well-known public real estate companies in the United States. Mr. Blankenship was the chief operating officer of Security Capital, which founded ProLogis, purchased and refocused Property Trust of America, which became Archstone-Smith Trust, and provided strategic guidance in the growth of companies such as CarrAmerica Realty Corporation and Regency Centers Corporation. See “Management.”

Senior management possesses a depth of real estate experience working together as a cohesive team

Our four-member senior management team has a combined 120 years of experience in the multifamily and industrial real estate sectors and brings deep national, regional and local industry relationships that it will utilize to grow and develop our business. Our senior management has substantial experience in all aspects of multifamily and industrial real estate acquisitions, dispositions, management, leasing, financing, developing and redeveloping across multiple real estate cycles. Mr. Blankenship worked with our chairman, Mr. Sanders, for a total of 19 years. Each member of our senior management team worked at Security Capital for between five and 12 years. Ronald Blankenship, David C. Dressler, Jr. and James C. Potts also worked together at Trammell Crow Residential prior to their tenure at Security Capital.

Deep multidisciplinary management expertise across various real estate sectors

Based on their real estate experience, including their years at Security Capital and at Verde, our senior management possesses significant expertise in investing and operating multifamily rental properties and industrial real estate at the same time. In addition to their multisector experience, senior management has a multidisciplinary track record of successfully deploying capital through acquisitions, development and redevelopment.

Fully integrated multifamily and industrial operating platform scaled for growth

We have a fully established and integrated multifamily and industrial real estate operating platform that is scaled for significant growth with minimal incremental overhead. We possess in-house expertise in all facets of owning, acquiring, developing, redeveloping and managing multifamily rental properties and industrial real estate assets. As of December 31, 2009, we employed approximately 246 employees and, in addition to our principal executive office in El Paso, Texas, we have 13 regional and market offices in the southwestern United States and northern Mexico, which enables us to perform a continual monitoring of market dynamics and opportunities in these high-growth markets. Our goal is to build on our existing operating, management and industry strengths as we seek to expand our platform in select high-growth markets in the western and southwestern United States.

 

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Existing portfolio of high-quality operating properties, including recently developed institutional-quality multifamily rental properties and industrial distribution facilities

As of November 30, 2009, the weighted average age of our multifamily rental properties was 1.1 years (excluding one property that is still in service but was acquired for future development) and the weighted average age of our industrial distribution facilities was 4.9 years (measured from the later of major renovation or completion of construction). This relatively young portfolio has the potential to serve as a foundation for organic growth and expansion of market share in key our markets. Our property-level focus is on customer satisfaction and continuous refinement of operating efficiencies aimed at maximizing performance of our assets. See “—Existing Portfolio.”

Balance sheet positioned to facilitate future growth

Following this offering, we will have cash and other liquid assets of approximately $             , approximately $             million of outstanding indebtedness and a debt to cost ratio of approximately     %. As of September 30, 2009, our mortgage debt had a weighted average interest rate of 6.00%, which we believe is significantly below the cost of new secured indebtedness available to us at similar leverage levels in the current market. In addition, our operating partnership had outstanding $69.6 million of convertible debentures as of September 30, 2009, with a weighted average interest rate of 4.75%, which we also believe is below the cost currently available for new indebtedness. Further, after giving effect to the application of the net proceeds of this offering as described in “Use of Proceeds” and assuming we complete our anticipated conversion of our construction loans into permanent financing, as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Financing Activities,” we will have no significant near-term maturities and no debt maturing before 2013. We intend to enter into a line of credit in the near term in order to increase the flexibility of our balance sheet.

Near-term visible growth due to the stabilization of recently completed multifamily rental properties

Almost all of our multifamily rental properties are recently developed and four are still in the process of being fully leased. We developed 13 of the 14 multifamily rental properties in our portfolio. Seven of these properties achieved stabilized occupancy levels during 2009; therefore, 2010 will be their first full year of stabilized operations. We completed development of one property during the third quarter of 2009, two during the fourth quarter of 2009, and one during the first quarter of 2010, all of which are currently pre-stabilized and had a weighted average physical occupancy of 77.3% as of November 30, 2009. It is expected that these four properties will achieve stabilized occupancy levels during 2010. Two of the pre-stabilized properties are expected to achieve stabilization in the third quarter of 2010, with the remaining two properties expected to reach stabilization in the fourth quarter of 2010. As a result, we believe that higher average occupancy levels for our multifamily rental portfolio, as well as effective rental rates consistent with other stabilized properties (rather than properties in lease up), will result in more robust near-term growth rates in net operating income than most of our competitors.

Strong alignment of interest between management and shareholders

Our executive officers and members of our board of trustees own a significant amount of our equity, representing over 19% of our common shares and common units of our operating partnership on an as-converted basis immediately prior to this offering and     % of our common shares and common units of our operating partnership on an as-converted basis upon completion of the offering. See “Principal Shareholders.” We intend to put in place a long-term incentive compensation plan to incentivize management through the awarding of options and equity-based compensation. See “Certain Relationships and Related Transactions.”

 

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Commitment to strong corporate governance

We are committed to strong corporate governance, as demonstrated by the following:

 

  Ÿ  

following the completion of this offering, all members of our board of trustees will serve annual terms;

 

  Ÿ  

we have opted out of two Maryland anti-takeover provisions; and

 

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we do not have a shareholder rights plan, and we do not intend to adopt a shareholder rights plan in the future unless our shareholders approve in advance the adoption of a plan, or, if adopted by our board of trustees, we submit the shareholder rights plan to our shareholders for ratification within 12 months of adoption or the plan will terminate.

Our Business Strategy

Capitalize on an attractive acquisition environment to expand our portfolio into key high-growth markets in the western and southwestern United States

We believe the next several years will present an attractive acquisition environment as a result of the current economic environment and its effect on the commercial real estate sector. We intend to capitalize on these opportunities by acquiring existing multifamily rental properties and industrial distribution facilities using a significant portion of the net proceeds of this offering.

We will target markets with significant potential for job growth that have been impacted by current economic conditions yet offer excellent prospects for recovery and property-level cash flow growth. We believe that there are near-term growth prospects in the western and southwestern United States, although we will maintain flexibility for acquisitions in high-growth markets in other regions. See “—Market Opportunities—Target Markets for Multifamily Rental Properties” and “—Market Opportunities—Target Markets for Industrial Distribution Facilities.” We expect to benefit from the operational capabilities and market insight that our existing, established platform provides. We believe any successful acquisitions should meaningfully drive shareholder returns, especially in the short term, because our targeted acquisition volumes are significant relative to the size of our existing asset base.

Take advantage of positive fundamentals for multifamily and industrial real estate assets and maximize cash flow at our properties through internal growth

We believe that multifamily and industrial real estate assets are well positioned to outperform the general economy as the economy recovers and as tenant demand reasserts itself in response to improving economic conditions and in response to demographic trends. Accordingly, we intend to grow our operations in these asset classes through acquisitions. From an internal growth perspective, we believe that our strong in-house leasing and property management capabilities, including our practice of having a local presence in each of our markets, will help us achieve results that are superior to those companies who rely on unaffiliated third-party service providers. In addition, for our industrial distribution facilities, our market officers provide significant local marketing and tenant-relationship support.

Achieve growth through acquisitions of operating properties, while pursuing the sale of undeveloped land parcels

In the near term, we anticipate that our growth will come primarily through acquisitions of multifamily and industrial operating properties and thus we do not currently intend to expend significant resources or management time and attention on development activities. Our objective with respect to land held in inventory is to maximize value within a reasonable period of time, taking into account general economic conditions, supply and demand for real estate in the markets in which the land is located and prospective alternative investment opportunities that would be facilitated by a sale of the land. In this regard, we may consider the following alternatives: sales of land to third parties, construction on industrial land in connection with build-to-suit opportunities that may arise in the future

 

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and, potentially, construction of industrial and/or multifamily properties for our own portfolio if, at some point in the future, we determine that market rents and other related conditions justify development of new properties. Our strategy with regard to each tract of land will depend on economic conditions in the relevant market, supply and demand conditions impacting the values of developed industrial and multifamily properties within the relevant market, the land holding cost and the strategic value of the site, when compared to other competitive sites within the relevant market.

Maintain a flexible capital allocation strategy

We believe that our ability to be flexible in the allocation of capital, combined with our in-house research capabilities, allows us to take advantage of evolving industry dynamics to seize the best opportunities to grow property-level cash flow based on our operating expertise. We intend to allocate capital between multifamily rental properties and industrial distribution segments based on the potential for value creation between each asset type. We will also strategically redeploy capital, generally from certain stabilized assets to higher growth opportunities as we broaden the scope of our target markets. Although we will initially focus on acquisitions, we will also utilize our expertise to develop and re-develop assets as markets rebound. Because of our established capabilities in property and asset management, we will consider lease-up and value-added assets in addition to stabilized assets.

Geographic focus in western and southwestern United States in key growth markets

Our geographic focus on acquisitions in the western and southwestern United States has positioned us to take advantage of strong growth fundamentals in markets within these regions as and when their economies strengthen, which we generally expect to commence in late 2010 and 2011. In both of our segments—multifamily rental properties and industrial distribution facilities—we intend to acquire properties in markets with strong job and population growth. In this regard, according to AXIOMETRICS, the four major Texas markets in which we currently operate are projected to be among the top U.S. metropolitan areas as measured by job growth over the period from 2010 to 2014. We expect the growth in these four markets to be driven by their diversified industrial base, business-friendly government environment, low cost of living and trade-oriented economies.

Market Opportunities

We believe that the extent of our opportunities to acquire desirable multifamily rental properties and industrial distribution facilities will be a function, in part, of the previous financial excesses in the commercial real estate sector, the current economic downturn and our ability to allocate capital consistent with desirable structural and economic growth trends.

The credit crisis and economic downturn that began in late 2007 brought, among other things, substantial volatility and reductions in equity and asset values worldwide, which has caused a significant reduction in the amount of equity capital and available financing in the real estate sector. This dramatic reduction in available liquidity, combined with weakening underlying market fundamentals, reflected in a significant decline in market occupancies and rents, has significantly reduced property values. We believe that these conditions have created opportunities in select markets to acquire well-located, current-generation distressed assets at below our estimated replacement cost. We expect that these opportunities will begin to appear slowly in early 2010 and will increase in volume through 2011. As we acquire our target assets at attractive prices and seek to improve their operating performance, we believe that we will be positioned to provide investors with attractive risk-adjusted returns.

Delinquency rates are rising sharply for construction loans, mezzanine loans, permanent mortgage debt and commercial mortgage-backed securities, or CMBS. We believe there will be strong pressure on financial institutions and CMBS portfolios over the next several years, especially for loans originated during 2006 and 2007 at the peak of investment activity and lending excess. We believe that refinancing needs will be confronted by an environment of constrained liquidity and tougher underwriting standards. This comes against a backdrop of high unemployment that has put significant pressure on property fundamentals.

 

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We believe that multifamily rental properties represent an attractive investment opportunity due to favorable demographics, lease characteristics and macroeconomic factors such as improving employment trends, population growth and the historically low levels of multifamily supply. In addition, we believe that a strong, high-quality management team can lead to stronger rent growth, higher resident retention and better expense control and risk management, which in turn, can significantly increase the operating performance and value of investments in multifamily rental properties. Further, mortgage financing is currently available for multifamily rental properties through Fannie Mae and Freddie Mac at attractive rates, which we believe provides us with the potential to actively manage our capital structure as we make acquisitions.

We believe that industrial distribution facilities represent an attractive investment opportunity due to, among other things, structural trends in distribution activity, minimal asset capital expenditure requirements, market cycle predictability, the ability to create customer relationships, low tenant turnover and the ability to pass on a significant portion of operating expenses to the tenants of such properties. Although the U.S. industrial real estate market is currently experiencing a downturn as a result of sharp declines in demand for industrial space, we believe that as the U.S. economy recovers, economic growth will lead to greater demand for industrial real estate, thus creating growth opportunities for owners of high-quality, well-positioned industrial real estate.

Through our internal market research expertise, we identify and prioritize markets, submarkets and assets where we believe cash flow growth can drive increased asset value. We are committed to measured growth using the analytics and research that we employ in our portfolio today.

 

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At a market level, we examine job growth and its sustainability, population growth, and the financial impact of governmental regulation (as it translates to property taxes, utility and insurance cost) and liquidity (such as institutional demand).

 

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At a submarket level, we consider the supply and construction pipeline, land availability and ease of entitlements, job locations, transportation infrastructure and lifestyle attributes.

 

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At a property level, we study competitive product pricing and service, product design, physical characteristics, condition, availability of financing (if applicable), replacement costs, visibility and location and specific opportunities to leverage our property management abilities.

We evaluate market, submarket and property opportunities using a standardized template and investment analysis. Any investment is subject to our thorough due diligence and investment committee process.

Historically, Verde has been focused on major southern and U.S.-Mexico border markets. As we seek to deploy capital that we raise in this offering, we intend to leverage our senior management team’s broad geographic experience and focus on multifamily rental properties and industrial opportunities within our existing U.S. and Mexican markets, as well as the western and southwestern United States, which may include the following select targeted markets: Los Angeles, California; Las Vegas, Nevada; Phoenix, Arizona; Riverside-San Bernardino, California; San Francisco, California; Seattle, Washington; and Denver, Colorado. See “Industry Overview” for a discussion of trends and investment opportunities in our current markets.

Target Markets for Multifamily Rental Properties

 

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Los Angeles.    The core Los Angeles metropolitan area has 9.9 million residents, including a high percentage in rental housing. The region has a very diversified economy that is currently suffering disproportionately, but which is also expected to experience solid long-term economic growth, driven in part by increasing trade with Asia.

 

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Phoenix.    With a current population of 4.3 million, Phoenix was one of the top metropolitan areas for growth throughout the last decade. This region experienced economic expansion from high-

 

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tech and aerospace industries, as well as Phoenix’s position as a low-cost alternative to the State of California. Although Phoenix currently has one of the weakest economies in the country, the region is expected to return to high rates of economic expansion within a few years.

 

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Las Vegas.    Like Phoenix, Las Vegas led the country in economic and population growth rates in the last decade, reaching a population of 1.9 million as of 2008. Las Vegas’s economy is one of the most challenged in the U.S.; however, long-term growth is expected to surpass those of most metropolitan regions.

 

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Seattle.    Seattle is a regional hub of the northwest, is the second-most important gateway to Asia and has a population of 3.3 million. In addition to international trade, the economy is based on high-technology and aerospace. Seattle is expected to remain one of the faster expanding economies and populations over the long term, and has a history of attracting and retaining residents for its quality-of-life characteristics.

 

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Denver.    Denver is the principal hub of the mountain region, a metropolitan region that reached a population of 2.5 million in 2008. Denver has successfully created a well-diversified economy, and ranks well in quality-of-life indices. Population and employment increases here have historically surpassed national averages and are expected to continue to do so in the future.

 

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Austin.    Over the past few decades, Austin has been one of fastest-growing metro areas in Texas and in the United States, both with respect to its economy and to its population, which is currently over 1.65 million. As the state capital of Texas and home to the University of Texas, one of the largest universities in the country, the government sector is very important. Austin is also one of the country’s leading centers for high technology.

 

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San Antonio.    San Antonio is a regional hub for the south Texas region. Its economy is based on biotechnology and medical research, aerospace and the military, which is currently undergoing an expansion. With a population of 2.0 million, San Antonio has one of the fastest-growing populations in the United States and is expected to continue to be a leader in demographic and economic growth for the foreseeable future.

The table below shows, for each of our targeted markets, job growth and, for the multifamily sector, new supply, increase in occupancy, net absorption per year and effective rent. We analyze each of these metrics in our decision to target particular markets in our acquisition strategy.

Multifamily Target Markets: 2010 to 2013 Forecasted Market Data

 

Market

   Cumulative Job
Growth(1)
    New Supply as
Percentage of
2010 Inventory(2)
    Cumulative
Increase in
Occupancy (in
Basis Points)
  Average Net
Absorption per
Year (Units)
   CAGR Annual
Effective Rent(3)
 

Los Angeles

   4.1   0.9  

60 bps

  2,885    1.8

Las Vegas

   7.6      3.5      200   2,037    2.0   

Phoenix

   6.8      2.2      290   3,588    2.1   

Seattle

   8.1      3.3      120   3,059    2.0   

Denver

   5.8      2.9      50   1,718    1.8   

Austin

   10.0      2.4      190   2,373    2.2   

San Antonio

   6.3      2.5      230   2,403    2.1   

Source: Reis (except as otherwise specified)

 

(1) Source: AXIOMETRICS. Constitutes total projected employment growth from 2010 to 2013 divided by 2010 projected employment.
(2) Constitutes new projected inventory from 2010 to 2013 divided by 2010 projected inventory.
(3) Compound annual growth rate, 2010 to 2013.