10-K 1 tci-10k_123118.htm ANNUAL REPORT tci-10k_123118.htm
 

 

UNITED STATES  

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549

 

 

 

FORM 10-K

 

  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2018

 

OR

 

  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 001-09240

 

 

 

Transcontinental Realty Investors, Inc.

(Exact name of registrant as specified in its charter)

 

Nevada 94-6565852

(State or other jurisdiction of  

Incorporation or organization) 

(IRS Employer 

Identification Number)

   

1603 LBJ Freeway, Suite 800 

Dallas, Texas  

75234
(Address of principal executive offices) (Zip Code)

 

(469) 522-4200  

Registrant’s Telephone Number, including area code   

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class Name of each exchange on which registered
Common Stock, $0.01 par value New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:   

NONE 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ☐    No   ☒ 

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No   ☒ 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No   ☐ 

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  ☒     No   ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ☒ 

 

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

 

Large accelerated filer   Accelerated filer  
Non-accelerated filer ☐    Smaller Reporting Company  
    Emerging Growth Company  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ☐  No   ☒ 

 

Based on the last sale at the close of business on June 30, 2018, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $45,527,090. The basis of the calculation does not constitute a determination by the Registrant as defined in Rule 405 of the Securities Act of 1933, as amended, such calculation, if made as of a date within sixty days of this filing, would yield a different value.

 

As of March 31, 2019, there were 8,717,767 shares of common stock outstanding. 

 

DOCUMENTS INCORPORATED BY REFERENCE:  

 

Consolidated Financial Statements of Income Opportunity Realty Investors, Inc. Commission File No. 001-14784  

Consolidated Financial Statements of American Realty Investors, Inc. Commission File No. 001-15663

 

 

 

 

 

INDEX TO  

ANNUAL REPORT ON FORM 10-K 

 

  Page
PART I  
     
Item 1. Business 3
Item 1A. Risk Factors 9
Item 1B. Unresolved Staff Comments 14
Item 2. Properties 15
Item 3. Legal Proceedings 18
Item 4. Mine Safety Disclosures 18
     
PART II  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 19
Item 6. Selected Financial Data 20
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 30
Item 8. Consolidated Financial Statements and Supplementary Data 32
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 68
Item 9A. Controls and Procedures 68
Item 9B. Other Information 68
     
PART III  
     
Item 10. Directors, Executive Officers and Corporate Governance 69
Item 11. Executive Compensation 76
Item 12. Security Ownership of Certain Beneficial Owners and Management 76
Item 13. Certain Relationships and Related Transactions, and Director Independence 78
Item 14. Principal Accounting Fees and Services 80
     
PART IV  
     
Item 15. Exhibits, Financial Statement Schedules 82
Signatures 84
  2  

 

  

FORWARD-LOOKING STATEMENTS 

 

Certain Statements in this Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words “estimate”, “plan”, “intend”, “expect”, “anticipate”, “believe”, and similar expressions are intended to identify forward-looking statements. The forward-looking statements are found at various places throughout this Report and in the documents incorporated herein by reference. The Company disclaims any intention or obligations to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that our expectations are based upon reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause our actual results to differ from estimates or projections contained in any forward-looking statements are described under Part I, Item 1A. “Risk Factors”.

 

PART I 

 

ITEM 1. BUSINESS

 

General  

 

As used herein, the terms “TCI”, “the Company”, “We”, “Our”, or “Us” refer to Transcontinental Realty Investors, Inc. a Nevada corporation which was formed in 1984. The Company is headquartered in Dallas, Texas and its common stock is listed and trades on the New York Stock Exchange (“NYSE”) under the symbol “TCI”. 

 

TCI is a “C” corporation for U.S. federal income tax purposes and files an annual consolidated income tax return with American Realty Investors, Inc. (“ARL”), whose common stock is traded on the NYSE under the symbol “ARL”. Subsidiaries and affiliates of ARL own in excess of 80% of the Company’s common stock. ARL and one of its subsidiaries own 77.68% and the parent of ARL owns 6.98% of the company. Accordingly, TCI’s financial results are consolidated with those of ARL’s on Form 10-K and related Consolidated Financial Statements. ARL’s common stock is listed and trades on the New York Stock Exchange under the symbol “ARL”. 

 

On July 17, 2009, the Company acquired an additional 2,518,934 shares of common stock of Income Opportunity Realty Investors, Inc. (“IOR”), and in doing so, increased its ownership from approximately 25% to over 80% of the shares of common stock of IOR outstanding. Upon acquisition of the additional shares in 2009, IOR’s results of operations began to be consolidated with those of the Company for tax and financial reporting purposes. As of December 31, 2018, TCI owned 81.25% of the outstanding IOR common shares. Shares of IOR common stock are listed and traded on the NYSE American under the symbol “IOR”. 

 

At the time of the acquisition, the historical accounting value of IOR’s assets was $112 million and liabilities were $43 million. In that the shares of IOR acquired by TCI were from a related party, the values recorded by TCI are IOR’s historical accounting values at the date of transfer. The Company’s fair valuation of IOR’s assets and liabilities at the acquisition date approximated IOR’s book value. The net difference between the purchase price and historical accounting basis of the assets and liabilities acquired is $25.6 million and has been reflected by TCI as deferred income. The deferred income will be recognized upon the sale of the land that IOR held on its books as of the date of sale, to an independent third party. 

 

TCI’s Board of Directors are responsible for directing the overall affairs of TCI and for setting the strategic policies that guide the Company. As of April 30, 2011, the Board of Directors delegated the day-to-day management of the Company to Pillar Income Asset Management, Inc. (“Pillar”), a Nevada corporation, under a written Advisory Agreement that is reviewed annually by TCI’s Board of Directors. The directors of TCI are also directors of ARL and IOR. The Chairman of the Board of Directors of TCI also serves as the Chairman of the Board of Directors of ARL and IOR. The officers of TCI also serve as officers of ARL, IOR and Pillar. 

 

Since April 30, 2011, Pillar, the sole shareholder of which is Realty Advisors, LLC, a Nevada limited liability company, the sole member of which is Realty Advisors, Inc. (“RAI”), a Nevada corporation, the sole shareholder of which is May Realty Holdings, Inc. (“MRHI”, formerly known as Realty Advisors Management, Inc.), effective August 7, 2014), a Nevada corporation, the sole shareholder of which is a trust known as the May Trust, became the Company’s external Advisor and Cash Manager.  Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities. Pillar also arranges, for the Company’s benefit, debt and equity financing with third party lenders and investors. Pillar also serves as an Advisor and Cash Manager to ARL and IOR.  As the contractual advisor, Pillar is compensated by TCI under an Advisory Agreement that is more fully described in Part III, Item 10. “Directors, Executive Officers and Corporate Governance – The Advisor”.  TCI has no employees. Employees of Pillar render services to TCI in accordance with the terms of the Advisory Agreement. 

 

  3  

 

 

Regis Realty Prime, LLC, dba Regis Property Management, LLC (“Regis”), manages our commercial properties and provides brokerage services. Regis receives property management fees, construction management fees and leasing commissions in accordance with the terms of its property-level management agreement. Regis is also entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Refer to Part III, Item 10. “Directors, Executive Officers and Corporate Governance – Property Management and Real Estate Brokerage”. TCI engages third-party companies to lease and manage its apartment properties.

 

Southern Properties Capital Ltd. (“Southern” or “SPC”) is a wholly owned subsidiary of TCI that was incorporated on August 16, 2016 for the purpose of raising funds by issuing debentures that cannot be converted into shares on the Tel-Aviv Stock Exchange ("TASE"). Southern operates in the United States and is primarily involved in investing in, developing, constructing and operating income-producing properties of multi-family residential real estate assets. Southern is included in the consolidated financial statements of TCI.

 

On January 1, 2012, the Company entered into a development agreement with Unified Housing Foundation, Inc. “UHF” a non-profit corporation that provides management services for the development of residential apartment projects in the future. This development agreement was terminated December 31, 2013. The Company has also invested in surplus cash notes receivables from UHF and has sold several residential apartment properties to UHF in prior years. Due to this ongoing relationship and the significant investment in the performance of the collateral secured under the notes receivable, UHF has been determined to be a related party.

 

On November 19, 2018, we executed an agreement between the Macquarie Group (“Macquarie”) and SPC and TCI to create a joint venture, Victory Abode Apartments, LLC (“VAA”) to address existing and future demand for quality multifamily residential housing through acquisition and development of sustainable Class A multifamily housing in focused secondary and tertiary markets. In connection with the formation of the joint venture, SPC and TCI contributed a portfolio of 49 income producing apartment complexes, and 3 development projects in various stages of construction and received cash consideration of $236.8 million. At the time of the transfer of the properties, the joint venture assumed all liabilities of those properties, including mortgage debt to the Department of Housing and Urban Development (“HUD”).

 

VAA is equally owned and controlled by Abode JVP, LLC, a wholly-owned subsidiary of SPC and Summerset Intermediate Holdings 2 LLC (“Summerset”), a wholly-owned indirect subsidiary of Macquarie.  Pursuant to the Agreement, Abode JVP, LLC and Summerset each own voting and profit participation rights of 50% and 49%, respectively (“Class A Members”).  The remaining 2% of the profit participation interest is held by Daniel J. Moos TCI’s President and Chief Executive Officer (“Class B Member”) who serves also as the Manager of the joint venture. 

 

Our primary business is the acquisition, development and ownership of income-producing residential and commercial real estate properties. In addition, we opportunistically acquire land for future development in in-fill or high-growth suburban markets. From time to time and when we believe it appropriate to do so, we will also sell land and income-producing properties. We generate revenues by leasing apartment units to residents, and leasing office, industrial and retail space to various for-profit businesses as well as certain local, state and federal agencies. We also generate revenues from gains on sales of income-producing properties and land.

  

At December 31, 2018, our income-producing properties consisted of: 

 

  Seven commercial properties consisting of five office buildings and two retail properties comprising in aggregate of approximately 1.7 million square feet;
     
  Nine residential apartment communities comprising 1,489 units, excluding apartments being developed.
     
  Forty nine residential apartment communities totaling 9,192 units owned by our 50% owned investee VAA.
  4  

 

 

The following table sets forth the location of our real estate held for investment (income-producing properties only) by asset type as of December 31, 2018:

 

    Apartments
(Company owned)
    Apartments
(VAA owned)
    Commercial
(Company owned)
 
Location   No.     Units     No.     Units     No.     SF  
Alabama     1       200       1       168              
Arkansas                 5       1,122              
Colorado                 2       260              
Florida     2       153       2       388       1       6,722  
Georgia                 1       222              
Louisiana     1       240       3       464              
Mississippi     2       400       1       196              
North Carolina                 1       201              
Nevada                 1       308              
Tennessee                 4       708              
Texas-Greater Dallas-Ft Worth                 13       2,384       4       1,473,634  
Texas-Greater Houston                 1       176       1       95,329  
Texas-Other     3       496       14       2,595              
Wisconsin                             1       122,205  
 Total     9       1,489       49       9,192       7       1,697,890  

 

We finance our acquisitions primarily through operating cash flow, proceeds from the sale of land and income-producing properties, and debt financing primarily in the form of property-specific, first-lien mortgage loans from commercial banks and institutional lenders. We finance our development projects principally with short-term, variable-rate construction loans that are refinanced with the proceeds of long-term, fixed-rate amortizing mortgages when the development has been completed and occupancy has been stabilized. When we sell properties, we may carry a portion of the sales price, generally in the form of a short-term interest bearing seller-financed note receivable, secured by the property being sold. We may also from time to time enter into partnerships or joint ventures with various investors to acquire land or income-producing properties, or to sell interests in some of our properties. 

 

We join with third-party development companies to construct residential apartment communities. At December 31, 2018, TCI and VAA each had three apartment projects in development. The third-party developer typically holds a general partner, as well as a limited partner interest in a limited partnership formed for the purpose of building a single property, while we generally take a limited partner interest in the limited partnership. We may contribute land to the partnership as part of our equity contribution or we may contribute the necessary funds to the partnership to acquire the land. We are required to fund all required equity contributions while the third-party developer is responsible for obtaining construction financing, hiring a general contractor and for the overall management, successful completion, initial lease-up and delivery of the project. We generally bear all the economic risks and rewards of ownership in these partnerships and therefore include these partnerships in our consolidated financial statements. The third-party developer is paid a developer fee typically equal to a percentage of the construction costs. When the project reaches stabilized occupancy, we acquire the third-party developer’s partnership interests in exchange for any remaining unpaid developer fees.

 

At December 31, 2018, our apartment projects in development included (dollars in thousands):

 

Property   Location   No. of Units     Costs to Date (1)     Total Projected
Costs (1)
 
Sugar Mill III   Addis, LA     72     $ 787     $ 11,862  
Parc at Denham Springs Phase II   Denham Springs, LA     144       6,532       18,768  
Overlook at Allensville Phase II   Sevierville, TN     144       12,646       20,244  
Total         360     $ 19,965     $ 50,874  

 

(1) Costs include construction hard costs, construction soft costs and loan borrowing costs.

 

We have made investments in a number of large tracts of undeveloped and partially developed land and intend to continue to improve these tracts of land for our own development purposes or make the improvements necessary to ready the land for sale to other developers.

 

At December 31, 2018, our investments in undeveloped and partially developed land consisted of the following (dollars in thousands):

 

Location   Acquired     Acres     Cost     Intended Use
Dallas, TX     1996-2013       21     $ 1,008     Mixed use
Farmers Branch, TX     2008       137       25,892     Mixed use
Kaufman County, TX    

2011

      1,963.68       51,961     Mixed use
Various     1990-2008       192       9,027     Various
Total Land Holdings             2,313.68     $ 87,888      
  5  

 

 

Significant Real Estate Acquisitions/Dispositions and Financings 

 

A summary of some of the significant transactions for the year ended December 31, 2018, are discussed below:

 

Purchases

 

During the year ended December 31, 2018, the Company purchased through one of its subsidiaries, seven residential apartment communities. A multi-family 80 unit community located in Baton Rouge, LA for a total purchase price of $12 million, paid through a seller’s financing note of $1.9 million, issuance of note payable of $8.6 million, and exercising an option to purchase of $1.5 million paid in the previous year. A multi-family 99 unit residential apartment community located in Mansfield, TX for a total purchase price of $14.8 million, paid through a seller’s financing note of $2.3 million, and an issuance of a note payable of $11.0 million. A multi-family 200 unit residential apartment community located in Gulf Shores, AL for a total purchase price of $18.1 million, paid through an issuance of a note payable of $11.5 million. A multi-family 144 unit residential apartment community located in Beaumont, TX for a total purchase price of $12.3 million. A multi-family 240 unit residential apartment community located in Houma, LA for a total purchase price of $20.1 million. A multi-family 208 unit residential apartment community located in Texarkana, TX for a total purchase price of $14.7 million. A multi-family 160 unit residential apartment community located in Tupelo, MS for a total purchase price of $11.1 million.

 

Sales

 

For the year ended December 31, 2018, TCI sold 62 acres of land to an independent third party for a total sales price of $3.0 million and recorded a gain of $1.3 million from the land sale. In the second quarter, a golf course comprising approximately 96.09 acres sold for an aggregate sales price of $2.3 million, out of which, $0.6 million was received in cash and $1.7 million in note receivables. During the first quarter, the Company sold six income-producing properties to a related party for an aggregate purchase price of $8.5 million, out of which, $2.1 million was received in cash and $6.4 million in note receivables. During the fourth quarter, the Company sold one income-producing property to a related party for a purchase price of $2.2 million. No gain or loss was recorded from the sale of income-producing properties.

 

In addition, on November 19, 2018, TCI through one of its subsidiaries formed VAA a joint venture with Macquarie. In connection with the formation of the joint venture, TCI contributed fifty-two properties and received a cash consideration of $236.8 million from Macquarie for a voting and profit participation right of 50% and 49%, respectively, 2% of the profits interest is held by Daniel J. Moos, who serves as the President and Chief Executive officer of the Company (“Class B Member”) and Manager of the joint venture. The Company recognized a gain of approximately $154.1 million from the sale of the contributed properties to the joint venture.

 

Mercer Crossing

 

In addition to the real estate sales noted above the Company recorded sales from a development project known as Mercer Crossing.

 

At November 2015, our real estate land holdings at Mercer Crossing consisted of land developable into residential homes and commercial projects, located in Farmers Branch, Texas. In November 2015, the Company entered into a sales contract with an unrelated party. The contract was for all of the developable land owned by the Company. In addition, IOR and ARL also sold land in this transaction. Total consideration for the sale was $75 million. The agreement among the parties to this transaction provides for TCI to hold the subordinated note from the buyer in the amount of $50 million. At the closing, due to the inadequate down payment from the buyer and the level of seller financing involved, the transaction was accounted for under the deposit method. Under the deposit method, no revenue is recognized and the asset sold remains on the books until the criteria for full revenue recognition are met.

 

During the third quarter of 2018, due to significant cumulative sales of real estate to unrelated third parties and cash received by TCI, the criteria for recording full accrual accounting had been met. Through the period ended August 21, 2018, approximately $28.1 million of the assets previously held by the Company were sold, resulting in a gain of $7.5 million.

  

On August 22, 2018 the Company reacquired all the unsold portions of the real estate from the November 2015 transaction for the amount that remained from the original sales price.

 

During the period August 23, 2018 through December 31, 2018 additional Mercer Crossing real estate was sold for $11.7 million resulting in a net gain on sale of real estate of $5.6 million.

 

  6  

 

 

As of December 31, 2018, the Company has approximately 86 acres of land, at various locations that were sold to related parties in multiple transactions.  These transactions are treated as “subject to sales contract” on the Consolidated Balance Sheets.  Due to the related party nature of the transactions TCI has deferred the recording of the sales in accordance with ASC 360-20.

 

We continue to invest in the development of apartment projects. During the year ended December 31, 2018, we have invested $14.8 million related to the construction or predevelopment of various apartment complexes and capitalized $0.1 million of interest costs.

 

Business Plan and Investment Policy

 

Our business objective is to maximize long-term value for our stockholders by investing in residential and commercial real estate through the acquisition, development and ownership of apartments, commercial properties and land. We intend to achieve this objective through acquiring and developing properties in multiple markets and operating as an industry-leading landlord. We believe this objective will provide the benefits of enhanced investment opportunities, economies of scale and risk diversification, both in terms of geographic market and real estate product type. We believe our objective will also result in continuing access to favorably priced debt and equity capital. In pursuing our business objective, we seek to achieve a combination of internal and external growth while maintaining a strong balance sheet and employing a strategy of financial flexibility. We maximize the value of our apartments and commercial properties by maintaining high occupancy levels while charging competitive rental rates, controlling costs and focusing on tenant retention. We also pursue attractive development opportunities either directly or in partnership with other investors.

 

For our portfolio of commercial properties, we generate increased operating cash flow through annual contractual increases in rental rates under existing leases. We also seek to identify best practices within our industry and across our business units in order to enhance cost savings and gain operating efficiencies. We employ capital improvement and preventive maintenance programs specifically designed to reduce operating costs and increase the long-term value of our real estate investments.

 

We seek to acquire properties consistent with our business objectives and strategies. We execute our acquisition strategy by purchasing properties which management believes will create stockholder value over the long-term. We will also sell properties when management believes value has been maximized or when a property is no longer considered an investment to be held long-term.

  

We are continuously in various stages of discussions and negotiations with respect to development, acquisition, and disposition of projects. The consummation of any current or future development, acquisition, or disposition, if any, and the pace at which any may be completed cannot be assured or predicted.

  

Substantially all of our properties are owned by subsidiary companies, many of which are single-asset entities. This ownership structure permits greater access to financing for individual properties and permits flexibility in negotiating a sale of either the asset or the equity interests in the entity owning the asset. From time-to-time, our subsidiaries have invested in joint ventures with other investors, creating the possibility of risks that do not exist with properties solely owned by a TCI subsidiary. In those instances where other investors are involved, those other investors may have business, economic, or other objectives that are inconsistent with our objectives, which may in turn, require us to make investment decisions different from those if we were the sole owner.

  

Real estate generally cannot be sold quickly. We may not be able to promptly dispose of properties in response to economic or other conditions. To offset this challenge, selective dispositions have been a part of our strategy to maintain an efficient investment portfolio and to provide additional sources of capital. We finance acquisitions through mortgages, internally generated funds, and, to a lesser extent, property sales. Those sources provide the bulk of funds for future acquisitions. We may purchase properties by assuming existing loans secured by the acquired property. When properties are acquired in such a manner, we customarily seek to refinance the asset in order to properly leverage the asset in a manner consistent with our investment objectives.

 

Our businesses are not generally seasonal with regard to real estate investments. Our investment strategy seeks both current income and capital appreciation. Our plan of operation is to continue, to the extent our liquidity permits, to make equity investments in income-producing real estate such as apartments and commercial properties. We may also invest in the debt or equity securities of real estate-related entities. We intend to pursue higher risk, higher reward investments, such as improved and unimproved land where we can obtain reasonably-priced financing for substantially all of a property’s purchase price. We intend to continue the development of apartment properties in selected markets in Texas and in other locations where we believe adequate levels of demand exist. We intend to pursue sales opportunities for properties in stabilized real estate markets where we believe our properties’ value has been maximized. We also intend to be an opportunistic seller of properties in markets where demand exceeds current supply. Although we no longer actively seek to fund or purchase mortgage loans, we may, in selected instances, originate mortgage loans or we may provide purchase money financing in conjunction with a property sale.

 

  7  

 

  

Our Board of Directors has broad authority under our governing documents to make all types of investments, and we may devote available resources to particular investments or types of investments without restriction on the amount or percentage of assets that may be allocated to a single investment or to any particular type of investment, and without limit on the percentage of securities of any one issuer that may be acquired. Investment objectives and policies may be changed at any time by the Board without stockholder approval.

 

The specific composition from time-to-time of our real estate portfolio owned by TCI directly and through our subsidiaries depends largely on the judgment of management to changing investment opportunities and the level of risk associated with specific investments or types of investments. We intend to maintain a real estate portfolio that is diversified by both location and type of property.

 

Competition

 

The real estate business is highly competitive and TCI competes with numerous companies engaged in real estate activities (including certain entities described in Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence”), some of which have greater financial resources than TCI. We believe that success against such competition is dependent upon the geographic location of a property, the performance of property-level managers in areas such as leasing and marketing, collection of rents and control of operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors include ease of access to a property, the adequacy of related facilities such as parking and other amenities, and sensitivity to market conditions in determining rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the residents. We believe that beyond general economic circumstances and trends, the degree to which properties are renovated or new properties are developed in the competing submarket are also competitive factors. Refer to Part I, Item 1A. “Risk Factors”.

 

To the extent that TCI seeks to sell any properties, the sales prices for the properties may be affected by competition from other real estate owners and financial institutions also attempting to sell properties in areas where TCI’s properties are located, as well as aggressive buyers attempting to dominate or penetrate a particular market.

 

As described above and in Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence”, the officers and directors of TCI serve as officers and directors of ARL and IOR. Both ARL and IOR have business objectives similar to those of TCI. TCI’s officers and directors owe fiduciary duties to both IOR and ARL as well as to TCI under applicable law. In determining whether a particular investment opportunity will be allocated to TCI, IOR, or ARL, management considers the respective investment objectives of each Company and the appropriateness of a particular investment in light of each Company’s existing real estate and mortgage notes receivable portfolio. To the extent that any particular investment opportunity is appropriate to more than one of the entities, the investment opportunity may be allocated to the entity which has had funds available for investment for the longest period of time, or, if appropriate, the investment may be shared among all three or two of the entities. 

 

In addition, as described in Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence”, TCI competes with related parties of Pillar having similar investment objectives related to the acquisition, development, disposition, leasing and financing of real estate and real estate-related investments. In resolving any potential conflicts of interest which may arise, Pillar has informed TCI that it intends to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.

  

We have historically engaged in and will continue to engage in certain business transactions with related parties, including but not limited to asset acquisitions and dispositions. Transactions involving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in the best interests of the Company. 

 

Available Information  

 

TCI maintains an internet site at http://www.transconrealty-invest.com. We make available through our website free of charge Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, reports filed pursuant to Section 16 and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission. In addition, we have posted the charters for our Audit Committee, Compensation Committee and Governance and Nominating Committee, as well as our Code of Business Conduct and Ethics, Corporate Governance Guidelines on Director Independence and other information on the website. These charters and principles are not incorporated in this Report by reference. We will also provide a copy of these documents free of charge to stockholders upon written request. The Company issues Annual Reports containing audited financial statements to its common shareholders. 

 

  8  

 

 

ITEM 1A. RISK FACTORS

  

An investment in our securities involves various risks. All investors should carefully consider the following risk factors in conjunction with the other information in this report before trading our securities. 

 

Risk Factors Related to our Business  

 

Adverse events concerning our existing tenants or negative market conditions affecting our existing tenants could have an adverse impact on our ability to attract new tenants, release space, collect rent or renew leases, and thus could adversely affect cash flow from operations and inhibit growth.

 

Cash flow from operations depends in part on the ability to lease space to tenants on economically favorable terms. We could be adversely affected by various facts and events over which the Company has limited or no control, such as: 

 

  lack of demand for space in areas where the properties are located;

 

  inability to retain existing tenants and attract new tenants;

 

  oversupply of or reduced demand for space and changes in market rental rates;

 

  defaults by tenants or failure to pay rent on a timely basis;

 

  the need to periodically renovate and repair marketable space;

 

  physical damage to properties;

 

  economic or physical decline of the areas where properties are located; and

 

  potential risk of functional obsolescence of properties over time.

  

At any time, any tenant may experience a downturn in its business that may weaken its financial condition. As a result, a tenant may delay lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent or declare bankruptcy. Any tenant bankruptcy or insolvency, leasing delay or failure to make rental payments when due, could result in the termination of the tenant’s lease and material losses to the Company. 

  

If tenants do not renew their leases as they expire, we may not be able to rent the space. Furthermore, leases that are renewed, and some new leases for space that is re-let, may have terms that are less economically favorable than expiring lease terms, or may require us to incur significant costs, such as renovations, tenant improvements or lease transaction costs. Any of these events could adversely affect cash flow from operations and our ability to make distributions to shareholders and service indebtedness. A significant portion of the costs of owning property, such as real estate taxes, insurance, and debt service payments, are not necessarily reduced when circumstances cause a decrease in rental income from the properties. 

 

We may not be able to compete successfully with other entities that operate in our industry.

 

We experience a great deal of competition in attracting tenants for the properties and in locating land to develop and properties to acquire. 

 

In our effort to lease properties, we compete for tenants with a broad spectrum of other landlords in each of the markets. These competitors include, among others, publicly-held REITs, privately-held entities, individual property owners and tenants who wish to sublease their space. Some of these competitors may be able to offer prospective tenants more attractive financial terms than we are able to offer. 

 

If the availability of land or high quality properties in our markets diminishes, operating results could be adversely affected. 

 

We may experience increased operating costs which could adversely affect our financial results and the value of our properties.  

 

Our properties are subject to increases in operating expenses such as insurance, cleaning, electricity, heating, ventilation and air conditioning, administrative costs and other costs associated with security, landscaping, repairs, and maintenance of the properties. While some current tenants are obligated by their leases to reimburse us for a portion of these costs, there is no assurance that these tenants will make such payments or agree to pay these costs upon renewal or new tenants will agree to pay these costs. If operating expenses increase in our markets, we may not be able to increase rents or reimbursements in all of these markets to offset the increased expenses, without at the same time decreasing occupancy rates. If this occurs, our ability to make distributions to shareholders and service indebtedness could be adversely affected.

 

  9  

 

 

Our ability to achieve growth in operating income depends in part on our ability to develop additional properties.  

 

We intend to continue to develop properties where warranted by market conditions. We have a number of ongoing development and land projects being readied for commencement. 

 

Additionally, general construction and development activities include the following risks: 

 

  construction and leasing of a property may not be completed on schedule, which could result in increased expenses and construction costs, and would result in reduced profitability for that property;

 

  construction costs may exceed original estimates due to increases in interest rates and increased cost of materials, labor or other costs, possibly making the property less profitable because of inability to increase rents to compensate for the increase in construction costs;

 

  some developments may fail to achieve expectations, possibly making them less profitable;

 

  we may be unable to obtain, or face delays in obtaining, required zoning, land-use, building, occupancy, and other governmental permits and authorizations, which could result in increased costs and could require us to abandon our activities entirely with respect to a project;

 

  we may abandon development opportunities after the initial exploration, which may result in failure to recover costs already incurred. If we determine to alter or discontinue its development efforts, future costs of the investment may be expensed as incurred rather than capitalized and we may determine the investment is impaired resulting in a loss;

 

  we may expend funds on and devote management’s time to projects which will not be completed; and

 

  occupancy rates and rents at newly-completed properties may fluctuate depending on various factors including market and economic conditions, and may result in lower than projected rental rates and reduced income from operations.

 

We face risks associated with property acquisitions.  

 

We acquire individual properties and various portfolios of properties and intend to continue to do so. Acquisition activities are subject to the following risks: 

 

  when we are able to locate a desired property, competition from other real estate investors may significantly increase the seller’s offering price;

  

  acquired properties may fail to perform as expected;

 

  the actual costs of repositioning or redeveloping acquired properties may be higher than original estimates;

 

  acquired properties may be located in new markets where we face risks associated with an incomplete knowledge or understanding of the local market, a limited number of established business relationships in the area and a relative unfamiliarity with local governmental and permitting procedures; and

 

  we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into existing operations, and results of operations and financial condition could be adversely affected.

  

We may acquire properties subject to liabilities and without any recourse, or with limited recourse, with respect to unknown liabilities. However, if an unknown liability was later asserted against the acquired properties, we might be required to pay substantial sums to settle it, which could adversely affect cash flow. 

 

  10  

 

 

Many of our properties are concentrated in our primary markets and the Company may suffer economic harm as a result of adverse conditions in those markets.  

 

Our properties are located principally in specific geographic areas in the southwestern, southeastern, and mid-western United States. The Company’s overall performance is largely dependent on economic conditions in those regions. 

 

Our investments in joint ventures may decrease our ability to manage risk.

 

We conduct some of our operations through a joint venture in which we share control over certain economic and business interests with our joint venture partner. Our joint venture partner may have economic, business or legal interests or goals that are inconsistent with our goals and interests or may be unable to meet their obligations. Failure by us, or an entity in which we have a joint-venture interest, to adequately manage the risks associated with any acquisitions or joint ventures could have a material adverse effect on the financial condition or results of operations of our joint ventures and adversely affect our business, financial condition, results of operations and cash flows.

 

We are leveraged and may not be able to meet our debt service obligations.

 

We had total indebtedness, including bonds and notes payable, at December 31, 2018 of approximately $449.4 million. Substantially all assets have been pledged to secure debt. These borrowings increase the risk of loss because they represent a prior claim on assets and most require fixed payments regardless of profitability. Our leveraged position makes us vulnerable to declines in the general economy and may limit the Company’s ability to pursue other business opportunities in the future.

 

We may not be able to access financial markets to obtain capital on a timely basis, or on acceptable terms.

 

We rely on proceeds from property dispositions and third party capital sources for a portion of our capital needs, including capital for acquisitions and development. The public debt and equity markets are among the sources upon which the Company relies. There is no guarantee that we will be able to access these markets or any other source of capital. The ability to access the public debt and equity markets depends on a variety of factors, including:

  

  general economic conditions affecting these markets;

 

  our own financial structure and performance;

 

  the market’s opinion of real estate companies in general; and

 

  the market’s opinion of real estate companies that own similar properties;

  

We may suffer adverse effects as a result of terms and covenants relating to the Company’s indebtedness.

 

Required payments on our indebtedness generally are not reduced if the economic performance of the portfolio declines. If the economic performance declines, net income, cash flow from operations and cash available for distribution to stockholders may be reduced. If payments on debt cannot be made, we could sustain a loss or suffer judgments, or in the case of mortgages, suffer foreclosures by mortgagees. Further, some obligations contain cross-default and/or cross-acceleration provisions, which means that a default on one obligation may constitute a default on other obligations.

  

We anticipate only a small portion of the principal of its debt will be repaid prior to maturity. Therefore, we are likely to refinance a portion of its outstanding debt as it matures. There is a risk that we may not be able to refinance existing debt or the terms of any refinancing will not be as favorable as the terms of the maturing debt. If principal balances due at maturity cannot be refinanced, extended, or repaid with proceeds from other sources, such as the proceeds of sales of assets or new equity capital, cash flow may not be sufficient to repay all maturing debt in years when significant “balloon” payments come due.

  

Our credit facilities and unsecured debt contain customary restrictions, requirements and other limitations on the ability to incur indebtedness, including total debt to asset ratios, secured debt to total asset ratios, debt service coverage ratios, and minimum ratios of unencumbered assets to unsecured debt. Our continued ability to borrow is subject to compliance with financial and other covenants. In addition, failure to comply with such covenants could cause a default under credit facilities, and we may then be required to repay such debt with capital from other sources. Under those circumstances, other sources of capital may not be available, or be available only on unattractive terms.

 

  11  

 

 

Our degree of leverage could limit our ability to obtain additional financing or affect the market price of our common stock.

 

The degree of leverage could affect our ability to obtain additional financing for working capital, capital expenditures, acquisitions, development or other general corporate purposes. The degree of leverage could also make us more vulnerable to a downturn in business or the general economy.

 

An increase in interest rates would increase interest costs on variable rate debt and could adversely impact the ability to refinance existing debt.

 

We currently have, and may incur more, indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will the interest costs, which could adversely affect cash flow and the ability to pay principal and interest on our debt and the ability to make distributions to shareholders. Further, rising interest rates could limit our ability to refinance existing debt when it matures.

 

Unbudgeted capital expenditures or cost overruns could adversely affect business operations and cash flow.

 

If capital expenditures for ongoing or planned development projects or renovations exceed expectations, the additional cost of these expenditures could have an adverse effect on business operations and cash flow. In addition, we might not have access to funds on a timely basis to pay the unexpected expenditures.

 

Construction costs are funded in large part through construction financing which the Company may guarantee. The Company’s obligation to pay interest on this financing continues until the rental project is completed, leased up and permanent financing is obtained, or the project is sold or the construction loan is otherwise paid. Unexpected delays in completion of one or more ongoing projects could also have a significant adverse impact on business operations and cash flow.

 

We may need to sell properties from time to time for cash flow purposes.

 

Because of the lack of liquidity of real estate investments, our ability to respond to changing circumstances may be limited and generally real estate investments cannot be sold quickly. In the event that we must sell assets to generate cash flow, we cannot predict whether there will be a market for those assets in the time period desired, or whether we will be able to sell the assets at a price that will allow the Company to fully recoup its investment. We may not be able to realize the full potential value of the assets and may incur costs related to the early pay-off of the debt secured by such assets.

 

We intend to devote resources to the development of new projects.

 

We plan to continue developing new projects as opportunities arise in the future. Development and construction activities entail a number of risks, including but not limited to the following: 

 

  we may abandon a project after spending time and money determining its feasibility;

  

  construction costs may materially exceed original estimates;

  

  the revenue from a new project may not be enough to make it profitable or generate a positive cash flow;

  

  we may not be able to obtain financing on favorable terms for development of a property, if at all;

  

  we may not complete construction and lease-ups on schedule, resulting in increased development or carrying costs; and

  

  we may not be able to obtain, or may be delayed in obtaining, necessary governmental permits.

 

The overall business is subject to all of the risks associated with the real estate industry.

 

We are subject to all risks incident to investment in real estate, many of which relate to the general lack of liquidity of real estate investments, including, but not limited to:

 

  our real estate assets are concentrated primarily in the southwest and any deterioration in the general economic conditions of this region could have an adverse effect;

 

  changes in interest rates may make the ability to satisfy debt service requirements more burdensome;

 

  lack of availability of financing may render the purchase, sale or refinancing of a property more difficult or unattractive;

 

  12  

 

 

  changes in real estate and zoning laws;

 

  increases in real estate taxes and insurance costs;

 

  federal or local economic or rent control;

 

  acts of terrorism; and

  

  hurricanes, tornadoes, floods, earthquakes and other similar natural disasters.

  

Our performance and value are subject to risks associated with our real estate assets and with the real estate industry.

 

Our economic performance and the value of our real estate assets, and consequently the value of our securities, are subject to the risk that if our properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow will be adversely affected. The following factors, among others, may adversely affect the income generated by our properties:

 

  downturns in the national, regional and local economic conditions (particularly increases in unemployment);

 

  competition from other office and commercial buildings;  

 

  local real estate market conditions, such as oversupply or reduction in demand for office or other commercial space;

 

  changes in interest rates and availability of financing;

 

  vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space;

 

  increased operating costs, including insurance expense, utilities, real estate taxes, state and local taxes and heightened security costs;

 

  civil disturbances, earthquakes and other natural disasters, or terrorist acts or acts of war which may result in uninsured or underinsured losses;

 

  significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs which are generally not reduced when circumstances cause a reduction in revenues from a property;

 

  declines in the financial condition of our tenants and our ability to collect rents from our tenants; and

 

 

decreases in the underlying value of our real estate. 

 

  13  

 

 

Adverse economic conditions and dislocations in the credit markets could have a material adverse effect on our results of operations, and financial condition.  

 

Our business may be affected by market and economic challenges experienced by the U.S. economy or real estate industry as a whole or by the local economic conditions in the markets in which our properties are located, including the current dislocations in the credit markets and general global economic recession. These current conditions, or similar conditions existing in the future, may adversely affect our results of operations, and financial condition as a result of the following, among other potential consequences: 

 

  the financial condition of our tenants may be adversely affected which may result in tenant defaults under leases due to bankruptcy, lack of liquidity, operational failures or for other reasons;

 

  significant job losses within our tenants may occur, which may decrease demand for our office space, causing market rental rates and property values to be negatively impacted;

 

  our ability to borrow on terms and conditions that we find acceptable, or at all, may be limited, which could reduce our ability to pursue acquisition and development opportunities and refinance existing debt, reduce our returns from our acquisition and development activities and increase our future interest expense;

 

  reduced values of our properties may limit our ability to dispose of assets at attractive prices or to obtain debt financing secured by our properties and may reduce the availability of unsecured loans; and

 

  one or more lenders could refuse to fund their financing commitment to us or could fail and we may not be able to replace the financing commitment of any such lenders on favorable terms, or at all.

  

Real estate investments are illiquid, and we may not be able to sell properties if and when it is appropriate to do so.  

 

Real estate generally cannot be sold quickly. We may not be able to dispose of properties promptly in response to economic or other conditions. In addition, provisions of the Internal Revenue Code may limit our ability to sell properties (without incurring significant tax costs) in some situations when it may be otherwise economically advantageous to do so, thereby adversely affecting returns to stockholders and adversely impacting our ability to meet our obligations. 

 

ITEM 1B.     UNRESOLVED STAFF COMMENTS

 

None.

 

  14  

 

 

ITEM 2. PROPERTIES

  

On December 31, 2018, our portfolio consisted of sixteen income-producing properties consisting of nine apartment communities totaling 1,489 units, seven commercial properties consisting of five office buildings and two retail centers. In addition, we own or control 3,199 acres of improved and unimproved land held for future development or sale. The average annual rental and other property revenue dollar per square foot is $6.53 for the Company’s residential apartment portfolio and $19.80 for the commercial portfolio. Through our joint venture VAA we have a 50 percent ownership interest to a portfolio of forty nine income-producing properties with a total of 8,887 units, which generated an average annual rental revenue of $12.83 per square foot. The table below shows information relating to those properties in which we own or have an ownership interest, all of which are suitable and adequate for the purpose for which each is utilized: 

 

Residential Apartments   Location   Units     Occupancy  
Chelsea   Beaumont, TX     144       95.14 %
Farnham Park   Port Arthur, TX     144       94.44 %
Landing Bayou   Houma, LA     240       77.08 %
Legacy at Pleasant Grove   Texarkana, TX     208       91.83 %
Toulon   Gautier, MS     240       99.17 %
Villager   Fort Walton, FL     33       100.00 %
Villas at Bon Secour   Gulf Shores, AL     200       99.00 %
Vista Ridge   Tupelo, MS     160       93.75 %
Westwood   Mary Ester FL     120       99.17 %
9   Total Apartment Units     1,489          

 

Office Buildings   Location     SqFt       Occupancy  
600 Las Colinas   Irving, TX     512,210       86.75 %
770 South Post Oak   Houston, TX     95,329       86.95 %
Browning Place (Park West I)   Farmers Branch, TX     625,378       98.15 %
Senlac (VHP)   Farmers Branch, TX     2,812       100.00 %
Stanford Center   Dallas, TX     333,234       97.79 %
5   Total Office Buildings     1,568,963          

 

Retail Centers   Location     SqFt       Occupancy  
Bridgeview Plaza   LaCrosse, WI     122,205       89.45 %
Fruitland Park   Fruitland Park, FL     6,722       100.00 %
2   Total Retail Centers     128,927          
    Total Commercial     1,697,890          
  15  

 

 

Our joint venture investee VAA, owns the following residential properties:

 

Residential Apartments   Location   Units     Occupancy  
Adobe Red Rock   Las Vegas, NV     308       41.60 %
Apalachee Point   Tallahassee, FL     200       96.24 %
Blue Lake Villas   Waxahachie, TX     186       93.25 %
Blue Lake Villas Phase II   Waxahachie, TX     70       92.92 %
Breakwater Bay   Beaumont, TX     176       92.72 %
Bridgewood Ranch   Kaufman, TX     106       95.75 %
Capitol Hill   Little Rock, AR     156       92.80 %
Centennial Village   Oak Ridge,TN     252       91.00 %
Crossings Of Opelika   Opelika, AL     168       94.83 %
Dakota Arms   Lubbock, TX     208       93.23 %
Desoto Ranch   DeSoto, TX     248       92.21 %
Eagle Crossing   Dallas, TX     150       95.46 %
Falcon Lakes   Arlington, TX     248       94.67 %
Heather Creek   Mesquite, TX     200       93.76 %
Lake Forest   Humble, TX     240       94.29 %
Lodge At Pecan Creek   Denton, TX     192       89.05 %
Lofts at Reynolds Village   Asheville, NC     201       93.90 %
Mansions Of Mansfield   Mansfield, TX     208       97.38 %
McKinney Point   McKinney, TX     198       95.24 %
Metropolitan   Little Rock, AR     260       92.41 %
Mission Oaks   San Antonio, TX     228       94.09 %
Northside On Travis   Sherman, TX     200       94.00 %
Oak Hollow Phase I   Seguin, TX     160       92.81 %
Oak Hollow Phase II   Seguin, TX     96       86.74 %
Oceanaire   Biloxi, MS     196       93.87 %
Overlook At Allensville   Sevierville, TN     144       95.26 %
Parc @ Wylie   Wylie, TX     198       92.99 %
Parc at Bentonville   Bentonville, AR     216       88.96 %
Parc At Clarksville   Clarksville, TN     168       95.21 %
Parc At Denham Springs   Denham Spring, LA     224       90.78 %
Parc at Garland   Garland, TX     198       94.97 %
Parc at Mansfield   Mansfield, TX     99       96.65 %
Parc At Maumelle   Little Rock, AR     240       90.18 %
Parc At Metro Center   Nashville, TN     144       98.61 %
Parc At Rogers   Rogers, AR     250       94.82 %
Preserve At Pecan Creek   Denton, TX     192       95.13 %
Preserve At Prairie Pointe   Lubbock, TX     184       93.65 %
Residences At Holland Lake   Weatherford, TX     208       95.08 %
Sawgrass Creek   New Port Richey, FL     188       30.57 %
Sonoma Court   Rockwall, TX     124       93.35 %
Sugar Mill Phase I   Baton Rouge, LA     160       89.25 %
Sugar Mill Phase II   Addis, LA     80       87.95 %
Tattersall Village   Hinesville, GA     222       90.03 %
Tradewinds   Midland, TX     214       97.31 %
Villas At Park West I   Pueblo, CO     148       91.84 %
Villas At Park West II   Pueblo, CO     112       94.53 %
Vistas Of Vance Jackson   San Antonio, TX     240       92.35 %
Waterford At Summer Park   Rosenberg, TX     196       96.50 %
Windsong   Fort Worth, TX     188       96.15 %
49   Total Apartment Units     9,192          

 

  16  

 

 

Commercial Lease Expirations 

 

The following table summarizes our commercial lease expirations as of December 31, 2018:

 

Year of Lease
Expiration
    Rentable Square Feet
Subject to
Expiring Leases
    Current Annualized(1)
Contractual Rent
Under Expiring Leases
    Current Annualized(1)
Contractual Rent
Under Expiring Leases (P.S.F.)
    Percentage
of Total
Square Feet
    Percentage
of Gross
Rentals
 
2019       250,228     $ 4,392,415     $ 17.55       14.7 %     14.3 %
2020       132,376       2,786,951       21.05       7.8 %     9.1 %
2021       135,017       2,800,861       20.74       8.0 %     9.1 %
2022       237,489       5,184,674       21.83       14.0 %     16.9 %
2023       339,701       5,717,047       16.83       20.0 %     18.6 %
2024       237,549       4,979,956       20.96       14.0 %     16.2 %
2025       113,829       2,604,020       22.88       6.7 %     8.5 %
2026       23,432       609,232       26.00       1.4 %     2.0 %
Thereafter       56,926       1,627,426       28.59       3.4 %     5.3 %
Total       1,526,547     $ 30,702,582           90.0 %     100 %

 

  (1) Represents the monthly contractual base rent and recoveries from tenants under existing leases as of December 31, 2018, multiplied by twelve. This amount reflects total rent before any rent abatements and includes expense reimbursements which may be estimates as of such date.

 

The table below shows information related to the land parcels we own as of December 31, 2018:

 

Land   Location   Acres  
2427 Valley View Ln   Farmers Branch, TX     0.19  
Bonneau Land   Farmers Branch, TX     5.01  
Cooks Lane   Fort Worth, TX     23.24  
Dedeaux   Gulfport, MS     10.00  
Dominion Mercer   Farmers Branch, TX     3.16  
Gautier   Gautier, MS     3.46  
Lacy Longhorn   Farmers Branch, TX     3.04  
Lake Shore Villas   Humble, TX     19.51  
Lubbock   Lubbock, TX     2.86  
McKinney 36   Collin County, TX     19.17  
Minivest   Dallas, TX     0.23  
Mira Lago   Farmers Branch, TX     6.55  
Nashville   Nashville, TN     6.25  
Nicholson Croslin   Dallas, TX     0.80  
Nicholson Mendoza   Dallas, TX     0.35  
Ocean Estates   Gulfport, MS     12.00  
Texas Plaza   Irving, TX     10.33  
Travis Ranch   Kaufman County, TX     8.66  
Travis Ranch Retail   Kaufman County, TX     8.13  
Union Pacific Railroad   Dallas, TX     0.04  
Valley View 34   Farmers Branch, TX     1.31  
Whorton Land   Bentonville, AR     64.44  
Willowick   Pensacola, FL     39.78  
Windmill Farms   Kaufman County, TX     1,855.68  
    Total Land/Development     2,104.18  

 

Land Subject to Sales Contract   Location   Acres  
Dominion Tract   Farmers Branch, TX     6.33  
Mercer Crossing   Farmers Branch, TX     186.59  
Windmill Farms   Kaufman County, TX     108.00  
    Total Land Subject to Sales Contract     300.92  
    Total Land     2,405.10  

 

  17  

 

 

ITEM 3.  LEGAL PROCEEDINGS

 

Dynex Capital, Inc.

 

On July 20, 2015, the 68th Judicial District Court in Dallas County, Texas issued its Final Judgment in Cause No. DC-03-00675, styled Basic Capital Management, Inc., American Realty Trust, Inc., Transcontinental Realty Investors, Inc., Continental Poydras Corp., Continental Common, Inc. and Continental Baronne, Inc. v. Dynex Commercial, Inc. The case, which was litigated for more than a decade, had its origin with Dynex Commercial making loans to Continental Poydras Corp., Continental Common, Inc. and Continental Baronne, Inc. (subsidiaries of Continental Mortgage & Equity Trust (“CMET”), an entity which merged into TCI in 1999 after the original suit was filed). Under the original loan commitment, $160 million in loans were to be made to the entities. The loans were conditioned on the execution of a commitment between Dynex Commercial and Basic Capital Management, Inc. (“Basic”).

 

An original trial in 2004, which also included Dynex Capital, Inc. as a defendant, resulted in a jury awarding damages in favor of Basic for “lost opportunity,” as well as damages in favor of ART and in favor of TCI and its subsidiaries for “increased costs” and “lost opportunity.” The original Trial Court judge ignored the jury’s findings, however, and entered a “Judgment Notwithstanding the Verdict” (“JNOV”) in favor of the Dynex entities (the judge held the Plaintiffs were not entitled to any damages from the Dynex entities). After numerous appeals by all parties, Dynex Capital, Inc. was ultimately dismissed from the case and the remaining claims against Dynex Commercial were remanded to the Trial Court for a new judgment consistent with the jury’s findings. The Court entered the new Final Judgment against Dynex Commercial, Inc. on July 20, 2015. 

 

The Final Judgment entered against Dynex Commercial, Inc. on July 20, 2015 awarded Basic $0.256 million in damages, plus pre-judgment interest of $0.192 million for a total amount of $0.448 million. The Judgment awarded ART $14.2 million in damages, plus pre-judgment interest of $10.6 million for a total amount of $24.8 million. The Judgment awarded TCI $11.1 million, plus pre-judgment interest of $8.4 million for a total amount of $19.5 million. The Judgment also awarded Basic, ART, and TCI post-judgment interest at the rate of 5% per annum from April 25, 2014 until the date their respective damages are paid. Lastly, the Judgement awarded Basic, ART, and TCI $1.6 million collectively in attorneys’ fees from Dynex Commercial, Inc. 

 

The Company is working with counsel to identify assets and collect on the Final Judgment against Dynex Commercial, Inc., as well as explore possible additional claims, if any, against Dynex Capital, Inc. 

 

Berger Litigation

 

On February 4, 2019, an individual claiming to be a stockholder holding 7,900 shares of Common Stock of Income Opportunity Realty Investors, Inc. (“IOR”) filed a Complaint in the United States District Court for the Northern District of Texas, Dallas Division, individually and allegedly derivatively on behalf of IOR, against Transcontinental Realty Investors, Inc. (“TCI”), American Realty Investors, Inc. (“ARL”), (TCI is a shareholder of IOR, ARL is a shareholder of TCI) Pillar Income Asset Management, Inc. (“Pillar”), ( collectively the “Companies”), certain officers and directors of the Companies (“Additional Parties”) and two other individuals. The Complaint filed alleges that the sale and/or exchange of certain tangible and intangible property between the Companies and IOR during the last ten years of business operations constitutes a breach of fiduciary duty by the one or more of Companies, the Additional Defendants and/or the directors of IOR. The case alleges other related claims. The Plaintiff seeks certification as a representative of IOR and all of its shareholders, unspecified damages, a return to IOR of various funds and an award of costs, expenses, disbursements (including Plaintiff’s attorneys’ fees) and prejudgment and post-judgment interest. The named Defendants intend to vigorously defend the action, deny all of the allegations of the Complaint, and believe the allegations to be wholly without any merit. While only in the early stages of defending the case, it is not clear that Plaintiff owns any shares of Common Stock of IOR or would be a proper representative of IOR or a class of minority stockholders.

 

Litigation. The ownership of property and provision of services to the public as tenants entails an inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, in the opinion of management, the outcome of such litigation will not have a material adverse impact upon the Company’s financial condition, results of operation or liquidity.

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

Not applicable. 

 

18

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

TCI’s Common stock is listed and traded on the NYSE American under the symbol “TCI”. The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the NYSE American for the quarters ended:

 

    2018     2017  
    High     Low     High     Low  
First Quarter   $ 46.00     $ 25.14     $ 21.50     $ 11.94  
Second Quarter   $ 52.00     $ 23.90     $ 27.64     $ 16.50  
Third Quarter   $ 38.25     $ 28.36     $ 29.69     $ 20.37  
Fourth Quarter   $ 37.42     $ 26.73     $ 35.00     $ 26.39  

 

On March 15, 2019, the closing price of TCI’s common stock as reported on the NYSE American was $34.70 per share, and was held by approximately 3,700 holders of record.

 

TCI’s Board of Directors established a policy that dividend declarations on common stock would be determined on an annual basis following the end of each year. In accordance with that policy, the board determined not to pay any dividends on common stock in 2018, 2017 or 2016. Future distributions to common stockholders will be determined by the Board of Directors in light of conditions then existing, including the Company’s financial condition and requirements, future prospects, restrictions in financing agreements, business conditions and other factors deemed relevant by the Board.

 

In December 1989, the Board of Directors approved a share repurchase program, authorizing the repurchase of a total of 687,000 shares of TCI’s Common stock. In June 2000, the Board increased this authorization to 1,387,000 shares. On August 10, 2010, the Board of Directors approved an increase in the share repurchase program for up to an additional 250,000 shares of common stock which resulted in a total authorization under the repurchase program for up to 1,637,000 shares of our common stock. This repurchase program has no termination date. There were no shares repurchased for the year ended December 31, 2018.

 

In November 2006, TCI issued 100,000 shares of Series D Preferred Stock with a liquidation preference of $100 per share. The preferred stock is not convertible into any other security, requires dividends payable at the initial rate of 7% annually. The dividend rate increases ratably from 7% to 9% in future periods and can be redeemed at any point after September 30, 2011. 

 

During the fourth quarter of 2018, all 100,000 shares of Series D Preferred Stock were redeemed for $17.2 million, of which $7.2 million was accrued unpaid dividends. At December 31, 2018, there were no preferred shares outstanding.

 

19

 

ITEM 6.  SELECTED FINANCIAL DATA

 

The following table sets forth selected consolidated financial data derived from our audited financial statements for each of the five years in the period ended December 31, 2018. The data presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in Part II, Item 7 of this Annual Report and the consolidated financial statements and the accompanying notes set forth in Part II, Item 8 of this Annual Report.

 

    For the Years Ended December 31,  
    2018     2017     2016     2015     2014  
    (dollars in thousands, except share and per share amounts)  
EARNINGS DATA                                        
Rental and other property revenues   $ 120,955     $ 125,233     $ 118,471     $ 102,220     $ 75,858  
Total operating expenses     104,834       105,128       100,824       92,919       75,087  
Operating income     16,121       20,105       17,647       9,301       771  
Other expenses     (1,401 )     (49,967 )     (36,628 )     (36,095 )     (17,613 )
Income (loss) before gain on disposition of 50% interest in VAA, gain on land sales, non-controlling interest, and taxes     14,720       (29,862 )     (18,981 )     (26,794 )     (16,842 )
Gain on disposition of 50% interest in VAA     154,126                          
Gain on sale of income producing properties           9,842       16,207       18,911       561  
Gain on land sales     17,404       4,884       3,121              
Income tax (expense) benefit     (3,210 )     (180 )     (24 )     (517 )     20,390  
Net income (loss) from continuing operations     183,040       (15,316 )     323       (8,400 )     4,109  
Net income (loss) from discontinuing operations                 (1 )     896       37,868  
Net income (loss)     183,040       (15,316 )     322       (7,504 )     41,977  
Net income attributable to non-controlling interest     (1,590 )     (499 )     (285 )     (132 )     (399 )
Net income (loss) attributable to Transcontinental Realty Investors, Inc.     181,450       (15,815 )     37       (7,636 )     41,578  
Preferred dividend requirement     (900 )     (900 )     (900 )     (900 )     (1,005 )
Net income (loss) applicable to common shares   $ 180,550     $ (16,715 )   $ (863 )   $ (8,536 )   $ 40,573  
                                         
PER SHARE DATA                                        
Earnings per share - basic                                        
Income (loss) from continuing operations   $ 20.71     $ (1.92 )   $ (0.10 )   $ (1.08 )   $ 0.32  
Income (loss) from discontinued operations                       0.10       4.42  
Net income (loss) applicable to common shares   $ 20.71     $ (1.92 )   $ (0.10 )   $ (0.98 )   $ 4.74  
Weighted average common shares used in computing earnings per share     8,717,767       8,717,767       8,717,767       8,717,767       8,559,370  
                                         
Earnings per share - diluted                                        
Income (loss) from continuing operations   $ 20.71     $ (1.92 )   $ (0.10 )   $ (1.08 )   $ 0.32  
Income (loss) from discontinued operations                       0.10       4.42  
Net income (loss) applicable to common shares   $ 20.71     $ (1.92 )   $ (0.10 )   $ (0.98 )   $ 4.74  
Weighted average common shares used in computing diluted earnings per share     8,717,767       8,717,767       8,717,767       8,717,767       8,559,370  
                                         
                                         
BALANCE SHEET DATA                                        
Real estate, net   $ 384,504     $ 979,870     $ 891,173     $ 844,019     $ 689,121  
Notes and interest receivable, net     83,541       70,166       79,308       69,551       83,457  
Investment in VAA     68,399             —        —        —   
Total assets     862,380       1,313,422       1,185,914       1,110,204       930,405  
Notes and interest payable     277,237       894,482       841,516       779,434       608,917  
Bonds and interest payable     158,574       113,047                    
Shareholders' equity     380,401       208,261       224,477       225,055       233,448  
Book value per share     43.64       23.89       25.75       25.82       27.27  

 

20

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report.

 

The Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws, principally, but not only, under the captions “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We caution investors that any forward-looking statements in this report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions made by, and information currently available to, management. When used, the words “anticipate”, “believe”, “expect”, “intend”, “may”, “might”, “plan”, “estimate”, “project”, “should”, “will”, “result” 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 from those anticipated, estimated or projected. We caution you that, while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update our forward-looking statements, whether as a result of new information, future events or otherwise. 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:

 

  general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, dependence on tenants’ financial condition, and competition from other developers, owners and operators of real estate);

 

  risks associated with the availability and terms of financing and the use of debt to fund acquisitions and developments;

 

  failure to manage effectively our growth and expansion into new markets or to integrate acquisitions successfully;

 

  risks and uncertainties affecting property development and construction (including, without limitation, construction delays, cost overruns, inability to obtain necessary permits and public opposition to such activities);

 

  risks associated with downturns in the national and local economies, increases in interest rates, and volatility in the securities markets;

 

  costs of compliance with the Americans with Disabilities Act and other similar laws and regulations;

 

  potential liability for uninsured losses and environmental contamination;

 

  risks associated with our dependence on key personnel whose continued service is not guaranteed; and

 

  the other risk factors identified in this Form 10-K, including those described under the caption “Risk Factors.”

 

The risks included here are not exhaustive. Other sections of this report, including Part I Item 1A. “Risk Factors,” include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and current reports on Form 8-K as we file them with the SEC, and to other materials we may furnish to the public from time to time through Forms 8-K or otherwise.

 

21

 

Overview

 

We are an externally advised and managed real estate investment company that owns a diverse portfolio of income-producing properties and land held for development. The Company’s portfolio of income-producing properties includes residential apartment communities, office buildings and other commercial properties. Our investment strategy includes acquiring existing income-producing properties as well as developing new properties on land already owned or acquired for a specific development project. We acquire land primarily in in-fill locations or high-growth suburban markets. We are an active buyer and seller of real estate and during 2018 we acquired $103.1 million and sold $57.9 million of land and income-producing properties. As of December 31, 2018, we owned 1,489 units in nine residential apartment communities, and seven commercial properties comprising approximately 1.7 million rentable square feet. In addition, we own 2,405 acres of land held for development. The Company currently owns income-producing properties and land in six states.

 

We finance our acquisitions primarily through operating cash flow, proceeds from the sale of land and income-producing properties and debt financing primarily in the form of property-specific first-lien mortgage loans from commercial banks and institutional lenders. We finance our development projects principally with short-term, variable interest rate construction loans that are converted to long-term, fixed rate amortizing mortgages when the development project is completed and occupancy has been stabilized. The Company will, from time to time, also enter into partnerships with various investors to acquire income-producing properties or land and to sell interests in some of its wholly-owned properties. When the Company sells assets, it may carry a portion of the sales price generally in the form of a short-term, interest bearing seller-financed note receivable. The Company generates operating revenues primarily by leasing apartment units to residents and leasing office, retail and industrial space to commercial tenants.

 

The Company has historically engaged in and may continue to engage in certain business transactions with related parties, including but not limited to asset acquisition and dispositions. Transactions involving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in our best interest.

 

Since April 30, 2011, Pillar is the Company’s external Advisor and Cash Manager under a contractual arrangement that is reviewed annually by our Board of Directors. Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities. Pillar also arranges, for TCI’s benefit, debt and equity financing with third party lenders and investors. Pillar also serves as an Advisor and Cash Manager to ARL and IOR. As the contractual Advisor, Pillar is compensated by TCI under an Advisory Agreement that is more fully described in Part III, Item 10. “Directors, Executive Officers and Corporate Governance – The Advisor”. TCI has no employees. Employees of Pillar render services to TCI in accordance with the terms of the Advisory Agreement.

 

Effective since January 1, 2011, Regis manages our commercial properties and provides brokerage services.  Regis is entitled to receive a fee for its property management and brokerage services. Refer to Part III, Item 10. “Directors, Executive Officers and Corporate Governance – Property Management and Real Estate Brokerage.”  The Company contracts with third-party companies to lease and manage our apartment communities. 

 

Critical Accounting Policies

 

We present our financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”).

 

The accompanying Consolidated Financial Statements include our accounts, our subsidiaries, generally all of which are wholly-owned, and all entities in which we have a controlling interest.

 

For entities in which we have less than a controlling financial interest or entities where we are not deemed to be the primary beneficiary, the entities are accounted for using the equity method of accounting. Accordingly, our share of the net earnings or losses of these entities are included in consolidated net income. TCI’s investment in ARL is accounted for under the equity method.

 

In accordance with the VIE guidance in ASC 810 “Consolidations,” the Company consolidated nine multifamily residential properties at December 31, 2018 and fifty-one at December 31, 2017, located throughout the United States ranging from 153 units to 496 units.  Assets totaling approximately $462 million and approximately $1,113 million at December 31, 2018 and 2017, respectively, are consolidated and included in “Real estate, at cost” on the balance sheet and are all collateral for their respective mortgage notes payable, none of which are recourse to the partnership in which they are in or to the Company. 

 

22

 

Real Estate

 

Upon acquisitions of real estate, we assess the fair value of acquired tangible and intangible assets, including land, buildings, tenant improvements, “above-” and “below-market” leases, origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities in accordance with ASC Topic 805 “Business Combinations”, and allocate the purchase price to the acquired assets and assumed liabilities, including land at appraised value and buildings at replacement cost.

 

We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, as well as available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant. We also consider an allocation of purchase price of other acquired intangibles, including acquired in-place leases that may have a customer relationship intangible value, including (but not limited to) the nature and extent of the existing relationship with the tenants, the tenants’ credit quality and expectations of lease renewals. Based on our acquisitions to date, our allocation to customer relationship intangible assets has been immaterial.

 

We record acquired “above-” and “below-market” leases at their fair values (using a discount rate which reflects the risks associated with the leases acquired) equal to the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) management’s estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases.

 

Other intangible assets acquired include amounts for in-place lease values that are based on our evaluation of the specific characteristics of each tenant’s lease. Factors to be considered include estimates of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, we consider leasing commissions, legal and other related expenses.

 

Transfers to or from our parent, ARL, or other related parties reflect a basis equal to the cost basis in the asset at the time of the sale. 

 

Depreciation and Impairment

 

Real estate is stated at depreciated cost. The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition costs. Costs directly related to the development of properties are capitalized. Capitalized development costs include interest, property taxes, insurance, and other direct project costs incurred during the period of development.

 

A variety of costs are incurred in the acquisition, development and leasing of properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. Our capitalization policy on development properties is guided by ASC Topic 835-20 “Interest - Capitalization of Interest” and ASC Topic 970 “Real Estate—General”. The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We consider a construction project as substantially completed and held available for occupancy upon the receipt of certificates of occupancy, but no later than one year from cessation of major construction activity. We cease capitalization on the portion (1) substantially completed and (2) occupied or held available for occupancy, and we capitalize only those costs associated with the portion under construction.

 

Management reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates impairment in value. An impairment loss is recognized if the carrying amount of its assets is not recoverable and exceeds its fair value. Fair value is determined by a recent appraisal, comparable based upon prices for similar assets, executed sales contract, a present value and/or a valuation technique based upon a multiple of earnings or revenue. If such impairment is present, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. 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. If we determine that impairment has occurred, the affected assets must be reduced to their fair value. We did not record any impairment charges for the years ended December 31, 2018 and 2017.

 

23

 

Real Estate Assets Held for Sale

 

We classify properties as held for sale when certain criteria are met in accordance with GAAP. At that time, we present the assets and obligations of the property held for sale separately in our consolidated balance sheet and we cease recording depreciation and amortization expense related to that property. Properties held for sale are reported at the lower of their carrying amount or their estimated fair value, less estimated costs to sell. We did not have any real estate assets classified as held for sale at December 31, 2018 or 2017.

 

Any properties that are treated as “subject to sales contract” on the Consolidated Balance Sheets and are listed in detail in Schedule III, “Real Estate and Accumulated Depreciation” are those in which we have not recognized the legal sale according to the guidance in ASC 360-20 due to various factors, disclosed in Item 1 “Significant Real Estate Acquisitions/Dispositions and Financing.” Any sale transaction where the guidance reflects that a sale had not occurred, the asset involved in the transaction, including the debt, if appropriate, and property operations, remained on the books of the Company. We continue to charge depreciation to expense as a period costs for the property until such time as the property has been classified as held for sale in accordance with guidance reflected in ASC 360-10-45 “Impairment or Disposal of Long-Lived Assets.”

 

Investment in Unconsolidated Real Estate Ventures

 

Except for ownership interests in variable interest entities, we account for our investments in unconsolidated real estate ventures under the equity method of accounting because the Company exercises significant influence over, but does not control, these entities. These investments are recorded initially at cost, as investments in unconsolidated real estate ventures, and subsequently adjusted for equity in earnings and cash contributions and distributions. Any difference between the carrying amount of these investments on the Company’s balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in earnings of unconsolidated real estate ventures over the life of the related asset. Under the equity method of accounting, our net equity is reflected within the Consolidated Balance Sheets, and our share of net income or loss from the joint ventures is included within the Consolidated Statements of Operations. The joint venture agreements may designate different percentage allocations among investors for profits and losses; however, our recognition of joint venture income or loss generally follows the joint venture’s distribution priorities, which may change upon the achievement of certain investment return thresholds. For ownership interests in variable interest entities, the Company consolidates those in which we are the primary beneficiary.

 

Recognition of Rental Income

 

Rental income for commercial property leases is recognized on a straight-line basis over the respective lease terms. In accordance with ASC Topic 805, we recognize rental revenue of acquired in-place “above-“and “below-market” leases at their fair values over the terms of the respective leases. On our Consolidated Balance Sheets, we include as a receivable the excess of rental income recognized over rental payments received pursuant to the terms of the individual commercial lease agreements.

 

Reimbursements of operating costs, as allowed under most of our commercial tenant leases, consist of amounts due from tenants for common area maintenance, real estate taxes and other recoverable costs, and are recognized as revenue in the period in which the recoverable expenses are incurred. We record these reimbursements on a “gross” basis, since we generally are the primary obligor with respect to purchasing goods and services from third-party suppliers; we have discretion in selecting the supplier and have the credit risk with respect to paying the supplier.

 

Rental revenue for residential property leases is recorded when due from residents and is recognized monthly as earned, which is not materially different than on a straight-line basis as lease terms are generally for periods of one year or less. An allowance for doubtful accounts is recorded for all past due rents and operating expense reimbursements considered to be uncollectible.

 

Revenue Recognition on the Sale of Real Estate

 

Sales and the associated gains or losses of real estate assets are recognized in accordance with the provisions of ASC Topic 360-20, “Property, Plant and Equipment—Real Estate Sale”. The specific timing of a sale is measured against various criteria in ASC 360-20 related to the terms of the transaction and any continuing involvement in the form of management or financial assistance associated with the properties. If the sales criteria for the full accrual method are not met, we defer some or all of the gain recognition and account for the continued operations of the property by applying the finance, leasing, deposit, installment or cost recovery methods, as appropriate, until the sales criteria are met.

 

24

 

Non-performing Notes Receivable

 

We consider a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower is not making interest payments in accordance with the terms of the agreement.

 

Interest Recognition on Notes Receivable

 

We record interest income as earned in accordance with the terms of the related loan agreements.

 

Allowance for Estimated Losses

 

We assess the collectability of notes receivable on a periodic basis, the assessment consists primarily of an evaluation of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment. Refer to Note 5 “Notes and Interest Receivable” for details on our notes receivable.

 

Fair Value of Financial Instruments

 

We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures,” to the valuation of real estate assets. These provisions define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date, establish a hierarchy that prioritizes the information used in developing fair value estimates and require disclosure of fair value measurements by level within the fair value hierarchy. The hierarchy gives the highest priority to quoted prices in active markets (Level 1 measurements) and the lowest priority to unobservable data (Level 3 measurements), such as the reporting entity’s own data.

 

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and includes three levels defined as follows:

     
Level 1  —  Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets.
     
Level 2  —  Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
     
Level 3      —  Unobservable inputs that are significant to the fair value measurement.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Related parties

 

We apply ASC Topic 805, “Business Combination”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.

 

Results of Operations

 

The discussion of our results of operations is based on management’s review of operations, which is based on our segments. Our segments consist of apartments, commercial buildings, land and other. For discussion purposes, we break these segments down into the following sub-categories; same property portfolio, acquired properties, and developed properties in the lease-up phase. The same property portfolio consists of properties that were held by us for the entire period for both years being compared. The acquired property portfolio consists of properties that we acquired but have not held for the entire period for both periods being compared. Developed properties in the lease-up phase consist of completed projects that are being leased-up. As we complete each phase of the project, we lease-up that phase and include those revenues in our continued operations. Once a developed property becomes leased-up (80% or more) and is held the entire period for both years under comparison, it is considered to be included in the same property portfolio. Income- producing properties that we have sold during the year are reclassified to discontinued operations for all periods presented. The other segment consists of revenue and operating expenses related to the notes receivable and corporate entities.

 

25

 

The following discussion is based on our Consolidated Statements of Operations for the years ended December 31, 2018, 2017, and 2016 as included in Item 8. “Consolidated Financial Statements and Supplementary Data”. Continuing operations relates to income-producing properties that were held during those years as adjusted for sales in the subsequent years.

 

At December 31, 2018, 2017 and 2016, we owned or had interests in a portfolio of nine, fifty-nine and fifty-nine income-producing properties, respectively. The total property portfolio represents all income-producing properties held as of December 31 for the year presented. The table below shows the number of income-producing properties held by year:

 

    2018     2017     2016  
Continued operations     9       59       59  
Total property portfolio     9       59       59  

 

Comparison of the year ended December 31, 2018 to the year ended December 31, 2017:

 

For the year ended December 31, 2018, we reported net income applicable to common shares of $180.1 million or $20.71 per share compared to a net loss applicable to common shares of $16.7 million or ($1.92) per share for the year ended December 31, 2017. The current year net income applicable to common shares includes a gain on disposition of our 50% interest in VAA of $154.1 million. Current year net income also includes gain on sales of land of $17.4 million and no gain on sales of income-producing properties, compared to the prior year net loss which included gain on sales of income producing properties of $9.8 million and gain on land sales of $4.9 million.

 

Revenues  

 

Rental and other property revenues were $121.0 million for the year ended December 31, 2018. This represents a decrease of $4.2 million, as compared to the prior year revenues of $125.2 million. The decrease is primarily due to the contribution of fifty-two properties to the joint venture VAA on November 19, 2018. 

  

Expenses

 

Property operating expenses were $59.4 million for the year ended December 31, 2018. This represents a decrease of $3.7 million, compared to the prior year operating expenses of $63.1 million. The decrease is primarily due to the contribution of fifty-two properties to the joint venture VAA on November 19, 2018. 

 

Depreciation and amortization expenses were $22.8 million for the year ended December 31, 2018. This represents a decrease of $2.8 million compared to prior year depreciation of $25.6 million. The decrease is primarily due to the contribution of fifty-two properties to the joint venture VAA on November 19, 2018. 

 

General and administrative expenses were $11.4 million for the year ended December 31, 2018. This represents an increase of $5.1 million compared to the prior year expenses of $6.3 million. The increase in general and administrative expenses was due primarily to an increase in fees paid to our Advisors of approximately $1.5 million, general fees of approximately $1.5 million associated with finalizing the formation of the joint venture, legal and regulatory fees of $0.8 million and general and professional fees of approximately $1.0 million.

   

Net income fee was $0.6 million for the year ended December 31, 2018. This represents an increase of $0.3 million compared to the prior year net income fee of $0.3 million. The net income fee paid to Pillar is calculated at 7.5% of net income.

 

Advisory fees were $10.7 million for the year ended December 31, 2018. This represents an increase of $0.7 million compared to the prior year advisory fees of $10.0 million. Advisory fees are computed based on a gross asset fee of 0.0625% per month (0.75% per annum) of the average of the gross asset value.

 

Other income (expense)  

 

Interest income was $15.8 million for the year ending December 31, 2018 compared to $13.9 million for the year ended December 31, 2017 for an increase of $1.9 million. This increase was primarily due to an increase of $2.7 million in interest on receivable owed from our Advisors, offset by a decrease of $0.8 in interest on notes receivable from other related parties.

 

26

 

Mortgage and loan interest expense was $58.9 million for the year ended December 31, 2018. This represents a decrease of $1.0 million compared to the prior year expense of $59.9 million. The decrease is primarily due to the contribution of fifty-two properties to the joint venture VAA on November 19, 2018. 

 

No gain on sales of income producing properties was recognized during the year ended December 31, 2018. Gain on sale of income-producing properties was $9.8 million for the year ended December 31, 2017, attributable to the recognition of deferred gain.

 

Gain on land sales was $17.4 million and $4.9 million for the years ended December 31, 2018 and 2017, respectively. The increase of approximately $12.5 million was primarily due to sales of land at Mercer Crossing recognized in 2018.

 

Other income was $28.2 million and $0.6 million for the years ended December 31, 2018 and 2017, respectively. The increase of $27.6 million was primarily due to a $17.6 million gain recognized in September 2018 for deferred income associated with the sale of assets, as well as income of approximately $7.6 million from insurance proceeds on Mahogany Run Golf Course.

 

Gain on disposition of 50% interest in VAA was $154.1 million for the year ended December 31, 2018. There was no such gain in prior years, the gain was the result of the contribution of fifty-two properties to the joint venture VAA.

 

Comparison of the year ended December 31, 2017 to the year ended December 31, 2016:

 

For the year ended December 31, 2017, we reported net loss applicable to common shares of $16.7 million or ($1.92) per diluted earnings per share compared to a net loss applicable to common shares of $0.9 million or ($0.10) per diluted earnings per share for the year ended December 31, 2016. The current year net loss applicable to common shares of $16.7 million included gain on sale of income-producing properties of $9.8 million and gain on land sales of $4.9 million compared to the prior year net loss applicable to common shares of $0.9 million which included gain on land sales of $3.1 million.

 

Revenues  

 

Rental and other property revenues were $125.2 million for the year ended December 31, 2017. This represents an increase of $6.7 million, as compared to the prior year revenues of $118.5 million. The change by segment is an increase in the apartment portfolio of $6.2 million and an increase in the commercial portfolio of approximately $0.5 million. We purchased four apartment communities during the year ended December 31, 2016, which produced rental revenue of $8.3 million and $2.0 million during the years ended December 31, 2017 and 2016, respectively, for a net increase of $6.3 million. In addition, we purchased one apartment property during 2017 that produced revenues of $0.8 million in rental revenues. 

  

Expenses

 

Property operating expenses were $63.1 million for the year ended December 31, 2017. This represents an increase of $1.2 million, as compared to the prior year operating expenses of $61.9 million. The growth in our apartment portfolio resulted in a $2.9 million increase in property operating expenses. The Company added a net 723 units during 2016 and 201 units during 2017. Property operating expenses for our commercial portfolio decreased $1.8 million.  In addition, we had a decrease in property operating expenses for our land portfolio of $1.0 million.

 

Depreciation and amortization expenses were $25.6 million for the year ended December 31, 2017. This represents an increase of $1.9 million as compared to prior year depreciation of $23.7 million. The increase is primarily due to the growth in our apartment portfolio which had an increase of $1.6 million year-over-year.

 

General and administrative expenses were $6.3 million for the year ended December 31, 2017. This represents an increase of $0.8 million, as compared to the prior year expenses of $5.5 million.

   

Net income fee remained constant at $0.3 million for the year ended December 31, 2017 and 2016. The net income fee paid to Pillar is calculated at 7.5% of net income.

 

Advisory fees were $10.0 million for the year ended December 31, 2017. This represents an increase of $0.5 million compared to the prior year advisory fees of $9.5 million. Advisory fees are computed based on a gross asset fee of 0.0625% per month (0.75% per annum) of the average of the gross asset value.

 

Other income (expense)  

 

Interest income was $13.9 million for the year ending December 31, 2017 compared to $14.7 million for the year ended December 31, 2016 for a decrease of $0.8 million.  This decrease was primarily due to a decrease of $2.3 in interest on notes receivable, partially offset by a $1.3 million increase in interest on receivable owed from Advisor.

 

27

 

Mortgage and loan interest expense was $59.9 million for the year ended December 31, 2017. This represents an increase of $6.8 million compared to the prior year expense of $53.1 million. The change by segment is an increase in the other portfolio of $9.7 million, an increase in the commercial portfolio of $0.4 million, partially offset by a decrease in the apartment portfolio of $3.0 million and a decrease in the land portfolio of $0.2 million. Within the other portfolio, the increase is due to incurring new mezzanine debt obligations. Within the apartment portfolio, the majority of the increase is due to the acquisition of a new property, partially offset by the refinancing of six loans during 2017 at lower rates.

 

The gain on sale of income-producing properties $9.8 million was attributable to recognition of deferred gains for the year ended December 31, 2017. During 2016, the Company sold one apartment community located in Irving, Texas to an independent third party for a total sales price of $8.1 million and one apartment community located in Topeka, Kansas to an independent third party for a total sales price of $12.3 million. We recorded an aggregate gain of $16.2 million from the sale of these two properties. The Company also sold an industrial warehouse consisting of approximately 177,805 square feet. The sale resulted in a loss of approximately $0.2 million.

 

Gain on land sales was $4.9 million and $3.1 million for the years ended December 31, 2017 and 2016, respectively. During 2016, we sold a combined 129.7 acres of land located in Forney, Texas, McKinney, Texas, Farmers Branch, Texas and Nashville, Tennessee to independent third parties for a total sales price of $29.1 million. We recorded an aggregate $3.1 million gain from the land sales. During 2015, we sold 578.8 acres of land in six transactions for a sales price of $102.9 million and recorded a gain of $18.9 million.

 

Liquidity and Capital Resources

 

General

 

Our principal liquidity needs are:

 

  fund normal recurring expenses;

 

  meet debt service and principal repayment obligations including balloon payments on maturing debt;

 

  fund capital expenditures, including tenant improvements and leasing costs;

 

  fund development costs not covered under construction loans; and

 

  fund possible property acquisitions.

 

Our principal sources of cash have been and will continue to be:

 

  property operations;

 

  proceeds from land and income-producing property sales;

 

  collection of mortgage notes receivable;

 

  collections of receivables from related companies;

 

  refinancing of existing mortgage notes payable; and

 

  additional borrowings, including mortgage notes payable, and lines of credit.

 

It is important to realize that the current status of the banking industry has had a significant effect on our industry. The banks’ willingness and/or ability to originate loans affects our ability to buy and sell property, and refinance existing debt. We are unable to foresee the extent and length of this down-turn. A continued and extended decline could materially impact our cash flows. We draw on multiple financing sources to fund our long-term capital needs. We generally fund our development projects with construction loans, which are converted to traditional mortgages upon completion of the project.

 

We may also issue additional equity securities, including common stock. Management anticipates that our cash as of December 31, 2018, along with cash that will be generated in 2019 from notes and interest receivables, will be sufficient to meet all of our cash requirements. Management intends to selectively sell land and income-producing assets, refinance or extend real estate debt and seek additional borrowings secured by real estate to meet its liquidity requirements. Although history cannot predict the future, historically, we have been successful at refinancing and extending a portion of the Company’s current maturity obligations.

 

28

 

Management reviews the carrying values of TCI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings. The note receivable review includes an evaluation of the collateral property securing such note.

 

Cash Flow Summary

 

The following summary discussion of our cash flows is based on the Consolidated Statements of Cash Flows in Part II, Item 8. “Consolidated Financial Statements and Supplementary Data” and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below (dollars in thousands):

 

    December 31,        
    2018     2017     Variance  
Net cash (used in) operating activities   $ (181,187 )   $ (25,074 )   $ (156,113 )
Net cash provided by (used in) investing activities   $ 147,625     $ (98,312 )   $ 245,937  
Net cash provided by financing activities   $ 51,785     $ 155,995     $ (104,210 )

 

The primary use of cash for operations is daily operating costs, general and administrative expenses, advisory fees, and land holding costs. Our primary source of cash from operating activities is from rental income on properties.

 

Our primary cash outlays for investing activities are for construction and development, acquisition of land and income-producing properties, and capital improvements to existing properties. Our primary sources of cash from investing activities are from the proceeds on the sale of land and income-producing properties. During the year ended December 31, 2018, we advanced $16.8 million toward various notes receivable, purchased income-producing properties for $10.6 million, and invested approximately $85.1 million for the development of new properties and improvement of income producing properties. In addition, we received $236.8 million from the formation of the joint venture with Macquarie. For the year ended December 31, 2017, we advanced $16.4 million toward various notes receivable, purchased income-producing properties for $37.0 million, and invested approximately $77.4 million for the development of new properties and improvement of income producing properties, offset by proceeds from notes receivables of $26.2 million.

 

Our primary sources of cash from financing activities are from proceeds on notes payables. Our primary cash outlays are for recurring debt payments and payments on maturing notes payable. For the year ended December 31, 2018, the increase in cash flow from financing activities was due primarily to proceeds from borrowings of $123.3 million, and proceeds received from the sale of nonconvertible Series B Bonds by Southern of $59.2 million, offset by payments to our notes payable of $124.6 million. For the year ended December 31, 2017, the increase in cash flow from financing activities was due primarily to proceeds from borrowings of $135.2 million, and proceeds from the issuance of Series A bonds for $115.3 million, offset by payments to notes payable of $83.1 million and bond issuance and financing costs payments of approximately $10.5 million.

 

Equity Investments     

 

TCI has from time to time purchased shares of IOR and ARL. The Company may purchase additional equity securities of IOR and ARL through open market and negotiated transactions to the extent TCI’s liquidity permits. Equity securities of ARL and IOR held by TCI may be deemed “restricted securities” under Rule 144 of the Securities Act of 1933 (“Securities Act”). Accordingly, TCI may be unable to sell such equity securities other than in a registered public offering or pursuant to an exemption under the Securities Act for a one-year period after they are acquired. Such restrictions may reduce TCI’s ability to realize the full fair value of such investments if TCI attempted to dispose of such securities in a short period of time.

 

TCI also holds a voting and profit participation right of 50% and 49%, respectively in VAA. VAA actively participates in the development and/or acquisitions of Class A multi-family assets.  

 

29

 

Contractual Obligations

 

The following table represents our contractual obligations at December 31, 2018 (in thousands):

 

    Total     2019     2020     2021     2022     2023     Thereafter  
Notes and interest payable (1)   $ 407,206     $ 51,265     $ 19,925     $ 53,010     $ 44,553     $ 38,451     $ 200,002  
Bonds and interest payable (1)     197,238       32,593       31,062       40,554       38,238       32,231       22,560  
Total   $ 604,444     $ 83,858     $ 50,987     $ 93,564     $ 82,791     $ 70,682     $ 222,562  

 

(1) The notes and bonds contain financial covenants that, if certain thresholds are not met, could allow the lender to accelerate principal payments or cause the note to become due immediately.

 

Environmental Matters

 

Under various federal, state and local environmental laws, ordinances and regulations, TCI may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.  

 

Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on TCI’s business, assets or results of operations.

 

Inflation

 

The effects of inflation on TCI’s operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sales values of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, TCI’s earnings from short-term investments, the cost of new financings and the cost of variable interest rate debt will be affected.

 

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

TCI’s primary market risk exposure consists of changes in interest rates on borrowings under our debt instruments that bear interest at variable rates that fluctuate with market interest rates and maturing debt that has to be refinanced. TCI’s future operations, cash flow and fair values of financial instruments are also partially dependent on the then existing market interest rates and market equity prices.

 

As of December 31, 2018, our outstanding notes payable consisted of approximately $285.8 million, including $244.6 million of fixed-rate notes and a variable-rate note of approximately $41.9 million with an interest rate of 5.34%. Our overall weighted average interest rate at December 31, 2018 and 2017 was 7.1% and 5.5%, respectively.

 

TCI’s interest rate sensitivity position is managed by the capital markets department. Interest rate sensitivity is the relationship between changes in market interest rates and the fair value of market rate sensitive assets and liabilities. TCI’s earnings are affected as changes in short-term interest rates affect its cost of variable-rate debt and maturing fixed-rate debt.

 

If market interest rates for variable-rate debt average 100 basis points more in 2019 than they did during 2018, TCI’s interest expense would increase and net income would decrease by $0.4 million. This amount is determined by considering the impact of hypothetical interest rates on TCI’s borrowing cost. The analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no change in TCI’s financial structure.

 

30

 

The following table contains exposures that existed at December 31, 2018. Anticipation of exposures or risk on positions that could possibly arise was not considered. TCI’s ultimate interest rate risk and its effect on operations will depend on future capital market exposures, which cannot be anticipated with a probable assurance level (dollars in thousands):

 

    2019     2020     2021     2022     2023     Thereafter     Total  
Note Receivable                                                        
Fixed interest rate - fair value                                                   $ 122,571  
Instrument’s maturities   $ 18,203     $ 38,030     $ 174     $     $     $ 66,164     $ 122,571  
Interest     11,192       6,323       3,950       4,383       4,383       39,445     $ 69,676  
Average Rate     9 %     8 %     9 %     8 %     8 %     8 %        
                                                         
Notes Payable:                                                        
Variable Rate - fair value                                                   $ 41,892  
Instrument’s maturities   $ 617     $ 645     $ 687     $ 39,943     $     $     $ 41,892  
Interest     2,232       2,191       1,078                       $ 5,501  
Average interest rate (1)     5.34 %     5.34 %     5.34 %     5.34 %                    
                                                         
Fixed interest rate - fair value                                                   $ 243,926  
Instrument’s maturities   $ 36,807     $ 8,178     $ 42,515     $ 3,362     $ 37,259     $ 115,805     $ 243,926  
Interest     10,926       8,912       8,730       1,248       1,191       84,195     $ 115,202  
Average interest rate     7.14 %     7.32 %     5.87 %     4.38 %     5.22 %     3.80 %        

 

(1) Interest rates on variable rate notes payable are equal to the variable rates in effect on December 31, 2018.

 

31

 

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO FINANCIAL STATEMENTS

   
  Page #
Financial Statements  
Report of Independent Registered Public Accounting Firm 33
Consolidated Balance Sheets—December 31, 2018 and 2017 34
Consolidated Statements of Operations—Years Ended December 31, 2018, 2017 and 2016 35
Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2018, 2017 and 2016 36
Consolidated Statements of Cash Flows—Years Ended December 31, 2018, 2017 and 2016 37
Statements of Consolidated Comprehensive Income (Loss) – Years Ended December 31, 2018, 2017 and 2016 38
Notes to Consolidated Financial Statements 39
   
Financial Statement Schedules  
Schedule III—Real Estate and Accumulated Depreciation 64
Schedule IV—Mortgage Loans Receivable on Real Estate 66

 

All other schedules are omitted because they are not required, are not applicable or the information required is included in the Financial Statements or the notes thereto.

 

32

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors of and

Stockholders of Transcontinental Realty Investors, Inc.

Dallas, Texas 

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes and schedules collectively referred to as the “consolidated financial statements.” In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Transcontinental Realty Investors, Inc. as of December 31, 2018 and 2017 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with U.S. generally accepted accounting principles.

 

Basis of Opinion

These consolidated financial statements are the responsibility of Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

Emphasis of Liquidity

As described in the Note 16, Transcontinental Realty Investors, Inc.’s management intends to sell land and income-producing properties and refinance or extend debt secured by real estate to meet the Company’s liquidity needs. 

 

Supplemental Information 

The supplemental information contained in Schedules III and IV has been subjected to audit procedures performed in conjunction with the audit of the Company’s financial statements. The supplemental information is the responsibility of the Company’s management. Our audit procedures included determining whether the supplemental information reconciles to the financial statements or the underlying accounting and other records, as applicable, and performing procedures to test the completeness and accuracy of the information presented in the supplemental information. In forming our opinion on the supplemental information, we evaluated whether the supplemental information, including its form and content, is presented in conformity with the Security and Exchange Commission’s rules. In our opinion, the supplemental information is fairly stated, in all material respects, the financial date required to be set forth therein in relation to the financial statements as a whole.

 

FARMER, FUQUA & HUFF, PC

Richardson, Texas

March 31, 2019

 

We have served as the Company’s auditor since 2004.

 

33

 

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

 

    December 31,  
    2018     2017  
    (dollars in thousands, except share and par value amounts)  
Assets                
Real estate, at cost   $ 461,718     $ 1,112,721  
Real estate subject to sales contracts at cost     2,014       45,739  
Less accumulated depreciation     (79,228 )     (178,590 )
Total real estate     384,504       979,870  
                 
Notes and interest receivable (including $51,945 in 2018 and $45,155 in 2017 from related parties)     83,541       70,166  
Cash and cash equivalents     36,358       33,563  
Restricted cash     70,207       54,779  
Investment in joint venture     68,399        
Investment in other unconsolidated investees     22,172       2,472  
Receivable from related party     133,642       111,665  
Other assets     63,557       60,907  
Total assets   $ 862,380     $ 1,313,422  
                 
Liabilities and Shareholders’ Equity                
Liabilities:                
Notes and interest payable   $ 277,237     $ 892,149  
Notes related to real estate held for sale           376  
Notes related to real estate subject to sales contracts           1,957  
Bonds and bond interest payable     158,574       113,047  
Deferred revenue (including $21,034 in 2018 and $40,574 in 2017 to related parties)     17,522       60,949  
Deferred tax liability     2,000        
Accounts payable and other liabilities (including $3 in 2018 and $7,236 in 2017 to related parties)     26,646       36,683  
Total liabilities     481,979       1,105,161  
                 
Shareholders’ equity:                
Preferred Stock, Series D: $0.01 par value, authorized 100,000 shares; issued 100,000 shares in 2018 and 2017; outstanding 0 shares in 2018 and 100,000 shares in 2017 (liquidation preference $100 per share)           1  
Common stock, $0.01 par value, authorized 10,000,000 shares; issued 8,717,967 shares in 2018 and 2017; outstanding 8,717,767 shares in 2018 and 2017     87       87  
Treasury stock at cost, 200 shares in 2018 and 2017     (2 )     (2 )
Paid-in capital     258,050       268,949  
Retained earnings (deficit)     101,585       (79,865 )
Total Transcontinental Realty Investors, Inc. shareholders' equity     359,720       189,170  
Non-controlling interest     20,681       19,091  
Total shareholders’ equity     380,401       208,261  
Total liabilities and shareholders’ equity   $ 862,380     $ 1,313,422  

   

The accompanying notes are an integral part of these consolidated financial statements.

 

34

 

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

    For the Years Ended December 31,  
    2018     2017     2016  
    (dollars in thousands, except per share amounts)  
Revenues:                
Rental and other property revenues (including $767, $839 and $708 for the years ended 2018, 2017 and 2016, respectively, from related parties)   $ 120,955     $ 125,233     $ 118,471  
                         
Expenses:                        
Property operating expenses  (including $943, $929 and $865 for the years ended 2018, 2017 and 2016, respectively, from related parties)     59,420       63,056       61,918  
Depreciation and amortization     22,761       25,558       23,683  
General and administrative (including $4,578, $3,120 and $3,574  for the years ended 2018, 2017 and 2016, respectively, from related parties)     11,359       6,269       5,476  
Net income fee to related party     631       250       257  
Advisory fee to related party     10,663       9,995       9,490  
Total operating expenses     104,834       105,128       100,824  
Net operating income     16,121       20,105       17,647  
                         
Other income (expenses):                        
Interest income (including $13,132, $11,485 and $13,348 for the years ended 2018, 2017 and 2016, respectively, from related parties)     15,793       13,862       14,670  
Other income (expense)     28,150       625       1,816  
Mortgage and loan interest (including $423, $1,174 and $568 for the year ended 2018, 2017 and 2016,  respectively, from related parties)     (58,872 )     (59,944 )     (53,088 )
Foreign currency transaction gain (loss)     12,399       (4,536 )      
Equity earnings from VAA     44              
Earnings (losses) from other unconsolidated investees     1,085       26       (26 )
Total other expenses     (1,401 )     (49,967 )     (36,628 )
Income (loss) before gain on disposition of 50% interest in VAA, gain on land sales, non-controlling interest, and taxes     14,720       (29,862 )     (18,981 )
                         
Gain on disposition of 50% interest in VAA     154,126              
Gain on sale of income producing properties           9,842       16,207  
Gain on land sales     17,404       4,884       3,121  
Net income (loss) from continuing operations before taxes     186,250       (15,136 )     347  
Income tax expense - current     (1,210 )     (180 )     (24 )
Income tax expense - deferred     (2,000 )            
Net income (loss) from continuing operations     183,040       (15,316 )     323  
Discontinued operations:                        
Net income (loss) from discontinued operations                 (2 )
Income tax benefit (expense) from discontinued operations                 1  
Net income (loss) from discontinued operations                 (1 )
Net income (loss)     183,040       (15,316 )     322  
Net (income) attributable to non-controlling interest     (1,590 )     (499 )     (285 )
Net income (loss) attributable to Transcontinental Realty Investors, Inc.     181,450       (15,815 )     37  
Preferred dividend requirement     (900 )     (900 )     (900 )
Net income (loss) applicable to common shares   $ 180,550     $ (16,715 )   $ (863 )
                         
Earnings per share - basic                        
Net income (loss) from continuing operations   $ 20.71     $ (1.92 )   $ (0.10 )
Net income (loss) applicable to common shares   $ 20.71     $ (1.92 )   $ (0.10 )
                         
Earnings per share - diluted                        
Net income (loss) from continuing operations   $ 20.71     $ (1.92 )   $ (0.10 )
Net income (loss) applicable to common shares   $ 20.71     $ (1.92 )   $ (0.10 )
                         
Weighted average common shares used in computing earnings per share     8,717,767       8,717,767       8,717,767  
Weighted average common shares used in computing diluted earnings per share     8,717,767       8,717,767       8,717,767  
                         
Amounts attributable to Transcontinental Realty Investors, Inc.                        
Net income (loss) from continuing operations   $ 181,450     $ (15,815 )   $ 38  
Net income from discontinued operations                 (1 )
Net income (loss) applicable to Transcontinental Realty, Investors, Inc.   $ 181,450     $ (15,815 )   $ 37  

  

The accompanying notes are an integral part of these consolidated financial statements.

 

35

 

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Three Years Ended December 31, 2018

(audited, dollars in thousands, except share amounts)

 

    Total     Comprehensive     Preferred     Common Stock     Treasury     Paid-in     Retained     Non-controlling  
    Equity     Income (Loss)     Stock     Shares     Amount     Stock     Capital     Deficit      Interest  
Balance, December 31, 2015   $ 225,055     $ (65,174 )   $ 1       8,717,967     $ 87     $ (2 )   $ 270,749     $ (64,087 )   $ 18,307  
Series D preferred stock dividends (9.0% per year)     (900 )                                   (900 )            
Net income     322       322                                     37       285  
Balance, December 31, 2016   $ 224,477     $ (64,852 )   $ 1       8,717,967     $ 87     $ (2 )   $ 269,849     $ (64,050 )   $ 18,592  
Series D preferred stock dividends (9.0% per year)     (900 )                                   (900 )            
Net loss     (15,316 )     (15,316 )                                   (15,815 )     499  
Balance, December 31, 2017   $ 208,261     $ (80,168 )   $ 1       8,717,967     $ 87     $ (2 )   $ 268,949     $ (79,865 )   $ 19,091  
Series D preferred stock dividends (9.0% per year)     (900 )                                   (900 )            
Redemption of Series D preferred stock     (10,000 )           (1 )                       (9,999 )            
Net income     183,040       181,450                                     181,450       1,590  
Balance, December 31, 2018   $ 380,401     $ 101,282     $       8,717,967     $ 87     $ (2 )   $ 258,050     $ 101,585     $ 20,681  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

36

 

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

 

    Year Ended December 31,  
    2018     2017     2016  
    (dollars in thousands)  
Cash Flow From Operating Activities:                        
Net income (loss)   $ 183,040     $ (15,316 )   $ 322  
Adjustments to reconcile net loss applicable to common shares to net cash flows from operating activities:                        
Gain on disposition of 50% interest in VAA     (154,126 )            
Gain on sale of income-producing properties           (9,842 )     (16,207 )
Gain on sale of land     (17,404 )     (4,884 )     (3,121 )
Depreciation and amortization     22,761       25,558       23,683  
Amortization of deferred borrowing costs     4,994       3,574       4,314  
Amortization of bond issuance costs     2,994       971        
Equity earnings from VAA     (44 )            
Earnings from other unconsolidated investees     (1,085 )     (26 )     (26 )
(Increase) decrease in assets:                        
Accrued interest receivable     (22,601 )     (668 )     (922 )
Other assets     (105,531 )     (1,433 )     (2,388 )
Prepaid expense     19,124       (5,661 )     (9,238 )
Rent receivables     (3,213 )     543       2,840  
Related party receivables     (14,995 )     (9,972 )     (11,134 )
Increase (decrease) in liabilities:                        
Accrued interest payable     (2,307 )     4,573       20  
Other liabilities     (92,794 )     (12,491 )     14,062  
Net cash (used in) operating activities     (181,187 )     (25,074 )     2,205  
                         
Cash Flow From Investing Activities:                        
Proceeds from disposition of 50% interest in VAA     236,752              
Proceeds from notes receivable     6,541       26,230       2,867  
Originations or advances on notes receivable     (16,801 )     (16,420 )     (11,703 )
Acquisition of land held for development                 (12,508 )
Acquisition of income-producing properties     (10,558 )     (37,044 )     (79,736 )
Proceeds from sale of income-producing properties     4,889             21,850  
Proceeds from sale of land     11,857       6,301       29,128  
Investment in unconsolidated real estate entities                 2,797  
Improvement of land held for development                 (3,023 )
Improvement of income-producing properties     (3,688 )     (64,443 )     (5,702 )
Construction and development of new properties     (81,367 )     (12,936 )     (10,836 )
Net cash provided by (used in) investing activities     147,625       (98,312 )     (66,866 )
                         
Cash Flow From Financing Activities:                        
Proceeds from notes payable     123,345       135,116       242,215  
Recurring payment of principal on notes payable     (107,866 )     (83,070 )     (20,205 )
Payments on maturing notes payable     (16,750 )           (160,745 )
Proceeds from bonds     59,213       115,335        
Bond issuance costs     (5,257 )     (6,887 )      
Deferred financing costs           (3,599 )     798  
Preferred stock dividends - Series D     (900 )     (900 )     (900 )
Net cash provided by financing activities     51,785       155,995       61,163  
                         
Net increase (decrease) in cash, cash equivalents and restricted cash     18,223       32,609       (3,498 )
Cash, cash equivalents and restricted cash, beginning of period     88,342       55,733       59,231  
Cash, cash equivalents and restricted cash, end of period   $ 106,565     $ 88,342     $ 55,733  
                         
Supplemental disclosures of cash flow information:                        
Cash paid for interest   $ 61,587     $ 49,791     $ 43,986  
                         
Schedule of noncash investing and financing activities:                        
Notes receivable received from sale of income-producing properties   $ 1,735     $     $  
Seller financing note - acquisition of income-producing properties   $ 1,895     $     $  
Notes payable issued on acquisition of income-producing properties   $ 31,175     $     $  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

37

 

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(unaudited)

 

    Year Ended December 31,  
    2018     2017     2016  
    (dollars in thousands)  
Net income (loss)   $ 183,040     $ (15,316 )   $ 322  
Comprehensive income attributable to non-controlling interest     (1,590 )     (499 )     (285 )
Comprehensive income (loss) attributable to Transcontinental Realty Investors, Inc.   $ 181,450     $ (15,815 )   $ 37  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

38

 

 

TRANSCONTINENTAL REALTY INVESTORS, INC.

 

NOTES TO FINANCIAL STATEMENTS

 

The accompanying Consolidated Financial Statements of Transcontinental Realty Investors, Inc. “TCI” and consolidated entities have been prepared in conformity with accounting principles generally accepted in the United States of America, the most significant of which are described in Note 1. “Summary of Significant Accounting Policies.” The Notes to Consolidated Financial Statements are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.

 

Certain prior year amounts have been reclassified to conform to the current year presentation on the consolidated statements of operations, consolidated balance sheets and the consolidated statements of cash flows.

 

NOTE 1.

ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Organization and business.   TCI, a Nevada corporation, is headquartered in Dallas, Texas and its common stock trades on the New York Stock Exchange (“NYSE American”) under the symbol “TCI”.

 

TCI is a “C” corporation for U.S. federal income tax purposes and files an annual consolidated income tax return with American Realty Investors, Inc. “ARL”, whose common stock is traded on the NYSE American under the symbol “ARL”. Subsidiaries of ARL own approximately 77.68% of the Company’s common stock.

 

In 2009, the Company acquired an additional 2,518,934 shares of common stock of Income Opportunity Realty Investors, Inc. “IOR”, and in doing so, increased its ownership from approximately 25% to over 80% of the shares of common stock of IOR outstanding. Upon acquisition of the additional shares in 2009, IOR’s results of operations began consolidating with those of the Company for tax and financial reporting purposes. As of December 31, 2017, TCI owned 81.25% of the outstanding IOR common shares. Shares of IOR are traded on the New York Exchange (“NYSE American”) under the symbol “IOR”.

 

At the time of the acquisition, the historical accounting value of IOR’s assets was $112 million and liabilities were $43 million. In that the shares of IOR acquired by TCI were from a related party, the values recorded by TCI are IOR’s historical accounting values at the date of transfer. The Company’s fair valuation of IOR’s assets and liabilities at the acquisition date approximated IOR’s book value. The net difference between the purchase price and historical accounting basis of the assets and liabilities acquired was $25.9 million and has been reflected by TCI as deferred income. The deferred income will be recognized upon the sale of the land that IOR held on its books as of the date of sale, to an independent third party.

 

TCI’s Board of Directors is responsible for directing the overall affairs of TCI and for setting the strategic policies that guide the Company. As of April 30, 2011, the Board of Directors delegated the day-to-day management of the Company to Pillar Income Asset Management, Inc. (“Pillar”), a Nevada corporation under a written Advisory Agreement that is reviewed annually by TCI’s Board of Directors. The directors of TCI are also directors of ARL and IOR. The Chairman of the Board of Directors of TCI also serves as the Chairman of the Board of Directors of ARL and IOR. The officers of TCI also serve as officers of ARL, IOR and Pillar.

 

Since April 30, 2011, Pillar, the sole shareholder of which is Realty Advisors, LLC, a Nevada limited liability company, the sole member of which is Realty Advisors, Inc. “RAI”, a Nevada corporation, the sole shareholder of which is May Realty Holdings, Inc. (“MRHI”, formerly known as Realty Advisors Management, Inc. “RAMI”, effective August 7, 2014), a Nevada corporation, the sole shareholder of which is a trust known as the May Trust, became the Company’s external Advisor and Cash Manager.  Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities. Pillar also arranges, for the Company’s benefit, debt and equity financing with third party lenders and investors. Pillar also serves as an Advisor and Cash Manager to ARL and IOR.  As the contractual advisor, Pillar is compensated by TCI under an Advisory Agreement that is more fully described in Part III, Item 10. “Directors, Executive Officers and Corporate Governance – The Advisor”.  TCI has no employees. Employees of Pillar render services to TCI in accordance with the terms of the Advisory Agreement. 

 

Regis Realty Prime, LLC, dba Regis Property Management, LLC (“Regis”), manages our commercial properties and provides brokerage services. Regis receives property management fees and leasing commissions in accordance with the terms of its property-level management agreement. Regis is also entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Refer to Part III, Item 10. “Directors, Executive Officers and Corporate Governance – Property Management and Real Estate Brokerage”.   TCI engages third-party companies to lease and manage its apartment properties.

 

39

 

 

Southern Properties Capital Ltd. (“Southern”) is a wholly owned subsidiary of TCI that was incorporated on August 16, 2016 for the purpose of raising funds by issuing debentures that cannot be converted into shares on the Tel-Aviv Stock Exchange ("TASE"). Southern operates in the United States and is primarily involved in investing in, developing, constructing and operating income-producing properties of multi-family residential real estate assets. Southern is included in the consolidated financial statements of TCI. 

 

On January 1, 2012, the Company entered into a development agreement with Unified Housing Foundation, Inc. “UHF” a non-profit corporation that provides management services for the development of residential apartment projects in the future. This development agreement was terminated December 31, 2013. The Company has also invested in surplus cash notes receivables from UHF and has sold several residential apartment properties to UHF in prior years. Due to this ongoing relationship and the significant investment in the performance of the collateral secured under the notes receivable, UHF has been determined to be a related party.

 

On November 19, 2018, we executed an agreement between the Macquarie Group (“Macquarie”) and Southern and TCI to create a joint venture, Victory Abode Apartments, LLC (“VAA”) to address existing and future demand for quality multifamily residential housing through acquisition and development of sustainable Class A multifamily housing in focused secondary and tertiary markets. In connection with the formation of the joint venture, Southern and TCI contributed a portfolio of 49 income producing apartment complexes, and 3 development projects in various stages of construction and received cash consideration of $236.8 million. At the time of the transfer of the properties, the joint venture assumed all liabilities of those properties, including mortgage debt to the Department of Housing and Urban Development (“HUD”).

 

VAA is equally owned and controlled by Abode JVP, LLC, a wholly-owned subsidiary of Southern and Summerset Intermediate Holdings 2 LLC (“Summerset”), a wholly-owned indirect subsidiary of Macquarie.  Pursuant to the Agreement, Abode JVP, LLC and Summerset each own voting and profit participation rights of 50% and 49%, respectively (“Class A Members”).  The remaining 2% of the profits interest is held by Daniel J. Moos, who serves as the President and Chief Executive officer of the Company (“Class B Member”) and Manager of the joint venture.

 

Our primary business is the acquisition, development and ownership of income-producing residential and commercial real estate properties. In addition, we opportunistically acquire land for future development in in-fill or high-growth suburban markets. From time to time and when we believe it appropriate to do so, we will also sell land and income-producing properties. We generate revenues by leasing apartment units to residents and leasing office and retail space to various for-profit businesses as well as certain local, state and federal agencies. We also generate income from gains on sales of income-producing properties and land. At December 31, 2018, we owned nine residential apartment communities comprising of 1,489 units, seven commercial properties comprising an aggregate of approximately 1.7 million rentable square feet, an investment in 2,405 acres of undeveloped and partially developed land. In addition, our joint venture VAA owns forty-nine residential apartment communities comprised of 9,192 units.

 

Basis of presentation.    The Company presents its financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”). The accompanying Consolidated Financial Statements include our accounts, our subsidiaries, generally all of which are wholly-owned, and all entities in which we have a controlling interest. Arrangements that are not controlled through voting or similar rights are accounted for as a Variable Interest Entity (VIE), in accordance with the provisions and guidance of ASC Topic 810 “Consolidation”, whereby we have determined that we are a primary beneficiary of the VIE and meet certain criteria of a sole general partner or managing member as identified in accordance with Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership when the Investor is the Sole General Partner and the Limited Partners have Certain Rights (“EITF 04-5”). VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders as a group lack adequate decision making ability, the obligation to absorb expected losses or residual returns of the entity, or have voting rights that are not proportional to their economic interests. The primary beneficiary generally is the entity that provides financial support and bears a majority of the financial risks, authorizes certain capital transactions, or makes operating decisions that materially affect the entity’s financial results. All significant intercompany balances and transactions have been eliminated in consolidation.

 

In determining whether we are the primary beneficiary of a VIE, we consider qualitative and quantitative factors, including, but not limited to: the amount and characteristics of our investment; the obligation or likelihood for us or other investors to provide financial support; our and the other investors’ ability to control or significantly influence key decisions for the VIE; and the similarity with and significance to the business activities of us and the other investors. Significant judgments related to these determinations include estimates about the current future fair values and performance of real estate held by these VIEs and general market conditions.

 

40

 

 

For entities in which we have less than a controlling financial interest or entities where it is not deemed to be the primary beneficiary, the entities are accounted for using the equity method of accounting. Accordingly, our share of the net earnings or losses of these entities are included in consolidated net income. TCI’s investments in ARL and VAA are accounted for under the equity method.

 

The Company in accordance with the VIE guidance in ASC 810 “Consolidations” consolidates nine and fifty-one multifamily residential properties located throughout the United States at December 31, 2018 and December 31, 2017, respectively, with total units of 1,489 and 8,427, respectively.  Assets totaling approximately $461.7 million and approximately $1,112.7 million at December 31, 2018 and 2017, respectively, are consolidated and included in “Real estate, at cost” on the balance sheet and are all collateral for their respective mortgage notes payable, none of which are recourse to the partnership in which they are in or to the Company. 

 

Real estate, depreciation, and impairment.    Real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired. Major replacements and betterments are capitalized and depreciated over their estimated remaining useful lives. Depreciation is computed on a straight-line basis over the useful lives of the properties (buildings and improvements—10-40 years; furniture, fixtures and equipment—5-10 years). We continually evaluate the recoverability of the carrying value of its real estate assets using the methodology prescribed in ASC Topic 360, “Property, Plant and Equipment,” Factors considered by management in evaluating impairment of its existing real estate assets held for investment include significant declines in property operating profits, annually recurring property operating losses and other significant adverse changes in general market conditions that are considered permanent in nature. Under ASC Topic 360, a real estate asset held for investment is not considered impaired if the undiscounted, estimated future cash flows of an asset (both the annual estimated cash flow from future operations and the estimated cash flow from the theoretical sale of the asset) over its estimated holding period are in excess of the asset’s net book value at the balance sheet date. If any real estate asset held for investment is considered impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value.

 

Properties that are treated as “subject to sales contract” on the Consolidated Balance Sheets and are listed in detail in Schedule III, “Real Estate and Accumulated Depreciation” are those in which we have not recognized the legal sale according to the guidance in ASC 360-20 due to various factors. For sales transactions where the guidance reflects a sale did not occur, the asset involved in the transaction, including the debt, if applicable, and property operations, remain on the books of the Company. We continue to charge depreciation to expense as a period cost for the property until such time as the property has been classified as held for sale in accordance with guidance reflected in ASC 360-10-45 “Impairment or Disposal of Long-Lived Assets.”

 

Real estate held for sale.    We classify properties as held for sale when certain criteria are met in accordance with GAAP. At that time, we present the assets and obligations of the property held for sale separately in our consolidated balance sheet and we cease recording depreciation and amortization expense related to that property. Properties held for sale are reported at the lower of their carrying amount or their estimated fair value, less estimated costs to sell. We did not have any real estate assets classified as held for sale at December 31, 2018 or 2017.

 

Effective as of January 1, 2015, we adopted the revised guidance in Accounting Standards Update No. 2014-08 regarding discontinued operations. For sales of real estate or assets classified as held for sale after January 1, 2015, we will evaluate whether a disposal transaction meets the criteria of a strategic shift and will have a major effect on our operations and financial results to determine if the results of operations and gains on sale of real estate will be presented as part of our continuing operations or as discontinued operations in our consolidated statements of operations. If the disposal represents a strategic shift, it will be classified as discontinued operations for all periods presented; if not, it will be presented in continuing operations.

 

Any properties that are treated as “subject to sales contract” on the Consolidated Balance Sheets and are listed in detail in Schedule III, “Real Estate and Accumulated Depreciation” are those in which we have not recognized the legal sale according to the guidance in ASC 360-20 due to various factors, disclosed in Item 1 “Significant Real Estate Acquisitions/Dispositions and Financing.” Any sale transaction where the guidance reflects that a sale had not occurred, the asset involved in the transaction, including the debt, if appropriate, and property operations, remained on the books of the Company. We continue to charge depreciation to expense as a period costs for the property until such time as the property has been classified as held for sale in accordance with guidance reflected in ASC 360-10-45 “Impairment or Disposal of Long-Lived Assets.”

 

Cost capitalization.     The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition costs. Costs directly related to planning, developing, initial leasing and constructing a property are capitalized and classified as Real Estate in the Consolidated Balance Sheets. Capitalized development costs include interest, property taxes, insurance, and other direct project costs incurred during the period of development.

 

41

 

 

A variety of costs are incurred in the acquisition, development and leasing of properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. Our capitalization policy on development properties is guided by ASC Topic 835-20 “Interest – Capitalization of Interest” and ASC Topic 970 “Real Estate - General”. The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We consider a construction project as substantially completed and held available for occupancy upon the receipt of certificates of occupancy, but no later than one year from cessation of major construction activity. We cease capitalization on the portion (1) substantially completed and (2) occupied or held available for occupancy, and we capitalize only those costs associated with the portion under construction.

 

We capitalize leasing costs which include commissions paid to outside brokers, legal costs incurred to negotiate and document a lease agreement and any internal costs that may be applicable. We allocate these costs to individual tenant leases and amortize them over the related lease term.

 

Fair value measurement.    We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures,” to the valuation of real estate assets. These provisions define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date, establish a hierarchy that prioritizes the information used in developing fair value estimates and require disclosure of fair value measurements by level within the fair value hierarchy. The hierarchy gives the highest priority to quoted prices in active markets (Level 1 measurements) and the lowest priority to unobservable data (Level 3 measurements), such as the reporting entity’s own data.

 

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and includes three levels defined as follows:

 

Level 1 Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets.
Level 2 Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 Unobservable inputs that are significant to the fair value measurement.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Related parties. We apply ASC Topic 805, “Business Combinations”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.

 

Recognition of revenue.    Our revenues, which are composed largely of rental income, include rents reported on a straight-line basis over the lease term. In accordance with ASC 805 “Business Combinations”, we recognize rental revenue of acquired in-place “above-” and “below-market” leases at their fair values over the terms of the respective leases.

 

Reimbursements of operating costs, as allowed under most of our commercial tenant leases, consist of amounts due from tenants for common area maintenance, real estate taxes and other recoverable costs, and are recognized as revenue in the period in which the recoverable expenses are incurred. We record these reimbursements on a “gross” basis, since we generally are the primary obligor with respect to purchasing goods and services from third-party suppliers; we have discretion in selecting the supplier and have the credit risk with respect to paying the supplier.

 

Rental revenue for residential property leases is recorded when due from residents and is recognized monthly as earned, which is not materially different than on a straight-line basis as lease terms are generally for periods of one year or less. An allowance for doubtful accounts is recorded for all past due rents and operating expense reimbursements considered to be uncollectible.

 

Sales and the associated gains or losses related to real estate assets are recognized in accordance with the provisions of ASC Topic 360-20, “Property, Plant and Equipment—Real Estate Sale.” The specific timing of a sale is measured against various criteria in ASC 360-20 related to the terms of the transaction and any continuing involvement in the form of management or financial assistance associated with the properties. If the sales criteria for the full accrual method are not met, the Company defers some or all of the gain recognition and accounts for the continued operations of the property by applying the finance, leasing, deposit, installment or cost recovery methods, as appropriate, until the sales criteria are met.

 

42

 

 

Non-performing notes receivable.    We consider a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower is not making interest payments in accordance with the terms of the agreement.

 

Interest recognition on notes receivable.    We record interest income as earned in accordance with the terms of the related loan agreements.

 

Allowance for estimated losses.    We assess the collectability of notes receivable on a periodic basis, the assessment consists primarily of an evaluation of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment. Refer to Note 5 “Notes and Interest Receivable” for details on our notes receivable.

 

Cash equivalents.    For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.

 

Restricted cash.     Restricted cash is comprised primarily of cash balances held in escrow by financial institutions under the terms of certain secured notes payable and certain unsecured bonds payable.

 

Concentration of credit risk.    The Company maintains its cash balances at commercial banks and through investment companies, the deposits of which are insured by the Federal Deposit Insurance Corporation (FDIC). At December 31, 2017 and 2016, the Company maintained balances in excess of the insured amount.

 

Earnings per share.    Income (loss) per share is presented in accordance with ASC 620 “Earnings per Share” and is computed based upon the weighted average number of shares of common stock outstanding during each year.

 

Use of estimates.    In the preparation of Consolidated Financial Statements in conformity with GAAP, it is necessary for management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expense for the year ended. Actual results could differ from those estimates.

 

Income taxes.    The Company is a “C” corporation” for U.S. federal income tax purposes. The Company and the rest of the ARL group are included in the MRHI, consolidated group for tax purposes. TCI is a member of a tax sharing agreement that specifies the manner in which the group will share the consolidated tax liability and also how certain tax attributes are to be treated among members of the group.

 

43

 

 

Recent accounting pronouncements.    

 

In May 2014, Accounting Standards Update (“ASU”) No. 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers,” was issued. This new guidance established a new single comprehensive revenue recognition model and provides for enhanced disclosures. Under the new policy, the nature, timing and amount of revenue recognized for certain transactions could differ from those recognized under existing accounting guidance. This new standard does not affect revenue recognized under lease contracts. ASU 2014-09 is effective for reporting periods beginning after December 15, 2017. The Company does not believe the adoption of this guidance had a material impact on its financial statements.

 

In February 2016, FASB issued ASU 2016-02 (“ASU 2016-02”), Leases. This guidance establishes a new model for accounting for leases and provides for enhanced disclosures. ASU 2016-02 is effective for reporting periods beginning after December 15, 2018. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its financial position and results of operations, if any.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years; however, early adoption is permitted. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively if retrospective application would be impracticable. The Company adopted this standard effective on January 1, 2018. ASU 2016-15 will impact our presentation of operating, investing and financing activities related to certain cash receipts and payments on our consolidated statements of cash flows.  

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which clarifies guidance on the classification and presentation of changes in restricted cash. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted, and will be applied retrospectively to all periods presented. Upon adoption, restricted cash balances will be included along with cash and cash equivalents as of the end of the period and beginning period, respectively, in the Company’s consolidated statement of cash flows for all periods presented. Upon adoption, separate line items showing changes in restricted cash balances will be eliminated from the Company’s consolidated statement of cash flows. The Company adopted this guidance effective on January 1, 2018. ASU 2016-18 will impact our presentation of operating, investing and financing activities related to restricted cash on our consolidated statements of cash flows.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The Company expects that acquisitions of real estate or in-substance real estate will not meet the revised definition of a business and thus will be treated as asset acquisitions. Acquisition costs for those acquisitions that are not businesses will be capitalized rather than expensed. The Company adopted this guidance effective January 1, 2018. The Company does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

 

In February 2017, the FASB issued ASU 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Topic 610-20), which requires that all entities account for the derecognition of a business in accordance with ASC 810, including instances in which the business is considered in-substance real estate. The ASU requires the Company to measure at fair value any retained interest in a partial sale of real estate. The ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2017. The Company adopted ASU 2017-05 effective January 1, 2018. The Company does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement that eliminates, adds and modifies certain disclosure requirements for fair value measurements. The effective date of the standard is for fiscal periods, and interim periods within those years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively. All other amendments should be applied retrospectively. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of ASU 2018-13 may have on its consolidated financial statements. 

 

44

 

 

NOTE 2.

INVESTMENT IN VAA

On November 19, 2018, we executed an agreement between the Macquarie Group (“Macquarie”) and SPC and TCI to create a joint venture, Victory Abode Apartments, LLC (“VAA”) to address existing and future demand for quality multifamily residential housing through acquisition and development of sustainable Class A multifamily housing in focused secondary and tertiary markets.  In connection with the formation of the joint venture, SPC and TCI contributed a portfolio of 49 income producing apartment complexes, and 3 development projects in various stages of construction. TCI received cash consideration of $236.8 million and recognized a gain of approximately $154.1 million. At the time of the transfer of the properties, the joint venture assumed all liabilities of those properties, including mortgage debt to the Department of Housing and Urban Development (“HUD”).

VAA is equally owned and controlled by Abode JVP, LLC, a wholly-owned subsidiary of SPC and Summerset Intermediate Holdings 2 LLC (“Summerset”), a wholly-owned indirect subsidiary of Macquarie.  Pursuant to the Agreement, Abode JVP, LLC and Summerset each own voting and profit participation rights of 50% and 49%, respectively (“Class A Members”).  The remaining 2% of the profit participation interest is held by Daniel J. Moos TCI’s President and Chief Executive Officer (“Class B Member”) who serves also as the Manager of the joint venture. In addition, upon the closing of the agreement the Class B Member received a one time consideration payment of $1.9 million.

The Company accounts for VAA as an equity method investment. Under the equity method of accounting, our net equity is reflected within the Consolidated Balance Sheets, and our share of net income or loss from the joint ventures is included within the Consolidated Statements of Operations. The joint venture agreements may designate different percentage allocations among investors for profits and losses; however, our recognition of joint venture income or loss generally follows the joint venture’s distribution priorities, which may change upon the achievement of certain investment return thresholds.

The following is a summary of the financial position and results of operations of VAA (dollars in thousands): 

 

VAA December 31, 2018  
Balance Sheet      
Net real estate assets $ 1,257,557
Other assets   67,020  
Debt, net   (791,225)
Other liabilities   (280,288)  
Total equity   (253,064)  

 

  For the period November 19
to December 31, 2018
 
Results of Operations      
Total revenue $ 12,887  
Total property, operating, and maintenance expenses   (4,507)  
Total other expense   (18,102)  
Net loss $ (9,722)

 

The following is a reconciliation from VAA's net loss to TCI's equity in earnings of VAA (dollars in thousands):

 

  For the period November 19
to December 31, 2018
VAA net loss $ (9,722 )
Adjustments to reconcile to earnings from VAA      
Interest expense on mezzanine loan   2,815  
In-place lease intangibles - amortization expense   3,983  
Depreciation basis differences   3,012  
 Adjusted net income $ 88  
Percentage ownership in VAA   50 %
Earnings from VAA $ 44  

  

The following table shows the location of properties owned by VAA:

 

    Apartments
Location   No.   Units
Alabama     1       168  
Arkansas     6       1,320  
Colorado     2       260  
Florida     2       388  
Georgia     1       222  
Louisiana     3       464  
Mississippi     1       196  
Nevada     1       308  
North Carolina     1       201  
Tennessee     4       708  
Texas-Greater Dallas-Ft Worth     13       2,323  
Texas-Greater Houston     1       176  
Texas-Other     13       2,458  
 Total     49       9,192  

 

At December 31, 2018, our apartment projects in development included (dollars in thousands):

 

Property   Location     No. of Units       Costs to Date (1)       Total Projected Costs (1)  
Terra Lago apartments   Rowlett, TX     451       66,395     $ —    
Lakeside lofts apartments   Farmers Branch, TX     494       50,357       80,622  
Sawgrass Creek apartments Phase II   Tampa, FL     143       25,113       26,799  
Total         1,088     $ 141,865     $ 107,421  

(1) Costs include construction hard costs, construction soft costs and loan borrowing costs.

45

 

 

NOTE 3.

REAL ESTATE

 

A summary of our real estate owned as of the end of the year is listed below (dollars in thousands):

 

    2018     2017  
Apartments   $ 126,274     $ 737,661  
Apartments under construction     25,289       104,791  
Commercial properties     224,167       200,803  
Land held for development     84,016       69,466  
Real estate subject to sales contract     3,986       45,739  
Total real estate, at cost, less impairment     463,732       1,158,460  
Less accumulated deprecation     (79,228 )     (178,590 )
Total real estate, net of depreciation   $ 384,504     $ 979,870  

 

Expenditures for repairs and maintenance are charged to operations as incurred. Significant betterments are capitalized. When assets are sold or retired, their costs and related accumulated depreciation are removed from the accounts with the resulting gains or losses reflected in net income or loss for the period.

 

Depreciation is computed on a straight line basis over the estimated useful lives of the assets as follows:

 

Land improvements 25 to 40 years
   
Buildings and improvements 10 to 40 years
   
Tenant improvements Shorter of useful life or terms of related lease
   
Furniture, fixtures and equipment 3 to 7 years

 

Fair Value Measurement

The Company applies the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures,” to the valuation of real estate assets. The Company is required to assess the fair value of its consolidated real estate assets with indicators of impairment. The value of impaired real estate assets is determined using widely accepted valuation techniques, including discounted cash flow analyses on the expected cash flow of each asset, as well as the income capitalization approach, which considers prevailing market capitalization rates, analyses of recent comparable sales transactions, information from actual sales negotiations and bona fide purchase offers received from third parties. The methods used to measure fair value may produce an amount that may not be indicative of net realizable value or reflective of future values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

The fair value measurements used in these evaluations are considered to be Level 2 and 3 valuations within the fair value hierarchy in the accounting rules, as there are significant observable (Level 2) and unobservable inputs (Level 3). Examples of Level 2 inputs the Company utilizes in its fair value calculations are appraisals and bona fide purchase offers from third parties. Examples of Level 3 inputs the Company utilizes in its fair value calculations are discount rates, market capitalization rates, expected lease rental rates, timing of new leases, an estimate of future sales prices and comparable sales prices of similar assets, if available. There was no provision for impairment during the years ended December 31, 2018, 2017 and 2016.

The highlights of our significant real estate transactions for the year ended December 31, 2018, are discussed below.

 

Purchases

 

During the year ended December 31, 2018, the Company purchased through one of its subsidiaries, eight residential apartment communities. A multi-family 80 unit community located in Baton Rouge, LA for a total purchase price of $12 million, paid through a seller’s financing note of $1.9 million, issuance of note payable of $8.6 million, and exercising an option to purchase of $1.5 million paid in the previous year. A multi-family 99 unit residential apartment community located in Mansfield, TX for a total purchase price of $14.8 million, paid through a seller’s financing note of $2.3 million, and an issuance of a note payable of $11.0 million. A multi-family 200 unit residential apartment community located in Gulf Shores, AL for a total purchase price of $18.1 million, paid through an issuance of a note payable of $11.5 million. A multi-family 144 unit residential apartment community located in Beaumont, TX for a total purchase price of $12.3 million. A multi-family 240 unit residential apartment community located in Houma, LA for a total purchase price of $20.1 million. A multi-family 208 unit residential apartment community located in Texarkana, TX for a total purchase price of $14.7 million. A multi-family 160 unit residential apartment community located in Tupelo, MS for a total purchase price of $11.1 million.

 

Sales

 

For the year ended December 31, 2018, TCI sold 62 acres of land to an independent third party for a total sales price of $3.0 million and recorded a gain of $1.3 million from the land sale. In the second quarter, a golf course comprising approximately 96.09 acres sold for an aggregate sales price of $2.3 million, out of which, $0.6 million was received in cash and $1.7 million in note receivables. During the first quarter, the Company sold six income-producing properties to a related party for an aggregate purchase price of $8.5 million, out of which, $2.1 million was received in cash and $6.4 million in note receivables. During the fourth quarter, the Company sold one income-producing properties to a related party for a purchase price of $2.2 million No gain or loss was recorded from the sale of income-producing properties.

 

  46  

 

 

In addition, on November 19, 2018 TCI through one of its subsidiaries formed VAA a joint venture with Macquarie. In connection with the formation of the joint venture, TCI contributed fifty-two properties and received a cash consideration of $236.8 million from Macquarie for a voting and profit participation right of 50% and 49%, respectively, 2% of the profits interest is held by Daniel J. Moos, who serves as the President and Chief Executive officer of the Company (“Class B Member”) and Manager of the joint venture. The Company recognized a gain of approximately $154.1 million from the sale of the contributed properties to the joint venture.

 

Mercer Crossing

 

In addition to the real estate sales noted above the Company recorded sales from a development project known as Mercer Crossing.

 

At November 2015, our real estate land holdings at Mercer Crossing consisted of land developable into residential homes and commercial projects, located in Farmers Branch, Texas. In November 2015, the Company entered into a sales contract with an unrelated party.  The contract was for all of the developable land owned by the Company. In addition, IOR and ARL also sold land in this transaction. Total consideration for the sale was $75 million. The agreement among the parties to this transaction provides for TCI to hold the subordinated note from the buyer in the amount of $50 million. At the closing, due to the inadequate down payment from the buyer and the level of seller financing involved, the transaction was accounted for under the deposit method. Under the deposit method, no revenue is recognized and the asset sold remains on the books until the criteria for full revenue recognition are met.

 

During the third quarter of 2018, due to significant cumulative sales of real estate to unrelated third parties and cash received by TCI, the criteria for recording full accrual accounting had been met. Through the period ended August 21, 2018 approximately $28.1 million of the assets previously held by the Company were sold, resulting in a gain of $7.5 million.

 

On August 22, 2018 the Company reacquired all the unsold portions of the real estate from the November 2015 transaction for the amount that remained from the original sales price.

 

During the period August 23, 2018 through December 31, 2018 additional Mercer Crossing real estate was sold for $11.7 million resulting in a net gain on sale of real estate of $5.6 million.

 

As of December 31, 2018, the Company has approximately 86 acres of land, at various locations that were sold to related parties in multiple transactions.  These transactions are treated as “subject to sales contract” on the Consolidated Balance Sheets.  Due to the related party nature of the transactions TCI has deferred the recording of the sales in accordance with ASC 360-20.

 

We continue to invest in the development of apartment projects. During the year ended December 31, 2018, we have invested $14.8 million related to the construction or predevelopment of various apartment complexes and capitalized $0.1 million of interest costs.

 

NOTE 4.

SUPPLEMENTAL CASH FLOW INFORMATION

 

For the years ended December 31, 2018 and 2017, the Company paid interest of $61.6 million and $36.4 million, respectively.

 

Cash and cash equivalents, and restricted cash for fiscal year ended 2018 and 2017 was $106.6 million and $88.5 million, respectively. The following is a reconciliation of the Company’s cash and cash equivalents, and restricted cash to the total presented in the consolidated statement of cash flows:

 

    December 31,  
    2018     2017  
Cash and cash equivalents   $ 36,358     $ 33,563  
Restricted cash (cash held in escrow)     37,946       44,705  
Restricted cash (certificate of deposits)     9,688       5,651  
Restricted cash (held with Trustee)     22,573       4,423  
Cash and cash equivalents and restricted cash   $ 106,565     $ 88,342  

 

Amounts included in restricted cash represent funds required to meet contractual obligations with certain financial institutions for the payment of reserve replacement and tax and insurance escrow. In addition, restricted cash includes funds to the Bond’s Trustee for payment of principal and interests.

 

47

 

 

NOTE 5.     

NOTES AND INTEREST RECEIVABLE

 

A portion of our assets are invested in mortgage notes receivable, principally secured by real estate. We may originate mortgage loans in conjunction with providing purchase money financing of property sales. Notes receivable are generally collateralized by real estate or interests in real estate and personal guarantees of the borrower and, unless noted otherwise, are so secured. Management intends to service and hold for investment the mortgage notes in our portfolio. A majority of the notes receivable provide for principal to be paid at maturity (dollars in thousands).

 

    Maturity   Interest            
Borrower   Date   Rate     Amount     Security
Performing loans:                          
H198, LLC (Las Vegas Land)     01/20     12.00 %     5,907     Secured
H198, LLC (Legacy at Pleasant Grove Land)     10/19     12.00 %     496     Secured
Oulan-Chikh Family Trust     03/21     8.00 %     174     Secured
H198, LLC (McKinney Ranch Land)     09/20     6.00 %     4,554     Secured
Forest Pines     09/19     5.00 %     2,223     Secured
Spyglass Apartments of Ennis, LP     11/19     5.00 %     5,083     Secured
Bellwether Ridge     05/20     5.00 %     3,429     Secured
Parc at Windmill Farms     05/20     5.00 %     6,066     Secured
Unified Housing Foundation, Inc. (Echo Station) (1)     12/32     12.00 %     1,481     Secured
Unified Housing Foundation, Inc. (Lakeshore Villas) (1)     12/32     12.00 %     2,000     Secured
Unified Housing Foundation, Inc. (Lakeshore Villas) (1)     12/32     12.00 %     6,369     Secured
Unified Housing Foundation, Inc. (Limestone Ranch) (1)     12/32     12.00 %     1,953     Secured
Unified Housing Foundation, Inc. (Limestone Ranch) (1)     12/32     12.00 %     2,000     Secured
Unified Housing Foundation, Inc. (Limestone Ranch) (1)     12/32     12.00 %     4,000     Secured
Unified Housing Foundation, Inc. (Timbers of Terrell) (1)     12/32     12.00 %     1,323     Secured
Unified Housing Foundation, Inc. (Tivoli) (1)     12/32     12.00 %     6,140     Secured
Unified Housing Foundation, Inc. (1)     12/19     12.00 %     10,401     Unsecured
Unified Housing Foundation, Inc. (1)     06/20     12.00 %     11,075     Unsecured
Other related party notes     Various     Various       2,290     Various secured interests
Other non-related party notes     Various     Various       1,631     Various secured interests
Accrued interest                   6,771      
Total Performing                 $ 85,366      
Allowance for estimated losses                   (1,825 )    
Total                 $ 83,541      

 

(1)  Related party notes
 
(2)  An allowance was taken for estimated losses at full value of note.

 

As of December 31, 2018, the obligors on $49.0 million or 57.4% of the mortgage notes receivable portfolio were due from related entities. The Company recognized $5.7 million of interest income from these related party notes receivables.

 

As of December 31, 2018, none of the mortgage notes receivable portfolio were non-performing.

 

The Company has various notes receivable from Unified Housing foundation, Inc. “UHF”. UHF is determined to be a related party due to our significant investment in the performance of the collateral secured under the notes receivable. Payments are due from surplus cash flow from operations, sale or refinancing of the underlying properties. These notes are cross collateralized to the extent that any surplus cash available from any of the properties underlying these notes will be used to repay outstanding interest and principal for the remaining notes. Furthermore, any surplus cash available from any of the properties UHF owns, besides the properties underlying these notes, can be used to repay outstanding interest and principal for these notes. The allowance on the notes was a purchase allowance that was netted against the notes when acquired.

 

48

 

 

NOTE 6.     

INVESTMENT IN UNCONSOLIDATED JOINT VENTURES AND INVESTEES

 

Investments in unconsolidated subsidiaries, jointly owned companies and other investees in which we have a 20% to 50% ownership interest or otherwise exercise significant influence are carried at cost, adjusted for the Company’s proportionate share of their undistributed earnings or losses, via the equity method of accounting. ARL is our parent company and is an unconsolidated joint venture.

 

Investments accounted for via the equity method consists of the following, except for VAA which is discussed in Note 2.

 

  Percentage ownership as of December 31,
  2018   2017   2016
American Realty Investors, INC. (1) 0.90%   0.90%   0.90%

 

(1)  Unconsolidated investment in parent company

 

The following is a summary of the financial position and results of operations of ARL (dollars in thousands). Summary data presented below excludes investments in VAA. For additional information refer to Note 2.

 

          December 31,        
    2018     2017     2016  
ARL            
Real estate, net of accumulated depreciation   $ 549     $ 12,349     $ 14,504  
Notes receivable     42,517       41,928       47,257  
Other assets     66,712       126,238       127,001  
Notes payable     (9,637 )     (6,507 )     (9,485 )
Other liabilities     (21,123 )     (102,014 )     (111,707 )
Shareholders’ equity/partners capital     (79,018 )     (71,994 )     (67,570 )

 

    For the Year Ended December 31,  
    2018     2017     2016  
Rents, interest and other income   $ 7,132     $ 9,193     $ 7,251  
Depreciation           (157 )     (175 )
Operating expenses     (2,420 )     (3,149 )     (3,633 )
Gain on land sales           4,765        
Interest expense     (7,191 )     (6,228 )     (6,274 )
Income (loss) from continuing operations   $ (2,479 )   $ 4,424     $ (2,831 )
Net  income (loss)   $ (2,479 )   $ 4,424     $ (2,831 )
                         
Company’s proportionate share of income (loss) (1)   $ (22 )   $ 40     $ (25 )

 

(1)

Income (loss) represents continued and discontinued operations

 

During the fourth quarter of 2018, TCI purchased from RAI 900,000 shares of ARL Series A convertible Preferred Stock for $9.0 million. The Series A Preferred Stock may be converted into common stock at 90.0% of the average daily closing price of ARL’s common stock for the prior 20 trading days.

The investment in ARL convertible Preferred Stock is being carried at the Company’s cost of $9 million and is included in investment in other unconsolidated investees. Additionally, TCI purchased from RAI $9.9 million accrued unpaid dividends related to the ARL Series A convertible Preferred Stock which is carried at the cost and included in investment in unconsolidated investees on the balance sheet.  

49

 

 

NOTE 7.    

NOTES AND INTEREST PAYABLE

 

Below is a summary of our notes and interest payable as of December 31, 2018 (dollars in thousands):

 

    Notes
Payable
    Accrued
Interest
    Total  
Apartments   $ 94,759     $ 270     $ 95,029  
Apartments under Construction     14,402             14,402  
Commercial     135,951       450       136,401  
Land     22,200       124       22,324  
Real estate held for sale     376             376  
Other     18,130             18,130  
                         
Total   $ 285,818     $ 844     $ 286,662  
                         
Unamortized deferred borrowing costs     (9,425 )           (9,425 )
    $ 276,393     $ 844     $ 277,237  

 

The following table summarizes our contractual obligations for principal payments as of December 31, 2018 (dollars in thousands): 

 

Year   Amount  
2019   $ 38,107  
2020     8,822  
2021     43,202  
2022     43,304  
2023     37,260  
Thereafter     115,123  
Total   $ 285,818  

 

Interest payable at December 31, 2018 was $0.8 million. Our debt has interest rates ranging from 2.5% to 9.5% per annum with maturity dates between 2019 and 2055. The mortgages were collateralized by deeds of trust on real estate having a net carrying value of $384.5 million.

 

During 2018 the Company refinanced or modified one loan with a total principal balance of $40.0 million. The refinancing resulted in a lower interest rate and the extension of the term of the loan. The transaction provides for lower monthly payments over the term of loan.

 

There are various land mortgages, secured by the property, that are in the process of a modification or extension to the original note due to expiration of the loan. We are in constant contact with these lenders, working together in order to modify the terms of these loans and we anticipate a timely resolution that is similar to the existing agreement or subsequent modification. 

 

In conjunction with the development of various apartment projects and other developments, we drew down $81.0 million in construction loans during the year ended December 31, 2018.

 

50

 

 

NOTE 8.    

BONDS AND BONDS INTEREST PAYABLE

 

In August 2016, Southern Properties Capital LTD (“Southern”), a British Virgin Islands corporation was incorporated for the purpose of raising funds by issuing Bonds to be traded on the TASE.  The Company transferred certain residential and commercial properties located in the United States to Southern, its wholly owned subsidiary. 

 

On February 13, 2017, Southern filed a final prospectus with the TASE for an offering and sale of nonconvertible Series A Bonds to be issued by Southern. The bonds are obligations of Southern.  During the year ended December 31, 2017 on three separate occasions Southern issued nonconvertible Series A Bonds with a total value of approximately NIS400 million New Israeli Shekels (“NIS”) or approximately $115 million dollars.  The Series A Bonds have a stated interest rate of 7.3%.  At March 31, 2018 the effective interest rate is 9.17%. The bonds require semi-annual equal installments on January 31 and July 31 of each year from 2019 to 2023 (inclusive). The interest will be repaid on January 31 and July 31 of each of the years 2018 to 2023 (inclusive), with the first payment commencing on July 31, 2017.

 

On January 25, 2018, interest payment of approximately NIS 14.6 million (or approximately $4.3 million) was paid to the Series A bondholders.

 

On February 15, 2018, Southern issued Series B bonds in the amount of NIS 137.7 million par value (approximately $39.2 million as of February 15, 2018). The Series B bonds are registered on the TASE. The bonds are reported in NIS and bear annual interest rate of 6.8%. Interest shall be repaid January 31 and July 31 of each of the years 2019 to 2023 (inclusive), first payment commencing on July 31, 2018. The principal shall be repaid in ten equal installments on January 31 and July 31 of each of the years from 2021 to 2025 (inclusive). A total bond issuance cost of $1.4 million was incurred. The effective interest rate is 7.99%.

 

On July 19, 2018, Southern closed a private placement of its Series B bonds in the amount of NIS 72.3 million (or approximately $19.8 million). The bonds are reported in NIS, are registered on the TASE, bear an annual interest rate of 6.8% and have an effective interest rate of 9.60%. Interest will be paid on January 31 and July 31 of each of the years 2019 and 2013 (inclusive). The principal will be repaid in ten equal installment on January 31 and July 31 of each of the years from 2021 to 2012 (inclusive). The Company incurred bonds issuance costs of approximately $1.9 million.

 

On July 26, 2018, interest payment of approximately NIS 18.9 million (or approximately $5.2 million) was paid to the Series A and B bondholders.

 

In December 2018, the Company deposited $16.2 million with the bond Trustee for upcoming January 2019 Series A and B bonds principal and interest payments.

 

The outstanding balance of these Bonds at December 31, 2018 is as follows:

 

    December 31,
2018
    December 31,
2017
 
Bonds (Series A)   $ 106,686     $ 115,336  
Bonds (Series B)     36,740        
Bonds (Series B expansion)     19,290        
Less: deferred issuance expense, net     (8,179 )     (5,916 )
Accrued Interest     4,037       3,627  
    $ 158,574     $ 113,047  

 

b. Aggregate maturities are as follows:        

  

    December 31,
2018
      December 31,
2017
First year   $ 21,345      $        —
Second Year     21,345        23,067
Third year     32,550        23,067
Fourth year     32,550        23,067
Fifth year     32,550        23,067
Thereafter     22,376        23,068
    $ 162,716      $  115,336

 

The funds were used primarily for the acquisition and development of additional real estate operations in the United States. The funds were raised and will be repaid in NIS, however the funds raised have been converted to US dollars. The Company records unrealized gains or losses each quarter based upon the relative exchange values of the US dollar and the NIS; however, no gain or loss will be realized until a conversion from US dollars to NIS actually occurs in the future. The recorded unrealized gain or loss is reflected as a separate line item to highlight the fact that it is a non-cash transaction until such time as actual payment of principal and interest on the bonds is made. For the year ended December 31, 2018, the Company recorded a gain on foreign currency transaction of approximately $12.4 million.

 

51

 

 

NOTE 9.    

RELATED PARTY TRANSACTIONS AND FEES

 

We apply ASC Topic 805, “Business Combinations”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.

 

The Company has historically engaged in and may continue to engage in certain business transactions with related parties, including but not limited to asset acquisition and dispositions. Transactions involving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in our best interest.

 

Since April 30, 2011, Pillar, the sole shareholder of which is Realty Advisors, LLC, a Nevada limited liability company, the sole member of which is RAI, a Nevada corporation, the sole shareholder of which is MRHI, a Nevada corporation, the sole shareholder of which is a trust known as the May Trust, became the Company’s external Advisor and Cash Manager.  Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities. Pillar also arranges, for the Company’s benefit, debt and equity financing with third party lenders and investors. Pillar also serves as an Advisor and Cash Manager to TCI and IOR.  As the contractual advisor, Pillar is compensated by TCI under an Advisory Agreement that is more fully described in Part III, Item 10. “Directors, Executive Officers and Corporate Governance – The Advisor”.  TCI has no employees. Employees of Pillar render services to TCI in accordance with the terms of the Advisory Agreement

 

Effective January 1, 2011, Regis Realty Prime, LLC, dba Regis Property Management, LLC (“Regis”), the sole member of which is Realty Advisors, LLC, manages our commercial properties and provides brokerage services. Regis receives property management fees, construction management fees and leasing commissions in accordance with the terms of its property-level management agreement. Regis is also entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement. Refer to Part III, Item 10. “Directors, Executive Officers and Corporate Governance – Property Management and Real Estate Brokerage”.   TCI engages third-party companies to lease and manage its apartment properties. 

 

Below is a description of the related party transactions and fees between Pillar and Regis:

 

Fees, expenses and revenue paid to and/or received from our advisor:

 

    2018     2017     2016  
    (dollars in thousands)  
Fees:                  
Advisory   $ 10,663     $ 9,995     $ 9,490  
Mortgage brokerage and equity refinancing     852       1,551       775  
Net income     631       250       257  
    $ 12,146     $ 11,796     $ 10,522  
Other Expense:                        
Cost reimbursements   $ 4,398     $ 2,895     $ 3,228  
Interest received     (7,404 )     (4,859 )     (4,216 )
    $ (3,006 )   $ (1,964 )   $ (988 )
Revenue:                        
Rental   $ 1,178     $ 783     $ 708  

52

 

 

Fees paid to Regis and related parties:

 

    2018     2017     2016  
    (dollars in thousands)  
Fees:                        
Property acquisition   $ 43,856     $ 9,819     $ 10,776  
Property management, construction management and leasing commissions     540       963       888  
Real estate brokerage     2,068       1,369       787  
    $ 46,464     $ 12,151     $ 12,451  

 

The Company received rental revenue of $1.2 million, $0.8 million, and $0.7 million in the years ended December 31, 2018, 2017, and 2016, respectively, from Pillar and its related parties for properties owned by the Company.

 

As of December 31, 2018, the Company had notes and interest receivable of $49.0 million due from UHF, a related party. During 2018, the Company recognized interest income of $5.7 million, originated $5.3 million, received no principal payments, and received interest payments of $6.1 million from these related party notes receivables.

 

On January 1, 2012, the Company entered into a development agreement with UHF, a non-profit corporation that provides management services for the development of residential apartment projects in the future. This development agreement was terminated December 31, 2013. The Company has also invested in surplus cash notes receivables from UHF and has sold several residential apartment properties to UHF in prior years. Due to this ongoing relationship and the significant investment in the performance of the collateral secured under the notes receivable, UHF has been determined to be a related party.

 

The Company is the primary guarantor, on a $39.1 million mezzanine loan between UHF and a lender. In addition, ARL, and an officer of the Company are limited recourse guarantors of the loan. As of December 31, 2018 UHF was in compliance with the covenants to the loan agreement.

 

The Company is part of a tax sharing and compensating agreement with respect to federal income taxes between ARL, TCI and IOR and their subsidiaries that was entered into in July of 2009. That agreement continued until August 31, 2012, at which time a new tax sharing and compensating agreement was entered into by ARL, TCI, IOR and MRHI for the remainder of 2012 and subsequent years. The expense (benefit) in each year was calculated based on the amount of losses absorbed by taxable income multiplied by the maximum statutory tax rate of 21%.

 

The following table reconciles the beginning and ending balances of accounts receivable from and (accounts payable) to related parties as of December 31, 2018 (dollars in thousands):

 

    Pillar     ARL     Total  
Related party receivable, December 31, 2017   $     $ 111,665     $ 111,665  
Cash transfers     71,034             71,034  
Advisory fees     (10,662 )           (10,662 )
Net income fee     (631 )           (631 )
Fees and commissions     (2,919 )           (2,919 )
Cost reimbursements     (4,398 )           (4,398 )
Interest income           7,229       7,229  
Notes receivable purchased     (5,314 )           (5,314 )
Expenses (paid)/received by advisor     1,221             1,221  
Financing (mortgage payments)     10,273             10,273  
Sales/Purchases transactions     (43,856 )           (43,856 )
Related party receivable, December 31, 2018   $ 14,748     $ 118,894     $ 133,642  

 

As of December 31, 2018, the Company has approximately 86 acres of land, at various locations that were sold to related parties in multiple transactions. These transactions are treated as “subject to sales contract” on the Consolidated Balance Sheets.

 

53

 

 

NOTE 10.    

DIVIDENDS 

 

TCI’s Board of Directors established a policy that dividend declarations on common stock would be determined on an annual basis following the end of each year. In accordance with that policy, no dividends on TCI’s common stock were declared for 2018, 2017, or 2016. Future distributions to common stockholders will be determined by the Board of Directors in light of conditions then existing, including the Company’s financial condition and requirements, future prospects, restrictions in financing agreements, business conditions and other factors deemed relevant by the Board.

 

NOTE 11.    

PREFERRED STOCK

 

In November 2006, TCI issued 100,000 shares of Series D Preferred Stock with a liquidation preference of $100 per share. The preferred stock is not convertible into any other security, requires dividends payable at the initial rate of 7% annually. The dividend rate increases ratably from 7% to 9% in future periods and can be redeemed at any point after September 30, 2011. 

 

During the fourth quarter of 2018, all 100,000 shares of Series D Preferred Stock were redeemed for $17.2 million, of which $7.2 million was accrued unpaid dividends. At December 31, 2018, there were no preferred shares outstanding.

 

 

54

 

 

NOTE 12.    

INCOME TAXES

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. We recognize deferred tax assets to the extent that we believe these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.

For financial reporting purposes, income before income taxes were:

 

    Years Ended December 31  
    2018     2017     2016  
    (in thousands)  
TOTAL   $ 186,250     $ (15,136 )   $ 345  
                         

The expense (benefit) for income taxes consists of:

 

    Years Ended December 31  
    2018     2017     2016  
    (in thousands)  
Current:                  
Federal   $ 42,805   $ (5,603 )     121 )
State     1,210       10        
                         
Deferred and other:                        
Federal     (40,805     5,603       (98 )
State         170        
                         
Total Tax Expense   $ 3,210     $ 180     $ 23  

55

 

The reconciliation between the Company’s effective tax rate on income from continuing operations and the statutory rate is as follows:

 

    Years Ended December 31