-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FpzbIrfbhrCa3RuYYNUDeAPT52F/vv0Q7/E+hWDXsbPVJCAAFpcbe22WlzHTD9ZS UkCt2ge3i6BJyIid8KPsRw== 0000928790-96-000076.txt : 19960402 0000928790-96-000076.hdr.sgml : 19960402 ACCESSION NUMBER: 0000928790-96-000076 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960401 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PARTICIPATING DEVELOPMENT FUND 86 CENTRAL INDEX KEY: 0000785940 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 061153833 STATE OF INCORPORATION: CT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-02294 FILM NUMBER: 96542618 BUSINESS ADDRESS: STREET 1: SHEARSON LEHAMAN DEVELOPMENT STREET 2: 3 WORLD FINANCIAL CENTER 29TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10285 BUSINESS PHONE: 2125263237 MAIL ADDRESS: STREET 1: 3 WORLD FINANCIAL CENTER STREET 2: 29TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10285 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended: December 31, 1995 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] Commission file number: 33-2294 PARTICIPATING DEVELOPMENT FUND 86 A Real Estate Limited Partnership Exact Name of Registrant as Specified in its Charter Connecticut 06-1153833 - ------------------------------ ---------------- State or other jurisdiction of IRS employer identification No. incorporation or organization 3 World Financial Center, 29th Floor New York, New York ATTN: Andre Anderson 10285 - --------------------------------------- ---------- Address of principal executive offices zip code Registrant's Telephone Number, Including Area Code: (212) 526-3237 Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: UNITS OF LIMITED PARTNERSHIP INTERESTS (Title of Class) 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 X No ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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. X State the aggregate market value of the voting stock held by non-affiliates of the Registrant: Not applicable. DOCUMENTS INCORPORATED BY REFERENCE: Portions of Prospectus dated February 21, 1986 filed with the Securities and Exchange Commission pursuant to Rule 424(b) on February 27, 1986 are incorporated by reference into Parts I, II, III, and IV of this report. Portions of Parts I, II, III and IV are incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. PART I Item 1. Business (a) General Development of Business Participating Development Fund 86, A Real Estate Limited Partnership (the "Partnership"), was formed on December 9, 1985 under the Uniform Limited Partnership Act of the State of Connecticut. The Partnership was originally formed to make five participating investments by entering into land purchase leaseback transactions and concurrently funding leasehold mortgage loans secured by commercial and multi-family residential real estate (the "Participating Investments"). The Partnership made its Participating Investments in the following five properties (the "Properties" or individually a "Property"): Sunnyvale R&D, a one-story research and development building located in Sunnyvale, California; Foothills Tech Plaza, two research and development/service buildings in Phoenix, Arizona; Harris Pond Apartments, a 170-unit luxury apartment complex in Charlotte, North Carolina; Pebblebrook Apartments, a 267-unit luxury apartment complex in Overland Park (Kansas City), Kansas; and 1899 Powers Ferry Road, a four-story office building located in Atlanta, Georgia. The Participating Investment in Harris Pond Apartments was sold on November 1, 1989. As a result of defaults under ground leases on the Sunnyvale, Phoenix, Atlanta and Overland Park Properties, the Partnership took title to these Properties in their entirety. The Partnership anticipated liquidating its remaining investments within seven years from their respective dates of funding, however, competitive market conditions limited favorable sales opportunities. The Partnership does not plan to invest in any additional property. On June 15, 1992, Phoenix Realty Management, Inc., ("Phoenix") sent a notice of resignation as co-General Partner of the Partnership to PDF86 Real Estate Services Inc. ("RE Services" or the "General Partner"), formerly Shearson Lehman Brothers/PDF 86, Inc. (See Item 10. "Certain Matters Involving Affiliates of RE Services"), the Partnership's other co-General Partner. The effective date of the resignation was June 16, 1992. As a result of the resignation of Phoenix, RE Services, as sole General Partner, manages the affairs of the Partnership. Foothills Tech Plaza was sold on September 29, 1995 for $10,011,512, net of $226,000 in contracted roof repairs. Additional information regarding the sale is incorporated by reference to the section entitled "Message to Investors" and Note 3 "Real Estate Investments" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. On May 11, 1995, the General Partner executed a letter of intent with an unaffiliated third party to sell Pebblebrook Apartments. During the 1995 third quarter, the prospective buyer rescinded its offer. However, the General Partner subsequently agreed to a letter of intent with another unaffiliated third party to sell Pebblebrook Apartments, and on January 31, 1995 the General Partner executed a purchase and sale agreement for a sales price of $10,570,000, net of commissions. The sale was originally expected to close in late January, 1996 and was subsequently posponed until March, 1996. However, during the due diligence period, the prospective buyer raised certain concerns regarding the physical condition of the Property. While negotiations are continuing and the General Partner remains confident that the sale will be successfully concluded, there is no assurance that an agreement can be reached with the buyer concerning the remaining issues. Therefore, it remains possible that the sale will be further delayed or possibly not close at all. Additional information regarding the historical development of business is incorporated by reference to Note 1 "Organization," Note 2 "Accounting Policies" and Note 3 "Real Estate Investments" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. (b) Financial Information About Industry Segment The Partnership's sole business is the ownership and operation of the Properties. All of the Partnership's revenues, operating profit or losses and assets relate solely to such industry segment. (c) Narrative Description of Business Incorporated by reference to Note 1 "Organization" and Note 3 "Real Estate Investments" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. (d) Competition Incorporated by reference to the section entitled "Property Profiles & Leasing Update" contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. (e) Employees The Partnership has no employees. Item 2. Properties Description of Properties and material leases incorporated by reference to the "Property Profiles & Leasing Update" and Note 3 "Real Estate Investments" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995, filed as an exhibit under Item 14. Item 3. Legal Proceedings Discussion regarding class action settlement agreement incorporated by reference to Note 7 "Litigation" of Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of Unit Holders during the fourth quarter of 1995. PART II Item 5. Market for the Partnership's Limited Partnership Units and Related Security Holder Matters (a) Market Information There is no established trading market for the Units of the Partnership. (b) Holders As of December 31, 1995, there were 7,759 holders of record, owning an aggregate of 1,124,000 Units. (c) Distributions A discussion of cash distributions paid to the Limited Partners for the two years ended December 31, 1995 is incorporated by reference to the section entitled "Message to Investors" contained in the Partnership's Annual Report To Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. Item 6. Selected Financial Data Incorporated by reference to the section entitled "Financial Highlights" contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources - ------------------------------- Foothills Tech Plaza was sold to an unaffiliated third party on September 29, 1995 for $10,011,512, net of $226,000 in contracted roof repairs. The gain on disposition of the property totaled $1,088,860. In anticipation of the sale of Pebblebrook Apartments, the property was reclassified, in the amount of $7,780,273, to "Real estate assets held for sale" on the Partnership's balance sheet. Land, buildings and improvements, net of accumulated depreciation, decreased by $17,452,829 from December 31, 1994 to December 31, 1995 primarily as a result of the Foothills Tech Plaza sale and reclassification of Pebblebrook Apartments. At December 31, 1995, the Partnership had cash and cash equivalents of $1,480,034 compared with $140,886 at December 31, 1994. The increase is primarily attributable to proceeds from the sale of Foothills Tech Plaza and net cash provided by operating activities in excess of cash distributions paid to Partners. The cash and cash equivalents balance includes amounts reserved for capital and tenant improvements, leasing costs, working capital reserves and cash flow generated from operations of the properties. The Partnership also maintains a restricted cash balance, which is comprised of tenant security deposits. Restricted cash totaled $100,286 at December 31, 1995, compared with $152,162 at December 31, 1994. The decrease is primarily due to the sale of Foothills Tech Plaza. Prepaid expenses totaled $273,681 at December 31, 1995, compared with $389,472 at December 31, 1994. The decrease is primarily the result of the amortization of leasing commissions associated with the lease-up of Powers Ferry in 1994 and the sale of Foothills Tech Plaza in 1995. Incentives to lease were $188,693 at December 31, 1995 compared to $283,555 at December 31, 1994. The decrease is largely the result of the amortization of a lease buyout at Powers Ferry Office Building. Deferred rent receivable totaled $193,634 at December 31, 1995, compared to $269,701 at December 31, 1994. The decrease is largely due to the write-off of deferred rent resulting from the sale of Foothills Tech Plaza. Accounts payable and accrued expenses totaled $133,022 at December 31, 1995, compared with $323,897 at December 31, 1994. The decrease primarily is due to a reduction in accrued lease incentives relating to a lease buyout at Powers Ferry Office Building. Security deposits payable totaled $100,286 at December 31, 1995, compared to $152,162 at December 31, 1994. The decrease is mainly due to the sale of Foothills Tech Plaza. Prepaid rent totaled $79,555 at December 31, 1995, compared to $4,085 at December 31, 1994. The increase is largely attributable to the timing of rental payments. The General Partner has determined that an adequate cash reserve exists to fund anticipated tenant improvement costs and leasing commissions associated with leasing efforts at the Properties, and pay cash distributions to the Limited Partners. For the year ended December 31, 1995, the Partnership declared cash distributions to the Limited Partners totaling $9.79 per Unit. Included in this total was a special distribution in the amount of $8.59 per Unit which was paid on November 24, 1995 and represented proceeds from the sale of Foothills Tech Plaza, and a fourth quarter cash distribution of $0.30 per Unit which was paid on February 9, 1996. In addition, on March 29, 1996 the Partnership paid a special cash distribution in the amount of $.55 per Unit. The distribution was made from the Partnership's cash reserves. The timing and amount of future distributions will depend on several factors, including the adequacy of rental income being generated by current leases and Partnership cash flow. On February 16, 1996, based upon, among other things, the advice of Partnership counsel, Skadden, Arps, Slate, Meagher & Flom, the General Partner adopted a resolution that states, among other things, if a Change of Control (as defined below) occurs, the General Partner may distribute the Partnership's cash balances not required for its ordinary course day-to-day operations. "Change of Control" means any purchase or offer to purchase more than 10% of the Units that is not approved in advance by the General Partner. In determining the amount of the distribution, the General Partner may take into account all material factors. In addition, the Partnership will not be obligated to make any distribution to any partner and no partner will be entitled to receive any distribution until the General Partner has declared the distribution and established a record date and distribution date for the distribution. The Partnership filed a form 8-K disclosing this resolution on February 23, 1996. Results of Operations 1995 Versus 1994 - ---------------- Partnership operations resulted in net income of $2,662,237 for the year ended December 31, 1995, compared with net income of $1,449,548 for the corresponding period in 1994. The increase in net income in 1995 is primarily attributable to the gain on the sale of Foothills Tech Plaza in the amount of $1,088,860. Rental income totaled $4,397,667 for the year ended December 31, 1995, compared to $4,387,259 for the year ended December 31, 1994. The increase is primarily attributable to higher average occupancy at Powers Ferry Office Building and higher rental rates at Pebblebrook Apartments and Powers Ferry Office Building, partially offset by the sale of Foothills Tech Plaza. Interest income totaled $142,161 for the year ended December 31, 1995, compared to $11,912 for the year ended December 31, 1994. The increase is largely due to the Partnership's higher average cash balance in 1995 resulting from the sale of Foothills Tech Plaza. Other income totaled $8,807 for the year ended December 31, 1995, compared to $189,508 for the year ended December 31, 1994. The decrease is mainly attributable to the receipt of a lease cancellation fee at Powers Ferry Office Building in 1994. Property operating expenses totaled $1,403,161 for the year ended December 31, 1995, relatively unchanged from $1,407,195 for the year ended December 31, 1994. Depreciation and amortization totaled $1,358,528 for the year ended December 31, 1995, compared to $1,513,099 for the year ended December 31, 1994. The decrease is primarily attributable to a lower depreciable asset base resulting from the sale of Foothills Tech Plaza. The Partnership recognized bad debt expense for the year ended December 31, 1994 totaling $16,905 reflecting the write-off of a former tenant's receivable balance. As of December 31, 1995, the lease levels at each of the properties were as follows: Powers Ferry Office Building - 94%; Sunnyvale R&D - 100%; and Pebblebrook Apartments - 96%. 1994 Versus 1993 - ---------------- Partnership operations resulted in net income of $1,449,548 for the year ended December 31, 1994, compared with net income of $931,882 for the corresponding period in 1993. The increase in net income in 1994 is primarily attributable to higher rental income and other income in 1994, as well as lower general administrative, bad debt and depreciation expenses. These were offset by lower interest income and higher property operating expenses. Rental income totaled $4,387,259 for the year ended December 31, 1994, compared with $3,990,962 in 1993. The increase in 1994 is primarily attributable to a rental rate increase at Sunnyvale, increased occupancy at Powers Ferry, scheduled rental rate increases at Pebblebrook and a tenant taking occupancy at Foothills. Other income was $189,508 for the year ended December 31, 1994, compared to $67,093 for the year ended December 31, 1993. The increase of $122,415 is due primarily to the receipt of a tenant's cancellation fee at Powers Ferry. Interest income totaled $11,912 for the year ended December 31, 1994 compared with $42,812 in 1993, reflecting the Partnership's lower average cash balances. Property operating expenses totaled $1,407,195 for the year ended December 31, 1994, compared to $1,206,605 in 1993. The $200,590 increase is primarily due to higher real estate taxes at the Pebblebrook property and higher repairs and maintenance, payroll, administrative and utility expenses at the Powers Ferry and Pebblebrook properties. Depreciation and amortization expense totaled $1,513,099 for the year ended December 31, 1994, compared with $1,690,501 in 1993. Depreciation and amortization expense was lower for the twelve month period in 1994 due to certain assets becoming fully depreciated during 1994, primarily at the Sunnyvale and Pebblebrook properties. As of December 31, 1994, the lease levels at each of the properties were as follows: Foothills Tech Plaza - 100%; 1899 Powers Ferry Road - 91%; Sunnyvale R&D - 100%; and Pebblebrook Apartments - 97%. Item 8. Financial Statements and Supplementary Data Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant The General Partner of the Partnership is PDF86 Real Estate Services Inc. ("RE Services"), formerly Shearson Lehman Brothers, Inc./PDF 86, Inc., an affiliate of Lehman Brothers Inc. ("Lehman"). See a section captioned "Certain Matters Involving Affiliates of RE Services" for a description of the sale of certain of Shearson Lehman Brothers, Inc. ("Shearson") domestic retail brokerage and asset management business to Smith Barney, Harris Upham & Co. Incorporated, which resulted in a change in the general partner's name. Brief descriptions of the business experience of the directors and officers of the General Partner are provided below. Each of the directors of the General Partner is elected annually. There is no family relationship among any of the persons currently serving as directors or officers of the General Partner. Certain officers and directors of RE Services are now serving (or in the past have served) as officers and directors of entities which act as general partners of a number of real estate limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships which have filed bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which the real estate is located and, consequently, the partnerships sought the protection of bankruptcy laws to protect the partnership's assets from losses through foreclosure. The executive officers and directors of RE Services are listed below. Name Office ---------- ------------- Kenneth L. Zakin President and Director William Caulfield Vice President and Chief Financial Officer Lawrence M. Ostow Vice President Kenneth L. Zakin, 48, is a Senior Vice President of Lehman Brothers Inc. and has held such title since November 1988. He is currently a senior manager in Lehman Brothers' Diversified Asset Group and was formerly group head of the Commercial Property Division of Shearson Lehman Brothers' Direct Investment Management Group responsible for the management and restructuring of limited partnerships owning commercial properties throughout the United States. From January 1985 through November 1988, Mr. Zakin was a Vice President of Shearson Lehman Brothers Inc. Mr. Zakin is a director of Lexington Corporate Properties, Inc. He is a member of the Bar of the State of New York and previously practiced as an attorney in New York City from 1973 to 1984 specializing in the financing, acquisition, disposition, and restructuring of real estate transactions. Mr. Zakin is a member of the Real Estate Lender's Association and is currently an associate member of the Urban Land Institute and a member of the New York District Council Advisory Services Committee. He received a Juris Doctor degree from St. John's University School of Law in 1973 and a B.A. degree from Syracuse University in 1969. William Caulfield, 36, is a Vice President of Lehman Brothers Inc. and is responsible for investment management of commercial real estate in the Diversified Asset Group. Prior to the Shearson/Hutton merger in 1988, Mr. Caulfield was a Senior Analyst with E.F. Hutton since October 1986 in Hutton's Partnership Administration Group. Before joining Hutton, Mr. Caulfield was a Business Systems Analyst at Eaton Corp. from 1985 to 1986. Prior to Eaton, he was an Assistant Treasurer with National Westminster Bank USA. Mr. Caulfield holds a B.S. degree in Finance from St. John's University and an M.B.A. from Long Island University - C.W. Post Campus. Lawrence M. Ostow, 28, is a Vice President of Lehman Brothers and is responsible for the management of commercial real estate in the Diversified Asset Group. Mr. Ostow joined Lehman Brothers in September 1992. Prior to that, Mr. Ostow was a Senior Consultant with Arthur Andersen & Co. in the Real Estate Services Group, beginning in July 1990. Mr. Ostow is a candidate for an M.B.A. from the Stern School of Business in 1997 and earned a B.A. degree in Economics from the University of Michigan in 1990. Certain Matters Involving Affiliates of RE Services - --------------------------------------------------- On July 31, 1993, Shearson Lehman Brothers, Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated ("Smith Barney"). Subsequent to the sale, Shearson changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the Partnership's General Partner. However, the assets acquired by Smith Barney included the name "Shearson." Consequently, the Shearson Lehman Brothers/PDF 86, Inc. general partner changed its name to PDF86 Real Estate Services Inc. to delete any reference to "Shearson." Item 11. Executive Compensation The General Partner and its Affiliates have received certain fees, commissions and reimbursements for expenses incurred as provided for on pages 13 through 17 of the Prospectus which are contained under "Management Compensation" (See Exhibit 3 incorporated herein by reference). The General Partner is entitled to receive a share of cash distributed when and as cash distributions are made to Unit Holders and a share of taxable income or taxable loss, and may be reimbursed for certain out-of-pocket expenses. In addition, the General Partner is entitled to receive various fees and distributions during the liquidation stages of the Partnership. Descriptions of such fees, distribution allocations, and reimbursements is incorporated by reference to Note 5 "Transactions with Related Parties" and Note 6 "Partners' Equity" of the Notes to Financial Statements. Certain officers and directors of the General Partner are employees of Lehman Brothers Inc. and are not compensated by the Partnership or the General Partner for services rendered in connection with the Partnership. Item 12. Security Ownership of Certain Beneficial Owners and Management (a) Security of Ownership of Certain Beneficial Owners No person (including any "group" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) is known to the Registrant to be the beneficial owner of more than five percent of the outstanding voting Interests as of December 31, 1995. (b) Security Ownership of Management No officer or director of the General Partner beneficially owned or owned of record directly or indirectly any Interests as of December 31, 1995. (c) Changes in Control None. Item 13. Certain Relationships and Related Transactions (a) Transactions With Management and Others Incorporated by reference to Note 3 "Real Estate Investments," Note 5 "Transactions with Related Parties" and Note 6 "Partners' Equity" of the Notes to Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1995 filed as an exhibit under Item 14. (b) Certain Business Relationships There have been no business transactions between any of the Directors and the Partnership. (c) Indebtedness of Management No management person is indebted in any amount to the Partnership. (d) Transactions With Promoters There have been no transactions with promoters other than as described above in (a). PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)(i) Index to Financial Statements Balance Sheets at December 31, 1995 and 1994 (1) Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 (1) Statements of Partners' Capital (Deficit) for the Years Ended December 31, 1995, 1994 and 1993 (1) Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 (1) Notes to the Financial Statements (1) Independent Auditors' Report (1) (a)(ii) Financial Statement Schedule Independent Auditors' Report on Schedule III F-1 Schedule III - Real Estate and Accumulated Depreciation F-2 (1) Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1995. (b) Reports on Form 8-K filed in the fourth quarter of 1995: The Partnership filed a report on Form 8-K on October 12, 1995 regarding the sale of Foothills Tech Plaza. (c) See Exhibit Index contained herein. Exhibit Number 3 - Agreement of Limited Partnership of Participating Development Fund 86, A Real Estate Limited Partnership. Reference is made to Exhibit A of the Prospectus (the "Prospectus") contained in Amendment No. 2 to Registrant's Form S-11 Registration Statement filed with the Securities and Exchange Commission on December 20, 1985 (the "Registration Statement"). 13 - Annual Report to Unitholders for the year ended December 31, 1995. 27 - Financial Data Schedule Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 29, 1996 PARTICIPATING DEVELOPMENT FUND 86 BY: PDF86 Real Estate Services Inc. General Partner BY: /s/Kenneth L. Zakin Name: Kenneth L. Zakin Title: Director and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. PDF86 REAL ESTATE SERVICES INC. General Partner Date: March 29, 1996 BY: /s/Kenneth L. Zakin Kenneth L. Zakin Director and President Date: March 29, 1996 BY: /s/William Caulfield William Caulfield Vice President and Chief Financial Officer Date: March 29, 1996 BY: /s/Lawrence M. Ostow Lawrence M. Ostow Assistant Vice President INDEPENDENT AUDITORS' REPORT The Partners Participating Development Fund 86: Under date of February 16, 1996 we reported on the balance sheets of Participating Development Fund 86 (a Connecticut limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partners' capital (deficit) and cash flows for each of the years in the three-year period ended December 31, 1995, as contained in the 1995 annual report to unit holders. These financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1995. In connection with our audits of the aforementioned financial statements, we also have audited the related financial statements schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits. In our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLP Boston, Massachusetts February 16, 1996 PARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership) Schedule III - Real Estate and Accumulated Depreciation December 31, 1995 Initial Cost to Partnership Buildings and Description Encumbrances (1) Land Improvements Commercial Property: Sunnyvale R&D Building Sunnyvale, CA -- $6,336,962 $4,848,999 1899 Powers Ferry Road Office Building Marietta, GA -- 2,050,628 6,774,215 8,387,590 11,623,214 Real Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS -- 2,095,205 8,118,985 $10,482,795 $19,742,199 PARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership) Schedule III - Real Estate and Accumulated Depreciation December 31, 1995 Cost Capitalized Subsequent To Acquisition -------------- Buildings and Description Improvements (3) Retirements Commercial Property: Sunnyvale R&D Building Sunnyvale, CA $3,141,469 $(2,976,402) 1899 Powers Ferry Road Office Building Marietta, GA 2,189,066 (1,282,863) 5,330,535 (4,259,265) Real Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS 863,301 (1,250,320) $6,193,836 $(5,509,585) PARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership) Schedule III - Real Estate and Accumulated Depreciation December 31, 1995 Gross Amount at Which Carried at Close of Period -------------------------- Buildings and Accumulated Description Land Improvements Total(1) Depreciation(2) Commercial Property: Sunnyvale R&D Building Sunnyvale, CA $6,336,962 $5,014,066 $11,351,028 $(1,369,338) 1899 Powers Ferry Road Office Building Marietta, GA 2,050,628 7,680,418 9,731,046 (2,314,185) 8,387,590 12,694,484 21,082,074 (3,683,523) Real Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS 2,095,205 7,731,966 9,827,171 (2,046,898) $10,482,795 $20,426,450 $30,909,245 $(5,730,421) PARTICIPATING DEVELOPMENT FUND 86 (A Real Estate Limited Partnership) Schedule III - Real Estate and Accumulated Depreciation December 31, 1995 Life on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed Commercial Property: Sunnyvale R&D Building Sunnyvale, CA 8/86 8/28/86 5 - 35 years 1899 Powers Ferry Road Office Building Marietta, GA 2/86 7/7/87 5 - 35 years Real Estate Held for Sale Pebblebrook Apartments Apartment Buildings Overland Park, KS N/A 9/4/86 5 - 35 years (1) For Federal Income Tax Purposes, the aggregate cost of land, building and improvements is $40,039,600. (2) For Federal income tax purposes, the amount of accumulated depreciation is $3,630,345. (3) Tenant improvements are depreciated over the terms of the respective leases. A reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended December 31, 1995, 1994 and 1993: Real Estate Investments: 1995 1994 1993 Beginning of year $42,595,901 $46,380,563 $46,170,294 Additions 211,470 1,691,770 493,591 Less Retirements (33,151) (5,476,432) (283,322) Dispositions (11,864,975) 0 0 End of year $30,909,245 $42,595,901 $46,380,563 Accumulated Depreciation: Beginning of year $ 7,744,521 $11,772,231 $10,371,081 Depreciation 1,251,637 1,448,722 1,684,472 Less Retirements (26,391) (5,476,432) (283,322) Depositions (3,239,346) 0 0 End of year $ 5,730,421 $ 7,744,521 $11,772,231 EX-13 2 Exhibit 13 Participating Development Fund 86 1995 Annual Report to Unitholders Participating Development Fund 86 (the "Partnership") is a limited partnership formed in 1986 to fund participating investments secured by commercial real estate properties. The Partnership subsequently took title to all of its remaining participating investments. Foothills Tech Plaza was sold on September 29, 1995 (See Message to Investors for details). The Partnership's remaining properties are a commercial office building, a combined office/research and development facility and an apartment complex. Provided below is a comparison of lease levels at the properties as of December 31, 1995 and 1994. Percentage Leased Property Location 1995 1994 Sunnyvale R&D Sunnyvale, CA 100% 100% Powers Ferry Office Building Atlanta, GA 94% 91% Pebblebrook Apartments Overland Park, KS 96% 97% Administrative Inquiries Performance Inquiries/Form 10-Ks Address Changes/Transfers First Data Investor Services Group Service Data Corporation P.O. Box 1527 2424 South 130th Circle Boston, Massachusetts 02104-1527 Omaha, Nebraska 68144-2596 Attn: Financial Communications 800-223-3464 (select option 1) 800-223-3464 (select option 2) ---------- Message to Investors ---------- The General Partner is pleased to present the 1995 Annual Report for Participating Development Fund 86 (the "Partnership"). Included in this report is information on the sale of Foothills Tech Plaza, an update on the pending sale of Pebblebrook Apartments and a discussion of operations and leasing progress at the Partnership's properties, and audited financial statements for the year ended December 31, 1995. Property Sales Pebblebrook Apartments - As previously reported, on May 11, 1995, the General Partner executed a letter of intent with an unaffiliated third party to sell Pebblebrook Apartments. During the 1995 third quarter, the prospective buyer rescinded its offer. However, the General Partner subsequently agreed to a letter of intent with another unaffiliated third party to sell Pebblebrook Apartments, and on January 31, 1995 the General Partner executed a purchase and sale agreement for a sales price of $10,570,000, net of commissions. The sale was originally expected to close in late January, 1996 and was subsequently postponed until March, 1996. However, during the due diligence period, the prospective buyer raised certain concerns regarding the physical condition of the Property. While negotiations are continuing and the General Partner remains confident that the sale will be successfully concluded, there is no assurance that an agreement can be reached with the buyer concerning the remaining issues. Therefore, it remains possible that the sale will be further delayed or possibly not close at all. Foothills Tech Plaza - As previously reported, on September 29, 1995, Foothills Tech Plaza was sold for $10,011,512, net of $226,000 in contracted roof repairs. Net proceeds to the Partnership, after accounting for selling expenses, were $9,714,490 and the Partnership distributed your share of the net proceeds on November 24, 1995. Cash Distributions For the year ended December 31, 1995, the Partnership paid cash distributions to the Limited Partners totaling $9.79 per Unit. Included in this total was a return of capital distribution in the amount of $8.59 per Unit representing proceeds from the sale of Foothills Tech Plaza paid on November 24, 1995, and the Partnership's fourth quarter cash distribution of $0.30 per Unit which was paid on February 9, 1996. In addition, on March 29, 1996 the Partnership paid a special cash distribution in the amount of $.55 per Unit. This distribution was made from the Partnership's cash reserves. Since inception, including the special distribution, the Partnership has paid cash distributions totaling $31.06 per original $50 Unit, including $14.66 per Unit in return of capital payments which have reduced the Unit size from $50 to $35.34. The timing and amount of future cash distributions will depend on several factors, including the adequacy of cash flow and the Partnership's cash reserve requirements. Information regarding cash distributions paid over the past two years is provided below. Cash Distributions Per Limited Partnership Unit First Second Third Fourth Quarter Quarter Quarter Quarter Total 1994 $.30 $.30 $.30 $.30 $1.20 1995 $.30 $.30 $8.89* $.30 $9.79 * Includes $8.59 in return of capital resulting from the sale of Foothills Tech Plaza. Market Overview Although still lagging behind other sectors of real estate, the commercial office market continued to improve during 1995, particularly in the suburban office sector. The national vacancy rate declined to approximately 11.5% as of the fourth quarter of 1995, down from approximately 16% as of year-end 1994. In general, the gap between supply and demand is gradually narrowing as the existing supply of office space is absorbed. However, demand for office space varies widely from region to region as corporate layoffs persist and companies continue to be selective in their choice of location. Moreover, despite the resurgence of investment in other segments of the real estate industry, lenders continue to be selective in providing capital for commercial office properties. With respect to the Partnership's properties, the Atlanta market continued to lead the nation in economic growth, and the commercial office market mirrored this improvement. The Sunnyvale market also strengthened during 1995, particularly in the latter half of the year, as a result of the recent business expansion in the computer technology, semiconductor and computer software industries. Summary We are pleased that we were able to close the sale of Foothills Tech Plaza during 1995 and remain confident that we can resolve the issues which have delayed the sale of Pebblebrook, in the near term. During the upcoming year, the General Partner intends to closely monitor generally improving market conditions to determine our future strategy for the Partnership's remaining properties. We will update you with respect to these efforts in future investor reports. Very truly yours, PDF86 Real Estate Services Inc. General Partner /s/Kenneth L. Zakin Kenneth L. Zakin President March 29, 1996 ---------- Property Profiles and Leasing Update ---------- POWERS FERRY OFFICE BUILDING Atlanta, Georgia Powers Ferry Office Building is a 96,508 square foot class-A office property located in the northwest section of Atlanta, Georgia, approximately 11 miles from downtown. The property offers several attractive amenities including a health club, cafe and a multi-user conference room. Leasing Update - During the year, the General Partner executed two new leases for a total of 2,383 square feet and one lease expansion for 2,091 square feet with a tenant which now leases 4,101 square feet. One tenant occupying 1,191 square feet vacated its space in April 1995 upon expiration of its lease. As a result, the property was 94% leased at December 31, 1995 compared with 91% at December 31, 1994. During 1996, nine leases totaling 18,459 square feet or 20% of the property's space are scheduled to expire. Some of these tenants have been contacted to discuss the renewal of their leases and we will contact the other tenants when appropriate. However, it is uncertain whether any of these tenants will renew. Atlanta Market Update - According to Market Focus, a respected industry publication, Atlanta continued to lead the nation in economic and job growth in 1995, with approximately 36,400 jobs created during the first half of the year. In particular, the services and trade sectors have experienced substantial growth. This growth positively impacted the entire Atlanta region, including the property's submarket, as evidenced by the submarket's improved vacancy rate of approximately 6% at year-end 1995 versus a rate of 10% in 1994. These conditions have spurred a gradual increase in rental rates and, consequently, property values have also begun to rise. These trends are expected to sustain their momentum beyond the upcoming 1996 Olympic Games which have created renewed interest in the Atlanta market. SUNNYVALE R&D Sunnyvale, California Sunnyvale R&D is a one-story research and development building containing 105,285 square feet of leasable area. The property, located in California's Silicon Valley, provides an attractive location for high technology companies. Leasing Update - Tandem Computers, Inc. ("Tandem"), continues to lease 100% of the property's space, pursuant to a lease scheduled to expire March 31, 1999. As previously reported, Tandem subleased its space to a computer networking company in 1994, but remains responsible for all lease obligations through the scheduled expiration of its own lease. Tandem's lease generated $859,126 or 20% of the Partnership's 1995 rental income. Sunnyvale Market Update - Market conditions in the Silicon Valley strengthened throughout the year. According to the 1996 edition of industry publication Emerging Trends in Real Estate, the turn-around in the research and development sector can be greatly attributed to the wave of high-technology and biotechnology industry expansions, in addition to an increasing number of start-up companies. Vacancy rates for the research and development sector in the Silicon Valley market declined at year-end 1995 to 4.9% from 10.8% a year earlier. The Sunnyvale market, located within Silicon Valley, also benefited from these trends. The vacancy rate in Sunnyvale fell to 5.2% as of the fourth quarter of 1995, from 13.6% for the corresponding period in 1994. The area started experiencing increases in rental rates during the latter half of 1995 which are expected to continue to increase during 1996. PEBBLEBROOK APARTMENTS Overland Park, Kansas Pebblebrook Apartments is a 267-unit luxury garden apartment complex comprised of eleven two-story buildings. Located in Johnson County, a suburban area southwest of Kansas City, Kansas, the property features a 2,088 square foot clubhouse, two waterscapes, a swimming pool and a jogging path. Market and Property Update - The strong recovery of multifamily housing in most regions of the country began to level off during 1995. New construction intensified competition in many areas with building permits for multifamily units up almost 22% in 1995 compared to 1994 levels. In addition, falling interest rates induced many renters to purchase homes. Despite these trends, overall vacancy rates for multifamily properties nationwide remained below 8% during 1995 as population and job growth contributed to a stable demand. Conditions in the Johnson County multifamily housing market mirrored these trends, as the property was 96% occupied at December 31, 1995, largely unchanged from 97% a year earlier. These trends are expected to continue throughout 1996. For the years ended December 31, 1995 1994 1993 1992 1991 Total revenues $ 4,548,635 $ 4,588,679 $ 4,100,867 $ 4,270,283 $ 4,182,842 Total expenses 2,975,258 3,139,131 3,168,985 2,990,192 3,220,001 Net income 2,662,237 1,449,548 931,882 1,280,091 962,841 Total assets 27,446,456 36,105,893 36,191,399 39,204,700 40,003,550 Net income per Unit 2.32 1.25 .80 1.10 .83 Cash distributions per Unit 9.79 1.20 2.70 2.40 2.04 The above selected financial data should be read in conjunction with the financial statements and related notes in this report. - - The slight decline in total revenues is largely due to lower other income, in addition to lower rental income associated with the sale of Foothills Tech Plaza. Other income was higher in 1994 due to the receipt of a lease cancellation fee at Powers Ferry Office Building. - - Total expenses decreased in 1995 primarily due to lower depreciation and amortization expense resulting from the sale of Foothills Tech Plaza. - - Net income increased in 1995 mainly due to the gain on sale of Foothills Tech Plaza totaling $1,088,860. Balance Sheets December 31, 1995 and 1994 Assets 1995 1994 Land $ 8,387,590 $12,419,476 Buildings and personal property 11,460,068 25,346,253 Tenant improvements 1,234,416 4,830,172 21,082,074 42,595,901 Less-accumulated depreciation (3,683,523) (7,744,521) 17,398,551 34,851,380 Real estate assets held for sale 7,780,273 -- Cash and cash equivalents 1,480,034 140,886 Restricted cash 100,286 152,162 1,580,320 293,048 Accounts receivable 31,304 18,737 Prepaid expenses, net of accumulated amortization of $111,997 in 1995 and $47,360 in 1994 273,681 389,472 Incentives to lease, net of accumulated amortization of $54,794 in 1995 and $18,889 in 1994 188,693 283,555 Deferred rent receivable 193,634 269,701 Total Assets $27,446,456 $36,105,893 Liabilities and Partners' Capital (Deficit) Liabilities: Accounts payable and accrued expenses $ 133,022 $ 323,897 Due to affiliates 48,744 64,809 Security deposits payable 100,286 152,162 Prepaid rent 79,555 4,085 Total Liabilities 361,607 544,953 Partners' Capital (Deficit): General Partner (436,797) (355,690) Limited Partners (1,124,000 units outstanding) 27,521,646 35,916,630 Total Partners' Capital 27,084,849 35,560,940 Total Liabilities and Partners' Capital $27,446,456 $36,105,893 Statements of Partners' Capital (Deficit) For the years ended December 31, 1995, 1994 and 1993 General Limited Partner Partners Total Balance at December 31, 1992 $ (274,176) $38,552,242 $38,278,066 Cash distributions (111,240) (3,596,800) (3,708,040) Net income 27,956 903,926 931,882 Balance at December 31, 1993 (357,460) 35,859,368 35,501,908 Cash distributions (41,716) (1,348,800) (1,390,516) Net income 43,486 1,406,062 1,449,548 Balance at December 31, 1994 (355,690) 35,916,630 35,560,940 Cash distributions (139,197) (10,999,131) (11,138,328) Net income 58,090 2,604,147 2,662,237 Balance at December 31, 1995 $ (436,797) $27,521,646 $27,084,849 Statements of Operations For the years ended December 31, 1995, 1994 and 1993 Income 1995 1994 1993 Rental $4,397,667 $4,387,259 $3,990,962 Interest 142,161 11,912 42,812 Other 8,807 189,508 67,093 Total Income 4,548,635 4,588,679 4,100,867 Expenses Property operating 1,403,161 1,407,195 1,206,605 Depreciation and amortization 1,358,528 1,513,099 1,690,501 General and administrative 213,569 201,932 247,106 Bad debt expense -- 16,905 24,773 Total Expenses 2,975,258 3,139,131 3,168,985 Income before gain on sale of real estate 1,573,377 1,449,548 931,882 Gain on sale of real estate 1,088,860 -- -- Net Income $2,662,237 $1,449,548 $ 931,882 Net Income Allocated: To the General Partner $ 58,090 $ 43,486 $ 27,956 To the Limited Partners 2,604,147 1,406,062 903,926 $2,662,237 $1,449,548 $ 931,882 Per limited partnership unit (1,124,000 outstanding) $2.32 $1.25 $.80 Statements of Cash Flows For the years ended December 31, 1995, 1994 and 1993 Cash Flows from Operating Activities: 1995 1994 1993 Net income $2,662,237 $1,449,548 $ 931,882 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,358,528 1,513,099 1,690,501 Gain on sale of real estate (1,088,860) -- -- Provision for losses on rent receivable -- -- 24,773 Increase (decrease) in cash arising from changes in operating assets and liabilities: Restricted cash 51,876 212,198 146,279 Accounts receivable (12,567) 47,928 (14,229) Prepaid expenses 51,564 (358,425) (60,019) Incentives to lease 58,957 (302,444) -- Deferred rent receivable 76,067 7,072 460,347 Accounts payable and accrued expenses (190,875) 109,552 67,434 Due to affiliates (16,065) (45,977) (21,959) Security deposits payable (51,876) 30,366 (14,572) Prepaid rent 75,470 (238,479) (268,046) Net cash provided by operating activities 2,974,456 2,424,438 2,942,391 Cash Flows from Investing Activities: Proceeds from sale of real estate assets 9,714,490 -- -- Additions to real estate assets (211,470) (1,691,770) (493,591) Net cash provided by (used for) investing activities 9,503,020 (1,691,770) (493,591) Cash Flows from Financing Activities: Cash distributions (11,138,328) (1,390,516) (3,708,040) Net cash used for financing activities (11,138,328) (1,390,516) (3,708,040) Net increase (decrease) in cash and cash equivalents 1,339,148 (657,848) (1,259,240) Cash and cash equivalents at beginning of year 140,886 798,734 2,057,974 Cash and cash equivalents at end of year $1,480,034 $ 140,886 $ 798,734 Supplemental Schedule of Non-Cash Investing Activity: Write-off of fully depreciated tenant improvements $ 33,152 $ 5,476,432 $ 283,322 Notes to the Financial Statements December 31, 1995, 1994 and 1993 1. Organization Participating Development Fund 86, a Real Estate Limited Partnership (the "Partnership") was formed on December 9, 1985, under the Uniform Limited Partnership Act of the State of Connecticut. The Partnership was originally formed to invest in participating investments, secured by commercial and multi-family residential real estate, by entering into land purchase leaseback transactions and funding leasehold mortgage loans on improvements constructed on such land (the "Participating Investments"). The Partnership ultimately took title to all five participating investments funded. Two Participating Investments were sold during 1989 and 1995. The Partnership now leases and operates the remaining properties. The General Partners were PDF86 Real Estate Services, Inc. ("PDF86"), formerly Shearson Lehman Brothers/PDF 86, Inc. (see below), and Phoenix Realty/PDF 86, Inc. ("Phoenix"), a Connecticut corporation and an indirect wholly-owned subsidiary of Phoenix Home Life Mutual Insurance Company ("Phoenix Mutual"). The Partnership commenced operations on April 23, 1986. On June 15, 1992, Phoenix Realty Management, Inc. ("Phoenix Realty") sent a notice of resignation as co-General Partner of the Partnership to PDF86. The effective date of resignation was June 16, 1992. As a result of the resignation of Phoenix, PDF86 as sole General Partner manages the affairs of the Partnership. Since PDF86 had been a co-General Partner and actively involved in the management of the Partnership since it was formed, the resignation of Phoenix Realty has not had any adverse impact on the continuing operations of the Partnership. On July 31, 1993, Shearson Lehman Brothers Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated ("Smith Barney"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the general partner. However, the assets acquired by Smith Barney included the name "Shearson." Consequently, effective October 22, 1993, Shearson Lehman Brothers/PDF 86, Inc. changed its name to PDF86 Real Estate Services Inc. to delete any reference to "Shearson." On February 16, 1996, based upon, among other things, the advice of Partnership counsel, Skadden, Arps, Slate, Meagher & Flom, the General Partner adopted a resolution that states, among other things, if a Change of Control (as defined below) occurs, the General Partner may distribute the Partnership's cash balances not required for its ordinary course day-to-day operations. "Change of Control" means any purchase or offer to purchase more than 10% of the Units that is not approved in advance by the General Partner. In determining the amount of the distribution, the General Partner may take into account all material factors. In addition, the Partnership will not be obligated to make any distribution to any partner and no partner will be entitled to receive any distribution until the General Partner has declared the distribution and established a record date and distribution date for the distribution. The Partnership filed a form 8-K disclosing this resolution on February 23, 1996. 2. Accounting Policies Properties - Properties are stated at cost, less accumulated depreciation and amortization. Costs related to the selection and acquisition of the Partnership's properties have been capitalized as part of the costs of those Properties. Leasing costs and costs incurred to construct tenant improvements are amortized over the term of the related lease agreements using the straight-line method. Depreciation on buildings, building improvements and personal property is provided over the estimated economic lives of the Properties (5 - 35 years) using the straight-line method. Tenant improvements and leasing costs are amortized over the term of the related lease agreements using the straight-line method. Real Estate Assets Held for Sale - Real estate held for sale is carried at the lower of cost or fair market value less selling costs. Effective December 31, 1995, depreciation on real estate held for sale has been suspended. Accounting for Impairment - In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS 121"), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Partnership adopted FAS 121 during the fourth fiscal quarter of 1995. Based on current circumstances, the adoption of FAS 121 had no impact on the financial statements. Rental Income and Deferred Rent - The Partnership rents its Properties to tenants under operating leases with terms ranging from one to eleven years. Rental income is recognized as earned over the terms of the lease agreements. Deferred rent receivable consists of rental income which is recognized on a straight line basis over the lease terms, but will not be received until later periods as a result of scheduled rental increases. Cash and Cash Equivalents - Cash equivalents consist of short-term, highly liquid debt instruments purchased with an original maturity of three months or less. The carrying value approximates fair value because of the short maturity of these instruments. Restricted Cash - Restricted cash represents cash held in connection with tenant security deposits. Income Taxes - The Partnership files Federal and applicable state partnership income tax returns which indicate each partner's and unit holder's share of taxable income or loss to be reported on their respective individual income tax returns. As a result, no provision for income taxes has been made in the accompanying financial statements. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair Value of Financial Instruments - Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments ("FAS 107"), requires that the Partnership disclose the estimated fair values of its financial instruments. Fair values generally represent estimates of amounts at which a financial instruments could be exchanged between willing parties in a current transaction other than in forced liquidation. Fair value estimates are subjective and are dependent on a number of significant assumptions based on management's judgment regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. In addition, FAS 107 allows a wide range of valuation techniques, therefore, comparisons between entities, however similar, may be difficult. 3. Real Estate Investments Foothills Tech Plaza - On May 30, 1986, the Partnership acquired the land and participating mortgage loan receivable on Foothills Tech Plaza from Phoenix Mutual, which had funded the investment on behalf of the Partnership on November 12, 1985. Foothills Tech Plaza is an office/service center located in Phoenix, Arizona, comprised of two single-story buildings containing an aggregate of 172,655 square feet of net leasable space. On May 20, 1986, Phoenix Mutual in its capacity as mortgagee, with the consent and on behalf of the Partnership, served notice of default for non-payment of rent and debt service to the mortgagor/lessee. As a result of the default and pursuant to certain terms provided in the Agreement of Ground Lease, the lessee transferred all of its rights and title under the ground lease to the Partnership on June 25, 1986, on which date the Partnership became the owner of the property in its entirety, including the improvements located thereon, in full satisfaction of the mortgagor/lessee's obligation under the terms of the mortgage and ground lease. On September 29, 1995, Foothills Tech Plaza was sold for $10,011,512 net of $226,000 in contracted roof repairs. The gain on disposition totaled $1,088,860. Write-offs related to the sale of the property consisted of deferred rent receivable and leasing costs in the amounts of $129,846 and $30,058, respectively, which have been included in Property operations. 1899 Powers Ferry Road - On May 30, 1986, the Partnership acquired the land and participating mortgage loan receivable on 1899 Powers Ferry Road ("Powers Ferry") from Phoenix Mutual, which had funded the investment on behalf of the Partnership on April 4, 1986. Powers Ferry is a four-story office building located in Marietta, Georgia containing approximately 93,000 square feet of space. The mortgagor/lessee of Powers Ferry did not make the ground rent and mortgage loan payments due May 1, 1987, and, as a result, the Partnership issued a notice of default. On July 7, 1987, the Partnership became the owner of the property in its entirety through a foreclosure sale transaction. On that date, the Partnership's Participating Investment in Powers Ferry, net of escrowed funds returned and debt service payments received totalled $8,916,094. For Federal income tax purposes, the debt service payments paid from mortgage loan proceeds in escrow ($904,593 including interest) were recorded as income and no depreciation was recorded through July 7, 1987. As a result, the Partnership's depreciable basis in the Powers Ferry property is greater for tax purposes than for financial reporting purposes. In connection with the acquisitions of Powers Ferry and Foothills Tech Plaza, the Partnership paid Phoenix Mutual $19,392,519, representing the cost to Phoenix Mutual plus net interest of $102,482 on funds disbursed by Phoenix Mutual. As of December 31, 1995 and 1994, the Property was 94% and 91% leased, respectively. Sunnyvale R&D - On August 28, 1986, the Partnership acquired the land and funded a participating mortgage loan on the improvements for the Sunnyvale R&D building located in Sunnyvale, California. Sunnyvale R&D is a one-story research and development building containing approximately 105,285 square feet of net leasable space. The Partnership purchased the land from the lessee for $6,050,000 and concurrently funded a mortgage loan of $4,531,190. On October 30, 1986, the Partnership served notice of default on the mortgagor/lessee for non-payment of amounts due under the ground lease and mortgage. As a result of the default and pursuant to certain terms provided in the Agreement of Ground Lease, the lessee transferred all of its right and title under the ground lease to the Partnership on November 26, 1986 and the Partnership became the owner of the Property in its entirety, including the improvements located thereon in full satisfaction of the mortgagor/lessee's obligation under the terms of the mortgage and ground lease. The Property is 100% leased to a single tenant (Tandem Computers Inc.) as of December 31, 1995. The tenant signed a six-year lease (the "Master Lease") which commenced April 1, 1988 at an annual rental rate of $7.68 per square foot, triple net, and on April 1, 1994 negotiated a five year extension at an average annual rental rate of $8.16 per square foot. The tenant has the option, beginning at the end of the third year of this extension period, to terminate the lease by providing the Partnership with written notification at least twelve months in advance and paying a substantial lease termination penalty specified in the lease agreement. During the fourth quarter of 1994 Tandem agreed to sublease its entire space, effective April 1, 1995. The sublease is subject to the terms, conditions and termination date of the above mentioned Master Lease and rent will continue accordingly. As long as the sublease is in full force and effect, Tandem will be unable to exercise its termination option under the Master Lease. In 1993, a defect in the building's floor was discovered. This defect caused water condensation to form on the property's floor, which, over time, loosened the adhesive that secures the floor tiling. Approximately 70,000 square feet of the building's leasable area was affected by the defect and approximately $165,000 was expended during 1994 to correct the situation. Pebblebrook Apartments - On September 4, 1986, the Partnership acquired the land for $2,000,000 and funded a mortgage loan of $7,750,000 on the improvements for the Pebblebrook Apartments ("Pebblebrook") located in Overland Park, Kansas. Pebblebrook is a 267-unit luxury garden apartment complex located in a suburb of Kansas City. During February of 1990, the General Partners on behalf of the Partnership initiated foreclosure proceedings against the mortgagor/lessee of Pebblebrook Apartments, which resulted in that entity filing for bankruptcy. On April 16, 1991, the bankruptcy proceedings were resolved and the Partnership became the owner of the property in its entirety through a special conveyance transaction. As of that date, the property has been considered a wholly-owned investment. During the 1995 third quarter the General Partner received an offer from an unaffiliated third party to purchase Pebblebrook Apartments. On January 31, 1995 the General Partner executed a purchase and sale agreement for a sales price of $10,570,000, net of commissions. The sale was originally expected to close in late March, 1996. However, during the due diligence period, the prospective buyer raised certain concerns regarding the physical condition of the Property. While negotiations are continuing, the General Partner remains confident that the sale will be successfully concluded. However, there is no assurance that an agreement can be reached with the buyer concerning the remaining issues. Therefore, it remains possible that the sale will be further delayed or possibly not close at all. As of December 31, 1995 and 1994 the property was 96% and 97% leased, respectively. 4. Leases and Rental Revenues The following is a schedule of future minimum annual rental payments receivable based on non-cancelable leases as of December 31, 1995 assuming no exercise of tenant renewal options: 1996 $2,000,702 1997 1,332,924 1998 1,006,145 1999 773,078 2000 539,682 Thereafter 372,586 $6,025,117 Certain leases contain provisions whereby the rent can change annually based upon changes in the Consumer Price Index. All the leases at Powers Ferry provide that tenants pay their pro-rata share of any increases in operating expenses over a base amount. The leases at Sunnyvale R&D and Foothills Tech Plaza are triple net with the tenants paying their pro-rata share of operating expenses. Leases of two tenants, Acoustic Imaging at Foothills Tech Plaza and Tandem at Sunnyvale R&D, generated rental revenue in excess of 10% of the Partnership's rental revenues for the year ended December 31, 1995. The rental income derived from these leases for 1995 was $470,664 and $859,126, respectively, or 11% and 20% of the Partnership's 1995 total rental income. As of December 31, 1995, Tandem is current in the rent payments. 5. Transactions With Related Parties Certain cash accounts reflected on the Partnership's balance sheet at December 31, 1995 and 1994 were on deposit with an affiliate of the General Partner. Pursuant to the Partnership Agreement, the General Partner(s) and their affiliates were paid fees and expenses for services rendered in connection with the formation of the Partnership and the acquisition of the Properties. In addition, the General Partners and their affiliates were paid or are due the following fees and expense reimbursements for ongoing services rendered to the Partnership: a) In connection with the acquisition of the Partnership's investments, the General Partners were paid Investment Fees totalling $2,248,000, which had been capitalized as part of the cost of the investments and allocated to land, buildings, tenant improvements and participating mortgage loans receivable based upon their relative valuations. b) The Partnership has agreed to pay the General Partner(s) a fee for managing and servicing the Partnership's investments. The Asset Management Fee will be equal to the lesser of $50,000 per annum or 1% of all cash revenues received by the Partnership, including any deferred interest after deducting (i) operating expenses, (ii) amounts set aside for working capital reserves, and (iii) payments on the Partnership's other current obligations as defined in the Partnership Agreement. Such fees incurred and expensed by the Partnership totalled $10,428, $8,111 and $37,080 in 1995, 1994 and 1993, respectively. c) The Partnership has agreed to reimburse the General Partner(s) and affiliates for the actual cost of goods and materials used for and by the Partnership and insurance premiums for insurance coverage provided through affiliates of the General Partners not to exceed the comparable costs for the same services charged by unaffiliated parties. d) The Partnership has agreed to pay the General Partner a Subordinated Disposition Fee, in an amount not to exceed the lesser of (i) one half of the competitive real estate commission applicable at the date of sale, or (ii) 3% of the amount payable to the Partnership in connection with the disposition of such investment. The fee is payable only after the Unit Holders have been returned their original investment and any unpaid Preferred Return. At December 31, due to affiliates of the Partnership is as follows: 1995 1994 Accounts payable to the General Partner: Administrative services $48,678 $63,256 Accounts payable to affiliates of the General Partner Operational expenses: 66 1,553 Total accounts payable to affiliates $48,744 $64,809 6. Partners' Equity The Unit Holders will be entitled to receive from distributions of cash from operations ("Current Cash Receipts") or Net Proceeds from Sales, Investment Repayment and Participation Proceeds (as defined in the Partnership Agreement) a cumulative, non-compounded Preferred Return on their average adjusted unreturned invested capital equal to 14% per annum calculated from January 1, 1987. To the extent that Current Cash Receipts distributed to the Unit Holders is less than the Preferred Return for that year, the unpaid amount may be paid from Current Cash Receipts in subsequent years, or upon sale of a Property or repayment of the Partnership's investments and any Participating Proceeds. The Partnership Agreement provides for the allocation of income, losses and the distribution of cash generally as follows: All items of income, loss, deduction and credit from Current Cash Receipts, as defined, will be distributed 97% to Unit Holders and 3% to the General Partner. Net proceeds from Sales, Investment Repayment and Participating Proceeds shall be distributed as follows: a) 99% to the Unit Holders and 1% to the General Partner until the Unit Holders have received cumulative distributions of net proceeds from Sales, Investment Repayment and Participating Proceeds plus Current Cash Receipts equal to their original invested capital plus any unpaid Preferred Return. As of December 31, 1995, the Preferred Return has not been met. b) To the General Partner in payment of any unpaid Subordinated Disposition Fee. c) 85% to the Unit Holders and 15% to the General Partner. All items of income, gain, loss, deduction and credit attributable to net proceeds from Sales, Investment Repayment and Participating Proceeds will be allocated between the Unit Holders, as a group, and the General Partner, in the same ratio that each such group received distributions of such net proceeds from Sales, Investment Repayment and Participating Proceeds. The Partnership distributed $10,999,131, $1,348,800, and $3,596,800 to the Unit Holders in 1995, 1994 and 1993, respectively. In addition, the Partnership distributed $139,197, $41,716 and $111,240 to the General Partners in 1995, 1994 and 1993. An additional cash distribution in the amount of $337,200 was paid to the Unit Holders ($.30 per unit) and $10,429 to the General Partner for the quarter ended December 31, 1995, in the first quarter of 1996, as was a special cash distribution in the amount of $618,200 and $19,120 to the Unit Holders ($.55 per Unit) and General Partner, respectively. 7. Litigation In May 1989, a group of Unit Holders in the Partnership commenced a purported class action on behalf of themselves and all other Unit Holders, claiming that the Unit Holders were induced to purchase Units in reliance upon misrepresentations of material facts allegedly made by the defendants. The action arose under the Federal securities law and principles of common law, and was brought against the Partnership, its General Partners, and the broker-dealer that acted as underwriter in the offering. In July, 1990, the court granted the plaintiffs' motion seeking class certification and in October, 1991, the parties reached a settlement agreement. According to the settlement agreement, proceeds of approximately $39,000 were paid to the Unit Holders in the cash distribution for the quarter ended March 31, 1993, on May 27, 1993. No Partnership funds were expended with respect to this lawsuit or its settlement. 8. Reconciliation of Financial Statement Net Income and Partners' Capital to Federal Income Tax Basis Net Income and Partners' Capital Reconciliation of financial statement net income to federal income tax basis net income: Year Ended December 31, 1995 1994 1993 Financial statement basis net income $2,662,237 $1,449,548 $ 931,882 Financial statement amortization over (under) tax basis amortization (328,909) 302,281 610,073 Financial statement depreciation over (under) tax basis depreciation 157,590 (82,705) (129,963) Financial statement rental income (over) under tax basis rental income 151,538 (231,408) 191,502 Financial statement gain on sale of property under tax basis gain on sale of property 70,288 -- -- Other 30,944 (24,774) 24,928 81,451 (36,606) 696,540 Federal income tax basis net income $2,743,688 $1,412,942 $1,628,422 Reconciliation of financial statement partners' capital to federal income tax basis partners' capital: Year Ended December 31, 1995 1994 1993 Financial statement basis partners' capital $27,084,849 $35,560,940 $35,501,908 Current year financial statement basis net income under federal income tax basis net income (loss) 81,451 (36,606) 696,540 Other -- (492) -- Current Year Accrued Distribution -- -- 579,381 Cumulative Federal income tax basis net income over financial statement net income 12,076,101 12,112,707 10,837,278 Federal income tax basis partners' capital $39,242,401 $47,637,041 $47,614,615 Because many types of transactions are susceptible to varying interpretations under Federal and State income tax laws and regulations, the amounts reported above may be subject to change at a later date upon final determination by the respective taxing authorities. ---------- Independent Auditors' Report ---------- The Partners Participating Development Fund 86: We have audited the accompanying balance sheets of Participating Development Fund 86 (a Connecticut limited partnership) as of December 31, 1995 and 1994, and the related statements of operations, partner's capital (deficit) and cash flows for each of the years in the three-year period ended December 31, 1995. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosure in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Participating Development Fund 86 as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Boston, Massachusetts February 16, 1996 Comparison of Acquisition Costs to Appraised Value and Determination of Net Asset Value Per $35.34 Unit at December 31, 1995 (Unaudited) Date of Acquisition or Funding of Equity Acquisition Appraised Property Convertible Loan Cost (1) Value (2) Sunnyvale R&D 08-28-86 $11,185,961 $ 9,000,000 1899 Powers Ferry 07-07-87 8,916,095 6,100,000 Pebblebrook Apartments 09-04-86 10,214,190 10,570,000 $30,316,246 $25,670,000 Cash and cash equivalents 1,480,034 Accounts receivable 31,304 Prepaid expenses 273,681 27,455,019 Less: Accounts payable and accrued expenses (133,022) Due to affiliates (48,744) Prepaid rent (79,555) Partnership Net Asset Value (3) $27,193,698 Net Asset Value Allocated: Limited Partners $26,921,761 General Partners 271,937 $27,193,698 Net Asset Value Per Unit (1,124,000 units outstanding) $23.95 (1) Purchase price plus General Partners' acquisition fees. (2) This represents the Partnership's share of the December 31, 1995 Appraised Values which were determined by an independent property appraisal firm, except for Pebblebrook Apartments which is currently in negotiation for sale with an unaffiliated buyer and accordingly, the tentative sale price, net of closing costs, has been used. (3) The Net Asset Value assumes a hypothetical sale at December 31, 1995 of all the Partnership's properties at their appraised values and the distribution of the proceeds of such sale, combined with the Partnership's cash, after liquidation of the Partnership's liabilities to the Partners. Real Estate Brokerage commissions payable to the General Partner or others are not determinable at this time and have not been included in the determination. Since the Partnership would incur real estate brokerage commissions and other selling expenses in connection with the sale of its properties and other assets, cash available for distribution to the Partners would be less than the appraised Net Asset Value. Limited Partners should note that appraisals are only estimates of current value and actual values realizable upon sale may be significantly different. A significant factor in establishing an appraised value is the actual selling price for properties which the appraiser believes are comparable. Further, the appraised value does not reflect the actual costs which would be incurred in selling the property. As a result of these factors and the illiquid nature of an investment in Units of the Partnership, the variation between the appraised value of the Partnership's properties and the price at which Units of the Partnership could be sold is likely to be significant. Fiduciaries of Limited Partners which are subject to ERISA or other provisions of law requiring valuation of Units should consider all relevant factors including, but not limited to Net Asset Value per Unit, in determining the fair market value of an investment in the Partnership for such purposes. EX-27 3 PARTICIPATING DEVELOPMENT FUND 86 FINANCIAL DATA SCHEDULE FOR 1995 FORM 10-K
5 12-MOS DEC-31-1995 DEC-31-1995 1,580,320 000 31,304 000 000 000 21,082,074 3,683,523 27,446,456 361,607 000 000 000 000 27,084,849 27,446,456 4,397,667 4,548,635 000 1,403,161 1,572,097 000 000 1,573,377 000 1,573,377 000 1,088,860 000 2,662,237 2.32 000
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