-----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, QizTxhGiUCOvG+NJ8Le5u/qXXcizHj2GOty5dKSrgeK0ShK/V6d/BT6mSzByO70e eao5RFN+kqqlq0yBORJQEA== 0000928790-97-000029.txt : 19970328 0000928790-97-000029.hdr.sgml : 19970328 ACCESSION NUMBER: 0000928790-97-000029 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970327 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: 97565246 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 For the fiscal year ended: December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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 incorporation or organization IRS employer identification No. 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, 1996 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, 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, unfavorable 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 Note 3 "Real Estate Investments" of the Notes to the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996 filed as an exhibit under Item 14. Pebblebrook Apartments was sold on May 23, 1996 for a net sales price of $10,210,955. The gain on disposition of the property totaled $2,405,209. Additional information regarding the sale is incorporated by reference to Note 3 "Real Estate Investments" of the Notes to the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996 filed as an exhibit under Item 14. Additional information regarding the historical development of business is incorporated by reference to Note 1 "Organization," Note 2 "Significant Accounting Policies" and Note 3 "Real Estate Investments" of the Notes to the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996 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 the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996 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, 1996 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 section entitled "Property Profiles & Leasing Update" and Note 3 "Real Estate Investments" of the Notes to the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996, filed as an exhibit under Item 14. Item 3. Legal Proceedings The Registrant is not subject to any material pending legal proceedings. 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 1996. 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, 1996, there were 7,731 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, 1996 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, 1996 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, 1996 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 - ------------------------------- Pebblebrook Apartments was sold to an unaffiliated third party on May 23, 1996 for a net sales price of $10,210,955. The gain on disposition of the property totaled $2,405,209. Proceeds from the sale were distributed to Limited Partners on August 30, 1996. At December 31, 1996, the Partnership had cash and cash equivalents of $736,429 compared with $1,480,034 at December 31, 1995. The decrease is primarily attributable to cash distributions and real estate additions exceeding proceeds from the sale of Pebblebrook Apartments and net cash provided by operating activities. 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. Net cash provided by operating activities totaled $1,382,587 for the year ended December 31, 1996 compared with $2,974,456 for the year ended December 31, 1995. The decrease is primarily due to lower rental income resulting from the September 1995 sale of Foothills Tech Plaza and the May 1996 sale of Pebblebrook Apartments. The Partnership also maintains a restricted cash balance, which is comprised of tenant security deposits. Restricted cash totaled $44,329 at December 31, 1996, compared with $100,286 at December 31, 1995. The decrease is primarily due to the sale of Pebblebrook Apartments. Prepaid expenses totaled $239,359 at December 31, 1996, compared with $273,681 at December 31, 1995. The decrease is primarily the result of the amortization of prepaid insurance and leasing commissions associated with the lease-up of 1899 Powers Ferry in 1994 and the sale of Pebblebrook Apartments in 1996. Incentives to lease were $155,595 at December 31, 1996 compared to $188,693 at December 31, 1995. The decrease is largely the result of the amortization of a lease buy-out at 1899 Powers Ferry. Accounts payable and accrued expenses totaled $85,080 at December 31, 1996, compared with $142,956 at December 31, 1995. The decrease is primarily due to the sale of Foothills Tech Plaza in 1995 and lower accrued real estate taxes resulting from the sale of Pebblebrook Apartments in 1996. Due to affiliates totaled $3,658 at December 31, 1996, compared to $38,810 at December 31, 1995. The decrease is primarily attributable to the write-off of accrued management fees. Security deposits payable totaled $40,070 at December 31, 1996, compared to $100,286 at December 31, 1995. The decrease is mainly due to the sale of Pebblebrook Apartments. Prepaid rent totaled $0 at December 31, 1996, compared to $79,555 at December 31, 1995. The decrease is largely attributable to the timing of rental payments. A discussion of leasing activity and material leases at the Partnership's Properties is incorporated by reference to the section entitled "Property Profiles & Leasing Update" and Note 3 "Real Estate Investments" of the Notes to the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996, filed as an exhibit under Item 14. 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, 1996, the Partnership declared cash distributions to the Limited Partners totaling $10.75 per Unit. Included in this total was a special distribution in the amount of $9.00 per Unit which was paid on August 30, 1996 and represented proceeds from the sale of Pebblebrook Apartments, and a fourth quarter cash distribution of $0.30 per Unit which was paid on February 13, 1997. 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 legal 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. Results of Operations - --------------------- 1996 Versus 1995 Partnership operations resulted in net income of $3,333,580 for the year ended December 31, 1996, compared with net income of $2,662,237 for the corresponding period in 1995. Net income for the 1996 period includes a gain on sale of real estate of $2,405,209, reflecting the sale of Pebblebrook Apartments on May 23, 1996. Net income for the 1995 period includes a gain on sale of real estate of $1,088,860, reflecting the sale of Foothills Tech Plaza on September 29, 1995. Excluding these gains, Partnership operations resulted in income before gain on sale of real estate of $928,371 for the year ended December 31, 1996, compared to $1,573,377 for the year ended December 31, 1995. The decrease is largely due to lower rental income, partially offset by lower property operating and depreciation and amortization expenses resulting from the sales of Pebblebrook Apartments and Foothills Tech Plaza. Rental income totaled $2,706,140 for the year ended December 31, 1996, compared to $4,397,667 for the year ended December 31, 1995. The decrease is primarily attributable to the sale of Foothills Tech Plaza in September 1995 and Pebblebrook Apartments in May 1996. Interest income totaled $201,466 for the year ended December 31, 1996, compared to $142,161 for the year ended December 31, 1995. The increase is largely due to the Partnership's higher average cash balance in 1996 resulting from the sale of Pebblebrook Apartments. Other income totaled $55,944 for the year ended December 31, 1996, compared to $8,807 for the year ended December 31, 1995. The increase is mainly attributable to the write-off of accrued management fees due to Phoenix, the former co-General Partner, and the receipt of an insurance reimbursement. Property operating expenses totaled $1,131,167 for the year ended December 31, 1996, compared to $1,403,161 for the year ended December 31, 1995. The decrease is primarily attributable to the sale of Pebblebrook Apartments in May 1996. Depreciation and amortization totaled $678,208 for the year ended December 31, 1996, compared to $1,358,528 for the year ended December 31, 1995. The decrease is primarily attributable to a lower depreciable asset base resulting from the sale of Foothills Tech Plaza and Pebblebrook Apartments. As of December 31, 1996, the lease levels at each of the properties were as follows: 1899 Powers Ferry - 84%; Sunnyvale R&D - 100%. 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 was 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 was primarily attributable to higher average occupancy at 1899 Powers Ferry and higher rental rates at Pebblebrook Apartments and 1899 Powers Ferry, 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 was 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 was mainly attributable to the receipt of a lease cancellation fee at 1899 Powers Ferry 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 was 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: 1899 Powers Ferry - 94%; Sunnyvale R&D - 100%; and Pebblebrook Apartments - 96%. Item 8. Financial Statements and Supplementary Data Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1996 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 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 Moshe Braver Vice President Kenneth L. Zakin, 49, is a Senior Vice President of Lehman Brothers 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 was a director of Lexington Corporate Properties, Inc. from 1993 to 1996. 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, 37, is a Vice President of Lehman Brothers and is responsible for investment management of commercial real estate in the Diversified Asset Group. Prior to the Shearson/E.F. Hutton merger in 1988, Mr. Caulfield was a Senior Analyst with E.F. Hutton since October 1986 in E.F. Hutton's Partnership Administration Group. Before joining E.F. Hutton, Mr. Caulfield was a Business Systems Analyst at Eaton Corp. from 1985 to 1986. Prior to Eaton Corp., 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. Moshe Braver, 43, is currently a Managing Director of Lehman Brothers and has held such position since October 1985. During this time, he has held positions with the Business Analysis Group, International and Capital Markets Administration and currently, with the Diversified Asset Group. Mr. Braver joined Shearson Lehman Brothers in August 1983 as Senior Vice President. Prior to joining Shearson, Mr. Braver was employed by the accounting firm of Coopers & Lybrand from January 1975 through August 1983 as an Audit Manager. He received a Bachelor of Business Administration degree from Bernard Baruch College in January 1975 and is a Certified Public Accountant. 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 the 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, 1996. (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, 1996. (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 the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1996 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, 1996 and 1995 (1) Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994 (1) Statements of Partners' Capital (Deficit) for the Years Ended December 31, 1996, 1995 and 1994 (1) Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 (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, 1996. (b) No reports on form 8-K were filed in the fourth quarter of the calendar year 1996. (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, 1996. 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 24, 1997 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 Dated: March 24, 1997 BY: /s/Kenneth L. Zakin Kenneth L. Zakin Director and President Dated: March 24, 1997 BY: /s/William Caulfield William Caulfield Vice President and Chief Financial Officer Dated: March 24, 1997 BY: /s/Moshe Braver Moshe Braver Vice President EX-13 2 Exhibit 13 ---------------------------------- Participating Development Fund 86 1996 Annual Report to Unitholders Participating Development Fund 86 ------------------------------------ Participating Development Fund 86 is a limited partnership formed in 1986 to fund participating investments secured by commercial and multi-family residential real estate properties. The Partnership subsequently took title to four of the five participating investments. One of the participating investments was sold and two of the Partnership's properties have been sold including Pebblebrook Apartments, which was sold on May 23, 1996. The Partnership's two remaining properties are a commercial office building and a combined office/research and development facility. Provided below is a comparison of lease levels at the properties as of December 31, 1996 and 1995. Percentage Leased Property Location 1996 1995 Sunnyvale R&D Sunnyvale, CA 100% 100% 1899 Powers Ferry Atlanta, GA 84% 94% 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 800-223-3464 Message to Investors ---------------------- We are pleased to present the 1996 Annual Report for Participating Development Fund 86 (the "Partnership"). Included in this report is a review of national market conditions, an update of Partnership operations, and financial highlights for the year. As previously reported, Pebblebrook Apartments was sold on May 23, 1996 for a net sales price of $10,210,955. Your share of the net proceeds, totaling $9.00 per Unit, was distributed on August 30, 1996. Please refer to the Property Profiles & Leasing Update section of this report for additional information regarding local market conditions for both of the Partnership's remaining properties, as well as their operating performance during 1996. Market Overview and Property Sales The commercial office market continued to recover throughout the year, particularly in the suburban office sector. Suburban office vacancy rates declined to approximately 11% at year-end 1996 versus approximately 15% a year earlier. Overall, demand for office space continues to increase, bringing about continually lower vacancy rates and, in many regions of the country, enabling property owners to raise rental rates. Accordingly, as many traditional investors express increased interest, the availability of financing for investment in this sector has risen substantially. Conditions in the markets where the Partnership's two remaining properties are located generally paralleled those in the national market. In view of these ongoing improvements in the real estate and capital markets, we believe that the current favorable environment may present further opportunities to sell the Partnership's properties. Accordingly, the General Partner anticipates marketing for sale at least one of the two remaining properties in 1997 as various leasing issues are resolved. It should be noted that there can be no assurance that any of the Partnership's future marketing efforts will result in a sale of a property or that a sale, if completed, will result in any particular price. Cash Distributions The Partnership paid cash distributions to Limited Partners totaling $10.75 per Unit for the year ended December 31, 1996, including a fourth quarter cash distribution of $0.30 per Unit that was either credited to your brokerage account or sent directly to you on February 13, 1997. Since inception, the Partnership has paid total cash distributions of $41.26 per original $50 Unit, including $23.66 per Unit in return of capital payments which have reduced the Unit size from $50 to $26.34. The timing and amount of future cash distributions will be determined quarterly and will depend on the adequacy of the Partnership's cash flow and cash reserve requirements. Cash Distributions Per Limited Partnership Unit First Second Third Fourth Quarter Quarter Quarter Quarter Total 1995 $0.30 $0.30 $8.89(1) $0.30 $ 9.79 1996 $0.85(2) $0.30 $9.30(3) $0.30 $10.75 (1) Includes $8.59 in return of capital from the sale of Foothills Tech Plaza paid on November 24, 1995. (2) Includes a special one time cash distribution of $0.55 per Unit paid on March 29, 1996. (3) Includes $9.00 in return of capital from the sale of Pebblebrook Apartments paid on August 30, 1996. General Information As you are probably aware, a third party has commenced a partial tender offer to purchase units of the Partnership at a price which is substantially below the Partnership's Net Asset Value. In response to the offer, we have recommended that limited partners reject the offer because it does not reflect the underlying value of the Partnership's assets. According to published industry sources, most investors who hold units of limited partnerships similar to the Partnership have rejected these types of tender offers due to their inadequacy. Please be assured that if any additional tender offers are made for your units, we will make every effort to provide you with our position regarding those offers on a timely basis. Summary In the coming year the General Partner will continue to explore opportunities to sell the Partnership's properties as market conditions warrant. Additionally, we intend to focus on leasing the vacant space at 1899 Powers Ferry so as to further improve the property's marketability and appeal. We will keep you apprised of significant developments affecting your investment in future reports. Very truly yours, PDF86 Real Estate Services Inc. General Partner /s/Kenneth L. Zakin Kenneth L. Zakin President March 24, 1997 Property Profiles & Leasing Update ------------------------------------ SUNNYVALE R&D Sunnyvale, California Located in California's Silicon Valley, Sunnyvale R&D is a one- story research and development building containing 105,285 square feet of leasable area. The property provides an attractive location for high technology companies. Leasing Update - Tandem Computers, Inc. ("Tandem") leases 100% of the property's space, pursuant to a lease scheduled to expire March 31, 1999. Tandem, which subleases its space to a computer networking company, is responsible for all lease obligations through the scheduled expiration of its own lease. Tandem's lease generated $859,126 or 32% of the Partnership's 1996 rental income. Sunnyvale Market Update - The continued expansion of the high- technology and biotechnology industry contributed to the Silicon Valley's stable population growth and low unemployment rate during the year, making the region one of the strongest economies in the United States. The demand for space within the area's research and development sector continued to increase throughout 1996, leading to a decline in vacancy rates to approximately 3.1% at year-end 1996 from approximately 4.9% one year earlier. The Sunnyvale market, located within the Silicon Valley, benefited from this increased demand as economic conditions in the area remained very strong. Vacancy rates for research and development space in Sunnyvale fell to 4.7% as of year-end 1996 from 5.2% a year earlier. The area also experienced an increase in rental rates throughout the year, which have contributed to significant increases in the values of most properties. 1899 POWERS FERRY Atlanta, Georgia Located in the northwest section of Atlanta, Georgia, 1899 Powers Ferry is a 96,508 square foot class-A office property. The property offers several attractive amenities including a health club, cafe and a multi-user conference room. Leasing Update - The General Partner executed a two-year lease extension representing 1,200 square feet and a three-year lease renewal representing 2,324 square feet, during the year. A tenant expanded its space by 1,543 square feet, renewing its lease for five years. Another tenant extended its lease for three years but reduced its space by 1,683 square feet. Additionally, five tenants leasing a total of 10,799 square feet vacated their spaces upon the expiration of their respective leases. As a result, the property was 84% leased at December 31, 1996 compared with 94% at December 31, 1995. As discussed below, market conditions in Atlanta are strong and we expect to re-lease the property's vacant space in the near future. During 1997, two leases totaling 3,690 square feet or approximately 4% of the property's space are scheduled to expire. Atlanta Market Update - Atlanta maintained its positioning as one of the leading markets nationwide as general economic conditions remained strong throughout the year. Aided in part by the 1996 Olympic Games, the services and trade sectors continued to experience substantial growth and the market sustained its high rate of job absorption. This growth positively impacted the entire Atlanta region, including the property's submarket, as evidenced by the submarket's slightly improved vacancy rate of approximately 5% at year-end 1996 versus 6% in 1995. As a result of these conditions, rental rates have risen and property values are continuing to increase. While these trends are expected to slow during the upcoming year, the region's economic forecast for 1997 is positive. Financial Highlights ---------------------- For The Years Ended December 31, 1996 1995 1994 1993 1992 Dollars in thousands except per Unit data Total revenues $ 2,964 $ 4,549 $ 4,589 $ 4,101 $ 4,270 Total expenses 2,035 2,975 3,139 3,169 2,990 Net income 3,334 2,662 1,450 932 1,280 Total assets 18,301 27,446 36,106 36,191 39,205 Net income per Unit 2.92 2.32 1.25 .80 1.10 Cash distributions per Limited Partnership Unit 10.75(2) 9.79(1) 1.20 2.70 2.40 (1) Includes $8.59 in return of capital from the sale of Foothills Tech Plaza paid on November 24, 1995. (2) Includes a special one time cash distribution of $0.55 per Unit paid on March 29, 1996, and $9.00 in return of capital from the sale of Pebblebrook Apartments paid on August 30, 1996. The above selected financial data should be read in conjunction with the financial statements and related notes included in this report. - - Total revenues and total expenses decreased in 1996 as a result of the sale of both Foothills Tech Plaza and Pebblebrook Apartments. - - The increase in net income is primarily attributable to the gain on the sale of Pebblebrook Apartments in the amount of $2,405,209 in 1996. Balance Sheets - -------------- At December 31, At December 31, 1996 1995 Assets Real estate, at cost: Land $ 8,387,590 $ 8,387,590 Buildings and personal property 11,445,862 11,460,068 Tenant improvements 1,193,476 1,234,416 21,026,928 21,082,074 Less accumulated depreciation (4,131,094) (3,683,523) 16,895,834 17,398,551 Real estate assets held for sale - 7,780,273 Cash and cash equivalents 736,429 1,480,034 Restricted cash 44,329 100,286 Accounts and other receivables, net of allowance for doubtful accounts of $10,000 in 1996 30,188 31,304 Prepaid expenses, net of accumulated amortization of $175,007 in 1996 and $111,997 in 1995 239,359 273,681 Incentives to lease, net of accumulated amortization of $87,892 in 1996 and $54,794 in 1995 155,595 188,693 Deferred rent receivable 199,336 193,634 Total Assets $18,301,070 $27,446,456 Liabilities and Partners' Capital (Deficit) Liabilities: Accounts payable and accrued expenses $ 85,080 $ 142,956 Due to affiliates 3,658 38,810 Security deposits payable 40,070 100,286 Prepaid rent - 79,555 Total Liabilities 128,808 361,607 Partners' Capital (Deficit): General Partner (547,912) (436,797) Limited Partners (1,124,000 units outstanding) 18,720,174 27,521,646 Total Partners' Capital 18,172,262 27,084,849 Total Liabilities and Partners' Capital $18,301,070 $27,446,456 Statement of Partners' Capital (Deficit) For the years ended December 31, 1996, 1995 and 1994 General Limited Partner Partners Total 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 Cash distributions (163,018) (12,083,149) (12,246,167) Net income 51,903 3,281,677 3,333,580 Balance at December 31, 1996 $(547,912) $ 18,720,174 $ 18,172,262 Statements of Operations For the years ended December 31, 1996 1995 1994 Income Rental $2,706,140 $4,397,667 $4,387,259 Interest 201,466 142,161 11,912 Other 55,944 8,807 189,508 Total Income 2,963,550 4,548,635 4,588,679 Expenses Property operating 1,131,167 1,403,161 1,407,195 Depreciation and amortization 678,208 1,358,528 1,513,099 General and administrative 225,804 213,569 201,932 Bad debt expense - - 16,905 Total Expenses 2,035,179 2,975,258 3,139,131 Income before gain on sale of real estate 928,371 1,573,377 1,449,548 Gain on sale of real estate 2,405,209 1,088,860 - Net Income $3,333,580 $2,662,237 $1,449,548 Net Income Allocated: To the General Partner $ 51,903 $ 58,090 $ 43,486 To the Limited Partners 3,281,677 2,604,147 1,406,062 $3,333,580 $2,662,237 $1,449,548 Per limited partnership unit (1,124,000 outstanding) $2.92 $2.32 $1.25 Statements of Cash Flows For the years ended December 31, 1996 1995 1994 Cash Flows From Operating Activities: Net income $ 3,333,580 $ 2,662,237 $ 1,449,548 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 678,208 1,358,528 1,513,099 Gain on sale of real estate (2,405,209) (1,088,860) - Increase (decrease) in cash arising from changes in operating assets and liabilities: Restricted cash 55,957 51,876 212,198 Accounts receivable 1,116 (12,567) 47,928 Prepaid expenses (42,564) 51,564 (358,425) Incentives to lease - 58,957 (302,444) Deferred rent receivable (5,702) 76,067 7,072 Accounts payable and accrued expenses (57,876) (208,995) 117,214 Due to affiliates (35,152) 2,055 (53,639) Security deposits payable (60,216) (51,876) 30,366 Prepaid rent (79,555) 75,470 (238,479) Net cash provided by operating activities 1,382,587 2,974,456 2,424,438 Cash Flows From Investing Activities: Proceeds from sale of real estate assets 10,210,955 9,714,490 - Additions to real estate (90,980) (211,470) (1,691,770) Net cash provided by (used for) investing activities 10,119,975 9,503,020 (1,691,770) Cash Flows From Financing Activities: Cash distributions (12,246,167) (11,138,328) (1,390,516) Net cash used for financing activities (12,246,167) (11,138,328) (1,390,516) Net increase (decrease) in cash and cash equivalents (743,605) 1,339,148 (657,848) Cash and cash equivalents, beginning of year 1,480,034 140,886 798,734 Cash and cash equivalents, end of year $ 736,429 $ 1,480,034 $ 140,886 Supplemental Schedule of Non-Cash Investing Activities: Write-off of fully depreciated building improvements $ 120,653 $ 33,152 $ 5,476,432 Notes to the Financial Statements ----------------------------------- December 31, 1996, 1995 and 1994 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 four of the Participating Investments funded. One Participating Investment was sold during 1989 and two of the four properties directly owned by the Partnership were sold during 1995 and 1996. The Partnership now leases and operates the remaining two 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 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 was actively involved in the management of the Partnership since it was formed, the resignation of Phoenix 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 legal 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. 2. Significant Accounting Policies Real Estate Investments - Buildings and personal property 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 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. 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. Rental Income and Deferred Rent - 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 and 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 - On May 30, 1986, the Partnership acquired the land and participating mortgage loan receivable on 1899 Powers Ferry ("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 totaled $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, 1996 and 1995, Powers Ferry was 84% and 94% 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. Sunnyvale R&D is 100% leased to a single tenant Tandem Computers Inc. ("Tandem") as of December 31, 1996. 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. Pebblebrook Apartments was sold on May 23, 1996 for a net sales price of $10,210,955. The transaction resulted in a gain on sale of $2,405,209. 4. Leases and Rental Revenues The following is a schedule of future minimum annual rental payments for Powers Ferry and Sunnyvale R&D based on non-cancelable leases as of December 31, 1996 assuming no exercise of tenant renewal options: 1997 $ 1,936,138 1998 1,846,046 1999 1,042,801 2000 637,679 2001 468,694 Thereafter _ $ 5,931,358 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 lease at Sunnyvale R&D is triple net with the tenant paying its pro-rata share of operating expenses. Tandem, occupying 100% of the Sunnyvale R&D building, generated rental revenue in excess of 10% of the Partnership's rental revenues for the years ended December 31, 1996, 1995 and 1994. For the years ended December 31, 1996, 1995 and 1994, Tandem has contributed $859,126 (32%), $859,126 (20%), and $846,491 (19%), respectively, of the Partnership's rental income and is current on its rent payments. 5. Transactions With Related Parties Certain cash and cash equivalents were on deposit with an affiliate of a General Partner during a portion of 1996 and all of 1995. As of December 31, 1996, no cash and cash equivalents were on deposit with an affiliate of the General Partner or the Partnership. 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 totaling $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 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 totaled $17,382, $10,428 and $8,111 in 1996, 1995 and 1994, respectively. c) The Partnership has agreed to reimburse the General Partner 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 Partner 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, amounts due to affiliates of the Partnership are as follows: 1996 1995 Accounts payable to the General Partner and affiliates: Asset management fee $3,476 $38,744 Out - of - pocket expenses 182 66 Total accounts payable to affiliates $3,658 $38,810 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. At December 31, 1996 the Unit Holders have not yet received their cumulative preferred return. 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 $12,083,149, $10,999,131, and $1,348,800 to the Unit Holders in 1996, 1995 and 1994, respectively. In addition, the Partnership distributed $163,018, $139,197 and $41,716 to the General Partners in 1996, 1995 and 1994. 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, 1996, in the first quarter of 1997. 7. 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, 1996 1995 1994 Financial statement basis net income $ 3,333,580 $2,662,237 $1,449,548 Financial statement amortization over (under) tax basis amortization (12,285) (328,909) 302,281 Financial statement depreciation over (under) tax basis depreciation (106,954) 157,590 (82,705) Financial statement rental income (over) under tax basis rental income (85,257) 151,538 (231,408) Financial statement gain on sale of property under tax basis gain on sale of property (2,213,064) 70,288 - Other 305 30,944 (24,774) (2,417,255) 81,451 (36,606) Federal income tax basis net income $ 916,325 $2,743,688 $1,412,942 Reconciliation of financial statement partners' capital to federal income tax basis partners' capital: Year Ended December 31, 1996 1995 1994 Financial statement basis partners' capital $18,172,262 $27,084,849 $35,560,940 Current year financial statement basis net income under federal income tax basis net income (loss) (2,417,255) 81,451 (36,606) Other - - - Current year accrued distribution - - - Cumulative Federal income tax basis net income over financial statement net income 12,157,552 12,076,101 12,112,707 Federal income tax basis partners' capital $27,912,559 $39,242,401 $47,637,041 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, 1996 and 1995, 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, 1996. 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 disclosures 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, 1996 and 1995, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Boston, Massachusetts February 4, 1997 Net Asset Valuation --------------------- Comparison of Acquisition Costs to Appraised Value and Determination of Net Asset Value Per $26.34 Unit at December 31, 1996 (Unaudited) Acquisition 1996 Appraised Property Date of Acquisition Cost (1) Value (2) Sunnyvale R&D 08-28-86 $ 11,185,961 $ 10,200,000 1899 Powers Ferry 07-07-87 8,916,095 7,300,000 $ 20,102,056 17,500,000 Cash and cash equivalents 736,429 Restricted cash 44,329 Accounts receivable 30,188 Prepaid expenses 6,269 18,317,215 Less: Total liabilities (128,808) Partnership Net Asset Value (3) $ 18,188,407 Net Asset Value Allocated: Limited Partners $ 18,006,523 General Partner 181,884 $ 18,188,407 Net Asset Value Per Unit (1,124,000 Units outstanding) $16.02 (1) Purchase price plus General Partners' acquisition fees. (2) This represents the Partnership's share of the December 31, 1996 Appraised Values which were determined by an independent property appraisal firm. (3) The Net Asset Value assumes a hypothetical sale at December 31, 1996 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. INDEPENDENT AUDITORS' REPORT ON SCHEDULE ------------------------------------------ The Partners Participating Development Fund 86: Under date of February 4, 1997 we reported on the balance sheets of Participating Development Fund 86 (a Connecticut limited partnership) as of December 31, 1996 and 1995, 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, 1996, as contained in the 1996 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 1996. In connection with our audits of the aforementioned financial statements, we also 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 4, 1997 Schedule III - Real Estate and Accumulated Depreciation December 31, 1996 Sunnyvale 1899 Office Buildings: R & D Powers Ferry Total Location Sunnyvale, CA Marietta, GA na Construction date 1986 1986 na Acquisition date 08-28-86 07-07-87 na Life on which depreciation in latest income statements is computed (3) (3) na Encumbrances - - - Initial cost to Partnership (1): Land 6,336,962 2,050,628 8,387,590 Buildings and improvements 4,848,999 6,774,215 11,623,214 Costs capitalized subsequent to acquisition: Land, buildings and improvements 3,141,469 2,254,573 5,396,042 Retirements (2,976,402) (1,403,516) (4,379,918) Gross amount at which carried at close of period: Land $ 6,336,962 $ 2,050,628 $ 8,387,590 Buildings and improvements 5,014,066 7,625,272 12,639,338 11,351,028 9,675,900 21,026,928 Accumulated depreciation 1,551,841 2,579,253 4,131,094 (1) Represents aggregate cost for both financial reporting and Federal income tax purposes. (2) The amount of accumulated depreciation for Federal income tax purposes is $5,371,049. (3) Buildings and personal property : 5 - 35 years, tenant improvements : 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, 1996, 1995, and 1994 follows: 1996 1995 1994 Real estate investments: Beginning of year $30,909,245 $42,595,901 $46,380,563 Additions 90,980 211,470 1,691,770 Retirements (120,653) (33,151) (5,476,432) Dispositions (9,852,644) (11,864,975) - End of year $21,026,928 $30,909,245 $42,595,901 Accumulated depreciation: Beginning of year $ 5,730,421 $ 7,744,521 $11,772,231 Depreciation expense 568,224 1,251,637 1,448,722 Retirements (120,653) (26,391) (5,476,432) Dispositions (2,046,898) (3,239,346) - End of year $ 4,131,094 $ 5,730,421 $ 7,744,521 EX-27 3 FINANCIAL DATA SCHEDULE FOR 1996 YEAR END 10-K WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE. Participating Development Fund 86
5 12-mos December-31-1996 December-31-1996 736,429 000 40,188 (10,000) 000 000 21,026,928 (4,131,094) 18,301,070 70,580 000 000 000 000 18,172,262 18,301,070 2,706,140 2,963,550 000 1,131,167 904,012 000 000 928,371 000 928,371 000 2,405,209 000 3,333,580 2.92 2.92
-----END PRIVACY-ENHANCED MESSAGE-----