-----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, V2TYFs3KC61nPbWgHa+723/mV6DaSAyr0OboaakzwFGtQ8GOotQOlKUkLBo+Itgc cTKCxasb+FazY46qOfrmZg== 0000928790-98-000037.txt : 19980331 0000928790-98-000037.hdr.sgml : 19980331 ACCESSION NUMBER: 0000928790-98-000037 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 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: SEC FILE NUMBER: 033-02294 FILM NUMBER: 98578162 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, 1997 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, 1997 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, previous unfavorable market conditions limited 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, 1997 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, 1997 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, 1997 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, 1997 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, 1997 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 "Message to Investors" 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, 1997, 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 1997. 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, 1997, there were 7,660 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, 1997 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, 1997 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, 1997 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 At December 31, 1997, the Partnership had cash and cash equivalents of $739,170, largely unchanged from $736,429 at December 31, 1996. The cash and cash equivalents balance includes funds held as a working capital reserve to fund tenant improvements and leasing commissions. Net cash provided by operating activities totaled $1,415,035 for the year ended December 31, 1997, also largely unchanged from $1,382,587 for the year ended December 31, 1996. The Partnership also maintains a restricted cash balance, which is comprised of tenant security deposits. Restricted cash totaled $39,381 at December 31, 1997, compared with $44,329 at December 31, 1996. Deferred leasing costs, net of accumulated amortization, totaled $180,242 at December 31, 1997, compared with $233,090 a year earlier. The decrease reflects scheduled leasing cost amortization during the year. Prepaid rent totaled $71,594 at December 31, 1997, compared to $0 at December 31, 1996. The 1997 balance represents January 1998 rent prepayments by the tenant at the Sunnyvale property. Cobb County, Georgia, has notified the Partnership of its intent, under its powers of eminent domain, to condemn a portion of the land at Powers Ferry for the widening of Powers Ferry Road. The condemnation may occur in 1998, however, the Partnership has not yet received a formal notice of condemnation from Cobb County. The condemnation may have a substantial impact on the value of the property since the road will be moved closer to the building, the driveway will be relocated and reduced in size and the vast majority of the landscaping in front of the building will be removed. Cobb County will be required, as a part of the process, to compensate the Partnership for the portion of the land actually taken and any consequential damages (damages occurring to the portion of the property not taken). The Partnership has retained legal counsel to ensure that it is sufficiently compensated for any damages that may result from the condemnation. The Partnership paid cash distributions to the Limited Partners of $1.20 per Unit for the year ended December 31, 1997. Further details regarding cash distributions is incorporated herein by reference to the section entitled "Message to Investors" contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1997 filed as an exhibit under Item 14. As a result of improving local market conditions, the General Partner has decided to begin marketing Sunnyvale R&D and 1899 Powers Ferry for sale. In light of this decision, the Partnership may need to make capital improvements to better position the properties for sale. In order to fund these improvements and maintain adequate cash reserves, cash distributions may be reduced or suspended in the future. The timing and amount of future cash distributions will be determined quarterly and will depend on the adequacy of the Partnership's cash flow from operations and cash reserve requirements. A discussion of leasing activity and material leases at the Partnership's Properties is incorporated by reference to the section entitled "Message to Investors " 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, 1997, filed as an exhibit under Item 14. As of December 31, 1997, lease levels at each of the Properties were as follows: Sunnyvale R&D - 100%; 1899 Powers Ferry - 87%. Results of Operations 1997 Versus 1996 The Partnership's operations resulted in net income of $714,981 for the year ended December 31, 1997, compared to $3,333,580 for the year ended December 31, 1996. Net income in 1996 included a gain from the sale of Pebblebrook Apartments of $2,405,209. Excluding this gain, income before gain on sale of real estate totaled $928,371 in 1996. The decrease from 1996 to 1997 is primarily a result of the sale of Pebblebrook and the resulting reduction in rental income. As a result of the sale of Pebblebrook Apartments, the following income and expense categories decreased from 1996 to 1997: rental income, property operating expense and depreciation and amortization. Rental income for the Partnership's two remaining properties, Sunnyvale R&D and 1899 Powers Ferry (the "Remaining Properties") totaled $2,062,875 for the year ended December 31, 1997, largely unchanged from $2,065,537 in 1996. Interest income totaled $33,664 for the year ended December 31, 1997, compared to $201,466 for the year ended December 31, 1996. The decrease is largely due to the Partnership's lower average cash balance in 1997. Property operating expenses for the Remaining Properties totaled $571,035 for the year ended December 31, 1997, compared with $817,102 in 1996. The decrease is primarily a result of lower repairs and maintenance, real estate taxes and administrative expenses at 1899 Powers Ferry. General and administrative expenses totaled $220,607 for the year ended December 31, 1997, largely unchanged from $225,804 in 1996, as decreases in legal, appraisal and other professional fees were offset by increases in audit expense and printing costs. 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%. Item 8. Financial Statements and Supplementary Data Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1997 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 Rocco F. Andriola Director Jeffrey C. Carter Director and President Michael T. Marron Vice President and Chief Financial Officer Rocco F. Andriola, 39, is a Managing Director of Lehman Brothers in its Diversified Asset Group and has held such position since October 1996. Since joining Lehman in 1986, Mr. Andriola has been involved in a wide range of restructuring and asset management activities involving real estate and other direct investment transactions. From June 1991 through September 1996, Mr. Andriola held the position of Senior Vice President in Lehman's Diversified Asset Group. From June 1989 through May 1991, Mr. Andriola held the position of First Vice President in Lehman's Capital Preservation and Restructuring Group. From 1986 to 1989, Mr. Andriola served as a Vice President in the Corporate Transactions Group of Shearson Lehman Brothers' office of the general counsel. Prior to joining Lehman, Mr. Andriola practiced corporate and securities law at Donovan Leisure Newton & Irvine in New York. Mr. Andriola received a B.A. from Fordham University, a J.D. from New York University School of Law, and an LL.M in Corporate Law from New York University's Graduate School of Law. Jeffrey C. Carter, 52, is a Senior Vice President of Lehman Brothers in the Diversified Asset Group. Mr. Carter joined Lehman Brothers in September 1988. From 1972 to 1988, Mr. Carter held various positions with Helmsley-Spear Hospitality Services, Inc. and Stephen W. Brener Associates, Inc. including Director of Consulting Services at both firms. From 1982 through 1987, Mr. Carter was President of Keystone Hospitality Services, an independent hotel consulting and brokerage company. Mr. Carter received his B.S. degree in Hotel Administration from Cornell University and an M.B.A. degree from Columbia University. Michael T. Marron, 34, is a Vice President of Lehman Brothers and has been a member of the Diversified Asset Group since 1990 where he has actively managed and restructured a diverse portfolio of syndicated limited partnerships. Prior to joining Lehman Brothers, Mr. Marron was associated with Peat Marwick Mitchell & Co. serving in both its audit and tax divisions from 1985 to 1989. Mr. Marron received his B.S. degree from the State University of New York at Albany and an M.B.A. from Columbia University. 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' Capital (Deficit)" 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, 1997. (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, 1997. (c)Changes in Control None. Item 13. Certain Relationships and Related Transactions (a)Transactions With Management and Others Incorporated by reference to Note 5 "Transactions with Related Parties" and Note 6 "Partners'Capital (Deficit)" of the Notes to the Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended December 31, 1997 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, 1997 and 1996 (1) Statements of Operations for the Years Ended December 31, 1997, 1996 and 1995 (1) Statements of Partners' Capital (Deficit) for the Years Ended December 31, 1997, 1996 and 1995 (1) Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 (1) Notes to the Financial Statements (1) Independent Auditors' Report (1) (a)(ii) Financial Statement Schedule Independent Auditors' Report 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, 1997. (b) No reports on form 8-K were filed in the fourth quarter of the calendar year 1997. (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, 1997. 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. PARTICIPATING DEVELOPMENT FUND 86 BY: PDF86 Real Estate Services Inc. General Partner Date: March 30, 1998 BY: /s/Jeffrey C. Carter Jeffrey C. Carter 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 30, 1998 BY: /s/Jeffrey C. Carter Jeffrey C. Carter President and Director Date: March 30, 1998 BY: /s/Rocco F. Andriola Rocco F. Andriola Director Date: March 30, 1998 BY: /s/Michael T. Marron Michael T. Marron Vice President and Chief Financial Officer EX-13 2 1997 ANNUAL REPORT TO UNITHOLDERS Exhibit 13 Participating Development Fund 86 1997 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 and two of the Partnership's properties have been sold. 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, 1997 and 1996. Percentage Leased Property Location 1997 1996 Sunnyvale R&D Sunnyvale, CA 100% 100% 1899 Powers Ferry Atlanta, GA 87% 84% Contents 1 Message to Investors 3 Financial Highlights 4 Financial Statements 7 Notes to the Financial Statements 13 Report of Independent Auditors 14 Net Asset Valuation 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 1997 Annual Report for Participating Development Fund 86 (the "Partnership"). Included in this report is an update on market conditions and operations at the Partnership's remaining properties, Sunnyvale R & D and 1899 Powers Ferry. Also included are financial highlights and the Partnership's 1997 audited financial statements. Market Update The commercial office market continued to improve during 1997, with a strong economy boosting demand for office space in most areas of the country. Atlanta and Silicon Valley, where the Partnership's properties are located, both reflected these positive trends. In Atlanta, the strong local economy and continuing influx of new businesses gave rise to an increase in rental rates from 1996 to 1997, while vacancy rates in the Northwest submarket where 1899 Powers Ferry is located, were at 7.6% at year end. In Silicon Valley, demand for research and development facilities such as the Partnership's remained high, and the region continues to rank among the strongest markets nationwide. As of third quarter 1997, vacancy rates declined to 4.4% from 5% a year earlier and rental rates continue to gradually increase. Although construction of new properties has commenced in Atlanta and Silicon Valley, it is expected that operating conditions will remain stable in both markets in the near term. Property Update As a result of these strong operating conditions, we will begin marketing the properties for sale and are in the process of selecting a broker to assist with these efforts. While we currently anticipate that they will be sold and the Partnership liquidated in 1998, there can be no assurance that either property will be sold within this time frame, or that a sale will result in a particular price. Once the properties are sold, the General Partner will distribute the net proceeds together with the Partnership's remaining cash reserves (after payment of or provision for, the Partnership's liabilities and expenses) and dissolve the Partnership. Sunnyvale R & D Sunnyvale, California Tandem Computers Inc. ("Tandem"), which leases 100% of Sunnyvale R & D, continues to sublease the entire space to a computer networking company. Tandem is responsible for all lease obligations through the scheduled expiration of the lease, on March 31, 1999. 1899 Powers Ferry Atlanta, Georgia At 1899 Powers Ferry, leasing activity was minimal during 1997, with one new lease for 874 square feet executed during the year and a tenant occupying 2,985 square feet pursuant to a lease which expired on September 30, 1997, continuing to occupy its space on a month-to-month basis. Another tenant representing 700 square feet, vacated its space upon expiration of the lease. As a result, the property was 87% leased at December 31, 1997, up slightly from 84% a year earlier. In the coming year, three leases totaling 10,275 square feet, or approximately 11% of the property's leasable area, are scheduled to expire. The General Partner is negotiating renewals with two of the tenants and has a lease out for signiture representing 3,311 square feet scheduled to close subsequent to the end of first quarter 1998. As previously reported, Cobb County, Georgia has notified the Partnership of its intent, under the powers of eminent domain, to condemn a portion of the land at Powers Ferry for the widening of Powers Ferry Road. The condemnation may occur in 1998, however, the Partnership has not yet received a formal notice of condemnation from Cobb County. The condemnation may have a substantial impact on the value of the property since the road will be moved closer to the building, the driveway will be relocated and reduced in size and the vast majority of the landscaping in front of the building will be removed. Cobb County will be required to compensate the Partnership for the portion of the land actually taken and any consequential damages (damages occurring to the portion of the property not taken). The Partnership has retained legal counsel to ensure that it is sufficiently compensated for any damages that may result from the condemnation. Cash Distributions The Partnership paid cash distributions to Limited Partners totaling $1.20 per Unit for the year ended December 31, 1997, 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, 1998. Since inception, the Partnership has paid total cash distributions of $42.46 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 1996 $0.851 $0.30 $9.302 $0.30 $ 10.75 1997 $0.30 $0.30 $0.30 $0.30 $ 1.20 1 Includes a special one-time cash distribution of $0.55 per Unit paid on March 29, 1996. 2 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, several third parties have commenced tender offers to purchase Units of the Partnership at prices which are below the Partnership's estimate of net asset value per Unit. In response, we recommended that Limited Partners reject these offers because we believe that they do not reflect the underlying value of the Partnership's assets. According to published industry sources, most of the investors who hold units of limited partnerships similar to the Partnership have rejected these types of tender offers due to their inadequacy. Summary As a result of the improving local market conditions and favorable capital markets, the General Partner has decided to begin marketing Sunnyvale R&D and 1899 Powers Ferry for sale. We are currently in the process of selecting a real estate broker to assist with our efforts to sell both of the Partnership's properties. While we are hopeful that the properties will be sold in 1998, there can be no assurance as to when the sales will occur or that the sales will result in a particular price. In the interim, we will continue 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/Jeffrey C. Carter Jeffrey C. Carter President March 30, 1998 Financial Highlights For The Years Ended December 31, 1997 1996 1995 1994 1993 Dollars in thousands except per Unit data Total revenues $2,142 $2,964 $4,549 $4,589 $4,101 Total expenses 1,427 2,035 2,975 3,139 3,169 Gain on sale of real estate - 2,405 1,089 - - Net income 715 3,334 2,662 1,450 932 Total assets 17,709 18,301 27,446 36,106 36,191 Net income per Unit .62 2.92 2.32 1.25 .80 Cash distributions per Limited Partnership Unit 1.20 10.75(1) 9.79(2) 1.20 2.70 (1) 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. (2) Includes $8.59 in return of capital from the sale of Foothills Tech Plaza paid on November 24, 1995. 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 1997 primarily as a result of the sale of Pebblebrook Apartments in 1996. - - The decrease in net income is primarily attributable to the gain on the sale of Pebblebrook Apartments in 1996. Income before the gain totaled $928,371 in 1996. The decrease from 1996 to 1997 is primarily a result of the sale of Pebblebrook and the resulting reduction in rental income. Balance Sheets At December 31, At December 31, 1997 1996 Assets Real estate, at cost: Land $8,387,590 $8,387,590 Buildings and personal property 11,450,426 11,445,862 Tenant improvements 915,023 1,193,476 20,753,039 21,026,928 Less accumulated depreciation (4,372,698) (4,131,094) 16,380,341 16,895,834 Cash and cash equivalents 739,170 736,429 Restricted cash 39,381 44,329 Accounts receivable, net of allowance for doubtful accounts of $10,000 in 1996 44,091 30,188 Deferred leasing costs, net of accumulated amortization of $173,403 in 1997 and $175,007 in 1996 180,242 233,090 Incentives to lease, net of accumulated amortization of $113,606 in 1997 and $87,892 in 1996 123,652 155,595 Deferred rent receivable 195,868 199,336 Prepaid expenses 5,816 6,269 Total Assets $17,708,561 $18,301,070 Liabilities and Partners' Capital (Deficit) Liabilities: Accounts payable and accrued expenses $ 93,906 $ 85,080 Due to General Partner 6,953 3,658 Security deposits payable 39,381 40,070 Prepaid rent 71,594 - Total Liabilities 211,834 128,808 Partners' Capital (Deficit): General Partner (568,179) (547,912) Limited Partners (1,124,000 units outstanding) 18,064,906 18,720,174 Total Partners' Capital 17,496,727 18,172,262 Total Liabilities and Partners' Capital $17,708,561 $18,301,070 Statement of Partners' Capital (Deficit) For the years ended December 31, 1997, 1996 and 1995 General Limited Partner Partners Total Balance at December 31, 1994 $(355,690) $35,916,630 $35,560,940 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 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 Distributions (41,716) (1,348,800) (1,390,516) Net income 21,449 693,532 714,981 Balance at December 31, 1997 $(568,179) $18,064,906 $17,496,727 Statements of Operations For the years ended December 31, 1997 1996 1995 Income Rental $2,062,875 $2,706,140 $4,397,667 Interest 33,664 201,466 142,161 Other 45,631 55,944 8,807 Total Income 2,142,170 2,963,550 4,548,635 Expenses Property operating 575,893 1,131,167 1,403,161 Depreciation and amortization 630,689 678,208 1,358,528 General and administrative 220,607 225,804 213,569 Total Expenses 1,427,189 2,035,179 2,975,258 Income before gain on sale of real estate 714,981 928,371 1,573,377 Gain on sale of real estate - 2,405,209 1,088,860 Net Income $ 714,981 $3,333,580 $2,662,237 Net Income Allocated: To the General Partner $ 21,449 $ 51,903 $ 58,090 To the Limited Partners 693,532 3,281,677 2,604,147 $714,981 $3,333,580 $2,662,237 Per limited partnership unit (1,124,000 outstanding) $.62 $2.92 $2.32 Statements of Cash Flows For the years ended December 31, 1997 1996 1995 Cash Flows From Operating Activities: Net income $ 714,981 $ 3,333,580 $ 2,662,237 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 537,271 678,208 1,251,637 Amortization 93,418 - 106,891 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 4,948 55,957 51,876 Accounts receivable (13,903) 1,116 (12,567) Prepaid expenses 453 (42,564) 51,564 Deferred leasing costs (8,627) - - Incentives to lease - - 58,957 Deferred rent receivable 3,468 (5,702) 76,067 Accounts payable and accrued expenses 8,826 (57,876) (208,995) Due to General Partner 3,295 (35,152) 2,055 Security deposits payable (689) (60,216) (51,876) Prepaid rent 71,594 (79,555) 75,470 Net cash provided by operating activities 1,415,035 1,382,587 2,974,456 Cash Flows From Investing Activities: Proceeds from sale of real estate - 10,210,955 9,714,490 Additions to real estate (21,778) (90,980) (211,470) Net cash (used for) provided by investing activities (21,778) 10,119,975 9,503,020 Cash Flows From Financing Activities: Cash distributions (1,390,516) (12,246,167) (11,138,328) Net cash used for financing activities (1,390,516) (12,246,167) (11,138,328) Net increase (decrease) in cash and cash equivalents 2,741 (743,605) 1,339,148 Cash and cash equivalents, beginning of year 736,429 1,480,034 140,886 Cash and cash equivalents, end of year $ 739,170 $ 736,429 $ 1,480,034 Supplemental Schedule of Non-Cash Investing Activities: Write-off of fully depreciated tenant improvements $295,667 $120,653 $33,152 Notes to the Financial Statements December 31, 1997, 1996 and 1995 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. ("RE Services"), 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 RE Services. The effective date of 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. Since RE Services 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." 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. 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, deferred leasing costs and incentives to lease are amortized over the term of the related lease agreements using the straight-line method. Impairment of Long-Lived Assets 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"), requires the Partnership to assess its real estate investments for impairment whenever events or changes in circumstances indicate that the carrying amount of the real estate may not be recoverable. Recoverability of real estate to be held and used is measured by a comparison of the carrying amount of the real estate to future net cash flows (undiscounted and without interest) expected to be generated by the real estate. If the real estate is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the real estate exceeds the fair value of the real estate. 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 The carrying amount of trade receivables and payables approximates fair value. 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 June 25, 1986, the Partnership acquired 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, 1997 and 1996, Powers Ferry was 87% and 84% 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, 1997. 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 with an option for an additional five years, by written notice, on or before six months from the expiration of this extension period. The rental rate over the additional option period will be equal to 95% of the fair market value for the Sunnyvale market at the time of notice. 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 addition, Tandem has assigned the option rights for the sublessee to negotiate with the Partnership. 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. On April 16, 1991, the Partnership became the owner of the property in its entirety through a special conveyance transaction. On May 23, 1996 Pebblebrook Apartments was sold by the Partnership 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, 1997 assuming no exercise of tenant renewal options: 1998 $1,895,699 1999 1,078,098 2000 700,765 2001 511,173 Thereafter - $4,185,735 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, 1997, 1996 and 1995. For the years ended December 31, 1997, 1996 and 1995, Tandem has contributed $859,126 (42%), $859,126 (32%), and $859,126 (20%), respectively, of the Partnership's rental income and is current on its rent payments. 5. Transactions With Related Parties 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 $13,905, $17,382 and $10,428 in 1997, 1996 and 1995, respectively. c) 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 General Partner are as follows: 1997 1996 Asset management fee $6,953 $3,476 Out - of - pocket expenses - 182 Total due to General Partner $6,953 $3,658 6. Partners' Capital (Deficit) 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, 1997 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, 1997, 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 $1,348,800, $12,083,149, and $10,999,131 to the Unit Holders in 1997, 1996 and 1995, respectively. In addition, the Partnership distributed $41,716, $163,018 and $139,197 to the General Partner in 1997, 1996 and 1995. An additional cash distribution in the amount of $337,200 was paid to the Unit Holders ($.30 per unit) and $10,428 was paid to the General Partner for the quarter ended December 31, 1997, in the first quarter of 1998. 7. Condemnation Issue Cobb County, Georgia, has notified the Partnership of its intent, under powers of eminent domain, to condemn a portion of the land located at Powers Ferry for the widening of Powers Ferry Road. The condemnation may occur in 1998, however, the Partnership has not yet received a formal notice of condemnation from Cobb County. The condemnation may have a substantial impact on the value of the property since the road will be moved closer to the building, the driveway will be relocated and reduced in size and the vast majority of the landscaping in front of the building will be removed. Cobb County will be required, as a part of the process, to compensate the Partnership for the portion of the land actually taken and any consequential damages (damages occurring to the portion of the property not taken). The Partnership has retained legal counsel to ensure that it is sufficiently compensated for any damages that may result from condemnation. 8. Reconciliation of Financial Statement Basis Net Income and Partners' Capital to Federal Income Tax Basis Net Income and Partners' Capital Reconciliation of financial statement basis net income to federal income tax basis net income: Year Ended December 31, 1997 1996 1995 Financial statement basis net income $714,981 $3,333,580 $2,662,237 Financial statement amortization under tax basis amortization (12,286) (12,285) (328,909) Financial statement depreciation over (under) tax basis depreciation (20,870) (106,954) 157,590 Financial statement rental income (over) under tax basis rental income 75,063 (85,257) 151,538 Financial statement gain on sale of property (over) under tax basis gain on sale of property - (2,213,064) 70,288 Other 291 305 30,944 42,198 (2,417,255) 81,451 Federal income tax basis net income $757,179 $916,325 $2,743,688 Reconciliation of financial statement partners' capital to federal income tax basis partners' capital: Year Ended December 31, 1997 1996 1995 Financial statement basis partners' capital $17,496,727 $18,172,262 $27,084,849 Current year financial statement basis net income (over) under federal income tax basis net income 42,198 (2,417,255) 81,451 Cumulative Federal income tax basis net income over financial statement net income 9,740,297 12,157,552 12,076,101 Federal income tax basis partners' capital $27,279,222 $27,912,559 $39,242,401 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, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Boston, Massachusetts February 18, 1998 Net Asset Valuation Comparison of Acquisition Costs to Appraised Value and Determination of Net Asset Value Per $26.34 Unit at December 31, 1997 (Unaudited) Acquisition 1997 Appraised Property Date of Acquisition Cost (1) Value (2) Sunnyvale R&D 08-28-86 $ 11,185,961 $ 15,500,000 1899 Powers Ferry 07-07-87 8,916,095 8,300,000 $ 20,102,056 23,800,000 Cash and cash equivalents 739,170 Accounts receivable 44,091 Prepaid expenses 5,816 24,589,077 Less: Total liabilities (172,453) Partnership Net Asset Value (3) $ 24,416,624 Net Asset Value Allocated: Limited Partners $ 24,172,458 General Partner 244,166 $ 25,216,624 Net Asset Value Per Unit (1,124,000 Units outstanding) $21.51 (1) Purchase price plus general partners' acquisition fees. (2)This represents the Partnership's share of the December 31, 1997 appraised values which were determined by an independent property appraisal firm. (3)The Net Asset Value assumes a hypothetical sale at December 31, 1997 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. Schedule III - Real Estate and Accumulated Depreciation December 31, 1997 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 3,146,034 2,271,786 5,417,820 Retirements (2,976,402) (1,699,183) (4,675,585) Gross amount at which carried at close of period: Land $ 6,336,962 $ 2,050,628 $ 8,387,590 Buildings and improvements 5,018,631 7,346,818 12,365,449 $ 11,355,593 $ 9,397,446 $ 20,753,039 Accumulated depreciation $ 1,735,017 $ 2,637,681 $ 4,372,698 (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 $5,623,052. (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, 1997, 1996, and 1995 follows: 1997 1996 1995 Real estate investments: Beginning of year $21,026,928 $30,909,245 $42,595,901 Additions 21,778 90,980 211,470 Retirements (295,667) (120,653) (33,151) Dispositions - (9,852,644) (11,864,975) End of year $20,753,039 $21,026,928 $30,909,245 Accumulated depreciation: Beginning of year $4,131,094 $ 5,730,421 $ 7,744,521 Depreciation expense 537,271 568,224 1,251,637 Retirements (295,667) (120,653) (26,391) Dispositions - (2,046,898) (3,239,346) End of year $4,372,698 $4,131,094 $ 5,730,421 INDEPENDENT AUDITORS' REPORT ON SCHEDULE III The Partners Participating Development Fund 86: Under date of February 18, 1998, we reported on the balance sheets of Participating Development Fund 86 (a Connecticut limited partnership) as of December 31, 1997 and 1996, 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, 1997, as contained in the 1997 annual report to unitholders. These financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1997. In connection with our audits of the aforementioned financial statements, we also have audited the related financial statement 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 18, 1998 EX-27 3 FINANCIAL DATA SCHEDULE FOR 1997 YEAR END 10-K WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE. Participating Development Fund 86
5 12-mos Dec-31-1997 December-31-1997 739,170 000 44,091 000 000 000 20,753,039 (4,372,698) 17,708,561 211,834 000 000 000 000 17,496,727 17,708,561 000 2,142,170 000 575,893 851,296 000 000 714,981 000 714,981 000 000 000 714,981 .62 .62
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