-----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, Gu6DKy6BYl711+o2gxWmY5azFP61MlcwY/ZHl836YiE/tiqzTGKf7aYnio66WbCz Lgd8pGvqUss9S/wTpoaPPg== 0000912057-97-011031.txt : 19970401 0000912057-97-011031.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-011031 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFIC REAL ESTATE INVESTMENT TRUST INC CENTRAL INDEX KEY: 0000230437 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 941572930 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-08725 FILM NUMBER: 97568725 BUSINESS ADDRESS: STREET 1: 1010 EL CAMINO REAL STE 210 CITY: MENLO PARK STATE: CA ZIP: 95025 BUSINESS PHONE: 4143277147 MAIL ADDRESS: STREET 1: 1010 EL CAMINO REAL STREET 2: STE 210 CITY: MENLO PARK STATE: CA ZIP: 95025 FORMER COMPANY: FORMER CONFORMED NAME: PACIFIC REAL ESTATE INVESTMENT TRUST DATE OF NAME CHANGE: 19920703 10-K405 1 10-405 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K (MARK ONE) /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 For the transition period from to -------------------- ----------------- Commission File Number 0-8725 PACIFIC REAL ESTATE INVESTMENT TRUST A California Trust (Exact name of registrant as specified in its charter) 94-1572930 (I.R.S. Employer Identification No.) 1010 El Camino Real, Suite 210, Menlo Park, California 94025 (Address of principal executive offices, including zip code) (415) 327-7147 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Shares of Beneficial Interest, par value $10 per share ("Trust Shares") 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 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 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] No market for Trust Shares currently exists and therefore a market value for such Trust Shares cannot be determined. The number of Trust Shares outstanding as of December 31, 1996 was 3,706,845, $10 par value per share. TABLE OF CONTENTS PAGE ---- PART I Item 1. Business........................................................ 1 Item 2. Properties...................................................... 7 Item 3. Legal Proceedings............................................... 14 Item 4. Submission of Matters to a Vote of Security Holders............. 14 PART II Item 5. Market for Registrant's Trust Shares and Related Shareholder Matters............................................ 15 Item 6. Selected Financial Data......................................... 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 18 Item 8. Consolidated Financial Statements and Supplementary Data........ 22 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................ 39 PART III Item 10. Directors and Executive Officers of Registrant.................. 39 Item 11. Executive Compensation.......................................... 40 Item 12. Security Ownership of Certain Beneficial Owners and Management..................................................... 40 Item 13. Certain Relationships and Related Transactions.................. 41 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................................................... 42 Signatures................................................................ 43 PART I ITEM 1. BUSINESS (a) Historical Development of Business: Pacific Real Estate Investment Trust (the "Trust") was organized pursuant to a Declaration of Trust on April 17, 1963. The Trust is a California real estate investment trust and qualifies as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended ("Code"). The Trust's total assets were $46 million at December 31, 1996 and $63 million at December 31, 1995. (b) Financial Information About Industry Segments: The Trust is currently involved in only one industry segment--real estate. The Trust operates and holds for investment, income producing real property and promissory notes secured by real property. All of these activities are included in the real estate industry segment. Therefore, all of the revenues, operating profits and assets reported in the Consolidated Financial Statements contained herein relate to this industry segment. (c) Narrative Description of the Business: TERMINATION OF TRANSACTION WITH PAN PACIFIC. On January 10, 1997, the Trust entered into a definitive merger agreement with Pan Pacific Development (U.S.) Inc. whereby both entities agreed to contribute certain properties into a subsidiary of the Trust, Pacific Real Estate Investment Trust, Inc. On March 25, 1997, the agreement was terminated for failure of certain conditions. The Trustees will continue to pursue alternative sources of financing or an alternative approach involving the orderly sale of the Trust's assets. OVERVIEW The Trust invests in real estate interests and mortgage notes. At December 31, 1996, the Trust owned (i) a 100% equity interest in two shopping centers, one of which is in receivership; (ii) a 40% controlling interest in Kingsco, a general partnership that owns a ground lessee's interest in a shopping center; and (iii) a ground lessee's interest in one strip shopping center for redevelopment. In addition, the Trust holds various notes receivable, most of which are secured by deeds of trust and acquired in connection with sales or assignments of Trust properties or contractual rights to acquire properties, and a leasehold interest in a parcel of land that could be developed as a retail or office building. Each of the Trust's shopping center properties is located in the metropolitan San Francisco Bay Area. Notes receivable are secured by deeds of trust on shopping center properties located in Northern California. The Trust's shopping centers attract local area customers and are typically anchored by a supermarket, superdrug, or other type of convenience store. Anchor retailers are critically important to the success of the shopping center because they attract consistent local traffic and repeat shoppers whose expenditures support a variety of other stores in the shopping center. Examples of anchor retailers in the Trust's shopping center properties are WalMart, Lucky Stores and Walgreen. The overall tenant mix in each of the Trust's shopping centers typically caters to the retailing of day-to-day consumer necessities rather than high-priced luxury or specialty items. 1 POLICIES AND OBJECTIVES WITH RESPECT TO CERTAIN ACTIVITIES The following is a discussion of the Trust's objectives and policies with respect to investment, disposition, financing and certain other activities in light of current conditions. Current capital constraints affecting the Trust effectively preclude new acquisitions of significance. The investment policies and other policies of the Trust are reviewed herein in the context of the Trust's current financial condition. These policies are determined by the Trustees, and may be amended or revised from time to time at the discretion of the Trustees without a vote of the holders of beneficial interests of the Trust ("shareholders"). No assurance can be given that these investment objectives will be attained or that the value of the Trust will not continue to decrease. INVESTMENT POLICY. The Trust's historic investment objective has been to invest in commercial real estate which would generate cash distributions and long-term capital appreciation. This policy was successful from 1964 until recent years. Since 1974 the Trust has sought to accomplish these objectives by acquisition, development and redevelopment of anchored neighborhood shopping centers and commercial property in Northern California. One reason the Trust concentrated in retail was because the anchor retail stores tended to limit oversupply by building only to demand. But in recent years the emergence of an entirely new group of retailers have changed that historical pattern of development completely, resulting in increasing over-construction in retail. In addition, during the last five years, the Trust's lack of access to equity capital coupled with adverse property market conditions have frustrated the Trust's achievement of its investment objectives. These circumstances have resulted in the suspension of cash distributions to shareholders, a reduction in the value of the Trust's assets and a lack of liquidity for shareholders. The Trust has not acquired new investment property since 1992 and its development activities have been suspended. Since 1991 the Trust has been actively seeking to recapitalize to overcome these challenges. This activity has been conducted both under the direction of several investment bankers as well as independently with institutional investors. Recapitalization strategies that have been considered include joint venture, merger and listing on one of the national stock exchanges. During the early 1990's the impact of a nationwide economic recession and the volatility of public capital markets have prevented a successful outcome to these efforts. The Trust has conducted active discussions with potential merger or joint venture candidates and the Trustees have explored exhaustively every reasonable opportunity. The value of the Trust's property portfolio has declined during the past several years. This decline is the result of multiple factors. During the early 1990's most prominent was the collapse of commercial real estate values nationwide as a result of overbuilding, fallout from the savings and loan collapse and the consequent liquidation of large numbers of commercial properties at prices significantly below replacement cost, severely depressing the nation's property markets. Other prominent factors include the pronounced depth and protracted nature of the recent economic recession and the permanent defense industry cutbacks which had a particularly adverse effect on California commercial real estate values. While the economy improved in 1995 and 1996, the value of the Trust's shopping center portfolio has continued to be adversely affected by simultaneous rapid and continuing changes in the retail industry. The proliferation of "big-box" discount retailers characterized by their predatory pricing and marketing practices is having a widespread impact, putting many traditional retailers at risk and some into bankruptcy. The corollary effect of this retailing revolution has been an aggressive overbuilding in the retail sector in excess of consumer demand leading to increased vacancy and tenant business failures, driving down rents and property values. While market conditions have improved during the latter half of 1996 and into 1997, retail property values in general are still off their valuation levels achieved in 1989 and 1990. In addition to these general economic and retail industry trends the value of the Trust's property portfolio has been damaged as a result of adverse developments at El Portal Shopping Center in San Pablo, California. Between 1994 through 1996 the Trust suffered the loss and closure of all of its anchor tenants in the El Portal Shopping Center, resulting in the loss of all its equity in the property, which formerly comprised a significant proportion of the Trust's net worth and provided substantial annual cash flow from operations. The cash drain, at the property level, created by these problems prompted the Trust to cease making payments on the El Portal property mortgage in October 1996. This action coupled with problems relating to an old toxic release on the property, caused the mortgage holder to file with the appropriate court jurisdiction to place the 2 property in receivership. This receivership was formally ratified by the court in January 1997. Meanwhile, at Monterey Plaza Shopping Center, the closure of the HomeBase Store and the ensuing more than two year vacancy (which ended in August 1996 when WalMart took over the lease) caused significant economic harm to the property, not least of which was a reduction in rent of more than $400,000 per year as well as other expensive concessions coupled with the failure of many smaller retailers. In considering dispositions, the Trust makes disposition decisions based on current market conditions and its objective of realizing maximum value for its shareholders. FINANCING. The Trust intends to restructure its portfolio during 1997 in order to reduce indebtedness and achieve liquidity, by either pursuing alternative financing or the sale of the Trust's properties and assets. DISTRIBUTIONS. Until 1993, the Trust's policy had been to pay dividends to its shareholders in an amount approximating 100% of its cash flows from operations (i.e., net operating income plus depreciation and amortization). Capital gains have been distributed on a case by case basis. That portion of a distribution which is sheltered by depreciation and amortization constitutes a nontaxable return of capital to the shareholders. Dividends were paid on a regular basis for twenty-nine years, since 1964. However, on February 25, 1993, the Trustees unanimously decided to suspend the payment of regular dividends in order to conserve the Trust's cash flow, in an effort to meet its capital needs, to maintain the quality of the Trust's properties and to protect the Trust's credit, since the Trustees concluded that the Trust could no longer rely on its traditional sources of liquidity (i.e., secured bank financing and "intrastate" equity offerings) for these purposes. The suspension of dividends is not expected to affect the Trust's qualification as a REIT and is expected to continue for the foreseeable future. WORKING CAPITAL RESERVES. The Trust seeks to maintain working capital reserves (and, when not sufficient, access to borrowings) in amounts that the Trustees determine to be adequate to meet normal capital demands in connection with the operation of the Trust's business and investments. As noted above, the Trust expects that it will either restructure or sell its portfolio in order to generate adequate working capital reserves. CONFLICTS OF INTEREST POLICIES. The Trust has adopted certain policies designed to reduce potential conflicts of interest. Such policies do not apply where a Trustee, officer or affiliate has acquired property for the sole purpose of facilitating its acquisition by the Trust, and the total consideration paid by the Trust does not exceed the cost of the property to such person (which cost is increased by such person's holding costs and decreased by any income received by such person from the property) and no special benefit results to such person. The Trustees may engage in real estate transactions which may be of the type conducted by the Trust, but it is not anticipated that such transactions will have a material effect upon the Trust's operations. OTHER POLICIES. The Trust intends to operate in a manner that will not subject it to regulation under the Investment Company Act of 1940, as amended. The Trust does not intend (i) to invest in the securities of other issuers for the purpose of exercising control over such issuers, (ii) to underwrite securities of other issuers or (iii) to trade actively in loans or other investments. The Trust may make investments other than as previously described, although it does not currently plan to do so. The Trust has authority to repurchase or otherwise reacquire Trust Shares it has issued or may issue and it may engage in such activities in the future. The Trustees have no present intention of causing the Trust to repurchase any of the Trust Shares, and any such action would be taken only in conformity with applicable federal and state laws and the requirements for qualifying as a REIT under the Code and the Treasury Regulations. Although the Trust may do so in the future in connection with the purchase of additional properties or otherwise, the Trust has not issued securities in exchange for property, nor has it reacquired any of its securities. The Trust may make loans to third parties, including, without limitation, to officers and to joint ventures in which the Trust decides to participate, although no such loans have been made. At all times, the Trust intends to meet the requirements of the Code to qualify as a REIT unless, because of changes in future economic, market or legal conditions, or changes in the Code or in the Treasury Regulations, the Trustees elect to revoke the Trust's REIT election. 3 MARKET CONDITIONS The Company does not believe that the real estate market is an efficient market. Local conditions and the type of commercial operations conducted at each property directly affect property values in ways that may be unrelated to overall nationwide, regional or neighborhood market trends. The real estate market is also highly competitive, and maintaining property values is difficult. Access to economically available equity capital is critical to creating and maintaining real estate values. Other real estate investment trusts (most of which are much larger than the Trust), pension trusts, private investors, and real estate syndicates compete directly with the Trust for capital. In addition to these geographic and industry considerations, the market for real estate is heavily influenced by the financial, bond and securities markets, as well as political, regulatory and Code factors. During the last several years, investors have become increasingly selective about real estate. This heightened selectivity has occurred against a complex marketplace backdrop characterized by declining values and reduced liquidity, lack of capital, adverse fall out resulting from reform of the tax code, property over-building, solvency crisis in the savings and loan industry and the related incidences of distress sales and dumping of swollen property inventories by the Resolution Trust Corporation. Most of this occurred within the context of a severe national economic recession. The Trustees do not expect values to recover to the market levels achieved in the late 1980's and early 1990's, prior to the downturn. This is particularly true for retail property and there can be no assurance that this improvement will occur or that 1997 will see any improvement. Thus there remain significant impediments to the Trust's ability either to resume cash distributions or to establish liquidity for its shareholders without improvement in market values or capital restructuring. The Trust is not involved in research and development activities other than market research. GOVERNMENT REGULATION ENVIRONMENTAL MATTERS. Under various federal, state and local laws, ordinances and regulations, an owner or operator of real property may become liable for the costs of removal or remediation of certain hazardous substances released on or in its property. Such laws impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of such substances, or the failure to properly remediate such substances, when released, usually reduces the value and adversely affects the ability to sell such real estate or to borrow using such real estate as collateral. The Trust has notified a governmental authority of a spill from a former dry cleaning shop at King's Court Shopping Center and the Regional Water Quality Control Board of Santa Clara County has issued a clean-up order to the Trust. Currently, a plan of remediation has been prepared with a proposed plan of action for clean-up of the contamination. The remediation clean-up is now underway and is expected to last at least two years. This plan has been approved by the pertinent regulatory agencies on an interim basis, pending review of remediation and testing results. The cost to Kingsco for the clean-up is estimated to be $1,032,000, of which $723,000 has already been expended. Reimbursements received from the insurance company total $503,000. The Trust was not a partner of Kingsco at the time the contamination occurred, and intends to look to the seller of the Trust's 40% interest in Kingsco, Kingsco's insurance carriers at the time of the contamination, the other partners of Kingsco and the entity that caused the contamination for payment of the clean-up costs. The Trust believes that the representations and warranties made by the seller in the agreement pursuant to which the Trust acquired its partnership interest give the Trust a cause of action against the seller for the clean-up costs. In another, unrelated, environmental audit of the gasoline service station pad ("Exxon Pad") at King's Court Shopping Center, the Phase I and II work identified gasoline and possibly other service station by-products in the soil underneath the station and its pumps. Exxon Corporation has assumed financial and legal responsibility of the hazardous materials and remediation of the Exxon Pad. The environmental firm responsible for maintaining and analyzing the data from various monitoring wells on the Pad continues to report to the Trust and governmental authorities on a quarterly basis. Remediation efforts are now underway and include both vapor extraction and "pump and treat" activities, depending upon the location of the materials in the soil and water. The Trust has also become aware of a spill from a former dry cleaning establishment at El Portal Shopping Center. This spill probably occurred prior to the Trust's ownership of the property. The Contra Costa 4 County Regional Water Quality Control Board is currently reviewing the situation and a clean-up remediation proposed by the Trust. The cost of clean-up and timetable have not yet been finalized, however, based on current knowledge, the cost is not expected to have a material adverse effect on the Trust's financial position, results of operations and cash flows. During 1996, the Trustees authorized remediation expenditure up to $100,000. At December 31, 1996, Other Liabilities in the accompanying consolidated financial statements include $100,000 for such costs. The Trust ground leases a parcel of land in San Pablo, California (the Wanlass property) which has been contaminated with a gasoline spill from an adjacent property. The source of contamination has been identified and Atlantic-Richfield Company, Inc. ("ARCO") has issued a letter of indemnification for the Trust's benefit respecting all financial and legal liability arising from this contamination. At Monterey Plaza Shopping Center the Phase One Environmental Assessment Report identified the possibility of oil and grease contamination in the soil as well as possible residues of pesticides, herbicides and insecticides due to prior agricultural use of the property. The property was acquired from the State of California, which held title immediately prior to the Trust and which, the Trust believes, would be liable for any such contamination under the controlling statutes. These possible hazardous waste contaminations are not considered to be of material significance to the Trust. Compliance with federal, state and local laws and regulations relating to the protection of the environment could have a significant impact on the financial position of the Trust. However, other than disclosed herein, the Trustees are not currently aware of any conditions that would have a material adverse effect on the Trust. AMERICANS WITH DISABILITIES ACT. The Trust's properties are subject to the Americans with Disabilities Act of 1990, as amended (the "ADA"). The ADA has separate compliance requirements for "public accommodations" and "commercial facilities" and generally requires that public facilities such as retail shopping centers be made accessible to people with disabilities. These requirements became effective in 1992. Compliance with the ADA requirements will require removal of access barriers and other capital improvements at the Trust's properties. Noncompliance could result in imposition of fines by the United States government or an award of damages to private litigants. However, the Trust does not believe that the costs of compliance will be material. If required changes involve a greater expenditure than the Trust currently anticipates, or if the changes must be made on a more accelerated basis than it anticipates, the Trust could be adversely affected. MANAGEMENT The search for suitable real estate capitalization and portfolio restructuring is pursued by the Trust's investment advisor, Collier Investments (the "Advisor"), a proprietorship owned by Charles R. Collier. Under the terms of an Investment Advisory Agreement between the Trust and the Advisor, the Advisor has agreed to use its best efforts to present to the Trust recapitalization and portfolio restructuring opportunities consistent with the investment policies and objectives of the Trust. After careful study and review, the Advisor may recommend to the Trustees those opportunities or strategies whose character is consistent with the investment program of the Trust. In addition to relying on the advice of the Advisor, the Trustees occasionally employ the services of independent professional consultants. The Trust employs no full-time executives or administrative staff, except for the President who is a part-time employee and he is compensated as such. The leasing and management of the Trust's properties and administration of the Trust itself is performed by an independent contractor, Menlo Management Company. Menlo Management is owned by Robert C. Gould who is also Vice President and a trustee of the Trust (see Related Party Transactions). California Bavarian Company, a privately held California corporation, provides shareholder communication and liaison support services to the Trust on a contractual basis for a monthly service fee. California Bavarian Company is not related to the Trust. However its director, Mark D. Mordell, is an agent of the Trust. The Trust has five trustees who meet once a month and who are compensated by the Trust. The Trustees include: Wilcox Patterson, who serves as President; Harry E. Kellogg, who serves as Treasurer; John 5 H. Hoefer and Robert C. Gould, who serve as Vice Presidents and William S. Royce, who serves as Secretary. Each of the Trustees, Officers and Advisor invest in the Trust. COMPETITION The Trust's properties are located in metropolitan communities in the San Francisco Bay Area. Each property is situated amidst fully developed commercial and retail areas. As such, there are other competing neighborhood and community shopping centers located in near proximity to the Trust's properties. These factors will have a bearing on the Trust's ability to rent its properties to tenants on economic terms and to impose effective mechanisms to control operating costs and resultant net income. The Trust must compete for tenants and services with other property owners who may have greater resources or more attractive locations than those available to the Trust and its officers, directors and agents. Moreover, the extent and increasing rates of changes in community demographics, public policy, retail usage patterns, merchandising practices, consumer tastes and financial strength of tenants, amongst other considerations, can all affect adversely a property's competitive position in varying ways. INSURANCE The Trust typically maintains comprehensive liability, fire, extended coverage and rental loss insurance with respect to its properties, and generally requires tenants to reimburse the Trust for their pro rata share of the Trust's insurance premiums and to maintain their own general liability insurance with respect to the properties with policy terms and insured limits customarily carried for similar properties. There are, however, certain types of losses (such as from wars, flood, riots or earthquakes) which may be uninsurable or insurable only at rates which, in the Trust's opinion, are prohibitive. King's Court Shopping Center is insured against damage from earthquakes. (d) Foreign Operations The Trust does not engage in any foreign operations or derive revenues from foreign sources. 6 ITEM 2. PROPERTIES DESCRIPTION OF THE TRUST'S PROPERTIES The following table sets forth certain information relating to the Trust's properties (excluding property in receivership at El Portal) as of and for the year ended December 31, 1996:
EFFECTIVE PERCENTAGE GROSS 1996 ANNUAL ANNUAL RENT PERCENT OWNERSHIP LEASABLE MINIMUM PER SQUARE PERCENT LEASED & ANCHORS AND NAME/LOCATION INTEREST AREA (SQ FT) RENT (3) FOOT LEASED OCCUPIED PRINCIPAL TENANTS - ------------------------------------------------------------------------------------------------------------------------------------ King's Court Shopping Center 40% 78,576 $ 1,338,000 $ 17.03 93% 93% Lunardi's Supermarket; Los Gatos, California Bank of America Wells Fargo Bank Monterey Plaza 100% 183,180 2,439,000 13.31 95% 39% Lucky Stores; Shopping Center WalMart (4); San Jose, California (1) (2) Walgreen Wanlass Shopping Center 100% (5) 36,135 72,000 1.99 28% 28% Mechanics Bank San Pablo, California
- ---------------------- (1) Lucky Stores owns its store at Monterey Plaza Shopping Center and, therefore, is not a tenant of the Trust. Even though the Trust does not benefit directly from the economic performance of this anchor store, the anchor is nonetheless critical to the success of the shopping center. (2) The aggregate gross leasable area does not include approximately 51,000 square feet at Monterey Plaza Shopping Center. This represents the store owned by Lucky Stores. (3) Annual minimum rent excludes (a) percentage rents, (b) additional rent payable by tenants such as common area maintenance, real estate taxes and other expense reimbursements, and (c) future contractual rent escalations or Consumer Price Index adjustments. Percentage rents are paid over and above base rents, and are calculated as a percentage of a tenant's gross sales above a predetermined threshold. The amount of percentage rents received to date by the Trust has not been material to the Trust's operations. Figures for total annual minimum rent in the above table have been calculated based on rental payments for the calendar year 1996, and have been adjusted for the effects of recognizing rent on a straight-line basis as reported in the Trust's financial statements. (4) WalMart has assumed the HomeBase lease and was currently paying a minimum rent at December 31, 1996. HomeBase also paid a partial rent until WalMart opened for business on January 29, 1997. (5) Title to the Wanlass Shopping Center is a leasehold estate based on a ground lease which expires in 2045. The lease contains an option to purchase for the benefit of the Trust, as well as a put option requiring the Trust to purchase the property freehold upon the death of one of the ground lessors or at any time after May 25, 1998. The property is proposed for redevelopment. KING'S COURT SHOPPING CENTER. This neighborhood shopping center is located in the town of Los Gatos, California. The center is anchored by Lunardi's Supermarket, a local supermarket chain, and an array of retail and service tenants such as Hallmark Cards, Wells Fargo Bank and Bank of America. King's Court Shopping Center has 78,576 square feet of gross leasable space. The Trust presently owns a 40% interest in Kingsco, the general partnership which owns this shopping center. In addition, the Trust manages King's Court Shopping Center and has control over the shopping center's operations, including any leasing, renovation, sale and financing activities. Kingsco owns a leasehold estate as to the land and fee title as to the improvements (excluding a gas station). The ground lease has only 27 years left in a 50-year term, expiring in 2024, and requiring minimum annual lease rental payments of $40,000 plus between 10% and 12% of the property's gross rental revenue in excess of $333,333 per annum. The Trust is presently negotiating with the ground lessors to extend the ground lease, however there can be no assurance that these negotiations will succeed on economically acceptable terms. The carrying cost of the center, which includes the other partners' interest in the property, was $5,784,000 after depreciation at December 31, 1996. The property is security for a first mortgage loan with an interest rate of prime +1.75%. At December 31, 1996 the rate was 10.25% and the outstanding balance was $1,307,000. 7 At December 31, 1996, King's Court Shopping Center was 93% leased. Tenants occupying 10% or more of the rentable space as of December 31, 1996 are:
PERCENT OF TOTAL GROSS LEASABLE GROSS LEASABLE ANNUALIZED TENANT AREA (SQ FT) AREA BASE RENT END OF LEASE TERM - ----------------------------------------------------------------------------------------------------- Lunardi's Supermarket 23,960 30% $ 140,000(1) November 2003 (1 option for 10 years)
(1) Additional percentage rents paid by Lunardi's Supermarket were $156,000 in 1996, $140,000 in 1995, and $99,000 in 1994. The Trust has discovered toxic pollution of the ground water under King's Court Shopping Center. See "Governmental Regulation--Environmental Matters" for discussion of this circumstance. MONTEREY PLAZA SHOPPING CENTER. This community shopping center is located in San Jose, California. The Trust began the development of this shopping center in 1987, and completed development in 1990. The center has 233,000 square feet of retail space, of which the Trust owns 183,180 square feet, or all but the Lucky Store. In addition to the Lucky Store anchor, other retailers include WalMart, Walgreen, McDonald's, Lyon's Restaurant and Taco Bell. Negotiations amongst the Trust, HomeBase and WalMart concerning the terms of WalMart's assumption of the HomeBase lease required that the base rents for the premises be reduced substantially from the contact rents required under the HomeBase lease. Also WalMart's merchandising practices demanded modifications to Walgreen's lease in respect of pharmaceutical, health and beauty product sales. As a result Walgreen's lease was amended to relieve Walgreen's of reimbursements of property taxes, to pay Walgreen up to one million dollars for release of its exclusive rights and to permit Walgreen to terminate its lease upon its sole discretion prior to maturity. Under the terms of the lease assumption HomeBase and the Trust each made certain financial contributions towards the remodel costs for the premises to accommodate WalMart. The Trust is in a dispute with WalMart concerning alleged deficiencies in the tenant's premises at Monterey Plaza. The sum in question is approximately $136,000 and represents roof and skylight repairs and upgrades. The Trust has declined to accept responsibility for these items and is contesting WalMart's claim of Landlord responsibilities. Trust management does not expect the ultimate outcome will have a material adverse effect on the Trust. Monterey Plaza is security for a first mortgage loan with an interest rate of 9.720%. At December 31, 1996, the outstanding balance was $18,412,000. This loan matures on February 7, 2000. At December 31, 1996 the Trust's investment in Monterey Plaza Shopping Center was $25,236,000 after accumulated depreciation. At December 31, 1996, Monterey Plaza Shopping Center was 95% leased. Tenants leasing 10% or more of the rentable space as of December 31, 1996 are:
PERCENT OF TOTAL GROSS LEASABLE GROSS LEASABLE ANNUALIZED TENANT AREA (SQ FT) AREA BASE RENT END OF LEASE TERM - -------------------------------------------------------------------------------------------- Wal-Mart 101,500 55% $761,000 August 6, 2006 (6 options for 5 years)
WANLASS SHOPPING CENTER. Wanlass Shopping Center is a strip shopping center located in San Pablo, California. The property has a total of 36,135 square feet of gross leasable area. Located adjacent to the Trust's El Portal Shopping Center and fronting onto San Pablo Avenue, it was acquired as a leasehold investment by the Trust in 1995 in connection with the plan to redevelop El Portal Shopping Center. However the property is able to stand alone as a retail investment, once certain physical improvements are made and retail tenants installed. If capital is available, the Trust expects to undertake these improvements for certain retail tenants on a build-to-suit basis. The property is a fee title as to the improvement and a leasehold estate as to the land under 8 a ground lease which expires in 2045 with annual ground rent of $192,000. There is currently no Trust indebtedness or financing secured by the leasehold. The anchor tenant is Mechanics Bank. The percentage of the center that is both leased and occupied at December 31, 1996 was 28%. Tenants leasing 10% or more of the rentable space as of December 31, 1996 are:
PERCENT OF TOTAL GROSS LEASABLE GROSS LEASABLE ANNUALIZED TENANT AREA (SQ FT) AREA BASE RENT END OF LEASE TERM - ---------------------------------------------------------------------------------------------- Mechanics Bank 6,000 17% $ 30,780 September 2006 (2 options for 10 years)
EL PORTAL SHOPPING CENTER. El Portal Shopping Center is a community shopping center located in the city of San Pablo, California. The center was acquired by the Trust in 1976, and repositioned and expanded in 1978 and 1986, respectively. The center has a total of 271,426 square feet of gross leasable area. From 1976 to 1995 El Portal was an important source of cash flow to the Trust. Between 1994 through 1996 El Portal suffered a complete reversal arising from the loss or closure of all of its anchor tenants. The resultant cash drain from the property prompted the Trust to suspend making any further mortgage payments to the Trust Deed Non-Recourse Note holder, Nationwide Life Insurance Company. The lender accordingly sought to place the property in receivership as a prerequisite to obtaining fee title to the property. This step was also prompted by the discovery in 1995 of a toxic spill emanating from a former dry cleaner tenant. This spill probably occurred prior to the Trust's acquisition of the property. The property was officially confirmed into permanent receivership in January 1997. The Trust expects that there is no residual equity for the Trust in the El Portal Shopping Center. VESTING OF TITLE TO PROPERTIES Monterey Plaza and El Portal are owned in fee title, King's Court Shopping Center and a parcel of land under the Wanlass Shopping Center fee title to the properties is owned by the Trust. For King's Court Shopping Center, the Trust acquired a 40% controlling interest in the general partnership which owns a leasehold estate as to the land and fee title as to the improvements (excluding a gas station). The ground lease term expires in 2024. In San Pablo the Trust leases a 2.513-acre parcel of land adjacent to the El Portal Shopping Center and fronting onto San Pablo Avenue (the Wanlass property). The ground lease expires in 2045 and contains a sell/put option to purchase upon either the death of one of the ground lessors or on or after March 1, 1998. PROPERTY CONDITION All of the buildings are suitable and adequate for the purposes for which they were designed, are being used for those purposes, where leased and occupied, and are in a good state of repair with the exception of El Portal Shopping Center, which is in receivership, and the Wanlass Shopping Center, which is a redevelopment property. However, due to changes in retail industry practice, in recent years it has become increasingly evident that tenant improvements for new and replacement tenants have escalated in cost significantly in excess of the rate of inflation and have tended to increase capitalization in Trust properties to a material extent. This trend is partially a consequence of the growing competitiveness of the rental marketplace in which the Trust's properties operate. Routine ongoing requirements of building upkeep and tenant replacements will necessitate capital expenditures during the future. The precise extent of such expenditures cannot yet be determined. PROPERTY SALES On February 29, 1996, the Trust sold Menlo Center for a sales price of $16,200,000. The existing financing was assumed by the buyer. After provision for closing costs, transfer fees and real estate commissions, the proceeds of this sale were all used to pay down other short-term Trust indebtedness and to provide working 9 capital for the Trust. The Trust remains liable to the buyer for an annual net income subsidy for the remaining term of the First Deed of Trust financing which matures in 2000. PRINCIPAL TENANTS WalMart Stores, Inc. ("WalMart") is the Trust's largest tenant. WalMart is a national discount retailer chain, which is traded on the New York Stock Exchange and, as of December 31, 1996, has credit rating of AA1 determined by Moody's and Standard and Poor's. In August 1996, WalMart assumed the HomeBase lease after significant modifications including rental reductions as well as concomitant economic rental concessions from Walgreen. Other significant tenants at the Trust's properties include Walgreen, Lunardi's Supermarkets and Wells Fargo Bank, which lease properties representing approximately 17% of the Trust's gross leasable area and 18% of its base rental revenues. Information with respect to the Trust's five largest tenants as of December 31, 1996 is set forth in the following table:
GROSS NUMBER OF LEASABLE AREA PERCENTAGE OF PERCENTAGE OF TENANT LEASES (SQ FT) TOTAL BASE RENT/YEAR TOTAL - ------------------------------------------------------------------------------------------------------- WalMart 1 101,500 34% $761,000 20% Lunardi's Supermarket 1 23,960 8% 140,000 4% Walgreen 1 14,000 5% 191,000 5% Wells Fargo Bank 1 5,670 2% 182,000 5% Bank of America 1 4,800 2% 150,000 4%
OCCUPANCY RATES FOR PAST FIVE YEARS The following table shows year-end rates for the past five fiscal years for rentable space both leased and occupied, expressed as a percentage of total rentable square footage for each of the Trust's properties:
Property 1992 1993 1994 1995 1996 - ------------------------------------------------------------------------------------------------------------ King's Court Shopping Center 100% 100% 98% 100% 93% Monterey Plaza Shopping Center (1) 91% 98% 43% 39% 39% Wanlass Shopping Center na na na na 28%
- ------------------ (1) The WalMart Store at Monterey Plaza Shopping Center opened for business January 29, 1997. See Description of Trust's Properties and Principal Tenants. (2) Wanlass Shopping Center was ground leased in May, 1995. AVERAGE EFFECTIVE ANNUAL BASE RENT PER SQUARE FOOT FOR PAST FIVE YEARS The following table shows average effective annual base rent per square foot for each of the Trust's properties for the past five years:
Property 1992 1993 1994 1995 1996 - ---------------------------------------------------------------------------------------------------------------------- King's Court Shopping Center $14.79 $14.85 $16.24 $16.55 $17.03 Monterey Plaza Center 13.73 14.14 14.03 14.58 13.31 Wanlass Shopping Center na na na na 1.99 (proposed for redevelopment)
(1) Wanlass Shopping Center was ground leased in May, 1995. 10 LEASE EXPIRATIONS The following table shows lease expirations for the next ten years for existing tenants at the Trust's properties as of December 31, 1996, assuming that none of the tenants exercise renewal options:
Approximate Percent of Total Percent of Gross Average Annual Lease Area in Leased Square Annualized Annual Rent Base Rent/year Square Feet Footage Base Rent/year Represented by Per Square Foot Lease Expiration Number of Under Expiring Represented by Under Expiring Expiring Under Expiring Year Leases Expiring Leases Expiring Leases Leases Leases Leases - ----------------------------------------------------------------------------------------------------------------------------- 1997 9 17,872 7.11% $ 338,028 9.45% $ 18.91 1998 4 4,637 1.85% 95,322 2.66% 20.56 1999 5 9,823 3.91% 215,423 6.02% 21.93 2000 6 6,871 2.74% 148,993 4.16% 21.68 2001 10 30,645 12.20% 774,294 21.64% 25.27 2002 1 264 .11% 1,980 .06% 7.50 2003 5 34,842 13.87% 484,628 13.54% 13.91 2004 2 4,887 1.95% 113,603 3.17% 23.25 2005 1 1,388 0.55% 29,148 .81% 21.00 2006 2 107,500 42.79% 792,030 22.14% 7.37 AFTER 2006 6 32,477 12.92% 584,648 16.35% 18.00 -- ------- ------ ----------- ------ ------- TOTAL 51 251,206 100.00% $ 3,578,097 100.00% $ 14.24 -- ------- ------ ----------- ------ ------- -- ------- ------ ----------- ------ -------
LEASES The majority of the anchor leases on the Trust's retail properties provide for initial lease terms of between ten and twenty years, and the leases on the Trust's smaller shop spaces typically provide for lease terms of between three and five years. The Trust typically seeks to structure the leases on its properties as "triple net" leases that impose on the tenant pro rata obligations for real property taxes and assessments, repairs and maintenance of common areas and insurance. Through the use of triple net leases, the Trust seeks to reduce its exposure to escalating operational costs and risks and the demands upon managerial time typically associated with investments in real estate. In this way, triple net leases provide opportunities for income growth from contractual rent increases without corresponding increases in operational costs. However, the Trust has agreed in certain instances to retain or limit the responsibility for some obligations that would otherwise be the responsibility of the tenant under a triple net lease. OUTSTANDING INDEBTEDNESS As of December 31, 1996, the combined total indebtedness of the Trust was approximately $33,400,000, consisting entirely of fixed rate debt except for $1,307,000 of floating rate debt. Aggregate indebtedness included $25,700,000 in long-term mortgage loans with maturity dates ranging from 1999 to 2000 and $7,700,000 in short-term notes payable with maturity dates in 1997. The following table sets forth certain information with respect to the Trust's mortgage loans: 11
PROPERTY OR INTERESTS MATURITY PRINCIPAL SCHEDULED ANNUAL ANNUAL DEBT BALANCE DUE PLEDGED AS COLLATERAL DATE BALANCE AMORTIZATION INTEREST RATE SERVICE AT MATURITY(1) - --------------------------------------------------------------------------------------------------------------------------- El Portal (2)(4) 07/01/00 $ 4,438,000 $683,000 9.625% $ 583,000 $ 3,755,000 King's Court 06/01/99 1,307,000 87,000 10.25%(3) 168,000 1,220,000 Monterey Plaza 02/07/00 18,412,000 569,000 9.720% 1,954,000 17,843,000 Mt. Shasta (4) 01/02/99 1,543,000 204,000 9.375% 238,000 1,338,000 ---------- ----------- ---------- ----------- TOTAL $25,700,000 $1,543,000 $2,943,000 $24,156,000 ----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
- ------------------- (1) Assumes no prepayments of principal prior to due dates thereof. The mortgage loan with respect to Monterey Plaza Shopping Center permits prepayment, but with substantial prepayment penalties. (2) This property is in receivership. (3) This mortgage loan bears interest at prime +1.75%, figure given is as of December 31, 1996. (4) This property is no longer owned by the Trust, but the Trust remains the primary obligor on the underlying mortgage and ground lease. See "Mortgage Notes Relating to Property Sales" below. The following table shows the scheduled maturity of the Trust's long-term mortgage loans over the next five years: PRINCIPAL AMOUNT PERCENTAGE OF TOTAL YEAR MATURING INDEBTEDNESS - ------------------------------------------------------------------------ 1997 $4,743,000 18.46% 1998 332,000 1.29% 1999 2,782,000 10.82% 2000 17,843,000 69.43% 2001 000 0.00% ------------- ------ Total, December 31, 1996 $ 25,700,000 100.00% ------------- ------ ------------- ------ The 1997 amount shown in above includes a $4,438,000 loan secured by the property in receivership at El Portal Shopping Center (see note to consolidated financial statements included elsewhere herein). MORTGAGE NOTES RELATING TO PROPERTY SALES As part of its strategy to focus on metropolitan "in-fill" locations as opposed to more rural locations, the Trust sold two properties, one each in 1988 and 1990. In connection with such sales, the Trust accepted seller financing: (i) WESTWOOD VILLAGE SHOPPING CENTER. In December 1988, the Trust sold the Westwood Village Shopping Center for $6,475,000, payable in cash of $1,100,000 and a $5,375,000 seller carry-back note receivable due in seven years with interest only payments at a rate of 9%. In March 1990, the purchaser obtained a $4,100,000 loan secured by a first mortgage on this shopping center to pay down the Trust's note. The remaining amount owed to the Trust is subordinate to this new loan. The principal balance owed to the Trust on December 31, 1996 was $1,104,000 and payments are current. This loan was to mature in December 1995, but has been successively extended and now matures December 1997. The shopping center income is sufficient to cover the payments on this Note. However, there is considerable chronic high level of vacancy at Westwood Village due to overbuilding of retail facilities in the Redding area. This has put downward pressure on rents and property values. The Trust feels that this Note may ultimately be only partially collectible and its book carrying value has been reduced to $600,000 at December 31, 1996. 12 (II) MT. SHASTA SHOPPING CENTER. In August 1990, the Trust sold the Mt. Shasta Shopping Center for $5,100,000, payable in cash of $900,000 and a $4,200,000 all-inclusive promissory note and second deed of trust due January 1, 1999 (the "Mt. Shasta Note"). The Mt. Shasta Note bears interest 9.25%. Because the interest rate was less than the market rate during the initial period, the Mt. Shasta Note was discounted by $303,000 which is being recognized as additional interest income over the term of the Mt. Shasta Note. The Mt. Shasta Note requires interest only payments until it matures on January 1, 1999. The Trust continues to be the primary obligor on the underlying first mortgage note, the principal balance of which at December 31, 1996 was $1,543,000. Payments on the Mt. Shasta note are current. The current owner of Mt. Shasta Shopping Center expects to refinance the property and thereby repay the Trust's remaining loan balance. There is no assurance, however, that this refinancing can be accomplished. PROPERTY IN RECEIVERSHIP On October 24, 1996, El Portal Shopping Center, located in San Pablo, California was placed in receivership by the Superior Court of the State of California. The receiver is an unrelated entity selected by Nationwide Life Insurance Company, the holder of a non-recourse first mortgage on the property, and the Superior Court. The Trust's decision to withhold further mortgage payment obligations to the holder of the first mortgage was a result of the property's continued negative cash flow resulting from recurring losses and required capital expenditures. At the time of the receivership, El Portal's first mortgage loan balance was $4,438,000. The Trust remains liable for environmental matters, including a toxic spill from a former dry cleaning establishment at El Portal Shopping Center. See discussion in Government Regulation-Environmental Matters. Loss on disposition of $987,000 was recorded in 1996. OTHER DEVELOPMENTS The Trust entered into a purchase and sale agreement in 1993 (the "1993 Agreement") and three additional purchase and sale agreements in 1994 (the "1994 Agreements") to purchase a total of four shopping centers. In 1994 the Trust assigned its interest in the 1993 Agreement and the 1994 Agreements to another real estate investment trust for the sum of $2,361,000, adjusted for certain closing costs and prorations. The Trust also guaranteed the payment of certain rentals at the properties to the buyer for a 24-month period. During 1994, the Trust recorded a gain of $994,000 net of a rent guarantee reserve accrual of $390,000, as the result the above transaction. In 1995, the Trust increased the reserve by an additional $213,000, In connection with the above transactions, on June 7, 1994, (i) Scotts Valley Plaza, a California limited partnership ("Scott"), granted to the Trust a one-year option to acquire the shopping center commonly known as Scotts Village Plaza and (ii) Scotts Village Phase II, a California limited partnership ("Scotts II"), granted a one-year option to the Trust to purchase Scotts Valley Square, both of which are located in Scotts Valley, California. Concurrently with the grant of these options and in connection with the transactions contemplated by that certain Assignment and Agreement dated May 9 1994 and amended May 25, 1994, executed by and between Pacific Real Estate Investment Trust and Western Investment Real Estate Trust, the Trust made a loan to Malcolm R. Riley, one of the principals in Scotts and Scotts II, in the amount of $750,000. The loan bears interest at 9% per annum, payable monthly, and the principal is due and payable in 6 years. Simultaneously, the Trust made a loan to Russell R. Pratt, in the amount of $500,000. That loan bears interest at 8% per annum, payable monthly, and the principal is due and payable in 6 years. Each of these loans is secured by the borrower's respective partnership interests in Scotts and Scotts II. The Trust also made a loan in the amount of $75,000 to Scotts, which bears interest at 8.6% per annum (payable monthly), is due in 6 years and is secured by a second deed of trust on Scotts Village Plaza. Payment on these notes are current. 13 ITEM 3. LEGAL PROCEEDINGS Between 1994 through 1996 El Portal suffered a complete reversal arising from the loss or closure of all of its anchor tenants. The resultant cash drain from the property prompted the Trust to suspend making any further mortgage payments to the Trust Deed Non-Recourse Note Holder, Nationwide Life Insurance Company. The unpaid balance of the mortgage loan was $4,438,000 at December 31, 1996. The lender accordingly sought to place the property in receivership as a prerequisite to obtaining fee title to the property. This step was also prompted by the discovery in 1995 of a toxic spill emanating from a former dry cleaner tenant, which probably occurred prior to the Trust's acquisition of the property. The property was officially confirmed into permanent receivership in January 1997. The Trust expects that there is no residual equity for the Trust in the El Portal Shopping Center and during 1996, wrote down the carrying value by $987,000 (see Note 10). The Trust is not presently involved in any other material litigation nor, to its knowledge, is any material litigation threatened against the Trust or its properties, other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by the Trust's liability insurance and all of which collectively is not expected to have a material adverse effect on the business or financial condition of the Trust. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 1996. 14 PART II ITEM 5. MARKET FOR REGISTRANT'S TRUST SHARES AND RELATED SHAREHOLDER MATTERS MARKET VALUE OF TRUST SHARES There is no established public trading market for Trust Shares. Historically, the Trust maintained consecutive offerings of new Trust Shares to existing shareholders and to the investing public at prices representing the then current estimated market value for the Trust Shares. The Trust's policy has been to review the prices at which Trust Shares were offered at least annually, and at such other times as the Trustees believed the estimated value of the Trust's assets had changed to a degree sufficient to alter the prices of Trust Shares. In the past, Trust Shares have been offered solely to California residents pursuant to an exemption from the registration requirements of the federal securities laws, and have been qualified with the State of California for issuance pursuant to offering circulars prepared by the Trust. The Trust's most recent offering circular expired on December 15, 1992, and no new Trust Shares have been sold since such date. The Trust also historically maintained a dividend reinvestment program through which existing shareholders were able to purchase Trust Shares at a discount from the then current offering price in lieu of receiving dividends in cash. The dividend reinvestment program has been suspended since the expiration of the Trust's last offering circular in December 1992. From time to time, to provide existing shareholders with a means of trading Trust Shares, Pacific Real Estate Securities Co., Inc. ("Presco") has acted as a crossing agent on behalf of the Trust so that persons interested in acquiring Trust Shares could purchase Trust Shares from persons interested in selling Trust Shares. Because there is no current offering circular in place, Presco is not presently effecting crossing transfers of Trust Shares, ceased operation as a broker/dealer in November 1995, and has subsequently been wound up. Shareholders wishing to liquidate their interests in the Trust must locate buyers for their Trust Shares independently. As of December 31, 1996, the Trust had been notified of 145,000 Trust Shares available for sale by existing shareholders. There may be many more shareholders who also wish to sell their shares, but lacking a market mechanism, have not formally notified the Trust of their intentions. At this time, the Trust cannot predict when or at what price these Trust Shares will be liquidated. As of December 31, 1996, there were 3,706,845 Trust Shares issued and outstanding which were held of record by approximately 3,500 shareholders. 15 DISTRIBUTION POLICY Historically, the Trust's policy has been to pay dividends to its shareholders in an amount approximating 100% of its cash flows from operations (i.e., net operating income plus depreciation and amortization). From its inception in 1963, the Trust made 155 consecutive bi-monthly or quarterly regular distributions. With respect to distributions paid in 1991, 1992 and the first quarter of 1993, 100% of the amount paid was sheltered from current taxable liability as a result of book depreciation expense. On February 25, 1993, the payment of dividends was suspended in order to conserve the Trust's cash flow, to provide for its capital improvements program, to maintain the quality of the Trust's properties and to protect the Trust's credit, since the Trustees concluded that the Trust could no longer rely on its traditional sources of liquidity (i.e., secured bank financing and "intrastate" equity offerings). Dividends have remained suspended through December 31, 1996. The Trust is applying the funds that would otherwise have been distributed to its shareholders (i) to fund capital expenditures necessary to maintain its properties, (ii) to make requisite principal payments on its mortgage indebtedness and (iii) to facilitate tenant improvements required upon developing and reletting of the Trust's properties. Because the Trust did not have taxable income for 1996, the suspension of dividends is not expected to affect the Trust's qualification as a REIT. 16 ITEM 6. SELECTED FINANCIAL DATA The following represents selected financial data for the Trust for the five years ended December 31, 1996. Acquisitions and dispositions which occurred during the periods presented below materially affect the comparability of the data. The data should be read in conjunction with the consolidated financial statements included elsewhere herein.
FOR THE YEAR ENDED DECEMBER 31: 1996 1995 1994 1993 1992 - ------------------------------- ------------ ------------ ------------ ------------ ------------ Operating Data: Rental revenues . . . . . . . . . . . $ 5,780,000 $ 9,183,000 $ 12,417,000 $ 9,725,000 $ 8,683,000 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Operating income (loss) . . . . . . . $ 216,000 $ 2,031,000 $ (3,870,000) $ 2,730,000 $ 2,919,000 Property acquisition expenses, prepayment penalty, reincorporation expenses and expenses of prospective offering. . . (230,000) (214,000) (1,430,000) (1,833,000) (80,000) Interest income/(expense)--net (2,759,000) (4,727,000) (7,197,000) (4,588,000) (3,450,000) Gain (loss) on lease termination (240,000) 3,577,000 Gain (loss) on options. . . . . . . . (213,000) 994,000 ------------ ------------ ------------ ------------ ------------ Loss before minority interest in joint venture . . . . . . (3,013,000) (3,123,000) (7,926,000) (3,691,000) (611,000) Less minority interest in joint venture's operations. . . . . . . . . (414,000) (325,000) (328,000) (238,000) (255,000) ------------ ------------ ------------ ------------ ------------ Net loss. . . . . . . . . . . . . . . $ (3,427,000) $ (3,448,000) $ (8,254,000) $ (3,929,000) $ (866,000) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Net loss per share of beneficial interest . . . . . . . . . $ (0.92) $ (0.93) $ (2.23) $ (1.06) $ (0.23) Cash dividends per share of beneficial interest . . . . . . . . . $ 0.00 $ 0.00 $ 0.00 $ 0.21 $ 0.62 AS OF DECEMBER 31: Balance Sheet Data: Total assets. . . . . . . . . . . . . $ 46,183,000 $ 62,875,000 $ 95,287,000 $112,697,000 $110,269,000 Mortgages and other loans payable . . $ 33,400,000 $ 48,008,000 $ 75,770,000 $ 84,887,000 $ 78,643,000 Weighted average number of shares outstanding. . . . . . . . . . 3,706,845 3,706,845 3,706,845 3,707,072 3,706,308
17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with "Selected Financial Data" and the Consolidated Financial Statements and the Notes thereto appearing elsewhere herein. RESULTS OF OPERATIONS COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995 During 1996 the Trust continued its efforts to recapitalize through a variety of ways, including joint venture or merger with a compatible real estate partner. This process has been hindered by the problems at El Portal Shopping Center and the until recently unresolved HomeBase vacancy at Monterey Plaza, as well as the toxic pollution at King's Court Shopping Center. In order to meet its debt obligations and reduce its debt expense, the Trust sold its Lakeshore Plaza Shopping Center in March 1995, Menlo Center in February 1996 and is considering further sale of assets in 1997 in order to achieve these goals. Net loss for the year ended December 31, 1996 was $3,427,000 as compared to a net loss of $3,448,000 for the year ended December 31, 1995, a decrease in the loss of $21,000. Rental revenues decreased from $9,183,000 to $5,780,000, a decrease of $3,403,000, or 37%, as a result of the sale of both Lakeshore Plaza Shopping Center in 1995 and Menlo Center in 1996, and the declining revenues at El Portal Shopping Center as a result of the HomeBase lease termination in 1994 and closures of Safeway Stores, Long's Drug store and Bank of America. Operating expenses decreased from $2,145,000 in 1995 to $1,619,000 in 1996, a decrease of $526,000, or 25% due to a decrease in expenses at Lakeshore Plaza Shopping Center in 1995 and Menlo Center in 1996, resulting from the sale of the both centers, which was partial offset by an increase in the Wanless ground lease expense. Property taxes decreased from $1,194,000 in 1995 to $483,000 in 1996, a decrease of $711,000, or 60% Property management fees decreased from $318,000 in 1995 to $197,000 in 1996, a decrease of $121,000, or 38%. Depreciation and amortization decreased from $2,886,000 in 1995 to $2,062,000 in 1996, a decrease of $824,000 or 29%. Each of these decreases resulted from the sale of Lakeshore Plaza Shopping Center in 1995 and Menlo Center in 1996. General and administrative expenses decreased from $609,000 in 1995 to $520,000 in 1996, a decrease of $89,000 or 15% due to cost saving measures. Loss on impairment of value was recognized $1,455,000 in 1996 due to the reduction in carry value of El Portal Shopping Center by $987,000 and the write down of the Trust's interest in the Westwood Village note of $468,000. Gain on the sale of property of $772,000 represents the gain on the sale of Menlo Center which was sold on February 29, 1996. Interest income increased by $8,000, or 1%, from $637,000 to $645,000, as a result of the interest earned on restricted funds. Interest expense decreased by $1,960,000, or 37%, from $5,364,000 to $3,404,000, due to the sale of both Lakeshore Plaza Shopping Center in 1995 and Menlo Center in 1996 and the assumption of related mortgage debt by the buyers as well as the pay-down of short-term debt from the net proceeds of the sales. In connection with the potential merger or joint venture activities, the Trust incurred expenses of $230,000 in 1996 compared to $214,000 in 1995. 18 Lease termination in 1996 is due to a lease termination in regards to parcel land at the Westwood Village Shopping Center located Redding, California (see Note 14 to the consolidated financial statements). The aggregate lease-up rate for two of the Trust's three properties (excluding El Portal) was approximately 94% at December 31, 1996 and 97% at December 31, 1995. At Monterey Plaza, the lease-up rate was 95%, while actual occupancy rate was 39% because the WalMart store was under construction until January 29, 1997. At King's Court the lease up rate and occupancy rate at December 31, 1996 was 93%. At a third property (Wanlass) the lease-up rate and occupancy rate was 28%. This property is proposed for redevelopment. The aggregate occupancy rate for the Trust's overall shopping center portfolio (excluding El Portal) at December 31, 1996 was 53%. COMPARISON OF YEAR ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994 During 1995 the Trust continued its efforts to recapitalize through a variety of ways, including joint venture or merger with a compatible real estate partner. The chief impediment was rising yield expectations of potential institutional investor partners. In addition, the process has been hindered by the problems at El Portal Shopping Center and the unresolved HomeBase vacancy at Monterey Plaza, as well as the toxic pollution at King's Court Shopping Center. In order to meet its debt obligations and improve its earnings from operations, the Trust sold its Lakeshore Plaza Shopping Center in March 1995 and Menlo Center in February 1996. In the course of generating proposals that culminated in the sale of Lakeshore Plaza, the Trust's property portfolio was formally exposed to the investment market. This exposure elicited several offers which were predicated on estimates of value for all the Trust's properties with the exception of the El Portal Shopping Center. El Portal was not a candidate for sale in this manner because of the losses in its tenant structure and its redevelopment needs. As a result of these estimates of value generated in competitive formal bids and subsequent informal negotiations, the Trustees were able to assess the probable current market value of most of its property portfolio. This had not previously been possible due to the dearth of comparable property transactions in the Bay Area since the decline of the real estate markets during the recent recession. El Portal's value was estimated separately. The estimated current market value information gathered in the process described above led the Trustees to the decision to adjust the Trust's book values to more closely reflect these current market values. The aggregate of these write-downs at December 31, 1994 was $8,000,000. The details of the amount of each adjustment are contained in the notes to the Trust's consolidated financial statements. Net loss for the year ended December 31, 1995 was $3,448,000 as compared to a net loss of $8,254,000 for the year ended December 31, 1994, a decrease in the loss of $4,806,000. This decrease was caused by a decrease in interest expense of $3,137,000 and a loss on impairment of property value of $8,000,000 offset by the early termination of a lease which resulted in a net gain of $3,578,000 after giving effect to writing off the remaining book value of the building and associated tenant improvements leased by the former tenant, the sale of options on four shopping center properties which resulted in a net gain of $994,000, a one time loan commitment fee expensed in 1993 which did not recur in 1994 and $1,400,000 increase in operating income. Rental revenues decreased from $12,417,000 to $9,183,000, a decrease of $3,234,000, or 26%, primarily as a result of the sale of Lakeshore Plaza Shopping Center and declining revenues at El Portal Shopping Center as a result of the HomeBase lease termination in 1994. Operating expenses decreased from $2,162,000 in 1994 to $2,145,000 in 1995, a decrease of $17,000, or 1% due to additional expense of El Portal ground lease and offset by a decrease in Lakeshore Plaza expense due to the sale of the center. Property taxes increased from $953,000 in 1994 to $1,194,000 in 1995, an increase of $241,000, or 25%. due to supplemental bills at Monterey Plaza Shopping Center. Property management fees decreased from $456,000 in 1994 to $318,000 in 1995, a decrease of $138,000, or 30%. Depreciation and amortization decreased from $3,862,000 in 1994 to $2,886,000 in 1995, a decrease of $976,000 or 25%. Each of these decreases resulted from the sale Lakeshore Plaza Shopping Center. 19 General and administrative expenses decreased from $854,000 in 1994 to $609,000 in 1995, a decrease of $245,000 due to cost saving measures. Interest income decreased by $396,000, or 38% from $1,033,000 to $637,000, as a result of the early repayment of two mortgage notes receivable during 1994. Interest expense decreased by $2,866,000, or 35%, from $8,230,000 to $5,364,000, due to a pay-down on the El Portal mortgage, the assumption of related mortgage from the sale of Lakeshore Plaza and the pay-down of short- term debt. In connection with a prospective offering of debt or equity securities, potential merger or joint venture activities, the potential acquisition of additional properties, and the proposed reincorporation as a Maryland Corporation, the Trust incurred expenses of $214,000 in 1995 as compared to $1,159,000 in 1994. These expenses were offset in part by a profit of $994,000 in 1994 on the sale of property options acquired during this effort. LIQUIDITY AND CAPITAL RESOURCES Cash flow provided by operating activities was $364,000 in 1996, compared to cash flow used by operating activities of $1,759,000 in 1995 and $3,930,000 provided in 1994. The increase in 1996 was primarily due to reduced expense resulting from property sales. The decrease in 1995 was primarily due to a one-time lease termination fee received in 1994 at one property. Cash flow provided by investing activities was $4,577,000 in 1996, as compared to cash flow provided by investing activities in 1995 of $13,697,000 and $5,513,000 provided in 1994. The reduction in cash flow in 1996 compared to 1995 was primarily due to timing differences in the receipt of rents and payments of trade payables. The decrease in cash flow in 1995 compared to 1994 was due to the early payoff of three mortgage notes payable paid early as a result of refinancing and also due to a mortgage loan pay-down due to the HomeBase lease buy-out at El Portal Shopping Center. Cash flow used by financing activities was $4,238,000 in 1996 as compared to $12,296,000 used in 1995 and $9,633,000 used in 1994. The decrease in 1996 is due to assumption of a smaller amount of mortgage debt and short- term notes payable as the result of the sale of Menlo Center compared to the assumption of a larger value of mortgage debt and short-term notes payable due to the sale of Lakeshore Plaza Shopping Center in 1995. The Trust's financial structure at December 31, 1996 shows debt financing, including short-term and unsecured notes, representing approximately 78% of the book value of the Trust's properties, before depreciation. The increase in leverage from the level of 68% in 1995 is primarily due to the Trust's use of the proceeds from the sale of Menlo Center to pay off the Menlo Center mortgage note and $4,100,000 of short term notes, as well as the exclusion of El Portal Shopping Center due to receivership. The Trust is obligated on a number of short-term secured Notes due in 1997. Menlo Management Company and/or Collier Investments is the general partner of the partnership lenders which hold these short-term mortgage notes. The aggregate balance owed on these Notes is $7,700,000 at December 31, 1996. These notes have the capacity to be increased to a total indebtedness of $8,050,000 and are scheduled to mature on December 31, 1997. The Trust has the intention and ability to obtain extensions on the maturity dates of these notes. Sources of liquidity for the Trust include five mortgage loans receivable, totaling approximately $6,103,000 at December 31, 1996. Two of these loans result from the sale of properties prior to 1991. Payments on these notes are due as follows: $1,104,000 in December 1997 and $4,200,000 in January 1999. The balance of $1,325,000 of these notes matures in 2000. The Trust has engaged in formal negotiations during 1994, 1995 and 1996 regarding restructuring the Trust and the sale of certain Trust properties. For further discussion see Item I Business - Investment Policy. 20 There has been no public market for Trust Shares, nor have there been any known market-makers. From time to time, in order to provide shareholders with a means of trading Trust Shares, Pacific Real Estate Securities Co., Inc. (Presco) has acted as a crossing agent on behalf of the Trust so that persons interested in acquiring Trust Shares could purchase Trust Shares from persons interested in selling Trust Shares. Presco ceased to function in this capacity in 1992 and the company has since been wound up. The price of Trust Shares sold by the Trust and selling shareholders was determined by the Trustees, based on their estimate of the value of the Trust's properties and other assets net of estimated liabilities, with the properties being valued based on estimates of the long-term investment value of each property, rather than on current market value or liquidation value, assuming that the properties were held as long-term assets rather than being sold in mid-term or liquidated in currently depressed market conditions. This valuation approach assumed that the Trust would continue as a "going concern", and did not take into account then current market value or liquidation value and costs of liquidation. All existing shareholders who resided in California were given the opportunity to purchase shares in cross-selling transactions. JOINT VENTURE INTEREST The Trust presently owns a 40% interest in Kingsco, the general partnership which owns King's Court Shopping Center. In addition, the Trust has managing control over King's Court Shopping Center operations, including any leasing, renovation, sale or financing activities. The term of the partnership continues until September 30, 2039. Cash flows and expenses of the partnership are allocated in accordance with the partners' respective percentage interests, with the Trust's allocation being equal to its 40% interest. The shopping center is managed by Menlo Management Company on behalf of the Trust; the Trust does not receive any portion of the management fee paid to Menlo Management Company for such management services. OTHER CAPITAL EXPENDITURES At the present time, there are no material deferred capital maintenance obligations outstanding for two of the Trust's existing shopping centers. However, the Trust expects that several of its buildings at the Wanlass Shopping Center may require significant capital investment in 1997. As a result of the problems arising at El Portal Shopping Center the buildings at El Portal have not been maintained on a current basis throughout all of 1996. In addition, at each of the Trust's properties leasehold improvements and lease commissions are expected to be incurred in connection with leasing activity. No detailed capital budgets have been prepared for these items. ECONOMIC CONDITIONS In the last several years, inflation has not had a significant impact on the Trust because of the relatively low inflation rate. Nonetheless, the majority of the Trust's leases contain provisions designed to mitigate the adverse impact of inflation. Such provisions include clauses enabling the Trust to receive percentage rents which generally increase as prices rise, and/or escalation clauses which are typically related to increases in the Consumer Price Index or similar inflation indices. Most of the Trust's leases require the tenant to pay its share of operating expenses, including common area maintenance, real estate taxes and insurance, thereby reducing the Trust's exposure to increases in costs and operating expenses resulting from inflation. However, the Trust has agreed in certain instances to retain or limit the responsibility for some obligations that would otherwise be the responsibility of the tenant under a triple net lease. The United States generally and the State of California are currently enjoying economic growth. This growth comes on the heels of recent deep economic recession, particularly in the State of California. However many industries in the State of California continue to show the effect of this recent recession. A repeat of these adverse changes in general or local economic conditions could result in the inability of some existing tenants of the Trust to meet their lease obligations and could adversely affect the Trust's ability to attract or retain tenants. In addition to economic conditions there are other major influences that can affect the success of tenants in achieving or maintaining sufficient sales volumes to pay rent. Competitive factors and overall changes in retail merchandising practices can have an equal or even greater impact than economic factors. The loss of an anchor retailer can lead to the diminution of retail sales and the loss of other retailers in the same shopping center. This can seriously affect the viability or value of a shopping center, as is particularly evident at El Portal Shopping Center and, to a lesser extent, at Monterey Plaza Shopping Center. 21 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PACIFIC REAL ESTATE INVESTMENT TRUST TABLE OF CONTENTS Page Independent Auditors' Report 23 Consolidated Financial Statements: Balance Sheets at December 31, 1996 and 1995 24 Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994 25 Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 26 Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 27 Notes to Consolidated Financial Statements 28 Financial Statement Schedules: III -- Commercial Properties and Accumulated Depreciation at December 31, 1996 36 IV -- Mortgage Loans on Real Estate at December 31, 1996 38 Financial statements and supplemental financial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in this report. 22 INDEPENDENT AUDITORS' REPORT The Trustees and Shareholders of Pacific Real Estate Investment Trust: We have audited the accompanying consolidated financial statements of Pacific Real Estate Investment Trust (the "Trust") and its joint venture listed in the foregoing table of contents. Our audits also included the financial statement schedules listed in the foregoing table of contents. These financial statements and financial statement schedules are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Trust and its joint venture at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information shown therein. DELOITTE & TOUCHE LLP San Francisco, California January 24, 1997 (March 25, 1997 as to Note 12) 23 PACIFIC REAL ESTATE INVESTMENT TRUST ------------------- CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 ASSETS
1996 1995 ------------- ------------ Investment in commercial properties: Land.................................................... $ 10,104,000 $ 14,308,000 Buildings and improvements.............................. 28,187,000 56,345,000 Accumulated depreciation................................. (7,271,000) (18,375,000) ------------- ------------ Commercial properties - net............................. 31,020,000 52,278,000 Property in receivership.................................. 4,438,000 Notes receivable (net of allowance of $507,000 in 1996 and $39,000 in 1995).......................................... 6,279,000 6,811,000 Cash...................................................... 1,011,000 308,000 Restricted cash........................................... 1,154,000 100,000 Accounts receivable (net of allowance of $143,000 in 1996 and $146,000 in 1995)..................................... 489,000 891,000 Deferred lease commissions - net.......................... 425,000 742,000 Deferred financing costs - net............................ 329,000 440,000 Other assets.............................................. 1,038,000 1,305,000 ------------- ------------ Total................................................. $ 46,183,000 $ 62,875,000 ------------- ------------ ------------- ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Mortgage loans.......................................... $ 25,700,000 $ 36,818,000 Short-term notes........................................ 7,700,000 11,190,000 Security deposits....................................... 118,000 231,000 Accounts payable and other liabilities.................. 1,968,000 566,000 ------------- ------------ Total liabilities..................................... $ 35,486,000 $ 48,805,000 ------------- ------------ Commitments and contingencies (Note 14)................... Minority interest in joint venture........................ 3,375,000 3,321,000 Shareholders' Equity: Shares of beneficial interest, $10 par value, authorized: 1996 and 1995, 10,611,863; shares issued and outstanding: 1996 and 1995, 3,706,845 37,068,000 37,068,000 Additional paid-in capital................................ 11,009,000 11,009,000 Accumulated deficit....................................... (40,755,000) (37,328,000) ------------- ------------ Shareholders' equity...................................... 7,322,000 10,749,000 ------------- ------------ Total................................................. $ 46,183,000 $ 62,875,000 ------------- ------------ ------------- ------------
See notes to consolidated financial statements. 24 PACIFIC REAL ESTATE INVESTMENT TRUST -------------------- CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 ----------- ----------- ----------- Rental revenues....................................... $ 5,780,000 $ 9,183,000 $12,417,000 ----------- ----------- ----------- Operating expenses (including related party amounts of $478,000, $694,000 and $996,000 in 1996, 1995 and 1994, respectively): Operating............................................ 1,619,000 2,145,000 2,162,000 Property tax......................................... 483,000 1,194,000 953,000 General and administrative........................... 520,000 609,000 854,000 Depreciation and amortization........................ 2,062,000 2,886,000 3,862,000 Property management fees............................. 197,000 318,000 456,000 Loss on impairment of value.......................... 1,455,000 8,000,000 Gain on sale of property............................. (772,000) ----------- ----------- ----------- Total operating expenses........................... 5,564,000 7,152,000 16,287,000 ----------- ----------- ----------- Operating income (loss)............................... 216,000 2,031,000 (3,870,000) ----------- ----------- ----------- Other income/(expense): Interest income...................................... 645,000 637,000 1,033,000 Interest expense..................................... (3,404,000) (5,364,000) (8,230,000) Gain (loss) on sale of options....................... (213,000) 994,000 Reincorporation/merger expenses...................... (230,000) (139,000) (355,000) Property acquisition expenses........................ (75,000) (503,000) Expenses of prospective offering..................... (301,000) Prepayment penalty................................... (271,000) Gain (loss) on lease termination..................... (240,000) 3,577,000 ----------- ----------- ----------- Total other expense--net........................... (3,229,000) (5,154,000) (4,056,000) ----------- ----------- ----------- Net loss before minority interest..................... (3,013,000) (3,123,000) (7,926,000) Minority interest in joint venture.................... (414,000) (325,000) (328,000) ----------- ----------- ----------- Net loss.............................................. $(3,427,000) $(3,448,000) $(8,254,000) ----------- ----------- ----------- ----------- ----------- ----------- Net loss per share of beneficial interest............. $ (0.92) $ (0.93) $ (2.23) ----------- ----------- ----------- ----------- ----------- -----------
See notes to consolidated financial statements. 25 PACIFIC REAL ESTATE INVESTMENT TRUST -------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
BENEFICIAL INTEREST ------------------------------ ADDITIONAL ACCUMULATED SHARES AMOUNT PAID-IN CAPITAL DEFICIT ------------------------------ ----------------- --------------- Balance January 1, 1994............. 3,707,072 $37,071,000 $11,010,000 $(25,626,000) Repurchase of shares................ (227) (3,000) (1,000) Net Loss............................ (8,254,000) ------------ --------------- ----------------- --------------- Balance December 31, 1994........... 3,706,845 37,068,000 11,009,000 (33,880,000) Net Loss............................ (3,448,000) ------------ --------------- ----------------- --------------- Balance December 31, 1995........... 3,706,845 37,068,000 11,009,000 (37,328,000) Net Loss............................ (3,427,000) ------------ --------------- ----------------- --------------- Balance December 31, 1996........... 3,706,845 $37,068,000 $11,009,000 $(40,755,000) ------------ --------------- ----------------- --------------- ------------ --------------- ----------------- ---------------
See notes to consolidated financial statements. 26 PACIFIC REAL ESTATE INVESTMENT TRUST ------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 ------------- ------------- -------------- Cash Flow from Operating Activities: Net loss............................................. $ (3,427,000) $ (3,448,000) $ (8,254,000) Adjustments to reconcile net loss to net cash provided (used) by operating activities: Depreciation......................................... 1,716,000 2,496,000 3,290,000 Amortization of note receivable discount............. (15,000) (64,000) (34,000) Amortization of deferred cost........................ 343,000 359,000 570,000 Minority interest in joint venture's operations...... 414,000 325,000 328,000 Provision for doubtful receivables................... 77,000 103,000 161,000 Loss (gain) on sale of options....................... 213,000 (994,000) Gain on sale of property............................. (772,000) Loss (gain) on lease termination..................... 240,000 (3,578,000) Proceeds from lease termination...................... 6,000,000 Loss on impairment value............................. 1,455,000 8,000,000 Changes in operating assets and liabilities: Accounts payable and other liabilities............. 117,000 (1,107,000) (501,000) Security deposits.................................. 10,000 (60,000) (38,000) Deferred lease commissions......................... (105,000) (97,000) (217,000) Deferred financing costs........................... (25,000) Accounts receivable................................ 293,000 (238,000) (417,000) Other assets....................................... 43,000 (241,000) (386,000) ------------- ------------- -------------- Net cash provided (used) by operating activities...... 364,000 (1,759,000) 3,930,000 ------------- ------------- -------------- Cash Flow from Investing Activities: Increase in restricted cash.......................... (100,000) Construction of properties........................... (347,000) (107,000) (1,491,000) Collection of notes receivable....................... 88,000 78,000 6,030,000 Additions of notes receivable........................ (9,000) (4,000) (1,327,000) Proceeds from sale of Lakeshore...................... 14,043,000 Proceeds from sale of Menlo Center................... 4,845,000 Proceeds (costs) from sale of options................ (213,000) 2,301,000 ------------- ------------- -------------- Net cash provided in investing activities............. 4,577,000 13,697,000 5,513,000 ------------- ------------- -------------- Cash Flow from Financing Activities: Costs of sale of Trust Shares........................ (4,000) Proceeds from short-term notes....................... 910,000 800,000 3,905,000 Proceeds from mortgage loans......................... 1,500,000 Re-payment of mortgage loans......................... (388,000) (4,691,000) (9,712,000) Re-payment of short-term notes....................... (4,400,000) (5,045,000) (4,810,000) Re-payment of unsecured note payable................. (3,000,000) Payment of financing costs........................... (152,000) Distributions to joint venture partner............... (360,000) (360,000) (360,000) ------------- ------------- -------------- Net cash used by financing activities................. (4,238,000) (12,296,000) (9,633,000) ------------- ------------- -------------- Increase (decrease) in cash........................... 703,000 (358,000) (190,000) Cash, January 1...................................... 308,000 666,000 856,000 ------------- ------------- -------------- Cash, December 31.................................... $ 1,011,000 $ 308,000 $ 666,000 ------------- ------------- -------------- ------------- ------------- --------------
NON CASH INVESTING AND FINANCING: Assumption of mortgage note payable by buyers of Lakeshore Plaza Shopping Center for $15,826,000 in 1995 and Menlo Center for $10,730,000 in 1996. Establishment of an impound account for approximately $1,000,000 for a Monterey Plaza Shopping Center tenant during 1996, which was funded by another tenant. (see Note 1). See notes to consolidated financial statements. 27 PACIFIC REAL ESTATE INVESTMENT TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES. ORGANIZATION Pacific Real Estate Investment Trust (the "Trust") is a trust organized under the laws of the State of California. The Trust is an investment vehicle whose purpose is to acquire, hold for investment, and ultimately sell, interests in neighborhood and community shopping centers and commercial property in selected Northern California metropolitan areas. The Trust has qualified and intends to continue to qualify as a real estate investment trust under provisions of the Internal Revenue Code. CONSOLIDATION The consolidated financial statements include the Trust and a joint venture ("Kingsco") in which the Trust has a 40% controlling interest. The joint venture is consolidated in the accompany financial statements as the Trust has control over the joint venture's operations, including all leasing, renovation, sale or refinancing activities. All significant intercompany transactions and balances have been eliminated. RECENT ACCOUNTING PRONOUNCEMENT During 1996, the Trust implemented Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long Lived-Assets to Be Disposed Of." This new standard was used to determine the 1996 loss on impairment of value as described in Note 10. ACCOUNTING 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. PROPERTIES Properties are stated at the lower of depreciated cost or estimated realizable value from the operation and ultimate sale of such properties. Acquisition fees and interest incurred during construction periods are capitalized. Property and improvements acquired by the Trust in connection with its acquisition of a controlling interest in a joint venture are stated at amounts agreed upon among the partners at the date of acquisition which approximated market value at such date. Depreciation is computed by the straight-line method over estimated useful lives ranging from three to forty years. Properties and the related accumulated depreciation are removed from the accounts at the time of sale. The related gain or loss is included in the statement of operations. The determination of estimated realizable value involves subjective judgement because the actual market value of real estate can be determined only by negotiation between the parties in a sales transaction. RESTRICTED CASH Restricted cash primarily consists of amounts held in an impound account for a Monterey Plaza tenant as a result of the tenant agreeing to waive its exclusive rights to sell certain products in the Plaza. The entire balance of this impound account is payable to such tenant, the timing of which is specified in its amended lease. The impound account was funded by another tenant at the Plaza and the funds were placed in the impound account under the control of the Trust and Prudential Insurance Company of American, the Lender on the First Deed of Trust. 28 DEFERRED LEASE COMMISSIONS Deferred lease commissions are amortized on a straight-line basis over the lives of the related leases, which range from two to forty years. DEFERRED FINANCING COSTS Deferred financing costs represent loan fees and points paid to obtain certain mortgage financing. These amounts are amortized on a straight-line basis over the lives of the related loans which range from six to ten years. OTHER ASSETS Other assets are primarily composed of expected reimbursements related to the clean up at Kings Courts Shopping Center (see Note 14) and rental revenues in excess of amounts currently billed. Certain lease agreements contain provisions for fixed rent increases for future periods and for periods of rent abatement during the earliest portion of such leases. Rental revenue from such leases is recognized on a straight-line basis over the lives of the related leases. PROPERTY ACQUISITION EXPENSE Property acquisition expense represents costs associated with investigating properties which were not subsequently acquired. INCOME TAXES The Internal Revenue Code provides that a trust qualifies as a real estate investment trust if, among other things, the trust distributes each year at least 95% of its taxable income to shareholders. If the Trust distributes at least 95% of its taxable income to shareholders, such distributions can be treated as deductions by the Trust for income tax purposes. Because it is the policy of the Trust to distribute amounts approximately equal to its taxable income plus depreciation and amortization, no provision for income taxes has been made in the accompanying financial statements. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of receivables and short-term notes payable are reasonable estimates of fair value due to the short period of time until their expected maturity. The carrying amount of mortgage loans is a reasonable estimate of fair value based on the borrowing rates currently available to the Trust for loans with similar terms and average maturities. NET LOSS PER SHARE OF BENEFICIAL INTEREST Net loss per share of beneficial interest, is computed by dividing net loss by the weighted average number of shares outstanding of 3,706,845 in 1996, 1995 and 1994. RECLASSIFICATIONS Certain 1995 and 1994 amounts have been reclassified to conform with the 1996 presentation. 2. INVESTMENT ADVISOR, PROPERTY MANAGEMENT AND SHAREHOLDER-SUPPORT SERVICES AGREEMENTS The Trust has entered into certain transactions with Collier Investment (the "Advisor"), which is both the investment advisor to the Trust and its real estate broker. Menlo Management Company, which manages the Trust's properties, and is formerly affiliated with the Advisor. Robert C. Gould, an officer and director of the Trust, is the owner of Menlo Management Company. California Bavarian Company, a privately held California corporation, provides shareholder communication and liaison support services to the Trust on a contractual basis 29 for a monthly service fee. California Bavarian Company is not related to the Trust. However its director, Mark D. Mordell, is an agent of the Trust. The amended investment advisory agreement provides that, commencing January 1, 1994, the Trust pays to the Advisor, an annual base advisory fee equal to 0.2% of the average gross invested assets of the Trust (as defined in the advisory agreement). The Advisor also may receive real estate brokerage commissions at negotiated rates in connection with the purchase, sale or refinancing of the Trust's properties. In July 1994 the Advisor offered to reduce the annual base advisory fee by 50% retroactive to January 1, 1994. The Investment Advisor also voluntarily waived real estate brokerage commissions in connection with both the sale of Lakeshore Plaza Shopping Center, which was sold on March 13, 1995, and the sale of Menlo Center, which was sold on February 29, 1996. The investment advisory agreement also provides for a yearly incentive compensation payment to the Advisor equal to the sum of: (1) 10% of net realized capital gains, excluding any depreciation, less accumulated realized capital losses, if any; plus (2) 7.5% of the amount, if any, by which net income, before depreciation but excluding capital gains, exceeded a minimum base yield of 8.6% per annum on average net worth (as defined in the agreement) during the preceding calendar year. Net income for this purpose is after deduction of the regular fee, whether or not such fees were paid. No incentive compensation fees were paid to the Advisor in 1996, 1995 or 1994. The Trust has a property management agreement with Menlo Management Company to manage the Trust's properties for a percentage of gross rentals ranging from 4% to 5% for each property. In addition, for each property, Menlo Management Company receives leasing commissions based on a percentage of the total lease rental revenues, with certain minimum commission charges. Menlo Management Company is the lessee of office space in one of the Trust's properties which was sold in 1996. The Trustees believe that the terms of the lease and property management agreements are comparable to terms the Trust would obtain from non-related parties. Menlo Management Company receives fees for administrative services provided to the Trust and development, planning and negotiating services in connection with development work at the Trust's properties. Pacific Real Estate Securities Company Inc.("Presco") is a former supplier of capital fund raising and shareholder services to the Trust. This company was a subsidiary of Menlo Management Company. It was dissolved in 1995. Fees paid or payable to the Advisor, Menlo Management Company and Presco in 1996, 1995 and 1994 were as follows: 1996 1995 1994 ---------- ---------- ----------- ADVISOR Advisory fee........................ $ 50,000 $ 68,000 $ 112,000 MENLO MANAGEMENT COMPANY Property management fees............ 197,000 313,000 456,000 Administrative services............. 150,000 199,000 260,000 Loan fees........................... 81,000 114,000 132,000 Lease commissions................... 82,000 68,000 126,000 Real estate brokerage commissions... 145,000 PRESCO Administrative services............. 36,000 ---------- ---------- ----------- Total............................ $ 560,000 $ 762,000 $ 1,267,000 ---------- ---------- ----------- ---------- ---------- ----------- Real estate brokerage commissions have been capitalized and lease commissions have been deferred. 30 3. NOTES RECEIVABLE. Notes receivable consist of the following at December 31, 1996 and December 31, 1995: 1996 1995 ---------- ---------- Mortgage notes. . . . . . . . . . . . . . . $6,571,000 $6,565,000 Unsecured loans (principally to tenants). . 215,000 285,000 Allowance for doubtful accounts . . . . . . (507,000) (39,000) ---------- ---------- Total . . . . . . . . . . . . . . . . . . $6,279,000 $6,811,000 ---------- ---------- ---------- ---------- The mortgage notes outstanding at December 31, 1996 result from sale of two shopping center properties located in Northern California which bear interest from 9% to 9.25% and from other loans (see Note 11). At the time of sale, the two shopping center notes were discounted to yield market interest rates ranging from 9.5% to 13%. The discounts are recognized as interest income over the life of the note. The mortgage notes receivable have been pledged as security for various short-term notes payable (see Note 4). Notes receivable are due as follows: 1997 . . . . . . . . . . . . . $1,133,000 1998 . . . . . . . . . . . . . 21,000 1999 . . . . . . . . . . . . . 4,216,000 2000 . . . . . . . . . . . . . 1,330,000 2001 . . . . . . . . . . . . . 1,000 Thereafter . . . . . . . . . . 143,000 Less discounts . . . . . . . . (58,000) Less allowance for bad debt. . (507,000) ---------- Total . . . . . . . . . . $6,279,000 ---------- ---------- The debtor of a note scheduled to mature in December 1996 requested an extension to December 1997 and the Trust granted this extension. During 1996, the Trust wrote down this note by $468,000 due to a decline in the value of the underlying collateral and management's estimate of the notes realizable value (see Note 10). 4. SHORT-TERM NOTES. At December 31, 1996, notes outstanding are $7,700,000, with interest rates ranging from 9.50% to 10.20%. The notes have the capacity to be increased to a total indebtedness of $8,050,000 and are secured by mortgage notes receivable from property sales (see Note 3), additional deeds of trust on existing properties and the Trust's interest in a joint venture. All of these notes at December 31, 1996 are held by private limited partnerships, independent of the Trust, in which Menlo Management Company and/or Collier Investments has a general partnership interest. Interest of $790,000, $1,163,000 and $1,442,000 was paid on these notes in 1996, 1995 and 1994, respectively. The notes are scheduled to mature in December 1997. The Trust has the intention and ability to obtain extensions on the maturity dates on these notes. 5. MORTGAGE LOANS. Operating properties are pledged as collateral for mortgage loans which have interest rates varying from 9.375% to 10.25% at December 31, 1996. The loans are payable monthly over periods through July 2000. In connection with the sale of one property in 1990, the Trust remains the primary obligor on the underlying non-recourse note payable, totaling $1,542,000, which is secured by a first deed of trust on the property sold. The all-inclusive promissory note receivable from the buyer was received by the Trust at the date of sale. Mortgage loans mature in future years as follows: 1997. . . . . . . . . . . . . . . . . . $ 4,743,000 1998. . . . . . . . . . . . . . . . . . 332,000 1999. . . . . . . . . . . . . . . . . . 2,782,000 2000. . . . . . . . . . . . . . . . . . 17,843,000 ----------- Total. . . . . . . . . . . . . . . $25,700,000 ----------- ----------- 31 The 1997 maturities shown above include $4,438,000 due on the property in receivership (see Note 7). Total interest costs in 1996, 1995 and 1994 were $3,404,000, $5,364,000 and $8,230,000. Interest paid was $3,404,000, $5,364,000 and $8,501,000, respectively. 6. COMMERCIAL PROPERTY OPERATING LEASES. Space in the Trust's operating properties is leased to tenants under long-term non-cancelable operating leases. The lease agreements provide for fixed minimum rentals and generally include provisions for reimbursement of a portion of common area maintenance expenses, property taxes, insurance, and percentage rents. Minimum rentals under these leases at December 31, 1996 are as follows (excluding the property in receivership): 1997 . . . . . . . . . . . . . . $ 3,475,000 1998 . . . . . . . . . . . . . . 3,193,000 1999 . . . . . . . . . . . . . . 2,986,000 2000 . . . . . . . . . . . . . . 2,891,000 2001 . . . . . . . . . . . . . . 2,644,000 Thereafter . . . . . . . . . . . 14,117,000 ----------- Total. . . . . . . . . . . . $29,306,000 ----------- ----------- Rental revenues in 1996, 1995 and 1994 included $201,000, $153,000 and $196,000 of contingent rentals based on individual tenants' sales volumes. For the years ending December 31, 1996, 1995 and 1994 rental revenues representing 31% in 1996, 14% in 1995 and 17% in 1994, of total revenues were earned from a single tenant at one of the Trust's properties in 1996 and 1995 and at two of the Trust's properties in 1994. 7. EL PORTAL SHOPPING CENTER. In December 1994, HomeBase, an anchor tenant at El Portal Shopping Center reached an agreement with the Trust whereby in exchange for a lease termination the Trust accepted a $6,000,000 lease buy-out payment. Under the terms of the mortgage loan secured by the property, $5,729,000 of this lease buy-out was applied towards the principal reduction and $271,000 was applied as a prepayment penalty. In connection with this transaction, the Trust determined that the HomeBase facility became functionally obsolete, therefore the remaining book value of $2,040,000 and associated deferred costs of $383,000 were charged against the lease termination payment resulting in a net gain of $3,577,000. Between 1994 through 1996 El Portal suffered a complete reversal arising from the loss or closure of all of its anchor tenants. The resultant cash drain from the property prompted the Trust to suspend making any further mortgage payments to the Trust Deed Non-Recourse Note Holder, Nationwide Life Insurance Company. The unpaid balance of the mortgage loan was $4,438,000 at December 31, 1996. The lender accordingly sought to place the property in receivership as a prerequisite to obtaining fee title to the property. This step was also prompted by the discovery in 1995 of a toxic spill emanating from a former dry cleaner tenant, which probably occurred prior to the Trust's acquisition of the property. The property was officially confirmed into permanent receivership in January 1997. The Trust expects that there is no residual equity for the Trust in the El Portal Shopping Center and, during 1996, wrote down the carrying value by $987,000 (see Note 10). 32 8. SALE OF LAKESHORE PLAZA. The Trust sold the Lakeshore Plaza Shopping Center on March 13, 1995 for a sales price of $31,292,000. The proceeds of this sale after provision for assumption of the existing First Deed of Trust financing ($15,826,000 at March 13, 1995), repayment of second mortgage ($4,000,000), closing costs, escrow holdbacks for supplemental property taxes, vacant spaces and pending tenant improvement allowances, legal fees, transfer taxes and miscellaneous selling expenses, were all used to pay down other short-term notes ($5,045,000) and an unsecured note payable including interest payable ($3,467,000). The loss on sale was recognized in 1994 (see Note 10). 9. SALE OF MENLO CENTER. The Trust sold Menlo Center on February 29, 1996. The sales price was $16,200,000. The buyer assumed the existing financing in the amount of $10,730,000. After payment of closing costs, transfer taxes, real estate commissions and miscellaneous selling expenses, all totalling approximately $445,000, the net proceeds of approximately $4,845,000 were used to repay short-term debt and to provide working capital. Under the terms of the sale contract, the Trust is obligated to subsidize the buyer's net operating income to the extent necessary to assure the buyer of an 8.5% investment yield from the operation of Menlo Center. The liability for this subsidy amounted to $37,000 in 1996. No liability is currently expected for 1997 and thereafter. The Trust's liability in this respect extends to the maturity date of the existing First Trust Deed financing which the buyer assumed in the purchase. This financing expires in 2000. 10. LOSS ON IMPAIRMENT OF VALUE. In 1994, the Trustees decided to reduce the carrying value of two of the Trust's properties to reflect their estimated current market value more accurately. Accordingly, Menlo Center's carrying value was reduced by $3,600,000 to $15,000,000 after depreciation. Lakeshore Plaza Shopping Center's carrying value was reduced by $3,500,000 and an additional $900,000 related to deferred lease commissions and financing costs. In 1996, loss on impairment of value is comprised of the following components. First, El Portal Shopping Center's carrying value was reduced by $987,000 to $4,438,000 after depreciation (see Note 7). Second, the Trust's interest in the Westwood Village Note was written down by $468,000 to $600,000 (see Note 3). 11. PROPERTY PURCHASE OPTIONS. The Trust entered into a purchase and sale agreement in 1993 (the "1993 Agreement") and three additional purchase and sale agreements in 1994 (the "1994 Agreements") to purchase a total of four shopping centers. In 1994 the Trust assigned its interest in the 1993 Agreement and the 1994 Agreements to another real estate investment trust for the sum of $2,361,000, adjusted for certain closing costs and prorations. The Trust also guaranteed the payment of certain rentals at the properties to the buyer for a 24-month period. During 1994, the Trust recorded a gain of $994,000 net of a rent guarantee reserve accrual of $390,000, as the result the above transaction. In 1995, the Trust increased the reserve by an additional $213,000. In connection with the above transactions, on June 7, 1994, (i) Scotts Valley Plaza, a California limited partnership ("Scott"), granted to the Trust a one-year option to acquire the shopping center commonly known as Scotts Village Plaza and (ii) Scotts Village Phase II, a California limited partnership ("Scotts II"), granted a one-year option to the Trust to purchase Scotts Valley Square, both of which are located in Scotts Valley, California. Concurrently with the grant of these options and in connection with the transactions contemplated by that certain Assignment and Agreement dated May 9 1994 and amended May 25, 1994, executed by and between Pacific Real Estate Investment Trust and Western Investment Real Estate Trust, the Trust made a loan to Malcolm R. Riley, one of the principals in Scotts and Scotts II, in the amount of $750,000. The loan bears interest at 9% per annum, payable monthly, and the principal is due and payable in 6 years. Simultaneously, the Trust made a loan to Russell R. Pratt, in the amount of $500,000. That loan bears interest at 8% per annum, payable monthly, and the principal is due and payable in 6 years. Each of these loans is secured by the borrower's respective partnership interests in Scotts and Scotts II. The Trust also made a loan in the amount of $75,000 to Scotts, which bears interest at 8.6% per annum (payable monthly), is due in 6 years and is secured by a second deed of trust on Scotts Village Plaza. Payment on these notes are current. 12. Reincorporation/Merger Transactions. The Trustees have formed Pacific Real Estate Investment Trust, Inc. ("PAC REIT") as a Maryland corporation for the purpose of effecting a reincorporation (the "Reincorporation Transactions"). PAC REIT has no material assets or liabilities and is a wholly-owned subsidiary of the Trust. The Trust held a Special Meeting 33 of the Shareholders on March 18, 1994, at which time the Reincorporation Transactions were approved by the Trust's shareholders. The Trust does not currently expect to effect the Reincorporation Transactions. On January 10, 1997, the Trust entered into a definitive merger agreement with Pan Pacific Development (U.S.) Inc. whereby both entities agreed to contribute certain properties into a subsidiary of the Trust, Pacific Real Estate Investment Trust, Inc. On March 25, 1997, the agreement was terminated for failure of certain conditions. The Trustees will continue to pursue alternative sources of financing or an alternative approach involving the orderly sale of the Trust's assets. 13. EXPENSES OF PROSPECTIVE OFFERING. During 1994 the Trust was involved in discussions with underwriters regarding a potential offering of the PAC REIT's Common Shares and/or debt securities to public or private purchasers, should the Reincorporation Transactions be consummated. The expenses incurred in connection with such a prospective offering are reflected in the accompanying consolidated statements of operations as expenses of prospective offering. 14. COMMITMENTS AND CONTINGENCIES. The Trust is obligated on four land leases. The first lease extends through 2012 and requires minimum annual payments of $26,000, plus 8% of the property's rental revenue in excess of $325,000. The second lease extends through 2024 and requires minimum annual payments of $40,000, plus 12% of the property's annual rental revenue in excess of $333,000. The third lease extends through 2045 and contains a dual option for the Trust to acquire fee title and for the ground lessor to "put" the property to the Trust. The option for the Trust to acquire commences upon the death of one of the ground lessors and lasts for five years from said date. The option for the ground lessors to "put" the property to the Trust begins March 1, 1998 and survives through the term of the ground lease. The annual rent is $184,400 with annual increases of 4%. The purchase price under the options is the minimum ground rent capitalized at a 10% yield. Land lease expense totaled $381,000 in 1996, $400,000 in 1995, and $236,000 in 1994. The fourth lease extends through December 31, 2007 and requires annual minimum rent payment of $45,000 plus real property taxes. This lease affects a parcel of land consisting of 5000 square feet and is located at the periphery of Westwood Village Shopping Center in Redding, CA. The Trust sold this parcel to a third party in 1987 for a sale price of $440,000. The Trust leased the land back from the new owner with the intent to sub-lease it to a retail or commercial user at a ground rent equal to or greater than the ground rent payable by the Trust to the buyer. The Trust has been unable to locate a ground lessee and it estimates that the current market lease rate for this parcel has declined. In order to eliminate the burden of the remaining eleven years of lease payments, the Trust intends to terminate its lease prior to maturity and to repurchase the land at its estimated current value of $200,000. The Limited Partnership which owns the land has agreed to sell the parcel back to the Trust in exchange for a payment equal to the current estimated value of the land at $200,000 plus a lease termination fee of $240,000, based on the present value of the rental commitment. The liability for the lease termination fee has been accrued as of December 31, 1996. In 1994, the Kingsco partnership initiated an environmental audit of the property. The Phase I and II stages of the environmental audit identified certain dry cleaning solvents which had contaminated the ground water beneath the shopping center. Currently, a Phase III plan of remediation has been prepared with a proposed plan of action for clean-up of the contamination expected to be completed in approximately two years or longer. The cost to Kingsco for the clean-up is estimated to be $1,032,000 of which $723,000 has been expended through 1996. Reimbursements received from the insurance company total $503,000. The Trust was not a partner of Kingsco at the time the contamination occurred, and intends to look to the seller of the Trust's 40% interest in Kingsco, Kingsco's insurance carriers at the time of the contamination, the other partners of Kingsco and the entity that caused the contamination for payment of the clean-up costs. The Trust believes that the representations and warranties made by the seller in the agreement pursuant to which the Trust acquired its partnership interest give the Trust a cause of action against the seller for the clean-up costs to the extent such costs are not reimbursed by the insurance carriers. The interim plan of remediation has been approved by the Regional Water Quality Control Board and remediation has commenced. Accordingly, $309,000 and $529,000 is reflected in the accompanying consolidated balance sheet at December 31, 1996 as Other Liabilities and Other Assets respectively, for expected future costs and reimbursements. 34 In another, unrelated, environmental audit of the gasoline service station pad ("Exxon Pad") at King's Court Shopping Center, the Phase I and II work identified gasoline and possibly other service station by-products in the soil underneath the station and its pumps. Exxon Corporation has assumed financial and legal responsibility for the hazardous materials and remediation of the Exxon Pad. The environmental firm responsible for maintaining and analyzing the data from various monitoring wells on the Pad continues to report to the Trust and governmental authorities on a quarterly basis. Remediation efforts have commenced and include both vapor extraction and "pump and treat" activities, depending upon the location of the materials in the soil and water. The Trust has also become aware of a spill from a former dry cleaning establishment at El Portal Shopping Center. This spill probably occurred prior to the Trust's ownership of the property. The Contra Costa County Regional Water Quality Control Board is currently reviewing the situation and a clean-up remediation proposed by the Trust. The cost of clean-up and timetable have not yet been finalized, however, based on current knowledge, the cost is not expected to have a material effect on the Trust's financial position. During 1996, the Trustees authorized remediation expenditure up to $100,000. At December 31, 1996, Other Liabilities in the accompanying consolidated financial statements include $100,000 for such costs. The Trust ground leases a parcel of land in San Pablo, California (the Wanlass property) which has been contaminated with a gasoline spill from an adjacent property. The source of contamination has been identified and Atlantic-Richfield Company, Inc. ("ARCO") has issued a letter of indemnification for the Trust's benefit respecting all financial and legal liability arising from this contamination. At Monterey Plaza Shopping Center the Phase One Environmental Assessment Report identified the possibility of oil and grease contamination in the soil as well as possible residues of pesticides, herbicides and insecticides due to prior agricultural use of the property. The property was acquired from the State of California, which held title immediately prior to the Trust and which would be liable for any such contamination. These possible hazardous waste contaminations are not expected to be of material significance to the Trust. The Trust is in a dispute with WalMart concerning alleged deficiencies in the tenant's premises at Monterey Plaza. The sum in question is approximately $136,000 and represents roof and skylight repairs and upgrades. The Trust has declined to accept responsibility for these items and is contesting WalMart's claim of Landlord responsibilities. Trust management does not expect the ultimate outcome will have a material adverse effect on the Trust. 15. SHAREHOLDERS' EQUITY. In January 1992, the Trust began a Rights Offering, which entitled each shareholder of record on December 31, 1991, to purchase an additional share in the Trust for each share owned. The rights were exercisable at $13.68 per share through March 20, 1992 when the offering expired. In addition, each right was accompanied by one warrant which entitles the owner to purchase an additional one-half share of beneficial interest for $7.00 during a two-year period beginning January 1, 1995. (This is equivalent to a purchase price of $14.00 for each whole share.) At December 31, 1996, 217,697 warrants, covering 108,848.5 shares of beneficial interest, were issued and outstanding. These warrants expired December 31, 1996. 35 SCHEDULE III PACIFIC REAL ESTATE INVESTMENT TRUST ----------------- COMMERCIAL PROPERTIES AND ACCUMULATED DEPRECIATION DECEMBER 31, 1996
COLUMN A COLUMN B COLUMN C COLUMN D COST CAPITALIZED INITIAL COST SUBSEQUENT TO TRUST(1) TO ACQUISITION -------------------------- -------------------------- BUILDINGS AND CARRYING DESCRIPTION ENCUMBRANCES(3) LAND IMPROVEMENT IMPROVEMENTS COSTS ----------- -------------- ------ ----------- ------------ -------- COMMERCIAL PROPERTIES: King's Court Shopping Center Los Gatos, California . . . . 1,307,000 9,137,000 777,000 Monterey Plaza Shopping Center San Jose, California . . . . 18,412,000 10,104,000 12,717,000 1,799,000 3,757,000 Mt. Shasta Shopping Mt. Shasta, California(9) . . 1,543,000 ----------- ------------ ------------ ----------- ----------- TOTAL 21,262,000 $ 10,104,000 $ 21,854,000 $ 2,576,000 $ 3,757,000 ----------- ------------ ------------ ----------- ----------- ----------- ------------ ------------ ----------- ----------- COLUMN E COLUMN F COLUMN G COLUMN H GROSS AMOUNT AT WHICH CARRIED AT CLOSE OF PERIOD(2) ------------------------------------ BUILDINGS ACCUMULATED AND TOTAL DEPRECIATION DATE OF DATE LAND IMPROVEMENTS (4) (5)(6) CONSTRUCTION ACQUIRED -------- ----------- --------- ------------ ------------ -------- COMMERCIAL PROPERTIES: King's Court Shopping Center Los Gatos, California. . . . . . 9,914,000 9,914,000 4,130,000 (7) 12/86 Monterey Plaza Shopping Center San Jose, California . . . . . . 10,104,000 18,273,000 28,377,000 3,141,000 (8) 7/87,1/88 4/88,7/88 Mt. Shasta Shopping 10/88,3/89 Mt. Shasta, California(9). . . . ------------ ------------ ------------ ----------- $ 10,104,000 $ 28,187,000 $ 38,291,000 $ 7,271,000 ------------ ------------ ------------ ----------- ------------ ------------ ------------ -----------
See notes on following page 36 SCHEDULE III PACIFIC REAL ESTATE INVESTMENT TRUST -------------- COMMERCIAL PROPERTIES AND ACCUMULATED DEPRECIATION DECEMBER 31, 1996
Notes: (1) Construction costs incurred under the initial construction subsequent to purchase of the land are included as initial cost to the Trust. (2) The aggregate cost for federal income tax purposes excluding El Portal Shopping Center property in receivership, is $34,077,000. (3) Amount excludes $4,438,000 loan secured by property in receivership at El Portal Shopping Center. (4) Balance, January 1, 1994............................................ $ 110,145,000 Improvements capitalized subsequent to acquisition.................. 1,491,000 Retirements...................................................... (3,000,000) -------------- Loss on impairment of property value............................. (7,100,000) -------------- Balance, December 31, 1994.......................................... 101,536,000 Improvements capitalized subsequent to acquisition............... 108,000 Retirements...................................................... (30,991,000) -------------- Balance, December 31, 1995.......................................... 70,653,000 Improvements capitalized subsequent to acquisition............... 347,000 Property in receivership......................................... (15,333,000) Retirements...................................................... (17,376,000) -------------- Balance, December 31, 1996.......................................... $ 38,291,000 -------------- -------------- (5) Balance, January 1, 1994............................................ $ 14,670,000 Additions charged to expense..................................... 3,290,000 Retirements...................................................... (960,000) -------------- Balance, December 31, 1994.......................................... 17,000,000 Additions charged to expense..................................... 2,496,000 Retirements...................................................... (1,121,000) -------------- Balance, December 31, 1995.......................................... 18,375,000 Additions charged to expense..................................... 1,716,000 Property in receivership......................................... (9,925,000) Retirements...................................................... (2,895,000) -------------- Balance, December 31, 1996.......................................... $ 7,271,000 -------------- -------------- (6) Depreciation is computed on lives ranging from three to forty years. (7) This property is owned by a joint venture in which the Trust has a 40% controlling interest. (8) This property was acquired at various times and development was completed in 1991. (9) This property has been sold, but the Trust remains primarily liable for the note payable, which is secured by the property sold. An all-inclusive promissory note receivable from the buyer was received by the Trust as the date of sale. Such financing is commonly referred to as "wraparound" financing.
37 SCHEDULE IV PACIFIC REAL ESTATE INVESTMENT TRUST ------------- MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1996
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F INTEREST MATURITY PERIODIC FACE AMOUNT CARRYING AMOUNT DESCRIPTION RATE DATE PAYMENT TERMS OF MORTGAGE OF MORTGAGE(1)(2) - ------------------------------ --------- --------- ------------------------------------- --------------- ------------------- SECURED LOANS: Westwood Shopping Center...... 9% 12/97 $7,967/mo. principal and interest. $ 5,375,000 $ 600,000 (3) (Second mortgage secured by Balloon payment of $1,121,000 due shopping center.) at maturity. Mt. Shasta Shopping Center.... 9.25% 1/99 $32,375/mo. interest only. Balloon 4,200,000 4,178,000 (4) (Wraparound second mortgage payment of $4,200,000 due at secured by shopping center) maturity. Scotts Valley Loans Malcom Riley.................. 9% 6/2000 $5,625 750,000 750,000 (5) Russell Pratt................. 8% 6/2000 $3,333 500,000 500,000 (5) Scotts Valley Plaza........... 8.6% 6/2000 $537.50 75,000 75,000 ------------- ------------- TOTAL SECURED LOANS $ 10,900,000 6,103,000 ------------- ------------- ------------- -------------
- -------------------------
Notes: (1) The aggregate cost for federal income tax purpose is $6,593,000. (2) Balance, January 1, 1994......................... $11,130,000 Deductions during year: Amortization of discount....................... 34,000 Additions...................................... 1,325,000 Collection of Principal........................ (5,974,000) (4,615,000) ------------- ------------- Balance at December 31, 1994..................... 6,515,000 Deductions during year: Amortization of discount....................... 64,000 Collection of Principal........................ (14,000) 50,000 ------------- ------------- Balance at December 31, 1995 6,565,000 Deductions during year: Amortization of discount....................... 22,000 Allowance for doubtful accounts................ (468,000) Collection of Principal........................ (16,000) (462,000) ------------- ------------- Balance at December 31, 1996..................... $ 6,103,000 ------------- ------------- (3) Net of discount of $37,000 based on an effective interest rate of 9.75% and allowance of doubtful accounts of $468,000. (4) Net discount of $22,000 based on an effective interest rate of 9.5%. (5) Loans secured by interest in partnership which owns commercial real estate.
38 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT Mr. Wilcox Patterson, age 56, was elected a Trustee in 1980, and President of the Trust in May 1985. Mr. Patterson is a director of Grove Farm Company, Inc., a sugar plantation and real estate development corporation located on Kauai in the Hawaiian Islands. He is also an independent real estate manager and investor. Mr. Patterson served as Regional Vice President of Northern California Savings and Loan Association between April 1979 and September 1980. Prior to that appointment, he served as a Vice President and Manager of the Menlo Park branch of Northern California Savings and Loan Association. In these capacities, he has gained considerable experience in real estate financing. Mr. John H. Hoefer, age 81, was elected a Trustee in 1982 and Vice President in June 1988. Mr. Hoefer is a Rear Admiral, United States Naval Reserve. He was founder of Hoefer, Dieterich and Brown, Inc., an advertising agency in San Francisco, and was its Chairman at the time of its merger with Chiat/Day, Inc. in 1979. He was also a Chairman of Chiat/Day, Inc. (San Francisco). Mr. Harry E. Kellogg, age 73, has served as a Trustee and Treasurer of the Trust since the date of its inception and was an initial investor. Mr. Kellogg was elected Executive Vice President of the Trust on December 5, 1978 and was President from February 1980 to May 1985. Mr. Kellogg has served as Trustee of the Seattle Retail Clerks Union Pension Fund, the GEMCO Retail Clerks Union Pension Trust Fund and is the former Vice President--Finance and Secretary of Leslie Salt Co., a salt production company, with extensive real estate holdings in the San Francisco Bay Area. At Leslie Salt Co., from which he retired in 1979, Mr. Kellogg was responsible for the financial, administrative and tax matters of the company. Mr. William S. Royce, age 78, has been an investor in the Trust since 1964 and was elected a Trustee in 1980 and Secretary on June 15, 1988. Mr Royce is an independent management consultant specializing in business planning and regional economic development. He retired in 1984 from SRI International (Stanford Research Institute). Mr. Royce also is a director of Diablo Research Corporation and Treasurer of the Silicon Valley Economic Roundtable. Mr. Robert C. Gould, age 52, was elected a Trustee and appointed Vice President in June 1989 and has previously served as a Vice President and Secretary of the Trust from 1985 through 1988. Mr. Gould is President and a director of Menlo Management Company of which he is the sole owner. Prior to his employment with Menlo Management, he was a real estate analyst with Shell-Mex/B.P. Ltd., a subsidiary of the Royal Dutch/Shell Group of Companies. He is a licensed California real estate broker. The Trust has an Audit Committee, which makes recommendations concerning the engagement of independent public accountants, reviews the plans and results of the audit engagement and reviews the adequacy of the Trust's internal accounting controls, and a Compensation Committee. The members of both the Audit Committee and the Compensation Committee are Mr. Hoefer and Mr. Royce. 39 ITEM 11. EXECUTIVE COMPENSATION During the fiscal year ended December 31, 1996, there were no officers and/or Trustees whose aggregate direct remuneration exceeded $100,000. With respect to the President of the Trust, aggregate direct remuneration, consisting of fees for services performed as a Trustee, paid during the last three fiscal years was as follows: NAME AND AGGREGATE DIRECT PRINCIPAL POSITION YEAR REMUNERATION ---------------------------------------------- Wilcox Patterson, 1996 $ 16,200 President 1995 $ 16,600 1994 $ 16,200 During fiscal 1996, aggregate direct remuneration paid to all Trustees and officers as a group (five persons) was $40,100 of which $23,900 consisted of fees for services performed as Trustees. Trustees are paid a monthly fee of $200 for their services and a fee of $200 per Trustee meeting attended. Committee members receive $100 per committee meeting attended. None of the Trustees or executive officers of the Trust has failed to file, on a timely basis, reports required to be filed pursuant to Section 16 of the Securities Exchange Act of 1934, as amended. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth as to each of the Trustees the number of Trust Shares owned, directly or indirectly, by him on December 31, 1996. No person is known by the Trust to be the beneficial owner of more than five percent of the Trust's outstanding Trust Shares. Each person identified in the table has sole voting and investment power with respect to all Trust Shares shown as beneficially owned by such person, except as otherwise set forth in the notes to the table. Unless otherwise indicated, the address of each person listed below is 1010 El Camino Real, Suite 210, Menlo Park, California 94025. NUMBER OF SHARES PERCENT OF NAME BENEFICIALLY OWNED CLASS(1) --------------------------------------------------------------- John H. Hoefer 68,003 1.835% Harry E. Kellogg (2) 7,293 .197% Wilcox Patterson (2)(3) 27,900 .753% William S. Royce 2,708 .073% Robert C. Gould 1,471 .040% (1) Based on 3,706,845 Trust Shares outstanding as of December 31, 1996, and exercisable warrants to purchase 108,848.5 Trust Shares held by certain shareholders as of December 31, 1996. These warrants expired December 31, 1996. (2) Voting and investment power are shared. (3) Includes 21,584 Trust Shares owned by members of Mr. Patterson's family as to which Mr. Patterson disclaims any beneficial ownership interest. 40 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS INCENTIVE COMPENSATION PLAN For 1990 and thereafter, the Trustees have approved an incentive compensation plan for Robert C. Gould, Trustee and Vice President of the Trust. The annual incentive bonus under the agreement will be determined as follows: 7.5% of the difference between "operating income" and 8.6% "adjusted average equity." "Operating income" is defined as income from operations before depreciation, gain on property sales, and deductions for investment advisory fee, but after deduction for amortization of deferred costs. "Adjusted average equity" is defined as the average of the year's beginning and ending shareholders' equity plus accumulated depreciation. Incentive compensation will be paid in stock, valued per share at the time the compensation is paid at a price equal to the net proceeds per share received by the Trust in sales of shares to the public. The Trustees intend to review and modify if appropriate for each succeeding year, the percentage return on adjusted average equity used in the above calculation so that it is comparable to rates of return being earned by competing real estate entities. For 1996, 1995 and 1994, the incentive compensation program resulted in no bonus payment to Mr. Gould. INVESTMENT ADVISOR, PROPERTY MANAGEMENT AGREEMENTS AND SALES SUPPORT SERVICES AGREEMENT Collier Investment acts as both investment advisor and real estate broker for the Trust. Menlo Management manages the Trust's properties. Until its dissolution in 1995, Presco provided support and capital fund raising services and acted as a crossing agent for shareholders wishing to purchase existing Trust shares. Collier Investment is a proprietorship of Russell Collier. Menlo Management Company is owned by Robert C. Gould, who is a Trustee and Vice President of the Trust. See Note 2 of Notes to Consolidated Financial Statements for a description of the compensation paid to Collier Investment and Menlo Management during the fiscal year ended December 31, 1996. Beginning on January 1, 1994, a revised investment advisory agreement became effective, which provides for a base advisory fee to Collier Investment of 1/5 of 1% of gross Trust assets. In July 1994, at Mr. Collier's request this fee was reduced by 50% to 1/10 of 1% of gross Trust assets retroactive to January 1, 1994. Mr. Collier also voluntarily waived his right to receive any real estate brokerage commissions as a result of the sales of Lakeshore Plaza Shopping Center, which was sold on March 13, 1995, and Menlo Center, which was sold on February 29, 1996. LOANS FROM AFFILIATES OF MENLO MANAGEMENT COMPANY Due to the shortage or unavailability of equity financing, the Trust obtained short-term financing at competitive rates to provide working capital and to complete the development of its Lakeshore Plaza Shopping Center through a group of private limited partnerships. At December 31, 1996, notes outstanding are $7,700,000, with interest rates ranging from 9.50% to 10.20%. The notes have the capacity to be increased to a total indebtedness of $8,050,000 and are secured by mortgage notes receivable from property sales (see Note 3), additional deeds of trust on existing properties and the Trust's interest in a joint venture. All of these notes at December 31, 1996 are held by private limited partnerships, independent of the Trust, in which Menlo Management Company and/or Collier Investments has a general partnership interest. Interest of $790,000, $1,163,000 and $1,442,000 was paid on these notes in 1996, 1995 and 1994, respectively. The notes are due in December 1997. The Trust has the intention and ability to obtain extensions on the maturity dates on these notes. 41 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K: (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. See Item 8 of this Annual Report or Form 10-K for Consolidated Financial Statements for the Trust, Notes thereto, and Consolidated Supplemental Schedules. A Table of Contents to Consolidated Financial Statements and Consolidated Supplemental Schedules is included in Item 8 and incorporated herein by reference. (b) REPORTS ON FORM 8-K. Report on Form 8-K was filed by the Trust on March 14, 1996, October 24, 1996 and January 24, 1997. (c) EXHIBITS: TABLE REFERENCE EXHIBIT LOCATION ------------------------------------------------------------------- 3 and 4 Declaration of Incorporated by reference Trust and Amendments from Form 10 and Form 8-K of May 4, 1982 The exhibits required by Item 601 of Regulation 5-K have been filed with previous reports by the registrant and are incorporated by reference thereto. 42 SIGNATURES 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. PACIFIC REAL ESTATE INVESTMENT TRUST Registrant BY: WILCOX PATTERSON ------------------------------- WILCOX PATTERSON, PRESIDENT (PRINCIPAL EXECUTIVE OFFICER) BY: HARRY E KELLOGG ------------------------------- HARRY E. KELLOGG, TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER) Date: March 27, 1997 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 and in the capacities and on the dates indicated. SIGNATURES DATE ---------- ---- /s/ WILCOX PATTERSON --------------------------------------- March 27, 1997 WILCOX PATTERSON, PRESIDENT AND TRUSTEE /s/ HARRY E KELLOGG --------------------------------------- March 27, 1997 HARRY E KELLOGG, TREASURER AND TRUSTEE /s/ ROBERT C. GOULD --------------------------------------- March 27, 1997 ROBERT C. GOULD, TRUSTEE /s/ WILLIAM S. ROYCE --------------------------------------- March 27, 1997 WILLIAM S. ROYCE, TRUSTEE /s/ JOHN H. HOEFER --------------------------------------- March 27, 1997 JOHN H. HOEFER, TRUSTEE 43 EX-27 2 EXHIBIT 27
5 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 2,165,000 0 6,929,000 650,000 0 2,654,000 42,729,000 (7,271,000) 46,183,000 2,086,000 33,400,000 0 0 37,068,000 (29,746,000) 46,183,000 0 6,425,000 0 9,438,000 414,000 649,000 3,404,000 (3,427,000) 0 (3,427,000) 0 0 0 (3,427,000) (.92) (.92) Includes $3,375,000 of Minority Interest in Joint Venture. Represents minority interest portion of Current Net Loss.
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