-----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, D9yPIp2CcBZNCE2N9N+R2qcFmI4ngXfX/JXbqPlWWMNWBXvbFhzUsa/l0KO3AWhJ Nbq2fgiiA/5PX2zX4/zFWA== 0000950134-98-002635.txt : 19980331 0000950134-98-002635.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950134-98-002635 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL INCOME REALTY TRUST CENTRAL INDEX KEY: 0000277577 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 942537061 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-09211 FILM NUMBER: 98578226 BUSINESS ADDRESS: STREET 1: 280 PARK AVE E BLDG 20TH FL STREET 2: SUITE 200 CITY: NEW YORK STATE: NY ZIP: 10017 BUSINESS PHONE: 2146924700 MAIL ADDRESS: STREET 1: 3100 MONTICELLO STREET 2: STE 200 CITY: DALLAS STATE: TX ZIP: 75205 FORMER COMPANY: FORMER CONFORMED NAME: CONSOLIDATED CAPITAL INCOME TRUST DATE OF NAME CHANGE: 19890726 10-K 1 FORM 10-K FOR PERIOD ENDING DECEMBER 31, 1997 1 UNITED STATES 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 [FEE REQUIRED]* FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 ----------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM ..............TO.................. COMMISSION FILE NUMBER 0-9211 NATIONAL INCOME REALTY TRUST ------------------------------------------------------ (Exact name of registrant as specified in its charter) CALIFORNIA 94-2537061 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 280 PARK AVENUE, EAST BUILDING, 20TH FLOOR, NEW YORK, NY 10017 - -------------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 949-5000 --------------- 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, NO PAR VALUE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. [ ] As of March 13, 1998, the registrant had 3,809,829 shares of beneficial interest outstanding. Of the total shares outstanding, 2,495,637 were held by other than those who may be deemed to be affiliated, for an aggregate value of $43,985,602 based on the last trade as reported by the National Association of Securities Dealers Automated Quotations System on March 13, 1998. The basis of this calculation does not constitute a determination by the registrant that all of such persons or entities are affiliates of the registrant as defined in rule 405 of the Securities Act of 1933, as amended. DOCUMENTS INCORPORATED BY REFERENCE NONE 1 2 INDEX TO ANNUAL REPORT ON FORM 10-K
Page ---- PART I Item 1. Business.............................................................. 3 Item 2. Properties............................................................ 6 Item 3. Legal Proceedings..................................................... 15 Item 4. Submission of Matters to a Vote of Security Holders................... 15 PART II Item 5. Market for Registrant's Shares of Beneficial Interest and Related Shareholder Matters................................................ 16 Item 6. Selected Financial Data............................................... 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................. 20 Item 7A. Quantitative and Qualitative Disclosures About Market Risk............ 30 Item 8. Financial Statements and Supplementary Data........................... 31 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................................... 68 PART III Item 10. Trustees, Executive Officers, and Advisor of the Registrant........... 68 Item 11. Executive Compensation................................................ 78 Item 12. Security Ownership of Certain Beneficial Owners and Management........ 79 Item 13. Certain Relationships and Related Transactions........................ 82 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...... 85 Signature Page........................................................ 87
2 3 PART I ITEM 1. BUSINESS General National Income Realty Trust (the "Trust") was organized as a California business trust pursuant to a declaration of trust dated October 31, 1978, (as amended, the "Declaration of Trust") and commenced operations on March 27, 1979. The Trust elected to be treated as a Real Estate Investment Trust ("REIT"), as defined under Sections 856 through 860 of the Internal Revenue Code of 1986 (the "Code") and, in the opinion of the Trust's management, has continuously qualified for federal taxation as a REIT. The Trust's principal offices are located at 280 Park Avenue, East Building, 20th Floor, New York, New York 10017. The telephone number is (212) 949-5000, and the facsimile number is (214) 949-8001. In the opinion of the Trust's management, these offices are suitable and adequate for its present operations. Business Plan and Investment Policy The Trust's business and only industry segment is investing in and developing income-producing real estate directly and through partnerships and joint ventures. At December 31, 1997, the Trust's real estate portfolio consisted of 61 properties, including 40 multifamily properties, 14 shopping centers, three office buildings, three parcels of land, and one single family residence, located throughout the continental United States, with concentrations in Florida, Texas, California, and Colorado. The Trust also held investments in eight real estate partnerships reported on the equity method (owning three office buildings and six apartment complexes, four of which are under construction). Due to the nature and diversity of the Trust's properties and tenants, the Trust's business is not significantly affected by seasonal factors. The Trust's acquisition strategy is opportunistic but focused on acquiring properties that add to the efficiency of the Trust's portfolio. For example, all 13 of the apartment properties purchased by the Trust since the beginning of 1995 were in markets where the Trust already had a presence. Unlike most REITs, the Trust acquires older and often troubled properties that are not considered of institutional quality as well as better performing, new, or high quality properties. The Trust has a policy of continuously improving and upgrading its older properties in order to achieve increased revenues. During 1997, $16.9 million in capital expenditures were made to the operating apartment portfolio. In addition, $1.4 million ($177 per unit) was expensed for recurring replacements and repairs and maintenance. Management believes that a significant portion of such expenditures was required to remedy deferred maintenance existing at the time of acquisition and to upgrade maintenance and curb appeal. Accordingly, such expenses are expected to decline on a per unit basis as the proportion of stabilized properties in the Trust's portfolio increases. The Trust has financed acquisitions and capital improvements largely through mortgages and internally generated funds. As a matter of policy, cash distributions have been held to less than fifty percent of funds from operations ("FFO"), as defined by the National Association of Real Estate Investment Trusts (see ITEM 6. "SELECTED FINANCIAL DATA - Other Data" for the definition of FFO). Funds for investment have also been generated by property sales and from the collection of mortgages receivable, which will not be a material future source. Accordingly, property sales and proceeds realized from financing or refinancing are expected to provide the bulk of funds available for investment. In this regard, the availability and cost of long term mortgage funds are key factors in the Trust's ability to continue to make new investments without additional equity offerings. 3 4 ITEM 1. BUSINESS (Continued) Possible Consolidation with Tarragon Realty Investors, Inc. On February 19, 1998, the Trust and Tarragon Realty Investors, Inc., ("TRI") jointly announced the agreement of their respective boards to form a single consolidated entity with TRI, for convenience, as the survivor. The surviving consolidated entity is intended to operate as a self-administered REIT. The consolidation transaction will be submitted to shareholders of each of the Trust and TRI for approval at special meetings to be held during 1998. Under the proposed agreement, each shareholder of the Trust will receive 1.97 shares of TRI common stock for each share of beneficial interest of the Trust held. TRI, also a REIT, has a similar opportunistic approach to real estate investment and had total consolidated assets of approximately $37 million as of December 31, 1997. Upon the approval and consummation of the consolidation transaction by the respective shareholders of each entity, TRI will acquire Tarragon Realty Advisors, Inc. ("Tarragon" or the "Advisor"), the Trust's advisor since April 1, 1994, and TRI's advisor since March 1, 1994, for 100,000 shares of common stock of TRI and options to acquire additional shares of common stock of TRI at prices ranging between $13 and $16 per share. The resulting consolidated enterprise with TRI as the survivor will emerge from these transactions as an integrated, self-administered, self-managed REIT controlling approximately 14,000 apartment units and 2.1 million square feet of retail and office space, primarily in California, Florida, and Texas. The consolidation transaction will be accounted for as a reverse acquisition of TRI by the Trust. William S. Friedman, President, Chief Executive Officer, and Trustee of the Trust, also serves as Director and Chief Executive Officer of Tarragon and as Director, President, and Chief Executive Officer of TRI. Tarragon is owned by Mr. Friedman and his wife, Lucy N. Friedman. The Friedman family also owns approximately 30% of the outstanding shares of common stock of TRI and approximately 33% of the outstanding shares of beneficial interest of the Trust. Management of the Trust The Board of Trustees (the "Board"), elected annually by the shareholders or appointed by the incumbent Board until the next annual shareholder meeting, is responsible for managing the affairs of the Trust. There are currently eight members on the Board, seven of whom are unaffiliated with the Trust. Day-to-day management is performed by Tarragon, which operates under the supervision of the Board pursuant to a written advisory agreement approved by shareholders. Tarragon's duties include, among other things, locating, investigating, evaluating, and recommending real estate investment and sale opportunities and financing and refinancing sources for the Trust. The Advisor also serves as a consultant in connection with the business plan and investment policy decisions made by the Board. A majority of the officers of the Trust are also officers of Tarragon. The Trust has no employees. Employees of Tarragon provide executive and administrative services to the Trust. Tarragon also serves as the advisor to TRI. All of the officers of the Trust are also officers of TRI. Tarragon and the Trust officers owe fiduciary duties to TRI as well as to the Trust. Historically, in determining to which entity to allocate a particular investment opportunity, Tarragon and the Trust officers have considered the respective investment objectives of each entity and the appropriateness of a particular investment in light of each entity's existing real estate portfolio. To the extent that any particular investment opportunity is appropriate for both entities, such investment opportunity has been allocated to the entity which had uninvested funds for the longer period of time, or, if appropriate, the investment has been shared between the entities. Tarragon periodically informs the Board of real estate investments made by any of its affiliates, and the Board periodically reviews the performance of such other investments. 4 5 ITEM 1. BUSINESS (Continued) Property Management Since April 1, 1994, Tarragon has provided property management services to the Trust for a fee of 4.5% of the monthly gross rents collected on multifamily properties and 1.5% to 5% of the monthly gross rents collected on commercial properties. Tarragon subcontracts with other entities for the provision of some of the property-level management services to the Trust. Beginning April 1, 1996, Tarragon Management, Inc. ("TMI"), a wholly-owned subsidiary of Tarragon, assumed the property-level management of most of the Trust's properties for a fee of 4.5% of the monthly gross rents collected. Competition The Trust has not experienced difficulty in locating investment opportunities. Management believes that ownership of properties in which the Trust invests is highly fragmented among individuals, partnerships, public and private corporations, and other REITs. No single entity or person dominates the market for such properties. At any given time, a significant number of multifamily properties are available for purchase in the various markets where the Trust seeks additional acquisitions. Management believes that there is and will continue to be a strong demand for well-maintained, affordable housing in these markets and that the factors discussed above provide a market where a sufficient number of attractive investment opportunities will be available to allow the Trust to continue to expand through acquisitions as well as through the development of new properties. However, since the success of any multifamily real estate investment is impacted by other factors outside the control of the Trust, including general demand for apartment living, interest rates, operating costs, and the ability to attract and retain qualified property managers, there can be no assurances that the Trust will be successful in its plan to continue to expand through acquisitions. Certain Factors Associated with Real Estate and Related Investments The Trust is subject to the risks associated with ownership, operation, and financing of real estate. These risks include, but are not limited to, liability for environmental hazards; changes in general or local economic conditions; changes in interest rates and the availability of permanent mortgage financing which may render the acquisition, sale, or refinancing of a property difficult or unattractive and which may make debt service burdensome; changes in real estate and zoning laws; changes in income taxes, real estate taxes, or federal or local economic or rent controls; floods, earthquakes, and other acts of nature; and other factors beyond the control of the Trust or Tarragon. The illiquidity of real estate investments generally may impair the ability of the Trust to respond promptly to changing circumstances. The Trust's management believes that some of these risks are partially mitigated by the diversification by geographic region and property type of the Trust's real estate. However, to the extent new investments continue to be concentrated in any particular region or property type, the advantages of diversification may diminish. 5 6 ITEM 2. PROPERTIES Details of the Trust's real estate portfolio at December 31, 1997, are set forth in Schedule III to the Consolidated Financial Statements and NOTE 3. "REAL ESTATE AND DEPRECIATION" of the Notes to Consolidated Financial Statements, both included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA." The discussion set forth below provides certain summary information concerning the Trust's real estate. To continue to qualify for federal taxation as a REIT under the Code, the Trust is required, among other things, to hold at least 75% of the value of its assets in real estate assets, government securities, and cash and cash equivalents at the close of each quarter of each taxable year. At December 31, 1997, 88% of the Trust's assets consisted of equity investments in real estate, 5% consisted of investments in partnerships which own real estate, and 2% consisted of cash and cash equivalents. The remaining 5% of the Trust's assets at December 31, 1997, was restricted cash and other assets. It should be noted, however, that the percentage of the Trust's assets invested in any one category at any particular time is subject to change, and no assurance can be given that the composition of the Trust's assets in the future will approximate the percentages listed above. During 1996 and 1997, the Trust purchased seven multifamily properties and one shopping center, added one multifamily property to its portfolio by increasing its interest in the partnership that owns it to 90%, acquired one shopping center through a deed in lieu of foreclosure of collateral securing a mortgage note receivable, and sold three multifamily properties and one office building. Its multifamily portfolio consists of 7,987 operating apartments and 1,062 apartment units under construction which are owned by unconsolidated partnerships. At December 31, 1997, the Trust's real estate portfolio consisted of 61 properties, 53 of which were held for investment. The remaining eight properties, some of which were obtained through foreclosure of collateral securing the Trust's mortgage notes receivable, were held for sale. Eleven Trust properties with an aggregate carrying value of $27.6 million were held free and clear. The other 50 Trust properties were pledged to secure mortgages totaling $182.5 million at December 31, 1997. A summary of 1997 activity in the Trust's owned real estate portfolio is as follows: Properties owned at January 1, 1997................................ 58 Properties purchased............................................... 6 Property consolidated due to increased partnership interest........ 1 Properties sold.................................................... (3) Condemned property written off..................................... (1) ----- Properties owned at December 31, 1997.............................. 61 =====
[This space intentionally left blank.] 6 7 ITEM 2. PROPERTIES (Continued) The Trust has divided the continental United States into the following six geographic regions. [MAP] [Northeast region comprised of the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont and the District of Columbia. Southeast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, and Virginia. Southwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma, and Texas. Midwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia, and Wisconsin. Mountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah, and Wyoming. Pacific region comprised of the states of California, Oregon, and Washington.] At December 31, 1997, the Trust held investments in each of the geographic regions of the continental United States, although its multifamily properties were concentrated in the Southeast and Southwest, as shown more specifically in the table below. The following table sets forth the percentages, by property type and geographic region, of the Trust's operating real estate (other than unimproved land and the single-family residence) at December 31, 1997:
Multifamily Commercial Region Properties Properties ------ ---------- ---------- Northeast 5.9% - Southeast 52.8% 55.6% Southwest 25% 10.5% Midwest 8.5% 21.3% Mountain 6.1% 3.6% Pacific 1.7% 9%
The foregoing table is based solely on the number of operating apartment units and amount of commercial square footage owned by the Trust and does not reflect the value of the investments in each region. 7 8 ITEM 2. PROPERTIES (Continued) Types of Real Estate Investments. The Trust's real estate consists of multifamily and commercial properties, primarily office buildings and shopping centers, or similar properties having established income-producing capabilities. In selecting real estate for investment, the Trust concentrates on properties for which intensive management coupled with capital improvements can materially increase value. The Trust favors buying or developing properties in areas in which the Advisor has current market knowledge. The location, age, and type of property, gross rentals, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values, and physical condition are also considered. The Trust may acquire properties subject to, or assume, existing debt and may mortgage, pledge, or otherwise obtain financing for a portion of its real estate. The Board may alter the types of and criteria for selecting new equity investments and for obtaining financing without a vote of shareholders to the extent such policies are not governed by the Declaration of Trust. Although the Trust has traditionally invested in a wide variety of developed, income-producing real estate, the Trust intends to invest increasing amounts in major apartment renovations and new construction or development projects either directly or in partnership with others. To the extent the Trust invests in construction and development projects, it is subject to the business risks, such as cost overruns and delays, associated with such higher risk activities. The Trust purchased The Vistas at Lake Worth ("The Vistas") in Fort Worth, Texas, in December 1994. The Trust has invested $13 million in the expansion and redevelopment of this property. Operations began at this property in December 1997, and the redevelopment of The Vistas was completed in the first quarter of 1998. During 1997, the Trust acquired interests in four partnerships that were each established to construct a luxury apartment complex. The following table presents the properties to be constructed by each partnership:
Number Estimated Expected Date Partnership Property Location of Units Cost of Completion ---------------- ------------------------- ---------------- -------- ------------- ------------------ RI Windsor, Ltd. Mayfaire at Windsor Parke Jacksonville, FL 324 $18.6 million First Quarter 1998 RI Panama City, Ltd. Harbour Green Panama City, FL 200 $10.5 million Second Quarter 1998 Danforth National Apartments, Ltd. The Club at Danforth Jacksonville, FL 288 $17.1 million Third Quarter 1998 Tarragon Savannah, L.P. The Links at Georgetown Savannah, GA 250 $14.5 million Second Quarter 1999
For more information on properties owned through partnerships, see the discussion below under "Partnership Properties." The following table presents certain information relating to real estate owned and mortgage loans secured by the Trust's real estate at December 31, 1997. The Trust also owns three parcels of land and a house held for rental which are not included in the table. 8 9 NATIONAL INCOME REALTY TRUST REAL ESTATE SUMMARY DECEMBER 31, 1997 (Unaudited)
Average Rent Per Sq. Ft.(a) Current Number Year Ended December 31, Market of Square -------------------------- Rent Per Property Location Units Footage 1997 1996 1995 Sq. Foot(b) - -------- -------- --------- --------- ------ ------ ------ ---------- PROPERTIES ACQUIRED PRIOR TO DECEMBER 31, 1995: Apartments: Acadian Place Baton Rouge, LA 120 143,450 $ 4.04 $ 3.74 $ 3.62 $ 5.68 Bay West Bradenton, FL 299 323,774 5.17 5.22 5.35 6.55 Bayfront Houston, TX 200 172,720 5.61 5.56 5.92 7.56 Bryan Hill Bethany, OK 232 193,500 4.77 4.59 4.36 5.55 Carlyle Towers Detroit, MI 163 247,850 5.41 5.39 5.27 6.42 Cornell Los Angeles, CA 55 30,150 13.70 12.70 12.06 15.00 Creekwood North Altamonte Springs, FL 180 166,500 5.99 5.56 5.07 7.07 Cross Creek Lexington, KY 144 102,258 7.32 7.14 6.91 9.01 Devonshire/Dunhill/ Sandstone Denver, CO 760 317,050 11.09 9.62 8.05 13.82 Diamond Loch Fort Worth, TX 138 139,354 5.78 5.57 4.96 6.84 Fenway Hall Los Angeles, CA 53 27,175 11.39 11.68 11.04 12.79 Forest Oaks Lexington, KY 154 132,460 5.71 5.68 5.49 6.78 Heather Hills Temple Hills, MD 459 401,029 7.83 7.87 8.61 10.24 Kirklevington Lexington, KY 126 99,080 6.77 6.56 5.97 7.94 Lake Point Memphis, TN 540 540,160 4.25 3.92 3.68 5.37 Marina Park North Miami, FL 90 86,850 8.89 7.76 6.55 10.49 Mariposa Manor Los Angeles, CA 41 19,710 7.48 9.25 9.03 10.35 Martins Landing Lakeland, FL 236 207,704 6.49 6.41 6.15 7.10 Meadowbrook Baton Rouge, LA 200 127,524 7.09 6.76 6.65 8.36 Mustang Creek Arlington, TX 120 167,880 5.19 5.11 5.06 6.79 Palm Court North Miami, FL 144 125,280 7.61 7.47 7.25 8.76 Park Dale Gardens Dallas, TX 224 206,640 5.36 5.26 5.04 6.68 Park Norton Los Angeles, CA 55 25,208 8.43 7.48 4.51 10.44 Park Place Los Angeles, CA 39 15,640 8.42 8.15 2.04 11.10 Pinecrest Ft. Lauderdale, FL 326 226,065 12.86 12.06 11.42 14.94 Prado Bay N. Bay Village, FL 123 109,756 9.64 8.72 8.45 10.40 Spring Pines Houston, TX 136 118,430 5.45 5.27 4.93 6.29 Summit on the Lake Fort Worth, TX 198 138,262 7.53 7.51 7.11 8.85 Woodcreek (CO) Denver, CO 120 99,622 8.64 8.36 7.97 9.46 Woodcreek (FL) Jacksonville, FL 260 198,623 7.30 6.82 6.33 7.88 --------- --------- ------ ------ ------ ------ SUBTOTAL OR WEIGHTED AVERAGE (e) 5,935 4,909,704 6.83 8.44 8.76 11.07 --------- --------- ------ ------ ------ ------ Office Buildings: Emerson Center Atlanta, GA -- 126,979 10.13 7.51 5.47 12.81 NW O'Hare Des Plaines, IL -- 105,363 12.30 11.38 10.94 15.39 Rancho Sorrento San Diego, CA -- 147,973 7.14 6.83 4.74 9.97 --------- --------- ------ ------ ------ ------ SUBTOTAL OR WEIGHTED AVERAGE (e) -- 380,315 9.57 8.32 6.70 12.42 --------- --------- ------ ------ ------ ------ Economic Occupancy(c) Year Ended December 31, Physical ----------------------- Occupancy Property Location 1997 1996 1995 Dec. 31, 1997 (d) - -------- -------- ---- ---- ---- ----------------- PROPERTIES ACQUIRED PRIOR TO DECEMBER 31, 1995: Apartments: Acadian Place Baton Rouge, LA 85% 84% 85% 89% Bay West Bradenton, FL 90% 92% 94% 94% Bayfront Houston, TX 83% 84% 92% 94% Bryan Hill Bethany, OK 93% 93% 91% 91% Carlyle Towers Detroit, MI 91% 91% 93% 94% Cornell Los Angeles, CA 97% 95% 94% 96% Creekwood North Altamonte Springs, FL 94% 90% 89% 94% Cross Creek Lexington, KY 89% 91% 90% 82% Devonshire/Dunhill/ Sandstone Denver, CO 92% 88% 80% 95% Diamond Loch Fort Worth, TX 91% 95% 91% 93% Fenway Hall Los Angeles, CA 95% 97% 92% 98% Forest Oaks Lexington, KY 91% 92% 93% 86% Heather Hills Temple Hills, MD 87% 87% 92% 93% Kirklevington Lexington, KY 92% 91% 91% 86% Lake Point Memphis, TN 91% 85% 83% 90% Marina Park North Miami, FL 92% 88% 88% 91% Mariposa Manor Los Angeles, CA 81% 93% 90% 100% Martins Landing Lakeland, FL 95% 95% 96% 95% Meadowbrook Baton Rouge, LA 93% 94% 92% 94% Mustang Creek Arlington, TX 85% 89% 93% 90% Palm Court North Miami, FL 91% 93% 96% 89% Park Dale Gardens Dallas, TX 89% 95% 96% 95% Park Norton Los Angeles, CA 90% 81% 51% 87% Park Place Los Angeles, CA 87% 85% 43% 90% Pinecrest Ft. Lauderdale, FL 93% 92% 90% 97% Prado Bay N. Bay Village, FL 96% 92% 92% 97% Spring Pines Houston, TX 94% 95% 93% 93% Summit on the Lake Fort Worth, TX 93% 95% 95% 89% Woodcreek (CO) Denver, CO 95% 96% 95% 99% Woodcreek (FL) Jacksonville, FL 95% 94% 94% 95% --- --- --- --- SUBTOTAL OR WEIGHTED AVERAGE (e) 91% 90% 90% 92% --- --- --- --- Office Buildings: Emerson Center Atlanta, GA 85% 65% 55% 90% NW O'Hare Des Plaines, IL 89% 88% 78% 87% Rancho Sorrento San Diego, CA 83% 80% 63% 83% --- --- --- --- SUBTOTAL OR WEIGHTED AVERAGE (e) 85% 77% 65% 87% --- --- --- ---
9 10 NATIONAL INCOME REALTY TRUST REAL ESTATE SUMMARY (CONTINUED) DECEMBER 31, 1997 (Unaudited)
Average Rent Per Sq. Ft.(a) Current Number Year Ended December 31, Market of Square -------------------------- Rent Per Property Location Units Footage 1997 1996 1995 Sq. Foot(b) - -------- -------- --- ------- ------ ------ ------ ----------- PROPERTIES ACQUIRED PRIOR TO DECEMBER 31,1995: Shopping Centers: Emerson Center Atlanta, GA -- 17,733 $12.86 $13.61 $12.41 $14.31 K-Mart Plaza Charlotte, NC (f) -- 117,200 .47 0.39 0.42 2.57 K-Mart Plaza Temple Terrace, FL -- 63,887 3.65 3.65 3.65 3.65 K-Mart Plaza Thomasville, GA (g) -- 55,552 2.96 2.96 2.96 2.96 Lakeview Mall Manitowoc, WI -- 214,620 .74 1.43 1.33 2.98 Midland Plaza Midland, MI -- 30,650 3.38 3.38 3.38 3.38 Midway Mills Carrollton, TX -- 72,065 9.74 9.70 8.91 10.96 Mountain View Las Vegas, NV -- 20,092 10.68 10.17 9.80 10.76 Northside Mall Gainesville, FL (h) -- 139,337 3.84 3.93 3.86 4.11 Southgate Waco, TX -- 80,725 2.48 2.47 2.93 5.25 Stewart Square Las Vegas, NV -- 39,600 9.43 8.96 8.04 11.07 Times Square Lubbock, TX -- 19,550 5.07 4.72 3.38 6.21 --------- --------- ------ ------ ------ ------ SUBTOTAL OR WEIGHTED AVERAGE (e) -- 871,011 3.52 3.67 3.51 4.89 --------- --------- ------ ------ ------ ------ SUBTOTAL PRIOR TO ACQUISITIONS (e) -- 6,161,030 6.58 7.75 7.89 10.28 --------- --------- ------ ------ ------ ------ 1996 Acquisitions: River City Landing Jacksonville, FL 352 356,800 2.99 2.79 -- 6.46 The Regent Jacksonville, FL (i) 304 288,320 3.74 1.74 -- 6.09 Woodbrier Oklahoma City, OK 128 114,900 4.63 4.59 -- 5.50 Jackson Square Jackson, MS (j) -- 341,361 1.23 1.32 -- 3.27 --------- --------- ------ ------ ------ ------ SUBTOTAL OR WEIGHTED AVERAGE (e) 784 1,101,381 2.81 2.24 -- 5.27 --------- --------- ------ ------ ------ ------ 1997 Acquisitions: English Village Memphis, TN 300 364,680 4.70 -- -- 5.43 Fountainhead Kissimmee, FL 184 172,578 7.78 -- -- 8.85 Landmark Tallahassee, FL 128 113,720 3.71 -- -- 6.69 Morningside Jacksonville, FL 112 89,200 5.90 -- -- 7.09 Newport Plantation, FL 152 139,364 7.71 -- -- 9.37 Courtyard at the Park Miami, FL 127 117,250 4.96 -- -- 8.75 Mariner Plaza Tallahassee, FL -- 52,288 5.34 -- -- 6.01 Vistas at Lake Worth Fort Worth, TX (k) 265 188,120 .04 -- -- 13.00 --------- --------- ------ ------ ------ ------ SUBTOTAL OR WEIGHTED AVERAGE (e) 1,268 1,237,200 4.81 -- -- 8.08 --------- --------- ------ ------ ------ ------ ACQUISITIONS SUBTOTAL OR WEIGHTED AVERAGE (e) 2,052 2,338,581 3.87 2.24 -- 6.76 --------- --------- ------ ------ ------ ------ GRAND TOTAL 7,987 8,499,611 5.80 6.92 7.89 9.31 ========= ========= ====== ====== ====== ====== Economic Occupancy(c) Year Ended December 31, Physical ----------------------- Occupancy Property Location 1997 1996 1995 Dec. 31, 1997 (d) - -------- -------- ---- ---- ----- ----------------- PROPERTIES ACQUIRED PRIOR TO DECEMBER 31,1995: Shopping Centers: Emerson Center Atlanta, GA 91% 100% 96% 77% K-Mart Plaza Charlotte, NC (f) 27% 21% 21% 3% K-Mart Plaza Temple Terrace, FL 100% 100% 100% 100% K-Mart Plaza Thomasville, GA (g) 100% 100% 100% 100% Lakeview Mall Manitowoc, WI 30% 43% 45% 38% Midland Plaza Midland, MI 100% 100% 100% 100% Midway Mills Carrollton, TX 93% 99% 95% 94% Mountain View Las Vegas, NV 100% 100% 100% 100% Northside Mall Gainesville, FL (h) 94% 94% 94% 98% Southgate Waco, TX 51% 50% 64% 43% Stewart Square Las Vegas, NV 93% 92% 87% 94% Times Square Lubbock, TX 83% 80% 59% 80% ---- ---- ---- ---- SUBTOTAL OR WEIGHTED AVERAGE (e) 66% 69% 70% 64% ---- ---- ---- ---- SUBTOTAL PRIOR TO ACQUISITIONS (e) 87% 87% 86% 88% ---- ---- ---- ---- 1996 Acquisitions: River City Landing Jacksonville, FL 54% 55% -- 76% The Regent Jacksonville, FL (i) 67% 31% -- 88% Woodbrier Oklahoma City, OK 94% 97% -- 89% Jackson Square Jackson, MS (j) 38% 46% -- 40% ---- ---- ---- ---- SUBTOTAL OR WEIGHTED AVERAGE (e) 57% 50% -- 69% ---- ---- ---- ---- 1997 Acquisitions: English Village Memphis, TN 95% -- -- 93% Fountainhead Kissimmee, FL 96% -- -- 96% Landmark Tallahassee, FL 75% -- -- 73% Morningside Jacksonville, FL 93% -- -- 95% Newport Plantation, FL 86% -- -- 85% Courtyard at the Park Miami, FL 68% -- -- 49% Mariner Plaza Tallahassee, FL 90% -- -- 88% Vistas at Lake Worth Fort Worth, TX (k) 1% -- -- 2% ---- ---- ---- ---- SUBTOTAL OR WEIGHTED AVERAGE (e) 75% -- -- 72% ---- ---- ---- ---- ACQUISITIONS SUBTOTAL OR WEIGHTED AVERAGE (e) 66% 50% -- 71% ---- ---- ---- ---- GRAND TOTAL 81% 81% 86% 83% ==== ==== ==== ====
10 11 NATIONAL INCOME REALTY TRUST REAL ESTATE SUMMARY (CONTINUED) DECEMBER 31, 1997 (Unaudited) (a) Amounts represent rental revenue per square foot on an annual basis. Rental revenue is equal to gross potential rent after giving effect to all rental losses including bad debts, vacancies, and discounts and concessions. Gross potential rent equals actual lease rates on leased units/space and market rates on vacant units/space. (b) Represents annualized market rate per square foot at December 31, 1997, based upon scheduled rents at such time. (c) Computed as follows: [(Annual gross potential rent less annual vacancy losses) divided by annual gross potential rent]. (d) Represents actual physical occupancy as of the end of the last week of the fiscal year ended December 31, 1997. (e) The weighted average rent per square foot and occupancy are based on the square footage in each property. (f) K-Mart's lease expired January 1994. At December 31, 1997, space had not been re-leased. (g) Lease expires September 2004. During the first quarter of 1995, K-Mart moved out and sublet the space to two tenants. (h) K-Mart's lease expires September 2002. K-Mart moved out in 1993 and continues to pay the scheduled rent on the portion of the space it has not sublet. (i) For the purpose of this schedule, this property is included with 1996 acquisitions because operations began during 1996 although the property was purchased in 1995. (j) This property was acquired through a deed in lieu of foreclosure in January 1996. (k) For purposes of this schedule, this property is included with 1997 acquisitions because operations began during 1997 although the property was purchased in 1994. Management believes that its properties are adequately covered by liability and casualty insurance, consistent with industry standards. 11 12 NATIONAL INCOME REALTY TRUST MORTGAGE LOANS SECURED BY OWNED PROPERTIES DECEMBER 31, 1997 (Dollars in thousands) (Unaudited)
Stated Balance Original Balance Interest Maturity Due at Name of Property Amount Dec 31, 1997 Rate (A) Date Maturity - ---------------- ------ ------------ -------- ---- -------- Residential Acadian Place (B) .................. $ 2,775 $ 2,775 8.47% Jun -00 $ 2,775 Bay West............................ 5,100 4,841 8.89% Jan -19 -- Bayfront............................ 2,086 2,013 8.99% Jul -00 1,953 Bryan Hill.......................... 3,500 3,500 6.93% Jan -08 2,998 Carlyle Towers...................... 4,500 3,844 10.19% Mar -99 3,625 Cornell............................. 1,623 1,490 8.50% Jan -99 1,467 Courtyard at the Park............... 2,973 2,953 7.38% Dec -00 2,779 Creekwood North..................... 3,050 3,009 8.05% May -06 2,683 Cross Creek......................... 2,720 2,716 7.54% Oct -07 2,363 Dunhill/Devonshire/Sandstone (B).... 13,200 13,200 8.47% Jun -00 13,200 English Village..................... 6,200 6,019 7.56% Dec -05 4,965 Fenway Hall......................... 1,375 1,303 8.50% Oct -98 1,288 Forest Oaks......................... 3,075 3,015 8.16% Jun -06 2,501 Fountainhead (B) ................... 5,650 5,650 8.47% Jun -00 5,650 Heather Hills....................... 16,790 16,865 7.88% Jan -31 117 Kirklevington....................... 2,470 2,415 9.00% Nov -99 2,364 Lake Point (B) ..................... 9,000 9,000 8.47% Jun -00 9,000 Landmark............................ 1,500 1,500 8.47% Jun -00 1,500 Marina Park......................... 2,500 2,403 9.00% May -98 2,388 Mariposa Manor...................... 784 757 8.13% Apr -02 703 Martins Landing..................... 5,000 4,856 7.65% Dec -05 4,014 Meadowbrook (B)..................... 2,513 2,513 8.47% Jun -00 2,513 Morningside......................... 1,641 1,623 8.35% Apr -03 1,474 Newport............................. 5,058 5,030 8.18% Apr -06 4,490 Palm Court.......................... 3,000 2,901 9.67% Dec -04 2,525 Park Dale Gardens................... 3,000 2,904 8.30% Jul -05 2,448 Park Norton......................... 564 545 6.05% Jun -05 473 Pinecrest........................... 14,500 14,420 7.96% Apr -17 8,799 Prado Bay........................... 4,800 4,800 7.05% Jan -08 4,124 River City Landing(B)............... 6,100 6,100 8.47% Jun -00 6,100 Spring Pines (B).................... 1,300 1,300 8.47% Jun -04 1,300 Summit on the Lake.................. 4,800 4,782 6.35% Aug -27 - Woodbrier........................... 1,300 1,165 7.93% Nov -03 872 Woodcreek (CO)...................... 3,000 2,812 10.19% Mar -99 2,750 Woodcreek (FL)...................... 3,800 3,683 9.73% Feb -05 3,203 ------- ------- ---- ------- 151,247 148,702 8.21% (C) 109,404 ------- ------- ---- -------
- --------------- (A) For loans with variable interest rates, the rate in effect for the month of December 1997 is presented. (B) Represents an advance under the $50 million revolving credit facility with GMAC Commercial Mortgage. (C) Represents weighted average interest rate for the month of December 1997. 12 13 NATIONAL INCOME REALTY TRUST MORTGAGE LOANS SECURED BY OWNED PROPERTIES (Continued) DECEMBER 31, 1997 (Dollars in thousands) (Unaudited)
Stated Balance Original Balance Interest Maturity Due at Name of Property Amount Dec 31, 1997 Rate (A) Date Maturity - ---------------- ------ ------------ -------- ---- -------- Office Buildings Emerson Center ................. $ 2,900 $ 2,854 8.75% May-99 $ 2,808 Emerson Center (B) ............. 1,218 923 -- May-99 841 Northwest O'Hare ............... 2,000 771 7.75% Nov-98 676 Northwest O'Hare ............... 415 227 8.75% Feb-01 159 Rancho Sorrento ................ 3,550 2,780 9.00% Aug-00 2,414 Rancho Sorrento ................ 2,650 2,604 8.13% Mar-09 1,575 --------- --------- --------- --------- 12,733 10,159 8.57%(C) 8,473 --------- --------- --------- --------- Shopping Centers Emerson Center ................. 1,250 1,212 9.50% Jul-99 1,193 K-Mart - Charlotte ............. 1,360 1,256 10.00% Oct-98 1,238 K-Mart - Temple Terrace ........ 1,750 948 8.50% May-05 -- K-Mart - Temple Terrace ........ 347 325 10.25% Oct-98 321 K-Mart - Thomasville ........... 1,300 744 9.63% Sep-05 -- K-Mart - Thomasville ........... 290 271 10.25% Oct-98 268 Midland Plaza .................. 305 283 10.00% Oct-98 278 Midway Mills ................... 4,200 4,101 8.64% Dec-05 3,465 Mountain View .................. 1,050 1,038 11.68% Jul-06 891 Northside Center ............... 3,100 1,710 9.00% Nov-05 -- Stewart Square ................. 2,070 2,070 8.47% Dec-04 1,681 --------- --------- --------- --------- 17,022 13,958 9.22%(C) 9,335 --------- --------- --------- --------- Line of credit (D) ................. 9,000 7,479 7.78% Sep-98 7,407 RI Windsor, Ltd., equity loan (E) .. 2,200 2,200 8.75% Jan-99 2,200 --------- --------- --------- --------- 11,200 9,679 8.00%(C) 9,607 --------- --------- --------- --------- Total .............................. $ 192,202 $ 182,498 8.29%(C) $ 136,819 ========= ========= ========= =========
- ---------------------- (A) For loans with variable interest rates, the rate in effect for the month of December 1997 is presented. (B) Represents non-interest bearing unsecured debt associated with the property payable from 30% of Excess Cash Flow, as defined, of the property or funds from the sale or refinance of the property. (C) Represents weighted average interest rate for the month of December 1997. (D) The line of credit is secured by mortgages on Diamond Loch Apartments, Mustang Creek Apartments, and The Regent Apartments. (E) The equity loan is secured by 352,000 shares of the Trust's shares of beneficial interest and is cross-collateralized with the line of credit. 13 14 ITEM 2. PROPERTIES (Continued) Partnership Properties. The Trust and Continental Mortgage and Equity Trust ("CMET") own two fully leased office buildings in the vicinity of Sacramento, California, as tenants-in-common with the Trust having a 70% undivided interest. Under the terms of the joint tenancy agreement, the Trust and CMET must agree over any material change in the operations of the properties, including sales, refinancings, and changes in property management. The Trust, as a noncontrolling partner, accounts for its investment in these properties using the equity method. In June 1995, the Trust acquired a 50% economic interest in an office building located at 801 Pennsylvania Avenue, Washington, D.C., (the "Property") through the purchase of a first lien mortgage note with a face value of $8.5 million (the "Note") for $3 million. In accordance with the terms of the Note, the Trust's $3 million investment, as well as any additional advances made to the Property, is to be repaid from Property cash flow after operating expenses with interest at the rate of 11% per annum. The $5.5 million remaining balance of the Note plus accrued interest entitles the Trust to 50% of all funds available after Property operating expenses plus 50% of the proceeds from any sale and any refinancing. The Note is nonrecourse to all parties and is secured only by the Property. The Trust accounts for this investment using the equity method. In January 1997, the Trust acquired 50% of RI Windsor, Ltd., which completed construction of a 324-unit luxury apartment complex in Jacksonville, Florida, known as The Mayfaire at Windsor Parke in March 1998. Initial operations began at the property in August 1997. A portion of the $18.6 million construction cost was financed by a $16 million construction loan. In June 1997, the Trust acquired 50% of RI Panama City, Ltd., which is constructing a 200-unit apartment property known as Harbour Green in Panama City, Florida. Construction, at a total estimated cost of $10.5 million, is expected to be complete in the second quarter of 1998. The partnership obtained an $8.8 million construction loan to finance a portion of the construction. The first units became available for rent in January 1998. In September 1997, the Trust acquired 60% of Danforth National Apartments, Ltd., which is constructing a 288-unit apartment complex to be known as The Club at Danforth in Jacksonville, Florida, for a total cost of $17.1 million. The partnership obtained a $13.7 million construction loan in January 1998. This property is expected to be complete in the third quarter of 1998. In February 1998, the Trust purchased another partner's interest in the partnership and currently has an 80% interest in the partnership. In December 1997, the Trust acquired a 50% interest in Tarragon Savannah, L.P., which is constructing a 250-unit apartment property to be known as The Links at Georgetown in Savannah, Georgia. Total development cost is estimated at $14.5 million, $12 million of which will be provided by a construction loan. Construction is expected to be complete in the second quarter of 1999. The Trust has advanced substantially all of the equity for these four construction projects as interest-bearing priority loans to these partnerships. Principals of the Trust's partners have personally guaranteed each of the construction loans. In December 1997, the Trust acquired a 70% interest in Ansonia Apartments, L.P. ("Ansonia"). This partnership purchased two operating apartment properties, Meriden East with 66 units in Meriden, Connecticut, and Autumn Ridge with 116 units in East Haven, Connecticut, in December 1997 for an aggregate purchase price of $3.8 million, $2.9 million of which was financed through mortgages on each property. 14 15 ITEM 2. PROPERTIES (Continued) The following table sets forth certain information relating to the operating properties owned by Trust partnerships (including Mayfaire at Windsor Parke for which initial operations began in August 1997) as of December 31, 1997. Although the two properties owned by Ansonia are operating, because they were purchased in December 1997 and have less than one month's activity during 1997, Ansonia is excluded from the following table.
Average Rent Economic Per Square Foot (a) Occupancy (b) Property Number Square ------------------- ------------------ Partnership Location of Units Footage 1997 1996 1997 1996 ----------- -------- -------- ------- ----- ----- ----- ---- RI Windsor, Ltd. Jacksonville, FL 324 339,886 $ .60 (C) 15% (C) Sacramento Nine Rancho Cordova, CA - 105,249 12.97 10.76 100% 91% 801 Pennsylvania Washington, D.C. - 62,229 11.63 9.32 82% 56%
- --------------------- (a) Amounts represent rental revenue per square foot on an annual basis. Rental revenue is equal to gross potential rent after giving effect to all rental losses including bad debts, vacancies, and discounts and concessions. Gross potential rent equals actual lease rates on leased units/space and market rates on vacant units/space. (b) Computed as follows: [(Annual gross potential rent less annual vacancy losses) divided by annual gross potential rent]. (c) Property was constructed and began operating during 1997. Therefore, there is no 1996 information. ITEM 3. LEGAL PROCEEDINGS The Trust is a party to various claims and routine litigation arising in the ordinary course of business. Management of the Trust does not believe that the results of these claims and litigation, individually or in the aggregate, will have a material adverse effect on its business, financial position, or results of operations. Also, see ITEM 10. "TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT" for a description of the results of the Olive modification. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders. [This space intentionally left blank.] 15 16 PART II ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS The Trust's shares of beneficial interest, no par value (the "Shares" and each a "Share"), are traded in the over-the-counter market of the National Association of Securities Dealers Automated Quotation ("NASDAQ") System under the symbol "NIRTS." The following table sets forth the high and low bid quotations of the Shares as reported by the NASDAQ System for the periods indicated, which consist of the last two fiscal years and the quarter ending for which this report is filed, all after giving retroactive effect to the 10% share distributions in September 1996 and September 1997. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commissions, and may not necessarily represent actual transactions.
1997 1996 -------------------------- --------------------------- High Low High Low ---------- ---------- ---------- ----------- First quarter $ 13 7/8 $ 11 1/8 $ 11 $ 9 1/8 Second quarter 14 1/2 13 7/8 11 5/8 11 Third quarter 15 5/8 14 1/8 11 5/8 11 1/8 Fourth quarter 17 15 1/4 11 1/4 10 7/8
For the first quarter of 1998 through March 13, 1998, the high and low bid quotations of the Shares as reported by the NASDAQ System were $18 and $15 3/4, respectively. During this period, the Trust's Shares traded as high as $18 1/8. According to the transfer agent's records, such shares were held by approximately 10,100 holders, including beneficial holders. Cash distributions paid to shareholders in 1997 and 1996 were as follows (restated to give effect to the 1997 and 1996 share distributions):
1997 1996 ------- ------- First quarter $ .18 $ .17 Second quarter .18 .17 Third quarter .18 .17 Fourth quarter .20 .18
[This space intentionally left blank.] 16 17 ITEM 6. SELECTED FINANCIAL DATA The following information should be read in conjunction with all of the financial statements and notes thereto and with the discussion set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K. Dollar amounts are in thousands, except per share amounts.
For the Years Ended December 31, ------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- OPERATING DATA Revenue ................................. $ 52,017 $ 49,962 $ 45,240 $ 40,135 $ 36,357 Expenses ................................ (51,749) (49,176) (46,214) (40,915) (40,370) ----------- ----------- ----------- ----------- ----------- Income (loss) before net gain on sale of real estate, gain on sale of investments, gain on insurance settlement, and extraordinary gain .... 268 786 (974) (780) (4,013) Net gain on sale of real estate ......... 4,350 3,700 533 385 945 Gain on sale of investments ............. 913 -- 412 141 -- Gain on insurance settlement ............ -- 451 -- -- -- ----------- ----------- ----------- ----------- ----------- Income (loss) from continuing operations ............................ 5,531 4,937 (29) (254) (3,068) Extraordinary gain ...................... 61 -- 737 -- 8,888 ----------- ----------- ----------- ----------- ----------- Net income (loss) ....................... $ 5,592 $ 4,937 $ 708 $ (254) $ 5,820 =========== =========== =========== =========== =========== PER SHARE DATA (1) EARNINGS PER SHARE Income (loss) from continuing operations ............................ $ 1.44 $ 1.21 $ (.01) $ (.06) $ (.69) Extraordinary gain ...................... .02 -- .18 -- 1.99 ----------- ----------- ----------- ----------- ----------- Net income (loss) ....................... $ 1.46 $ 1.21 $ .17 $ (.06) $ 1.30 =========== =========== =========== =========== =========== Weighted average shares (2) ............. 3,832,535 4,070,183 4,101,453 4,262,073 4,469,426 EARNINGS PER SHARE - ASSUMING DILUTION Income (loss) from continuing operations ............................ $ 1.43 $ 1.21 $ (.01) $ (.06) $ (.69) Extraordinary gain ...................... .01 -- .18 -- 1.99 ----------- ----------- ----------- ----------- ----------- Net income (loss) ....................... $ 1.44 $ 1.21 $ .17 $ (.06) $ 1.30 =========== =========== =========== =========== =========== Weighted average shares - assuming dilution (3) ................. 3,871,248 4,088,382 4,101,961 4,262,073 4,469,426 Distributions (4) ....................... $ .74 $ .69 $ .62 $ .47 $ .14
- ------------------- (1) Share and per share data have been restated to give effect to 10% share distributions paid in September of each of 1994 through 1997. (2) Represents the weighted average shares of beneficial interest used in the computation of earnings per share. (3) Represents the weighted average shares of beneficial interest used in the computation of earnings per share-assuming dilution. (4) 1997 and 1993 distributions were taxable to shareholders as ordinary income. Distributions in 1996, 1995, and 1994 represented return of capital. 17 18 ITEM 6. SELECTED FINANCIAL DATA (Continued)
December 31, ---------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- BALANCE SHEET DATA Real estate ......................... $ 233,936 $ 193,722 $ 195,675 $ 184,658 $ 168,013 Notes and interest receivable(1) .... -- -- 6,388 9,997 12,909 Investments in partnerships ......... 13,839 4,739 10,780 11,026 11,804 Total assets ........................ 265,640 211,341 222,038 217,040 199,486 Notes, debentures, and interest payable ................. 184,126 134,270 144,497 138,316 114,351 Shareholders' equity ................ 71,091 69,063 69,627 73,360 78,174 Book value per share ................ $ 18.65 $ 19.60 $ 20.53 $ 22.81 $ 22.94
For the Years Ended December 31, --------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- OTHER DATA Cash flows provided by (used in): Operating activities............... $ 3,261 $ 3,795 $ 2,030 $ 1,852 $ 3,620 Investing activities............... (43,813) (436) (5,436) (1,409) 1,272 Financing activities............... 40,952 (1,171) 1,596 1,981 (5,582) Calculation of funds from operations: Net income (loss) ................. $ 5,592 $ 4,937 $ 708 $ (254) $ 5,820 Extraordinary gain ................ (61) -- (737) -- (8,888) Gain on insurance settlement (2) .. -- (451) -- -- -- Gain on sale of real estate ....... (4,350) (3,700) (533) (385) (945) Gain on sale of investments ....... (215) -- -- -- -- Depreciation and amortization of real estate assets ........... 7,225 5,374 5,959 4,992 4,639 Depreciation and amortization of real estate assets of partnerships ................. 356 305 882 1,086 918 Distributions from partnerships in excess of the Trust's investments in the partnerships . (41) (899) -- -- -- ---------- ---------- ---------- ---------- ---------- Funds from operations (3) .............. $ 8,506 $ 5,566 $ 6,279 $ 5,439 $ 1,544 ========== ========== ========== ========== ==========
- --------------------------------------------- (1) Notes and interest receivable at December 31, 1997 and 1996, are classified with other assets. (2) The gain on insurance settlement represents the Trust's share of the gain realized by Indcon, L.P., in which the Trust held a 40% interest until November 1997. One of Indcon's warehouses was destroyed by fire in September 1995. An insurance settlement totaling $2.2 million was reached by the partnership in March 1996. As the partnership did not intend to rebuild the property, upon receipt of the insurance proceeds, the property was written off. This resulted in a gain of $1.1 million, of which the Trust's share was $451,000. 18 19 ITEM 6. SELECTED FINANCIAL DATA (Continued) OTHER DATA (Continued) - ------------------------- (3) The Trust generally considers funds from operations ("FFO") to be an appropriate measure of the performance of an equity real estate investment trust ("REIT"). FFO, as defined by the National Association of Real Estate Investment Trusts ("NAREIT"), equals net income (loss), computed in accordance with generally accepted accounting principles ("GAAP"), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO on the same basis. The amortization of deferred financing costs is not added back to net income (loss) in the Trust's calculation. This treatment is consistent with the Trust's historical calculation of FFO. The Trust believes that FFO is useful to investors as a measure of the performance of an equity REIT because, along with cash flows from operating activities, investing activities, and financing activities, it provides investors an understanding of the ability of the Trust to incur and service debt and to make capital expenditures. The Trust believes that in order to facilitate a clear understanding of its operating results, FFO should be examined in conjunction with net income (loss) as presented in the financial statements included elsewhere in this report. FFO does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indication of the Trust's operating performance or to cash flow as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs and cash distributions. The Trust's calculation of FFO may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs. Effective January 1, 1997, the Trust modified its calculation of FFO to include the add back of amortization of leasing commissions associated with its commercial properties. The Trust believes that this treatment is consistent with a majority of other REITs. If the Trust had calculated FFO in the same manner for each of the years ended December 31, 1996, 1995, 1994, and 1993, FFO would have been higher by $262,000, $272,000, $235,000, and $244,000, respectively. Included in FFO for the years ended December 31, 1997, 1995, and 1994, are gains totaling $698,000, $412,000, and $141,000, respectively, resulting from the Trust's sale of investments in marketable equity securities. Included in FFO for the years ended December 31, 1993 and 1996, are provisions for losses of $1.4 million and $300,000, respectively. Included in FFO for the year ended December 31, 1995, is a provision for losses credit of $425,000. See NOTE 2. "ALLOWANCE FOR ESTIMATED LOSSES AND PROVISIONS FOR LOSSES" in the Notes to Consolidated Financial Statements for descriptions of the 1996 and 1995 provisions for losses. The 1993 provision for losses was recorded to provide allowances for estimated losses against one property held for sale and one mortgage note receivable. 19 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes thereto. Introduction National Income Realty Trust (the "Trust") invests in income-producing real estate through acquisitions, leases and partnerships. The Trust was organized on October 31, 1978, and commenced operations on March 27, 1979. At December 31, 1997, the Trust's real estate portfolio included 61 properties (eight held for sale) located throughout the United States, with concentrations in the Southeast and Southwest. These properties include 40 apartment complexes, 14 shopping centers, three office buildings, three parcels of land, and one single-family residence. All of the Trust's real estate, except for eleven properties, is encumbered by mortgages. The Trust's current policy is to make mortgage loans only in connection with, and to facilitate, the sale or acquisition of real estate. Accordingly, as existing mortgages are paid off, the Trust's portfolio of mortgage notes receivable has declined and is expected to continue to decline. The Trust's objective is to maximize the long term value of its real estate portfolio with an emphasis on increasing operating income and future cash distributions to shareholders. Management focuses on both the appreciation of the existing real estate portfolio, through intensive management and capital improvements, and enlarging the portfolio with highly selective and opportunistic acquisitions concentrated on older, under-managed, and under-performing multifamily projects in geographical regions where the Trust presently owns properties. The Trust also intends to invest increasing amounts in new construction of apartment properties either directly or through partnerships. In the first quarter of 1998, the Trust completed construction of two apartment properties, one of which is owned through a partnership. The Trust currently has three apartment properties under construction, all of which are owned through partnerships. To the extent it invests in construction projects, the Trust is subject to business risks, such as cost overruns and delays, associated with such higher risk activities. In addition to raising capital through operating income, the Trust intends to generate capital through mortgage refinancings and selective disposition of certain assets. Liquidity and Capital Resources Cash and cash equivalents aggregated $4.3 million at December 31, 1997, compared with $3.9 million at December 31, 1996. The Trust's principal sources of cash have been property operations and external sources, such as property sales and refinancings. The Trust expects these sources will continue to be sufficient to meet projected cash requirements, including debt service obligations, property maintenance and improvements, and continuation of regular distributions. Operating Activities The Trust's cash flow from property operations (rentals collected less payments for property operating expenses) continues to increase from $17.6 million in 1995 to $19.3 million in 1996 and $20.7 million in 1997, primarily due to acquisitions made in 1995, 1996, and 1997. In September 1996, the Trust sold Century Centre II Office Building ("Century Centre") for $28.2 million. In 1995 and 1996, Century Centre had accounted for $1.4 million and $1.5 million, respectively, of cash flow from operations. See NOTE 3. "REAL ESTATE AND DEPRECIATION" in the Notes to Consolidated Financial Statements for a discussion of the sale. 20 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Investing Activities The Trust purchased six apartment communities in 1995, two in 1996, and five in 1997, increasing the Trust's multifamily portfolio by 1,991 units. The Trust also purchased a 52,288 square foot shopping center in 1997. The aggregate purchase prices for the 1995, 1996, and 1997 acquisitions were $11.4 million, $9.4 million, and $23.4 million respectively. The aggregate cash portions of the purchase prices for the 1995, 1996, and 1997 acquisitions were $3.8 million, $3.2 million, and $13.7 million, respectively. The balance of the acquisition cost was financed through mortgages on certain of the properties. The Trust also added 300 units to its multifamily portfolio through its acquisition of an additional 40% interest in English Village Partners, L.P. ("English Village"), increasing its total ownership to 90%, for $1 million in July 1997. While the Trust previously accounted for its investment in English Village using the equity method, English Village is now consolidated. In 1997, the Trust sold multifamily properties in Sacramento, California, Philadelphia, Pennsylvania, and Kansas City, Missouri, each in which the Trust owned only a single property, in separate transactions for an aggregate sale price of $14 million, receiving net cash proceeds of $6.4 million. In September 1996, the Trust sold Century Centre for $28.2 million, receiving net cash proceeds of $6.2 million. During 1995, the Trust sold major portions of Lake Highlands land in Dallas, Texas, and K-Mart Shopping Center in Kansas City, Missouri. The Trust received aggregate net cash proceeds of $1.6 million in connection with the 1995 sales. During 1995, 1996, and 1997, the Trust made real estate improvements totaling $8 million, $13.5 million, and $27.3 million, respectively, to its properties, including $1.1 million, $5.9 million, and $9.7 million, respectively, on construction at redevelopment properties. Construction at The Vistas at Lake Worth was completed in the first quarter of 1998 with 1998 construction costs of $1.3 million. The Trust anticipates capital improvement expenditures on its other properties during 1998 to total approximately $13.3 million. In addition to capital improvements noted above, payments for property operating expenses in 1995, 1996, and 1997 include property replacements of $2.5 million, $2.8 million, and $2.1 million, respectively. Property replacements include such items as plumbing replacements, landscaping, exterior painting, parking lot improvements, and, in 1995 and 1996, carpet and appliances. In 1997, the Trust began capitalizing carpet, appliances, and heating, ventilation, and air conditioning replacements. See discussion below under "Implementation of Change in Accounting Estimate." During 1995, 1996, and 1997, the Trust received $3.6 million, $2.1 million, and $187,000, respectively, representing collections of notes receivable. The Trust expects mortgage note collections to continue to decline as existing mortgage loans are paid off and does not anticipate funding mortgage loans in the future, except in connection with, or to facilitate, the sale of real estate. In January and February 1995, the Trust sold its remaining 39,500 shares of beneficial interest of Continental Mortgage and Equity Trust ("CMET") for $593,000 in cash. 21 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Investing Activities (Continued) In June 1995, the Trust acquired a 50% economic interest in an office building in Washington, D.C., through the purchase of a first lien mortgage note with a face value of $8.5 million (the "Note") for $500,000 in cash and a $2.5 million promissory note which the Trust paid off in September 1995. In accordance with the terms of the agreement with the property owner, the Trust's $3 million investment is to be repaid with interest at 11% per annum from cash flow after operating expenses. The remaining $5.5 million balance of the Note plus accrued interest may be satisfied by payment of 50% of all funds available after property operating expenses plus 50% of the proceeds from any sale and any refinancing. The Trust intends to refinance the property in 1998 for an amount substantially in excess of its investment. The Trust and CMET were partners in Income Special Associates ("ISA"), a general partnership in which the Trust had a 40% interest in earnings, losses, and distributions. ISA in turn owned a 100% interest in Indcon, L.P. ("Indcon"), which owned four industrial warehouses at December 31, 1997. During the first half of 1996, Indcon sold 27 warehouses for $41.2 million, receiving net cash proceeds of $16.8 million, after the payoff of the existing $23.5 million mortgage loan and related closing costs. Indcon distributed $6.8 million to the Trust as its proportionate share of the sale proceeds plus an allowance for brokerage commissions. In November 1997, the Trust sold its interest in the partnership to CMET for $1.6 million in cash. During 1997, the Trust acquired interests in five partnerships in exchange for capital contributions totaling $1.6 million. Four of the partnerships are each constructing a luxury apartment complex for a total of 1,062 units. The fifth partnership purchased two operating properties with a total of 182 units in December 1997. The Trust also made aggregate advances to these partnerships of $8.4 million. The advances bear interest at market rates and are to be repaid out of the first funds available to the respective partnership. Also, during 1997, the Trust made investments in marketable equity securities of unaffiliated real estate companies of $2.5 million. During this same period, the Trust sold $2.6 million in marketable equity securities and realized gains on these sales totaling $698,000. As of December 31, 1997, there were unrealized gains on the remaining investments of $133,000. During the fourth quarter of 1997, the Trust advanced $696,000 to National Omni Associates, L.P., ("Omni") in exchange for a 46% interest in the partnership. In January and February 1998, the Trust advanced an additional $4.6 million to the partnership. In February 1998, Omni purchased 5600 Collins Avenue, a 289-unit luxury high rise apartment building in Miami Beach, Florida, for $32 million. $26 million of the purchase price was financed through first and second lien mortgage debt. 22 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Financing Activities During 1997, the Trust obtained first and interim mortgage financing (including advances under line of credit facilities) totaling $77.3 million secured by 15 properties and received $38.5 million of net cash proceeds after the payoff of $32.9 million in existing mortgage debt on such properties, establishing required escrows, and paying associated closing costs. In addition, the Trust paid off a $1.3 million mortgage loan secured by Southgate Shopping Center, scheduled to mature in 2003, for $850,000. In connection with the payoff, the Trust recognized a $431,000 extraordinary gain on forgiveness of debt. The Trust also made $2.5 million of other principal payments in 1997. During 1996, the Trust obtained first mortgage financing totaling $34.3 million secured by nine Trust properties and received net cash proceeds of $7.3 million after the payoff of $24.4 million in existing mortgage debt on such properties, establishing required escrows, and paying associated closing costs. The Trust also paid off mortgage loans scheduled to mature in 1996 totaling $689,000 and made $3.4 million of other principal payments. During 1995, the Trust obtained $18 million in first mortgage financing on five Trust properties and received net cash proceeds of $4.5 million after the payoff of $12.2 million in existing mortgage debt. The Trust also obtained short term financing totaling $5.5 million, $2.5 million of which was paid off in 1996, which was used to facilitate the payoff of three mortgage loans totaling $6.4 million. Additionally, in September 1995, the Trust paid $2.4 million in satisfaction of the note payable which financed the acquisition of the 801 Pennsylvania Avenue investment. The Trust also extended or paid off mortgage loans scheduled to mature in 1995 totaling $5 million and made other principal payments totaling $2.3 million. Mortgage principal payments totaling $16.2 million are due in 1998, including $14.1 million of balloon payments. The Trust intends to either pay off the maturing mortgages or extend the due dates while seeking to obtain long term refinancing. However, while management is confident of its ability to acquire financing as needed, there is no assurance that the Trust will continue to be successful in its efforts in this regard. Based on the performance of the Trust's properties, the Trust's Board of Trustees (the "Board") voted in July 1993 to resume the payment of regular quarterly cash distributions to shareholders. Cash distributions paid to shareholders totaled $2.5 million, $2.7 million, and $2.1 million in 1995, 1996, and 1997, respectively. The Trust also paid 10% share distributions in September of each of 1995, 1996, and 1997. During 1995, 1996, and 1997, the Trust repurchased 123,500, 285,189, and 48,472, of its shares of beneficial interest at a cost of $1.4 million, $3.7 million, and $748,000, respectively. During 1996, the Board authorized the Trust to repurchase up to an additional 281,592 shares of beneficial interest, of which 216,363 were purchased during 1996 and 1997. Two partnerships in which the Trust holds interests obtained first mortgage financing during 1995. The Trust received distributions totaling $3 million representing its share of the net refinancing proceeds. 23 24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations 1997 COMPARED TO 1996. The Trust reported net income of $5.6 million for the year ended December 31, 1997, compared to $4.9 million for the year ended December 31, 1996. The improvement in operating results is primarily related to increased net rental income as discussed below. Other components of this change are discussed in the following paragraphs. Net rental income increased from $19.4 million for the year ended December 31, 1996, to $22.1 million for the corresponding period in 1997. Multifamily Properties The Trust's multifamily portfolio, which represented 79% of the Trust's real estate and included 7,987 operating apartments at December 31, 1997, reported an increase in net rental income of $3.5 million, or 24%, for the year ended December 31, 1997, compared to the corresponding period in 1996. Of this increase, $1.3 million is related to properties acquired in 1996 and 1997. A decrease of $511,000 resulted from the sale of three multifamily properties in 1997. The portfolio of 30 apartment properties with 5,935 units owned for all of 1996 and 1997 generated an increase of $2.7 million, or 21%. Net rental income as a percentage of rental revenue for the 5,935 units increased from 38% to 44%. Rental revenue for the same store multifamily properties increased $1.6 million, or 5%, chiefly due to higher rental rates at certain properties. Average monthly rental revenue per unit for the same store properties increased 5% from $474 to $496. Property operating expenses on a same store basis decreased $1.1 million, or 5%, $957,000 of which is due to a decrease in replacements resulting from the change in accounting pursuant to which the Trust began capitalizing carpet, appliances, and heating, ventilation, and air conditioning replacements in 1997. See discussion below under "Implementation of Change in Accounting Estimate." Overall occupancy levels for multifamily properties held in both years increased slightly in 1997 compared to 1996. Commercial Properties The Trust's commercial portfolio included 1.6 million square feet at December 31, 1997. An increase in net rental income of $112,000 resulted from the addition of Jackson Square and Mariner Plaza Shopping Centers, acquired in January 1996 and August 1997, respectively. A decrease of $1.2 million resulted from the sale of Century Centre in September 1996. Commercial properties held in both years reported an overall increase in net rental income of $598,000 principally due to higher rents coupled with lower economic vacancies resulting from improved overall physical occupancy levels. Equity in income of partnerships was $643,000 for the year ended December 31, 1997, compared to $1.5 million for the corresponding period in 1996. This decrease was primarily due to 1996 income related to the distribution of financing proceeds by Sacramento Nine ("SAC 9") and English Village in excess of the Trust's investments in those partnerships. 24 25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) Interest expense was $12.6 million for the year ended December 31, 1997, compared to $12 million for the year ended December 31, 1996. An increase of $1.1 million resulted from interest on mortgage loans obtained or assumed in connection with 1996 and 1997 property acquisitions. In addition, long term and interim first mortgage financing, including advances under line of credit facilities, obtained on existing properties during 1996 and 1997 increased mortgage loans by $35.8 million and the related interest expense by $1.7 million for this period. A $1.4 million decrease resulted from the sale of four properties during 1996 and 1997. The remaining decrease is due to interest capitalized to the carrying values of unencumbered development properties during 1996 and 1997. Depreciation expense increased from $5.4 million for the year ended December 31, 1996, to $7 million for the corresponding period in 1997 due to additional depreciation associated with the 1996 and 1997 property acquisitions and capital improvements to its existing real estate between 1995 and 1997. Advisory fees to Tarragon Realty Advisors, Inc. ("Tarragon"), were $1.4 million in 1997 and $1.1 million in 1996. The advisory fee is an incentive fee equal to 16% per annum of adjusted funds from operations, as defined in the advisory agreement approved by the Board and shareholders. Funds from operations ("FFO"), as defined by the National Association of Real Estate Investment Trusts, increased from $5.6 million for the year ended December 31, 1996, to $8.5 million for the year ended December 31, 1997. However, for purposes of calculating the advisory fee, the effect of the accounting change is excluded from FFO. See ITEM 6. "SELECTED FINANCIAL DATA" for the calculation and definition of FFO. During 1997, the Trust recognized gains totaling $4.4 million on the sale of Plaza Hills Apartments, Huntington Green Apartments, and Pheasant Pointe Apartments and a $54,000 loss related to the sale of a warehouse owned by Indcon, in which the Trust held an effective 40% interest until November 1997. During 1997, the Trust recognized gains totaling $698,000 related to the sale of investments in marketable equity securities and a gain of $215,000 on the sale of the Trust's investment in Indcon. 1997 extraordinary items include an extraordinary gain on debt forgiveness of $431,000 in connection with the discounted payoff of the mortgage loan secured by Southgate Shopping Center and prepayment penalties and the write-off of deferred financing expenses totaling $370,000 in connection with certain 1997 refinancings. 1996 COMPARED TO 1995. The Trust reported net income of $4.9 million for the year ended December 31, 1996, compared to $708,000 for the year ended December 31, 1995. The primary reason for the improvement in operating results is the $3.7 million gain on the sale of Century Centre in September 1996. The other underlying components of the change in the Trust's results of operations are discussed in the following paragraphs. Net rental income increased from $18.1 million for the year ended December 31, 1995, to $19.4 million for the corresponding period in 1996. 25 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) Multifamily Properties The Trust's multifamily portfolio, which represented 75% of the Trust's real estate and included 7,078 operating units at December 31, 1996, reported an increase in net rental income of $1.2 million, or 9%, for the year ended December 31, 1996, as compared to the corresponding period in 1995, primarily due to properties acquired after 1994. Net rental income for multifamily properties held in both years remained relatively stable. Increased rental revenue from higher rental rates was offset by increased operating expenses related to the Trust's continued efforts to improve its properties. Overall, both physical and economic occupancy levels increased slightly for multifamily properties held in both years. Commercial Properties The Trust's commercial portfolio included 1.6 million square feet at December 31, 1996. An increase in net rental income of $206,000 resulted from the addition of Jackson Square Shopping Center, acquired through a deed in lieu of foreclosure in January 1996. A decrease of $549,000 resulted from the sale of two commercial properties in 1995 and 1996. Century Centre, which was sold in September 1996, generated net rental income of $1.2 million in 1996 prior to its sale and $1.6 million in 1995. Commercial properties held in both years reported an overall increase in net rental income of $459,000, principally due to lower vacancies. Interest revenue decreased from $1.1 million for the year ended December 31, 1995, to $631,000 for the corresponding period in 1996. This decrease resulted from the payoff of the Greentree mortgage note receivable in September 1995 and the acquisition of Jackson Square Shopping Center through deed in lieu of foreclosure in January 1996. Equity in income of partnerships was $1.5 million for the year ended December 31, 1996, compared to $770,000 for the corresponding period in 1995. This increase was primarily due to distribution of financing proceeds by SAC 9 and English Village in excess of the Trust's investments in those partnerships. Interest expense was $12 million for the year ended December 31, 1996, as compared to $12.3 million for the year ended December 31, 1995. An increase of $302,000 resulted from interest on mortgage loans obtained or assumed in connection with 1995 and 1996 property acquisitions. In addition, long term and interim first mortgage financing obtained during 1995 and 1996 increased mortgage loans by $14.2 million and the related interest expense by $459,000 for this period. Decreases totaling $1.2 million resulted from the sale of two commercial properties in 1995 and 1996 and interest capitalized to the carrying values of unencumbered development properties during 1995 and 1996. Depreciation expense decreased from $6 million for the year ended December 31, 1995, to $5.4 million for the corresponding period in 1996. Effective January 1, 1996, the Trust's adopted Statement of Financial Accounting Standards ("SFAS") No. 121, which required the Trust to cease depreciation of its real estate held for sale. 26 27 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (Continued) Advisory fees to Tarragon were $1.1 million in 1996 and $1 million in 1995. The advisory fee is an incentive fee equal to 16% per annum of adjusted funds from operations, as defined in the advisory agreement approved by the Board and shareholders. Prior to April 1995, the advisory agreement also called for a $100,000 annual base fee. FFO decreased from $6.3 million for the year ended December 31, 1995, to $5.6 million for the year ended December 31, 1996. See ITEM 6. "SELECTED FINANCIAL DATA" for the calculation and definition of FFO. In September 1996, the Trust recorded a $300,000 provision for loss to reduce the carrying value of Mariposa Manor Apartments to its then estimated fair value. During 1995, the Trust recorded a provision for loss credit of $425,000. This credit was comprised of a provision for loss of $275,000 to reduce the net carrying value of K-Mart Shopping Center in Kansas City, Missouri, to its net sale proceeds and a reversal of a previously provided allowance for estimated loss of $700,000 against Pepperkorn Office Building which was determined to no longer be necessary after litigation involving the property was decided in favor of the Trust. In addition to the $3.7 million gain on the sale of Century Centre discussed previously, during 1996, the Trust reported a gain of $22,000 on the sale of real estate related to the sale of 27 Indcon warehouses and a $451,000 gain due to Indcon's insurance settlement received as a result of the warehouse fire in September 1995. During 1995, the Trust reported a gain of $412,000 on the sale of shares of beneficial interest of CMET and gains totaling $533,000 on sales of portions of Lake Highlands land. Implementation of Change in Accounting Estimate Effective January 1, 1997, the Trust implemented prospectively a change in accounting estimate whereby capital expenditures for carpet, appliances, and heating, ventilation, and air conditioning (HVAC) replacements are capitalized rather than expensed. The Trust believes that capitalizing these expenditures and depreciating them over lives ranging from three to five years more appropriately reflects the timing of the economic benefits to be received from these expenditures. Additionally, the Trust believes this treatment is consistent with policies currently being used by a majority of other REITs. However, comparability of FFO between REITs is affected by the method of accounting for these items. For the year ended December 31, 1997, the effect of this change in accounting estimate was to decrease property operating expenses and increase net income by $957,000. Had the Trust implemented this change on January 1, 1995, property operating expenses for the years ended December 31, 1995 and 1996, would have been reduced by $1 million and $1.1 million, respectively. This change has no effect on the advisory fee as Tarragon waived any fee resulting from this change in accounting estimate. 27 28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Implementation of Change in Accounting Estimate (Continued) For the year ended December 31, 1997, capitalized expenditures for these items resulting from the change in accounting estimate were as follows: Carpet...................................... $ 561 Appliances.................................. 143 HVAC replacements........................... 253 -------- $ 957 ========
Allowance for Estimated Losses and Provisions for Losses The Trust's management periodically evaluates the carrying values of the Trust's properties held for sale. Generally accepted accounting principles require that the carrying value of or a property held for sale cannot exceed the lower of its cost or its estimated fair value less estimated costs to sell. In those instances in which estimates of fair value less estimated selling costs are less than the carrying values thereof at the time of evaluation, an allowance for loss is provided by a charge against operations. The evaluation generally includes selective site inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance requirements, discussions with the manager of the property, and a review of the surrounding area. Future evaluations could cause the Trust's management to adjust current estimates of fair value. The Trust's management also evaluates the Trust's properties held for investment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. This evaluation generally consists of a review of the property's cash flow and current and projected market conditions, as well as any changes in general and local economic conditions. If an impairment loss exists based on the results of this evaluation, a loss is recognized by a charge against current earnings and a corresponding reduction in the respective asset's carrying value. The amount of this impairment loss is equal to the amount by which the carrying value of the property exceeds its estimated fair value. Environmental Matters Under various federal, state, and local environmental laws, ordinances, and regulations, the Trust may be potentially liable for removal or remediation costs, as well as certain other potential costs (including governmental fines and injuries to persons and property) relating to hazardous or toxic substances where property-level managers have arranged for the removal, disposal, or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery from the Trust for personal injury associated with such materials. The Trust's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Trust's business, financial position, or results of operations. 28 29 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Tax Matters For the years ended December 31, 1997, 1996, and 1995, the Trust elected, and in the opinion of the Trust's management qualified, to be taxed as a Real Estate Investment Trust ("REIT"), as defined under Sections 856 through 860 of the Internal Revenue Code of 1986 (the "Code"). The Code requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, as defined in Section 857 of the Code, on an annual basis to shareholders. Impact of the Year 2000 Issue The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Trust's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Trust has initiated an assessment to determine the extent to which the Trust is vulnerable to Year 2000 Issues. Management does not anticipate a material impact on the Trust's business, financial position, or results of operations from the Year 2000 Issue. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130 - "Reporting Comprehensive Income," which is effective for fiscal years beginning after December 15, 1997. Comprehensive income is defined as "the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." The Trust will adopt this statement, as required, on January 1, 1998, and expects the only effect of adoption to be reporting of comprehensive income in the Consolidated Statements of Operations. Also in June 1997, the FASB issued SFAS No. 131 - "Disclosures About Segments of an Enterprise and Related Information," which supersedes SFAS No. 14 - "Financial Reporting for Segments of a Business Enterprise," SFAS No. 18 - "Financial Reporting for Segments of a Business Enterprise - Interim Financial Statements," SFAS No. 24 - "Reporting Segment Information in Financial Statements that are Presented in Another Enterprise's Financial Report," and SFAS No. 30 - "Disclosure of Information About Major Customers." This statement is effective for financial statements for periods beginning after December 15, 1997. The Trust's management has not fully evaluated the effects of implementing this statement but expects the Company's current financial statement disclosures will not be affected. 29 30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Possible Consolidation with Tarragon Realty Investors, Inc. On February 19, 1998, the Trust and Tarragon Realty Investors, Inc., ("TRI") jointly announced the agreement of their respective boards to form a single consolidated entity with TRI, for convenience, as the survivor. The surviving consolidated entity is intended to operate as a self-administered REIT. The consolidation transaction will be submitted to shareholders of each of the Trust and TRI for approval at special meetings to be held during 1998. Under the proposed agreement, each shareholder of the Trust will receive 1.97 shares of TRI common stock for each share of beneficial interest of the Trust held. TRI, also a REIT, has a similar opportunistic approach to real estate investment and had total consolidated assets of approximately $37 million as of December 31, 1997. Upon the approval and consummation of the consolidation transaction by the respective shareholders of each entity, TRI will acquire Tarragon, the Trust's advisor since April 1, 1994, and TRI's advisor since March 1, 1994, for 100,000 shares of common stock of TRI and options to acquire additional shares of common stock of TRI at prices ranging between $13 and $16 per share. The resulting consolidated enterprise with TRI as the survivor will emerge from these transactions as an integrated, self-administered, self-managed REIT controlling approximately 14,000 apartment units and 2.1 million square feet of retail and office space, primarily in California, Florida, and Texas. The consolidation transaction will be accounted for as a reverse acquisition of TRI by the Trust. William S. Friedman, President, Chief Executive Officer, and Trustee of the Trust, also serves as Director and Chief Executive Officer of Tarragon and as Director, President, and Chief Executive Officer of TRI. Tarragon is owned by Mr. Friedman and his wife, Lucy N. Friedman. The Friedman family also owns approximately 30% of the outstanding shares of common stock of TRI and approximately 33% of the outstanding shares of beneficial interest of the Trust. Risks Associated with Forward-Looking Statements Included in this Form 10-K This Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. These statements include the plans and objectives of management for future operations, including plans and objectives relating to capital expenditures on Trust properties. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive, and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Trust. Although the Trust believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate, and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-K will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Trust or any other person that the objectives and plans of the Trust will be achieved. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This item is not applicable to the Trust at this time. 30 31 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Reports of Independent Public Accountants............................ 32 Consolidated Balance Sheets - December 31, 1997 and 1996......................................... 33 Consolidated Statements of Operations - Years Ended December 31, 1997, 1996, and 1995...................... 34 Consolidated Statements of Shareholders' Equity - Years Ended December 31, 1997, 1996, and 1995...................... 35 Consolidated Statements of Cash Flows - Years Ended December 31, 1997, 1996, and 1995...................... 36 Notes to Consolidated Financial Statements........................... 39 Schedule III - Real Estate and Accumulated Depreciation............. 62
All other schedules are omitted because they are not required or are not applicable or because the information required is included in the Consolidated Financial Statements or the notes thereto. 31 32 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Trustees of National Income Realty Trust We have audited the accompanying consolidated balance sheets of National Income Realty Trust and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of National Income Realty Trust and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Supplemental Schedule III is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP Dallas, Texas March 27, 1998 32 33 NATIONAL INCOME REALTY TRUST CONSOLIDATED BALANCE SHEETS
December 31, ------------------------ 1997 1996 --------- --------- Assets (dollars in thousands) Real estate held for sale (net of accumulated depreciation of $593 in 1997 and $397 in 1996) ......................... $ 5,123 $ 12,198 Less - allowance for estimated losses ....................... (1,194) (1,529) --------- --------- 3,929 10,669 Real estate held for investment (net of accumulated depreciation of $45,440 in 1997 and $41,854 in 1996) ...... 230,007 183,053 Investments in partnerships ................................. 13,839 4,739 Cash and cash equivalents ................................... 4,262 3,862 Restricted cash ............................................. 4,300 2,850 Other assets, net (including $42 in 1997 and $30 in 1996 due from affiliates) .............................. 9,303 6,168 --------- --------- $ 265,640 $ 211,341 ========= ========= Liabilities and Shareholders' Equity Liabilities Notes and interest payable .................................. $ 184,126 $ 134,270 Other liabilities (including $67 in 1997 and $10 in 1996 due to affiliates) ........................................ 10,423 8,008 --------- --------- 194,549 142,278 Commitments and contingencies................................ Shareholders' equity Shares of beneficial interest, no par value; authorized shares, unlimited; shares outstanding, 3,812,404 in 1997 and 3,523,729 in 1996 (after deducting 896,962 shares in 1997 and 767,294 shares in 1996 held in treasury) ......... 11,446 10,579 Paid-in capital ............................................. 281,638 277,795 Accumulated distributions in excess of accumulated earnings ...................................... (222,126) (219,311) Unrealized gains on marketable equity securities ............ 133 -- --------- --------- 71,091 69,063 --------- --------- $ 265,640 $ 211,341 ========= =========
The accompanying notes are an integral part of these Consolidated Financial Statements. 33 34 NATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, ------------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (dollars in thousands, except per share data) Revenue Rentals ................................................... $ 50,745 $ 47,831 $ 43,381 Interest .................................................. 629 631 1,089 Equity in income of partnerships .......................... 643 1,500 770 ----------- ----------- ----------- 52,017 49,962 45,240 Expenses Property operations (including $1,649 in 1997, $1,014 in 1996, and $330 in 1995 to affiliates) .......... 28,596 28,411 25,279 Interest .................................................. 12,602 12,042 12,306 Depreciation .............................................. 7,022 5,374 5,959 Advisory fee to affiliate ................................. 1,438 1,117 1,037 General and administrative (including $1,411 in 1997, $1,176 in 1996, and $960 in 1995 to affiliates) .......... 2,091 1,932 2,058 Provision for losses ...................................... -- 300 (425) ----------- ----------- ----------- 51,749 49,176 46,214 ----------- ----------- ----------- Income (loss) before net gain on sale of real estate, gain on sale of investments, gain on insurance settlement, and extraordinary gain .................................... 268 786 (974) Net gain on sale of real estate ............................. 4,350 3,700 533 Gain on sale of investments ................................. 913 -- 412 Gain on insurance settlement ................................ -- 451 -- ----------- ----------- ----------- Income (loss) from continuing operations .................... 5,531 4,937 (29) Extraordinary gain .......................................... 61 -- 737 ----------- ----------- ----------- Net income .................................................. $ 5,592 $ 4,937 $ 708 =========== =========== =========== Earnings per share Income (loss) from continuing operations .................... $ 1.44 $ 1.21 $ (.01) Extraordinary gain .......................................... .02 -- .18 ----------- ----------- ----------- Net income .................................................. $ 1.46 $ 1.21 $ .17 =========== =========== =========== Weighted average shares of beneficial interest used in computing earnings per share ...................... 3,832,535 4,070,183 4,101,453 =========== =========== =========== Earnings per share - assuming dilution Income from continuing operations ........................... $ 1.43 $ 1.21 $ (.01) Extraordinary gain .......................................... .01 -- .18 ----------- ----------- ----------- Net income .................................................. $ 1.44 $ 1.21 $ .17 =========== =========== =========== Weighted average shares of beneficial interest used in computing earnings per share - assuming dilution ....... 3,871,248 4,088,382 4,101,961 =========== =========== ===========
The accompanying notes are an integral part of these Consolidated Financial Statements. 34 35 NATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Unrealized Distributions Gains on Shares of in Excess of Marketable Beneficial Interest Paid-in Accumulated Equity Shareholders' Shares Amount Capital Earnings Securities Equity ----------- ----------- ----------- ----------- ----------- ------------ (dollars in thousands) Balance, December 31, 1994 .................. 3,216,267 $ 9,657 $ 275,178 $ (211,887) $ 412 $ 73,360 Repurchase of shares of beneficial interest . (123,500) (370) (1,069) -- -- (1,439) Cash distributions ($0.62 per share) ........ -- -- -- (2,590) -- (2,590) Share distributions ......................... 297,960 894 2,607 (3,501) -- -- Realized gains on marketable equity securities ............................... -- -- -- -- (412) (412) Net income .................................. -- -- -- 708 -- 708 ----------- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 1995 .................. 3,390,727 10,181 276,716 (217,270) -- 69,627 Repurchase of shares of beneficial interest . (285,189) (856) (2,812) -- -- (3,668) Conversion of convertible subordinated debenture ................................ 93,076 279 721 -- -- 1,000 Cash distributions ($0.69 per share) ........ -- -- -- (2,833) -- (2,833) Share distributions ......................... 325,115 975 3,170 (4,145) -- -- Net income .................................. -- -- -- 4,937 -- 4,937 ----------- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 1996 .................. 3,523,729 10,579 277,795 (219,311) -- 69,063 Repurchase of shares of beneficial interest . (48,472) (145) (603) -- -- (748) Cash distributions ($0.74 per share) ........ -- -- -- (2,949) -- (2,949) Share distributions ......................... 337,147 1,012 4,446 (5,458) -- -- Unrealized gains on marketable equity securities ............................... -- -- -- -- 831 831 Realized gains on marketable equity securities ............................... -- -- -- -- (698) (698) Net income .................................. -- -- -- 5,592 -- 5,592 ----------- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 1997 .................. 3,812,404 $ 11,446 $ 281,638 $ (222,126) $ 133 $ 71,091 =========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these Consolidated Financial Statements. 35 36 NATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, ----------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (dollars in thousands) Cash Flows from Operating Activities Rentals collected ......................................... $ 50,578 $ 48,054 $ 42,763 Interest collected ........................................ 634 553 1,062 Interest paid ............................................. (11,564) (11,336) (12,638) Payments for property operations (including $1,649 in 1997, $1,014 in 1996, and $330 in 1995 to affiliates) ................................. (29,886) (28,752) (25,179) General and administrative expenses paid (including $1,411 in 1997, $1,176 in 1996, and $960 in 1995 to affiliates) ............................. (2,134) (2,117) (2,179) Advisory fee paid to affiliate ............................ (1,452) (1,168) (1,022) Deferred borrowing costs paid ............................. (2,915) (1,439) (777) ----------- ----------- ----------- Net cash provided by operating activities ............... 3,261 3,795 2,030 ----------- ----------- ----------- Cash Flows from Investing Activities Acquisition of real estate ................................ (14,656) (3,199) (3,786) Proceeds from sale of real estate ......................... 6,378 6,156 1,646 Earnest money deposits paid ............................... (245) -- -- Real estate improvements .................................. (27,349) (13,547) (8,022) Collections on notes receivable ........................... 187 2,140 3,609 Investments in marketable equity securities ............... (2,462) -- -- Proceeds from sale of marketable equity securities ........ 2,606 -- 593 Loans and advances to partnerships ........................ (9,133) -- -- Acquisition of partnership interest ....................... -- -- (462) Distributions from partnership's investing activities .............................................. -- 6,817 -- Distribution of partnership's insurance settlement proceeds ................................................ -- 760 -- Proceeds from sale of partnership interest ................ 1,600 -- -- Net (contributions to) distributions from partnerships..... (739) 437 986 ----------- ----------- ----------- Net cash (used in) investing activities ................. (43,813) (436) (5,436) ----------- ----------- -----------
The accompanying notes are an integral part of these Consolidated Financial Statements. 36 37 NATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
For the Years Ended December 31, ----------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (dollars in thousands) Cash Flows from Financing Activities Proceeds from borrowings .................................................... $ 79,477 $ 34,323 $ 23,500 Payments on notes payable ................................................... (36,034) (28,500) (23,571) Repair escrow (deposits) receipts, net ...................................... (847) (292) 1,214 Distributions to shareholders ............................................... (2,105) (2,731) (2,486) Repurchase of shares of beneficial interest ................................. (748) (3,668) (1,439) Borrowings on margin account ................................................ 1,209 280 785 Advances from (repayment of advances from) affiliates ................................................................ -- (583) 583 Distributions from partnerships' financing activities ....................... -- -- 3,010 ----------- ----------- ----------- Net cash provided by (used in) financing activities ....................... 40,952 (1,171) 1,596 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents ........................... 400 2,188 (1,810) Cash and cash equivalents, beginning of year ................................... 3,862 1,674 3,484 ----------- ----------- ----------- Cash and cash equivalents, end of year ......................................... $ 4,262 $ 3,862 $ 1,674 =========== =========== =========== Reconciliation of net income to net cash provided by operating activities Net income ................................................................ $ 5,592 $ 4,937 $ 708 Net gain on sale of real estate ........................................... (4,350) (3,700) (533) Gain on sale of investments ............................................... (913) -- (412) Gain on insurance settlement .............................................. -- (451) -- Extraordinary gain ........................................................ (61) -- (737) Depreciation and amortization ............................................. 7,938 6,333 6,499 Provision for losses ...................................................... -- 300 (425) Equity in (income) of partnerships ........................................ (643) (1,500) (770) Changes in other assets and other liabilities, net of effects of noncash investing and financing activities: (Increase) decrease in interest receivable ............................. 5 (55) (7) (Increase) in other assets ............................................. (6,608) (2,665) (1,962) Increase in other liabilities .......................................... 1,962 543 333 Increase (decrease) in interest payable ................................ 339 53 (664) ----------- ----------- ----------- Net cash provided by operating activities ...................................... $ 3,261 $ 3,795 $ 2,030 =========== =========== ===========
The accompanying notes are an integral part of these Consolidated Financial Statements. 37 38 NATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
For the Years Ended December 31, ----------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (dollars in thousands) SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Changes in assets and liabilities in connection with the acquisition or foreclosure of real estate: Real estate ................................................................... $ 30,762 $ 14,954 $ 11,024 Notes and interest receivable ................................................. -- (8,568) -- Allowance for estimated losses ................................................ -- 3,000 -- Other assets .................................................................. 416 44 525 Notes and interest payable .................................................... (15,756) (6,157) (7,556) Other liabilities ............................................................. (766) (74) (207) ----------- ----------- ----------- Cash paid ................................................................... $ 14,656 $ 3,199 $ 3,786 =========== =========== =========== Assets disposed of and liabilities released in connection with the sale of real estate: Real estate ................................................................... $ 9,572 $ 23,221 $ 2,464 Allowance for estimated losses ................................................ -- -- (275) Other assets .................................................................. 29 596 -- Notes and interest payable .................................................... (7,493) (21,127) (1,076) Other liabilities ............................................................. (134) (212) -- Net gain on sale .............................................................. 4,404 3,678 533 ----------- ----------- ----------- Cash received ............................................................... $ 6,378 $ 6,156 $ 1,646 =========== =========== =========== Mortgage debt released in connection with litigation settlement ....................................................... $ -- $ -- $ 1,020 Real estate written off pursuant to condemnation ................................................................ $ 2,210 $ -- $ -- Note payable written off pursuant to the condemnation of the collateral property ..................................... $ 1,725 $ -- $ -- Allowance for estimated losses charged off in connection with the write-off of real estate ...................................................................... $ 485 $ -- $ --
The accompanying notes are an integral part of these Consolidated Financial Statements. 38 39 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying Consolidated Financial Statements of National Income Realty Trust, subsidiaries, and the consolidated partnerships have been prepared in conformity with generally accepted accounting principles ("GAAP"), the most significant of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES." The preparation of financial statements in accordance with GAAP 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. The Notes to Consolidated Financial Statements are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 1995 and 1996 have been reclassified to conform to the 1997 presentation. NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Trust business. National Income Realty Trust ("NIRT" or the "Trust") is a California business trust organized on October 31, 1978. The Trust was formed to invest in real estate, including commercial and multifamily properties. Basis of consolidation. The Consolidated Financial Statements include the accounts of NIRT, its subsidiaries, and partnerships which it controls. All significant intercompany transactions and balances have been eliminated. Real estate and depreciation. Real estate held for sale is carried at the lower of cost or estimated fair value less estimated costs to sell. Real estate held for investment is carried at cost unless an impairment is determined to exist, as discussed below. Impaired properties are written down to their estimated fair values. Foreclosed real estate is initially recorded at new cost, defined as the lower of the Trust's note receivable carrying amount or the fair value of the collateral property less estimated costs of sale. The Trust capitalizes property improvements and major rehabilitation projects which increase the value of the respective property and have useful lives greater than one year, except for individual expenditures less than $10,000 which are not part of a planned renovation project. Under this policy, during 1997, expenditures of $27.9 million were capitalized, including $10 million related to the redevelopment of The Vistas at Lake Worth, and property replacements of $2.1 million were expensed. Property replacements include, but are not limited to, such items as landscaping, exterior painting, and parking lot improvements. Depreciation is provided against real estate held for investment by the straight-line method over the estimated useful lives of the assets, which range from three to 40 years. The Trust capitalizes interest on funds used in constructing property from the date of initiation of construction activities through the time the property is ready for leasing. The Trust also capitalizes property taxes and insurance costs during the construction period. Interest, property taxes, and insurance expenditures of $945,000 and $693,000 were capitalized during 1997 and 1996, respectively. 39 40 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Effective January 1, 1997, the Trust implemented prospectively a change in accounting estimate whereby capital expenditures for carpet, appliances, and heating, ventilation, and air conditioning (HVAC) replacements are capitalized rather than expensed. The Trust believes that capitalizing these expenditures and depreciating them over lives ranging from three to five years more appropriately reflects the timing of the economic benefits to be received from these expenditures. Additionally, the Trust believes this treatment is consistent with policies currently being used by other real estate investment trusts. This change has no effect on the advisory fee as Tarragon Realty Advisors, Inc. ("Tarragon"), the Trust's advisor since April 1, 1994, waived any fee resulting from this change in accounting estimate. The Trust's management evaluates the Trust's properties held for investment for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. This evaluation generally consists of a review of the property's cash flow and current and projected market conditions, as well as any changes in general and local economic conditions. If an impairment loss exists based on the results of this review, a loss is recognized by a charge against current earnings and a corresponding reduction in the respective asset's carrying value. The amount of this impairment loss is equal to the amount by which the carrying value of the property exceeds the estimated fair value. At least annually, all properties held for sale are reviewed by the Trust's management, and a determination is made if the held for sale classification remains appropriate. Following are among the factors considered in determining that a change in classification to held for investment is appropriate: (i) the property has been held for at least one year; (ii) Trust management has no intent to dispose of the property within the next twelve months; (iii) the property is a "qualifying asset" as defined in the Internal Revenue Code of 1986 (the "Code"); (iv) property improvements have been funded; and (v) the Trust's financial resources are such that the property can be held long-term. The Trust adopted Statement of Financial Accounting Standards ("SFAS") No. 121 - "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" on January 1, 1996. There was no cumulative effect nor any impact on the Trust's financial position as a result of the adoption. Pursuant to the adoption, the Trust ceased depreciation of its properties held for sale. Allowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable and properties held for sale to the extent that the investment in the notes or properties exceeds the Trust's estimate of fair value less estimated selling costs of the collateral securing the notes or the properties. The provisions for losses are based on estimates, and actual losses may vary from current estimates. Such estimates are reviewed periodically. Any additional provision determined to be necessary or the reversal of any existing allowance no longer required is recorded by a charge or credit to current earnings. Cash equivalents. The Trust considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents. Restricted cash. Restricted cash represents escrow accounts, generally held by the lenders of certain of the Trust's mortgage notes payable, for taxes, insurance, and property repairs. 40 41 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) Other assets. Other assets consist primarily of notes and interest receivable, marketable equity securities, tenant accounts receivable, deferred borrowing costs, and prepaid leasing commissions. Marketable equity securities are considered to be available-for-sale and are carried at fair value, defined as year end closing market value. Net unrealized holding gains and losses are reported as a separate component of shareholders' equity. Deferred borrowing costs are amortized on the straight-line method (which approximates the effective interest method) over the related loans terms, and such amortization is included in interest expense. Prepaid leasing commissions are amortized to leasing commission expense, included in property operating expenses, on the straight-line method over the related lease terms. Revenue recognition on the sale of real estate. Gains on sales of real estate are recognized when and to the extent permitted by SFAS No. 66. - "Accounting for Sales of Real Estate." Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using the deposit, installment, cost recovery, or financing methods, whichever is appropriate. Investment in noncontrolled partnerships. The Trust uses the equity method to account for investments in partnerships it does not control. Under the equity method, the Trust's initial investment is increased by the Trust's proportionate share of the partnership's operating income and additional advances and decreased by the Trust's proportionate share of the partnership's operating losses and distributions received. Earnings per share. Net income per share of beneficial interest (the "Shares" and each a "Share") is computed based upon the weighted average number of Shares outstanding during each year. Share and per share data have been restated to give effect to 10% share distributions paid in September 1996 and September 1997. On December 31, 1997, the Trust adopted SFAS No. 128 - "Reporting Earnings Per Share," which superseded the Accounting Principles Board's Opinion No. 15 ("APB No. 15") "Earnings Per Share." This statement requires business enterprises with other than simple capital structures to report both basic and diluted earnings per share for each period for which a statement of operations is presented. There was no cumulative effect nor any impact on the Trust's financial position as a result of the adoption. Fair value of financial instruments. SFAS No. 107 - "Disclosures About Fair Value of Financial Instruments" requires the Trust to disclose the estimated fair values of its financial instrument assets and liabilities. Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 1997 and 1996. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimated fair values presented do not purport to present amounts to be ultimately realized or paid by the Trust, which may vary significantly from the estimated fair values presented. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values. 41 42 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) As of December 31, 1997 and 1996, the Trust's management estimates that the carrying amounts approximate fair value for cash and cash equivalents and restricted cash because of the short maturities of those instruments. In addition, the carrying amounts of notes receivable and other liabilities approximate fair value. The fair values of the Trust's notes payable are estimated by discounting future expected cash flows using current rates for loans with similar terms and maturities. Share option plans. On January 1, 1996, the Trust adopted SFAS No. 123 - "Accounting and Disclosure of Stock-Based Compensation," which requires disclosures based on the fair values of share options at the date of grant. There was no cumulative effect nor any impact on the Trust's financial position as a result of the adoption. The Trust will continue to measure any compensation costs associated with the issue of share options using the guidance provided by APB No. 25. Under APB No. 25, compensation costs related to share options issued pursuant to compensatory plans are measured based on the difference between the quoted market price of the shares at the measurement date (ordinarily the date of grant) and the exercise price and should be charged to expense over the periods during which the grantee performs the related services. All share options issued to date by the Trust have exercise prices equal to the market price of the shares at the dates of grant. See NOTE 9. "SHARE OPTIONS." NOTE 2. ALLOWANCE FOR ESTIMATED LOSSES AND PROVISIONS FOR LOSSES Activity in the allowance for estimated losses was as follows:
1997 1996 ------- ------- Balance January 1 ............................ $ 1,529 $ 4,529 Reclassified from other assets ............... 150 -- Amounts charged off .......................... (485) (3,000) ------- ------- Balance December 31 .......................... $ 1,194 $ 1,529 ======= =======
Amounts charged off in 1997 related to the write-off of K-Mart Shopping Center in Indianapolis, Indiana, in March 1997. Amounts charged off in 1996 relate to the acquisition of Jackson Square Shopping Center through deed in lieu of foreclosure in January 1996. Additionally, during 1996, the Trust recorded a provision for loss of $300,000 to write down Mariposa Manor Apartments to its then estimated fair value. In 1995, the Trust recorded a provision for loss credit of $425,000 comprised of the reversal of a $700,000 allowance provided in 1993 against Pepperkorn Office Building and a provision of $275,000 to reduce the carrying value of K-Mart Shopping Center in Kansas City, Missouri, to the net sale proceeds received in July 1995. For further discussion of these transactions, see NOTE 3. "REAL ESTATE AND DEPRECIATION." 42 43 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 3. REAL ESTATE AND DEPRECIATION During 1997, 1996, and 1995, the Trust purchased 13 multifamily properties comprising 1,991 units and one 52,288 square foot shopping center as presented below. In connection with these acquisitions the Trust paid Tarragon real estate acquisition fees totaling $538,000. These properties are located in the same geographical areas where the Trust currently operates and were acquired in separate transactions from unaffiliated sellers.
Cost of Acquisition Date Square -------------------------- Property Location Acquired Units Footage Cash Debt ----------------- ------------ ---------- ------- --------- ---------- --------- 1997 Acquisitions: Morningside Jacksonville, FL Feb-97 112 89,200 $ 521 $ 1,641 Newport Plantation, FL Jun-97 152 139,364 1,526 5,058 Fountainhead Kissimmee, FL Jun-97 184 172,578 7,690 -- Courtyard at the Park Miami, FL Jul-97 127 117,250 728 2,973 Mariner Plaza Tallahassee, FL Aug-97 -- 52,288 1,458 -- Landmark Tallahassee, FL Oct-97 128 113,720 1,822 -- -------- ---------- ---------- --------- 703 684,400 13,745 9,672 -------- ---------- ---------- --------- 1996 Acquisitions: Woodbrier Oklahoma City, OK Apr-96 128 114,900 1,277 1,230 River City Landing Jacksonville, FL Jun-96 352 356,800 1,922 4,930 -------- ---------- ---------- --------- 480 471,700 3,199 6,160 -------- ---------- ---------- --------- 1995 Acquisitions: Park Place Los Angeles, CA Feb-95 39 15,640 380 -- Marina Park North Miami, FL Apr-95 90 86,850 993 2,500 Mustang Creek Arlington, TX May-95 120 167,880 830 2,680 Park Norton Los Angeles, CA Jun-95 55 25,208 154 564 The Regent Jacksonville, FL Sep-95 304 288,320 1,480 -- Meadowbrook Baton Rouge, LA Oct-95 200 127,524 -- 1,813 -------- ---------- ---------- --------- 808 711,422 3,837 7,557 -------- ---------- ---------- --------- 1,991 1,867,522 $ 20,781 $ 23,389 ======== ========== ========== =========
In connection with obtaining the acquisition financing of $2.7 million and $564,000, respectively, for Mustang Creek and Park Norton in 1995, the Trust paid Tarragon mortgage brokerage fees totaling $32,440. Also, in connection with the acquisition of River City Landing in 1996, the seller paid Mr. Bruce A. Schnitz, Chief Operating Officer of the Trust and Tarragon, a commission of $82,563 pursuant to a brokerage agreement entered into prior to Mr. Schnitz's affiliation with Tarragon and the Trust. The Trust also added 300 units to its multifamily portfolio in July 1997 when it acquired an additional 40% interest in English Village Partners, L.P., for $1 million. As the Trust now holds a 90% interest in the partnership, the operations of English Village Apartments, located in Memphis, Tennessee, and subject to a $6.1 million mortgage, have been consolidated since July 1997. 43 44 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 3. REAL ESTATE AND DEPRECIATION (Continued) The Trust sold Plaza Hills Apartments in Kansas City, Missouri, Huntington Green Apartments in Philadelphia, Pennsylvania, and Pheasant Pointe Apartments in Sacramento, California, during 1997 for an aggregate sale price of $14 million, receiving net cash proceeds of $6.4 million and recognizing gains on the sales totaling $4.4 million. In November 1995, the City of Indianapolis, Indiana, (the "City") initiated condemnation proceedings against the Trust's K-Mart Shopping Center acquired through a deed in lieu of foreclosure in December 1994. The shopping center was vacant at the time the Trust acquired it, although leased to K-Mart under a net lease expiring in 1999. The lease was assigned by K-Mart to the City in September 1995. In March 1996, the Trust ceased payments on the $1.7 million non-recourse mortgage loan secured by the shopping center. In March 1997, the Trust wrote off the property and related debt, as the mortgage is now secured by the condemnation award. No loss was recognized in excess of amounts previously provided. In October 1995, the Trust and the borrower on an $8.6 million first mortgage receivable, which matured in December 1995, negotiated a settlement of the outstanding balance whereby the borrower agreed to relinquish the collateral property, Jackson Square Shopping Center, a 342,000 square foot property in Jackson, Mississippi, through a deed in lieu of foreclosure. The Trust took possession of the property in January 1996. As the estimated fair value of the property exceeded the Trust's net carrying value of the mortgage loan, the Trust recognized no loss in excess of amounts previously provided. The Trust is in the final stages of reconstructing and expanding The Vistas at Lake Worth in Fort Worth, Texas, to 265 apartment units at a cost of approximately $14.3 million, $13 million of which had been expended as of December 31, 1997. Operations began at the property in December 1997, and redevelopment was completed in March 1998. In September 1996, the Trust sold Century Centre II Office Building for $28.2 million in cash. After closing costs, prorations, and the payoff of the $21 million mortgage secured by the property, the Trust received net cash proceeds of $6.2 million. In connection with this transaction, the Trust recognized a gain of $3.7 million. During 1995, the Trust sold portions of Lake Highlands land in Dallas, Texas, for $885,000 in cash. Net cash proceeds were $790,000 after closing costs. The Trust recorded gains of $533,000 from the sales. In July 1995, the Trust purchased a tract of land adjacent to its K-Mart Shopping Center in Kansas City, Missouri, for $125,000 and simultaneously sold the K-Mart Shopping Center and the tract of land, keeping a portion of the undeveloped land, for $1.8 million, including a $414,000 lease termination payment from K-Mart. After the first lien payoff of $1.1 million and other related closing costs, net cash proceeds to the Trust were $856,000. In June 1995, the Trust recorded a provision for loss of $275,000 to account for the excess carrying value of the property over the related sale price. 44 45 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 3. REAL ESTATE AND DEPRECIATION (Continued) The Trust purchased Pepperkorn Office Building located in Manitowoc, Wisconsin, ("Pepperkorn") in July 1991 for $1.1 million, paying $130,000 in cash and financing the remainder through a $1 million promissory note. Concurrently with the acquisition, the former owner and primary tenant (the "Seller") signed a lease at another one of the Trust's properties, Lakeview Mall, also located in Manitowoc, Wisconsin. In 1993, the State of Wisconsin commenced eminent domain proceedings to acquire Pepperkorn, and the Trust recorded a provision for loss of $700,000, equal to the amount by which the carrying value of the property exceeded the proposed condemnation award. In May 1995, the court ordered the $1 million promissory note executed by the Trust rescinded and found certain provisions of the Seller's lease at Lakeview Mall were unenforceable. Accordingly, the note balance was offset against the carrying value of the property, the net rent receivable, and the condemnation award. As a result, the Trust reversed the $700,000 allowance during the second quarter of 1995 with a corresponding credit to earnings. The Trust collected the $232,000 condemnation award in 1997. Results of operations for real estate held for sale for the years ended December 31, 1997, 1996, and 1995, were $192,000, $323,000, and $114,000, respectively. Operations for these properties include rental revenue, property operating expenses, interest expense, and, prior to January 1, 1996, depreciation expense. For a listing of properties held for sale, see Schedule III. NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS Investments in and advances to partnerships consisted of the following at December 31:
1997 1996 --------- --------- Sacramento Nine ("SAC 9") .................................. $ 557 $ 469 Income Special Associates ("ISA") .......................... -- 1,508 Ansonia Apartments, L.P. ("Ansonia") ........................ 970 -- Danforth National Apartments, Ltd. ("Danforth") ............. 2,892 -- 801 Pennsylvania Avenue ..................................... 2,936 2,762 National Omni Associates, L.P. ("Omni") ..................... 721 -- RI Windsor, Ltd. ("Windsor") ................................ 2,697 -- RI Panama City, Ltd. ("Panama") ............................. 1,677 -- Tarragon Savannah, L.P. ("Savannah") ........................ 1,389 -- --------- --------- $ 13,839 $ 4,739 ========= =========
In January 1997, in exchange for a capital contribution of $214,000, which was matched by the other partners, the Trust received a 1% general partner interest and a 49% limited partner interest in Windsor, a limited partnership formed to construct a 324-unit luxury apartment complex to be known as The Mayfaire at Windsor Parke in Jacksonville, Florida, at an estimated cost of $16 million. Initial operations began at the property in August 1997, and the property was completed in the first quarter of 1998. The partnership obtained a $16 million construction loan to finance the construction. The Trust has also loaned the partnership $2.5 million which is to be repaid following completion and lease-up of the property. Until lease-up of the property, the construction loan is guaranteed by the other general partner. As the Trust holds a non-controlling interest, it accounts for its investment in the partnership using the equity method. 45 46 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued) The bulk of the proceeds for the Trust's loan to the partnership were obtained from a $2.2 million loan secured by 352,000 of the Trust's shares of beneficial interest. The lender has no voting rights with and does not receive cash distributions on these shares, which are unregistered. Therefore, these shares are not included with outstanding shares in the accompanying December 31, 1997, Consolidated Balance Sheet and the Consolidated Statement of Shareholders' Equity for the year ended December 31, 1997. The loan matures in January 2000; however, the Trust intends to repay the loan prior to December 1998 with proceeds received from the partnership's construction loan. In June 1997, in exchange for a capital contribution of $200,000, the Trust received a 1% general partner interest and a 49% limited partner interest in Panama. This partnership was formed to construct a 200-unit luxury apartment complex to be known as Harbour Green Apartments in Panama City, Florida, at an estimated cost of $10.5 million. The first units became available for rent in January 1998. The property is expected to be completed in the second quarter of 1998. The partnership has obtained an $8.8 million construction loan to finance construction. The Trust has also loaned the partnership $1.5 million which is to be repaid from construction loan proceeds following completion and lease-up of the property. Until lease-up of the property, the construction loan is guaranteed by the other general partner. The Trust also accounts for its investment in this partnership using the equity method. In September 1997, the Trust received a 1% general partner and a 59% limited partner interest in Danforth in exchange for a $6,000 capital contribution. This partnership was formed to construct a 288-unit luxury apartment complex to be known as The Club at Danforth Apartments in Jacksonville, Florida, at an estimated cost of $17.1 million. The property is expected to be completed in the third quarter of 1998. The Partnership has obtained a $13.7 million construction loan to finance construction. The Trust has also loaned the partnership $2.9 million which is to be repaid following completion and lease-up of the property. In connection with the acquisition of the land on which the property is being constructed, Danforth paid an acquisition fee of $30,000 to Tarragon. In February 1998, the Trust acquired an additional 20% limited partner interest in this partnership. Because both general partners actively participate in the decision-making of the partnership activities, the Trust accounts for its investment in this partnership using the equity method. In December 1997, in exchange for a $200,000 capital contribution, the Trust received a 1% general partner interest and a 49% limited partner interest in Savannah. This partnership was formed to construct a 250-unit luxury apartment complex to be known as The Links at Georgetown located in Savannah, Georgia, at an estimated cost of $14.5 million. The property is expected to be completed in the second quarter 1999. The partnership has obtained a $12 million construction loan to finance construction. The Trust also loaned the partnership $1.2 million which is to be repaid following completion and lease-up of the property. Until lease-up of the property, the construction loan is guaranteed by the other general partner. As the Trust holds a non-controlling interest in the partnership, it accounts for its investment in the partnership using the equity method. 46 47 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued) In December 1997, in exchange for a capital contribution of $970,000, the Trust acquired a 70% general partner interest in Ansonia, which purchased Autumn Ridge Apartments, a 116-unit property in East Haven, Connecticut, for $2 million and Meriden East Apartments, a 66-unit property in Meriden, Connecticut, for $1.8 million. Both properties were purchased in December 1997, and $2.9 million of the aggregate acquisition cost was financed through mortgages on each property. In connection with the acquisition of these properties, Ansonia paid Tarragon acquisition fees totaling $38,000. Because both partners participate in the decision-making of partnership activities, the Trust is a noncontrolling partner and accounts for its investment in Ansonia using the equity method. Advances to partnerships included in the accompanying December 31, 1997, Consolidated Balance Sheet include $721,000 the Trust advanced in December 1997 to Omni in exchange for a 46% interest in this partnership. Subsequent to year end, the Trust advanced an additional $4.6 million to this partnership, which purchased 5600 Collins Avenue in Miami Beach, Florida. See NOTE 16. "SUBSEQUENT EVENTS." As the Trust holds a noncontrolling interest in Omni, its investment in this partnership is accounted for using the equity method. The Trust and Continental Mortgage and Equity Trust ("CMET") own SAC 9, a tenancy-in-common which currently owns two office buildings in the vicinity of Sacramento, California. The Trust has a 70% undivided interest in SAC 9. Under the terms of the joint tenancy, unanimous consent is required of both the Trust and CMET for any material changes in the operations of the properties, including sales, refinancings, and changes in property management. The Trust, as a noncontrolling partner, accounts for its investment in SAC 9 using the equity method. In August 1995, SAC 9 obtained first mortgage financing in the amount of $3.5 million secured by a previously unencumbered office building. Net financing proceeds of $3.4 million were distributed, of which the Trust's proportionate share was $2.4 million. In connection with the financing, SAC 9 paid a mortgage brokerage fee of $35,000 to Tarragon. Distribution of the financing proceeds to the Trust resulted in cumulative distributions exceeding the Trust's investment in SAC 9. Accordingly, during 1996, the Trust recorded income of $129,000 representing the excess of cumulative distributions over the Trust's investment in SAC 9. The Trust and CMET were partners in ISA, a general partnership in which the Trust had a 40% interest in earnings, losses, and distributions. ISA in turn owned a 100% interest in Indcon, L.P. ("Indcon"), which owned four industrial warehouses at December 31, 1997. The Trust, as a noncontrolling partner, accounted for its investment in ISA using the equity method. In August 1997, Indcon sold a warehouse for $60,000 receiving net cash proceeds of $54,000 of which the Trust's proportionate share was $22,000. In connection with the sale, Indcon recorded a loss on the sale totaling $134,000, and the Trust recorded a $54,000 loss representing its proportionate share of the loss on sale. In November 1997, the Trust sold its interest in the partnership to CMET for $1.6 million cash. In connection with this transaction, the Trust recognized a gain on the sale of $215,000. During the first half of 1996, Indcon sold 27 warehouses for $41.2 million, receiving net cash proceeds of $16.8 million after the payoff of the existing $23.5 million mortgage loan and closing costs. The Trust's share of the sales proceeds was $6.7 million plus $130,000 representing an allowance for brokerage commissions which the Trust retained and which offset the Trust's share of Indcon's loss on the sale, resulting in a net gain on the sale of $22,000. In September 1995, one of Indcon's warehouses was destroyed in a fire. An insurance settlement totaling $2.2 million was reached by the partnership in March 1996 resulting in a $1.1 million gain, of which the Trust's proportionate share was $451,000. The Trust received cash proceeds of $760,000 representing its proportionate share of the insurance settlement proceeds. Indcon does not anticipate rebuilding the property. 47 48 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued) In July 1997, the Trust acquired an additional 40% interest in English Village Partners, L.P., ("English Village") increasing its total interest to 90%, in exchange for a capital contribution of $1 million. As the Trust now holds a controlling interest, the operations of English Village Apartments, the partnership's sole property, have been consolidated since July 1997. See NOTE 3. "REAL ESTATE AND DEPRECIATION." Prior to July 1997, the Trust held a 49% limited partner interest and a 1% general partner interest in English Village and, as a noncontrolling partner, accounted for its investment using the equity method. In November 1995, English Village refinanced the mortgage debt secured by English Village Apartments, increasing the first mortgage loan balance to $6.2 million. Net refinancing proceeds were $1.3 million, of which the Trust's portion was $619,000. Distribution of the refinancing proceeds resulted in cumulative distributions exceeding the Trust's investment in English Village. Also, during 1996, distributions to the Trust from the operations of English Village Apartments exceeded the Trust's share of the partnership's net income. Accordingly, during 1996, the Trust recorded income of $771,000 representing the excess of cumulative distributions over the Trust's investment in English Village. In June 1995, the Trust acquired a 50% economic interest in an office building located at 801 Pennsylvania Avenue, Washington, D.C. (the "Property"). This interest was acquired through the purchase of a first lien mortgage note with a face value of $8.5 million (the "Note") for $500,000 in cash and a $2.5 million promissory note, which bore interest at the Prime Rate plus 1% per annum and was repaid at a $67,000 discount in September 1995. In accordance with the terms of the Note, the Trust's $3 million investment, as well as any additional advances made to the Property, is to be repaid from Property cash flow after operating expenses with interest at the rate of 11% per annum. The $5.5 million remaining balance of the Note plus accrued interest may be satisfied by payment of 50% of all funds available after Property operating expenses plus 50% of the proceeds from any sale and any refinancing. The Note is nonrecourse to all parties and is secured only by the Property. Set forth below are summarized financial data for all partnerships the Trust accounts for using the equity method (unaudited):
December 31, ---------------------- 1997 1996 --------- --------- Real estate (net of accumulated depreciation of $2,898 in 1997 and $5,817 in 1996) ............. $ 36,969 $ 14,316 Other assets ..................................... 1,868 1,525 Notes payable .................................... (24,759) (8,937) Other liabilities ................................ (8,615) (276) --------- --------- Partners' capital ................................ $ 5,463 $ 6,628 ========= =========
48 49 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)
For the Years Ended December 31, ------------------------------------ 1997 1996 1995 ---------- ---------- ---------- Rental revenue ................................... $ 3,823 $ 5,090 $ 9,889 Property operating expenses ...................... (1,419) (2,179) (3,290) Interest expense ................................. (829) (1,421) (3,202) Depreciation expense ............................. (519) (535) (2,013) ---------- ---------- ---------- Income before loss on sale of real estate and gain on insurance settlement ................... 1,056 955 1,384 Loss on sale of real estate ...................... (134) (270) -- Gain on insurance settlement ..................... -- 1,126 -- ---------- ---------- ---------- Net income ....................................... $ 922 $ 1,811 $ 1,384 ========== ========== ==========
NOTE 5. INVESTMENTS IN MARKETABLE EQUITY SECURITIES In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," investments in marketable equity securities are carried at fair value. These investments are included in "Other assets" in the accompanying December 31, 1997, Consolidated Balance Sheet. Unrealized gains are included as a separate component of shareholders' equity. During 1997, unrealized gains increased $831,000, and investments with a cost basis of $1.9 million (determined by the average cost method) were sold for $2.6 million, resulting in realized gains of $698,000. At December 31, 1994, the Trust owned 39,500 shares of beneficial interest of CMET, purchased through open market transactions, at a total cost to the Trust of $181,000. During the first quarter of 1995, the Trust sold the shares for $593,000 and recognized a $412,000 gain on the sale. NOTE 6. NOTES AND INTEREST PAYABLE Note and interest payable consisted of the following at December 31:
1997 1996 ---------------------------- ---------------------------- Estimated Estimated Fair Book Fair Book Value Value Value Value ---------- --------- ---------- ---------- Notes payable ................................... $ 180,461 $ 182,498 $ 134,988 $ 132,981 ========== ========== Accrued interest ................................ 1,628 1,289 --------- --------- $ 184,126 $ 134,270 ========= =========
Notes payable at December 31, 1997, bear interest at rates ranging from 6.05% to 11.68% per annum and mature from 1998 through 2031. These notes are generally nonrecourse and are collateralized by deeds of trust on real estate with an aggregate carrying value of $208 million. 49 50 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 6. NOTES AND INTEREST PAYABLE (Continued) During 1997, 1996, and 1995, the Trust obtained permanent mortgage financing on sixteen Trust properties, including Martins Landing and Forest Oaks as discussed below, totaling $78.7 million, receiving net cash proceeds of $19.7 million after the payoff of $51.6 million in existing debt. The remainder of the financing proceeds was used to fund escrows for replacements and repairs and to pay the associated closing costs. In connection with these financings, the Trust paid commissions of $611,000 to Tarragon. At December 31, 1997, scheduled principal payments on notes payable are due as follows: 1998.......................................................... $ 16,188 1999 ........................................................ 17,051 2000 ........................................................ 53,324 2001.......................................................... 2,071 2002 ........................................................ 2,767 Thereafter.................................................... 91,097 --------- $ 182,498 =========
In September 1995, the Trust negotiated a $2.7 million payoff of the $3.2 million mortgage loan secured by Forest Oaks Apartments in Lexington, Kentucky. In exchange for the discounted payoff of the Forest Oaks mortgage loan, the Trust agreed to pay the full balance of the $4.5 million mortgage loan, originally scheduled to mature February 2023, secured by Martins Landing Apartments located in Lakeland, Florida. In December 1995, the Trust obtained interim financing in the amount of $2 million secured by Forest Oaks. For services provided in connection with obtaining the interim financing, the Trust paid Tarragon a mortgage brokerage fee of $20,000. The combined $6.7 million proceeds of the interim financing and the new $5 million first mortgage loan secured by Martins Landing, which was also obtained in December 1995, along with general working capital of the Trust, were used to satisfy the mortgage payoffs, and, in December 1995, the Trust recognized an extraordinary gain of $560,000 due to the forgiveness of debt. In May 1996, the Trust obtained permanent mortgage financing secured by Forest Oaks in the amount of $3.1 million. Also in September 1995, the Trust entered into a Loan Sale Agreement (the "Agreement") with the U. S. Department of Housing and Urban Development ("HUD") for the discounted purchase of two mortgage loans for $3.9 million, secured separately by Bryan Hill Apartments located in Bethany, Oklahoma, acquired in November 1994, and Meadowbrook Apartments, a 200-unit complex in Baton Rouge, Louisiana. The Trust paid $3.5 million of the purchase price with funds obtained in November 1995 through interim financing secured by first mortgages against both properties. The balance was paid through the application of existing escrow accounts and general working capital of the Trust. In November 1995, simultaneously with the final payment to HUD, the Trust recognized an extraordinary gain of $110,000 in connection with the purchase of the $2.2 million Bryan Hill mortgage. Through the discounted purchase of the mortgage loan secured by Meadowbrook, effective October 1, 1995, the Trust acquired control of the property and recorded the acquisition as of the same date. The Trust paid a mortgage brokerage fee of $35,000 to Tarragon for obtaining the interim financing. 50 51 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 6. NOTES AND INTEREST PAYABLE (Continued) In August 1996, the Trust obtained a $9 million line of credit secured by mortgages on four of its multifamily properties, Diamond Loch, Meadowbrook, Mustang Creek, and The Regent. All of these properties except The Regent previously collateralized other mortgage loans. The prior loans totaling $3.9 million secured by Diamond Loch and Mustang Creek were paid off at closing. Additionally, a principal payment of $500,000 was made at closing on the $3.5 million interim mortgage loan obtained in 1995 secured by both Meadowbrook and Bryan Hill in exchange for the release of Meadowbrook. During 1996, $8.8 million was advanced under the line of credit, and, after prior loan payoffs and closing costs, the Trust received net cash proceeds of $4.2 million. The Trust paid Tarragon financing fees totaling $88,000 for services rendered in connection with this transaction. In 1997, the remaining $200,000 was advanced under the line of credit, and the Trust paid Tarragon a $2,000 financing fee. In September 1997, Meadowbrook was released as collateral on the line of credit, and a $2.5 million advance secured by this property was obtained under the revolving credit facility with GMAC Commercial Mortgage. See discussion below. Pursuant to a Master Repurchase Agreement (the "Agreement") with an investment bank entered into in April 1996, the Trust purchased the $3.1 million Fannie Mae mortgage backed security ("Fannie Mae MBS") issued by the lender in connection with the financing of Forest Oaks at a 1/2% discount in June 1996 and the $16.8 million Government National Mortgage Association mortgage backed security ("GNMA MBS") issued by the lender in connection with the financing of Heather Hills at a 2.7% discount in July 1996. The investment bank purchased the Fannie Mae MBS and the GNMA MBS from the Trust for 92% of the aggregate value, or $17.9 million, and the Trust agreed to repurchase the MBSs from the investment bank one month later at the same price plus interest at the London Interbank Offered Rate ("LIBOR") plus 1/2% per annum. As provided for in the Agreement, the Trust and the investment bank extended the repurchase date monthly. In January 1997, the Trust entered into a similar repurchase transaction with a government sponsored enterprise which purchased the MBSs for 97% of their aggregate value, or $19.3 million, and the Trust agreed to repurchase them in February 1997 for the same price plus interest at 5.4% per annum. The Trust and the government sponsored enterprise have since extended the repurchase date monthly. In November 1997, the Trust purchased the $2.7 million Fannie Mae MBS issued by the lender in connection with the financing of Cross Creek Apartments ("Cross Creek") at a 3% discount. The government sponsored enterprise purchased the Cross Creek Fannie Mae MBS along with the other MBSs in November 1997 pursuant to the same reverse repurchase transaction. The repurchase date has been extended to March 1998, and the current repurchase price is $22.4 million. The repurchase transaction has resulted in effective interest rates as of December 31, 1997, on the Forest Oaks, Heather Hills, and Cross Creek financings of 6.85%, 6.11%, and 6.87% respectively. The Trust is exposed to a demand for additional collateral or, in the alternative, credit loss in the event the interest rate associated with the repurchase transaction fluctuates in a manner that is unfavorable to the Trust's interest in the MBSs. However, the Trust intends to either pay off the mortgages or modify the mortgages to increase the interest rate prior to any significant credit loss. In May 1997, the Trust accepted a commitment from GMAC Commercial Mortgage Corporation for a $50 million revolving credit facility. Advances under the facility are available to finance properties currently owned by the Trust as well as new acquisitions. The outstanding balance is limited to the lesser of 75% of the value of the collateral properties or an amount supported by a debt service coverage ratio of 1.25. The borrowing base 51 52 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 6. NOTES AND INTEREST PAYABLE (Continued) may be increased by adding new or existing properties to the collateral pool. Advances are limited to the lesser of 75% of the appraised value of the property as stabilized or 80% of total acquisition costs which include the purchase price of a newly acquired property and the cost of improvements incurred between the date of acquisition and the date that any mortgage secured by that property is recorded. A newly acquired property is defined as a property owned by the Trust for less than one year. The outstanding balance under the facility bears interest at the 30 day LIBOR plus a variable spread of between 2% and 2.5% which is determined based on the loan-to-value and debt service coverage maintained. Payment terms include interest only monthly with the outstanding balance due at maturity, which is 36 months from the date of the first advance. The Trust may extend the maturity by two six-month terms, but no new fundings may occur under the facility during any extension period. In 1997, the Trust obtained fundings under this revolving credit facility totaling $42 million secured by first mortgages against eight Trust properties. The Trust received net cash proceeds of $26.3 million from these fundings after the payoff of existing mortgages of $13.5 million, establishing escrows for taxes, insurance, and repairs, and paying the associated closing costs. In connection with these fundings, the Trust paid Tarragon financing fees totaling $420,000. In December 1993, the Trust issued a $1 million convertible subordinated debenture to Mr. John A. Doyle, Chief Financial Officer of the Trust until September 1996, in exchange for his participation interest in the profits of the Consolidated Capital Properties II ("CCP II") assets, which the Trust acquired in November 1992. Mr. Doyle was granted this participation as consideration for his services in connection with the CCP II acquisition. In February 1996, Mr. Doyle converted the debenture into 93,076 Shares. In September 1996, the Trust repurchased 50,000 of these Shares from Mr. Doyle for $700,000. NOTE 7. DISTRIBUTIONS TO SHAREHOLDERS The Trust paid cash distributions in 1995, 1996, and 1997 of $2.6 million, $2.8 million, and $2.9 million, respectively. The Trust reported to the Internal Revenue Service that the 1997 distributions were taxable to shareholders as ordinary income and the 1996 and 1995 distributions represented return of capital. Additionally, in September 1995, 1996, and 1997, the Trust paid 10% share distributions which resulted in the Trust issuing 297,960 Shares, 325,115 Shares, and 337,147 Shares, respectively. 52 53 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 8. EARNINGS PER SHARE Following is a reconciliation of the weighted average shares of beneficial interest outstanding used in the computation of earnings per share and earnings per share - assuming dilution.
For the Years Ended December 31, --------------------------------- 1997 1996 1995 --------- --------- --------- Weighted average shares of beneficial interest ................. 3,832,535 4,070,183 4,101,453 Share options .......................... 38,713 18,199 508 --------- --------- --------- Weighted average shares of beneficial interest outstanding - assuming dilution ................... 3,871,248 4,088,382 4,101,961 ========= ========= =========
NOTE 9. SHARE OPTIONS In November 1995, the Trust's shareholders approved two share option plans: the Independent Trustee Share Option (the "Trustee Plan") and the Share Option and Incentive Plan (the "Incentive Plan"). Options granted pursuant to the Trustee Plan are immediately exercisable and expire on the earlier of the first anniversary of the date on which a Trustee ceases to be a Trustee of the Trust or ten years from the date of grant. For each year of service, an Independent Trustee will be awarded an option to purchase 1,000 shares on January 1 of such year. The Trustee Plan provides for options for 72,600 shares. Under the Incentive Plan, options have been granted to certain Trust officers and key employees of Tarragon and Tarragon Management, Inc.("TMI"), a wholly-owned subsidiary of Tarragon. The Incentive Plan provides for options for 363,000 shares. All grants are determined by the Option Committee, which is presently comprised of two Trustees, Mr. William S. Friedman (President, Chief Executive Officer, and Trustee of the Trust) and Mr. Carl B. Weisbrod (Chairman of the Board). Options granted pursuant to the Incentive Plan are exercisable beginning one year after the date of grant and expire five years from the date of grant. [This space intentionally left blank.] 53 54 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 9. SHARE OPTIONS (Continued)
The following table summarizes share option activity: Exercise Price Outstanding Exercisable -------------- ----------- ----------- December 31, 1994, balance ........ $ -- -- -- Options granted ................... 9 1/8 25,410 25,410 --------------- -------- -------- December 31, 1995, balance ........ 9 1/8 25,410 25,410 Options granted ................... 9 1/8 - 11 5/8 104,830 79,860 Options forfeited ................. 9 1/8 (24,970) -- --------------- -------- -------- December 31, 1996, balance ........ 9 1/8 - 11 5/8 105,270 105,270 Options granted ................... 10 7/8 - 15 1/4 55,070 7,700 Options forfeited ................. 15 1/4 (400) -- --------------- -------- -------- December 31, 1997, balance ........ $9 1/8 - 15 1/4 159,940 112,970 =============== ======== ========
The following table summarizes information about the options outstanding at December 31, 1997:
Outstanding Exercisable --------------------------------------------------- --------------------------- Range of Weighted Average Weighted Average Weighted Average Exercise Prices Options Contractual Life Exercise Price Options Exercise Price ----------------- ------- ---------------- -------------- ------- --------------- $ 9 1/8 - $11 5/8 132,440 4.9 years $10.00 112,970 $9.83 14 1/8 - 15 1/4 27,500 4.6 years 15.02 - - ------------------ ------- --------- ------ ------- ----- $ 9 1/8 - $15 1/4 159,940 4.8 years $10.86 112,970 $9.83 ================== ======= ========= ====== ======= =====
Subsequent to year end, in January 1998, the Trust granted options covering 7,000 shares, all of which were immediately exercisable, pursuant to the Trustee Plan. Also, an additional 19,470 of the December 31, 1997, outstanding options became exercisable in January 1998. The Trust applies APB No. 25 and related Interpretations in accounting for its plans. All share options issued to date by the Trust have exercise prices equal to the market price of the shares at the dates of grant. Accordingly, no compensation cost has been recognized for its share option plans. Had compensation cost for the Trust's two share option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Trust's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
For the Years Ended December 31, ------------------------------------------------- 1997 1996 ------------------------------------------------- As Reported Pro Forma As Reported Pro Forma ----------- --------- ----------- --------- Net income................................ $ 5,592 $ 5,554 $ 4,937 $ 4,841 Earnings per share Net income................................ $ 1.46 $ 1.45 $ 1.21 $ 1.19 Earnings per share - assuming dilution Net income................................ $ 1.44 $ 1.43 $ 1.21 $ 1.18
54 55 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 9. SHARE OPTIONS (Continued) The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
For the Years Ended December 31, -------------------------------- 1997 1996 ------------ ------------ Dividend yield .................. 6% 6% Expected volatility ............. 20% 25% Risk-free interest rate ......... 6.21% 5.5% Expected lives (in years) ....... 3 3 Forfeitures ..................... 10% 10%
The weighted average fair value per share of options granted in 1997 and 1996 was $1.53 and $1.47, respectively. NOTE 10. ADVISORY AGREEMENT Although the Trust's Board of Trustees (the "Board") is directly responsible for managing the affairs of the Trust and setting the policies which guide it, the day-to-day operations of the Trust are performed by an advisory firm which operates under the supervision of the Board pursuant to a written advisory agreement approved by shareholders. The duties of the advisor include, among other things, locating, investigating, evaluating, and recommending real estate investment and sale opportunities and financing and refinancing sources for the Trust. The advisor also serves as a consultant in connection with the business plan and investment policy decisions made by the Board. Since April 1, 1994, Tarragon has provided advisory services to the Trust under an advisory agreement approved by the Board and ratified by the shareholders on November 20, 1995. Mr. Friedman, President, Chief Executive Officer, and Trustee of the Trust, serves as a Director and Chief Executive Officer of Tarragon. Tarragon is owned by Mr. Friedman and Lucy N. Friedman, his wife. The Friedman family owns approximately 33% of the outstanding shares of the Trust. Under the Trust's initial advisory agreement, the Trust paid Tarragon an annual base advisory fee of $100,000 plus an incentive advisory fee equal to 16% of the Trust's adjusted funds from operations before deduction of the advisory fee. Adjusted funds from operations is defined as funds from operations ("FFO"), as defined by the National Association of Real Estate Investment Trusts, plus any loss due to the write-down or sale of any real property or mortgage loan acquired prior to January 1, 1989. FFO represents net income (loss), computed in accordance with GAAP, excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Additionally, Tarragon could receive commissions of 1% based upon (i) acquisition cost of real estate, (ii) mortgage loans acquired, and (iii) mortgage loans obtained or refinanced and a 10% incentive sales commission based on gains from the sale of real estate. 55 56 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 10. ADVISORY AGREEMENT (Continued) At the March 1995 Board meeting, a majority of the Trustees approved a revised advisory agreement, effective April 1, 1995, which was approved by the shareholders at the November 20, 1995, shareholder meeting. In addition to technical changes designed to clarify the responsibilities and rights of Tarragon, the new agreement eliminated the $100,000 annual base fee, the incentive sales compensation, and mortgage loan acquisition commissions. Moreover, it provides that real estate brokerage commissions shall be payable to Tarragon and its affiliates only following specific Board approval for each transaction rather than as a general practice. No such commissions have been paid under the revised agreement. The renewal of the advisory agreement between the Trust and Tarragon was approved by shareholders on March 20, 1997. Employees of Tarragon render services to the Trust, as the Trust has no employees. In accordance with the terms of the advisory agreements, certain services provided by the advisor, including, but not limited to, accounting, legal, investor relations, data processing, and the related departmental overhead, are reimbursed directly by the Trust. Under the advisory agreement (as required by the Trust's Declaration of Trust), all or a portion of the advisory fee must be refunded by the advisor to the Trust if Operating Expenses, as defined, exceed certain specified limitations based on the book value, net asset value, and net income of the Trust during such fiscal year. The operating expenses of the Trust did not exceed such limitation in 1995, 1996, or 1997. For additional information regarding compensation paid to the advisor, see NOTE 12. "RELATED PARTY TRANSACTIONS" and ITEM 10. "TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT - The Advisor." NOTE 11. PROPERTY MANAGEMENT Since April 1, 1994, Tarragon has provided property management services to the Trust for a fee of 4.5% of the monthly gross rents collected on multifamily properties and 1.5% to 5% of the monthly gross rents collected on commercial properties. Tarragon subcontracts with other entities for the provision of some of the property-level management services for the Trust. Beginning April 1, 1996, TMI assumed the property-level management of a majority of the Trust's properties for a fee of 4.5% of the monthly gross rents collected. 56 57 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 12. RELATED PARTY TRANSACTIONS Fees and expense reimbursements to Tarragon and affiliates for 1997, 1996, and 1995 were as follows:
1997 1996 1995 --------- --------- --------- Fees Advisory ......................... $ 1,438 $ 1,117 $ 1,037 Real estate acquisition .......... 234 106 198 Equity refinancing ............... 773 187 247 Property management* ............. 1,610 1,014 330 Commercial lease commissions ..... 39 -- -- --------- --------- --------- $ 4,094 $ 2,424 $ 1,812 ========= ========= ========= Expense reimbursements ........... $ 1,411 $ 1,176 $ 960 ========= ========= =========
- ---------------------------------- * Net of property management fees paid to subcontractors. Other liabilities at December 31, 1995, included non-interest bearing cash advances of $283,000 and $300,000 from Tarragon and Lucy N. Friedman (50% stockholder of Tarragon and a principal shareholder of the Trust), respectively. Such advances were made to the Trust on a short term basis to facilitate the negotiated discounted payoffs of the mortgage loans secured by Bryan Hill, Meadowbrook, and Forest Oaks. In connection with the discounted payoffs, the Trust realized extraordinary gains on debt forgiveness totaling $670,000. The Trust repaid the advances during 1996. NOTE 13. INCOME TAXES For 1997, 1996, and 1995, the Trust has elected and qualified to be treated as a Real Estate Investment Trust ("REIT"), as defined in Sections 856 through 860 of the Code, and, as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to shareholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed. See NOTE 7. "DISTRIBUTIONS TO SHAREHOLDERS." As a result of the Trust's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, no deferred tax asset or liability or related valuation allowance was recorded. No provision has been made for federal income taxes because the Trust believes it has qualified as a REIT and expects that it will continue to do so. The Trust's basis in its net assets for tax purposes differs from that for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties, and investments in partnerships. At December 31, 1997 and 1996, the Trust's tax basis in its net real estate exceeded its basis for financial statement purposes by $22.8 million and $19.6 million, respectively. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes, and the Trust will be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1997, the Trust had a tax net operating loss carryforward of $43 million expiring through 2011. 57 58 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 14. RENTALS UNDER OPERATING LEASES The Trust's rental operations include the leasing of office buildings and shopping centers subject to leases with terms greater than one year. The leases thereon expire at various dates through 2010. The following is a schedule of future minimum rentals on non-cancelable operating leases as of December 31, 1997: 1998 ........................................................ $ 7,325 1999 ........................................................ 6,816 2000 ........................................................ 5,622 2001 ........................................................ 4,350 2002 ........................................................ 2,903 Thereafter ................................................. 4,766 ---------- $ 31,782 ==========
NOTE 15. COMMITMENTS AND CONTINGENCIES Olive Litigation. In February 1990, the Trust, together with CMET, Income Opportunity Realty Investors, Inc., ("IORI"), and Transcontinental Realty Investors, Inc. ("TCI"), three real estate entities with, at the time, the same officers, directors or trustees, and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive, et. al. v. National Income Realty Trust, et. al., relating to the operation and management of each of the entities. On April 23, 1990, the court granted final approval of the terms of the original settlement. On May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Modification"), which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994, and final court approval was entered on December 12, 1994. The effective date of the Modification was January 11, 1995. The Modification provided for, among other things, the addition of at least three new unaffiliated members to the Trust's Board of Trustees and set forth new requirements for the approval of any transactions with affiliates over the next five years. In accordance with the procedures set forth in the Modification, Irving E. Cohen, Lance Liebman, Sally Hernandez-Pinero, and L. G. Schafran were appointed to the Board. In addition, Basic Capital Management, the Trust's previous advisor, Mr. Gene E. Phillips, and Mr. Friedman agreed to pay a total of $1.2 million to the Trust, CMET, IORI, and TCI, of which the Trust's share was $150,000. As of December 31, 1996, the Trust had collected the entire $150,000. Under the Modification, the Trust, CMET, IORI, TCI, and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, CMET, IORI, and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips and Friedman or their affiliates shall be (i) voted in favor of the reelection of all current Board members that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new Board members appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification. 58 59 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 15. COMMITMENTS AND CONTINGENCIES (Continued) The Modification also terminated a number of the provisions of the Stipulation of Settlement, including the requirement that the Trust, CMET, IORI, and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court will retain jurisdiction to enforce the Modification. Other litigation. The Trust is also party to various claims and routine litigation arising in the ordinary course of business. Management of the Trust does not believe that the results of such claims and litigation, individually or in the aggregate, will have a material adverse effect on its business, financial position, or results of operations. NOTE 16. SUBSEQUENT EVENTS In December 1997, the Trust advanced $721,000 to National Omni Associates, L.P., ("Omni") in exchange for a 46% interest in the partnership. In January and February 1998, the Trust advanced the partnership an additional $4.6 million. Omni purchased 5600 Collins Avenue, a 289-unit, high rise apartment building in Miami Beach, Florida, for $32 million in February 1998. $26 million of the purchase price was financed through first and second lien mortgage debt. In connection with the acquisition, Omni paid Tarragon a $150,000 acquisition fee. In January 1998, the Trust obtained a $1.2 million advance under the $50 million revolving credit facility secured by Mariner Plaza Shopping Center, which the Trust acquired in August 1997. In connection with this funding, the Trust paid Tarragon a fee of $12,000. In January and February 1998, the Trust obtained $13.8 million in mortgage financing secured separately by three properties. After the payoff of the existing debt, establishing required escrows, and closing costs, the Trust received net cash proceeds of $4 million. In connection with these transactions, the Trust paid Tarragon fees totaling $137,620. On February 19, 1998, the Trust and Tarragon Realty Investors, Inc., ("TRI") jointly announced the agreement of their respective boards to form a single consolidated entity with TRI, for convenience, as the survivor. The surviving consolidated entity is intended to operate as a self-administered REIT. The consolidation transaction will be submitted to shareholders of each of the Trust and TRI for approval at special meetings to be held during 1998. Under the proposed agreement, each shareholder of the Trust will receive 1.97 shares of TRI common stock for each share of beneficial interest of the Trust held. TRI, also a REIT, has a similar opportunistic approach to real estate investment and had total consolidated assets of approximately $37 million as of December 31, 1997. Upon the approval and consummation of the consolidation transaction by the respective shareholders of each entity, TRI will acquire Tarragon, the Trust's advisor since April 1, 1994, and TRI's advisor since March 1, 1994, for 100,000 shares of common stock of TRI and options to acquire additional shares of common stock of TRI at prices ranging between $13 and $16 per share. The resulting consolidated enterprise with TRI as the survivor will emerge from these transactions as an integrated, self-administered, self-managed REIT controlling approximately 14,000 apartment units and 2.1 million square feet of retail and office space, primarily in California, Florida, and Texas. The consolidation transaction will be accounted for as a reverse acquisition of TRI by the Trust. 59 60 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 17. QUARTERLY RESULTS OF OPERATIONS The following is a tabulation of the quarterly results of operations for the years ended December 31, 1997 and 1996:
First Second Third Fourth 1997 Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- Revenue .......................................... $ 12,180 $ 12,506 $ 13,399 $ 13,932 Expenses ......................................... (11,839) (12,141) (13,593) (14,176) ----------- ----------- ----------- ----------- Income (loss) before net gain on sale of real estate, gain on sale of investments, and extraordinary gain (loss) .................. 341 365 (194) (244) Net gain on sale of real estate .................. -- 1,576 2,774 -- Gain on sale of investments ...................... -- -- 686 227 ----------- ----------- ----------- ----------- Income (loss) from continuing operations ......... 341 1,941 3,266 (17) Extraordinary gain (loss) ........................ -- -- 353 (292) ----------- ----------- ----------- ----------- Net income (loss) ................................ $ 341 $ 1,941 $ 3,619 $ (309) =========== =========== =========== =========== Earnings per share Income (loss) from continuing operations ......... $ .09 $ .51 $ .86 $ -- Extraordinary gain (loss) ........................ -- -- .09 (.08) ----------- ----------- ----------- ----------- Net income (loss) ................................ $ .09 $ .51 $ .95 $ (.08) =========== =========== =========== =========== Weighted average shares (1) ...................... 3,859,018 3,840,352 3,819,027 3,812,404 =========== =========== =========== =========== Earnings per share - assuming dilution Income (loss) from continuing operations ......... $ .09 $ .50 $ .85 $ -- Extraordinary gain (loss) ........................ -- -- .09 (.08) ----------- ----------- ----------- ----------- Net income (loss) ................................ $ .09 $ .50 $ .94 $ (.08) =========== =========== =========== =========== Weighted average shares - assuming dilution (2) .......................... 3,865,646 3,850,113 3,829,714 3,825,180 =========== =========== =========== ===========
- -------------------- (1) Represents weighted average shares of beneficial interest used in computing earnings per share. Share and per share amounts have been restated to give effect to the September 1997 10% share distribution. (2) Represents weighted average shares of beneficial interest used in computing earnings per share - assuming dilution. 60 61 NATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 17. QUARTERLY RESULTS OF OPERATIONS (Continued)
First Second Third Fourth 1996 Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- Revenue .................................. $ 12,020 $ 13,233 $ 12,566 $ 12,143 Expenses ................................. (12,048) (12,332) (13,037) (11,759) ----------- ----------- ----------- ----------- Income (loss) before gains on sale of real estate and insurance settlement ... (28) 901 (471) 384 Gain on sale of real estate .............. 224 (213) 3,681 8 Gain on insurance settlement ............. 451 -- -- -- ----------- ----------- ----------- ----------- Net income ............................... $ 647 $ 688 $ 3,210 $ 392 =========== =========== =========== =========== Earnings per share - basic and diluted Net income ............................... $ .16 $ .17 $ .79 $ .10 =========== =========== =========== =========== Weighted average shares (1) ............. 4,077,884 4,123,790 4,087,317 3,992,407 =========== =========== =========== =========== Weighted average shares - assuming dilution (2) ........................ 4,081,144 4,127,672 4,091,060 3,995,789 =========== =========== =========== ===========
- ----------------------- (1) Represents weighted average shares of beneficial interest used in computing earnings per share. Share and per share amounts have been restated to give effect to the September 1996 and 1997 10% share distributions. (2) Represents weighted average shares of beneficial interest used in computing earnings per share - assuming dilution. 61 62
SCHEDULE III NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997 (DOLLARS IN THOUSANDS) COSTS(A) CAPITALIZED GROSS CARRYING AMOUNTS INITIAL COST TO TRUST SUBSEQUENT AT END OF YEAR ----------------------- TO ACQUISITION -------------------------------- BUILDINGS AND -------------- BUILDINGS AND DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS IMPROVEMENTS LAND IMPROVEMENTS TOTAL - ----------- ------------ ---- ------------ -------------- ---- -------------- ----- PROPERTIES HELD FOR INVESTMENT Apartments Acadian Place ............... $ 2,775(E) $ 897 $ 2,608 $ 1,856 $ 897 $ 4,464 $ 5,361 Baton Rouge, LA Bay West .................... 4,841 891 3,566 648 891 4,214 5,105 Bradenton, FL Bayfront .................... 2,013 457 2,052 1,471 457 3,523 3,980 Houston, TX Bryan Hill .................. 3,500 447 1,803 330 447 2,133 2,580 Bethany, OK Carlyle Towers .............. 3,844 559 5,939 1,135 559 7,074 7,633 Southfield, MI Cornell ..................... 1,490 822 1,183 128 822 1,311 2,133 Los Angeles, CA Courtyard at the Park ....... 2,953 771 3,086 405 771 3,491 4,262 Miami, FL Creekwood North ............. 3,009 532 2,127 760 532 2,887 3,419 Altamonte Springs, FL Cross Creek ................. 2,716 221 883 196 221 1,079 1,300 Lexington, KY Diamond Loch ................ 9,679(B) 380 2,791 924 380 3,715 4,095 North Richland Hills, TX Dunhill/Devonshire/ Sandstone .. 13,200(E) 1,048 3,162 2,491 792 5,909 6,701 Denver, CO English Village ............. 6,019 1,382 5,525 -- 1,382 5,525 6,907 Memphis, TN Fenway Hall ................. 1,303 461 1,460 14 461 1,474 1,935 Los Angeles, CA Forest Oaks ................. 3,015 691 2,685 425 691 3,110 3,801 Lexington, KY Fountainhead ................ 5,650(E) 1,573 6,291 32 1,573 6,323 7,896 Kissimmee, FL Heather Hills ............... 16,865 643 14,562 6,773 765 21,213 21,978 Temple Hills, MD Kirklevington ............... 2,415 490 1,961 636 490 2,597 3,087 Lexington, KY Lake Point .................. 9,000(E) 2,075 6,225 2,095 2,075 8,320 10,395 Memphis, TN Landmark .................... 1,500 376 1,504 11 376 1,515 1,891 Tallahassee, FL LIFE ON WHICH DEPRECIATION IN LATEST STATEMENT ACCUMULATED DATE OF DATE OF OPERATIONS DESCRIPTION DEPRECIATION CONSTRUCTION ACQUIRED IS COMPUTED - ----------- ------------- ------------- -------- ------------- PROPERTIES HELD FOR INVESTMENT Apartments Acadian Place ................. $ 1,275 1922 Mar-84 5-40 years Baton Rouge, LA Bay West ...................... 684 1974 Nov-92 5-40 years Bradenton, FL Bayfront ...................... 893 1971 Feb-87 5-40 years Houston, TX Bryan Hill .................... 196 1970 Nov-94 5-40 years Bethany, OK Carlyle Towers ................ 1,646 1970 Nov-88 5-40 years Southfield, MI Cornell ....................... 265 1929 Apr-90 5-40 years Los Angeles, CA Courtyard at the Park ......... 41 1972 Jul-97 5-40 years Miami, FL Creekwood North ............... 310 1973 Nov-92 5-40 years Altamonte Springs, FL Cross Creek ................... 156 1966 Nov-92 5-40 years Lexington, KY Diamond Loch .................. 1,166 1978 Oct-85 5-40 years North Richland Hills, TX Dunhill/Devonshire/Sandstone .. 1,331 1969 Mar-89 5-40 years Denver, CO English Village ............... 73 1973 Jul-97 5-40 years Memphis, TN Fenway Hall ................... 285 1929 Apr-90 5-40 years Los Angeles, CA Forest Oaks ................... 235 1971 Nov-94 5-40 years Lexington, KY Fountainhead .................. 93 1988 Jun-97 5-40 years Kissimmee, FL Heather Hills ................. 7,539 1976 May-86 5-40 years Temple Hills, MD Kirklevington ................. 363 1975 Nov-92 5-40 years Lexington, KY Lake Point .................... 945 1974 May-93 5-40 years Memphis, TN Landmark ...................... 10 1967 Oct-97 5-40 years Tallahassee, FL
62 63 SCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
COSTS(A) CAPITALIZED GROSS CARRYING AMOUNTS INITIAL COST TO TRUST SUBSEQUENT AT END OF YEAR ------------------------- TO ACQUISITION --------------------------------------- BUILDINGS AND -------------- BUILDINGS AND DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS IMPROVEMENTS LAND IMPROVEMENTS TOTAL - ----------- ------------ ---------- ----------- -------------- ---------- ---------- ---------- PROPERTIES HELD FOR INVESTMENT (Continued) Apartments (Continued) Marina Park ........... $ 2,403 $ 657 $ 2,625 $ 1,132 $ 657 $ 3,757 $ 4,414 North Miami, FL Mariposa Manor ........ 757 225 901 (293) 225 608 833 Los Angeles, CA Martins Landing ....... 4,856 1,038 4,201 416 1,038 4,617 5,655 Lakeland, FL Meadowbrook ........... 2,513(E) 307 1,230 142 307 1,372 1,679 Baton Rouge, LA Morningside ........... 1,623 420 1,678 210 420 1,888 2,308 Jacksonville, FL Mustang Creek ......... (C) 718 2,872 1,736 718 4,608 5,326 Arlington, TX Newport ............... 5,030 1,334 5,338 297 1,334 5,635 6,969 Plantation, FL Palm Court ............ 2,901 599 2,393 705 599 3,098 3,697 North Miami, FL Park Dale Gardens ..... 2,904 354 1,416 654 531 1,893 2,424 Dallas, TX Park Norton ........... 545 144 576 457 144 1,033 1,177 Los Angeles, CA Park Place ............ -- 76 304 152 76 456 532 Los Angeles, CA Pinecrest ............. 14,420 3,612 8,427 5,830 3,612 14,257 17,869 Ft. Lauderdale, FL Prado Bay ............. 4,800 614 3,482 1,105 614 4,587 5,201 North Bay Village, FL The Regent ............ (B) 303 1,212 4,572 303 5,784 6,087 Jacksonville, FL River City Landing .... 6,100 (E) 1,236 5,602 4,756 1,236 10,358 11,594 Jacksonville, FL LIFE ON WHICH DEPRECIATION IN LATEST STATEMENT ACCUMULATED DATE OF DATE OF OPERATIONS DESCRIPTION DEPRECIATION CONSTRUCTION ACQUIRED IS COMPUTED - ----------- ------------ ------------ -------- ----------- PROPERTIES HELD FOR INVESTMENT (Continued) Apartments (Continued) Marina Park ........... $ 268 1974 Apr-95 5-40 years North Miami, FL Mariposa Manor ........ 70 1924 Sep-94 5-40 years Los Angeles, CA Martins Landing ....... 389 1973 Nov-94 5-40 years Lakeland, FL Meadowbrook ........... 73 1968 Oct-95 5-40 years Baton Rouge, LA Morningside ........... 43 1973 Feb-97 5-40 years Jacksonville, FL Mustang Creek ......... 287 1974 May-95 5-40 years Arlington, TX Newport ............... 84 1973 Jun-97 5-40 years Plantation, FL Palm Court ............ 647 1971 Oct-89 5-40 years North Miami, FL Park Dale Gardens ..... 310 1975 Dec-91 5-40 years Dallas, TX Park Norton ........... 26 1924 Jun-95 5-40 years Los Angeles, CA Park Place ............ 23 1929 Sep-95 5-40 years Los Angeles, CA Pinecrest ............. 2,474 1965 Jul-90 5-40 years Ft. Lauderdale, FL Prado Bay ............. 949 1966 Oct-90 5-40 years North Bay Village, FL The Regent ............ 186 1972 Sep-95 5-40 years Jacksonville, FL River City Landing .... 242 1965 Jun-96 5-40 years Jacksonville, FL
63 64 SCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
COSTS(A) CAPITALIZED GROSS CARRYING AMOUNTS INITIAL COST TO TRUST SUBSEQUENT AT END OF YEAR -------------------------- TO ACQUISITION ---------------------------------------- BUILDINGS AND -------------- BUILDINGS AND DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS IMPROVEMENTS LAND IMPROVEMENTS TOTAL - ----------- ------------ ---------- ------------ ------------ ---------- ------------ ---------- PROPERTIES HELD FOR INVESTMENT (Continued) Apartments (Continued) Spring Pines ................. $ 1,300(E) $ 371 $ 1,486 $ 237 $ 371 $ 1,723 $ 2,094 Houston, TX Summit on the Lake ........... 4,782 895 3,582 522 895 4,104 4,999 Ft. Worth, TX Woodbrier .................... 1,165 508 2,034 135 508 2,169 2,677 Oklahoma City, OK Woodcreek (CO) ............... 2,812 913 3,193 (533) 690 2,883 3,573 Denver, CO Woodcreek (FL) ............... 3,683 472 4,977 1,186 451 6,184 6,635 Jacksonville, FL Vistas at Lake Worth ......... -- 752 92 13,045 752 13,137 13,889 Ft. Worth, TX Office Buildings Emerson Center ............... 3,777(C) 131 8,781 (358) 1,048 7,506 8,554 Atlanta, GA NW O'Hare .................... 998 1,990 7,965 (2,202) 1,104 6,649 7,753 Des Plaines, IL Rancho Sorrento .............. 5,384 1,251 12,901 854 968 14,038 15,006 San Diego, CA Shopping Centers Emerson Center ............... 1,212 -- 363 -- -- 363 363 Atlanta, GA Jackson Square ............... -- 1,115 4,451 21 1,115 4,472 5,587 Jackson, MS K-Mart Plaza ................. 1,273 689 1,608 -- 689 1,608 2,297 Temple Terrace, FL Lakeview Mall ................ -- 513 2,050 612 341 2,834 3,175 Manitowoc, WI Mariner Plaza ................ -- 295 1,180 -- 295 1,180 1,475 Tallahassee, FL LIFE ON WHICH DEPRECIATION IN LATEST STATEMENT ACCUMULATED DATE OF DATE OF OPERATIONS DESCRIPTION DEPRECIATION CONSTRUCTION ACQUIRED IS COMPUTED ----------- ------------ ---------- ----------- PROPERTIES HELD FOR INVESTMENT (Continued) Apartments (Continued) Spring Pines ................. $ 460 1964 Feb-88 5-40 years Houston, TX Summit on the Lake ........... 368 1986 Mar-94 5-40 years Ft. Worth, TX Woodbrier .................... 96 1970 Apr-96 5-40 years Oklahoma City, OK Woodcreek (CO) ............... 1,159 1980 Aug-86 5-40 years Denver, CO Woodcreek (FL) ............... 2,330 1975 Nov-86 5-40 years Jacksonville, FL Vistas at Lake Worth ......... -- 1970 Dec-94 5-40 years Ft. Worth, TX Office Buildings Emerson Center ............... 4,190 1974 Jul-86 5-40 years Atlanta, GA NW O'Hare .................... 3,361 1972 Apr-86 5-40 years Des Plaines, IL Rancho Sorrento .............. 5,002 1980 May-86 5-40 years San Diego, CA Shopping Centers Emerson Center ............... 26 1974 Jul-86 5-40 years Atlanta, GA Jackson Square ............... 115 1970 Jan-96 5-40 years Jackson, MS K-Mart Plaza ................. 243 1979 Dec-91 5-40 years Temple Terrace, FL Lakeview Mall ................ 1,207 1968 Apr-87 5-40 years Manitowoc, WI Mariner Plaza ................ 10 1968 Aug-97 5-40 years Tallahassee, FL
64 65 SCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
COSTS(A) CAPITALIZED GROSS CARRYING AMOUNTS INITIAL COST TO TRUST SUBSEQUENT AT END OF YEAR ------------------------- TO ACQUISITION -------------------------------------- BUILDINGS AND -------------- BUILDINGS AND DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS IMPROVEMENTS LAND IMPROVEMENTS TOTAL - ----------- ---------- --------- ------------- -------------- ---------- ------------- ---------- PROPERTIES HELD FOR INVESTMENT (Continued) Shopping Centers (Continued) Midland Plaza ..... $ 283 $ 321 $ 748 $ 59 $ 321 $ 807 $ 1,128 Midland, MI Midway Mills ...... 4,101 588 2,365 1,468 1,227 3,194 4,421 Carrollton, TX Northside Mall .... 1,710 1,591 3,712 238 1,591 3,950 5,541 Gainesville, FL Southgate ......... -- 578 2,430 674 602 3,080 3,682 Waco, TX Stewart Square .... 2,070 294 1,460 620 294 2,080 2,374 Las Vegas, NV ---------- ---------- ---------- ---------- ---------- ---------- ---------- 179,189 39,620 177,048 58,779 39,658 235,789 275,447 ---------- ---------- ---------- ---------- ---------- ---------- ---------- LIFE ON WHICH DEPRECIATION IN LATEST STATEMENT ACCUMULATED DATE OF DATE OF OPERATIONS DESCRIPTION DEPRECIATION CONSTRUCTION ACQUIRED IS COMPUTED ----------- ------------ ---------- ----------- PROPERTIES HELD FOR INVESTMENT (Continued) Shopping Centers (Continued) Midland Plaza ..... $ 113 1976 Dec-91 5-40 years Midland, MI Midway Mills ...... 1,269 1986 Oct-91 5-40 years Carrollton, TX Northside Mall .... 651 1977 Dec-91 5-40 years Gainesville, FL Southgate ......... 485 1959 Jul-91 5-40 years Waco, TX Stewart Square .... 778 1971 Oct-87 5-40 years Las Vegas, NV ---------- 45,440 ----------
65 66 SCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
COSTS(A) CAPITALIZED GROSS CARRYING AMOUNTS INITIAL COST TO TRUST SUBSEQUENT AT END OF YEAR ----------------------- TO ACQUISITION -------------------------------- BUILDINGS AND -------------- BUILDINGS AND DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS IMPROVEMENTS LAND IMPROVEMENTS TOTAL - ----------- ------------ ---- ------------ -------------- ---- -------------- ----- PROPERTIES HELD FOR SALE Shopping Centers K-Mart Plaza ................. $ 1,256 $ 571 $ 1,333 $ 12 $ 571 $ 1,345 $ 1,916 Charlotte, NC K-Mart Plaza ................. 1,015 497 1,159 -- 497 1,159 1,656 Thomasville, GA Mountain View ................ 1,038 118 578 226 140 782 922 Las Vegas, NV Times Square ................. -- 125 499 47 125 546 671 Lubbock, TX Other Snyder Residence ............. -- -- 39 -- -- 39 39 Gilbert, AZ Land Orangeburg, SC ............... -- 122 -- -- 122 -- 122 Dallas, TX ................... -- 737 3,782 (4,438)(D) 81 -- 81 Kansas City, MO .............. -- 802 1,871 (2,364) 309 -- 309 ---------- ---------- ---------- ---------- ---------- ---------- ---------- 3,309 2,972 9,261 (6,517) 1,845 3,871 5,716 ---------- ---------- ---------- ---------- ---------- ---------- ---------- $ 182,498 $ 42,592 $ 186,309 $ 52,262 $ 41,503 $ 239,660 $ 281,163 ========== ========== ========== ========== ========== ========== ========== Allowance for estimated losses (1,194) ---------- $ 279,969 ========== LIFE ON WHICH DEPRECIATION IN LATEST STATEMENT ACCUMULATED DATE OF DATE OF OPERATIONS DESCRIPTION DEPRECIATION CONSTRUCTION ACQUIRED IS COMPUTED - ----------- ------------ ------------ -------- ----------- PROPERTIES HELD FOR SALE Shopping Centers K-Mart Plaza ................. $ 136 1977 Dec-91 5-40 years Charlotte, NC K-Mart Plaza ................. 118 1974 Dec-91 5-40 years Thomasville, GA Mountain View ................ 246 1971 Oct-87 5-40 years Las Vegas, NV Times Square ................. 93 1985 Jul-89 5-40 years Lubbock, TX Other Snyder Residence ............. -- -- -- -- Gilbert, AZ Land Orangeburg, SC ............... -- -- Jun-89 -- Dallas, TX ................... -- -- Jun-86 -- Kansas City, MO .............. -- -- Dec-91 -- ---------- 593 ---------- $ 46,033 ========== Allowance for estimated losses
- ---------------------------------------- (A) Represents property improvements and write-down of properties due to permanent impairment. (B) Represent the Trust's line of credit with a current balance of $7.5 million and the $2.2 million equity loan, both collateralized by mortgages on Diamond Loch Apartments, Mustang Creek Apartments, and The Regent Apartments. The $2.2 million equity loan is also secured by 352,000 of the Trust's shares of beneficial interest. (C) Includes $923,000 of unsecured debt associated with the property. (D) Basis charged against allowance previously provided. (E) Represents advances under the $50 million revolving credit facility with GMAC Commercial Mortgage. 66 67 SCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION
1997 1996 1995 --------- --------- --------- (dollars in thousands) Reconciliation of real estate Balance at January 1, ...................... $ 237,502 $ 240,822 $ 224,785 Additions Acquisitions and improvements ......... 58,683 22,896 20,025 Foreclosures .......................... -- 5,575 -- Deductions Sales ................................. (12,762) (31,491) (2,598) Write-offs ............................ (2,260) -- (1,390) Write-downs due to permanent impairment -- (300) -- --------- --------- --------- Balance at December 31, .................... $ 281,163 $ 237,502 $ 240,822 ========= ========= ========= Reconciliation of accumulated depreciation Balance at January 1, ...................... $ 42,251 $ 45,147 $ 39,427 Additions Depreciation .......................... 7,022 5,374 5,959 Deductions Sale of real estate ................... (3,190) (8,270) (166) Write-offs ............................ (50) -- (73) --------- --------- --------- Balance at December 31, .................... $ 46,033 $ 42,251 $ 45,147 ========= ========= =========
67 68 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ------------------------------- PART III ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT Trustees The affairs of National Income Realty Trust (the "Trust") are managed and controlled by a Board of Trustees (the "Board"), presently consisting of eight members. The Trustees are elected at the annual meeting of shareholders or appointed by the incumbent Board and serve until the next annual meeting of shareholders or until a successor has been elected or approved. In May 1994, the Trust, together with Continental Mortgage and Equity Trust ("CMET"), Income Opportunity Realty Investors, Inc. ("IORI"), and Transcontinental Realty Investors, Inc. ("TCI"), entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Modification"), which settled subsequent claims of breaches of the settlement which were asserted by plaintiffs and modified certain provisions of a 1990 settlement of the action styled Olive, et. al. v. National Income Realty Trust, et. al. (the "Olive Case"). The original settlement, approved April 23, 1990, by the Court, related to the operation and management of each of the entities. The Modification was approved by the Court on December 12, 1994, and became effective January 11, 1995. The Modification provided for, among other things, the resignation of certain trustees, the addition of at least three new, unaffiliated members to be appointed to the Board, and set forth new requirements for approval of any transactions with affiliates over the next five years. Under the Modification, the Trust, the other entities, and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust and other entities also agreed to waive any demand requirement for plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by William S. Friedman or his affiliates shall be voted (i) in favor of the re-election of all current Board members that stand for re-election during the two calendar years following January 11, 1995, and (ii) in favor of all new Board members appointed pursuant to the terms of the Modification that stand for re-election during the three calendar years following January 11, 1995. The Modification also terminated a number of provisions of the original Stipulation of Settlement, including the requirement that the Trust or the other entities maintain a Related Party Transaction Committee and a Litigation Committee of the Board. Pursuant to the requirements (and in anticipation of the effectiveness) of the Modification, the Trust did not hold an Annual Meeting of Shareholders in 1994, John A. Doyle (a Trustee since February 1994) resigned as a Trustee on April 22, 1994, Ted P. Stokely (a Trustee since April 1990) resigned as a Trustee in August 1994, A. Bob Jordan (a Trustee since October 1992) resigned as a Trustee in June 1994, Bennett B. Sims (a Trustee since April 1990) resigned as a Trustee in August 1994, Geoffrey C. Etnire ( a Trustee since January 1993) ceased to be a Trustee on March 9, 1995, and Willie K. Davis (a Trustee since October 1988) retired as a Trustee effective March 31, 1995. Carl B. Weisbrod (a Trustee since February 1994) was elected Chairman of the Board on March 9, 1995, to replace Mr. Friedman, who remains as President, Chief Executive Officer, and Trustee of the 68 69 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) Trustees (Continued) Trust. Between May 1994 and March 1995, the Board appointed four new, independent Trustees to replace a number of those who resigned, and the number of members of the Board was reduced from ten at December 31, 1993, to eight at March 31, 1995. Independent Trustees appointed are Irving E. Cohen (June 2, 1994), Sally Hernandez-Pinero (May 19, 1994), Lance Liebman (March 9, 1995), and L. G. Schafran (March 9, 1995). Dan L. Johnston, Raymond V. J. Schrag, and Messrs. Friedman and Weisbrod have continued as Trustees. All of the Trustees listed below were re-elected as members of the Board at the annual meeting of shareholders held on March 20, 1997. The current Trustees are listed below, together with their ages, terms of service, all positions and offices with the Trust and Tarragon Realty Advisors, Inc. ("Tarragon" or the "Advisor"), the Trust's advisor since April 1, 1994, their principal occupations, business experience, and directorships with other companies during the last five years or more. The designation "Affiliated," when used below with respect to a Trustee, means that the Trustee is an officer, director, or employee of Tarragon or an officer of the Trust. The designation "Independent," when used below with respect to a Trustee, means that the Trustee is not an officer of the Trust nor a director, officer, or employee of Tarragon, although the Trust may have certain business or professional relationships with such Trustee as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships." Also, see ITEM 11. "EXECUTIVE COMPENSATION" for compensation paid to Independent Trustees. IRVING E. COHEN: Age 51, Trustee (since June 1994) (Independent). Vice President and Regional Director (since 1997), Cherokee Environmental Realty Advisors, LLC, a real estate investor; Managing Director and Chief Acquisition Officer (since 1996), Dames & Moore/Brookhill, LLC, a real estate development company; Managing Director (since 1994), CPR Group, a real estate consulting company; and Managing Partner (1990 to 1994), Fuller Corporate Realty Partners, a New York City real estate asset management entity. WILLIAM S. FRIEDMAN: Age 54, Trustee (Affiliated). Trustee or Director (since March 1988), Chief Executive Officer (since December 1993), President (since December 1988), Acting Chief Financial Officer (May 1990 to February 1991), Treasurer (August to September 1989), and Acting Principal Financial and Accounting Officer (December 1988 to August 1989) of the Trust and Tarragon Realty Investors, Inc. ("TRI"); Trustee or Director (March 1988 to February 1994), Chief Executive Officer (December 1993 to February 1994), President (December 1988 to February 1994), Acting Chief Financial Officer (May 1990 to February 1991), Treasurer (August to September 1989), and Acting Principal Accounting Officer (December 1988 to August 1989) of CMET, IORI, and TCI; Director and Chief Executive Officer (since December 1990) of Tarragon; President (February 1989 to May 1993) and Director (February to December 1989) of Basic Capital Management, Inc. ("BCM"), the advisor to the Trust (March 1989 to March 1994); General Partner (1987 to March 1994) of Syntek Asset Management, L.P., ("SAMLP") which is the General Partner of National Realty, L.P., ("NRLP") and National Operating, L.P. ("NOLP"); Director and President (March 1989 to February 1994) and Secretary (March 1989 to December 1990) of 69 70 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) Trustees (Continued) Syntek Asset Management, Inc., the Managing General Partner of SAMLP and a corporation owned by BCM; and practicing Attorney (since 1971) with the Law Offices of William S. Friedman. SALLY HERNANDEZ-PINERO: Age 45, Trustee (since May 1994) (Independent). Of Counsel (since October 1994), Kalkines, Arky, Zall and Bernstein, New York City; Chairwoman (February 1992 to April 1994), New York City Housing Authority; Director (since July 1994) of Consolidated Edison; Director (since April 1994) of Dime Savings Bank; and Attorney at Law (since 1978). DAN L. JOHNSTON: Age 59, Trustee (April 1990 to June 1990 and since February 1991) (Independent). Attorney in solo practice, New York, New York (1991 to 1994 and since August 1995); Partner in the law firm of Johnston, Kaplan and Lombardi (January to July 1995), New York City; Director (since 1992) of the Complex Drug Investigation and Prosecution Project for the Jefferson Institute for Justice Studies; Director or Trustee (April 1990 to June 1990 and February 1991 to January 1995) of CMET, IORI, and TCI; and Director (December 1992 to May 1995) of TRI. LANCE LIEBMAN: Age 56, Trustee (since March 1995) (Independent). William S. Beinecke Professor of Law and Dean (1991-1996), Columbia School of Law, New York City; Director (since 1991) of Greater New York Insurance Co. (both mutual and stock companies); Director (since 1995) of M & F Worldwide; Director (since 1996) of World Financial Properties, Inc.; and Attorney at Law (since 1967). L. G. SCHAFRAN: Age 59, Trustee (since March 1995) (Independent). Managing General Partner (since 1984), L. G. Schafran & Associates, a real estate investment and development firm in New York City; Director, Publicker Industries, Inc. (since 1986), an Old Greenwich, Connecticut, NYSE listed holding company that operates through subsidiaries in manufacturing services; Director, Capsure Holdings Corp. (since 1986), a Chicago, Illinois, NYSE listed property and casualty insurer; Director, Oxigene, Inc. (since March 1993), a U.S. and Swedish pharmaceutical developer; Director, Glasstech, Inc. (1) (since January 1995), Perrysberg, Ohio, manufacturer of glass bending and tempering equipment; and Director (since December 1993), Member (since September 1994), and Chairman (since December 1994) of the Executive Committee of The Dart Group Corporation, a Landover, Maryland, NYSE listed holding company engaged with other publicly traded subsidiaries in discount automotive parts and accessories (Trak Auto Corporation), discount bookstores (Crown Bookstores), discount supermarkets, beverages, and real estate; and Chairman (since January 1996), Delta-Omega Technologies, Inc., a Broussard, Louisiana, manufacturer and distributor of environmentally safe line foams and industrial cleaners and degreasers. - ---------------------------------------------- (1) On May 24, 1993, Glasstech, Inc., filed a voluntary petition under Chapter 11 of The United States Bankruptcy Code for the District of Delaware. An Order confirming a plan of reorganization became effective January 3, 1995, which is the same day Mr. Schafran became a director of Glasstech, Inc. 70 71 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) Trustees (Continued) RAYMOND V. J. SCHRAG: Age 52, Trustee (since October 1988) (Independent). Attorney, Law Offices of Raymond V. J. Schrag in New York, New York (since January 1995); attorney, Law Offices of Paul J. Schrag in New York, New York (since 1975); Director (October 1988 to May 1995) of TRI; and Director or Trustee (October 1988 to August 1994) of CMET, IORI, and TCI. CARL B. WEISBROD: Age 53, Chairman of the Board (since March 1995) and Trustee (since February 1994) (Independent). Trustee (since 1996), Ford Foundation; President (since 1994), Alliance for Downtown New York, Inc.; Director (February 1994 to May 1995) of TRI; and President and Chief Executive Officer (April 1990 to 1994) of New York City Economic Development Corporation. LITIGATION AND CLAIMS INVOLVING MR. FRIEDMAN RELATED TO SOUTHMARK CORPORATION Separation of Messrs. Phillips and Friedman from Southmark. Until January 1989, Mr. Friedman was an executive officer and director of Southmark Corporation ("Southmark"), serving as Vice Chairman of the Board (since 1982), Director (since 1980), and Secretary (since 1984) of Southmark. As a result of a deadlock on Southmark's Board of Directors, Mr. Friedman and Gene E. Phillips (who served as Trustee of the Trust until December 7, 1992) reached a series of related agreements (later modified) with Southmark on January 17, 1989 (collectively, the "Separation Agreement"), whereby Messrs. Friedman and Phillips resigned their positions with Southmark and certain of Southmark's subsidiaries and affiliates. Southmark filed a voluntary petition in bankruptcy under Chapter 11 of the United States Bankruptcy Code on July 14, 1989. Subsequent to the filing of the Southmark bankruptcy, several lawsuits were filed against Southmark, its former officers and directors (including Mr. Friedman), and others, alleging, among other things, that such persons and entities misrepresented the financial condition of Southmark. Mr. Friedman denies all of such allegations. Those lawsuits in which Mr. Friedman was also a defendant during the last five years are summarized below. The Trust was not a defendant in any of these lawsuits, all of which have been dismissed or settled. Mr. Friedman also served as a director of Pacific Standard Life Insurance Company ("PSL"), a wholly-owned subsidiary of Southmark, from October 1984 to January 1989. In a proceeding brought by the California Insurance commissioner (the "Commissioner"), a California Superior Court appointed a conservator for PSL on December 11, 1989. On October 12, 1990, the Commissioner filed suit against the former directors of PSL (including Mr. Friedman) seeking damages of $12 million and additional punitive damages. Such lawsuit alleged, among other things, that the defendants knowingly and willfully conspired among themselves to breach their duties as directors of PSL to benefit Southmark. Such suit further alleged that PSL's board of directors failed to convene meetings and delegated to Mr. Phillips authority to make decisions regarding loans, investments, and other transfers and exchanges of PSL assets. In August 1993, five former directors of PSL, including Mr. Friedman, settled this lawsuit without admitting any liability. Mr. Friedman complied with his obligation under the settlement and was discharged from any further liability in January 1998. 71 72 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) Trustees (Continued) One of Southmark's principal businesses was real estate syndication, and, from 1981 through 1987, Southmark raised over $500 million in investments from limited partners in several hundred limited partnerships. Seven lawsuits were filed by investors alleging breach of fiduciary duties on the part of Mr. Friedman and others. Two cases were settled in July and October 1993 for nominal payments. In one case, all claims were dismissed by the Court, and the defendants (including Mr. Friedman) were awarded sanctions against plaintiff's counsel. The other four cases were voluntarily dismissed by the plaintiffs without payment of any kind by the defendants. San Jacinto Savings Association. On November 30, 1990, San Jacinto Savings Association ("SJSA"), a savings institution that had been owned by Southmark since 1983, was placed under conservatorship of the Resolution Trust Corporation ("RTC") by federal banking authorities. The Office of Thrift Supervision ("OTS") also conducted a formal investigation of SJSA and its affiliates. During late November 1994, Mr. Friedman entered into certain agreements with the RTC and OTS settling all claims relating to (i) his involvement with SJSA and (ii) any guarantor arrangement of Mr. Friedman as to other financial institutions taken over by the RTC. Mr. Friedman's liability terminated on September 30, 1996, when the respondents as a group had paid a total of $4 million out of the total requirement. Mr. Friedman also consented to an order prohibiting him from participating in an insured depository institution without the prior written approval of the Director of OTS. Board Committees The Board held three meetings and acted by written consent seven times during 1997. For such year, no incumbent Trustee attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Board during the period for which he (she) had been a Trustee and (ii) the total number of meetings held by all committees of the Board on which he (she) served during the periods that he (she) served. The Board has an Audit Committee, an Advisory Review Committee, and an Option Committee. The Audit Committee, consisting of three Independent trustees, Messrs. Schrag (Chairman), Johnston, and Weisbrod, reviews the Trust's operating and accounting procedures. This committee met once during 1997. The Advisory Review Committee, established in March 1995, monitors actions taken by the Advisor which have the potential for a conflict of interest, in particular decisions relating to the allocation of investment opportunities among the Trust and the other entities affiliated with the Advisor. The committee consists of Mr. Weisbrod (Chairman), Ms. Hernandez-Pinero, and Mr. Cohen and did not meet during 1997. The Option Committee was formed in 1995 for purposes of authorizing option grants under the Share Option and Incentive Plan, approved at the November 1995 shareholder meeting. This committee is presently comprised of two members including Messrs. Friedman and Weisbrod and acted by written consent twice during 1997. The Board does not have Nominating or Compensation Committees. Executive Officers William S. Friedman, President and Chief Executive Officer, currently serves as the only executive officer of the Trust. His position with the Trust is not subject to a vote of shareholders. Mr. Friedman's age, term of service, all positions and offices with the Trust and Tarragon, other principal occupations, business experience, and directorships with other companies during the last five years or more are set forth above. 72 73 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) Officers Although not executive officers of the Trust, the following persons currently serve as officers of the Trust. Their positions with the Trust are not subject to a vote of shareholders. Their ages, terms of service, all positions and offices with the Trust and Tarragon, other principal occupations, business experience, and directorships with other companies during the last five years are set forth below: BRUCE SCHNITZ: Age 48, Chief Operating Officer. Chief Operating Officer (since January 1996) of the Trust, TRI, and Tarragon; President of Tarragon Management, Inc. ("TMI") (since February 1996); President and Chief Executive Officer (1993 to 1994) of McNeil Acquisition Corporation; and President, Chief Operating Officer, and Director (1991 to 1993), McNeil Real Estate Management, Inc. ROBERT C. IRVINE: Age 48, Executive Vice President and Chief Financial Officer. Chief Financial Officer (since September 1996) of the Trust, TRI, Tarragon, and TMI; Executive Vice President and Chief Financial Officer of FYI, Inc. (February 1996 to July 1996); Executive Vice President, Secretary, Treasurer, Chief Financial Officer, and Director (1991 to 1995) of McNeil Real Estate Management, Inc.; Vice President of McNeil Investors (1991 to 1995); and Certified Public Accountant (since 1977). CHRIS W. CLINTON: Age 51, Senior Vice President - Asset Management. Senior Vice President - Asset Management (since May 1995), and Senior Vice President - Commercial Asset Management (March 1994 to April 1995) of the Trust and TRI; Senior Vice President (since March 1994) of Tarragon; and Vice President (October 1988 to March 1994) of the Trust, American Realty Trust, Inc. ("ART"), CMET, IORI, NIRT, TCI, and BCM. WILLIAM L. GRIGSBY: Age 49, Senior Vice President-Construction. Senior Vice President - Construction (since September 1996) of the Trust and TRI; Senior Vice President (since September 1996) of Tarragon; Director of Construction (December 1994 to August 1996) of the Trust and TRI; Area Vice President of Property Management, Grapat Group Real Estate Management (1993 - 1994); and Registered Landscape Architect since 1979. PETER LARSEN: Age 56, Senior Vice President - Acquisitions. Senior Vice President - Acquisitions (since July 1997) of the Trust and TRI, Senior Vice President (since July 1997) of Tarragon; Vice President - Acquisitions (April 1996 to June 1997) of the Trust and TRI; Vice President (April 1996 to June 1997) of Tarragon; Independent Consultant (January 1995 to June 1996); and Vice President (May 1992 to December 1994) of BCM and Carmel Realty Services, Inc. ("CRSI"). 73 74 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) Officers (Continued) TODD C. MINOR: Age 39, Treasurer. Treasurer (since December 1996), Senior Vice President - Mortgage Servicing and Financing (May 1995 to November 1996), and Senior Vice President - Finance (March 1994 to April 1995 and July 1993 to January 1994) of the Trust and TRI; Senior Vice President (since March 1994) of Tarragon; Senior Vice President - Finance (July 1993 to March 1994) of BCM, ART, CMET, IORI, and TCI; Vice President (January 1989 to July 1993) of BCM; and Vice President (April 1991 to July 1993) of the Trust, ART, CMET, IORI, TRI, and TCI. NEIL SWINGRUBER: Age 38, Senior Vice President - Director of Property Management. Senior Vice President - Director of Property Management (since June 1997) of the Trust and TRI; Executive Vice President (since February 1996) of TMI; Vice President of Property Management (1994 to 1995) of Binings; and Vice President of Property Management (1986 to 1993) of McNeil Real Estate Management, Inc. JANICE CLINE: Age 48, Vice President - Asset Management. Vice President - Asset Management of the Trust and TRI (since March 1997); Vice President of Tarragon (since March 1997); Asset Manager for MBL Life Insurance Company (August 1995 to March 1997); Senior Asset Analyst, Structured Finance, for J.E. Robert Companies (January to July 1995); and Senior Investment Administrator, Asset Manager, and Real Estate Paralegal for The Travelers Corporation and Travelers Realty Investment Company (October 1987 to May 1994). ERIN D. DAVIS: Age 36, Vice President and Chief Accounting Officer. Vice President and Chief Accounting Officer (since September 1996) of the Trust, TRI, and Tarragon; Accounting Manager of the Trust, TRI, and Tarragon (June 1995 to August 1996); Senior Associate, BDO Seidman (January 1993 to June 1995); and Certified Public Accountant (since 1990). In addition to the foregoing officers, the Trust has other officers who are not listed herein. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Under the securities laws of the United States, the Trust's Trustees, certain officers, and any persons holding more than ten percent of the Trust's shares of beneficial interest are required to report their ownership of the Trust's shares and any changes in that ownership to the Securities and Exchange Commission (the "Commission"). Specific due dates for these reports have been established, and the Trust is required to report any failure to file by these dates during fiscal 1997. All of these filing requirements were satisfied during 1997. In making these statements, the Trust has relied on the written representations of its incumbent Trustees and officers, its ten percent holders, and copies of the reports that they have filed with the Commission. 74 75 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) The Advisor Although the Board is directly responsible for managing the affairs of the Trust and for setting the policies which guide it, the day-to-day operations of the Trust are performed by an advisory firm which operates under the supervision of the Board pursuant to a written advisory agreement approved by shareholders. The duties of the advisor include, among other things, locating, investigating, evaluating, and recommending real estate investment and sale opportunities and financing and refinancing sources for the Trust. The advisor also serves as a consultant in connection with the business plan and investment policy decisions made by the Board. Tarragon has provided advisory services to the Trust since April 1, 1994. On March 20, 1997, the shareholders approved the renewal of the advisory agreement dated April 1, 1995, between Tarragon and the Trust. Mr. Friedman serves as a Director and Chief Executive Officer of Tarragon. Tarragon is owned by Mr. Friedman and Lucy N. Friedman, his wife. The Friedman family owns approximately 33% of the outstanding shares of beneficial interest of the Trust. The advisory agreement provides for an incentive advisory fee equal to 16% of the Trust's adjusted funds from operations before deduction of the advisory fee. Adjusted funds from operations is defined as funds from operations ("FFO"), as defined by the National Association of Real Estate Investment Trusts, plus any loss due to the write-down or sale of any real property or mortgage loan acquired prior to January 1, 1989. FFO represents net income , computed in accordance with generally accepted accounting principles, before gains (or losses) from the sales of properties and debt restructurings plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. The incentive fee is cumulative within any fiscal year to maintain the 16% per annum rate. Between April 1994 and April 1995, the advisory agreement also provided for a $100,000 annual base advisory fee. In addition to the advisory fee, the advisory agreement provides for the following compensation to Tarragon: (a) Tarragon is to receive an acquisition commission of 1% of the acquisition cost of real estate for supervising the acquisition, purchase, or long-term lease of real estate for the Trust, except that no fee will be paid for any acquisition through or from an affiliate of the Trust or Tarragon. The aggregate of each purchase price of each property including the acquisition commission and all real estate brokerage fees may not exceed such property's appraised value at acquisition. (b) For obtaining loans to the Trust or refinancing on its properties, Tarragon is to receive a mortgage brokerage and refinancing fee equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from Tarragon or an affiliate without the approval of the Board. No fee shall be paid on loan extensions. In addition, the advisory agreement provides that real estate brokerage commissions shall be payable to Tarragon and its affiliates only following specific approval by the Board for each transaction rather than as a general practice. 75 76 ITEM 10. TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) The Advisor (Continued) If and to the extent that the Trust were to request the advisor or an affiliate of the advisor to render services for the Trust other than those specifically required by the advisory agreement, such services would be separately compensated on terms to be agreed upon between such party and the Trust from time to time. The advisor is required to formulate and submit annually for approval by the Board a budget and business plan for the Trust containing a twelve-month forecast of operations and cash flow, a general plan for asset sales or acquisitions, borrowing activity, and other investments, and the advisor is required to report quarterly to the Board on the Trust's performance against the business plan. In addition, all transactions or investments by the Trust shall require prior approval by the Board unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the advisor by the Board. The advisory agreement also requires prior approval of the Board for retention of all consultants and third party professionals, other than legal counsel. The agreement provides that the advisor shall be deemed to be in a fiduciary relationship to the Trust's shareholders; contains guidelines for the advisor's allocation of investment opportunities as among itself, the Trust, and other entities it advises; and contains a broad standard governing the advisor's liability for losses incurred by the Trust. Under the advisory agreement, neither the advisor nor any of its stockholders, directors, officers, or employees shall be liable to the Trust, the Trustees, or the holders of securities of the Trust for any losses from the operations of the Trust if the advisor had determined, in good faith, that the course of conduct which caused the loss or liability was in the best interests of the Trust, and the loss or liability was not the result of negligence or misconduct by the advisor. In no event will the directors, officers, or employees of the advisor be personally liable for any action unless it was the result of willful misfeasance, bad faith, gross negligence, or reckless disregard of duty. Employees of the advisor render services to the Trust, as the Trust has no employees. In accordance with the terms of the advisory agreement, certain services provided by the advisor including, but not limited to, accounting, legal, investor relations, data processing, and the related departmental overhead are reimbursed directly by the Trust. Under the advisory agreement, all or a portion of the advisory fee must be refunded by the advisor to the Trust if the Operating Expenses, as defined, exceed certain limits based on book value, net asset value, and net income of the Trust during such fiscal year. The operating expenses of the Trust did not exceed such limitation in 1995, 1996, or 1997. The advisory agreement may be assigned only with the prior consent of the Trust. 76 77 ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT (Continued) The directors and principal officers of Tarragon are set forth below: WILLIAM S. FRIEDMAN: Director and Chief Executive Officer BRUCE A. SCHNITZ: Chief Operating Officer ROBERT C. IRVINE: Executive Vice President and Chief Financial Officer CHRIS W. CLINTON: Senior Vice President WILLIAM L. GRIGSBY: Senior Vice President PETER LARSEN: Senior Vice President TODD C. MINOR: Treasurer JANICE CLINE: Vice President ERIN D. DAVIS: Vice President and Chief Accounting Officer EILEEN GOLDBERG: Secretary Property Management Since April 1, 1994, Tarragon has provided property management services to the Trust for a fee of 4.5% of the monthly gross rents collected. Until April 1996, Tarragon subcontracted with other entities for the provision of the property-level management services to the Trust. TMI currently provides property-level management services to most of the Trust 's properties for a fee of 4.5% of the monthly gross rents collected. Since April 1, 1994, Tarragon 's real estate brokerage affiliate has been available to and may act as a broker in both purchases and sales of Trust property with commissions payable in amounts customarily charged in arm's-length transactions by others rendering similar property acquisition services in the same geographical location and for comparable property. Such commissions require Board approval. 77 78 ITEM 11. EXECUTIVE COMPENSATION The Trust has no employees and pays no compensation to its executive officer. The Trustees and executive officers of the Trust who are also officers or employees of Tarragon are compensated by Tarragon. Such affiliated Trustees and executive officers perform a variety of services for the advisor, and the amount of their compensation is determined solely by Tarragon. The Independent Trustees are paid an annual stipend directly by the Trust and granted certain share options, as discussed below. The Independent Trustees (i) review the business plan of the Trust to determine that it is in the best interest of the shareholders, (ii) review the Trust's agreement with the advisor, (iii) supervise the performance of the advisor and review the reasonableness of the compensation which the Trust pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Trust, and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired by the Trust. The Independent Trustees receive compensation in the amount of $15,000 per year plus $25,000 per year to the Chairman of the Board and reimbursement of expenses. In addition, each Independent Trustee receives (i) $2,000 per year for each committee of the Board of Trustees on which he (she) serves, (ii) $1,000 per year for each committee chairmanship, and (iii) $1,000 per day for any special services rendered to the Trust outside of the ordinary duties as Trustee, plus reimbursement for expenses, provided such services are specifically requested by the Board. Fees paid to Independent Trustees during 1996 and 1997 are as follows:
1996 1997 --------- ---------- Irving E. Cohen............................ $ 17,000 $ 17,000 Sally Hernandez-Pinero..................... 17,000 17,000 Dan L. Johnston............................ 17,000 17,000 Lance Liebman.............................. 15,000 15,000 L.G. Schafran.............................. 15,000 15,000 Raymond V. J. Schrag....................... 18,000 18,000 Carl B. Weisbrod........................... 40,000 40,000 --------- ---------- $ 139,000 $ 139,000 ========= ==========
Pursuant to the approval of the Independent Trustee Share Option Plan (the "Trustee Plan") in November 1995, the Trust issued to each of the seven Independent Trustees on November 20, 1995, options to acquire 3,000 shares (a total of 21,000 shares). The exercise price of the options is equal to the market price on the grant date. The options expire on the earlier of the first anniversary of the date on which a Trustee ceases to be a Trustee of the Trust or ten years from the date of grant (the "Termination Date") and are exercisable at any time between the date of grant and the Termination Date. In addition, for each year such Trustee continues to serve as a Trustee, he (she) will be awarded an option covering 1,000 shares on January 1 of each year. Accordingly, on each of January 1, 1996, 1997, and 1998, the Trust issued to each Independent Trustee additional options covering 1,000 shares (a total of 21,000 shares) with exercise prices equal to the market price on the dates of grant and the same Termination Date as the options granted in November 1995. The options issued in November 1995 and January 1996 and 1997 have been adjusted to give effect to the 10% share distributions paid in September 1996 and 1997 so that all Trustee options now cover a total of 48,580 shares. The Trustee Plan provides for a total of 72,600 shares. 78 79 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Security Ownership of Certain Beneficial Owners. The following table sets forth the ownership of the Trust's shares of beneficial interest, both beneficially and of record, both individually and in the aggregate for those persons or entities known by the Trust to be beneficial owners of more than 5% of its shares of beneficial interest as of the close of business on March 13, 1998.
Amount and Nature Name and Address of of Beneficial Percent of Beneficial Owner Ownership Class (1) ---------------- ------------------------- --------- Lucy N. Friedman 1,255,914 (2)(3)(4)(5) 33% 280 Park Avenue (6)(7)(8) East Building, 20th Floor New York, New York 10017
(1) Percentages are based upon 3,809,829 shares of beneficial interest outstanding at March 13, 1998. (2) Includes 18,465 shares owned by Lucy N. Friedman's husband, William S. Friedman. (3) Includes 804,393 shares owned by Mrs. Friedman. (4) Does not include 19,965 shares owned by Mrs. Friedman's adult son, Ezra Friedman, and 25,413 shares owned by Mrs. Friedman's adult daughter, Tanya Friedman. Mrs. Friedman disclaims beneficial ownership of such shares. (5) Includes 35,052 shares owned by a trust for the benefit of the children and grandchildren of Samuel Friedman, deceased, William S. Friedman's father, for which Robert A. Friedman and Gerald C. Friedman, siblings of William S. Friedman, are the trustees. Such shares are distributable, per stirpes, to two of Mr. Friedman's siblings and his four children. Mrs. Friedman disclaims beneficial ownership of such shares. (6) Includes 47,456 shares owned by Tarragon Capital Corporation ("TCC"), of which Mrs. Friedman and Mr. Friedman are executive officers and directors, and 38,984 shares owned by Tarragon Partners, Ltd., of which Mrs. Friedman and Mr. Friedman are limited partners. (7) Includes 13,943 shares and 14,099 shares owned by Mrs. Friedman's minor sons, Gideon and Samuel Friedman. Mrs. Friedman disclaims beneficial ownership of such shares. It also includes 266,200 shares owned by Beachwold Partners, L.P., in which Mrs. Friedman and Mr. Friedman are the general partners and their four children are the limited partners. (8) Includes 17,322 shares held by William S. Friedman Grantor Trust for benefit of the children of Mr. Friedman, of which Mrs. Friedman is the trustee. 79 80 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued) Security Ownership of Management. The following table sets forth the ownership of the Trust's shares of beneficial interest, both beneficial and of record, both individually and in the aggregate for the Trustees and executive officers of the Trust as of the close of business on March 13, 1998.
Amount and Nature of Beneficial Percent of Name of Beneficial Owner Ownership Class (1) ------------------------ --------------------------- --------- William S. Friedman 1,255,914 (2)(3)(4)(5) 33% (6)(7)(8)(9) Irving E. Cohen 7,571 (10) * Sally Hernandez-Pinero 6,940 (11) * Dan L. Johnston 7,055 (12) * Lance Liebman 7,545 (13) * L. G. Schafran 6,940 (11) * Raymond V.J. Schrag 14,726 (14) * Carl B. Weisbrod 7,501 (15) * All Trustees and Executive 1,314,192 (2)(3)(4)(5)(6) 34.5% Officers as a group (7)(8)(9)(10)(11) (8 individuals) (12)(13)(14)(15)
- ---------------- * Less than 1%. (1) Percentages are based upon 3,809,829 shares of beneficial interest outstanding at March 13, 1998. (2) Mr. Friedman owns 18,465 shares of beneficial interest personally. (3) Includes 804,393 shares owned by Mrs. Friedman. Mr. Friedman disclaims beneficial ownership of such shares. (4) Does not include 19,965 shares owned by Mr. Friedman's adult son, Ezra Friedman, and 25,413 shares owned by Mr. Friedman's adult daughter, Tanya Friedman. Mr. Friedman disclaims beneficial ownership of such shares. 80 81 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued) (5) Includes 35,052 shares owned by a trust for the benefit of the children and grandchildren of Samuel Friedman, deceased, William S. Friedman's father, for which Robert A. Friedman and Gerald C. Friedman, siblings of William S. Friedman, are the trustees. Such shares are distributable, per stirpes, to two of Mr. Friedman's siblings and his four children. Mr. Friedman disclaims beneficial ownership of such shares. (6) Includes 47,456 shares owned by TCC. (7) Includes 38,984 shares owned by Tarragon Partners, Ltd. (8) Includes 13,943 shares and 14,099 shares owned by Mr. Friedman's minor sons, Gideon and Samuel Friedman. Mr. Friedman disclaims beneficial ownership of such shares. It also includes 266,200 shares owned by Beachwold Partners, L.P. (9) Includes 17,322 shares held by William S. Friedman Grantor Trust. (10) Includes 631 shares owned by Irving E. Cohen directly and 6,940 shares covered by four separate presently exercisable options. (11) Includes 6,940 shares covered by four separate presently exercisable options. (12) Includes 115 shares owned by Dan L. Johnston directly and 6,940 shares covered by four separate presently exercisable options. (13) Includes 605 shares owned by Lance Liebman directly and 6,940 shares covered by four separate presently exercisable options. (14) Includes 7,786 shares owned by Raymond V. J. Schrag directly and 6,940 shares covered by four separate presently exercisable options. Does not include 665 shares owned by Mr. Schrag's wife as custodian for his minor son, Ben, or 665 shares owned by Mr. Schrag's adult daughter, Rebecca, as to which Mr. Schrag disclaims any beneficial ownership. (15) Includes 561 shares owned by Carl B. Weisbrod directly and 6,940 shares covered by four separate presently exercisable options. [This space intentionally left blank.] 81 82 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Certain Business Relationships Since April 1, 1994, Tarragon has served as the Trust's advisor pursuant to an advisory agreement. Mr. Friedman serves as Director and Chief Executive Officer of Tarragon. Tarragon is owned by Mr. Friedman and Lucy N. Friedman, his wife. The Friedman family owns approximately 33% of the outstanding shares of the Trust. Since March 1, 1994, Tarragon has also served as TRI's advisor. William S. Friedman also serves as a Director, President, and Chief Executive Officer of TRI. TRI has the same relationship with Tarragon as the Trust. Mr. Friedman owes fiduciary duties to TRI as well as the Trust under applicable law. In February 1998, National Omni Associates, L.P., in which the Trust holds a 46% interest, paid a brokerage commission of $100,000 to Highland Funding Corp., for which Chester Beck, who serves as a Director for TRI, serves as President, for consulting services provided in connection with the acquisition of 5600 Collins Avenue. From January 1993 to December 1997, FMS, Inc., a company of which Mr. Willie K. Davis, former Trustee of the Trust and current Director of TRI, is Chairman, President, and sole shareholder, provided property-level management services for several properties owned by the Trust. In 1997 and 1996, FMS, Inc., earned fees of $82,292 and $80,920, respectively, for performing such services. The Trust believes that such fees were at least as favorable to the Trust as those that would have been paid to unaffiliated third parties for the performance of similar services. Related Party Transactions Historically, the Trust has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Prior to January 11, 1995, all related party transactions entered into by the Trust were to be approved by a majority of the Trust's Board of Trustees, including a majority of the Independent Trustees. In addition, the Related Party Transaction Committee of the Board was to review all such transactions prior to their submission to the Board for consideration. The Trust's management believes that all of the related party transactions were at least as advantageous to the Trust as could have been obtained from unrelated third parties. The Trust is a partner with CMET in Sacramento Nine ("SAC 9"). SAC 9, which currently owns two office buildings in the vicinity of Sacramento, California, is owned 70% by the Trust which is a non-controlling partner. The SAC 9 joint tenancy agreement requires unanimous consent of both the Trust and CMET for any material changes in the operations of SAC 9's properties, including sales, refinancings, and property management changes. Until March 9, 1995, Geoffrey C. Etnire, a Trustee of CMET, was also a Trustee of the Trust. Since that time, the Trust and CMET share no Trustees. On December 10, 1990, the Board, based on the recommendation of its Related Party Transaction Committee, authorized the purchase of up to $1 million of the shares of beneficial interest of CMET through negotiated or open market transactions. At December 31, 1994, the Trust owned 39,500 shares of beneficial interest of CMET which it purchased in 1990 and 1991 through open market transactions at a total cost to the Trust of $180,500. During the first quarter of 1995, the Trust sold the shares for $592,500 and, as a result, recorded a $412,000 gain on sale of investments. 82 83 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued) Related Party Transactions (Continued) In December 1993, the Board approved the issuance of a $1 million convertible subordinated debenture to Mr. Doyle, Chief Financial Officer of the Trust until September 1996, in exchange for his 10% participation in the profits of the Consolidated Capital Properties II ("CCP II") assets, which the Trust had acquired in November 1992. This participation was granted as consideration for Mr. Doyle's services to the Trust in connection with the CCP II portfolio. The debenture bore interest at 6% per annum and was scheduled to mature in December 1999. In February 1996, Mr. Doyle converted the debenture into 93,076 Shares. The Trust repurchased 50,000 of these shares from Mr. Doyle in September 1996 for $700,000. Other liabilities at December 31, 1995, included non-interest bearing cash advances of $300,000 and $283,000 from Lucy N. Friedman (50% stockholder of Tarragon and a principal shareholder of the Trust) and Tarragon, respectively. Such advances were made to the Trust on a short term basis to facilitate the 1995 negotiated discounted payoffs of the mortgage loans secured by Bryan Hill Apartments, Meadowbrook Apartments, and Forest Oaks Apartments. In connection with the discounted payoffs, the Trust realized extraordinary gains on debt forgiveness totaling $670,000. The Trust repaid the advances in 1996. The remaining $255,000 due to affiliates at December 31, 1995, represented accrued mortgage brokerage commissions, advisory fees, and expense reimbursements to Tarragon which were paid in January 1996. The Trust has incurred fees and expense reimbursements paid to Tarragon and TMI as follows (dollars in thousands):
1996 1997 ------- -------- Advisory fees....................... $ 1,117 $ 1,438 Property management fees ........... 1,014 1,610 Commercial lease commissions........ - 39 Real estate acquisition fees........ 106 234 Equity refinancing fees............. 187 773 Expense reimbursements.............. 1,176 1,411
The Trust's Declaration of Trust provides that: "[t]he Trustees shall not . . . purchase, sell, or lease any Real Properties or Mortgages to or from . . . the Advisor or any of [its] Affiliates," and that "[t]he Trustees shall not . . . make any loan to . . . the Advisor or any of [its] Affiliates." Moreover, the Declaration of Trust further provides that: "[t]he Trust shall not purchase or lease, directly or indirectly, any Real Property or purchase any Mortgage from the Advisor or any affiliated Person, or any partnership in which any of the foregoing may also be a general partner, and the Trust will not sell or lease, directly or indirectly, any of its Real Property or sell any Mortgage to any of the foregoing Persons." The Declaration of Trust further provides that "the Trust shall not directly or indirectly, engage in any transaction with any Trustee, officer, or employee of the Trust or any director, officer, or employee of the Advisor . . . or of any company or other organization of which any of the foregoing is an Affiliate, except for . . . [among other things] transactions with . . . the Advisor or Affiliates thereof involving loans, real estate brokerage services, real property management services, the 83 84 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued) Related Party Transactions (Continued) servicing of Mortgages, the leasing of real or personal property, or other services, provided such transactions are on terms not less favorable to the Trust than the terms on which nonaffiliated parties are then making similar loans or performing similar services for comparable entities in the same area and are not entered into on an exclusive basis." The Declaration of Trust defines "Affiliate" as follows: "[A]s to any Person, any other Person who owns beneficially, directly, or indirectly, 1% or more of the outstanding capital stock, shares, or equity interests of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person or is an officer, retired officer, director, employee, partner, or trustee (excluding independent trustees not otherwise affiliated with the entity) of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person." As discussed in "Related Party Transactions" above, beginning September 1990, the Trust had invested in shares of CMET. As of December 31, 1994, the Trust owned 39,500 shares of CMET. CMET had the same advisor as the Trust and certain of its Trustees were also Trustees of CMET at the time such shares were acquired. Under the terms of its Declaration of Trust, as amended, the Trust was prohibited from holding the shares of CMET beyond July 30, 1996. Prior to March 31, 1995, all remaining 39,500 CMET shares were sold in open market transactions. Prior to January 11, 1995, all related party transactions that the Trust contemplated were to be reviewed by the Related Party Transaction Committee of the Trust's Board of Trustees to determine whether such transactions were (i) fair to the Trust and (ii) permitted by the Trust's governing documents. Each of the members of the Related Party Transaction Committee was a Trustee who was not an officer, director, or employee of the Trust's advisor, Tarragon, and was not an officer or employee of the Trust. Such committee was disbanded in February 1995 and its responsibilities assumed by the Independent Trustees. Pursuant to the terms of the Modification in the Olive case, which became effective January 11, 1995, any related party transaction which the Trust may enter into prior to April 27, 1999, with two categories of exceptions, will require the unanimous approval of the Trust's Board of Trustees. In addition, except for the categories noted below, certain defined related party transactions may only be entered into in exceptional circumstances and after determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction. Two categories of exception are: (i) direct contractual agreements for services between the Trust and the Advisor or one of its affiliates (i.e., the Advisory Agreement, property management contracts, etc.) which require prior approval by two-thirds of the Trustees of the Trust and, if required, approval by a majority of the Shareholders; (ii) joint ventures among the Trust and another party to the Modification in the Olive case or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with specified persons, or any affiliate of such persons, may be entered into on the affirmative vote of a majority of the Trustees of the Trust. 84 85 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Report: 1. Consolidated Financial Statements Report of Independent Public Accountants - Arthur Andersen LLP Consolidated Balance Sheets - December 31, 1997 and 1996 Consolidated Statements of Operations - Years Ended December 31, 1997, 1996, and 1995 Consolidated Statements of Shareholders' Equity Years Ended December 31, 1997, 1996, and 1995 Consolidated Statements of Cash Flows Years Ended December 31, 1997, 1996, and 1995 Notes to Consolidated Financial Statements 2. Financial Statement Schedules Schedule III - Real Estate and Accumulated Depreciation All other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the notes thereto. 3. Exhibits The following documents are filed as Exhibits to this report: Exhibit Number Description - -------- ------------------------------------------------------------ 3.1 Second Amended and Restated Declaration of Trust (incorporated by reference to the Registrant's Current Report on Form 8-K dated August 14, 1987). 3.2 Amendment No. 1 to the Second Amended and Restated Declaration of Trust, (incorporated by reference to the Registrant's Current Report on Form 8-K dated July 5, 1989) reporting change in name of Trust. 85 86 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Continued) Exhibit Number Description - -------- ------------------------------------------------------------ 3.3 Amendment No. 2 to the Second Amended and Restated Declaration of Trust, (incorporated by reference to the Registrant's Current Report on Form 8-K dated March 22, 1990) reporting deletion of liquidation provisions. 3.4 Amendment No. 3 to the Second Amended and Restated Declaration of Trust, (incorporated by reference to the Registrant's Current Report on Form 8-K dated June 3, 1992) reporting the extension of the holding period of the Trust's marketable equity securities. 3.5 Amendment No. 4 to the Second Amended and Restated Declaration of Trust, dated March 20, 1997, (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997) reporting amendments to various authority provisions of the Declaration of Trust. 3.6 Restated Trustees' Regulations dated as of April 21, 1989 (incorporated by reference to the Registrant's Current Report on Form 8-K dated March 24, 1989). 10.1 Advisory Agreement dated April 1, 1995, between National Income Realty Trust and Tarragon Realty Advisors, Inc. (incorporated by reference to Exhibit No. 10.1 to the Registrant's Current Report on Form 8-K dated April 1, 1995). 21.0 Subsidiaries of the Registrant. 27.0 Financial Data Schedule. (b) No reports on Form 8-K were filed during the fourth quarter covered by this report or with respect to events occurring after the period covered by this report but prior to the filing of this report. [This space intentionally left blank.] 86 87 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. NATIONAL INCOME REALTY TRUST Dated: March 30, 1998 By: /s/ William S. Friedman ----------------------- ------------------------------ William S. Friedman President, Chief Executive Officer, and Trustee 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 date indicated.
Signature Capacities In Which Signed Date /s/ Carl B. Weisbrod Trustee and Chairman of the Board March 13, 1998 - -------------------------------- Carl B. Weisbrod /s/ William S. Friedman President, Chief Executive Officer, March 30, 1998 - -------------------------------- and Trustee William S. Friedman (Principal Executive Officer) /s/ Robert C. Irvine Executive Vice President and March 30, 1998 - -------------------------------- Chief Financial Officer Robert C. Irvine (Principal Financial Officer) /s/ Erin D. Davis Vice President and March 30, 1998 - -------------------------------- Chief Accounting Officer Erin D. Davis (Principal Accounting Officer) /s/ Irving E. Cohen Trustee March 30, 1998 - -------------------------------- Irving E. Cohen /s/ Sally Hernandez-Pinero Trustee March 30, 1998 - -------------------------------- Sally Hernandez-Pinero /s/ Dan L. Johnston Trustee March 30, 1998 - -------------------------------- Dan L. Johnston /s/ Lance Liebman Trustee March 30, 1998 - -------------------------------- Lance Liebman - -------------------------------- Trustee Lawrence G. Schafran /s/ Raymond V.J. Schrag Trustee March 30, 1998 - -------------------------------- Raymond V. J. Schrag
87 88 EXHIBIT INDEX
Exhibit Number Description - -------- ------------------------------------------------------------ 3.1 Second Amended and Restated Declaration of Trust (incorporated by reference to the Registrant's Current Report on Form 8-K dated August 14, 1987). 3.2 Amendment No. 1 to the Second Amended and Restated Declaration of Trust, (incorporated by reference to the Registrant's Current Report on Form 8-K dated July 5, 1989) reporting change in name of Trust. 3.3 Amendment No. 2 to the Second Amended and Restated Declaration of Trust, (incorporated by reference to the Registrant's Current Report on Form 8-K dated March 22, 1990) reporting deletion of liquidation provisions. 3.4 Amendment No. 3 to the Second Amended and Restated Declaration of Trust, (incorporated by reference to the Registrant's Current Report on Form 8-K dated June 3, 1992) reporting the extension of the holding period of the Trust's marketable equity securities. 3.5 Amendment No. 4 to the Second Amended and Restated Declaration of Trust, dated March 20, 1997, (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997) reporting amendments to various authority provisions of the Declaration of Trust. 3.6 Restated Trustees' Regulations dated as of April 21, 1989 (incorporated by reference to the Registrant's Current Report on Form 8-K dated March 24, 1989). 10.1 Advisory Agreement dated April 1, 1995, between National Income Realty Trust and Tarragon Realty Advisors, Inc. (incorporated by reference to Exhibit No. 10.1 to the Registrant's Current Report on Form 8-K dated April 1, 1995). 21.0 Subsidiaries of the Registrant. 27.0 Financial Data Schedule.
EX-21 2 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21.0 NATIONAL INCOME REALTY TRUST SUBSIDIARIES OF THE REGISTRANT The following is a list of all subsidiaries and partnership interests of National Income Realty Trust, the state or other jurisdiction of organization or incorporation (indention means direct parent relationship):
Jurisdiction of Organization or Name of Entity Incorporation -------------- -------------- National Income Realty Trust California Collegewood Property, Inc. Florida Forest Oaks National, Inc. Texas Lamplighter Associates (99%) California Heron Cove National, Inc. Florida National Omni Associates, L.P. (45.5%) Delaware Lake Point National, Inc. Tennessee Tarragon Lake Point L.P. (1%) Tennessee Morningside National, Inc. Florida Mountain View National, Inc. Nevada Danforth National Apartments, Ltd. (1%) Florida Mountain View National, L.P. (1%) Nevada RI Panama City, Ltd. (1%) Florida RI Windsor, Ltd. (1%) Florida Tarragon Savannah L.P. (1%) Georgia Plaza Hills National, Inc. Missouri National Income Realty Investors, Inc. Nevada JS Acquisition Corp. Nevada Parkdale Gardens National Corp. Texas PB Acquisition Corp. Nevada Ansonia Apartments, L.P. (70%) Delaware Regency Green National Corp. Nevada Regent Circle, LLC (1%) Florida Consolidated Capital Properties II (.5%) Texas Consolidated Century Centre Associates (1%) California Heather Limited Partnership (1%) Maryland Lamplighter Associates (1%) California Martins Landing Associates (1%) Georgia Midway Mills Partners, L.P. (1%) Texas Summit on the Lake Associates (1%) Texas Vistas at Lake Worth L.P. (1%) Texas West Dale National Associates, L.P. (1%) Texas Woodbrier National L.P. (1%) Oklahoma Woodcreek National Associates, L.P. (1%) Colorado RI Panama City, Ltd. (49%) Florida RI Windsor, Ltd. (49%) Florida Rancho Sorrento Leasing Corp. Nevada
2 Exhibit 21.0 (Continued) NATIONAL INCOME REALTY TRUST SUBSIDIARIES OF THE REGISTRANT
Jurisdiction of Organization or Name of Entity Incorporation -------------- -------------- Stewart Square National, Inc. Nevada Texas National Construction, Inc. Texas Bayfront National Associates, L.P. (100%) Texas Bryan Hill Associates (1%) Georgia Carlyle Tower National Associates L.P. (100%) Michigan Consolidated Capital Properties II (99.5%) Texas Bryan Hill Associates (99%) Georgia English Village Partners (90%) California Consolidated Century Centre Associates (99%) California Danforth National Apartments, Ltd. (59%) Florida Heather Limited Partnership (99%) Maryland Marina Park National Partners (90%) Florida Martins Landing Associates (99%) Georgia Midway Mills Partners, L.P. (99%) Texas Mountain View National, L.P. (99%) Nevada Regent Circle, LLC (99%) Florida Summit on the Lake Associates (99%) Texas Tarragon Lake Point L.P. (99%) Tennessee Tarragon Savannah L.P. (49%) Georgia Vistas at Lake Worth L.P. (99%) Texas West Dale National Associates, L.P. (99%) Texas Woodbrier National L.P. (99%) Oklahoma Woodcreek National Associates, L.P. (99%) Colorado
EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 DEC-31-1997 4,262 0 0 (1,194) 0 0 281,163 (46,033) 265,640 0 184,126 0 0 0 71,091 265,640 0 52,017 0 28,596 8,460 0 12,602 5,531 0 5,531 0 61 0 5,592 1.46 1.44
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