-----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, BKsxVJrruTbuGiHfhtLN09A05pNk1jYICsXJAXdOQ8TlWHY3+xKEVWH98ie8rIYJ TQq1ZoXN6gZQr0yErgJe1w== 0000711642-03-000142.txt : 20030331 0000711642-03-000142.hdr.sgml : 20030331 20030331164152 ACCESSION NUMBER: 0000711642-03-000142 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DAVIDSON DIVERSIFIED REAL ESTATE II LIMITED PARTNERSHIP CENTRAL INDEX KEY: 0000750258 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 621207077 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-14483 FILM NUMBER: 03631429 BUSINESS ADDRESS: STREET 1: 55 BEATTIE PLACE STREET 2: POST OFFICE BOX 1089 CITY: GREENVILLE STATE: SC ZIP: 29602 BUSINESS PHONE: 8642391000 MAIL ADDRESS: STREET 1: 1873 SOUTH BELLAIRE STREET STREET 2: 17TH FLOOR CITY: DENVER STATE: CO ZIP: 80222 FORMER COMPANY: FORMER CONFORMED NAME: FREEMAN DIVERSIFIED REAL ESTATE II LP DATE OF NAME CHANGE: 19910501 10KSB 1 ddre2.txt DDRE2 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 Form 10-KSB (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________to _________ Commission file number 0-14483 DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. (Name of small business issuer in its charter) Delaware 62-1207077 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 55 Beattie Place, PO Box 1089 Greenville, South Carolina 29602 (Address of principal executive offices) (864) 239-1000 Issuer's telephone number Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Units of Limited Partnership (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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___ Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] State issuer's revenues for its most recent fiscal year. $5,516,000 State the aggregate market value of the voting partnership interests held by non-affiliates computed by reference to the price at which the partnership interests were sold, or the average bid and asked prices of such partnership interests as of December 31, 2002. No market exists for the limited partnership interests of the Registrant, and, therefore, no aggregate market value can be determined. DOCUMENTS INCORPORATED BY REFERENCE None The matters discussed in this report contain certain forward-looking statements, including, without limitation, statements regarding future financial performance and the effect of government regulations. The discussions of the Registrant's business and results of operations, including forward-looking statements pertaining to such matters, do not take into account the effects of any changes to the Registrant's business and results of operations. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors including, without limitation: national and local economic conditions; the terms of governmental regulations that affect the Registrant and interpretations of those regulations; the competitive environment in which the Registrant operates; financing risks, including the risk that cash flows from operations may be insufficient to meet required payments of principal and interest; real estate risks, including variations of real estate values and the general economic climate in local markets and competition for tenants in such markets; and possible environmental liabilities. Readers should carefully review the Registrant's financial statements and the notes thereto, as well as the risk factors described in the documents the Registrant files from time to time with the Securities and Exchange Commission. PART I Item 1. Description of Business Davidson Diversified Real Estate II, L.P. (the "Partnership" or "Registrant") is a Delaware limited partnership organized in June 1984. The general partners of the Partnership are Davidson Diversified Properties, Inc., a Tennessee corporation ("Managing General Partner"); Davidson Equities, Limited, ("Associate General Partner"); and David W. Talley ("Individual General Partner") (collectively, the "General Partners"). Prior to February 25, 1998, the Managing General Partner was a wholly-owned subsidiary of MAE GP Corporation ("MAE GP"). Effective February 25, 1998, MAE GP was merged into Insignia Properties Trust ("IPT"), which was merged into Apartment Investment and Management Company ("AIMCO") effective February 26, 1999. Thus, the Managing General Partner is now a wholly-owned subsidiary of AIMCO, a publicly traded real estate investment trust. The Partnership Agreement provides that the Partnership is to terminate on December 31, 2008, unless terminated prior to such date. The offering of the Registrant's limited partnership units (the "Units") commenced on October 16, 1984, and terminated on October 15, 1985. The Registrant received gross proceeds from the offering of $24,485,000 and net proceeds of $21,760,500. Upon termination of the offering, the Registrant had accepted subscriptions for 1,224.25 Units. Since its initial offering, the Registrant has not received, nor are limited partners required to make, additional capital contributions. The Registrant is engaged in the business of operating and holding real estate properties for investment. In 1984 and 1985, during its acquisition phase, the Registrant acquired eight existing multifamily residential and commercial properties of which two have been sold and two have been foreclosed upon by the mortgage holder. The last commercial shopping center was sold on December 30, 1999. As of December 31, 2002, the Registrant owned and operated four multifamily residential properties including one property held for sale which are further described in "Item 2. Description of Properties". The Registrant has no employees. Management and administrative services are provided by the Managing General Partner. These services were provided by affiliates of the Managing General Partner for the years ended December 31, 2002 and 2001. Risk Factors The real estate business in which the Partnership is engaged is highly competitive. There are other residential properties within the market area of the Registrant's properties. The number and quality of competitive properties, including those which may be managed by an affiliate of the Managing General Partner in such market area could have a material effect on the rental market for the apartments at the Registrant's properties and the rents that may be charged for such apartments. While the Managing General Partner and its affiliates own and/or control a significant number of apartment units in the United States, such units represent an insignificant percentage of total apartment units in the United States and competition for the apartments is local. Laws benefiting disabled persons may result in the Partnership's incurrence of unanticipated expenses. Under the Americans with Disabilities Act of 1990, or ADA, all places intended to be used by the public are required to meet certain Federal requirements related to access and use by disabled persons. Likewise, the Fair Housing Amendments Act of 1988, or FHAA, requires apartment properties first occupied after March 13, 1990 to be accessible to the handicapped. These and other Federal, state and local laws may require modifications to the Partnership's properties, or restrict renovations of the properties. Noncompliance with these laws could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any non-complying feature, which could result in substantial capital expenditures. Although the Managing General Partner believes that the Partnership's properties are substantially in compliance with present requirements, the Partnership may incur unanticipated expenses to comply with the ADA and the FHAA. Both the income and expenses of operating the properties owned by the Registrant are subject to factors outside of the Registrant's control, such as changes in the supply and demand for similar properties resulting from various market conditions, increases/decreases in unemployment or population shifts, changes in the availability of permanent mortgage financing, changes in zoning laws, or changes in patterns or needs of users. In addition, there are risks inherent in owning and operating residential properties because such properties are susceptible to the impact of economic and other conditions outside of the control of the Registrant. There have been, and it is possible there may be other, Federal, state and local legislation and regulations enacted relating to the protection of the environment. The Partnership is unable to predict the extent, if any, to which such new legislation or regulations might occur and the degree to which such existing or new legislation or regulations might adversely affect the properties owned by the Partnership. The Registrant monitors its properties for evidence of pollutants, toxins and other dangerous substances, including the presence of asbestos. In certain cases environmental testing has been performed which resulted in no material adverse conditions or liabilities. In no case has the Partnership received notice that it is a potentially responsible party with respect to an environmental clean up site. Insurance coverage is becoming more expensive and difficult to obtain. The current insurance market is characterized by rising premium rates, increasing deductibles, and more restrictive coverage language. Recent developments have resulted in significant increases in insurance premiums and have made it more difficult to obtain certain types of insurance. As an example, many insurance carriers are excluding mold-related risks from their policy coverages, or are adding significant restrictions to such coverage. Continued deterioration in insurance market place conditions may have a negative effect on the Partnership's operating results. A further description of the Registrant's business is included in "Management's Discussion and Analysis or Plan of Operation" included in "Item 6." of this Form 10-KSB. Item 2. Description of Properties The following table sets forth the Registrant's investments in properties as of December 31, 2002:
Date of Property Purchase Type of Ownership Use Big Walnut Apartments 03/28/85 Fee ownership subject to Apartment - Columbus, Ohio first mortgage (1) 251 units The Trails Apartments 08/30/85 Fee ownership subject to Apartment - Nashville, Tennessee first mortgage (1) 248 units Reflections Apartments (formerly 09/30/85 Fee ownership subject to Apartment - Greensprings Manor Apartments) first mortgage (2) 582 units Indianapolis, Indiana
(1) The property is held by a Limited Partnership in which the Registrant owns a 99.90% interest. (2) The property is held by a Limited Partnership wholly owned by the Registrant. On January 30, 2003, the Partnership sold Lafontenay I and II Apartments to an unaffiliated third party for $9,700,000. After payment of closing costs of approximately $254,000, and the assumption of the mortgage debt of approximately $6,899,000 by the purchaser, the net proceeds received by the Partnership were approximately $2,547,000. The sale of the property resulted in a gain on the sale during the first quarter of 2003 of approximately $5,470,000. In addition, the Partnership recorded a loss on early extinguishment of debt of approximately $68,000 as a result of the write off of unamortized loan costs. The Partnership used the proceeds received from the sale to make payments on the loan balances due to the Managing General Partner (see "Note D"). In accordance with Statement of Financial Accounting Standards No. 144, the assets and liabilities of the property have been classified as held for sale at December 31, 2002 and the operations of the property have been shown as income from discontinued operations for the years ended December 31, 2002 and 2001. Schedule of Properties Set forth below for each of the Registrant's properties is the gross carrying value, accumulated depreciation, depreciable life, method of depreciation and Federal tax basis.
Gross Carrying Accumulated Federal Property Value Depreciation Rate Method Tax Basis (in thousands) (in thousands) Big Walnut Apartments $ 9,947 $ 6,177 5-25 yrs S/L $ 2,134 The Trails Apartments 9,764 5,853 5-25 yrs S/L 2,100 Reflections Apartments 24,062 8,615 5-25 yrs S/L 13,995 $43,773 $20,645 $18,229
See "Note A" to the consolidated financial statements included in "Item 7 - Financial Statements" for a description of the Registrant's capitalization and depreciation policies. The gross carrying value, accumulated depreciation, and federal tax basis of Lafontenay I and II Apartments, which is classified as assets held for sale as of December 31, 2002, was approximately $10,492,000, $6,597,000 and $2,402,000, respectively. Schedule of Property Indebtedness The following table sets forth certain information relating to the loans encumbering the Registrant's properties.
Principal Principal Balance At Stated Balance December 31, Interest Period Maturity Due At Property 2002 Rate Amortized Date Maturity (in thousands) (in thousands) Big Walnut Apartments 1st mortgage $ 5,720 (1) 360 months 09/16/07 $ 5,042 The Trails Apartments 1st mortgage 4,961 (2) 240 months 12/01/09 2,973 Reflections Apartments 1st mortgage (3) 10,626 (3) (3) 01/01/04 9,997 Totals 21,307 $18,012 Less unamortized discounts (872) Total $20,435
The loan encumbering Lafontenay I and II Apartments of approximately $6,907,000, included in liabilities related to assets held for sale, was repaid subsequent to December 31, 2002. See "Item 7. Financial Statements - Note G - Subsequent Event". (1) Adjustable rate based on the Fannie Mae discounted mortgage-backed security index ("DMBS") plus 85 basis points. The rate at December 31, 2002 was 2.16%. (2) Adjustable rate based on 75% of the interest rate on new-issue long-term A-rated utility bonds as determined on the first day of each calendar quarter. The rate at December 31, 2002 was 4.60%. (3) On January 16, 2001, the mortgages encumbering Reflections Apartments were refinanced in order to finance the rehabilitation of the property. The maximum new loan amount is $13,600,000. Effective January 16, 2001, the lender made an initial advance of $5,040,000. Prior to the initial advance, the Managing General Partner loaned the Partnership approximately $3,673,000 in order for the Partnership to close the refinancing of the property. This amount will be repaid from the further refinancing that will occur after the completion of the rehabilitation project, estimated to be July 2004. During the year ended December 31, 2001, the lender advanced Reflections Apartments an additional amount of approximately $3,845,000 and during the year ended December 31, 2002 the lender advanced Reflections Apartments an additional $1,741,000. Subsequent advances of up to $2,973,000 will also be made to cover renovation work that is needed at the property. The new loan matures in January 2004, with 2 one-year extension options. Interest payments started in February 2001 based on LIBOR plus 280 basis points (4.18% at December 31, 2002). Due to the rehabilitation project, approximately $769,000 and $585,000 of the interest expense for the years ended December 31, 2002 and 2001, respectively, was capitalized. In addition, monthly cash flow payments will be made to the lender until the anticipated completion date of the renovations. If any amount remains from these advances on the completion date of the renovation, it will be applied to the principal balance. Principal payments will begin in February 2003, and monthly deposits into a replacement reserve will be required. In connection with the refinancing, the Partnership incurred loan costs of approximately $469,000 during the year ended December 31, 2001. Additional loan costs of approximately $19,000 were incurred during the year ended December 31, 2002. These loan costs are included in other assets in the accompanying consolidated balance sheet and are being amortized over the life of the mortgage. In connection with the refinancing, the assets and liabilities of the property were transferred from one subsidiary, Big Walnut L.P., to a newly formed subsidiary, AIMCO Greensprings L.P. The loan is collateralized by the property as well as the interest of both the Partnership and Davidson Diversified Properties, Inc. in AIMCO Greensprings L.P. The new mortgage replaced a first mortgage of approximately $7,518,000 and a second mortgage of approximately $294,000. The Partnership recognized a loss on early extinguishment of debt of approximately $554,000 consisting of a prepayment penalty of approximately $359,000 and the write-off of unamortized loan costs and mortgage discounts of approximately $195,000. See "Item 7. Financial Statements - Note B" for information with respect to the Registrant's ability to prepay the loans and other specific details about the loans. On September 16, 2002, the Partnership refinanced the mortgages encumbering Big Walnut Apartments. The refinancing replaced a first mortgage of approximately $3,930,000 and a second mortgage of approximately $167,000 with a new mortgage of $5,720,000. Total capitalized loan costs were approximately $155,000 during the year ended December 31, 2002. The Partnership recognized a loss on the early extinguishment of debt of approximately $17,000 due to the write-off of unamortized loan costs. In addition, $85,000 was deposited in an escrow account to be used to complete required repairs. Big Walnut Apartments was initially refinanced during 2002 under an interim credit facility ("Interim Credit Facility") which had a term of three months. The Interim Credit Facility included properties in other partnerships that are affiliated with the Partnership. However, the Interim Credit Facility created separate loans for each property that were not cross-collateralized or cross-defaulted with the other property loans. During the three month term of the Interim Credit Facility, the properties were required to make interest-only payments. The first month's interest, which was paid at the date of the refinancing, was calculated at LIBOR plus 70 basis points. Interest for the following two months was calculated at LIBOR plus 150 points and was due monthly. During December 2002, the Interim Credit Facility encumbering Big Walnut Apartments was sold to Fannie Mae under a permanent credit facility ("Permanent Credit Facility"). The Permanent Credit Facility has a maturity of five years, with one five-year extension option. This Permanent Credit Facility also creates separate loans for each property that are not cross-collateralized or cross-defaulted with the other property loans. Each note under this Permanent Credit Facility will begin as a variable rate loan with the option of converting to a fixed rate loan after three years. The interest rate on the variable rate loan is the Fannie Mae DMBS index plus 85 basis points. The rate was 2.16% at December 31, 2002 and will reset monthly. Each loan will automatically renew at the end of each month. In addition, monthly principal payments are required based on a 30-year amortization schedule, using the interest rate in effect during the first month that any property is in the Permanent Credit Facility. The loans are prepayable without penalty. Rental Rates and Occupancy Average annual rental rates and occupancy for 2002 and 2001 for each property: Average Annual Average Rental Rates Occupancy (per unit) Property 2002 2001 2002 2001 Big Walnut Apartments (1) $6,948 $7,135 96% 86% The Trails Apartments 7,296 7,637 94% 94% Reflections Apartments (2) 6,480 5,909 45% 37% (1) The Managing General Partner attributes the increase in occupancy at Big Walnut Apartments to new emphasis on marketing to the local community, an improved job market and reduced average rental rates. (2) The Managing General Partner attributes the increase in occupancy at Reflections Apartments to completion of some of the units under construction at the property. The property is currently undergoing a major renovation project to enhance the appearance of the property to attract additional tenants. At December 31, 2002, 52.9% of the units cannot be rented due to the construction. As noted under "Item 1. Description of Business", the real estate industry is highly competitive. All of the properties are subject to competition from other residential apartment complexes in the area. The Managing General Partner believes that all of the properties are adequately insured. Each property is an apartment complex which leases units for terms of one year or less. As of December 31, 2002, no residential tenant leases 10% or more of the available rental space. All of the properties are in good condition subject to normal depreciation and deterioration as is typical for assets of this type and age. Schedule of Real Estate Taxes and Rates Real estate taxes and rates in 2002 for each property were: 2002 2002 Taxes Rates (in thousands) Big Walnut Apartments $ 135 5.89% The Trails Apartments 132 3.84% Reflections Apartments 235 2.79% Capital Improvements Big Walnut Apartments: During the year ended December 31, 2002, the Partnership completed approximately $191,000 of capital expenditures at Big Walnut Apartments consisting primarily of floor covering and air conditioning unit replacements, structural improvements, office computers, and survey fees. These improvements were funded from operating cash flow and replacement reserves. The Partnership is currently evaluating the capital improvements needs of the property for the upcoming year and currently expects to budget approximately $75,000. Additional improvements may be considered during 2003 and will depend on the physical condition of the property as well as the anticipated cash flow generated by the property. LaFontenay I & II Apartments: During the year ended December 31, 2002, the Partnership completed approximately $225,000 in capital expenditures at LaFontenay I & II Apartments consisting primarily of structural improvements, water heater and natural gas line upgrades, and floor covering, air conditioning unit, and roofing replacements. These improvements were funded from operating cash flow and replacement reserves. Subsequent to December 31, 2002, LaFontenay Apartments was sold to an unrelated party. The Trails: During the year ended December 31, 2002, the Partnership completed approximately $92,000 in capital expenditures at The Trails Apartments consisting primarily of floor covering replacements, water heater upgrades, major landscaping, and structural improvements. These improvements were funded primarily from operating cash flow. The Partnership is currently evaluating the capital improvements needs of the property for the upcoming year and currently expects to budget approximately $74,000 for The Trails. Additional improvements may be considered during 2003 and will depend on the physical condition of the property as well as the anticipated cash flow generated by the property. Reflections: During the year ended December 31, 2002, the Partnership completed approximately $5,587,000 in capital expenditures at Reflections Apartments consisting primarily of architect and consultant fees, development services, building construction, furniture and fixtures, water submetering and structural improvements. These expenditures included capitalized construction period interest of approximately $769,000, tax and insurance expenses of approximately $162,000 and other construction period expenses of approximately $431,000. These improvements were funded primarily from a construction loan, loans from the Managing General Partner and operating cash flow. In January 2001, the Managing General Partner refinanced the mortgage encumbering this property. The proceeds are being used to fund the rehabilitation project for this property which is anticipated to be completed by the end of 2003. The Partnership has budgeted approximately $6,589,000 for 2003 to complete this project. Additional improvements may be considered during 2003 and will depend on the physical condition of the property as well as anticipated cash flow generated by the property and further refinancing proceeds. Item 3. Legal Proceedings In March 1998, several putative unit holders of limited partnership units of the Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, its Managing General Partner and several of their affiliated partnerships and corporate entities. The action purports to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) which are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities which were, at one time, affiliates of Insignia; past tender offers by the Insignia affiliates to acquire limited partnership units; management of the partnerships by the Insignia affiliates; and the series of transactions which closed on October 1, 1998 and February 26, 1999 whereby Insignia and Insignia Properties Trust, respectively, were merged into AIMCO. The plaintiffs seek monetary damages and equitable relief, including judicial dissolution of the Partnership. On June 25, 1998, the Managing General Partner filed a motion seeking dismissal of the action. In lieu of responding to the motion, the plaintiffs filed an amended complaint. The Managing General Partner filed demurrers to the amended complaint which were heard February 1999. Pending the ruling on such demurrers, settlement negotiations commenced. On November 2, 1999, the parties executed and filed a Stipulation of Settlement, settling claims, subject to court approval, on behalf of the Partnership and all limited partners who owned units as of November 3, 1999. Preliminary approval of the settlement was obtained on November 3, 1999 from the Court, at which time the Court set a final approval hearing for December 10, 1999. Prior to the December 10, 1999 hearing, the Court received various objections to the settlement, including a challenge to the Court's preliminary approval based upon the alleged lack of authority of prior lead counsel to enter the settlement. On December 14, 1999, the Managing General Partner and its affiliates terminated the proposed settlement. In February 2000, counsel for some of the named plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who negotiated the settlement. On June 27, 2000, the Court entered an order disqualifying them from the case and an appeal was taken from the order on October 5, 2000. On December 4, 2000, the Court appointed the law firm of Lieff Cabraser Heimann & Bernstein LLP as new lead counsel for plaintiffs and the putative class. Plaintiffs filed a third amended complaint on January 19, 2001. On March 2, 2001, the Managing General Partner and its affiliates filed a demurrer to the third amended complaint. On May 14, 2001, the Court heard the demurrer to the third amended complaint. On July 10, 2001, the Court issued an order sustaining defendants' demurrer on certain grounds. On July 20, 2001, Plaintiffs filed a motion for reconsideration of the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer. On September 7, 2001, Plaintiffs filed a fourth amended class and derivative action complaint. On September 12, 2001, the Court denied Plaintiffs' motion for reconsideration. On October 5, 2001, the Managing General Partner and affiliated defendants filed a demurrer to the fourth amended complaint, which was heard on December 11, 2001. On February 2, 2002, the Court served its order granting in part the demurrer. The Court has dismissed without leave to amend certain of the plaintiffs' claims. On February 11, 2002, plaintiffs filed a motion seeking to certify a putative class comprised of all non-affiliated persons who own or have owned units in the partnerships. The Managing General Partner and affiliated defendants oppose the motion. On April 29, 2002, the Court held a hearing on plaintiffs' motion for class certification and took the matter under submission after further briefing, as ordered by the court, was submitted by the parties. On July 10, 2002, the Court entered an order vacating the current trial date of January 13, 2003 (as well as the pre-trial and discovery cut-off dates) and stayed the case in its entirety through November 7, 2002 so that the parties could have an opportunity to discuss settlement. On October 30, 2002, the court entered an order extending the stay in effect through January 10, 2003. On January 8, 2003, the parties filed a Stipulation of Settlement in proposed settlement of the Nuanes action and the Heller action described below. The Court has scheduled the hearing on preliminary approval for April 4, 2003 and the hearing on final approval for June 2, 2003. In general terms, the proposed settlement provides for certification for settlement purposes of a settlement class consisting of all limited partners in this Partnership and others (the "Partnerships") as of December 20, 2002, the dismissal with prejudice and release of claims in the Nuanes and Heller litigation, payment by AIMCO of $9.9 million (which shall be distributed to settlement class members after deduction of attorney fees and costs of class counsel and certain costs of settlement) and up to $ 1 million toward the cost of independent appraisals of the Partnerships' properties by a Court appointed appraiser. An affiliate of the Managing General Partner has also agreed to make a tender offer to purchase all of the partnership interests in the Partnerships within one year of final approval, if it is granted, and to provide partners with the independent appraisals at the time of these tenders. The proposed settlement also provides for the limitation of the allowable costs which the Managing General Partner or its affiliates will charge the Partnerships in connection with this litigation and imposes limits on the class counsel fees and costs in this litigation. If the Court grants preliminary approval of the proposed settlement in April, a notice will be distributed to partners providing detail on the terms of the proposed settlement. During the third quarter of 2001, a complaint (the "Heller action") was filed against the same defendants that are named in the Nuanes action, captioned Heller v. Insignia Financial Group. On or about August 6, 2001, plaintiffs filed a first amended complaint. The first amended complaint in the Heller action is brought as a purported derivative action, and asserts claims for among other things breach of fiduciary duty; unfair competition; conversion, unjust enrichment; and judicial dissolution. Plaintiffs in the Nuanes action filed a motion to consolidate the Heller action with the Nuanes action and stated that the Heller action was filed in order to preserve the derivative claims that were dismissed without leave to amend in the Nuanes action by the Court order dated July 10, 2001. On October 5, 2001, the Managing General Partner and affiliated defendants moved to strike the first amended complaint in its entirety for violating the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer in the Nuanes action, or alternatively, to strike certain portions of the complaint based on the statute of limitations. Other defendants in the action demurred to the fourth amended complaint, and, alternatively, moved to strike the complaint. On December 11, 2001, the court heard argument on the motions and took the matters under submission. On February 4, 2002, the Court served notice of its order granting defendants' motion to strike the Heller complaint as a violation of its July 10, 2001 order in the Nuanes action. On March 27, 2002, the plaintiffs filed a notice appealing the order striking the complaint. Before completing briefing on the appeal, the parties stayed further proceedings in the appeal pending the Court's review of the terms of the proposed settlement described above. The Managing General Partner does not anticipate that any costs to the Partnership, whether legal or settlement costs, associated with these cases will be material to the Partnership's overall operations. The Partnership is unaware of any other pending or outstanding litigation that is not of a routine nature arising in the ordinary course of business. Item 4. Submission of Matters to a Vote of Security Holders During the quarter ended December 31, 2002, no matters were submitted to a vote of Unit holders through the solicitation of proxies or otherwise. PART II Item 5. Market for the Partnership Equity and Related Partner Matters The Partnership, a publicly-held limited partnership, offered and sold 1,224.25 Limited Partnership Units ("Units") aggregating $24,485,000. As of December 31, 2002 there were 796 holders of record owning an aggregate of 1,224.25 Units. Affiliates of the Managing General Partner owned 620.25 units or 50.66% at December 31, 2002. There is no established market for the Units and it is not anticipated that any will develop in the future. No distributions were made to the partners during 2002 or 2001. Future cash distributions will depend on the levels of net cash generated from operations, the availability of cash reserves and timing of debt maturities, refinancings and/or property sales. The Registrant's cash available for distribution is reviewed on a monthly basis. In light of the rehabilitation project at Reflections apartments and the significant amount due to the Managing General Partner at December 31, 2002, it is not anticipated that the Partnership will make distributions in the foreseeable future. See "Item 2. Description of Properties - Capital Improvements" for information relating to anticipated capital expenditures at the properties. In addition to its indirect ownership of the managing and associate general partner interest in the Partnership, AIMCO and its affiliates owned 620.25 limited partnership units in the Partnership representing 50.66% of the outstanding Units at December 31, 2002. A number of these Units were acquired pursuant to tender offers made by AIMCO or its affiliates. It is possible that AIMCO or its affiliates will acquire additional Units of limited partnership interest in the Partnership in exchange for cash or a combination of cash and units in the operating partnership of AIMCO either through private purchases or tender offers. Under the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters which would include voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner. As a result of its ownership of 50.66% of the outstanding Units, AIMCO is in a position to control all such voting decisions with respect to the Registrant. Although the Managing General Partner owes fiduciary duties to the limited partners of the Partnership, the Managing General Partner also owes fiduciary duties to AIMCO as its sole stockholder. As a result, the duties of the Managing General Partner, as managing general partner, to the Partnership and its limited partners may come into conflict with the duties of the Managing General Partner to AIMCO, as its sole stockholder. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATION This item should be read in conjunction with the consolidated financial statements and other items contained elsewhere in this report. Results of Operations The Registrant's net loss for the year ended December 31, 2002 was approximately $166,000 as compared to a net loss of approximately $1,448,000 for the year ended December 31, 2001. The decrease in net loss for the year ended December 31, 2002 was primarily due to a decrease in total expenses and an increase in total revenues, partially offset by an increase in loss from discontinued operations. On January 30, 2003, the Partnership sold Lafontenay I and II Apartments to an unaffiliated third party for $9,700,000. After payment of closing costs of approximately $254,000, and the assumption of the mortgage debt of approximately $6,899,000 by the purchaser, the net proceeds received by the Partnership were approximately $2,547,000. The sale of the property resulted in a gain on the sale during the first quarter of 2003 of approximately $5,470,000. In addition, the Partnership recorded a loss on early extinguishment of debt of approximately $68,000 as a result of the write off of unamortized loan costs. The Partnership used the proceeds received from the sale to make payments on the loan balances due to the Managing General Partner. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 provides accounting guidance for financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Partnership adopted SFAS 144 effective January 1, 2002. In accordance with SFAS 144, LaFontenay I and II Apartments is considered as held for sale as of December 31, 2002. As a result, the accompanying consolidated statements of operations (restated as of January 1, 2001 for the year ended December 31, 2001) reflect the operations of LaFontenay I and II Apartments as loss from discontinued operations. The consolidated balance sheet reflects the assets and liabilities of LaFontenay I and II Apartments as assets held for sale and liabilities related to assets held for sale, respectively. The loss from continuing operations at December 31, 2002 was approximately $15,000 as compared to a net loss of approximately $1,427,000 for the year ended December 31, 2001. The decrease in net loss from continuing operations was due to a decrease in total expenses and an increase in total revenues. The increase in loss from discontinued operation was due to a decrease in total revenues, partially offset by a decrease in total expenses at LaFontenay I and II Apartments. Total revenues decreased due to reduced occupancy and lower average rental rates at the property. Total expenses decreased primarily due to reduced property tax expense partially offset by increased depreciation expense. Property tax expense decreased due to a prior year tax adjustment paid in 2001. Depreciation expense increased due to capital improvements completed during the past twelve months that are now being depreciated. The decrease in total expenses is due to a decrease in loss on early extinguishment of debt and decreases in interest and general and administrative expenses partially offset by an increase in operating and property tax expenses. The losses on early extinguishment of debt for 2002 and 2001 relate to the refinancing of the mortgages encumbering Big Walnut Apartments in September 2002 and Reflections Apartments in January 2001 as discussed in "Liquidity and Capital Resources". Interest expense decreased due to the increase in capitalization of interest at Reflections Apartments and the refinancing of the mortgage encumbering Big Walnut Apartments at a lower interest rate. These decreases were partially offset by an increase in interest on advances from the Managing General Partner due to increased debt balances. General and administrative expenses decreased primarily due to reduced partnership taxes and professional fees associated with administration of the Partnership and reduced costs of services included in the management reimbursements to the Managing General Partner as allowed under the Partnership Agreement. Also included in general and administrative expenses at both December 31, 2002 and 2001 are costs associated with the quarterly and annual communications with investors and regulatory agencies and the annual audit required by the Partnership Agreement. Operating expenses increased due to increases in property expense partially offset by decreases in administrative, maintenance, and advertising expense. Property expense increased due to increases in utilities and payroll and related benefits expenses, primarily at Reflections Apartments. Administrative expense decreased primarily due to a decrease in contract security patrol expense at Reflections Apartments. Maintenance expense decreased at all of the Partnership's properties due to the increased capitalization of certain direct and indirect costs, primarily payroll related costs (see "Item 7. Financial Statements - Note A - Organization and Significant Accounting Policies"). Advertising expense decreased primarily due to a decrease in periodical advertising at Big Walnut and The Trails Apartments. Property tax expense increased due to prior year tax refunds received at Reflections and Big Walnut Apartments during 2001 partially offset by an increase in capitalized taxes at Reflections Apartments. Total revenues increased primarily due to an increase in rental income and to a casualty gain recorded at Reflections Apartments during 2002. Rental income increased primarily due to an increase in occupancy at Reflections, and Big Walnut Apartments and an increase in the average rental rate at Reflections Apartments, which were partially offset by a decrease in average rental rates at Big Walnut and The Trails Apartments. The net casualty gain that was recorded at Reflections Apartments related to a fire that occurred in October 2001. The gain was the result of insurance proceeds of approximately $204,000 less the net book value of the damaged property of approximately $45,000. The proceeds are being held in escrow by the lender until the repairs are completed and are included in receivables and deposits on the accompanying consolidated balance sheet. As part of the ongoing business plan of the Partnership, the Managing General Partner monitors the rental market environment of the investment properties to assess the feasibility of increasing rents, maintaining or increasing occupancy levels and protecting the Partnership from increases in expense. As part of this plan, the Managing General Partner attempts to protect the Partnership from the burden of inflation-related increases in expenses by increasing rents and maintaining a high overall occupancy level. However, due to changing market conditions, which can result in the use of rental concessions and rental reductions to offset softening market conditions, there is no guarantee that the Managing General Partner will be able to sustain such a plan. Liquidity and Capital Resources At December 31, 2002, the Partnership had cash and cash equivalents of approximately $591,000 as compared to approximately $743,000 on December 31, 2001. Cash and cash equivalents decreased approximately $152,000 since December 31, 2001 primarily due to approximately $6,273,000 of cash used in investing activities, partially offset by $4,490,000 of cash provided by financing activities and $1,631,000 of cash provided by operating activities. Cash used in investing activities consisted of property improvements and replacements, partially offset by net withdrawals from restricted escrow accounts. Cash provided by financing activities consisted of advances from affiliates, additional proceeds from the construction note encumbering Reflections Apartments, and proceeds from the refinance of Big Walnut Apartments, partially offset by principal payments on the mortgages encumbering the Partnership's properties, payments on advances from affiliates, repayment of mortgage notes payable, and loan costs paid. The Partnership invests its working capital reserves in interest bearing accounts. On September 16, 2002, the Partnership refinanced the mortgages encumbering Big Walnut Apartments. The refinancing replaced a first mortgage of approximately $3,930,000 and a second mortgage of approximately $167,000 with a new mortgage of $5,720,000. Total capitalized loan costs were approximately $155,000 during the year ended December 31, 2002. The Partnership recognized a loss on the early extinguishment of debt of approximately $17,000 due to the write-off of unamortized loan costs. In addition, $85,000 was deposited in an escrow account to be used to complete required repairs. Big Walnut Apartments was initially refinanced under an interim credit facility ("Interim Credit Facility") which had a term of three months. The Interim Credit Facility included properties in other partnerships that are affiliated with the Partnership. However, the Interim Credit Facility created separate loans for each property that were not cross-collateralized or cross-defaulted with the other property loans. During the three month term of the Interim Credit Facility, the properties were required to make interest-only payments. The first month's interest, which was paid at the date of the refinancing, was calculated at LIBOR plus 70 basis points. Interest for the following two months was calculated at LIBOR plus 150 points and was due monthly. During December 2002, the Interim Credit Facility encumbering Big Walnut Apartments was sold to Fannie Mae under a permanent credit facility ("Permanent Credit Facility"). The Permanent Credit Facility has a maturity of five years, with one five-year extension option. This Permanent Credit Facility also creates separate loans for each property that are not cross-collateralized or cross-defaulted with the other property loans. Each note under this Permanent Credit Facility will begin as a variable rate loan with the option of converting to a fixed rate loan after three years. The interest rate on the variable rate loan is the Fannie Mae discounted mortgage-backed security index plus 85 basis points. The rate was 2.16% at December 31, 2002 and will reset monthly. Each loan will automatically renew at the end of each month. In addition, monthly principal payments are required based on a 30-year amortization schedule, using the interest rate in effect during the first month that any property is on the Permanent Credit Facility. The loans are prepayable without penalty. On January 16, 2001, the mortgages encumbering Reflections Apartments were refinanced in order to finance the rehabilitation of the property. The maximum new loan amount is $13,600,000. Effective January 16, 2001, the lender made an initial advance of $5,040,000. Prior to the initial advance, the Managing General Partner loaned the Partnership approximately $3,673,000 in order for the Partnership to close the refinancing of the property. This amount will be repaid from the further refinancing that will occur after the completion of the rehabilitation project, estimated to be July 2004. During the year ended December 31, 2001, the lender advanced Reflections Apartments an additional amount of approximately $3,845,000 and during the year ended December 31, 2002 the lender advanced Reflections Apartments an additional $1,741,000. Subsequent advances of up to $2,973,000 will also be made to cover renovation work that is needed at the property. The new loan matures in January 2004, with 2 one-year extension options. Interest payments started in February 2001 based on LIBOR plus 280 basis points (4.18% at December 31, 2002). Due to the rehabilitation project, approximately $769,000 and $585,000 of the interest expense for the years ended December 31, 2002 and 2001, respectively, was capitalized. In addition, monthly cash flow payments will be made to the lender until the anticipated completion date of the renovations. If any amount remains from these advances on the completion date of the renovation, it will be applied to the principal balance. Principal payments will begin in February 2003, and monthly deposits into a replacement reserve will be required. In connection with the refinancing, the Partnership incurred loan costs of approximately $469,000 during the year ended December 31, 2001. Additional loan costs of approximately $19,000 were incurred during the year ended December 31, 2002. These loan costs are included in other assets in the accompanying consolidated balance sheet and are being amortized over the life of the mortgage. In connection with the refinancing, the assets and liabilities of the property were transferred from one subsidiary, Big Walnut L.P., to a newly formed subsidiary, AIMCO Greensprings L.P. The loan is collateralized by the property as well as the interest of both the Partnership and Davidson Diversified Properties, Inc. in AIMCO Greensprings L.P. The new mortgage replaced a first mortgage of approximately $7,518,000 and a second mortgage of approximately $294,000. The Partnership recognized a loss on early extinguishment of debt of approximately $554,000 consisting of a prepayment penalty of approximately $359,000 and the write-off of unamortized loan costs and mortgage discounts of approximately $195,000. Effective April 1, 2002, the Partnership adopted Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44 and 64." SFAS No. 4 "Reporting Gains and Losses from Extinguishment of Debt," required that all gains and losses from extinguishment of debt be aggregated and, if material, classified as an extraordinary item. SFAS No. 145 rescinds SFAS No. 4, and accordingly, gains and losses from extinguishment of debt should only be classified as extraordinary if they are unusual in nature and occur infrequently. Neither of these criteria applies to the Partnership. As a result, the accompanying consolidated statements of operations reflect the loss on early extinguishment of debt at Reflections Apartments in 2001 and at Big Walnut Apartments in 2002 in operations rather than as extraordinary items. The sufficiency of existing liquid assets to meet future liquidity and capital expenditure requirements is directly related to the level of capital expenditures required at the various properties to adequately maintain the physical assets and other operating needs of the Partnership and to comply with Federal, state, and local legal and regulatory requirements. The Managing General Partner monitors developments in the area of legal and regulatory compliance and is studying new federal laws, including the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 mandates or suggests additional compliance measures with regard to governance, disclosure, audit and other areas. In light of these changes, the Partnership expects that it will incur higher expenses related to compliance, including increased legal and audit fees. The Partnership is currently evaluating the capital improvement needs of the properties for the upcoming year and currently expects to budget approximately $6,738,000 for the Partnership's investment properties. Additional improvements may be considered during 2003 and will depend on the physical condition of the properties as well as replacement reserves and anticipated cash flow generated by the properties. The additional capital expenditures will be incurred only if cash is available from operations, Partnership reserves or further refinancing proceeds. To the extent that such budgeted capital improvements are completed, the Registrant's distributable cash flow, if any, may be adversely affected at least in the short term. The Registrant's assets are thought to be sufficient for any near-term needs (exclusive of capital improvements) of the Registrant. The mortgage indebtedness of approximately $20,435,000, net of discount, is amortized over varying periods with required balloon payments ranging from January 2004 to December 2009. The mortgage indebtedness of approximately $6,907,000 on LaFontenay I and II Apartments was repaid subsequent to December 31, 2002 (see "Item 7. Financial Statements - Note G Subsequent Event"). The Managing General Partner will attempt to refinance and/or sell the properties prior to such maturity dates. If the properties cannot be refinanced or sold for a sufficient amount, the Partnership may risk losing such properties through foreclosure. Pursuant to the Partnership Agreement, the term of the Partnership is scheduled to expire on December 31, 2008. Accordingly, prior to such date the Partnership will need to either sell the investment properties or extend the term of the Partnership. No cash distributions were made during the years ended December 31, 2002 or 2001. Future cash distributions will depend on the levels of net cash generated from operations, the availability of cash reserves, and the timing of debt maturities, refinancings and/or property sales. The Registrant's cash available for distribution is reviewed on a monthly basis. In light of the rehabilitation project at Reflections Apartments and the significant amounts due to the Managing General Partner at December 31, 2002, it is not anticipated that the Partnership will make distributions in the foreseeable future. Other In addition to its indirect ownership of the managing and associate general partner interest in the Partnership, AIMCO and its affiliates owned 620.25 limited partnership units in the Partnership representing 50.66% of the outstanding Units at December 31, 2002. A number of these Units were acquired pursuant to tender offers made by AIMCO or its affiliates. It is possible that AIMCO or its affiliates will acquire additional Units of limited partnership interest in the Partnership in exchange for cash or a combination of cash and units in the operating partnership of AIMCO either through private purchases or tender offers. Under the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters which would include voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner. As a result of its ownership of 50.66% of the outstanding Units, AIMCO is in a position to control all such voting decisions with respect to the Registrant. Although the Managing General Partner owes fiduciary duties to the limited partners of the Partnership, the Managing General Partner also owes fiduciary duties to AIMCO as its sole stockholder. As a result, the duties of the Managing General Partner, as managing general partner, to the Partnership and its limited partners may come into conflict with the duties of the Managing General Partner to AIMCO, as its sole stockholder. Critical Accounting Policies and Estimates A summary of the Partnership's significant accounting policies is included in "Note A - Organization and Significant Accounting Policies" which is included in the consolidated financial statements in "Item 7. Financial Statements". The Managing General Partner believes that the consistent application of these policies enables the Partnership to provide readers of the consolidated financial statements with useful and reliable information about the Partnership's operating results and financial condition. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires the Partnership to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Judgments and assessments of uncertainties are required in applying the Partnership's accounting policies in many areas. The Partnership believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity. Impairment of Long-Lived Assets Investment properties are recorded at cost, less accumulated depreciation, unless considered impaired. If events or circumstances indicate that the carrying amount of a property may be impaired, the Partnership will make an assessment of its recoverability by estimating the undiscounted future cash flows, excluding interest charges, of the property. If the carrying amount exceeds the aggregate future cash flows, the Partnership would recognize an impairment loss to the extent the carrying amount exceeds the fair value of the property. Real property investments are subject to varying degrees of risk. Several factors may adversely affect the economic performance and value of the Partnership's investment properties. These factors include changes in the national, regional and local economic climate; local conditions, such as an oversupply of multifamily properties; competition from other available multifamily property owners and changes in market rental rates. Any adverse changes in these factors could cause an impairment in the Partnership's assets. Revenue Recognition The Partnership generally leases apartment units for twelve-month terms or less and the Partnership fully reserves all balances outstanding over thirty days. Rental income attributable to leases is recognized monthly as it is earned. The Partnership will offer rental concessions during particularly slow months or in response to heavy competition from other similar complexes in the area. Concessions are charged to income as incurred. Item 7. Financial Statements DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. LIST OF FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors Consolidated Balance Sheet - December 31, 2002 Consolidated Statements of Operations - Years ended December 31, 2002 and 2001 Consolidated Statements of Changes in Partners' Deficit - Years ended December 31, 2002 and 2001 Consolidated Statements of Cash Flows - Years ended December 31, 2002 and 2001 Notes to Consolidated Financial Statements Report of Ernst & Young LLP, Independent Auditors The Partners Davidson Diversified Real Estate II, L.P. We have audited the accompanying consolidated balance sheet of Davidson Diversified Real Estate II, L.P. as of December 31, 2002, and the related consolidated statements of operations, changes in partners' deficit, and cash flows for each of the two years in the period ended December 31, 2002. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 the Partnership's 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 consolidated financial position of Davidson Diversified Real Estate II, L.P. at December 31, 2002, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. As discussed in Note A to the consolidated financial statements, in 2002 the Partnership adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" and Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64." As a result, the accompanying consolidated financial statements for 2001, referred to above, have been restated to conform to the presentation adopted in 2002 in accordance with accounting principles generally accepted in the United States. /s/ERNST & YOUNG LLP Greenville, South Carolina February 14, 2003 DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED BALANCE SHEET (in thousands, except unit data) December 31, 2002
Assets Cash and cash equivalents $ 591 Receivables and deposits 439 Restricted escrows 85 Other assets 469 Investment properties (Notes B & E): Land $ 1,953 Buildings and related personal property 41,820 43,773 Less accumulated depreciation (20,645) 23,128 Assets held for sale (Note G) 4,046 $ 28,758 Liabilities and Partners' Deficit Liabilities Accounts payable 640 Tenant security deposit payable 117 Accrued property taxes 527 Other liabilities 394 Due to an affiliate (Note D) 7,133 Mortgage notes payable (Note B) 20,435 Liabilities related to assets held for sale (Note G) 7,121 Partners' Deficit General partners $ (587) Limited partners (1,224.25 units issued and outstanding) (7,022) (7,609) $ 28,758 See Accompanying Notes to Consolidated Financial Statements
Davidson Diversified Real Estate II, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per unit data)
Years Ended December 31, 2002 2001 (Restated) Revenues: Rental income $ 4,875 $ 4,419 Other income 482 381 Casualty gain (Note F) 159 -- Total revenues 5,516 4,800 Expenses: Operating 2,331 2,189 General and administrative 344 500 Depreciation 1,472 1,492 Interest 973 1,183 Property taxes 394 309 Loss on early extinguishment of debt (Note B) 17 554 Total expenses 5,531 6,227 Loss from continuing operations $ (15) $ (1,427) Loss from discontinued operations (151) (21) Net loss (Note C) $ (166) $ (1,448) Net loss allocated to general partners (2%) $ (3) $ (29) Net loss allocated to limited partners (98%) (163) (1,419) $ (166) $ (1,448) Per limited partnership unit: Loss from continuing operations $ (12.25) $(1,141.92) Loss from discontinued operations (120.89) (17.16) Net loss $ (133.14) $(1,159.08) See Accompanying Notes to Consolidated Financial Statements
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' DEFICIT (in thousands, except unit data)
Limited Partnership General Limited Units Partners Partners Total Original capital contributions 1,224.25 $ 1 $24,485 $24,486 Partners' deficit at December 31, 2000 1,224.25 $ (555) $(5,440) $(5,995) Net loss for the year ended December 31, 2001 -- (29) (1,419) (1,448) Partners' deficit at December 31, 2001 1,224.25 (584) (6,859) (7,443) Net loss for the year ended December 31, 2002 -- (3) (163) (166) Partners' deficit at December 31, 2002 1,224.25 $ (587) $(7,022) $(7,609) See Accompanying Notes to Consolidated Financial Statements
Davidson Diversified Real Estate II, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Years Ended December 31, 2002 2001 Cash flows from operating activities: Net loss $ (166) $(1,448) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation 1,988 1,997 Amortization of discounts and loan costs 305 310 Loss on early extinguishment of debt 17 554 Casualty gain (159) -- Change in accounts: Receivables and deposits (109) (7) Other assets 6 -- Accounts payable (542) 351 Tenant security deposit liabilities 19 (3) Accrued property taxes 71 (32) Other liabilities 150 (307) Due to affiliate 51 (19) Net cash provided by operating activities 1,631 1,396 Cash flows from investing activities: Property improvements and replacements (6,418) (5,524) Net withdrawals from restricted escrows 145 199 Net cash used in investing activities (6,273) (5,325) Cash flows from financing activities: Advances from affiliates 2,783 3,778 Payments on advances from affiliates (1,015) -- Payments on mortgage notes payable (469) (481) Proceeds from debt refinancing 7,462 8,885 Repayment of mortgage notes payable (4,097) (7,812) Prepayment penalty -- (359) Loan costs paid (174) (469) Net cash provided by financing activities 4,490 3,542 Net decrease in cash and cash equivalents (152) (387) Cash and cash equivalents at beginning of year 743 1,130 Cash and cash equivalents at end of year $ 591 $ 743 Supplemental disclosure of cash flow information: Cash paid for interest $ 1,892 $ 2,039 Supplemental disclosure of non-cash activity: Property improvements and replacements in accounts payable $ 527 $ 850 Insurance proceeds in receivables and deposits $ 204 $ -- See Accompanying Notes to Consolidated Financial Statements
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002 Note A - Organization and Significant Accounting Policies Organization Davidson Diversified Real Estate II, L.P. (the "Partnership" or "Registrant") is a Delaware limited partnership organized in June 1984 to acquire and operate residential and commercial real estate properties. The Partnership's managing general partner is Davidson Diversified Properties, Inc (the "Managing General Partner"). Prior to February 25, 1998, the Managing General Partner was a wholly-owned subsidiary of MAE GP Corporation ("MAE GP"). Effective February 25, 1998, MAE GP merged into Insignia Properties Trust ("IPT"), which was merged into Apartment Investment and Management Company ("AIMCO") effective February 26, 1999. Thus the Managing General Partner is now a wholly-owned subsidiary of AIMCO, a publicly traded real estate investment trust. The directors and officers of the Managing General Partner also serve as executive officers of AIMCO. The Partnership commenced operations on October 16, 1984, and completed its acquisition of investment properties prior to December 31, 1985. The Partnership Agreement provides that the Partnership is to terminate on December 31, 2008, unless terminated prior to such date. As of December 31, 2002, the Partnership operates four apartment properties located in or near major urban areas in the United States, including one property held for sale. Principles of Consolidation The Registrant's financial statements include all the accounts of the Partnership and its three 99.9% owned partnerships and one wholly owned Partnership. The general partner of these partnerships is Davidson Diversified Properties, Inc. Davidson Diversified Properties, Inc. may be removed as the general partner of these partnerships by the Registrant; therefore, the consolidated partnerships are controlled and consolidated by the Registrant. All significant interpartnership balances have been eliminated. Allocations of Profits, Gains & Losses Net income, other than that arising from the occurrence of a sale or refinancing, and net loss shall be allocated 2% to the general partners and 98% to the limited partners. Allocation of Cash Distributions Cash distributions by the Partnership are allocated between general and limited partners in accordance with the Partnership Agreement. The Partnership Agreement provides that 98% of distributions of adjusted cash from operations are allocated to the limited partners and 2% to the general partners. Cash from operations is defined as the excess of cash received from operations less operating expenses paid, adjusted for certain specified items which primarily include mortgage payments on debt, property improvements and replacements not previously reserved, and the effects of other adjustments to reserves including reserve amounts deemed necessary by the Managing General Partner. Distributions made from reserves no longer considered necessary by the general partners are considered to be additional adjusted cash from operations for allocation purposes. No cash distributions to the partners were made during the years ended December 31, 2002 or 2001. Cash from sales or refinancings (as defined in the Partnership Agreement) shall be distributed to the limited partners until each limited partner has received his original invested capital plus an amount equal to a cumulative 8% per annum of the average of the limited partners' adjusted invested capital, less any prior distributions. The general partners are then entitled to receive 3% of the selling price of properties sold where they acted as a broker. The limited partners will then be allocated 85% of any remaining distributions and the general partners will receive 15%. Restricted Escrows Repair Escrow - At the time of the refinancing of Big Walnut Apartments in 2002, the Partnership was required to establish a repair escrow of approximately $85,000 to be used to complete required repairs. The balance in this account at December 31, 2002 was $85,000. Reserve Account - A general Reserve Account of $203,000 was established with the 1992 refinancing proceeds for Big Walnut Apartments. These funds were established to cover necessary repairs and replacements of existing improvements, debt service, out-of-pocket expenses incurred for ordinary and necessary administrative tasks, and payment of real property taxes and insurance premiums. The Partnership was required to deposit net operating income (as defined in the mortgage note) from the property to the reserve account until the reserve account equaled a minimum of $400 per apartment up to a maximum of $1,000 per apartment ($100,000 to $251,000). Upon the refinance of the property during 2002 the balance in this account was returned to the Partnership. Investment Properties Investment properties consist of four apartment complexes, including one apartment complex held for sale at December 31, 2002, and are stated at cost. Acquisition fees are capitalized as a cost of real estate. Expenditures in excess of $250 that maintain an existing asset which has a useful life of more than one year are capitalized as capital replacement expenditures and depreciated over the estimated useful life of the asset. Expenditures for ordinary repairs and maintenance and apartment turnover costs are expensed as incurred. The Partnership capitalized interest costs of approximately $769,000, tax and insurance expenses of approximately $162,000, and other construction period expenses of approximately $431,000 during the year ended December 31, 2002 with respect to the renovation project that is currently in process at Reflections Apartments. Total interest expense incurred before recognition of the capitalized amount was approximately $2,278,000 for the year ended December 31, 2002. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Partnership records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. Costs of apartment properties that have been permanently impaired have been written down to appraised value. No adjustments for impairment of value were recorded in the years ended December 31, 2002 or 2001. During 2001, AIMCO, an affiliate of the Managing General Partner, commissioned a project to study process improvement ideas to reduce operating costs. The result of the study led to a re-engineering of business processes and eventual redeployment of personnel and related capital spending. The implementation of these plans during 2002, accounted for as a change in accounting estimate, resulted in a refinement of the Partnership's process for capitalizing certain direct and indirect project costs (principally payroll related costs) and increased capitalization of such costs by approximately $85,000 in 2002 compared to 2001. Depreciation Depreciation is provided by the straight-line method over the estimated lives of the apartment properties and related personal property. For Federal income tax purposes, the accelerated cost recovery method is used for real property over 18 years for additions after March 15, 1984, and before May 9, 1985, and 19 years for additions after May 8, 1985, and before January 1, 1987. As a result of the Tax Reform Act of 1986, for additions after December 31, 1986, the modified accelerated cost recovery method is used for depreciation of (1) real property additions over 27 1/2 years, and (2) personal property additions over 5 years. Loan Costs Loan costs of approximately $770,000 less accumulated amortization of approximately $390,000 are included in other assets and are being amortized on the straight-line method over the life of the respective loans. Amortization expense was approximately $209,000 for the year ended December 31, 2002. Loan cost amortization is included in interest expense in the accompanying statements of operations. Amortization expense is expected to be approximately $224,000 in 2003, $53,000 in 2004, $37,000 in 2005 and 2006 and $29,000 in 2007. Cash and Cash Equivalents Cash and equivalents include cash on hand and in banks. At certain times, the amount of cash deposited at a bank may exceed the limit on insured deposits. Cash balances include approximately $449,000 at December 31, 2002 that are maintained by an affiliated management company on behalf of affiliated entities in cash concentration accounts. Tenant Security Deposits The Partnership requires security deposits from lessees for the duration of the lease and such deposits are included in receivables and deposits. The security deposits are refunded when the tenant vacates, provided the tenant has not damaged their space and is current on rental payments. Leases The Partnership generally leases apartment units for twelve-month terms or less. The Partnership recognizes income as earned on its leases and fully reserves all balances outstanding over thirty days. In addition, the Managing General Partner's policy is to offer rental concessions during particularly slow months or in response to heavy competition from other similar complexes in the area. Concessions are charged against rental income as incurred. Advertising Costs Advertising costs of continuing operations of approximately $96,000 and $117,000 for the years ended December 31, 2002 and 2001, respectively, are charged to operating expense as incurred. Fair Value of Financial Instruments SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", as amended by SFAS No. 119, "Disclosures about Derivative Financial Instruments and Fair Value of Financial Instruments", requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate fair value. Fair value is defined in the SFAS as the amount at which the instruments could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes that the carrying amounts of its financial instruments (except for long term debt) approximate their fair values due to the short term maturity of these instruments. The fair value of the Partnership's long term debt at December 31, 2002, after discounting the scheduled loan payments to maturity, approximates its carrying balance. Segment Reporting SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" established standards for the way public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also established standards for related disclosures about products and services, geographic areas, and major customers. As defined in SFAS No. 131, the Partnership has only one reportable segment. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Reclassifications Certain reclassifications have been made to the 2001 balances to conform to the 2002 presentation. Recent Accounting Pronouncements In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 provides accounting guidance for financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Partnership adopted SFAS 144 effective January 1, 2002. In accordance with SFAS 144 LaFontenay I and II Apartments is considered as assets held for sale as of December 31, 2002. As a result, the accompanying consolidated statements of operations restated as of January 1, 2001 for the year ended December 31, 2001 reflect the operations of LaFontenay I and II Apartments as loss from discontinued operations. The consolidated balance sheet reflects the assets and liabilities of LaFontenay I and II Apartments as assets held for sale and liabilities related to assets held for sale, respectively. Approximately $1,849,000 and $2,025,000 in revenues is included in the loss from discontinued operations of LaFontenay I and II Apartments for the years ended December 31, 2002 and 2001, respectively. Effective April 1, 2002, the Partnership adopted Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44 and 64." SFAS No. 4 "Reporting Gains and Losses from Extinguishment of Debt," required that all gains and losses from extinguishment of debt be aggregated and, if material, classified as an extraordinary item. SFAS No. 145 rescinds SFAS No. 4, and accordingly, gains and losses from extinguishment of debt should only be classified as extraordinary if they are unusual in nature and occur infrequently. Neither of these criteria applies to the Partnership. As a result, the accompanying consolidated statements of operations have been restated to reflect the loss on early extinguishment of debt at Reflections Apartments in 2001 and at Big Walnut Apartments in 2002 in operations rather than as extraordinary items. 52 Note B - Mortgage Notes Payable
Principal Monthly Principal Balance At Payment Stated Balance December 31, Including Interest Maturity Due At Property 2002 Interest Rate Date Maturity (in thousands) (in thousands) Big Walnut Apartments 1st mortgage $ 5,720 $ 22 (1) 9/16/07 $ 5,042 The Trails Apartments 1st mortgage 4,961 39 (2) 12/01/09 2,973 Reflections Apartments 1st mortgage 10,626 93 (3) 01/01/04 9,997 21,307 $ 154 $18,012 Less unamortized discounts (872) Total $20,435
The mortgage note payable encumbering LaFontenay I and II Apartments of approximately $6,907,000 included in liabilities related to investment property assets held for sale was repaid subsequent to December 31, 2002 (see Note G - Subsequent Event). (1) Adjustable interest rate is based on Fannie Mae discounted mortgage-backed security index plus 85 basis points. The rate at December 31, 2002, was 2.16%. (2) Adjustable rate based on 75% of the interest rate on new-issue long-term A-rated utility bonds as determined on the first day of each calendar quarter. The rate at December 31, 2002 was 4.60%. (3) Interest rate is based on LIBOR (which changes monthly) plus 280 basis points. The rate at December 31, 2002 was 4.18%. The mortgage discount is reflected as a reduction of the mortgage notes payable and increases the effective rate of the debt to 8.00% for The Trails Apartments. The Multifamily Housing Revenue Bonds and Note Agreement collateralized by The Trails Apartments were called and, therefore, payable in full on February 1, 1997 in accordance with the terms of the agreements. On June 30, 1997, the Partnership entered into a Modification of Bond Documents with the issuer. Pursuant to the modification, the call notice was rescinded. The modification converted the monthly payments from interest only to principal and interest payments with an amortization period of twenty years. The note and bond mature on December 1, 2009 with a balloon payment. Pursuant to the modified terms, the Bondholder shall not exercise the call right on the Bond on a date prior to the fifth anniversary of the modification. On September 16, 2002, the Partnership refinanced the mortgages encumbering Big Walnut Apartments. The refinancing replaced a first mortgage of approximately $3,930,000 and a second mortgage of approximately $167,000 with a new mortgage of $5,720,000. Total capitalized loan costs were approximately $155,000 during the year ended December 31, 2002. The Partnership recognized a loss on the early extinguishment of debt of approximately $17,000 due to the write-off of unamortized loan costs. In addition, $85,000 was deposited in an escrow account to be used to complete required repairs. Big Walnut Apartments was initially refinanced under an interim credit facility ("Interim Credit Facility") which had a term of three months. The Interim Credit Facility included properties in other partnerships that are affiliated with the Partnership. However, the Interim Credit Facility created separate loans for each property that were not cross-collateralized or cross-defaulted with the other property loans. During the three month term of the Interim Credit Facility, the properties were required to make interest-only payments. The first month's interest, which was paid at the date of the refinancing, was calculated at LIBOR plus 70 basis points. Interest for the following two months was calculated at LIBOR plus 150 points and was due monthly. During December 2002, the Interim Credit Facility encumbering Big Walnut Apartments was sold to Fannie Mae under a permanent credit facility ("Permanent Credit Facility"). The Permanent Credit Facility has a maturity of five years, with one five-year extension option. This Permanent Credit Facility also creates separate loans for each property that are not cross-collateralized or cross-defaulted with the other property loans. Each note under this Permanent Credit Facility will begin as a variable rate loan with the option of converting to a fixed rate loan after three years. The interest rate on the variable rate loans is the Fannie Mae discounted mortgage-backed security index plus 85 basis points. The rate was 2.16% at December 31, 2002 and will reset monthly. Each loan will automatically renew at the end of each month. In addition, monthly principal payments are required based on a 30-year amortization schedule, using the interest rate in effect during the first month that any property is on the Permanent Credit Facility. The loans are prepayable without penalty. On January 16, 2001, the mortgages encumbering Reflections Apartments were refinanced in order to finance the rehabilitation of the property. The maximum new loan amount is $13,600,000. Effective January 16, 2001, the lender made an initial advance of $5,040,000. Prior to the initial advance, the Managing General Partner loaned the Partnership approximately $3,673,000 in order for the Partnership to close the refinancing of the property. This amount will be repaid from the further refinancing that will occur after the completion of the rehabilitation project, estimated to be July 2004. During the year ended December 31, 2001, the lender advanced Reflections Apartments an additional amount of approximately $3,845,000 and during the year ended December 31, 2002 the lender advanced Reflections Apartments an additional $1,741,000. Subsequent advances of up to $2,973,000 will also be made to cover renovation work that is needed at the property. The new loan matures in January 2004, with 2 one-year extension options. Interest payments started in February 2001 based on LIBOR plus 280 basis points. Due to the rehabilitation project, approximately $769,000 and $585,000 of the interest expense for the years ended December 31, 2002 and 2001, respectively, was capitalized. In addition, monthly cash flow payments will be made to the lender until the anticipated completion date of the renovations. If any amount remains from these advances on the completion date of the renovation, it will be applied to the principal balance. Principal payments will begin in February 2003, and monthly deposits into a replacement reserve will be required. In connection with the refinancing, the Partnership incurred loan costs of approximately $469,000 during the year ended December 31, 2001. Additional loan costs of approximately $19,000 were incurred during the year ended December 31, 2002. These loan costs are included in other assets in the accompanying consolidated balance sheet and are being amortized over the life of the mortgage. In connection with the refinancing, the assets and liabilities of the property were transferred from one subsidiary, Big Walnut L.P., to a newly formed subsidiary, AIMCO Greensprings L.P. The loan is collateralized by the property as well as the interest of both the Partnership and Davidson Diversified Properties, Inc. in AIMCO Greensprings L.P. The new mortgage replaced a first mortgage of approximately $7,518,000 and a second mortgage of approximately $294,000. The Partnership recognized a loss on early extinguishment of debt of approximately $554,000 consisting of a prepayment penalty of approximately $359,000 and the write-off of unamortized loan costs and mortgage discounts of approximately $195,000. Mortgages are nonrecourse and are collateralized by the related property and improvements and by pledge of revenues from the property and improvements of the Partnership. Certain of the notes require prepayment penalties if repaid prior to maturity and prohibit resale of the properties subject to existing indebtedness. Scheduled principal payments of the mortgage notes payable subsequent to December 31, 2002, are as follows (in thousands): 2002 $ 1,013 2003 10,395 2004 413 2005 429 2006 5,450 Thereafter 3,607 $21,307 Note C- Income Taxes The Partnership received a ruling from the Internal Revenue Service that it is to be classified as a partnership for Federal income tax purposes. Accordingly, no provision for income taxes is made in the consolidated financial statements of the Partnership. Taxable income or loss of the Partnership is reported in the income tax returns of its partners. The following is a reconciliation of reported net loss and Federal taxable income (loss) (in thousands, except per unit data): 2002 2001 Net loss as reported $ (166) $ (1,448) Add (deduct) Casualty (92) -- Depreciation differences 212 109 Amortization of discounts 63 87 Unearned income 105 15 Miscellaneous (67) 123 Federal taxable income (loss) $ 55 $ (1,114) Federal taxable income (loss) per limited partnership unit $ 43.65 $(2,180.62) The following is a reconciliation between the Partnership's reported amounts and Federal tax basis of net liabilities (in thousands): Net liabilities as reported $ (7,609) Land and buildings 3,128 Accumulated depreciation (9,520) Other 802 Net liabilities - Federal tax basis $(13,199) Note D - Transactions with Affiliated Parties The Partnership has no employees and is dependent on the Managing General Partner and its affiliates for the management and administration of all Partnership activities. The Partnership Agreement provides for (i) payments to affiliates for services and (ii) reimbursement of certain expenses incurred by affiliates on behalf of the Partnership. During the years ended December 31, 2002 and 2001, affiliates of the Managing General Partner were entitled to receive 5% of gross receipts from all of the Registrant's properties for providing property management services. The Registrant paid to such affiliates approximately $359,000 and $341,000 for the years ended December 31, 2002 and 2001, respectively, which is included in operating expenses and loss from discontinued operations. An affiliate of the Managing General Partner received reimbursement of accountable administrative expenses amounting to approximately $815,000 and $465,000 for the years ended December 31, 2002 and 2001, respectively, which is included in general and administrative expense and investment properties. Included in these amounts are fees related to construction management services provided by an affiliate of the Managing General Partner of approximately $576,000 and $192,000 for the years ended December 31, 2002 and 2001, respectively. The fees are calculated based on a percentage of current year additions to investment properties. In addition to reimbursement for services of affiliates, the Partnership paid an affiliate of the Managing General Partner approximately $57,000 for loan costs related to the refinancing of Big Walnut Apartments during the year ended December 31, 2002. These costs were capitalized and are included in other assets on the consolidated balance sheet. In accordance with the Partnership Agreement, the Managing General Partner has loaned the Partnership funds to cover operational expenses and to assist in the closing of the refinancing required at Reflections Apartments. At December 31, 2002, the amount of the outstanding loans and accrued interest to cover operational expenses was approximately $3,649,000 and the amount of the outstanding loan and accrued interest to assist in the refinancing was approximately $3,484,000. Both amounts are included in Due to affiliates on the accompanying consolidated balance sheet. Interest is charged at prime plus 1%. Interest expense was approximately $402,000 and $416,000 for the years ended December 31, 2002 and 2001, respectively. The Managing General Partner is considering the remedies it can pursue including accelerating repayment of the outstanding loans it has made to the Partnership to cover operational expenses and to assist in the refinancing of Reflections Apartments. In connection with the subsequent sale of LaFontenay I and II Apartments, approximately $1,908,000 of the outstanding loans were paid to the Managing General Partner subsequent to December 31, 2002. The Partnership accrued a real estate commission of $48,000 upon the sale of Shoppes at River Rock due to the Managing General Partner during the year ended December 31, 1999. Approximately $18,000 is accrued at December 31, 2002 and is included in other liabilities in the accompanying consolidated balance sheet. Payment of this commission is subordinate to the limited partners receiving their original invested capital plus a cumulative non-compounded annual return of 8% on their adjusted invested capital. Beginning in 2001, the Partnership began insuring its properties up to certain limits through coverage provided by AIMCO which is generally self-insured for a portion of losses and liabilities related to workers compensation, property casualty and vehicle liability. The Partnership insures its properties above the AIMCO limits through insurance policies obtained by AIMCO from insurers unaffiliated with the Managing General Partner. During the years ended December 31, 2002 and 2001, the Partnership was charged by AIMCO and its affiliates approximately $155,000 and $116,000, respectively, for insurance coverage and fees associated with policy claims administration. In addition to its indirect ownership of the managing and associate general partner interest in the Partnership, AIMCO and its affiliates owned 620.25 limited partnership units in the Partnership representing 50.66% of the outstanding Units at December 31, 2002. A number of these Units were acquired pursuant to tender offers made by AIMCO or its affiliates. It is possible that AIMCO or its affiliates will acquire additional Units of limited partnership interest in the Partnership in exchange for cash or a combination of cash and units in the operating partnership of AIMCO either through private purchases or tender offers. Under the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters which would include voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner. As a result of its ownership of 50.66% of the outstanding Units, AIMCO is in a position to control all such voting decisions with respect to the Registrant. Although the Managing General Partner owes fiduciary duties to the limited partners of the Partnership, the Managing General Partner also owes fiduciary duties to AIMCO as its sole stockholder. As a result, the duties of the Managing General Partner, as managing general partner, to the Partnership and its limited partners may come into conflict with the duties of the Managing General Partner to AIMCO, as its sole stockholder. Note E - Investment Properties and Accumulated Depreciation Initial Cost To Partnership (in thousands)
Buildings Net Cost and Related Capitalized Personal Subsequent to Apartment Properties Encumbrances Land Property Acquisition (in thousands) (in thousands) Big Walnut Apartments $ 5,720 $ 520 $ 6,505 $ 2,922 The Trails Apartments 4,961 586 7,054 2,124 Reflections Apartments 10,626 847 9,684 13,531 21,307 Less unamortized Discounts (872) Total $20,435 $ 1,953 $23,243 $18,577
Gross Amount At Which Carried At December 31, 2002 (in thousands)
Buildings And Related Personal Accumulated Date of Date Depreciable Description Land Property Total DepreciationConstructionAcquired Life-Years Apartment Properties Big Walnut $ 520 $ 9,427 $ 9,947 $ 6,177 1971 03/28/85 5/25 The Trails 586 9,178 9,764 5,853 1984-1985 08/30/85 5/25 Reflections 847 23,215 24,062 8,615 1970-1975 09/30/85 5/25 Totals $1,953 $41,820 $43,773 $20,645
Reconciliation of "investment properties and accumulated depreciation" Years Ended December 31, 2002 2001 (in thousands) Investment Properties Balance at beginning of year $48,297 $41,923 Property improvements 6,095 6,374 Write-offs (127) -- Investment property held for sale (10,492) ______ Balance at end of year $43,773 $48,297 Accumulated Depreciation Balance at beginning of year $25,336 $23,339 Additions charged to expense 1,988 1,997 Write-offs (82) -- Investment property held for sale (6,597) ______ Balance at end of year $20,645 $25,336 The aggregate cost of the real estate for Federal income tax purposes at December 31, 2002 and 2001, is approximately $57,393,000 and $50,966,000, respectively. The accumulated depreciation taken for Federal income tax purposes at December 31, 2002 and 2001, is approximately $36,762,000 and $34,986,000, respectively. LaFontenay I and II Apartments, sold on January 30, 2003, is excluded from these schedules and is classified as held for sale at December 31, 2002. The gross carrying value and accumulated depreciation of LaFontenay I and II Apartments, which is classified as assets held for sale as of December 31, 2002, was $10,492,000 and $6,597,000, respectively. Note F - Casualty Event During the year ended December 31, 2002, a net casualty gain was recorded at Reflections Apartments. The casualty gain related to a fire that occurred at Reflections Apartments in October 2001. The gain was the result of insurance proceeds of approximately $204,000 less the net book value of the damaged property of approximately $45,000. The proceeds are being held in escrow by the lender until the repairs are completed and are included in receivables and deposits on the accompanying consolidated balance sheet. Note G - Subsequent Event On January 30, 2003, the Partnership sold Lafontenay I and II Apartments to an unaffiliated third party for $9,700,000. After payment of closing costs of approximately $254,000, and the assumption of the mortgage debt of approximately $6,899,000 by the purchaser, the net proceeds received by the Partnership were approximately $2,547,000. The sale of the property resulted in a gain on the sale during the first quarter of 2003 of approximately $5,470,000. In addition, the Partnership recorded a loss on early extinguishment of debt of approximately $68,000 as a result of the write off of unamortized loan costs. The Partnership used the proceeds received from the sale to make payments on the loan balances due to the Managing General Partner (see "Note D"). In accordance with Statement of Financial Accounting Standards No. 144, the assets and liabilities of the property have been classified as held for sale at December 31, 2002 and the operations of the property have been shown as income from discontinued operations for the years ended December 31, 2002 and 2001. Note H - Legal Proceedings In March 1998, several putative unit holders of limited partnership units of the Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, its Managing General Partner and several of their affiliated partnerships and corporate entities. The action purports to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) which are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities which were, at one time, affiliates of Insignia; past tender offers by the Insignia affiliates to acquire limited partnership units; management of the partnerships by the Insignia affiliates; and the series of transactions which closed on October 1, 1998 and February 26, 1999 whereby Insignia and Insignia Properties Trust, respectively, were merged into AIMCO. The plaintiffs seek monetary damages and equitable relief, including judicial dissolution of the Partnership. On June 25, 1998, the Managing General Partner filed a motion seeking dismissal of the action. In lieu of responding to the motion, the plaintiffs filed an amended complaint. The Managing General Partner filed demurrers to the amended complaint which were heard February 1999. Pending the ruling on such demurrers, settlement negotiations commenced. On November 2, 1999, the parties executed and filed a Stipulation of Settlement, settling claims, subject to court approval, on behalf of the Partnership and all limited partners who owned units as of November 3, 1999. Preliminary approval of the settlement was obtained on November 3, 1999 from the Court, at which time the Court set a final approval hearing for December 10, 1999. Prior to the December 10, 1999 hearing, the Court received various objections to the settlement, including a challenge to the Court's preliminary approval based upon the alleged lack of authority of prior lead counsel to enter the settlement. On December 14, 1999, the Managing General Partner and its affiliates terminated the proposed settlement. In February 2000, counsel for some of the named plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who negotiated the settlement. On June 27, 2000, the Court entered an order disqualifying them from the case and an appeal was taken from the order on October 5, 2000. On December 4, 2000, the Court appointed the law firm of Lieff Cabraser Heimann & Bernstein LLP as new lead counsel for plaintiffs and the putative class. Plaintiffs filed a third amended complaint on January 19, 2001. On March 2, 2001, the Managing General Partner and its affiliates filed a demurrer to the third amended complaint. On May 14, 2001, the Court heard the demurrer to the third amended complaint. On July 10, 2001, the Court issued an order sustaining defendants' demurrer on certain grounds. On July 20, 2001, Plaintiffs filed a motion for reconsideration of the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer. On September 7, 2001, Plaintiffs filed a fourth amended class and derivative action complaint. On September 12, 2001, the Court denied Plaintiffs' motion for reconsideration. On October 5, 2001, the Managing General Partner and affiliated defendants filed a demurrer to the fourth amended complaint, which was heard on December 11, 2001. On February 2, 2002, the Court served its order granting in part the demurrer. The Court has dismissed without leave to amend certain of the plaintiffs' claims. On February 11, 2002, plaintiffs filed a motion seeking to certify a putative class comprised of all non-affiliated persons who own or have owned units in the partnerships. The Managing General Partner and affiliated defendants oppose the motion. On April 29, 2002, the Court held a hearing on plaintiffs' motion for class certification and took the matter under submission after further briefing, as ordered by the court, was submitted by the parties. On July 10, 2002, the Court entered an order vacating the current trial date of January 13, 2003 (as well as the pre-trial and discovery cut-off dates) and stayed the case in its entirety through November 7, 2002 so that the parties could have an opportunity to discuss settlement. On October 30, 2002, the court entered an order extending the stay in effect through January 10, 2003. On January 8, 2003, the parties filed a Stipulation of Settlement in proposed settlement of the Nuanes action and the Heller action described below. The Court has scheduled the hearing on preliminary approval for April 4, 2003 and the hearing on final approval for June 2, 2003. In general terms, the proposed settlement provides for certification for settlement purposes of a settlement class consisting of all limited partners in this Partnership and others (the "Partnerships") as of December 20, 2002, the dismissal with prejudice and release of claims in the Nuanes and Heller litigation, payment by AIMCO of $9.9 million (which shall be distributed to settlement class members after deduction of attorney fees and costs of class counsel and certain costs of settlement) and up to $ 1 million toward the cost of independent appraisals of the Partnerships' properties by a Court appointed appraiser. An affiliate of the Managing General Partner has also agreed to make a tender offer to purchase all of the partnership interests in the Partnerships within one year of final approval, if it is granted, and to provide partners with the independent appraisals at the time of these tenders. The proposed settlement also provides for the limitation of the allowable costs which the Managing General Partner or its affiliates will charge the Partnerships in connection with this litigation and imposes limits on the class counsel fees and costs in this litigation. If the Court grants preliminary approval of the proposed settlement in April, a notice will be distributed to partners providing detail on the terms of the proposed settlement. During the third quarter of 2001, a complaint (the "Heller action") was filed against the same defendants that are named in the Nuanes action, captioned Heller v. Insignia Financial Group. On or about August 6, 2001, plaintiffs filed a first amended complaint. The first amended complaint in the Heller action is brought as a purported derivative action, and asserts claims for among other things breach of fiduciary duty; unfair competition; conversion, unjust enrichment; and judicial dissolution. Plaintiffs in the Nuanes action filed a motion to consolidate the Heller action with the Nuanes action and stated that the Heller action was filed in order to preserve the derivative claims that were dismissed without leave to amend in the Nuanes action by the Court order dated July 10, 2001. On October 5, 2001, the Managing General Partner and affiliated defendants moved to strike the first amended complaint in its entirety for violating the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer in the Nuanes action, or alternatively, to strike certain portions of the complaint based on the statute of limitations. Other defendants in the action demurred to the fourth amended complaint, and, alternatively, moved to strike the complaint. On December 11, 2001, the court heard argument on the motions and took the matters under submission. On February 4, 2002, the Court served notice of its order granting defendants' motion to strike the Heller complaint as a violation of its July 10, 2001 order in the Nuanes action. On March 27, 2002, the plaintiffs filed a notice appealing the order striking the complaint. Before completing briefing on the appeal, the parties stayed further proceedings in the appeal pending the Court's review of the terms of the proposed settlement described above. The Managing General Partner does not anticipate that any costs to the Partnership, whether legal or settlement costs, associated with these cases will be material to the Partnership's overall operations. The Partnership is unaware of any other pending or outstanding litigation that is not of a routine nature arising in the ordinary course of business. Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act Davidson Diversified Real Estate II, L.P. (the "Registrant" - or the "Partnership") does not have any directors or officers. The Managing General Partner of the Registrant is Davidson Diversified Properties, Inc. The names and ages of, as well as the position and officers held by the present executive officers and director of the Managing General Partner are set forth below. There are no family relationships between or among any officers or the director. Name Age Position Patrick J. Foye 45 Executive Vice President and Director Paul J. McAuliffe 46 Executive Vice President and Chief Financial Officer Thomas C. Novosel 44 Senior Vice President and Chief Accounting Officer Patrick J. Foye has been Executive Vice President and Director of the Managing General Partner since October 1, 1998. Mr. Foye has served as Executive Vice President of AIMCO since May 1998, where he is responsible for continuous improvement, acquisitions of partnership securities, consolidation of minority interests, and corporate and other acquisitions. Prior to joining AIMCO, Mr. Foye was a Merger and Acquisitions Partner in the law firm of Skadden, Arps, Slate, Meagher & Flom LLP from 1989 to 1998. Paul J. McAuliffe has been Executive Vice President and Chief Financial Officer of the Managing General Partner since April 1, 2002. Mr. McAuliffe has served as Executive Vice President of AIMCO since February 1999 and Chief Financial Officer of AIMCO since October 1999. From May 1996 until he joined AIMCO, Mr. McAuliffe was Senior Managing Director of Secured Capital Corp. Thomas C. Novosel has been Senior Vice President and Chief Accounting Officer of the Managing General Partner since April 1, 2002. Mr. Novosel has served as Senior Vice President and Chief Accounting Officer of AIMCO since April 2000. From October 1993 until he joined AIMCO, Mr. Novosel was a partner at Ernst & Young LLP, where he served as the director of real estate advisory services for the southern Ohio Valley area offices but did not work on any assignments related to AIMCO or the Partnership. One or more of the above persons are also directors and/or officers of a general partner (or general partner of a general partner) of limited partnerships which either have a class of securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934, or are subject to the reporting requirements of Section 15(d) of such Act: Further, one or more of the above persons are also directors and/or officers of Apartment Investment and Management Company and the general partner of AIMCO Properties, L.P., entities that have a class of securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934, or are subject to the reporting requirements of Section 15 (d) of such Act. The executive officers and director of the Managing General Partner fulfill the obligations of the Audit Committee and oversee the Partnership's financial reporting process on behalf of the Managing General Partner. Management has the primary responsibility for the financial statements and the reporting process including the systems of internal controls. In fulfilling its oversight responsibilities, the executive officers and director of the Managing General Partner reviewed the audited financial statements with management including a discussion of the quality, not just the acceptability, of the accounting principles, the reasonableness of significant judgments, and the clarity of disclosures in the financial statements. The executive officers and director of the Managing General Partner reviewed with the independent auditors, who are responsible for expressing an opinion on the conformity of those audited financial statements with accounting principles generally accepted in the United States, their judgments as to the quality, not just the acceptability, of the Partnership's accounting principles and such other matters as are required to be discussed with the Audit Committee or its equivalent under auditing standards generally accepted in the United States. In addition, the Partnership has discussed with the independent auditors the auditors' independence from management and the Partnership including the matters in the written disclosures required by the Independence Standards Board and considered the compatibility of non-audit services with the auditors' independence. The executive officers and director of the Managing General Partner discussed with the Partnership's independent auditors the overall scope and plans for their audit. In reliance on the reviews and discussions referred to above, the executive officers and director of the Managing General Partner have approved the inclusion of the audited financial statements in the Form 10-KSB for the year ended December 31, 2002 for filing with the Securities and Exchange Commission. The Managing General Partner has reappointed Ernst & Young LLP as independent auditors to audit the financial statements of the Partnership for 2003. Fees for 2002 were audit services of approximately $49,000 and non-audit services (principally tax-related) of approximately $24,000. Item 10. Executive Compensation None of the directors and officers of the Managing General Partner received any remuneration from the Registrant. Item 11. Security Ownership of Certain Beneficial Owners and Management Except as noted below, no person or entity was known by the Registrant to be the beneficial owner of more than 5% of the Limited Partnership Units of the Registrant as of December 31, 2002. Entity Number of Units Percentage Cooper River Properties, LLC 122.75 10.03% (an affiliate of AIMCO) Insignia Properties, LP 35.75 2.92% (an affiliate of AIMCO) Davidson Diversified Properties, Inc. 0.25 0.02% (an affiliate of AIMCO) AIMCO Properties, LP 461.50 37.69% (an affiliate of AIMCO) Cooper River Properties, LLC, Insignia Properties, LP, and Davidson Diversified Properties, Inc., are indirectly ultimately owned by AIMCO. Their business address is 55 Beattie Place, Greenville, SC 29602. AIMCO Properties, LP is indirectly ultimately controlled by AIMCO. Its business address is 4582 S. Ulster St. Parkway, Suite 1100, Denver, Colorado 80237. No director or officer of the Managing General Partner owns any Units. Item 12. Certain Relationships and Related Transactions The Partnership has no employees and is dependent on the Managing General Partner and its affiliates for the management and administration of all Partnership activities. The Partnership Agreement provides for (i) payments to affiliates for services and (ii) reimbursement of certain expenses incurred by affiliates on behalf of the Partnership. During the years ended December 31, 2002 and 2001, affiliates of the Managing General Partner were entitled to receive 5% of gross receipts from all of the Registrant's properties for providing property management services. The Registrant paid to such affiliates approximately $359,000 and $341,000 for the years ended December 31, 2002 and 2001, respectively, which is included in operating expenses and loss from discontinued operations. An affiliate of the Managing General Partner received reimbursement of accountable administrative expenses amounting to approximately $815,000 and $465,000 for the years ended December 31, 2002 and 2001, respectively, which is included in general and administrative expense and investment properties. Included in these amounts are fees related to construction management services provided by an affiliate of the Managing General Partner of approximately $576,000 and $192,000 for the years ended December 31, 2002 and 2001, respectively. The fees are calculated based on a percentage of current year additions to investment properties. In addition to reimbursement for services of affiliates, the Partnership paid an affiliate of the Managing General Partner approximately $57,000 for loan costs related to the refinancing of Big Walnut Apartments during the year ended December 31, 2002. These costs were capitalized and are included in other assets on the consolidated balance sheet. In accordance with the Partnership Agreement, the Managing General Partner has loaned the Partnership funds to cover operational expenses and to assist in the closing of the refinancing required at Reflections Apartments. At December 31, 2002, the amount of the outstanding loans and accrued interest to cover operational expenses was approximately $3,649,000 and the amount of the outstanding loan and accrued interest to assist in the refinancing was approximately $3,484,000. Both amounts are included in Due to affiliates on the accompanying consolidated balance sheet. Interest is charged at prime plus 1%. Interest expense was approximately $402,000 and $416,000 for the years ended December 31, 2002 and 2001, respectively. The Managing General Partner is considering the remedies it can pursue including accelerating repayment of the outstanding loans it has made to the Partnership to cover operational expenses and to assist in the refinancing of Reflections Apartments. In connection with the subsequent sale of LaFontenay I and II Apartments, approximately $1,908,000 of the outstanding loans were paid to the Managing General Partner subsequent to December 31, 2002 The Partnership accrued a real estate commission of $48,000 upon the sale of Shoppes at River Rock due to the Managing General Partner during the year ended December 31, 1999. Approximately $18,000 is accrued at December 31, 2002 and is included in other liabilities in the accompanying consolidated balance sheet. Payment of this commission is subordinate to the limited partners receiving their original invested capital plus a cumulative non-compounded annual return of 8% on their adjusted invested capital. Beginning in 2001, the Partnership began insuring its properties up to certain limits through coverage provided by AIMCO which is generally self-insured for a portion of losses and liabilities related to workers compensation, property casualty and vehicle liability. The Partnership insures its properties above the AIMCO limits through insurance policies obtained by AIMCO from insurers unaffiliated with the Managing General Partner. During the years ended December 31, 2002 and 2001, the Partnership was charged by AIMCO and its affiliates approximately $155,000 and $116,000, respectively, for insurance coverage and fees associated with policy claims administration. In addition to its indirect ownership of the managing and associate general partner interest in the Partnership, AIMCO and its affiliates owned 620.25 limited partnership units (the "Units") in the Partnership representing 50.66% of the outstanding units at December 31, 2002. A number of these Units were acquired pursuant to tender offers made by AIMCO or its affiliates. It is possible that AIMCO or its affiliates will acquire additional Units of limited partnership interest in the Partnership in exchange for cash or a combination of cash and units in the operating partnership of AIMCO either through private purchases or tender offers. Under the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters which would include voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner. As a result of its ownership of 50.66% of the outstanding Units, AIMCO is in a position to control all such voting decisions with respect to the Registrant. Although the Managing General Partner owes fiduciary duties to the limited partners of the Partnership, the Managing General Partner also owes fiduciary duties to AIMCO as its sole stockholder. As a result, the duties of the Managing General Partner, as managing general partner, to the Partnership and its limited partners may come into conflict with the duties of the Managing General Partner to AIMCO, as its sole stockholder. Item 13. Exhibits and Reports on Form 8-K (a) Exhibits: See attached Exhibit Index. (b) Reports on Form 8-K filed in the fourth quarter of calendar year 2002: None. Item 14. Controls and Procedures The principal executive officer and principal financial officer of the Managing General Partner, who are the equivalent of the Partnership's principal executive officer and principal financial officer, respectively, have, within 90 days of the filing date of this annual report, evaluated the effectiveness of the Partnership's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) and have determined that such disclosure controls and procedures are adequate. There have been no significant changes in the Partnership's internal controls or in other factors that could significantly affect the Partnership's internal controls since the date of evaluation. The Partnership does not believe any significant deficiencies or material weaknesses exist in the Partnership's internal controls. Accordingly, no corrective actions have been taken. SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. By: Davidson Diversified Properties, Inc. Managing General Partner By: /s/Patrick J. Foye Patrick J. Foye Executive Vice President and Director By: /s/Thomas C. Novosel Thomas C. Novosel Senior Vice President and Chief Accounting Officer Date: March 28, 2003 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Partnership and in the capacities and on the dates indicated. /s/Patrick J. Foye Executive Vice President Date: March 28, 2003 Patrick J. Foye and Director /s/Thomas C. Novosel Senior Vice President Date: March 28, 2003 Thomas C. Novosel and Chief Accounting Officer CERTIFICATION I, Patrick J. Foye, certify that: 1. I have reviewed this annual report on Form 10-KSB of Davidson Diversified Real Estate II, L.P.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 28, 2003 /s/Patrick J. Foye Patrick J. Foye Executive Vice President of Davidson Diversified Properties, Inc., equivalent of the chief executive officer of the Partnership CERTIFICATION I, Paul J. McAuliffe, certify that: 1. I have reviewed this annual report on Form 10-KSB of Davidson Diversified Real Estate II, L.P.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 28, 2003 /s/Paul J. McAuliffe Paul J. McAuliffe Executive Vice President and Chief Financial Officer of Davidson Diversified Properties, Inc., equivalent of the chief financial officer of the Partnership DAVIDSON DIVERSIFIED REAL ESTATE II, LP EXHIBIT INDEX Exhibit Number Description of Exhibit 2.1 Agreement and Plan of Merger, dated as of October 1, 1999, by and between AIMCO and IPT (incorporated by reference to Exhibit 2.1 of IPT's Current Report on Form 8-K, File No. 1-14179, dated October 1, 1999). 3 Partnership Agreement dated June 11, 1984, as amended is incorporated by reference to Exhibit A to the Prospectus of the Registrant dated October 16, 1984 as filed with the Commission pursuant to Rule 424(b) under the Act. 3B Amendment No. 1 to the Partnership Agreement dated August 1, 1985 is incorporated by reference to Exhibit 3B to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985. 4 Certificate of Limited Partnership dated June 11, 1984 is incorporated by reference to Exhibit 4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. 4A Certificate of Amendment to Limited Partnership dated July 17, 1984 is incorporated by reference to Exhibit 4A to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. 4B Restated Certificate of Limited Partnership dated October 5, 1984 is incorporated by reference to Exhibit 4B to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. 10A Agent's Agreement dated October 16, 1984 between the Registrant and Harvey Freeman & Sons, Inc. is incorporated by reference to Exhibit 10B to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984. 10B Agreement among Agents dated October 16, 1984 by and among Harvey Freeman & Sons, Inc., Harvey Freeman & Sons, Inc. of Arkansas, Harvey Freeman & Sons, Inc. of Florida, Harvey Freeman & Sons, Inc. of Georgia, Harvey Freeman & Sons, Inc. of Indiana, Harvey Freeman & Sons, Inc. of Kentucky, Harvey Freeman & Sons, Inc. of Mississippi, Harvey Freeman & Sons, Inc. of North Carolina, Harvey Freeman & Sons, Inc. of Ohio, and Harvey Freeman & Sons, Inc. of South Carolina, is incorporated by reference to Exhibit 10C to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984. 10C Acquisition and Disposition Services Agreement dated October 16, 1984 between the Registrant and Criswell Freeman Company is incorporated by reference to Exhibit 10D to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984. 10D Purchase Agreement Phases I and II dated October 3, 1984 between NTS-LaFontenay Partners and Tennessee Trust Company, Trustee, is incorporated by reference to Exhibit 10E to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 (Registration No. 2-92313) as filed on October 15, 1984. 10E Modification of Purchase Agreements dated October 31, 1984 by and among NTS-LaFontenay Partners, the Registrant and LaFontenay Associates is incorporated by reference to Exhibit 10F to Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-11 (Registration No. 2-92313) as filed on January 15, 1985. 10F Contract for Sale of Real Estate for Outlets Ltd. Mall dated November 15, 1984 between Company Stores Development Corp. and Tennessee Trust Company, as Trustee, is incorporated by reference to Exhibit 10G to Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-11 (Registration No. 2-92313) as filed on January 15, 1985. 10G Submanagement Agreement dated December 31, 1984 between Harvey Freeman & Sons, Inc., Company Stores Management Corp. and the Registrant is incorporated by reference to Exhibit 10H to Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-11 (Registration No. 2-92313) as filed on January 15, 1985. 10H Assignment of Purchase Agreement dated October 25, 1984 between Tennessee Trust Company, Trustee, and the Registrant relating to assignment of Purchase Agreement for LaFontenay Apartments is incorporated by reference to Exhibit 10I to Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-11 (Registration No. 2-92313) as filed on January 15, 1985. 10I Contract for Sale of Real Estate for Big Walnut Apartments dated December 6, 1984 between Community Development Company, an Ohio limited partnership and Tennessee Trust Company, as Trustee is incorporated by reference to Exhibit 10(b) to the Registrant's Current Report on Form 8-K dated March 28, 1985. 10J Assignment of Contract for Sale of Real Estate dated March 22, 1985 between Tennessee Trust Company, Trustee, and the Registrant, relating to assignment of Purchase Agreement for Big Walnut Apartments is incorporated by reference to Exhibit 10(a) to the Registrant's Current Report on Form 8-K dated March 28, 1985. 10K Contract for Sale of Real Estate for The Trails Apartments dated July 31, 1985 between Trails of Nashville Associates, Ltd., a Tennessee limited partnership by reference to Exhibit 10(b) to the Registrant's Current Report on Form 8-K dated August 30, 1985. 10L Assignment of Contract for Sale of Real Estate dated August 28, 1985 between Tennessee Trust Company, as Trustee and the Registrant, relating to assignment of Contract for Sale of Real Estate for The Trails Apartments is incorporated by reference to Exhibit 10(a) to the Registrant's Current Report on Form 8-K dated August 30, 1985. 10M Contract for Sale of Real Estate for Greensprings Manor Apartments dated July 15, 1985 between Greensprings Apartments Associates, an Indiana limited partnership and Tennessee Trust Company, as Trustee, is incorporated by reference to Exhibit 20(d) to the Registrant's Current Report on Form 8-K dated August 30, 1985. 10N Assignment of Contract for Sale of Real Estate dated August 28, 1985 between Tennessee Trust Company, as Trustee and the Registrant, relating to assignment of Contract for Sale of Real Estate for Greensprings Manor Apartments is incorporated by reference to Exhibit 10(c) to the Registrant's Current Report on Form 8-K dated August 30, 1985. 10O Tennessee Note dated September 25, 1980 executed by Company Stores Development Corp. payable to TVB Mortgage Corporation relating to Outlets, Ltd. Mall is incorporated by reference to Exhibit 10GG to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985. 10W Deed of Trust and Security Agreement dated December 1, 1984 between Trails of Nashville Associates, Ltd., and Capital Holding Corporation relating to The Trails Apartments is incorporated by reference to Exhibit 10QQ to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985. 10X Note dated December 28, 1984 executed by Trails of Nashville Associates, Ltd., payable to The Industrial Development Board of the Metropolitan Government of Nashville and Davidson County relating to The Trails Apartments is incorporated by reference to Exhibit 10RR to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985. 10AA Memorandum of Understanding among SEC Realty Corp., Tennessee Properties, L.P., Freeman Mortgage Corporation, J. Richard Freeman, W. Criswell Freeman and Jacques-Miller Properties, Inc. is incorporated by reference to Exhibit 10DDD to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988. 10BB Partnership Administration and Consultation Agreement among Freeman Properties, Inc., Freeman Diversified Properties, Inc., Residual Equities Limited and Jacques-Miller Properties, Inc. is incorporated by reference to Exhibit 10EEE to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988. 10CC Partnership Agreement of LaFontenay, L.P. dated May 15, 1990 owned 99.9% by the Registrant relating to refinancing of LaFontenay Apartments is incorporated by reference to Exhibit 10FFF to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. 10DD Multifamily Note with Addendum dated May 24, 1990 executed by LaFontenay, payable to the Patrician Mortgage Company relating to LaFontenay, L.P. payable to the Patrician Mortgage Company relating to LaFontenay Apartments is incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. 10EE Multifamily Mortgage with Rider dated May 24, 1990 executed by LaFontenay, L.P. in favor of the Patrician Mortgage Company relating to LaFontenay Apartments is incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990. 10FF Termination Agreement, dated December 31, 1991 among Jacques-Miller, Inc., Jacques-Miller Property Management, Davidson Diversified Properties, Inc., and Supar, Inc. is incorporated by reference to Exhibit 10JJJ to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. 10GG Assignment of Limited Partnership Interest of Freeman Equities, Limited, dated December 31, 1991 between Davidson Diversified Properties, Inc. and Insignia Jacques-Miller, L.P. is incorporated by reference to Exhibit 10KKK to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. 10HH Assignment of General Partner Interests of Freeman Equities, Limited, dated December 31, 1991 between Davidson Diversified Properties, Inc. and MAE GP Corporation is incorporated by reference to Exhibit 10LLL to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. 10II Stock certificate, dated December 31, 1991 showing ownership of 1,000 shares of Davidson Diversified Properties, Inc. by MAE GP Corporation is incorporated by reference to Exhibit 10MMM to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991. 10MM Multifamily Note secured by a Mortgage or Deed of Trust dated August 6, 1997, between LaFontenay, L.L.C. and Patrician Financial Company Limited Partnership related to LaFontenay Apartments, is incorporated by reference to the exhibit filed with the Form 10-QSB dated September 30, 1997. 10NN Multifamily Note secured by a Mortgage or Deed of Trust dated January 16, 2001 between AIMCO Greenspring, L.P. and Financial Services, Inc., a Delaware Corporation, is incorporated by reference to the exhibit filed with the Form 10-KSB dated December 31, 2001. 10OO Multifamily Note secured by a Mortgage or Deed of Trust dated September 16, 2002, between Big Walnut, L.P. and GMAC Commercial Mortgage Corporation, a California Corporation, related to Big Walnut Apartments is incorporated by reference to the exhibit filed with the Form 10-QSB dated September 30, 2002. 10.1 Contract for sale of real estate for Outlet Mall, Ltd. dated December 30, 2000, between Davidson Diversified Real Estate II, a Delaware limited partnership and The Cadle Company is incorporated by reference to the exhibit filed with Form 8-K dated January 6, 2000. 10.2 First amendment to contract for sale of real estate for Outlet Mall, Ltd. dated December 30, 2000, between Davidson Diversified Real Estate II, a Delaware limited partnership and The Cadle Company is incorporated by reference to the exhibit filed with Form 8-K dated January 6, 2000. 10.3 Second amendment to contract for sale of real estate for Outlet Mall, Ltd. dated December 30, 2000, between Davidson Diversified Real Estate II, a Delaware limited partnership and The Cadle Company is incorporated by reference to the exhibit filed with Form 8-K dated January 6, 2000. 99A Agreement of Limited Partnership for Big Walnut, L.P. between Davidson Diversified Properties, Inc. and Davidson Diversified Real Estate II, L.P. entered into on August 23, 1991 is incorporated by reference to Exhibit 99A to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992. 99B Agreement of Limited Partnership for Outlet's Mall, L.P. between Outlet's Mall GP Limited Partnership and Davidson Diversified Real Estate II, L.P. is incorporated by reference to Exhibit 99B to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1992. 99C Certification of Chief Executive Officer and Chief Financial Officer. Exhibit 99C Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report on Form 10-KSB of Davidson Diversified Real Estate II, L.P. (the "Partnership"), for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Patrick J. Foye, as the equivalent of the Chief Executive Officer of the Partnership, and Paul J. McAuliffe, as the equivalent of the Chief Financial Officer of the Partnership, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Partnership. /s/Patrick J. Foye Name: Patrick J. Foye Date: March 28, 2003 /s/Paul J. McAuliffe Name: Paul J. McAuliffe Date: March 28, 2003 This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Partnership for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. -----END PRIVACY-ENHANCED MESSAGE-----