-----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, E9savwMgIl5TeXrDariZ6NcWo4ACIhlwE5UT2aykdJJQ2ju9u5P8S2nbc9keBF2V QM7dNzuXpnkf16wfFfjFnA== 0000845613-99-000003.txt : 19990308 0000845613-99-000003.hdr.sgml : 19990308 ACCESSION NUMBER: 0000845613-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990304 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRANKLIN SELECT REALTY TRUST CENTRAL INDEX KEY: 0000845613 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 943095938 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12708 FILM NUMBER: 99557385 BUSINESS ADDRESS: STREET 1: 2000 ALAMEDA DE LAS PULGAS CITY: SAN MATEO STATE: CA ZIP: 94404 BUSINESS PHONE: 6503123000 MAIL ADDRESS: STREET 1: P O BOX 7777 CITY: SAN MATEO STATE: CA ZIP: 94403-7777 FORMER COMPANY: FORMER CONFORMED NAME: FRANKLIN SELECT REAL ESTATE INCOME FUND DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: FRANKLIN CALIFORNIA REAL ESTATE FUND DATE OF NAME CHANGE: 19890307 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998. Commission File No. 0-12708 FRANKLIN SELECT REALTY TRUST (Exact Name of Company as Specified in its Charter) California 94-3095938 - ------------------------------------------------------------------------------- (State or other jurisdiction or (I.R.S. Employer Identification number) incorporation or organization) 2000 Alameda de Las Pulgas, San (650) 312-2000 Mateo, CA 94404 - ------------------------------------------------------------------------------- (Address of principal and executive Company's telephone number, including Office) Area Code Securities registered pursuant to Section 12(b) of Act: Title of each class Name of each exchange on which registered Common Stock Series A American Stock Exchange - ------------------------------------------------------------------------------- Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Company (1) has filed all reports required to be filed by Section 12 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Company's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] At February 19, 1999, 10,533,653 shares of the Company's Series A common stock were held by non-affiliates of the Company. The aggregate market value of the voting stock held by non-affiliates of the Company, based upon the closing price of $5.9375 as of February 19, 1999, is $62,543,565. Indicate the number of shares outstanding of each of the Company's classes of common stock at December 31, 1998: 12,250,372 shares of Series A common stock and 745,584 shares of Series B common stock. PART I Item 1. BUSINESS DESCRIPTION OF BUSINESS Franklin Select Realty Trust, formerly Franklin Select Real Estate Income Fund, (the "Company") is a California corporation formed on January 5, 1989, for the purpose of acquiring, managing and holding for investment income-producing real estate assets. The Company is a real estate investment trust ("REIT"). At December 31, 1998, the Company's property portfolio consisted of ownership interests in the following seven properties: (i) four industrial research and development ("R & D") properties containing approximately 546,000 rentable square feet of space; and (ii) three suburban office properties containing approximately 403,000 rentable square feet of space. The Company's properties are concentrated in the greater San Francisco and Los Angeles areas from which the Company derived 60% and 32% of its 1998 rental revenue, respectively. The Company's day-to-day operations are managed by Franklin Properties, Inc. (the "Advisor") under the terms of an advisory agreement which is renewable annually. The Company does not have any employees. The Company's commercial properties are managed by Continental Property Management Co. ("CPMC"), an affiliate of the Advisor. As property manager, CPMC performs the leasing, re-leasing and management-related services for the properties. The Advisor is a wholly-owned subsidiary of Franklin Resources, Inc., ("Franklin") whose primary business is the Franklin Templeton Group of Funds. In 1995, the Boards of Directors of the Company and of two other real estate investment trusts that the Advisor advised, Franklin Real Estate Income Fund ("FREIF") and Franklin Advantage Real Estate Income Fund ("Advantage"), agreed to the merger of the three real estate investment trusts. At a Special Meeting of Stockholders held on May 7, 1996, the proposed merger of Advantage and FREIF into the Company was approved (the "Merger") by a majority of the outstanding shares of each of the three companies, and the surviving entity was renamed Franklin Select Realty Trust. Shares of the Company were issued in exchange for the shares of Advantage and FREIF on the basis described in a Joint Proxy Statement/Prospectus filed with the Securities and Exchange Commission. The financial and operating results of periods prior to the Merger have been restated to give effect to the Merger. In 1996, the Company formed a limited partnership, FSRT L.P.("FSRT"), in order to acquire two R & D buildings located in Fremont, California (the "Lam Research Buildings"). FSRT assumed the existing financing on the Lam Research Buildings and issued 1,625,000 limited partnership units to the owner of the property in exchange for its equity interest in the property. The limited partnership units are convertible into Series A shares of the Company's common stock on a one-for-one basis. The Company is the sole general partner of FSRT and holds an approximate 70% ownership interest in FSRT. The Company may contribute all of its remaining properties to FSRT at some later date. The Company is subject to certain restrictions regarding the sale or refinance of certain properties owned by FSRT. All references to the Company in this report refer to Franklin Select Realty Trust and its majority owned, consolidated limited partnership, FSRT. Unless otherwise specified, information about the Company and the properties includes the operations of FSRT, and refers to the Company after the completion of the Merger, and the combined operations of the Company, FREIF, and Advantage prior to the completion of the Merger. INVESTMENT AND OPERATING STRATEGY During 1998, the Company formed a Special Committee of the Board of Directors to undertake a review of the strategic alternatives available to the Company, and the Special Committee engaged the services of Prudential Securities, Inc. to assist it in this effort. The Special Committee is exploring ways to improve shareholder value including changing the Company's business strategy to consider a strategic alliance, merger, sale, or other transaction or transactions involving the Company or its securities. The Company is actively continuing with its consideration of the advisability and feasibility of one or more of these strategic alternatives, and the Special Committee's advisors are continuing to be actively involved in this process. Unless and until any such strategic alternative is chosen, the Company intends to follow its existing investment and operating strategy, while at the same time not foreclosing the adoption of one or more new strategic alternatives. As a result, the following description reflects the Company's current investment and operating strategy but does not reflect any changes that may result from the Special Committee's review. The Company acquires income-producing real estate investments located in California with cash flow growth potential, although it has the flexibility to purchase properties elsewhere. Although at present, the Company's properties are concentrated in the San Francisco Bay area and the Los Angeles metropolitan area, the Company's investment strategy has been to acquire suitable properties within the five major metropolitan areas in California: the Los Angeles metropolitan area, Orange County, the Sacramento metropolitan area, San Diego County and the San Francisco Bay area. In addition, the Company may consider strategic acquisitions in other states. The Company's investment program includes providing stockholders with a professionally managed diversified portfolio of income-producing equity real estate investments in strategic markets which present the potential for current cash flow and for capital appreciation. The Company's business strategy is to expand the size and scope as well as increase the profitability of its current operations. Traditionally, the Company has identified individual properties suitable for acquisition and acquired them for cash. The Company also acquires property portfolios in exchange for equity. In particular, the Company seeks to establish strategic relationships with, and acquire property portfolios from, selected real estate operating companies that appear to have competitive advantages within their local market areas. This strategy potentially will allow the Company to increase its asset size, significantly diversify its portfolio and increase its revenues and profitability while reducing its exposure to any single property type or market area. The Company anticipates that a portion of its future acquisitions may be achieved through the issuance of common stock or partnership interests. The Company will carefully limit its use of debt financing as discussed under "Financing Policy and Related Matters". It is anticipated that the Company will issue additional limited partnership units of FSRT, or of similarly structured partnerships, to make certain acquisitions. The issuance or exchange of such partnership units can provide important tax benefits to a real estate seller that can enhance the price and other terms of the acquisition, or induce a seller to sell its property when other forms of consideration may not be as attractive. The Company may decide to contribute all of its remaining properties to FSRT at some later date. It is expected that the Company will serve as the general partner and hold a majority ownership interest in any new acquisition partnership vehicles. After properties are acquired, the Company places a strong emphasis on leasing and tenant retention in combination with a program of regular maintenance, periodic renovation and capital improvement. Sophisticated management and accounting systems linked together through a computer network provide detailed and timely reports on property operations to the Advisor's asset management staff. The Company views aggressive and involved property management as crucial to maintaining and improving both cash flow from, and the market value of, its properties. Properties are acquired with a view to holding them as long-term investments. When appropriate, however, the Company seeks to realize the value of its properties through financings, refinancings, sales or exchanges. While the Company currently follows the investment policies described above, they are guidelines only and may be changed by the Board of Directors without a vote of the Company's stockholders. FINANCING POLICY AND RELATED MATTERS The Company's present policy is to maintain a debt to total assets ratio not to exceed 50%. At December 31, 1998, the Company's debt to total assets ratio was 20%. The Company may from time to time modify its debt policy in light of then current economic conditions, relative costs of debt and equity financings, fluctuations in the fair market price of the Company's common stock, growth and acquisition opportunities and other factors. Accordingly, the Company may increase its debt to total assets ratio beyond the limit described above. However, the Company's by-laws prohibit the aggregate amount of the Company's indebtedness from exceeding 300% of its net assets, and prohibit unsecured borrowings which result in asset coverage of less than 300%. Management continues to evaluate properties for acquisition in evaluating various strategic alternatives for the Company. Any costs of acquisitions, capital expenditures, costs associated with lease renewals and reletting of space, repayment of indebtedness, and development of properties will be funded from (i) cash flow from operations, (ii) borrowings under its credit facility and, if available, other indebtedness (which may include indebtedness assumed in acquisitions), (iii) the sale of real estate investments, (iv) the sale of the Company's equity securities, and (v) the issuance of partnership interests in connection with acquisitions. The Company is subject to the risks normally associated with debt financing, including the risk that the Company's cash flow will be insufficient to meet required payments of principal and interest, that the Company will not be able to refinance existing indebtedness on the encumbered properties or that the terms of such refinancing will not be as favorable as the terms of existing indebtedness. Management does not believe that the outcome of the litigation described in Note 10 to the accompanying financial statements will have a materially adverse effect on the Company's financial condition, results of operations, or cash flows. CASH DISTRIBUTION POLICY Distributions are declared quarterly at the discretion of the Board of Directors. The Company's present distribution policy is to evaluate the current distribution rate, at least annually, in light of anticipated tenant turnover over the next two to three years, the estimated level of associated improvements and leasing commissions, planned capital expenditures, any debt service requirements and the Company's other working capital requirements. After balancing these considerations, and considering the Company's earnings and cash flow, the level of its liquid reserves and other relevant factors, the Company seeks to establish a distribution rate which: i) provides a stable distribution which is sustainable despite short term fluctuations in property cash flows; ii) maximizes the amount of cash flow paid out as distributions consistent with the above listed objective; and iii) complies with the Internal Revenue Code requirement that a REIT annually pay out as distributions not less than 95% of its taxable income. MATTERS THAT MAY AFFECT THE COMPANY'S RESULTS The Company is subject to the risks generally associated with the ownership of real property, including the possibility that operating expenses, debt service payments and fixed costs may exceed property revenues; economic conditions may adversely change in the California and national markets; the real estate investment climate may change; local market conditions may change adversely due to general or local economic conditions and neighborhood characteristics; interest rates may fluctuate and the availability, costs and terms of mortgage financing may change; unanticipated maintenance and renovations may arise; changes in real estate tax rates and other operating expenses may arise; governmental rules and fiscal policies may change; natural disasters, including earthquakes, floods or tornadoes may result in losses beyond the coverage of the Company's insurance policies; the financial condition of the tenants of properties may deteriorate; and other factors which are beyond the control of the Company may occur. All of the Company's properties are located in areas that are subject to earthquake activity. The Company currently carries earthquake insurance coverage for its properties and intends to continue to carry earthquake coverage to the extent that it is available at economically reasonable rates. However, the Company's earthquake insurance coverage may, from time to time, be subject to substantial deductibles. The real estate business is competitive, and the Company is in competition with many other entities engaged in real estate investment activities, many of which have greater assets than the Company. The Company's real estate investments in rental properties are subject to the risk of the Company's inability to attract or retain tenants and a consequent decline in rental income. Furthermore, real estate investments tend to be long-term, and under the REIT provisions of the Internal Revenue Code, might be subject to minimum holding periods to avoid adverse tax consequences; consequently, the Company will have only minimal ability to vary its property portfolio in response to changing economic, financial and investment conditions. The Company's fixed rate debt is subject to prepayment penalties which may make it disadvantageous for the Company to prepay the loans, which it may otherwise do in the absence of prepayment penalties. In connection with any lease renewal or new lease, the Company typically incurs costs for tenant improvements and leasing commissions which will be funded first from operating cash flow and, if necessary, from cash reserves or the line of credit. In addition, while the Company has historically been successful in renewing and releasing space, it will be subject to the risk that leases expiring in the future may be renewed or re-leased at terms that are less favorable than current lease terms. The opportunities for sale, and the profitability of any sale, of any particular property by the Company will be subject to the risk of adverse changes in real estate market conditions, which may vary depending upon the size, location and type of each property. GOVERNMENT REGULATION Under various federal, state and local laws, ordinances and regulations, an owner or operator of real property may become liable for the costs of removal or remediation of certain hazardous substances released on or in its property. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances, the presence of such substances, or the failure to properly remediate such substances, when released. As part of the investigation of properties prior to acquisition, the Company typically has obtained inspection reports concerning the condition of the property, including specialized environmental inspection reports concerning the presence of hazardous substances on the property. The Company intends to continue this practice. None of these inspection reports has revealed any environmental conditions requiring material expenditures for remediation. Such inspection reports, however, do not necessarily reveal all hazardous substances or sources thereof, and substances not considered hazardous when a property is acquired may subsequently be classified as such by amendments to local, state, and federal laws, ordinances and regulations. If it is ever determined that hazardous substances on or in a Company property must be removed or the release of such substances remediated, the Company could be required to pay all costs of any necessary cleanup work, although under certain circumstances, claims against other responsible parties could be made by the Company. The Company could also experience lost revenues during any such cleanup, or lower lease rates, decreased occupancy or difficulty selling or borrowing against the affected property either prior to or following any such cleanup. The Company believes that it is in compliance in all material respects with all federal, state and local laws regarding hazardous or toxic substances, and the Company has not been notified by any governmental authority of any non-compliance or other claim in connection with any of its present or former properties. The Company does not anticipate that compliance with federal, state and local environmental protection regulations will have any material adverse impact on the financial position, results of operations or liquidity of the Company. The Company is aware of the existence of certain hazardous substances at the Data General Building site. The Data General Building is located in an area of Manhattan Beach, California which was formerly part of a site used for storage of crude oil and various refined petroleum products. As a result, methane gas is present in the soil and the groundwater is contaminated throughout the area where the property is located. A vapor ventilation system was installed on the property by a prior owner, who also maintains and monitors the system. According to environmental reports acquired by the Company, the vapor ventilation system has mitigated any material risk associated with the presence of the methane gas. The Company has not incurred any costs for monitoring or remediating the presence of methane gas or the groundwater contamination at the Data General Building and does not anticipate incurring any cost with regard to such activities in the future. The contamination in the groundwater generally presents a risk only if the groundwater is used as drinking water, which it is not. The Company has not received any reports from federal or state agencies relieving it of future clean-up responsibilities, but federal and state agencies have investigated these matters and have not, to date, required any clean-up. The Company has no reason to believe at this time that it will be required to take remediation steps in the foreseeable future, particularly given the geographic scope of the contaminated area. It is therefore difficult to predict what, if any, costs might be incurred by the Company should the position of the federal or state agencies change. In any event, if the Company were required to clean up the contamination of the Data General Building site, it would seek full indemnity from the oil companies that were the source of the contamination. The Data General Building's transite exterior panels and roof coverings contain asbestos. Transite is "non-friable," which means that the asbestos fibers are not released into the air, unless the transite is broken, cut or otherwise damaged. The Company believes that absent such breakage or damage, the existence of asbestos in the transite presents no measurable risk of asbestos-related injuries. However, the presence of asbestos in the transite panels means that protective measures may need to be taken if the transite panels are repaired or if they are damaged by the elements. The Americans with Disabilities Act ("ADA"), which generally requires that buildings be made accessible to people with disabilities, has separate compliance requirements for "public accommodations" and "commercial facilities". If certain uses by tenants of a building constitute a "public accommodation", the ADA imposes liability for non-compliance on both the tenant and the owner/operator of the building. The Company has conducted inspections of its properties to determine whether the exterior and common areas of such properties are in compliance with the ADA and it believes that its properties are in substantial compliance. If, however, it were ever determined that one or more of the Company's properties were not in compliance, the Company may be subjected to unanticipated expenditures incurred to remove access barriers, or to pay fines or damages related to such non-compliance. The Company's due diligence review of prospective acquisitions of office, industrial and retail property includes an examination of such property's compliance with the ADA, and the cost of remedial work, if any, believed to be required to meet such requirements. Item 2. PROPERTIES PORTFOLIO SUMMARY At December 31, 1998, the Company's property portfolio consisted of seven income-producing properties located in the greater San Francisco and Los Angeles areas of California. The Company's properties were 95% leased at December 31, 1998 as compared to 97% leased at the end of 1997. During the year, the average occupancy of the properties held by the Company at December 31, 1998 was 97%, compared to 98% in 1997. The following table describes the Company's rental properties:
Total Rentable Year Average Occupance 1998 Rental Property Name/ Location Square Footage Acquired During 1998 Revenue - --------------------------------------- --------------------- ---------- ----------------- ----------------- Industrial R&D Properties: The Northport Buildings Fremont, California 144,624 1991 100% $1,833,000 The Lam Research Buildings Fremont, California 211,680 1996 100% 2,479,000 The Tanon Building Fremont, California 108,600 1997 100% 1,201,000 The Hathaway Business Park Fremont, California 80,752 1997 89% 903,000 --------------------- ------------------ 545,656 $6,416,000 --------------------- ------------------ Office Properties: The Shores Redwood City, California 138,546 1989 88% 3,369,000 The Data General Building Manhattan Beach, California 119,996 1989 97% 2,796,000 The Fairway Center Brea, California 144,727 1992 100% 2,804,000 --------------------- ------------------ 403,269 $8,969,000 --------------------- ------------------ Total for properties at 12/31/98 948,925 $15,385,000 ===================== Properties sold during 1998 $2,250,000 ================== Total rental revenue $17,635,000
The Company or FSRT owns a fee interest in each property. For information related to the encumbrances of the individual properties, see Note 4 to Consolidated Financial Statements and Schedule III. At December 31, 1998, the Company's property portfolio contained a total of 45 leases. The Company's portfolio represents in the aggregate 948,925 rentable square feet of which 902,979 square feet were leased at year-end. The following table sets forth for all of the Company's properties the lease expiration dates and the related annual base rental income at December 31, 1998. % of No. of Current Current Leases Total Annualized Annual Year Expiring Sq. Ft. Base Rent1 Base Rent - ---- -------- --------- ---------- --------- 1999 5 47,891 $ 1,157,000 9% 2000 9 48,490 1,085,000 8% 2001 9 118,454 2,001,000 15% 2002 9 178,666 3,172,000 24% 2003 8 205,445 2,173,000 16% 2004 2 63,953 814,000 6% 2008 1 22,400 321,000 2% 2012 1 6,000 308,000 2% 2014 1 211,680 2,463,000 18% - ---- -------- --------- ---------- --------- Total 45 902,979 $13,494,000 100% ==== ======== ========= ========== ========= 1 Annualized Base Rent means 12 multiplied by the monthly base rent in effect with respect to each property at December 31, 1998 or, if such monthly base rent has been reduced by a temporary rent concession, the monthly base rent that would have been in effect at such date in the absence of such concession. Annualized Base Rent does not reflect any increases or decreases in monthly rental rates or lease expirations which are scheduled to occur or which may occur after the date of calculation or the cost of any leasing commissions or tenant improvements. SIGNIFICANT TENANTS One of the Company's tenants provides 10% or more of the Company's annual base rental income as defined above at December 31, 1998. Annualized % of Base Total Square Rent at Base Lease Renewal Tenant Name/Property Feet 12/31/98 Rent Expiration Options - --------------------------- ------ --------- ----- ---------- -------- Lam Research Corporation: Lam Research Buildings 211,680 $2,463,000 18% 12/31/2014 2-5 yr. Northport Buildings 58,130 $506,000 7% 07/31/2003 1-5 yr. Item 3. LEGAL PROCEEDINGS The Company is currently defending the former directors of Advantage against a purported class action complaint filed in the California Superior Court for San Mateo on December 2, 1996 by two stockholders for themselves and purportedly on behalf of certain other minority stockholders of Advantage. Other defendants to the complaint currently include Franklin Resources, Inc. and the Company's advisor, Franklin Properties, Inc. The complaint alleges that defendants breached fiduciary duties to plaintiffs and other minority stockholders in connection with the purchase by Franklin Resources, Inc. in August 1994 of a 46.6% interest in Advantage and in connection with the Merger of Advantage into the Company in May 1996, which was approved by a majority of the outstanding shares of each of the three companies. Plaintiffs also allege that defendants misstated certain material facts or omitted to state material facts in connection with these transactions. The complaint includes a variety of additional claims, including claims relating to the investment of Advantage assets, the suspension of the dividend reinvestment program, the allocation of merger-related expenses, revisions to the investment policies of Advantage, and the restructuring of the contractual relationship with the Advisor. Plaintiffs seek damages in an unspecified amount and certain equitable relief. The defendants deny any wrongdoing in these matters and intend to vigorously defend the action. Discovery is continuing. On June 3, 1997, Herbert S. Hodge, Jr., on behalf of himself and certain other shareholders of FREIF, filed an alleged class action complaint in the California Superior Court for San Mateo County against the Company, certain of its directors, the Company's advisor, Franklin Properties, Inc., Franklin Resources, Inc., and Bear Stearns Co., Inc. The complaint alleges that defendants breached fiduciary duties to plaintiff and certain other shareholders in connection with the merger of FREIF into Franklin Select Realty Trust in May 1996. Plaintiff also alleges that defendants misstated certain material facts or omitted to state material facts in connection with this transaction. Plaintiff seeks damages in an unspecified amount. The defendants deny any wrongdoing in these matters and intend to vigorously defend the action. Discovery is continuing. While the outcome of litigation of these claims cannot be predicted with certainty, the Company's management does not believe that the outcome of litigation of these matters will have a material adverse effect on the Company's financial condition, results of operations or cash flows. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the last quarter covered by this report. PART II Item 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company has one class of common stock in two series, designated Series A and Series B (the "Common Stock"). At December 31, 1998, the Company had 12,250,372 Series A common shares outstanding and 745,584 Series B common shares outstanding, and there were approximately 2,400 Series A stockholders of record. The common stock votes together as one class with each share being entitled to one vote. The Series B shares are owned by Franklin Properties, the Advisor. There are no restrictions on sales or purchases of the Company's Series A common stock other than those that may be imposed by any applicable federal or state securities laws or by the Company's Articles of Incorporation or Bylaws with respect to maintaining the Company's status as a qualified real estate investment trust under applicable tax laws and regulations. On January 14, 1994, the Company registered its Series A common stock on the American Stock Exchange (AMEX) where it is currently traded under the symbol "FSN". Prior to January 14, 1994, there was no established public trading market for the common stock. Set forth below are the quarterly high and low share reported sales prices for the past two years and the distributions per share declared each quarter. DISTRIBUTIONS QUARTER ENDED HIGH LOW DECLARED ------------- ---- --- -------- December 31, 1998 $ 7 $ 5 3/8 $ .12 September 30, 1998 8 1/8 6 1/2 .12 June 30, 1998 8 1/8 6 5/16 .12 March 31, 1998 7 6 5/16 .12 December 31, 1997 $ 7 $ 5 11/16 .12 September 30, 1997 6 1/8 5 1/2 .11 June 30, 1997 6 1/4 5 1/2 .11 March 31, 1997 6 1/4 5 3/8 .11 The Company has a policy, subject to the discretion of the Board of Directors, of making quarterly cash distributions to stockholders aggregating on an annual basis at least 95% of its taxable income. For the years ended December 31, 1998, and 1997, the Company declared distributions to the Series A stockholders of approximately $5,880,000 ($.48 per share) and $5,513,000 ($.45 per share), respectively. Cash distributions to stockholders are currently paid on approximately the 15th day of January, April, July and October. Stockholders may elect to direct their distributions into any or one of the eligible funds in the Franklin Templeton Group of Funds, which are managed by an affiliate of the Advisor, or participate in the Company's Dividend Reinvestment Plan. DIVIDEND REINVESTMENT PLAN The Company has established a Dividend Reinvestment Plan (the "Plan") which is designed to enable Company Series A stockholders to choose to have distributions automatically invested in additional shares of Company common stock at market value, without the payment of any brokerage commission, service charge or other expense. Under the Plan, the Company's Dividend Reinvestment Agent makes open market purchases of the Company's Series A common stock, administers the Plan and performs other duties related to the Plan. No new shares have been issued in connection with the Plan. In order to participate in the Plan, investors must designate that they would like their distributions reinvested. Company Series A stockholders may elect to participate in the Plan at any time. The Plan does not accept cash contributions from Company stockholders to purchase additional shares of existing Company common stock. Only distributions related to existing Company common stock may be reinvested. For information on how to participate in the Dividend Reinvestment Plan, please contact the Company's transfer agent at (800) 851-4217. RETURN OF CAPITAL Because depreciation is a non-cash expense, cash flow will typically be greater than earnings from operations and net income. Therefore, quarterly distributions will generally be higher than quarterly earnings, which causes a portion of the distributions to be considered a return of capital. The portion of distributions that represented a return of capital for financial statement purposes on a consolidated basis, for the years ended December 31, 1998, and 1997, was $535,000 and $1,345,000, respectively. REIT QUALIFICATION MATTERS The Company is a REIT and elected REIT status commencing with the 1989 tax year pursuant to the provisions of the Internal Revenue Code (the "Code") and applicable state income tax law. Under those provisions, the Company will not be subject to income tax on that portion of its taxable income which is distributed annually to stockholders if at least 95% of its taxable income (which term excludes capital gains) is distributed and if certain other conditions are met. During such time as the Company qualifies as a REIT, the Company intends to make quarterly cash distributions to the stockholders aggregating on an annual basis at least 95% of its taxable income. Among other requirements, the Company must, in order to continue its status as a REIT under the Code, not have more than 50% in value of its outstanding shares owned by five or fewer individuals during the last half of a taxable year (the "5/50 Provision"). In order to meet these requirements, the Company has the power to redeem a sufficient number of shares in order to maintain or to bring the ownership of the shares into conformity with these requirements, and to prohibit the transfer of shares to persons whose acquisition would result in a violation of these requirements. The price to be paid in the event of the redemption of shares will be the last reported sale price of the Series A common stock on the last business day prior to the redemption date on the principal national securities exchange on which the Series A common stock is listed or admitted to trading or otherwise, as determined in good faith by the Board of Directors of the Company. In order to assure compliance with the 5/50 Provision, described above, the Company's Bylaws permit the Directors of the Company to impose a lower percentage limit on the remaining stockholders, in the event certain stockholders (including Franklin and its affiliates) acquire in excess of 9.9% of the outstanding shares of Common Stock during the offering period. The Directors of the Company have exercised this authority under the Bylaws to lower the percentage limitation such that stockholders may not acquire additional shares if such shareholder then holds, or would then hold, in excess of 7% of the total outstanding voting shares of the Company. Any shares acquired in excess of the foregoing limitation will be deemed to be held in trust for the Company, and will not be entitled to receive distributions or to vote. The Directors of the Company may impose, or seek judicial or other imposition of additional restrictions if deemed necessary or advisable, including but not limited to further reductions in the foregoing percentage limitation with or without notice, or redemption of shares, in order to protect the Company's status as a qualified REIT. Item 6. SELECTED FINANCIAL DATA (In thousands except per Restated 1 Restated 1 share amounts) 1998 1997 1996 1995 1994 -------- ------- ------- ------- ------- Total revenues $17,937 $17,726 $14,568 $14,111 $12,990 Net income $5,055 $4,168 $3,807 $4,462 $4,273 Per Series A common share1: Net income $0.41 $0.34 $0.28 $0.32 $0.30 Distributions declared $0.48 $0.45 $0.44 $0.44 $0.44 Weighted average number of shares of 12,250 12,250 13,830 14,145 14,145 Series A common stock outstanding Balance Sheet Data: Total assets $133,892 $150,097 $131,298 $116,457 $117,873 Debt $26,762 $42,487 $22,745 $7,145 $7,279 Stockholders' equity $94,501 $95,316 $96,653 $106,986 $108,316 Other Data: Funds from operations2 $7,699 $8,171 $7,235 $7,795 $7,396 Cash flow from Operating activities $8,591 $9,187 $7,831 $8,359 $8,771 Investing activities $11,144 $(17,734) $4,140 $31 $(5,904) Financing activities $(22,300) $9,810 $(15,599) $(6,404) $(3,184) Total rentable square footage of properties at 948,925 1,152,516 963,624 751,944 751,944 end of period Number of properties at end 7 11 8 7 7 of period 1 Amounts reported for 1994 and 1995 have been restated to give effect to the Merger. 2 See discussion of funds from operations in Item 7 of this report -Management Discussion and Analysis of Financial Condition and Results of Operations. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION Franklin Properties, Inc. (the "Advisor," or "Management") manages the Company's day-to-day operations under the terms of an advisory agreement which is renewable annually. The Company does not have any employees. Property management, including leasing, re-leasing and management-related services, for the Company's seven operating rental properties is provided by Continental Property Management Co. ("CPMC"), an affiliate of the Advisor. Both CPMC and the Advisor are wholly owned subsidiaries of Franklin Resources, Inc. whose primary business is the Franklin Templeton Group of Funds. In 1995, the Boards of Directors of the Company and of two other real estate investment trusts that the Advisor advised, Franklin Real Estate Income Fund ("FREIF") and Franklin Advantage Real Estate Income Fund ("Advantage"), agreed to the merger of the three real estate investment trusts. At a Special Meeting of Stockholders held on May 7, 1996, the proposed merger of Advantage and FREIF into the Company was approved (the "Merger") by a majority of the outstanding shares of each of the three companies, and the surviving entity was renamed Franklin Select Realty Trust. The consolidated financial information of the Company has been presented as a reorganization of entities under common control; therefore, the results of periods prior to the Merger have been restated so as to give retroactive effect to the Merger. The following discussion is based primarily on the consolidated financial statements of the Company for the years ended December 31, 1996, 1997 and 1998. This discussion should be read in conjunction with the accompanying consolidated financial statements and notes. When used in the following discussion, the words "believes," "anticipates" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected, including, but not limited to, those set forth in the section entitled "Potential Factors Affecting Future Operating Results," below. Readers are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date hereof. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. GENERAL BACKGROUND During 1998, the Company's rental revenue was generated by investments in ten properties including three retail properties which were sold during the year. The remaining seven properties consist of four industrial R&D properties comprising 546,000 rentable square feet of space and three office properties comprising 403,000 rentable square feet of space. The Company's properties are located in the greater San Francisco and Los Angeles areas from which the Company derived 60% and 32% of its 1998 rental revenue, respectively. The remainder of the Company's rental revenues was earned from properties that the Company sold during the year which were located outside these areas. 1998 SUMMARY The Company's property operations were stable in relation to the prior year, both with respect to rental rates and average occupancy. Average occupancy rates decreased slightly from 98% in 1997 to 95% in 1998. The transactions that had the greatest influence on the Company's reported results in 1998 were: (i) the sale of Carmel Mountain, a retail property, in July 1998. (ii) the sale of the Mira Loma Retail Shopping Center, ("Mira Loma") and the Glen Cove Shopping Center, ("Glen Cove") in November 1998. During 1998, the Company formed a Special Committee of the Board of Directors to undertake a review of the strategic alternatives available to the Company, and the Special Committee engaged the services of Prudential Securities, Inc. to assist it in this effort. The Special Committee is exploring ways to improve shareholder value including changing the Company's business strategy to consider a strategic alliance, merger, sale, or other transaction or transactions involving the Company or its securities. The Company is actively continuing with its consideration of the advisability and feasibility of one or more of these strategic alternatives, and the Special Committee's advisors are continuing to be actively involved in this process. Unless and until any such strategic alternative is chosen, the Company intends to follow its existing investment and operating strategy, while at the same time not foreclosing the adoption of one or more new strategic alternatives. As a result, the following description reflects the Company's current investment and operating strategy but does not reflect any changes that may result from the Special Committee's review. RESULTS OF OPERATIONS COMPARISON OF YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997 Total revenue increased 1% in 1998 compared to 1997. Rental revenues remained at substantially the same levels as the prior year, despite property acquisitions in 1997 and dispositions in 1998. The acquisition of the Hathaway and Tanon buildings in 1997 provided increased revenue for 1998, as a full year's revenue was received in 1998. However, property sales in 1998 and reduced rental revenue from Fairway combined to offset the increases associated with the property acquisitions. The average portfolio occupancy rate remained stable for the existing properties occupied throughout both periods. The increase in interest income was due to increases in marketable securities and Notes receivable. Total expenses rose $600,000 (5%) in 1997 primarily due to the acquisition of the Hathaway and Tanon Buildings and increased general and administrative expenses associated with a strategic review being undertaken by the Special Committee of the Board of Directors. Interest expense increased $157,000 (6%) over the prior year as a result of the increased debt to fund acquisitions in 1997, offset by the paydowns of debt made in 1998 due to the sales of properties. Debt decreased $15.7 million in 1998, as property sales allowed the Company to pay off its variable rate debt. The weighted average interest rate on borrowings decreased from 8.63% in 1997 to 7.63% in 1998. Property operating expenses stayed relatively stable in 1998 as compared to the prior year. Decreased utilities and repair expenditures offset increased administrative and maintenance costs primarily related to the Fairway window defects discussed under Liquidity and Capital Resources, below. There were no changes made to the agreements between the Company and related parties during the year. Related party fees remained at 1997 levels. General and administrative expenses increased $428,000 (66%) in 1998 as compared to the prior year. The increases were primarily the result of costs related to the Company's evaluation of its strategic alternatives and legal fees incurred with respect to the pending legal actions that are described in Note 10 to the accompanying financial statements. The minority interest in FSRT L.P. net income increased $48,000 (7%) in 1998 as compared to the prior year due to an increase in the distribution rate to the limited partners. The increase in net income for the periods under review was primarily due to the gains recorded on the sale of real estate and also the changes in revenues and expenses described above. COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 Total revenue increased 22% in 1997 over 1996. The increase was attributable to a 26% increase in rental revenue offset by a decrease in interest income. Rental revenues increased over the prior year as a result of the Lam Research Buildings acquisition that took place in the last quarter of 1996 as well as the acquisition of the Tanon Building and Hathaway Business Park that took place in 1997. Occupancy rates and rental revenues remained stable on the existing properties occupied throughout both periods. The decline in interest income was due to the sale of securities used to finance the purchase of dissenting shareholders' stock in 1996. Total expenses rose $2.3 million (21%) in 1997 primarily due to the acquisition of property by the Company. The addition of the Lam buildings in October 1996 and the acquisitions in 1997 has led to an increase in interest expense, depreciation and operational costs. Interest expense increased $1,874,000 (208%), net of amounts capitalized, over the prior year as a result of the additional borrowings used to finance the purchase of the three new properties in 1997 and on borrowings used to finance the Lam Research Building acquired in October, 1996. An additional $19,742,000 of debt was added in 1997 net of repayments. The weighted average interest rate on borrowings decreased from 8.75% in 1996 to 8.63% in 1997. Property operating expenses increased 11% in 1997 as compared to the prior year. This was consistent with the increase in property owned by the Company. Property taxes and utility expenses formed the bulk of the increased costs experienced in 1997. There was no change in the agreements between the Company and related parties during the year. The $249,000 (21%) increase in related party expense was primarily due to the increase in the total gross book value of real estate owned by the Company, which caused the advisory fees to increase by $215,000 (40%) over the prior year. General and administrative expenses remained at 1996 levels, despite the Company's expansion. Lower director's and officer's insurance expense, stock exchange fees and general expenses in 1997 reflect the economies of scale achieved by the merger of the REITs in 1996. These benefits were offset by legal fees totaling approximately $110,000 which were incurred in defending the Company against two shareholder lawsuits (see Note 10 to the Consolidated Financial Statements). The minority interest in FSRT L.P. net income increased $537,000 (502%) in 1997 as compared to the prior year as the partnership was set up in October 1996 and therefore 1997 reflects a full year of activity. Consolidated net income increased 9.5% to $4,168,000 in 1997 as a result of the increased revenue from properties acquired in the period that was in excess of the additional costs incurred. In addition, 1997 net income increased with the absence of merger related expenses and a realization of some of the economies of scale associated with the completion of the Merger. These benefits were partially offset by reduced interest income related to the sale of securities in 1996, and to increased legal expenses. Net income per share increased by a greater amount, 21%, due to the reduced number of shares of common stock outstanding during 1997. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, the Company's cash and cash equivalents aggregated $1,256,000 which the Company believes is adequate to meet its short-term operating cash requirements. The Company also has access to a revolving line of credit in the amount of $25 million that was unused at year end. On January 5, 1999 the Company collected the $7,700,000 note receivable that was outstanding at December 31, 1998 which the Company received from the sale of the Mira Loma and Glen Cove properties in 1998. The Company also holds $7,700,000 of mortgage-backed securities. During 1998, the Company's cash and cash equivalents decreased to $1,256,000 compared to $3,821,000 at December 31, 1997. The decrease in cash reflects lower cash generated from operating cash flows, an increase in the amount used to improve rental property and an increase in the distributions to shareholders and minority interests. Operations generated $8,591,000, a decrease of $596,000 from the previous year as a result of increased expenses, as described above. The sale of property and other investing activities produced $11,144,000 in 1998, compared to an outflow of cash in 1997 of $17,734,000 primarily from the purchase of Tanon, Hathaway and the undeveloped land. The Company's investment in mortgage-backed securities at December 31, 1998, is represented by a GNMA certificate and a FNMA adjustable rate pass-through certificate with market values of approximately $7,323,000 and $377,000, respectively. Although payments of principal and interest are guaranteed by these agencies, changes in market interest rates may cause the market values to fluctuate, which could result in a gain or loss if the security is sold before maturity. In 1998, the Company amended its credit agreement with Bank of America to extend the maturity date of its facility to July 1, 1999. The facility consists of a $25 million secured revolving line of credit to provide funding for future acquisitions and general business purposes. Borrowings under the line of credit bear interest at the London Interbank Offered Rate ("LIBOR") plus 1.90%, or at the bank's Reference rate at the Company's option. The credit facility is secured by mortgages on three of the Company's properties, together with the rental proceeds from such properties (which collectively accounted for 45% of the Company's 1998 rental revenue). At December 31, 1998, these properties comprised approximately 46% of the Company's net real estate assets. The credit agreement contains customary representations, restrictive covenants, and events of default, including a covenant limiting quarterly distributions to 98% of funds from operations. The Company does not anticipate that this covenant will adversely affect the ability of the Company to declare distributions to shareholders under the Company's current distribution policy. At December 31, 1998, the unused balance available under the line of credit was $25 million. The Company's mortgage indebtedness has the following balloon payments: 2003-$3.0 million; 2004-$3.9 million; and 2006-$13.3 million. In addition, the Company's $25 million credit facility, which was unused at December 31, 1998, matures in July, 1999 with the option of a further extension until January 2000. The Company does not anticipate that its cash flow from operations will be sufficient to make all of the balloon payments of principal when due under its mortgage indebtedness and its credit facility. The Company intends to make such payments by refinancing or extending the indebtedness or by raising funds through the sale of equity securities or properties. If the Company is unable to extend, refinance, or payoff its indebtedness when due, the mortgaged properties could become the property of the mortgagee with a subsequent loss of income and asset value to the Company. The Company's revolving line of credit bears interest at a floating rate tied to LIBOR. The Company intends to use the line of credit to provide short term financing for future acquisitions and as a source of additional working capital, if required. An increase in interest rates may have an adverse effect on the Company's net income and Funds from Operations. In 1999, the Company is expecting to evaluate various options to remedy defects discovered in the window system at Fairway Center. The Company currently estimates the remediation cost to total approximately $1.5 million, although certain less expensive alternatives are also being considered. The Company has received $525,000 and expects to receive a further $312,500 in settlement of claims related to the defects. The remediation is not expected to have a material long term impact on the Company's cash flow, financial condition or results of operations. IMPACT OF INFLATION The Company's policy of negotiating leases which incorporate operating expense "pass-through" provisions is intended to protect the Company against increased operating costs resulting from inflation. POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS YEAR 2000 The Company has evaluated whether its computer systems, including on-site and embedded systems, and those of significant third party service organizations with whom the Company interacts will function properly by, at or during the year 2000. The Company has determined certain of its own systems are not currently year 2000 compliant. Management has a plan to replace or upgrade these systems within the next nine months. The Company does not expect that the costs associated with these replacements or upgrades will have a materially adverse impact on its financial position, results of operations or cash flows in future periods. However, failure to successfully replace or upgrade these systems could result in material disruptions to its business. The Company is managed and advised by certain affiliates of Franklin Resources, Inc. It is reliant on these entities for its basic computer network and certain other applications. The Company is also reliant on a third-party transfer agent for maintaining its basic shareholder records. Management is monitoring the progress of these entities in achieving year 2000 compliance and does not currently anticipate a materially adverse impact on the Company's business as a result of their potential non-compliance. LEASING TURNOVER In connection with any lease renewal or new lease, the Company typically incurs costs for tenant improvements and leasing commissions which will be funded first from operating cash flow and, if necessary, from cash reserves or existing credit facilities. In addition, while the Company has historically been successful in renewing and re-leasing space, the Company will be subject to the risk that leases expiring in the future may be renewed or re-leased at terms that are less favorable than current lease terms. LEASING TURNOVER - TANON MANUFACTURING, INC. On December 3, 1998, Tanon Manufacturing, Inc. (TMI), the sole tenant of the Tanon Building, filed for Chapter 11 bankruptcy protection. The current base rent for the property pursuant to the lease is $8.16 per square foot annually on a net lease basis. The Company estimates that the market base rental rate for the property may be in excess of $12.00 per square foot annually. TMI has not paid rent due for the period November 1, 1998 to December 3, 1998 of approximately $100,000, including operating expense reimbursements; however, it re-commenced contractual rental payments effective December 3, 1998. On February 1, 1999, Smartflex Systems, Inc. ("SSI") purchased substantially all of the assets of TMI and the bankruptcy court gave SSI until March 11, 1999 to determine whether it will assume or reject the lease. SSI has asked the court to extend that time and the request to extend will be considered on March 11. If SSI assumes the lease, it would be required to cure all defaults, including paying unpaid rent. If SSI rejects the lease, the Company would have a claim against TMI for damages, including unpaid rent then due. If SSI rejects the lease, the Company intends to pursue all available remedies and to re-lease the Tanon Building. If the Company must re-lease the Tanon Building, its rental income will decline approximately $100,000 for each month that the property is vacant, and it is likely to incur costs for tenant improvements, leasing commissions and other expenses. The total costs for such items cannot be determined at this time, but are not expected to be material to the Company's results of operations or financial position. LEASING TURNOVER - DATA GENERAL BUILDING The Company's leasing exposure at Data General Building consists of approximately 34,000 square feet that was vacated by the Data General Corporation on January 31, 1999. During 1998, the Company recorded rental income from the Data General lease that was equivalent to approximately $31.03 per square foot on a full service basis. Compared to the current estimated market rate of $24.00 per square foot, management estimates that the Company's rental income from this space will decline approximately $240,000 annually, or 1.3% of the Company's total revenue in 1998. In addition to receiving less rent, the Company will incur costs for tenant improvements and leasing commissions upon re-leasing the space, which we estimate will total between $750,000 and $1 million. Management believes that the Company's sources of capital as described under Liquidity and Capital Resources are adequate to meet its liquidity needs in the reasonably foreseeable future. FUNDS FROM OPERATIONS ("FFO") The Company considers FFO to be a useful measure of the operating performance of an equity REIT because, together with net income and cash flows, FFO provides investors with an additional basis to evaluate the ability of a REIT to support general operating expense and interest expense before the impact of certain activities, such as gains and losses from property sales and changes in the accounts receivable and accounts payable. However, it does not measure whether income is sufficient to fund all of the Company's cash needs including principal amortization, capital improvements and distributions to stockholders. FFO should not be considered an alternative to net income or any other GAAP measurement of performance, as an indicator of the Company's operating performance or as an alternative to cash flows from operating, investing or financing activities as a measure of liquidity. As defined by the National Association of Real Estate Investment Trusts ("NAREIT"), FFO is net income (computed in accordance with GAAP), excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization, and after adjustment for unconsolidated joint ventures. The Company reports FFO in accordance with the revised NAREIT definition. The measure of FFO as reported by the Company may not be comparable to similarly titled measures of other companies that follow different definitions. FUNDS FROM OPERATIONS (dollars in thousands) Year ended December 31, 1998 1997 1996 -------- -------- -------- Net income $5,055 $4,168 $3,807 Add: Depreciation and 3,979 4,003 3,428 amortization Less: Gain on sale (1,335) - - -------- -------- -------- Funds from Operations $7,699 $8,171 $7,235 ======== ======== ======== The primary cause of the decline in FFO in 1998 compared to 1997 was an increase in general and administrative expenses as discussed under "Results of Operations". The increase in FFO from 1996 to 1997 was mostly caused by a decline in merger-related expenses and losses on the sale of mortgage-backed securities. FFO in 1997 also benefited from the Company's property acquisitions in 1996 and 1997. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE Report of Independent Accountants 21 Consolidated Balance Sheets as of December 31, 1998 and 1997 22 Consolidated Statements of Income for the years ended December 31, 1998, 1997 23 and 1996 Consolidated Statements of Stockholders' Equity for the years ended December 24 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 26 1997 and 1996 Notes to Consolidated Financial Statements 27 Schedule III - Real Estate and Accumulated Depreciation 37
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors and Stockholders Franklin Select Realty Trust In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Franklin Select Realty Trust at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP San Francisco, California January 20, 1999 C O N S O L I D A T E D B A L A N C E S H E E T S FRANKLIN SELECT REALTY TRUST In thousands except per share amounts - ------------------------------------------------------------------------------ As of December 31, 1998 and 1997 1998 1997 - ------------------------------------------------------------------------------ ASSETS Real estate Rental property: Land $34,054 $38,787 Buildings and improvements 100,241 110,733 --------------------- 134,295 149,520 Less: accumulated depreciation 21,341 20,817 --------------------- 112,954 128,703 Property held-for-sale, net of accumulated depreciation of $0 and $472 respectively - 12,395 --------------------- Real estate, net 112,954 141,098 Cash and cash equivalents 1,256 3,821 Mortgage-backed securities, available for sale 7,700 501 Note receivable 7,700 - Deferred rent receivable 1,543 1,863 Deferred costs and other assets 2,739 2,814 ===================== Total assets $133,892 $150,097 ===================== - ------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Debt $26,762 $42,487 Tenant deposits, accounts payable and accrued expenses 1,807 1,391 Distributions payable 1,641 1,645 --------------------- Total liabilities 30,210 45,523 --------------------- Minority interest 9,181 9,258 --------------------- Commitments and contingencies (Notes 6 and 10) - - STOCKHOLDERS' EQUITY: Common stock, Series A, without par value; stated value $10 per share; 50,000 shares authorized; 12,250 shares issued and outstanding 103,161 103,161 issued and outstanding Common stock, Series B, without par value; stated value $10 per share; 1,000 shares authorized; 746 shares issued and outstanding 6,294 6,294 Accumulated other comprehensive income (18) (28) Accumulated distributions in excess of net income (14,936) (14,111) --------------------- Total stockholders' equity 94,501 95,316 ===================== Total liabilities and stockholders' equity $133,892 $150,097 ===================== The accompanying notes are an integral part of these consolidated financial statements. C ON S O L I D A T E D S T A T E M E N T S O F I N C O M E FRANKLIN SELECT REALTY TRUST In thousands, except per share amounts - ------------------------------------------------------------------- For the years ended December 31, 1998 1997 1996 1998, 1997 and 1996 - ------------------------------------------------------------------- REVENUES: Rent $17,635 $17,522 $13,926 Interest, dividends, and other 302 204 642 ------------------------------ Total revenue 17,937 17,726 14,568 ------------------------------ EXPENSES: Property operating 4,081 4,036 3,635 Interest 2,930 2,773 899 Related party 1,459 1,454 1,205 General and administrative 1,076 648 642 Consolidation - - 695 Loss on sale of mortgage-backed - - 151 securities Depreciation and amortization 3,979 4,003 3,427 ------------------------------ Total expenses 13,525 12,914 10,654 ------------------------------ Operating income before gain on sales of properties and minority 4,412 4,812 3,914 interest Gain on sales of properties 1,335 - - ------------------------------ Net income before minority interest 5,747 4,812 3,914 ------------------------------ Minority interest (692) (644) (107) ------------------------------ NET INCOME $5,055 $4,168 $3,807 ============================== Net income per share, based on the weighted average shares outstanding of Series A common stock of 12,250, 12,250 and 13,830 for the years ended December 31, 1998, 1997 and 1996, respectively $0.41 $.34 $.28 ============================== Distributions per share, based on the weighted average shares outstanding of Series A common stock of 12,250, 12,250 and 13,343 for the years ended December 31, 1998, 1997 and 1996, respectively $0.48 $.45 $.44 ============================== - ------------------------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements. C O N S O L I D A T E D S T A T E M E N T S O F S T O C K H O L D E R S' E Q U I T Y
FRANKLIN SELECT REALTY TRUST In thousands As of and for the years ended December 31, 1998, 1997, and 1996 COMMON STOCK Accumulated Accumulated other distributions Series A Series B comprehensive in excess of Shares Amount Shares Amount income net income Total ---------------------------------------------------------------------- ------------------- --------------- ---------- Balance, January 1, 1996, restated 14,145 $111,569 746 $6,294 $(164) $(10,713) $106,986 Dissenting stockholders' interest (1,895) (8,408) - - - - (8,408) Comprehensive income: Net income - - - - - 3,807 3,807 Unrealized loss on mortgage-backed securities - - - - (23) - (23) Reclassification adjustment for losses included in net income 151 151 ---------------- Total comprehensive income 3,935 Cash distributions on common stock - - - - - (5,860) (5,860) - ----------------------------- ------------ --------------- ------ ----------- ---------------- ------------------ ---------------- Balance, December 31, 1996 12,250 103,161 746 6,294 (36) (12,766) 96,653 Comprehensive income: Net income - - - - - 4,168 4,168 Unrealized gain on mortgage-backed securities - - - - 8 - 8 ---------------- Total comprehensive income 4,176 Cash distributions on common stock - - - - - (5,513) (5,513) - ----------------------------- ------------ --------------- ------ ----------- ---------------- ------------------ ---------------- Balance, December 31, 1997 12,250 103,161 746 6,294 (28) (14,111) 95,316 Comprehensive income: Net income - - - - - 5,055 5,055 Unrealized gain on mortgage-backed securities - - - - 10 - 10 ---------------- Total comprehensive income 5,065 Cash distributions on common stock - - - - - (5,880) (5,880) ============================= ============ =============== ====== =========== ================ ================== ================ Balance, December 31, 1998 12,250 $103,161 746 $6,294 $(18) $14,936 $94,501 ============================= ============ =============== ====== =========== ================ ================== ================
The accompanying notes are an integral part of these consolidated financial statements. C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S FRANKLIN SELECT REALTY TRUST In thousands - ---------------------------------------------------------------------------- For the years ended December 31, 1998,1997 and 1998 1997 1996 1996 - ---------------------------------------------------------------------------- NET INCOME $5,055 $4,168 $3,807 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,163 4,171 3,440 Gain on sales of properties (1,335) - - Loss on sale of mortgage-backed securities - - 151 Minority interest 692 644 107 (Increase) decrease in deferred rent (29) 53 54 receivable (Increase) in other assets (293) (135) (27) Increase in tenant deposits, accounts payable, and accrued expenses 283 312 337 and accrued expenses (Increase) decrease in advance rents 55 (26) (38) --------------------------- 3,536 5,019 4,024 --------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 8,591 9,187 7,831 --------------------------- Disposition (acquisition) of rental property 20,499 (16,383) (1,428) Improvements to rental property (1,778) (784) (627) Leasing commissions paid (388) (652) (339) (Acquisition) disposition of mortgage-back (7,189) 85 6,534 securities --------------------------- NET CASH PROVIDED BY (USED IN) INVESTING 11,144 (17,734) 4,140 ACTIVITIES --------------------------- Borrowings under notes payable - 23,938 16,222 Repayment of notes payable (15,725) (7,791) (16,781) Payment of loan costs - (288) (599) Repurchase of dissenting stockholders' - - (8,408) interest Distributions paid to stockholders and (6,575) (6,049) (6,033) minority interest --------------------------- NET CASH (USED IN) PROVIDED BY FINANCING (22,300) 9,810 (15,599) ACTIVITIES --------------------------- NET (DECREASE) INCREASE IN CASH AND CASH (2,565) 1,263 (3,628) EQUIVALENTS CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,821 2,558 6,186 =========================== CASH AND CASH EQUIVALENTS, END OF YEAR $1,256 $3,821 $2,558 =========================== Supplemental cash flow information and non-cash investing and financing activities - Notes 2 and 4. - ---------------------------------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS ACTIVITY Franklin Select Realty Trust (the "Company") (formerly Franklin Select Real Estate Income Fund) is a California corporation formed on January 5, 1989 for the purpose of investing in income-producing real property. Franklin Properties, Inc. (the "Advisor", or "management") manages the Company's day-to-day operations under the terms of an advisory agreement that is renewable annually. On May 7, 1996, Franklin Real Estate Income Fund ("FREIF") and Franklin Advantage Real Estate Income Fund ("Advantage") merged into the Company. In connection with the Merger of the three companies (the "Merger"), the Company issued approximately 7,945,000 shares of Series A common stock and 559,718 shares of Series B common stock in exchange for 3,363,877 and 3,013,713 shares of Series A common stock and 319,308 and 124,240 shares of Series B common stock of FREIF and Advantage, respectively, in each case excluding dissenting shares. The Merger was accounted for as a combination of entities under common control. On November 1, 1996, the Company purchased approximately 635,638 shares of FREIF Series A common stock and 1,077,667 shares of Company Series A common stock from shareholders who had elected to exercise dissenter's rights pursuant to Chapter 13 of the California General Corporation Law. At December 31, 1998, the Company's real estate portfolio consisted of ownership interests in seven properties: four industrial research and development properties, and three suburban office properties. BASIS OF PRESENTATION The accompanying consolidated financial statements of the Company include all accounts of the Company and its majority owned partnership, FSRT L.P. ("FSRT"). The Company is the sole General Partner of FSRT. All significant intercompany amounts and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REAL ESTATE Rental property is stated at cost and depreciated using the straight-line method over an estimated useful life of 35 years for buildings and improvements. Tenant improvements are generally amortized over the lesser of the improvements' useful life or the lease term. Significant improvements and betterments are capitalized. Maintenance and repairs are charged to expense when incurred. The Company capitalizes interest on property under development. Pursuant to the Company's investment objectives, property purchased is generally held for extended periods. During the holding period, management periodically, but at least annually, evaluates whether rental property has suffered an impairment in value. Management's analyses include consideration of estimated undiscounted future cash flows during the expected holding period in comparison with carrying values, prevailing market conditions and other economic matters. If the current carrying value of an individual property exceeds estimated future undiscounted cash flows, the Company will reduce the carrying value of the asset to fair value; however, to date, such adjustments have not been required. Property held-for-sale is held at the lower of cost or fair value. Property is designated available-for-sale when it is being actively marketed and the sale of the property is anticipated within twelve months. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, demand deposits with banks, debt instruments with original maturities of three months or less, and money market funds, which are readily convertible into cash. Due to the relatively short-term nature of these investments, the carrying value approximates fair value. MORTGAGE-BACKED SECURITIES Mortgage-backed securities held by the Company are classified as available for sale and are carried at fair value. The resulting unrealized gains and losses are reported as a component of other comprehensive income within stockholders' equity until realized. Realized gains and losses are recognized on the specific identification method and are included in earnings. DEFERRED COSTS Lease commissions are deferred and amortized using the straight-line method over the term of the related lease. Loan fees and loan costs are deferred, amortized and recorded in interest expense using the straight-line method, which approximates the effective interest method, over the term of the related loan. RENTAL REVENUES Rental revenues are recorded on the straight-line method to reflect scheduled rent increases and free rent over the related lease term. As a result, a deferred rent receivable is created when rental receivables are less than the amount earned using the straight-line method or when rental income is recognized during free rent periods of a lease. INCOME TAXES The Company is a real estate investment trust ("REIT"), having elected to qualify as a REIT under the applicable provisions of the Internal Revenue Code since 1989. Under the Internal Revenue Code and applicable state income tax law, a qualified REIT is not subject to income tax if at least 95% of its taxable income is currently distributed to its stockholders and other REIT tests are met. The Company is in compliance with these tests. Accordingly, no provision is made for income taxes in these financial statements. CONCENTRATIONS OF CREDIT RISK Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of mortgage-backed securities and operating leases with tenants. The Company places excess cash in short-term deposits with Franklin Money Fund, managed by an affiliate of the Advisor, and in money market securities of companies with strong credit ratings and, by policy, limits credit exposure to any one issuer. The Company performs ongoing credit evaluations of its tenants and generally does not require collateral for commercial tenants. The Company reserves for potential credit losses, as appropriate. NEW PRONOUNCEMENTS BY THE FINANCIAL ACCOUNTING STANDARDS BOARD The Company has adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"), which establishes the disclosure requirements for reporting comprehensive income. Comprehensive income for the Company includes unrealized gains and losses on mortgage-backed securities currently reported as components of stockholders' equity. FAS 130 requires the Company to classify items of comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately in the equity section of the consolidated balance sheet. The Company has adopted Statement of Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information", ("FAS 131"), which establishes new requirements for reporting segment information. The Company has determined that it has one reportable segment under FAS 131. NOTE 2 - REAL ESTATE SALES On January 21, 1998, the Company sold a 12.5-acre parcel of undeveloped land that was acquired in June 1997. Net proceeds of $4,471,000 were received and of that amount approximately $4,100,000 was used to repay the line of credit and the Company retained the remainder. Gain from sale of the property amounted to approximately $170,000. On July 1, 1998, the Company sold Carmel Mountain Gateway Plaza for a gross price of $8,900,000. Approximately $8,600,000 was used to repay the line of credit and the Company retained the remainder. Gain from sale of the property amounted to approximately $382,000. On November 17, 1998 the Company sold Mira Loma and Glen Cove. These two properties were sold for a gross price of $15,400,000 under an installment sale contract in which $7,700,000 was paid to the Company at closing on November 18, 1998. The balance of $7,700,000 was paid to the Company on January 5, 1999, under the terms of a note receivable. This note, which was included as a Note Receivable at December 31, 1998, bore interest at 8% annually which was paid at maturity. Approximately $800,000 of the net sale proceeds were used to repay the outstanding balance of the Company's line of credit, and the remainder was held by the Company for general corporate purposes. Gain from sale of these properties was approximately $783,000. NOTE 3 - MORTGAGE-BACKED SECURITIES, AVAILABLE FOR SALE Mortgage-backed securities, available for sale at December 31, 1998, and 1997, were as follows: (IN THOUSANDS) 1998 1997 ----------------------- Amortized cost $7,718 $529 Unrealized loss (18) (28) ======================= Fair value $7,700 $501 ======================= Mortgage-backed securities, available for sale at December 31, 1998, had a coupon rate of between 6.88% and 7.22% and maturities between 2017 and 2024. At purchase, the securities yielded 5.6% and 6.9%, respectively. NOTE 4 - DEBT At December 31, 1998 and 1997 debt was comprised of the following: (IN THOUSANDS) 1998 1997 ------------------------ FAIRWAY CENTER Bonds payable, net of prepaid reserve of $207,000, collateralized by a lien, including serial bonds maturing through October 1, 2016, at interest rates ranging from 4.00% to 6.50%, and term bonds maturing October 1, 2026, at an interest rate of 6.625%. The payments on the bonds are calculated in an amount sufficient to fully amortize the indebtedness. $2,418 $2,453 HATHAWAY BUSINESS PARK Note payable, collateralized by a deed of trust. The note bears interest at a fixed rate of 7.75%. The combined interest and principal payment of $30,786 is payable monthly until maturity in 2003. 3,484 3,580 TANON BUILDING Note payable, collateralized by a deed of trust. The note bears interest at a fixed rate of 8.47%. The combined interest and principal payment of $41,445 is payable monthly until maturity in 2004. 5,070 5,134 LAM RESEARCH BUILDINGS Notes payable, collateralized by deeds of trust. The two notes bear interest at a fixed rate of 8.44%. The combined principal and interest payment of $129,969 is payable monthly until maturity in 2006. 15,790 16,007 GLEN COVE Note payable, collateralized by a deed of trust. The note bears interest, payable monthly, at the lender's Reference Rate plus 1.5% (aggregating 10% at December 31, 1998), together with monthly principal payments of $3,700 until maturity in 1999. - 1,848 CARMEL MOUNTAIN Note payable, collateralized by a deed of trust. The note bears interest, payable monthly, at the lender's Reference Rate plus 1.5% (aggregating 10% at December 31, 1998), together with variable monthly principal payments until maturity in 1999. - 2,265 ------------------------ TOTAL NOTES AND BONDS PAYABLE 26,762 31,287 SECURED LINE OF CREDIT Interest is payable monthly based on the London Interbank Offer Rate ("LIBOR"), or the bank's reference rate, plus 1.9%. The line of credit matures in July 1999. - 11,200 ------------------------ $26,762 $42,487 ======================== Each of the Company's debt facilities outstanding at December 31, 1998 has associated prepayment penalties. Loans secured on the Hathaway, Tanon and Lam properties carry yield maintenance prepayment penalties and the bonds secured by the Fairway center can be prepaid commencing October 2001 with a 1% penalty. Aggregate principal payments required in future years related to notes and bonds payable are as follows: (IN THOUSANDS) 1999 $450 2000 485 2001 527 2002 3,591 2003 479 Thereafter 21,230 ------------- $26,762 ============= In December 1998, the Company renewed a $25 million revolving secured line of credit agreement with a bank to provide funding for future acquisitions and working capital. Borrowings under the line of credit bear interest at the applicable London Interbank Offering Rate, or at the bank's reference rate, plus 1.9% and are secured by three of the Company's rental properties. The weighted average interest rate paid during 1998 under the line of credit was 7.6%. Among other covenants, the agreement restricts payment of quarterly dividends to an amount not to exceed 98% of funds from operations, as defined in the agreement. The line of credit agreement expires in July 1999 at which time the outstanding balance is due and payable. The Company has the option to either extend the line for an additional six months upon payment of a fee equal to 0.125% of the total line or convert amounts outstanding at the maturity date to a five year term note under the same variable interest rate structure. In addition, the Company pays an annualized fee of .25% of the unused portion of the line of credit, payable quarterly. At December 31, 1998 this credit facility was unused. For the years ended December 31, 1998, 1997 and 1996, interest paid was $2,742,000, $2,618,000 and $773,000, respectively. Management estimates that the carrying amount of aggregate debt approximates fair value based on a comparison to interest rates available for debt with similar terms and maturities NOTE 5 - COMMON STOCK AND INCOME PER SHARE The Company has one class of common stock in two series: Series A and Series B. Series A and Series B common stock have the same voting rights. Distributions on Series A common stock are declared at the discretion of the Board of Directors. No distribution may be paid or declared on the Series B shares prior to exercise of the exchange rights, as defined below. After exercising their exchange rights, the Advisor will receive distributions on its Series A shares. The Series B common stock held by the Advisor may be exchanged for Series A common stock when the Series A common stock achieves certain trading prices for 20 consecutive trading days. The Series B shares become eligible for exchange for a total of 622,395 Series A shares when the trading price of the Series A shares is between $8.42 and $11.33. To date, the market price of the Series A shares has not met these conditions and thus the Series B shares are not currently convertible. The rates of exchange and trading prices will be subject to change under certain circumstances as provided in the Exchange Rights Agreement. In October 1997, 1,625,000 limited partnership units (the "FSRT Units") became eligible for exchange into a like number of Series A common shares in the Company in accordance with the partnership agreement of FSRT. No units were exchanged for common stock during the year. The Company filed a related shelf registration on Form S-3 that became effective on December 10, 1997. The FSRT Units are entitled to receive quarterly distributions of $0.121 per unit, subject to periodic annual increases, as specified in the partnership agreement. Residual cash flow after distributions to the FSRT Units is distributable to the Company. In the future, the Company may contribute its remaining assets to FSRT at which time the distribution rate on the FSRT Units may be modified at the Company's discretion in accordance with the partnership agreement. The Company is subject to certain restrictions regarding the sale or refinance of the properties owned by FSRT. For the purposes of determining the weighted average number of shares to be used in the net income per share calculation, approximately 1.9 million shares attributable to the dissenting shareholders of FREIF and Advantage were deemed to be share equivalents during the period May 7, 1996 to November 1, 1996. The convertible partnership units are deemed anti-dilutive; consequently there is no difference between basic and diluted earnings per share. In addition, because the Series B shares are not currently convertible, they are not included in the earnings per share calculation. NOTE 6 - RENTAL INCOME The Company's rental income from commercial properties is received principally from tenants under non-cancelable operating leases. The tenant leases typically provide for guaranteed minimum rent plus contingent rents. Minimum future rentals on non-cancelable tenant operating leases at December 31, 1998 are as follows: (IN THOUSANDS) 1999 $13,002 2000 12,451 2001 11,087 2002 9,245 2003 5,525 Thereafter 37,185 ----------- $88,495 =========== Minimum future rentals do not include reimbursements of property operating expenses which were $2,125,000, $2,141,000, and $1,725,000 for the years ended December 31, 1998, 1997 and 1996, respectively. During the years ended December 31, 1998, 1997 and 1996, tenants whose base rental revenues comprised more than 10% of base rental revenues were Lam Research Corporation and Continental Casualty Company who together represented 28%, 31% and 14% of those revenues, respectively. NOTE 7 - RELATED PARTY TRANSACTIONS The Company has an agreement with the Advisor to administer the day-to-day operations of the Company. Under the terms of the agreement, which is renewable annually, the Advisor receives an annualized fee equal to 0.5% of the Company's gross real estate assets, defined generally as the book value of the assets before depreciation, payable quarterly. The fee will be reduced to 0.4% for gross real estate assets exceeding $200 million. The Company's properties are managed by Continental Property Management Co. ("CPMC"), an affiliate of the Advisor. The Company pays a property management fee, leasing commission and construction supervision fee to CPMC based on actual services performed. The fees paid to CPMC do not include any fees or expenses paid to on-site property managers or leasing commissions paid to third parties, both of which are borne by the Company. The agreements between the Company and the Advisor, or affiliates of the Advisor, provide for certain types of compensation and payments including, but not limited to, the following for the years ended December 31, 1998, 1997 and 1996: In thousands 1998 1997 1996 ----------------------------------- Related Party expense: Advisory fee $753 $766 $551 Reimbursement for data processing, accounting and certain other expenses 84 61 63 Property management fee 622 627 591 ----------------------------------- $1,459 $1,454 $1,205 Leasing commissions, capitalized and amortized over the term of the related lease $217 $196 $28 Construction supervision fee, capitalized and Amortized over the life of the related investment or the term of the related lease, as applicable $80 $31 $33 The Company's Board of Directors (including all of its Independent Directors) have determined that the compensation paid to the Advisor and to CPMC is fair and reasonable to the Company. At December 31, 1998 and 1997, cash equivalents included $759,000 and $3,563,000, respectively, which was invested in Franklin Money Fund, an investment company managed by an affiliate of the Advisor. Distributions earned from Franklin Money Fund totaled $148,000, $135,000 and $60,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Advisor and its parent company, Franklin Resources, Inc, are co-defendants in lawsuits brought against the Company described in Note 10. At December 31, 1998 and 1997, accrued expenses included $168,000 and $210,000, respectively, payable to the Advisor or its affiliates. NOTE 8 - DISTRIBUTIONS The allocation of cash distributions per share for individual stockholders' income tax purposes, as reported on Internal Revenue Service Form 1099-DIV, for the years ended December 31, 1998, 1997 and 1996 was as follows: Ordinary Return of Capital Total Year Paid Income Capital Gain Paid - -------------------------------- -------------- ------------ --------- --------- Franklin Select Realty Trust 1998 $0.35 $0.04 $0.09 $0.48 1997 $0.40 $0.04 - $0.44 1996 $0.42 $0.02 - $0.44 Franklin Real Estate Income Fund 1996 (to May 7, 1996) $0.18 $0.03 - $0.21 Franklin Advantage Real Estate Income Fund 1996 (to May 7, 1996) $0.19 $0.03 - $0.22 In December 1994, the Company implemented a Dividend Reinvestment and Share Purchase Plan (the "Plan"), under which a stockholder's cash distributions may be reinvested in shares of Series A common stock of the Company, subject to the terms and conditions of the Plan. Under the Plan, the Company's Dividend Reinvestment Agent makes open market purchases of the Company's Series A common stock, administers the Plan and performs other duties related to the Plan. No new shares have been issued in connection with the Plan. NOTE 9 - SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands, except per share amounts. THREE MONTHS ENDED ------------------------ ---------------------- ------------------------------ ---------------------------- MARCH 31, 1998 JUNE 30, 1998 SEPTEMBER 30, 1998 DECEMBER 31, 1998 ------------------------ ---------------------- ------------------------------ ---------------------------- Revenue $4,593 $4,832 $4,339 $4,173 Net income $1,200 $1,152 $1,082 $1,621 Net income per share $.10 $.09 $.09 $.13 THREE MONTHS ENDED ------------------------ ---------------------- ------------------------------ ---------------------------- MARCH 31, 1997 JUNE 30, 1997 SEPTEMBER 30, 1997 DECEMBER 31, 1997 ------------------------ ---------------------- ------------------------------ ---------------------------- Revenue $4,132 $4,502 $4,491 $4,601 Net income $1,079 $1,095 $1,074 $920 Net income per share $.09 $.09 $.09 $.08
NOTE 10 - LITIGATION The Company is currently defending the former directors of Advantage against a purported class action complaint filed in the California Superior Court for San Mateo on December 2, 1996 by two stockholders for themselves and purportedly on behalf of certain other minority stockholders of Advantage. Other defendants to the complaint currently include Franklin Resources, Inc. and the Company's advisor, Franklin Properties, Inc. The complaint alleges that defendants breached fiduciary duties to plaintiffs and other minority stockholders in connection with the purchase by Franklin Resources, Inc. in August 1994 of a 46.6% interest in Advantage and in connection with the Merger of Advantage into the Company in May 1996, which was approved by a majority of the outstanding shares of each of the three companies. Plaintiffs also allege that defendants misstated certain material facts or omitted to state material facts in connection with these transactions. The complaint includes a variety of additional claims, including claims relating to the investment of Advantage assets, the suspension of the dividend reinvestment program, the allocation of merger-related expenses, revisions to the investment policies of Advantage, and the restructuring of the contractual relationship with the Advisor. Plaintiffs seek damages in an unspecified amount and certain equitable relief. The defendants deny any wrongdoing in these matters and intend to vigorously defend the action. Discovery is continuing. On June 3, 1997, Herbert S. Hodge, Jr., on behalf of himself and certain other shareholders of FREIF, filed an alleged class action complaint in the California Superior Court for San Mateo County against the Company, certain of its directors, the Company's advisor, Franklin Properties, Inc., Franklin Resources, Inc., and Bear Stearns Co., Inc. The complaint alleges that defendants breached fiduciary duties to plaintiff and certain other shareholders in connection with the merger of FREIF into Franklin Select Realty Trust in May 1996. Plaintiff also alleges that defendants misstated certain material facts or omitted to state material facts in connection with this transaction. Plaintiff seeks damages in an unspecified amount. The defendants deny any wrongdoing in these matters and intend to vigorously defend the action. Discovery is continuing. While the outcome of litigation of these claims cannot be predicted with certainty, the Company's management does not believe that the outcome of litigation of these matters will have a material adverse effect on the Company's financial condition, results of operations or cash flows. NOTE 11 - COMMITMENTS AND CONTINGENCIES Management is currently considering a number of options regarding remediation of certain defects in the window system at Fairway Center. The Company has received $525,000 from third parties and expects to receive an additional $312,500 in final settlement of litigation on this matter. Settlement amounts received are included in accrued expenses as the Company evaluates various options to remedy the defects. Present alternatives to correct the defects being investigated include an option to replace a portion of the window system which is estimated to cost $1.5 million. Any additional costs to correct the defects over amounts received from settlement are expected to be capitalized and amortized over the remaining estimated useful life of the building. Any remediations are expected to be funded from cash flow from operations, the liquidation of investments and the Company's existing debt facilities. R E A L E S T A T E A N D A C C U M U L A T E D D E P R E C I A T I O N
FRANKLIN SELECT REALTY TRUST As of December 31, 1998 In thousands COST CAPITALIZED INITIAL SUBSEQUENT TO GROSS AMOUNT AT WHICH COST TO FUND ACQUISITION CARRIED AT CLOSE OF PERIOD Life on Which Depreciation in Buildings Accumu- Latest And lated Year of Operations Encum- Improve- Improve- Deprecia- construc- Date Statement is Description brances Land Buildings ments Land ments Total tion tion Acquired Computed - ---------------------------------------- -------- --------- ------------------------------------- --------- ----------------------- The Shores Redwood City, CA (Note 4) $7,033 $20,499 $2,323 $7,033 $22,822 $29,855 $7,073 82, 87 09/89 35 Data General Building Manhattan Beach, CA - 5,372 16,994 3,787 5,372 20,781 26,153 6,446 82 12/89 35 Northport Buildings Fremont, CA (Note 4) 2,874 8,708 662 2,874 9,370 12,244 2,685 85 01/91 35 Fairway Center (Note 4) Brea, CA $2,418 7,430 14,273 1,508 7,430 15,781 23,211 3,413 87 01/92 35 Lam Research Buildings Fremont, CA 15,790 7,337 19,591 - 7,337 19,591 26,928 1,213 96 10/96 35 Tanon Building Fremont, CA 5,070 1,855 6,680 161 1,855 6,841 8,696 341 83 4/97 35 Hathaway Business Park Fremont, CA 3,484 2,153 5,015 40 2,153 5,055 7,208 170 85 11/97 35 ------------------ -------- --------- -------- --------- ----------------- Total real estate $26,762 $34,054 $91,760 $8,481 $34,054 $100,241 $134,295 $21,341 ======================================== ======== ========= ======== ========= ===================================================
R E A L E S T A T E A N D A C C U M U L A T E D D E P R E C I A T I O N NOTES: (1) The aggregate cost for federal income tax purposes is $127,724. (2) RECONCILIATION OF REAL ESTATE 1998 1997 1996 --------------------------------------- Balance at beginning of $162,387 $141,625 $114,070 period Dispositions (28,870) - - Additions during period: Acquisitions - 19,781 26,928 Improvements and carrying 1,778 981 627 costs --------------------------------------- Balance at end of period $134,295 $162,387 $141,625 ======================================= (3) RECONCILIATION OF ACCUMULATED DEPRECIATION 1998 1997 1996 --------------------------------------- Balance at beginning of $21,289 $17,583 $14,416 period Dispositions (3,554) - - Depreciation expense for 3,606 3,706 3,167 the period --------------------------------------- Balance at end of period $21,341 $21,289 $17,583 ======================================= (4) These assets are pledged as collateral under the Company's $25 million line of credit which was unused at December 31, 1998. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III The information required by Items 10 through 12 of Part III is incorporated herein by reference from the Company's Proxy Statement which will be mailed to stockholders in connection with the Company's annual meeting of stockholders scheduled to be held on April 27, 1999. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company is managed by the Advisor under the terms of an Advisory Agreement, which is renewable annually and is subject to the overall approval of the Board of Directors, a majority of whom are independent of the Advisor. The Company pays the Advisor, as an asset management fee, an annualized fee of 0.5% of the book value of its real estate assets before depreciation. This fee is reduced to 0.4% of the book value before depreciation of real estate assets exceeding $200 million. The fee is calculated and paid at the end of each fiscal quarter of the Company, based on the real estate assets at the end of such quarter. The properties formerly owned by FREIF and Advantage became subject to the Company's advisory fee structure upon the Merger of FREIF and Advantage into and with the Company in May 1996. The Advisory fee paid to the Advisor during the year ended December 31, 1998, is stated in the table below. The Company pays all expenses of its operations except for the following, which are borne by the Advisor; (i) employment expenses of the Company's Chairman, President, Senior Vice President, Chief Financial Officer, Secretary and of the Company's directors who are also officers of the Advisor, (ii) office expenses of the Advisor, and (iii) overhead expenses of the Advisor not properly attributable to the performance of its duties and obligations under the Advisory Agreement. The Advisor and its parent company, Franklin Resources, Inc, are co-defendants in lawsuits brought against the Company described in Item 3 - "Legal Proceedings" above and in the Notes to the Financial Statements. All of the Company's properties are managed by Continental Property Management Co. ("CPMC"), an affiliate of the Advisor. The Company pays a property management fee, leasing commission and construction supervision fee to CPMC based on actual services performed. The fees paid to CPMC do not include any fees or expenses paid to on-site property managers or leasing commissions paid to third parties, both of which are borne by the Company. The fees paid to CPMC for the year ended December 31, 1998, are listed in the table below. During the year ended December 31, 1998, the Company paid or accrued the following amounts for the reimbursements and services noted above: Advisory fee, charged to related party expense $753 Reimbursement for data processing, accounting and certain other expenses charged to related party expense $84 Property management fee, charged to related party expense $622 Leasing commission, capitalized and amortized over the term of $217 the related lease Construction supervision fee, capitalized and amortized over the life of the related investment or the term of the $80 related lease The Company's Board of Directors (including all of its Independent Directors) have determined that the compensation paid to the Advisor and to CPMC is fair and reasonable to the Company. David P. Goss, Mark A. TenBoer and Richard S. Barone, who are officers of the Company, are also officers of the Advisor. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. The financial statements of the Company included in Item 8 of this report are listed on the index on page 20. 2. The supplemental financial statement schedule of the Company included in Item 8 of this report is found on page 37. 3. Exhibits: Exhibit NO. LIST OF EXHIBITS FOOTNOTE 3.1 Articles of Incorporation (1) 3.2 First Amendment to Articles of Incorporation (2) 3.2a Second Amended and Restated Bylaws of Franklin Select Realty Trust (2) 10.1* Amended and Restated Advisory Agreement 10.2 Property Management Agreement (3) 10.3 Agreement of Limited Partnership of FSRT, L.P. between the Company and Northport Associates No. 18, a California limited liability company, dated as October 30, 1996. (4) 10.4 Contribution Agreement, dated as of October 30, 1996, between FSRT, L.P., the Company, Northport Associates No. 18, a California limited liability company, and the members of Northport Associates No. 18. (4) 10.5 Exchange Rights Agreement, dated as of October 30, 1996, among the Company, FSRT L.P., and Northport Associates No. 18, a California limited liability company. (4) 10.6 Registration Rights Agreement, dated as of October 30, 1996, among the Company and Northport Associates No. 18, a California limited liability company. (4) 10.7 Secured line of credit loan agreement, dated December 10, 1996, by and between the Company and Bank of America. 21.1* Subsidiaries of the Company. 23.1* Consent of independent accountants 27.1* Financial data schedule * Filed herewith. FOOTNOTES (1) Documents were filed in the Company's Form S-11 Registration Statement, dated March 30, 1989 (Registration No. 033-26562) and are incorporated herein by reference. (2) Documents were filed in the Company's Form S-4 Registration Statement, dated November 13, 1995, (Registration No. 033-64131), and are incorporated herein by reference. (3) Documents were filed in the Company's Form 10-K for the year ended December 31, 1994, and are incorporated herein by reference. (4) Documents were filed in the Company's Form 8-K, dated October 31, 1996, and are incorporated herein by reference. (b) Reports filed on Form 8-K During the quarter ended December 31, 1998, the Company filed reports on Form 8K as follows: (i) On December 2, 1998, the Company filed a report dated July 1, 1998, (date of earliest event reported). This report contained information about the sale of its three retail properties i.e. Carmel Mountain Gateway Plaza, Mira Loma Shopping Center and Glen Cove Center. (ii) On December 15, 1998, the Company filed a report dated December 3, 1998 (date of earliest event reported). This report contained information about Tanon Manufacturing, Inc., a tenant that filed a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code. SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN SELECT REALTY TRUST (Company) Date: MARCH 3, 1999 By: S/ DAVID P. GOSS ------------------------------ ----------------- David P. Goss Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company, and in the capacities and on the dates indicated. SIGNATURE TITLE DATE - --------- ----- ---- s/David P. Goss Chief Executive Officer, March 3, 1999 - ----------------------------- and Director ------------------------ David P. Goss s/Barry C. L. Fernald Director1 March 3, 1999 - ----------------------------- ------------------------ Barry C. L. Fernald s/Lloyd D. Hanford, Jr. Director1 March 3, 1999 - ----------------------------- ------------------------ Lloyd D. Hanford, Jr. s/Egon H. Kraus Director1 March 3, 1999 - ----------------------------- ------------------------ Egon H. Kraus s/Frank W. T. LaHaye Director1 March 3, 1999 - ----------------------------- ------------------------ Frank W. T. LaHaye s/Larry D. Russel Director1 March 3, 1999 - ----------------------------- ------------------------ Larry D. Russel s/E. Samuel Wheeler Director1 March 3, 1999 - ----------------------------- ------------------------ E. Samuel Wheeler 1 Independent Director Exhibit 10.1 Amended and Restated Advisory Agreement AMENDED AND RESTATED ADVISORY AGREEMENT between FRANKLIN SELECT REALTY TRUST and FRANKLIN PROPERTIES, INC. THIS AMENDED AND RESTATED ADVISORY AGREEMENT ("Agreement") is dated as of January 1, 1999, between FRANKLIN SELECT REALTY TRUST, a California corporation (the "Company"), and FRANKLIN PROPERTIES, INC., a California corporation (the "Advisor"). WHEREAS, the Company and the Advisor entered into a certain agreement (the "Old Agreement") captioned "Advisory Agreement between Franklin Select Real Estate Income Fund and Franklin Properties, Inc.," dated as of March 1, 1989. WHEREAS, the Company and the Advisor entered into a certain agreement captioned "First Amendment to Advisory Agreement between Franklin Select Real Estate Income Fund and Franklin Properties Inc.," dated as of October 1, 1994, pursuant to which the Agreement was amended to reflect certain changes in the compensation paid to the Advisor as approved by the shareholders. WHEREAS, the Company and the Advisor desire to amend and restate the Old Agreement so that all of the terms between the Company and the Advisor are set forth in one agreement, as hereinafter set forth. NOW, THEREFORE, in consideration of the premises and of the mutual covenants in the Old Agreement and this Agreement, the parties agree as follows: 1. DUTIES OF ADVISOR. The Advisor agrees to use its best efforts to present to the Company (a) a continuing and suitable investment program consistent with the investment policies and objectives of the Company and (b) investment opportunities of a character consistent with the investment program as the Directors may adopt from time to time. In performance of this undertaking, subject to the supervision of the Directors and upon their direction, and consistent with the provisions of the Articles of Incorporation and Bylaws of the Company, the Advisor shall: (a) furnish or obtain and supervise the day-to-day operations of the Company; (b) serve as the Company's investment and financial advisor and provide research, economic and statistical data in connection with the Company's investments and investment and financial policies; (c) on behalf of the Company, investigate, select and conduct relationships with consultants, investment banks, lenders, mortgagors, brokers, investors, shareholders, transfer agents, builders, developers and others; (d) consult with the Directors and furnish the Directors with advice and recommendations with respect to making, acquiring (by purchase, investment, exchange or otherwise), holding and disposing (through sale, exchange or otherwise) of investments consistent with the policies and provisions of the Company; (e) on behalf of the Company, investigate, select and commit to purchase (subject to board approval) investments consistent with the policies and provisions of the Company and in accordance with the policies and guidelines established by the Directors, provided that actual investments shall be made only with the prior approval of a majority of a quorum of the Directors or by written consent of all Directors; (f) obtain for the Directors such services as may be required in acquiring and disposing of investments, disbursing and collecting the funds of the Company, paying the debts and fulfilling the obligations of the Company and handling, prosecuting and settling any claims of the Company; (g) obtain for the Company such services as may be required for property management, including property management services rendered by an affiliate of the Advisor, and other activities relating to the investment portfolio of the Company; (h) advise in connection with and conduct negotiations by or on behalf of the Company with investment banking firms, securities brokers or dealers and other institutions or investors for public or private sales of Shares or other securities of the Company, or obtain loans for the Company, but in no event in such a way that the Advisor could be deemed to be acting as a broker-dealer or underwriter; (i) provide, at the Company's expense, office space, office furnishings, personnel and other overhead items necessary and incidental to the Company's business and operations; (j) from time to time or at any time requested by the Directors, make reports to the Directors of its performance of services under this Agreement; (k) obtain appraisal reports, where appropriate, on investments or contemplated investments of the Company; (l) provide, at the Company's expense and at the direction of the Board of Directors, accounting and related services necessary to the preparation of the Company's financial statements, regulatory filings, and tax returns; and (m) do all things necessary to assure its ability to render the services described in this Agreement. 2. NO PARTNERSHIP OR JOINT VENTURE. The Company and the Advisor are not partners or joint venturers with each other and nothing in this Agreement shall be construed to make the parties partners or joint venturers or impose any liability as a partner or joint venturer on either of them. 3. RECORDS. At all times, the Advisor shall keep proper books of account and records relating to services performed under this Agreement, which shall be accessible for inspection by the Company at any time during ordinary business hours. 4. REIT QUALIFICATIONS. Notwithstanding anything else in this Agreement, the Advisor shall refrain from any action (including, without limitation, performing services for tenants of property or managing or operating real property) which, in its sole judgment made in good faith or in the judgment of the Directors of which the Advisor has written notice, would adversely affect the status of the Company as a real estate investment trust as defined and limited in the Code, which would violate any law, rule, regulation or statement of policy of any governmental body or agency having jurisdiction over the Company or over its securities, or which would otherwise not be permitted by the Company's Bylaws. 5. BANK ACCOUNTS. The Advisor, at the expense of the Company, may establish and maintain one or more bank accounts in its own name, and may collect and deposit into any one or more accounts, and disburse from any account or accounts, any money on behalf of the Company, on the terms and conditions as the Directors may approve, provided that no funds shall be commingled with funds of the Advisor; and the Advisor shall from time to time give an appropriate accounting of collections and payments to the Directors and to the auditors of the Company. 6. BOND. The Advisor, if and to the extent that the Directors require, shall maintain a fidelity bond with a responsible surety company in such amount as the Directors may require from time to time, covering all directors, officers, employees and agents of the Advisor handling funds of the Company and any investment documents or records pertaining to investments of the Company. The bond shall inure to the benefit of the Company in respect of losses of any property from acts of the directors, officers, employees and agents of the Advisor through theft, embezzlement, fraud, negligence, error or omission or otherwise. The premium for the bond shall be an expense of the Company. 7. INFORMATION FURNISHED ADVISOR. The Directors shall at all times keep the Advisor fully informed with regard to the investment policy of the Company, the capitalization policy of the Company and, generally, their current intentions as to the future of the Company. In particular, the Directors shall notify the Advisor promptly of their intention to sell or otherwise dispose of any of the Company's investments or to make any new investment. The Company shall furnish the Advisor with a certified copy of all financial statements, a signed copy of each report prepared by independent certified public accountants and all other information with regard to the Company's affairs as the Advisor may reasonably request. 8. CONSULTATION AND ADVICE. In addition to the services described elsewhere in this Agreement, the Advisor shall consult with the Directors, and shall, at the request of the Directors or the officers of the Company, give advice and recommendations with respect to other aspects of the business and affairs of the Company. In general, the Advisor shall inform the Directors of any factors, which come to its attention which the Advisor believes would influence the policies of the Company, except to the extent that giving that information would involve a breach of fiduciary duty. 9. DEFINITIONS. As used in this Agreement, the following terms shall have the meanings indicated: (a) "Affiliate" means as to any Person (i) any other Person directly or indirectly controlling, controlled by or under common control with such Person, (ii) any other person owning or controlling 10% or more of the outstanding voting securities or beneficial interest of such Person, (iii) any officer, director, trustee or general partner of such Person and (iv) if such other Person is an officer, director, trustee or partner of another entity, then the entity for which that Person acts in any such capacity. (b) "Average Invested Assets" means for any period the average of the aggregate book value of the assets of the Company invested, directly or indirectly, in equity interests in and loans secured by real estate, before reserves for depreciation or bad debts or other similar non-cash reserves computed by taking the average of such values at the end of each month during such period. (c) "Fiscal Year" means any period for which an income tax return is submitted to the Internal Revenue Service and which is treated by the Internal Revenue Service as a reporting period for the Company. (d) "Mortgage Investment" means the assets of the Company invested in any mortgage loans, mortgage-backed securities, notes, bonds or other evidences of indebtedness or obligations which are secured or collateralized by interests in real estate. (e) "Net Income" means the total revenues of the Company for any period, computed on the basis of its results of operations for that period, after deduction of all expenses, excluding, however, any additions to reserves for depreciation or bad debts or other similar non-cash reserves. (f) "Person" means an individual, corporation, partnership, joint venture, association, company, trust, bank or other entity, or government and any agency and political subdivision of a government. (g) "Real Estate Assets" means for any calendar quarter, the aggregate book value of the assets of the Company on the last day of the quarter, invested directly or indirectly in interests in real estate, before reserves for depreciation, bad debts, or other similar non-cash reserves, as set forth in the Company's financial statements (which may be unaudited except as elsewhere provided in this Agreement), prepared quarterly on an accrual basis in accordance with generally accepted accounting principles. Real Estate Assets do not include Mortgage Investments. 10. ADVISOR COMPENSATION (a) At the end of each calendar quarter or such other interval as the parties shall agree, the Company shall pay to the Advisor as compensation for the advisory services rendered to the Company hereunder an annualized fee equal to the sum of (a) one-half of one percent (.5%) of the Real Estate Assets up to and including $200,000,000 and (b) four-tenths of one percent (.4%) of the Real Estate Assets, if any, in excess of $200,000,000. (b) The Board has commenced a review of various strategic alternatives available to Franklin Select Realty Trust (the "Company") which may lead to a merger or sale of the REIT and/or its assets. However, it is difficult to forecast how long this process may take or whether such a transaction will occur. The Board recognizes that under these circumstances it may be difficult for the Adviser to retain key employees necessary to the operation of the Company. Moreover, the Board acknowledges that the Company will derive substantial benefit in the execution of its strategic objectives if certain key employees are retained until the strategic review is complete. Therefore, the Board, on behalf of the company, may determine to establish a fund for the purpose of creating an incentive to certain key employees of the Advisor who might otherwise depart before the completion of the Board's strategic review. The fund will be disbursed at the discretion of the Board with the advice of the Advisor. Any such funds will be paid to Advisor and paid to employees. 11. STATEMENTS. The Advisor shall furnish to the Company at least quarterly, beginning with the second calendar quarter of the term of this Agreement, a statement showing the computation of the fee payable in respect of the preceding calendar quarter under Section 10, even after the termination of this Agreement. The final settlement of any fees for each Fiscal Year shall be subject to adjustment in accordance with, and upon completion of, the annual audit of the Company's financial statement; any payment by the Company or repayment by the Advisor indicated as a result of the audit shall be made promptly after the completion of the audit and shall be reflected in the audited statements to be published by the Company. 12. COMPENSATION FOR ADDITIONAL SERVICES. (a) Where appropriate in the sole judgment of the Directors or the Advisor, an Affiliate of the Advisor may be retained to perform property management services for the Company. (b) If and to the extent that the Company shall request the Advisor, or any director, officer, partner or employee of the Advisor, to perform services for the Company other than those required under this Agreement, the additional services, if performed, will be compensated separately on terms to be agreed between that party and the Company. 13. EXPENSES OF THE ADVISOR. Without regard to the amount of compensation received under this Agreement by the Advisor, the Advisor shall bear the following expenses: (a) employment expenses of the officers and directors of the Advisor; (b) telephone, utilities, office furniture and furnishings and other office expenses of the Advisor; and (c) miscellaneous administrative and other expenses of the Advisor not relating to the performance by the Advisor of its functions hereunder. 14. EXPENSES OF THE COMPANY. Except as expressly otherwise provided in this Agreement, the Company shall pay all its expenses not expressly assumed by the Advisor, and without limiting the generality of the foregoing it is specifically agreed that the following expenses of the Company shall be paid by the Company and shall not be paid by the Advisor: (a) the cost of money borrowed by the Company; (b) taxes on income and taxes and assessments on real property and all other taxes applicable to the Company; (c) real estate brokerage and sales commissions with respect to the purchase or sale of real estate assets of the Company payable to real estate brokers who cooperate with the Advisor in such transactions, and brokerage and sales commissions with respect to the purchase or sale of Mortgage Investments payable to mortgage brokers who cooperate with the Advisor in such transactions; (d) legal, accounting, underwriting commissions and fees and any other fees and costs, including due diligence, qualification of securities for sale in various states, listing of securities on a securities exchange, printing, engraving and other expenses and taxes incurred in connection with the issuance, distribution, transfer, registration, marketing and listing of the Company's securities, including compensation of employees of the Advisor and direct expenses of officers and employees of the Advisor and affiliates while directly engaged in such activities on behalf of the Company; (e) fees, salaries and other employment costs, taxes and expenses paid to Directors, officers and employees of the Company, including persons who may be employees of the Advisor, other than officers of the Advisor, or of any company which controls, is controlled by or is under common control with the Advisor, incurred with respect to and allocable to the prudent operation and business of the Company, other than as provided under Section 13(a) above. (f) fees and expenses paid to independent contractors, appraisers, consultants, managers and other agents retained by or on behalf of the Company and expenses (including expenses for Persons who may also be officers or employees of the Advisor) connected with the acquisition, financing, refinancing, disposition and ownership of real estate interests or other property, including insurance premiums, legal services, brokerage and sales commissions, maintenance, repair and improvement of property; (g) expenses of maintaining and managing real estate interests; (h) insurance as required by the Directors (including Directors' liability insurance); (i) the expenses of organizing, revising, amending, converting, modifying or terminating the Company; (j) expenses connected with payments of dividends or interest or distributions in cash or any other form made or caused to be made by the Directors to holders of securities of the Company; (k) all expenses connected with communications to holders of securities of the Company and the other bookkeeping and clerical work necessary in maintaining relations with holders of securities, including the cost of printing and mailing certificates for securities, proxy solicitation materials and reports to holders of the Company's securities; (1) the cost of any accounting, statistical or bookkeeping equipment necessary for the maintenance of the books and records of the Company; (m) transfer agent's, registrar's, dividend disbursing agent's, dividend reinvestment plan agent's and indenture trustee's fees and charges; (n) legal, accounting and auditing fees and expenses not included in (d) and (f) of this Section 14; and (o) other ordinary and necessary expenses of the business and affairs of the Company, other than those allocable to the Advisor under Section 13 above. The Company shall reimburse the Advisor or its affiliates for the cost of rent, goods or materials furnished or advanced by them for the benefit of the Company, and for services rendered for the benefit of the Company. The Company's costs for services and goods provided by the Advisor to the Company shall be based upon the cost to the Advisor and an allocable portion of the actual compensation (including employment taxes and benefits) of Persons involved plus an appropriate share of overhead allocable to each Person who rendered services for the benefit of and on the business affairs of the Company. The amounts charged to the Company by the Advisor and its Affiliates shall not exceed those which the Company would be required to pay to independent parties for comparable rent, materials, goods or services. 15. REFUND BY ADVISOR. In addition to the provisions of Section 10 hereof, within 60 days after the end of any calendar year which begins following the date the Company first commences operations after reaching its minimum capital subscription amount, the Advisor will refund to the Company the amount, if any, by which the Operating Expenses (as defined in this Section 15) of the Company during such Calendar Year exceeded the greater of (a) 2% of the Average Invested Assets or (b) 25% of Net Income unless the Independent Directors of the Company shall have affirmatively determined that due to unusual and non-recurring factors, such higher level of Operating Expenses is justified for such year. For the purposes of this Section 15, "Operating Expenses" during the Calendar Year means the aggregate annual expenses of every character regarded as Operating Expenses in accordance with generally accepted accounting principles, as determined by independent accountants selected by the Directors, including regular compensation payable to the Advisor, excluding, however, the following: (i) the cost of money borrowed by the Company; (ii) taxes on income and taxes and assessments on real property and all other taxes applicable to the Company; (iii) expenses of acquiring, financing, refinancing, disposing of, maintaining, managing and owning real estate equity interests or other property (including the costs of legal services, brokerage and sales commissions, maintenance, repair and improvement of property); (iv) insurance as required by the Directors (including any Directors' liability insurance); (v) expenses of organizing, revising, amending, converting, or terminating the Company; (vi) expenses connected with payments of dividends or interest or distributions in cash or any other form made or caused to be made by the Directors to holders of securities of the Company; (vii) all expenses connected with communications to holders of securities of the Company and the other bookkeeping and clerical work necessary in maintaining relations with holders of securities of the Company, including the cost of printing and mailing certificates for securities and proxy solicitation materials and reports to holders of securities of the Company; (viii) transfer agent's, registrar's, dividend disbursing agent's, warrant agent's, dividend reinvestment plan agent's and indenture trustee's fees and charges, (ix) other legal, accounting and auditing fees and expenses; and (x) non-cash expenditures (including depreciation, amortization and bad debt reserve). 16. OTHER ACTIVITIES. Nothing in this Agreement shall prevent the Advisor or any of its officers, directors or employees or any of its affiliates from engaging in other business activities related to real estate investments, from making investments permitted to the Company by the Company's Bylaws or from acting as advisor to any other person or entity even though having investment policies similar to the Company (including another real estate investment trust). The Advisor and its officers, directors or employees and any of its Affiliates shall be free from any obligation to present to the Company any particular investment opportunity which comes to the Advisor or such persons, regardless of whether such opportunity is within the Company's investment policies, provided, that the Advisor will give due consideration to the investment objectives and financial capabilities of the Company in determining whether to present an investment opportunity to the Company or to another entity for which the Advisor provides similar services. 17. TERM: TERMINATION OF AGREEMENT. This Agreement shall continue in force through December 31, 1999, and thereafter it may be renewed annually, subject to the approval thereof by a majority of the Independent Directors. Notice of renewal shall be given in writing by the Directors to the Advisor not less than 60 days before the expiration of this Agreement or of any extension of this Agreement. Notwithstanding any other provision to the contrary, this Agreement may be terminated for any reason upon 60 days' written notice by the Company to the Advisor or 180 days' written notice by the Advisor to the Company, in the former case by the action of the Directors, the Independent Directors or a majority of the shareholders of the Company. 18. AMENDMENTS. This Agreement shall not be changed, modified, terminated or discharged in whole or in part except by an instrument in writing signed by both parties, or their respective successors or assigns, or otherwise as provided in this Agreement. 19. ASSIGNMENT. This Agreement shall not be assignable by the Advisor without the consent of the Company, except an assignment to an Affiliate of the Advisor, or to a corporation, association, trust or other successor organization which may take over the property and carry on the affairs of the Advisor. A proper assignment or any other assignment of this Agreement by the Advisor shall bind the assignee under this Agreement and by the terms of the assignment in the same manner as the Advisor is bound. This Agreement shall not be assignable by the Company without the consent of the Advisor, except in the case of assignment by the Company to a corporation, association, trust or other organization which is a successor to the Company. The successor shall be bound under this Agreement and by the terms of said assignment in the same manner as the Company is bound. 20. DEFAULT, BANKRUPTCY, ETC. At the option solely of the Directors, this Agreement shall be and become terminated immediately upon written notice of termination from the Directors to the Advisor if any of the following events shall occur: (a) If the Advisor shall violate any provision of this Agreement, and after notice of the violation shall not have cured the default within thirty (30) days or begun action within thirty (30) days to cure the default which shall be completed with reasonable diligence; or (b) If the Advisor shall be adjudged bankrupt or insolvent by a court of competent jurisdiction, or an order shall be made by a court of competent jurisdiction for the appointment of a receiver, liquidator or trustee of the Advisor or of all or substantially all of its property by reason of the foregoing, or approving any petition filed against the Advisor for its reorganization, and the adjudication or order shall remain in force or unstayed for a period of thirty (30) days; or (c) If the Advisor shall institute proceedings for voluntary bankruptcy or shall file a petition seeking reorganization under the federal bankruptcy laws, or for relief under any law for the relief of debtors, or shall consent to the appointment of a receiver for itself or for all or substantially all its property, or shall make a general assignment for the benefit of its creditors, or shall admit in writing its inability to pay its debts generally as they become due. The Advisor agrees that if any of the events specified in subsections (b) and (c) of this Section 20 shall occur, it will give written notice of the event to the Directors within seven (7) days after the occurrence of the event. 21. ACTION UPON TERMINATION. From and after the effective date of termination of this Agreement, pursuant to Sections 17, 19 or 20 herein, the Advisor shall not be entitled to compensation for further services performed after the date of termination, but shall be paid all compensation accruing to the date of termination, including compensation which may have been earned but deferred. The Advisor shall promptly upon termination: (a) pay over to the Company all moneys collected and held for the account of the Company pursuant to this Agreement, after deducting any accrued compensation and reimbursement for its expenses to which it is then entitled; (b) deliver to the Directors a full accounting, including a statement showing all payments collected by it and a statement of all moneys held by it, covering the period following the date of the last accounting furnished to the Directors; (c) deliver to the Directors all property and documents of the Company then in the custody of the Advisor except for copies of documents, which the Advisor may keep; and (d) cooperate with the Directors to provide an orderly management transition. 22. CHANGE OF NAME. Upon termination of this Agreement by either party, the Directors shall forthwith cause the name of the Company to be changed to a name not containing the name "Franklin" or any approximations or abbreviations of that name and sufficiently dissimilar to that name as to be unlikely to cause confusion with that name. 23. INDEMNIFICATION. The Advisor, its officers, directors, shareholders, employees, agents, subsidiaries and assigns shall be indemnified by the Company against any liability to the Company or its shareholders resulting from errors in judgment or other acts or omissions, whether or not disclosed, unless a court of competent jurisdiction determines that the liabilities or losses resulted from fraud, negligence, misconduct or other breach of fiduciary duty by that Person. 24. MISCELLANEOUS. The Advisor assumes no responsibility under this Agreement other than to perform the services called for in good faith, and shall not be responsible for any action of the Directors in following or declining to follow any advice or recommendations of the Advisor. Neither the Advisor nor its shareholders, directors, officers or employees shall be liable to the Company, the Directors, the holders of securities of the Company or to any successor or assigns of the Company except by reason of acts constituting the negligent performance of their duties. 25. NOTICES. Any notice, report or other communication required or permitted to be given hereunder shall be in writing unless some other method of giving such notice, report or other communication is accepted by the party to whom it is given, and shall be given by being delivered at the following addresses: The Directors and/or the Company: Franklin Select Realty Trust 777 Mariners Island Boulevard San Mateo, California 94403-7777 The Advisor: Franklin Properties, Inc. 777 Mariners Island Boulevard San Mateo, California 94403-7777 Either party may at any time give notice in writing to the other party of a change of its address for the purpose of this Section 25. 26. HEADINGS. The section headings have been inserted for convenience of reference only and shall not be construed to affect the meaning, construction or effect of this Agreement. 27. GOVERNING LAW. The provisions of this Agreement shall be construed and interpreted in accordance with the laws of the State of California as they apply to agreements solely among California residents to be executed and performed entirely in California. 28. EXECUTION. This instrument is executed and made on behalf of the Company by an officer who is a Director of the Company, not individually but solely as an officer pursuant to the Company's Bylaws and the obligations under this Agreement are not binding upon, nor shall resort be had to the private property of, any of the Directors, shareholders, officers, employees or agents of the Company personally, but bind only the Company. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. COMPANY: FRANKLIN SELECT REALTY TRUST By /s/ David P. Goss President ADVISOR: FRANKLIN PROPERTIES, INC. By /s/ David P. Goss President Exhibit 21.1 Subsidiaries of Franklin Select Realty Trust SUBSIDIARY NAME STATE OF ORGANIZATION NAME UNDER WHICH SUBSIDIARY IS DOING BUSINESS FSRT L.P. Delaware FSRT L.P. Exhibit 23.1 Consent of independent accountants We consent to the incorporation by reference in the registration statement of Franklin Select Realty Trust (the "Company") on Form S-3 (File No 333-38463) of our report dated January 20, 1999, on our audits of the consolidated financial statements and financial statement schedule of the Company as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998, which is included in this Annual Report on Form 10-K. PRICEWATERHOUSECOOPERS LLP San Francisco, California March 4, 1999 EX-27 2
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM REGISTRANT'S FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1998 DEC-31-1998 1,256 7,700 11,982 0 0 20,938 134,295 21,341 133,892 30,210 0 0 0 109,455 (14,954) 133,892 0 19,272 0 11,287 0 0 2,930 5,055 0 0 0 0 0 5,055 0.41 0.41
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