<PAGE>
PROSPECTUS
2,833,334 Shares
RESOURCE ASSET INVESTMENT TRUST
Common Shares
Resource Asset Investment Trust ("RAIT" and, together with its
subsidiaries, the "Company") is a newly organized Maryland real estate
investment trust. RAIT will elect to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). RAIT
has formed two subsidiaries that will be the general partner and initial
limited partner, respectively, of a newly-formed Delaware limited partnership,
RAIT Partnership, L.P. (the "Operating Partnership"), through which
substantially all of the Company's assets will be owned.
All of the 2,833,334 common shares of beneficial interest of the Company
(the "Common Shares") offered pursuant to this Prospectus (the "Offering") are
being offered by the Company. In addition, 500,000 Common Shares will be sold
by the Company to Resource America, Inc. ("RAI") upon the completion of this
Offering at the initial public offering price net of any underwriting discounts
or commissions.
Prior to this Offering, there has been no market for the Common Shares.
The public offering price has been determined by negotiation between the
Company and the Underwriters. See "Underwriting." The Common Shares have been
approved for listing on the American Stock Exchange ("Amex"), subject to
official notice of issuance, under the symbol "RAS".
See "Risk Factors" beginning on page 13 for certain factors relevant to an
investment in the Common Shares including, among others:
o The Company's principal business activity will be to provide mortgage
financing in situations that, generally, will not conform to the
underwriting standards of institutional lenders or sources that provide
financing through securitization, and will emphasize wraparound loans and
other forms of junior lien or subordinate financing. Financing provided by
the Company, accordingly, will be subject to greater risks of loss than
institutional and senior lien financing.
o Discounted loans acquired by the Company (including eight discounted loans
with an aggregate loan receivable amount of $72.4 million to be acquired
from RAI for $10.0 million as part of the Company's Initial Investments)
typically will be in default under their original loan terms, but will be
subject to forbearance agreements between lenders and borrowers that
postpone exercise of default remedies so long as certain payment and other
conditions are met. These loans may be subject to high rates of default
following expiration of the forbearance agreements.
o The Company has committed only 45% of the net proceeds of the Offering
(assuming the Underwriters do not exercise their overallotment option) to
specific investments. Accordingly, investors will not have an opportunity
to evaluate a material portion of the Company's investments.
o The Company has broad discretion in acquiring real properties or interests
in real properties.
o The Company's investments will be sensitive to many economic factors over
which the Company has no control.
o The Company's senior management has limited prior experience in managing a
REIT.
o The Company's investment policies may be revised by the Board of Trustees
without shareholder approval.
o The Company is a newly-formed entity with no history of operations upon
which to base an investment decision.
o The Company may incur debt in its business activities and, accordingly,
will be subject to the risks associated with the use of leverage.
o Ownership of the Common Shares by each shareholder other than RAI is
limited to 8.3% of the outstanding Common Shares, which may deter third
parties from seeking control of, or seeking to acquire, the Company.
o As a result of relationships among the Company, RAI, Brandywine
Construction & Management, Inc. ("Brandywine") and their affiliates,
conflicts of interest may arise in connection with the price and terms at
which investments are sold or services provided to the Company by RAI,
Brandywine and their affiliates.
o The Company will be taxed as a regular corporation if it fails to qualify
as a REIT.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
===============================================================================
Price to Underwriting Proceeds to
Public Discount(1) Company(2)
- -------------------------------------------------------------------------------
Per Share ......... $15.00 $1.05 $13.95
- -------------------------------------------------------------------------------
Total(3)(4) ...... $49,343,760 $2,843,751 $46,500,009
===============================================================================
(1) Does not reflect: (i) reimbursement by the Company of certain out-of-pocket
expenses incurred by the Underwriters, to a maximum of $100,000; (ii)
warrants granted to Friedman, Billings, Ramsey & Co., Inc., the
representative of the Underwriters (the "Representative"), to purchase up
to 141,667 Common Shares at the initial public offering price, exercisable
for a period of four years commencing one year following the effective
date of the Offering; and (iii) a two year right granted to the
Representative to be first offered the right to act as financial advisor
to or lead underwriter for the Company with respect to certain
transactions, including sales of assets, equity or debt securities,
mergers, acquisitions and capital markets transactions. The Company also
has agreed to indemnify the Underwriters against certain liabilities,
including liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(Cover page continued on following page.)
The Common Shares are offered by the Underwriters, subject to receipt and
acceptance by the Underwriters, approval of certain legal matters by counsel
for the Underwriters and certain other conditions. The Underwriters reserve the
right to withdraw, cancel or modify such offers and to reject orders in whole
or in part. It is expected that delivery of the Common Shares will be made in
New York, New York on or about January 14, 1998.
--------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
The date of this Prospectus is January 8, 1998.
<PAGE>
(2) Before deducting expenses in connection with the Offering, estimated at
$714,000, including the Underwriters' expenses referred to in (1), above,
which will be payable by the Company.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
425,000 additional Common Shares to cover over-allotments. If all such
Common Shares are purchased, the total Price to Public, Underwriting
Discount and Proceeds to Company before expenses of this Offering will be
$55,718,760, $3,290,001 and $52,428,759, respectively. See "Underwriting."
(4) The total Price to Public and the total Proceeds to Company include the
proceeds of the sale of 500,000 Common Shares to RAI and up to 125,000
Common Shares to directors, trustees and officers of the Company, RAI and
Brandywine Construction & Management, Inc. (an affiliate of RAI), together
with members of their respective families and relatives, in each case net
of the Underwriting Discount.
After the sale of Common Shares to RAI, RAI will own 15% of the Company's
outstanding Common Shares, assuming that the Underwriters do not exercise their
over-allotment option. The Company will purchase 88% of its initial mortgage
loan investments (the "Initial Investments") from RAI for $18.1 million, which
will constitute 45% of the aggregate of the net proceeds of this offering and
the proceeds of the sale of Common Shares to RAI (40% if the Underwriters
exercise their over-allotment option). In addition, the Company will reimburse
RAI for legal, accounting and filing fees and expenses, executive salaries,
rent and other organizational expenses (which are estimated to be $526,900) and
for the expenses incurred by RAI, including an allocation of employee
compensation, in sponsoring the Company (which are estimated to be $562,000).
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON SHARES,
INCLUDING STABILIZATION, THE PURCHASE OF COMMON SHARES TO COVER SYNDICATE SHORT
POSITIONS, AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
2
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TABLE OF CONTENTS
Page
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PROSPECTUS SUMMARY .......................................... 5
FORMATION AND STRUCTURE ....................................... 12
RISK FACTORS ................................................ 13
Investment Activity Risks .................................... 13
Financing Considerations .................................... 13
Value of Company's Financings Dependent on Condi-
tions Beyond Company's Control 13
Longer Term, Subordinate and Non-Conforming Financ-
ing Is Illiquid and Value May Decrease 13
Lengthy Financing Commitment Periods May Reduce
Company's Returns ....................................... 13
Investment in Subordinate Financing May Involve
Increased Risk of Loss ................................. 13
Investment in Non-Conforming Loans May Involve
Increased Risk of Loss ................................. 14
Interest Rate Changes May Adversely Affect Company's
Investments ............................................. 14
Limited Number of Investments Will Make Company
More Dependent Upon Performance of Individual
Investments ............................................. 15
Lack of Geographic Diversification Exposes Company's
Investments to Higher Risk of Loss Due to Regional
Economic Factors ....................................... 15
Competition for Financing May Inhibit Company's Abil-
ity to Achieve Objectives 15
Participations May Reduce Interest Rates Without
Resulting in Additional Returns ........................ 15
Loans Secured by Interests in Entities Owning Real
Properties May Involve Increased Risk of Loss ............ 16
Usury Statutes May Impose Interest Ceilings and Sub-
stantial Penalties for Violations 16
Discounted Loans May Have High Rates of Default ............ 16
Construction Financing May Increase Repayment Risk . 17
Real Property Considerations ................................. 17
Value of Company's Property Interests Dependent on
Conditions Beyond Company's Control ..................... 17
Property Interests are Illiquid and Value May Decrease . 17
Uninsured and Underinsured Losses May Affect Value
of, or Returns from, Property Interests .................. 17
Investments in Joint Ventures, Partnerships or Other
Interests May Result in Less Control by Company ......... 17
Compliance with Americans with Disabilities Act and
Other Governmental Rules and Regulations Will
Decrease Returns on Property Interests .................. 18
Property Taxes Decrease Returns on Property Interests . 18
Real Properties with Environmental Problems May Create
Liability for the Company ................................. 18
Considerations Relating to Initial Investments ............... 18
Multifamily and Commercial Loans Included in Initial
Investments Involve a Greater Risk of Loss than
Single Family Loans .................................... 18
Geographic Concentration of Initial Investments in
Pennsylvania May Make Company's Performance
Subject to Economic Conditions in Pennsylvania ......... 19
Initial Investments Include Loans in Default Under
Original Loan Terms and This May Involve Higher
Payment Risks than Performing Loans ..................... 19
Other Investment Activity Risks .............................. 19
Appropriate Investments May Not Be Available and Full
Investment of Net Proceeds May Be Delayed ............... 19
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Page
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Newly-Formed Entity; Limited REIT Management
Experience of Senior Management ........................ 19
Importance of Key Personnel ................................. 20
Leverage Can Reduce Income Available for Distribution
and Cause Losses ....................................... 20
Legal and Tax Risks .......................................... 20
Failure to Maintain REIT Status Would Result in Com-
pany Being Taxed as a Regular Corporation 20
"Phantom Income" May Require Company to Borrow or
Sell Assets to Meet REIT Distribution Requirements . 21
Origination Fees Which May Be Received by the Com-
pany Will Not Be REIT Qualifying Income 21
Income from Wraparound Loans May Not Be REIT
Qualifying Income in Some Instances ..................... 21
Gain on Disposition of Assets Deemed Held for Sale in
Ordinary Course Subject to 100% Tax ..................... 22
Loss of Investment Company Act Exemption Would
Affect Company Adversely ................................. 22
Investment in Common Stock by Certain Benefit Plans
May Give Rise to Prohibited Transaction under
ERISA and the Code ....................................... 22
Board of Trustees May Change Policies Without Share-
holder Consent 23
Limitation of Liability of Officers and Trustees ............ 23
Conflicts of Interest in the Business of the Company ...... 23
Failure to Develop Active Market for Common Shares
May Result in Decreased Market Price ..................... 23
Ownership Limitation May Restrict Business Combina-
tion Opportunities 23
Preferred Shares May Prevent Change in Control ............ 23
Maryland Anti-Takeover Statutes May Restrict Business
Combination Opportunities .............................. 23
Future Offerings of Capital Stock May Result in Dilution
of the Book Value Per Common Share ..................... 24
CONFLICTS OF INTEREST ....................................... 24
USE OF PROCEEDS ............................................. 26
INVESTMENT OBJECTIVES AND POLICIES ........................... 27
General ................................................... 27
Types of Financing .......................................... 27
Loan Origination Sources .................................... 28
Certain Financial Guidelines .............................. 29
Location of Properties Relating to Financings ............... 29
Types of Properties Relating to Financings .................. 29
Acquisition of Loans at Discount ........................... 30
Lending Procedures .......................................... 30
Acquisition of Property Interests ........................... 31
Leverage ................................................... 32
Portfolio Turnover .......................................... 32
Other Policies ............................................. 32
Initial Investments ....................................... 33
Certain Legal Aspects of Real Property Loans and
Investments ............................................. 39
General ................................................ 39
Types of Mortgage Instruments ........................... 40
Leases and Rents ....................................... 40
Condemnation and Insurance .............................. 40
Foreclosure ............................................. 41
Bankruptcy Laws .......................................... 42
Default Interest and Limitations on Prepayments ......... 43
3
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Page
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Forfeitures in Drug and RICO Proceedings ............ 43
Environmental Matters ................................. 44
Applicability of Usury Laws ........................... 45
Americans With Disabilities Act ..................... 45
THE COMPANY ................................................ 46
Management ............................................. 46
Trustees and Executive Officers ........................ 46
Option Plan ............................................. 48
Employment Agreements .................................... 49
Indemnification of Trustees and Executive Officers ...... 49
DISTRIBUTION POLICY ....................................... 50
CAPITALIZATION ............................................. 50
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION .................................... 51
DESCRIPTION OF SHARES OF BENEFICIAL
INTEREST ................................................ 52
General ................................................ 52
Common Shares .......................................... 52
Preferred Shares ....................................... 53
Restrictions on Ownership and Transfer .................. 53
Dividend Reinvestment Plan .............................. 55
Reports to Shareholders ................................. 55
Transfer Agent and Registrar ........................... 55
CERTAIN PROVISIONS OF MARYLAND LAW AND
OF THE COMPANY'S DECLARATION OF TRUST
AND BYLAWS ............................................. 55
Board of Trustees ....................................... 55
Business Combinations .................................... 56
Control Share Acquisitions .............................. 56
Amendment of Declaration of Trust and Bylaws ............ 57
Meetings of Shareholders ................................. 57
Advance Notice of Trustees' Nominations and New
Business ............................................. 57
Dissolution of the Company .............................. 57
Indemnification; Limitation of Trustees' and Officers'
Liability ............................................. 57
Indemnification Agreements .............................. 58
Possible Anti-Takeover Effect of Certain Provisions of
Maryland Law and of Declaration of Trust and
Bylaws ................................................ 58
Maryland Asset Requirements .............................. 58
<PAGE>
Page
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COMMON SHARES AVAILABLE FOR FUTURE SALE. 59
OPERATING PARTNERSHIP AGREEMENT ........................... 59
General ................................................ 59
General Partner Not to Withdraw ........................ 60
Capital Contribution .................................... 60
Redemption Rights ....................................... 61
Operations ............................................. 61
Distributions .......................................... 61
Allocations ............................................. 61
Term ................................................... 62
Tax Matters ............................................. 62
FEDERAL INCOME TAX CONSIDERATIONS ........................ 62
Taxation of RAIT ....................................... 62
Requirements for Qualification ........................... 63
Income Tests .......................................... 64
Asset Tests .......................................... 67
Distribution Requirements ........................... 68
Recordkeeping Requirements ........................... 69
Failure to Qualify ....................................... 69
Taxation of Taxable U.S. Shareholders Generally ......... 69
Taxation of Shareholders on the Disposition of Common
Shares ................................................ 71
Capital Gains and Losses ................................. 71
Information Reporting Requirements and Backup With-
holding 71
Taxation of Tax-Exempt Shareholders ..................... 71
Taxation of Non-U.S. Shareholders ........................ 72
State and Local Taxes .................................... 73
Sale of RAIT's Property ................................. 73
BENEFIT PLAN CONSIDERATIONS .............................. 74
Employee Benefit Plans, Tax-Qualified Retirement Plans
and IRAs ............................................. 74
Status of the Company under ERISA's Plan Asset Rules. 75
UNDERWRITING ............................................. 76
LEGAL MATTERS ............................................. 77
EXPERTS ................................................... 77
ADDITIONAL INFORMATION .................................... 78
GLOSSARY ................................................... 79
CONSOLIDATED FINANCIAL STATEMENT ........................... F-2
4
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information included elsewhere in this Prospectus. Unless otherwise indicated,
the information contained in this Prospectus assumes that the Underwriters'
overallotment option is not exercised. In addition, unless the context
otherwise requires, all references in this Prospectus to (i) the "Company"
shall mean Resource Asset Investment Trust and (a) its wholly-owned
subsidiaries, RAIT General, Inc. (the "General Partner") and RAIT Limited, Inc.
(the "Initial Limited Partner") and (b) RAIT Partnership, L.P. (the "Operating
Partnership"), in which the General Partner initially will own a 1% interest
and the Initial Limited Partner initially will own a 99% interest; and (ii) the
"Common Shares" shall mean the Company's common shares of beneficial interest,
par value $.01 per share. Capitalized terms used but not defined herein shall
have the meanings set forth in the Glossary beginning on page 79.
The Company
General. RAIT is a newly-formed Maryland real estate investment trust that
will elect to be taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended (the "Code"). The Company's principal
business activity will be to acquire or provide loans secured by mortgages on
real property (or interests in such loans) ("Financing") in situations that,
generally, do not
conform to the underwriting standards of institutional lenders or sources that
provide financing through securitization. The Company believes that its
anticipated Financing activity provides it with an underserved niche market in
the real estate finance industry. See "Investment Objectives and
Policies -- General."
Investment Objectives and Policies. The Company intends to purchase or
originate Financing relating to multi-family residential, office and other
commercial properties for its own account. The Company will emphasize
wraparound loans and, to a lesser extent, other forms of junior lien and
subordinated financing with principal amounts or, with respect to acquired
loans, acquistion prices generally between
$1 million and $8 million. The Company is not, however, limited in the type of
Financing it may provide and, accordingly, may originate or acquire first lien
loans for its portfolio. A wraparound loan is a junior lien or unsecured loan
having a principal amount equal to the sum of the outstanding principal
balances of loans with senior priority of lien plus the net amount advanced by
the wraparound lender. The wraparound lender pays principal and interest to
holders of the senior lien loans from payments it receives on the wraparound
loan.
The Company will seek to include in its loans provisions allowing it to
participate in any appreciation in the value of the properties underlying the
Financings or in any increase in property revenues (in addition to any increase
in yields resulting from amortization of the principal amount of senior debt).
The Company will typically seek a minimum participation rate of 25%. There can
be no assurance that the Company will be able to obtain that rate, or any
participation interests at all.
The Company's Financings will consist of direct loans to borrowers and the
acquisition of existing loans. In its direct Financings, the Company will seek
to adapt the financing terms to the needs of its borrowers, utilizing a variety
of financing techniques such as staged payments, event specific loan advances,
different rates of interest payment and interest accrual, deferred (or
"balloon") principal payments and similar techniques. In acquiring existing
Financings, the Company will focus on Financings that, because of one or more
past defaults under the original loan terms (due to complex ownership
structures of the entities that own the properties underlying the Financings,
lack of a strong operating history for the properties, historical credit or
cash flow problems of the borrowers or the underlying properties, or other
factors), can be acquired at a discount to their outstanding balances and the
appraised value of the underlying properties. The Company will not acquire any
such Financings unless material steps have been taken by prior lienholders (or
others) to resolve the past problems.
As appropriate, either as part of the Company's investment strategy or for
tax planning purposes, the Company may acquire direct or indirect interests in
real property including interests in partnerships, joint
5
<PAGE>
ventures or limited liability companies owning real property ("Property
Interests"). Although the Company will generally seek to obtain Property
Interests that have preferences as to current distributions and return of
capital, the Company is not limited as to the kinds of Property Interests it
may acquire, and some or all of its Property Interests may not have a preferred
position. The Company believes that acquiring Property Interests will be
advantageous for three reasons. First, it will give the Company flexibility in
addressing the financial needs and tax situations of borrowers in situations
where debt financing may not be appropriate. Second, it will provide the
Company with the possibility of capital appreciation in addition to the current
income realized from its loan portfolio. Third, it will assist the Company in
tax planning. It is anticipated that certain of the Financings made by the
Company may result in recognition of income for federal income tax purposes in
advance of the receipt of the related cash flow, which will increase the amount
that the Company must distribute to its shareholders in order to avoid a
corporate income tax in such year without a contemporaneous corresponding
receipt of cash by the Company. Depreciation deductions associated with the
Company's investments in Property Interests, however, should help offset such
adverse tax effects. See "Federal Income Tax Considerations -- Requirements for
Qualification -- Distribution Requirements."
The Company intends to fund its activities with the proceeds of this
Offering and future equity offerings. Although the Company is permitted to
incur debt to originate or acquire Financings or Property Interests, the
Company generally will not do so unless it does not have immediately available
capital sufficient to invest in a particular opportunity. The Company
anticipates that, in normal operations, it will not exceed a debt to equity
ratio of 0.5:1. However, the Company is not limited in the amount of debt which
it may incur and, accordingly, may exceed that ratio in the future. See
"Investment Objectives and Policies -- Leverage" and "Risk Factors -- Other
Investment Activity Risks -- Leverage Can Reduce Income Available for
Distribution and Cause Losses."
Risk Factors
An investment in the Common Shares involves various material risks.
Prospective investors should carefully consider the matters set forth under
"Risk Factors" in connection with an investment in the Common Shares. Such
risks include, among others:
o The Company's principal business activity will be to provide mortgage
financing in situations that, generally, will not conform to the
underwriting standards of institutional lenders or sources that provide
financing through securitization. The Company intends to emphasize
wraparound loans and, to a lesser extent, other forms of junior lien or
subordinated financing. Financing provided by the Company will,
accordingly, be subject to greater risks of loss than institutional and
senior lien financing.
o Discounted loans acquired by the Company (including eight discounted
loans with an aggregate loan receivable amount of $72.4 million to be
acquired from RAI for $10.0 million as part of the Company's Initial
Investments) typically will be in default under their original loan terms,
but will be subject to forbearance agreements between lenders and
borrowers that postpone exercise of default remedies so long as certain
payment and other conditions are met. These loans may be subject to high
rates of default following expiration of the forbearance agreements. See
"Investment Objectives and Policies -- Acquisition of Loans at Discount"
and " -- Initial Investments."
o The Company has committed only 45% of the net proceeds of this Offering
(assuming the Underwriters do not exercise their overallotment option) to
specific investments. Accordingly, investors will not have an opportunity
to evaluate a material portion of the Company's investments.
o The Company has broad discretion in acquiring real properties or
interests in real properties. See "Risk Factors -- Real Property
Considerations."
o The Company may be subject to intense competition in identifying suitable
loans for acquisition or origination.
6
<PAGE>
o The value of, and income from, the Company's portfolio of Financings and
Property Interests may be adversely affected by economic factors over
which the Company has no control.
o The Company's senior management has limited prior experience in managing
a REIT.
o The Company's investment policies may be revised by the Board of Trustees
without shareholder approval.
o The Company is a newly-formed entity with no history of operations upon
which to base an investment decision.
o Geographic concentration of the Company's Financings and Property
Interests in Philadelphia, Pennsylvania, and the Baltimore/Washington,
D.C. corridor may subject them to regional economic fluctuations.
o Environmental risks may adversely affect the value of the Company's
Financings and Property Interests.
o The Company may incur debt in furtherance of its business activities and
operations and, accordingly, will be subject to the risks associated with
the use of leverage.
o Ownership of the Common Shares by each shareholder other than RAI is
limited to 8.3% of the outstanding Common Shares, which may deter third
parties from seeking control of, or seeking to acquire, the Company.
o As a result of relationships among the Company, RAI, Brandywine and their
affiliates, conflicts of interest may arise in connection with the price
and terms at which investments are sold or services provided to the
Company by RAI, Brandywine and their affiliates. See "Conflicts of
Interest."
o If the Company fails to qualify or maintain its qualification as a REIT,
the Company will be taxed as a regular corporation for federal income tax
purposes, which would materially adversely affect income available for
distribution to shareholders.
o The Company may provide Financing that may result in recognition of
income for federal income tax purposes in advance of the receipt of the
related cash flow, which will increase the amount that the Company must
distribute to its shareholders in that year in order to avoid corporate
income tax without a contemporaneous corresponding receipt of cash by the
Company. To the extent the Company does not acquire Property Interests
generating sufficient non-cash tax deductions to offset such income, or
does not generate funds for distribution to shareholders (through cash on
hand, borrowings, asset sales, or otherwise) sufficient to distribute all
of its taxable income, the Company could be subject to corporate income
tax and an excise tax, either of which would materially adversely affect
shareholder distributions.
o If the Company fails to qualify for an exemption from registration as an
investment company under the Investment Company Act of 1940 (the
"Investment Company Act"), the Company will be required to change the
manner in which it conducts operations so as to avoid the registration
requirement or register as an investment company, either of which could
have an adverse effect on the Company.
Initial Investments
The Company has identified 12 loans for acquisition at an aggregate
investment estimated at $18.1 million and will acquire certain senior debt
relating to four of such loans at a cost of $2.5 million (the "Initial
Investments"). The 12 loans will be purchased from RAI; the senior debt will be
acquired from third parties. Two of the Initial Investments were originated by
the Company and will be purchased from
7
<PAGE>
RAI at cost. Eight of the Initial Investments are being acquired at a discount
to the outstanding balance due from the borrower on the loan. The aggregate
outstanding balance was $72.4 million at October 31, 1997. The Company's
investment, on a cost basis, in the Initial Investments is 59% of the appraised
value of the underlying properties. There is an aggregate of $17.9 million of
debt held by third parties (including the $2.5 million to be acquired by the
Company) that is secured by the properties underlying certain of the Initial
Investments and to which such Initial Investments are subordinated. In
addition, in one of the Initial Investments, RAI will retain a $2.5 million
senior secured interest to which the Company's interest will be subordinated.
See "Investment Objectives and Policies -- Initial Investments" and "Use of
Proceeds."
Management of the Company
The Company will be internally managed through its Board of Trustees and
senior officers. For a description of the background of such persons, see "The
Company -- Trustees and Executive Officers."
Conflicts of Interest
The relationships among the Company, RAI, Brandywine and their affiliates
may give rise to conflicts of interest. RAI will own 15% of the outstanding
Common Shares upon consummation of the Offering, assuming the Underwriters do
not exercise their overallotment option. Until such time as RAI ownership of
outstanding Common Shares is less than 5%, RAI has the right to nominate one
member of the Board of Trustees. One of the Company's current trustees,
Jonathan Z. Cohen, is serving as RAI's nominee. Mr. Cohen is the son of Betsy
Z. Cohen, the Chairman and Chief Executive Officer of the Company, and her
spouse, Edward E. Cohen. Edward E. Cohen is the Chairman, Chief Executive
Officer and President of RAI. Of the Initial Investments, 88% by cost will be
purchased by the Company from RAI (including one loan, and an interest in a
second loan that will be subordinated to a $2.5 million senior secured interest
retained by RAI, that were originated by the Company and that will be acquired
from RAI at cost). RAI will also be reimbursed for legal, accounting and filing
fees, salaries of the Company's executive officers, rent and other
organizational expenses advanced to the Company prior to the completion of the
Offering (which are estimated to be $526,900) and for expenses incurred by RAI
in sponsoring the Company, including an allocation of compensation of RAI
employees (which are estimated to be $562,000). See "Investment Objectives and
Policies -- Initial Investments" and "Conflicts of Interest." The Company
anticipates that, subject to the limitations referred to in the next paragraph,
it will purchase additional investments from RAI. The Company may also from
time to time (but is not obligated to) retain RAI to perform due diligence
investigations on properties underlying proposed Financings (excluding
Financings being acquired from RAI) or on Property Interests the Company is
considering for acquisition. Brandywine, an affiliate of RAI, will also provide
real property management or management supervisory services to properties
underlying the Company's Financings or included in the Company's Property
Interests. Accordingly, the Company's relationship with RAI, Brandywine and
their affiliates will be subject to various conflicts of interest including
conflicts over the price at which investments are sold or services rendered to
the Company by those entities.
The Company has instituted certain procedures to mitigate the effects of
any such conflicts, including (i) requiring that a majority of its Trustees be
persons who, within the past two years, have not (a) been affiliates of RAI,
Brandywine or their affiliates, (b) been officers of the Company, or (c) had
any material business or professional relationship with the Company, RAI,
Brandywine or their affiliates ("Independent Trustees"), (ii) requiring that
the acquisition price of any investment acquired from RAI, or in which an
officer or trustee of the Company has an interest (including the Initial
Investments) be determined based upon independent appraisal of the underlying
property, (iii) limiting the investments which may be acquired from RAI to a
maximum of 30% of the Company's investments (excluding the Initial
Investments), based upon the Company's investment cost (the amount of the
investment plus legal, filing and other related fees and expenses), (iv)
requiring that any fees for services performed by RAI, Brandywine or their
affiliates be no greater than prevailing fees in the area for similar services
provided by unrelated third parties, (v) requiring that any service
arrangements with an affiliated entity provide that services will
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be rendered only as and to the extent requested by the Company from time to
time and that, in any event, the arrangements be cancelable by the Company,
without penalty, on no more than 30 days' notice, (vi) requiring that any
investment acquisition (including the Initial Investments) or services
arrangement, and every transaction with RAI, Brandywine and their affiliates,
or relating to any property in which any such persons (including Mrs. Cohen)
has an interest, receive the prior approval of a majority of the Independent
Trustees (who, in giving such approval, may rely upon information provided by
RAI, Brandywine or their affiliates), and (vii) with respect to real estate
management or management supervisory services performed by Brandywine,
requiring that the aggregate of the fee received by Brandywine and the manager
being supervised may not exceed the normal and customary fee for similar
property management services with respect to similar properties in the same
area. The Company will not, however, be required to obtain the approval of the
Independent Trustees to retain RAI to perform a due diligence investigation of
a property where the amount of the fee for such services will not exceed the
lesser of 1% of the property's appraised value or $10,000. The non-Independent
Trustees are Betsy Z. Cohen and Jonathan Z. Cohen. The Independent Trustees are
Jerome S. Goodman, Joel R. Mesznik, Daniel Promislo and Jack L. Wolgin, who
currently constitute two-thirds of the Company's Trustees.
Since each of the Company and RAI seek to originate or acquire mortgage
loans, there may be conflicts of interest between the Company and RAI regarding
the allocation of loan opportunities. Also, since Mrs. Cohen is the Chairman
and Chief Executive Officer of JeffBanks, Inc. ("Jeffbanks") (a banking
institution with which the Company will have normal depository relationships,
and from which, subject to the approval of a majority of the Independent
Trustees, it may sublease office space), similar conflicts may arise between
the Company and JeffBanks. The Company believes, however, that these conflicts
are substantially mitigated since there are significant differences between the
investment objectives of the Company, RAI and JeffBanks. RAI has advised the
Company that it seeks to acquire loans which are either in default, or at risk
of imminent default, requiring active intervention by RAI in the workout
process. The Company, however, seeks to acquire loans where the workout process
has already been initiated and there is no need for its active intervention.
JeffBanks has advised the Company that it seeks to provide customary commercial
lending services emphasizing (with respect to real estate loans) first lien
financing that is subject to specified underwriting standards. The Company
seeks to provide Financing that does not conform to JeffBanks' underwriting
standards. The Company believes that conflicts are further mitigated because
the anticipated sources of the Company's loan referrals are different from
those of RAI and JeffBanks.
To further limit conflicts between the Company and RAI, the Company and
RAI have agreed that, for two years following the completion of the Offering,
(i) RAI will not sponsor another REIT with investment objectives and policies
which are the same as, or substantially similar to, those of the Company; (ii)
if RAI proposes to provide new wraparound or other junior lien or subordinated
Financing with respect to multifamily, office or other commercial properties to
a borrower (other than to a borrower with an existing loan from RAI), RAI must
first offer the opportunity to the Company; and (iii) if RAI desires to sell
any loan it has acquired that conforms to the Company's investment objectives
and policies with respect to acquired loans, it must first offer to sell it to
the Company. RAI has also agreed that if, after expiration of the two year
period, RAI sponsors a REIT with investment objectives similar to those of the
Company, RAI's representative on the Board of Trustees (should RAI have a
representative on the Board at that time) will recuse himself from considering
or voting upon matters relating to Financings which may be deemed to be within
the lending guidelines of both of the Company and the REIT sponsored by RAI.
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The Offering
Shares offered to the public(1) ..................... 2,833,334
Shares to be outstanding after offering(1)(2) ...... 3,333,434
Amex symbol ....................................... RAS
- -------------
(1) Assumes that the Underwriters' option to purchase up to an additional
425,000 shares to cover over-allotments is not exercised. Includes up to
125,000 shares that may be sold to officers, directors and trustees of the
Company, RAI and Brandywine, together with members of their respective
families and relatives. Excludes 141,667 shares issuable pursuant to
warrants granted to the Representative (see "Underwriting").
(2) Includes 500,000 shares to be purchased by RAI. Does not include 450,000
shares reserved for issuance pursuant to a stock option plan the Company
intends to establish at or before the completion of the Offering.
Use of Proceeds
The Company has contracted (subject to the approval of the Independent
Trustees) to acquire the Initial Investments upon completion of this Offering
for an investment cost of approximately $20.6 million, which is equal to
approximately 45% of the net proceeds of this Offering (40% if the Underwriters
exercise their overallotment option). The Initial Investments will consist of
those Financings described at "Investment Objectives and Policies -- Initial
Investments." Of the Initial Investments, $18.1 million will be acquired from
RAI; $2.5 million will be acquired from third parties, as described in the next
paragraph. Two of the Initial Investments (with an aggregate purchase price of
approximately $5.8 million) were originated by the Company and will be acquired
from RAI at RAI's cost. In addition, the Company will reimburse RAI for legal,
accounting and filing fees and expenses, executive salaries, rent and other
organizational expenses (which are estimated to be $526,900) and for the
expenses incurred by RAI in sponsoring the Company, including an allocation of
employee compensation (which are estimated to be $562,000).
At the time of their acquisition, the Initial Investments being acquired
from RAI will be subject to $20.4 million of loan participation interests or
other debt that is senior to the loan interests acquired from RAI. The Company
anticipates acquiring $2.5 million of such senior lien interests from the
proceeds of the Offering. However, the Company also anticipates that, following
acquisition, the Company will seek to borrow against the loans as to which it
has acquired the prior senior lien interests or that borrowers may seek to
refinance some portion of the loans and, accordingly, that the Company will
obtain the return of some portion or all of the funds utilized to acquire the
senior lien interests. For certain information concerning the senior interests
to be acquired see "Investment Objectives and Policies -- Initial Investments."
There can be no assurance, however, that any such borrowings or refinancings
will occur.
The balance of the Offering proceeds (including any funds obtained from
borrowing against or refinancing loans as referred to above) will be invested
in the manner described in "Investment Objectives and Policies." It is
anticipated that the investment process will take up to six months after the
Offering has been completed, although there can be no assurance that the
process will not take longer. Pending such investment, the balance of the net
proceeds will be invested in readily marketable, interest-bearing securities
which, following the expiration of the one year investment period provided by
the Code, will be limited to those securities allowing the Company to continue
to qualify as a REIT. See "Federal Income Tax Considerations Requirements for
Qualification -- Asset Tests."
Distribution Policy
The Company intends to distribute to its shareholders at least 95% of its
net taxable income each year (subject to certain adjustments) so as to qualify
for the tax benefits accorded to REITs under the Code. It
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is anticipated that distributions will generally be taxable as ordinary income
or return on capital, although in certain circumstances a portion of any
distribution may constitute long-term capital gain or a return of capital. The
Company intends to make distributions quarterly. It is anticipated that the
first distribution to shareholders will be made promptly after the first
calendar quarter following completion of the Offering. See "Distribution
Policy."
Tax Status of the Company
The Company intends to qualify and will elect to be taxed as a REIT under
sections 856 through 860 of the Code, commencing with its taxable year ending
December 31, 1997. If the Company qualifies for taxation as a REIT, it
generally will not be subject to federal corporate income tax on its taxable
income that is distributed to its shareholders. A REIT is subject to a number
of organizational and operational requirements, including a requirement that it
currently distribute at least 95% of its annual taxable income. Although the
Company does not intend to request a ruling from the Internal Revenue Service
(the "Service") as to its REIT status, Ledgewood Law Firm, P.C., counsel to the
Company, has rendered its opinion, based on certain assumptions and
representations about the Company's proposed method of operation, investment
activities and other matters, that the Company will qualify to be taxed as a
REIT under the Code, and the Company's organization and proposed method of
operation will enable it to continue to meet the requirements for qualification
and taxation as a REIT under the Code. There can be no assurance that the
Company will be able to comply with such assumptions and representations in the
future. Furthermore, counsel's opinion is not binding on either the Service or
any court. If the Company fails to qualify as a REIT in any taxable year, it
would be subject to federal income tax at regular corporate rates and
distributions to its shareholders would not be deductible. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to certain
federal, state and local taxes on its income and property. The Company will
adopt the calendar year as its taxable year. In connection with the Company's
election to be taxed as a REIT, its Declaration of Trust imposes restrictions
on the transfer and ownership of the Common Shares. See "Risk Factors -- Legal
and Tax Risks," "Federal Income Tax Considerations -- Taxation of RAIT" and
"Description of Shares of Beneficial Interest -- Restrictions on Ownership and
Transfer."
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FORMATION AND STRUCTURE
RAIT, the Operating Partnership, the General Partner of the Operating
Partnership and the Initial Limited Partner of the Operating Partnership were
each formed in August, 1997. The Operating Partnership will undertake the
business of the Company, including the origination and acquisition of
Financings and the acquisition of Property Interests. The following diagram
illustrates the structure of the Company, the Operating Partnership, the
General Partner and the Initial Limited Partner, and their relationship with
RAI, assuming successful completion of the Offering:
[GRAPHIC OMITTED]
(1) RAIT will sell 15% of its Common Shares to RAI and 85% to public investors,
assuming the Underwriters do not exercise their overallotment option.
(2) RAIT has incorporated and capitalized the General Partner and the Initial
Limited Partner.
(3) The General Partner and the Initial Limited Partner have formed and will
capitalize the Operating Partnership. The General Partner initially owns a
1% general partnership interest and the Initial Limited Partner initially
owns a 99% limited partnership interest in the Operating Partnership.
Because RAIT initially owns 100% of each of the General Partner, the
Initial Limited Partner and, indirectly, the Operating Partnership, they
should not be treated as entities separate from RAIT for federal income
tax purposes. See "Federal Income Tax Considerations -- Requirements for
Qualification."
(4) RAI will sell certain of the Initial Investments to the Operating
Partnership, and may sell additional investments to the Operating
Partnership, for cash. See "Investment Objectives and Policies -- Initial
Investments." An affiliate of RAI may also provide certain property
management services to properties underlying Financings or Property
Interests held by the Operating Partnership. See "Conflicts of Interest."
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RISK FACTORS
An investment in the Common Shares involves various risks. Prospective
investors should carefully consider the following risk factors, in addition to
the other information set forth in this Prospectus, in connection with an
investment in the Common Shares.
Investment Activity Risks
Financing Considerations
Value of Company's Financings Dependent on Conditions Beyond Company's
Control. The Company's principal portfolio assets are anticipated to be
Financings, consisting primarily of loans relating to real property. In the
event of a default on one or more of these loans, the Company's current return
on its investments may be reduced or eliminated, adversely affecting the
overall return on the Company's investment portfolio. Moreover, a default on a
loan may require the Company to become involved in expensive and time-consuming
proceedings, including bankruptcy, reorganization or foreclosure proceedings,
in attempting to recover some portion or all of its investment. See "Investment
Objectives and Policies -- Certain Legal Aspects of Real Property Loans and
Investments." In many cases (including all of the Company's Initial
Investments) the real property underlying the loan will be the primary or sole
source of any recovery for the Company. Accordingly, the Company will be
materially dependent upon the value of the real property underlying its loans,
which value may be affected by numerous factors outside the control of the
Company. See "Risk Factors -- Investment Activity Risks -- Real Property
Considerations." The Company intends to make a material number of loans
(including all of the Company's Initial Investments) that will provide payment
structures other than self-amortization, including structures that defer
payment of some portion of accruing interest, or defer repayment of principal,
until loan maturity. Where a borrower has an obligation to pay a loan balance
in a large lump sum payment, its ability to satisfy this obligation may be
dependent upon its ability to obtain suitable refinancing or otherwise to raise
a substantial cash amount. In addition, in some jurisdictions (including those
in which the properties underlying the Initial Investments are located),
mortgage lenders can lose any priority of their lien to mechanics',
materialmen's and other liens. For these and other reasons, the total amount
which may be recovered by the Company may be less than the total amount of the
Company's loan, or its cost of acquisition, with resultant loss to the Company.
Longer Term, Subordinate and Non-Conforming Financing is Illiquid and
Value May Decrease. The Company's Financings (including eight of the Initial
Investments) typically will have maturities between 4 and 10 years. The
Company's Financings generally (and the Initital Investments in particular)
will not conform to standard loan underwriting criteria. Many of the Company's
Financings will be subordinate loans. As a consequence, the Company's
Financings will be relatively illiquid investments, and the Company will be
unable to vary its portfolio promptly in response to changing economic,
financial and investment conditions. Many of these risks may be intensified by
existing and potential economic developments and uncertainties. See "Risk
Factors -- Investment Activity Risks -- Real Property Considerations." As a
result of the foregoing, the fair market value of some or all of the Company's
Financings may decrease in the future. Although the Company will attempt to
obtain participation features in its loans to provide it with additional
compensation and a hedge against inflation, economic and other factors may have
a material adverse effect upon the value of any participation feature obtained
or its ability to provide an inflation hedge.
Lengthy Financing Commitment Periods May Reduce Company's Returns. The
Company will typically issue a loan commitment to a borrower prior to the
closing of a loan. During the period of time the funds are committed by the
Company but not used by the borrower, the funds will be held in temporary
investments, which the Company does not anticipate will produce substantial
investment returns. If there is a substantial period between loan commitment
and loan closing, or if a borrower determines not to utilize the Financing to
which the Company has committed, the Company's investment returns (and, thus,
its ability to make distributions to shareholders) will be adversely affected.
Investment in Subordinate Financing May Involve Increased Risk of Loss.
The Company will emphasize wraparound loans and, to a lesser extent, other
junior lien loans or subordinated financing. Six of the Initial Investments
(after acquisition by the Company of senior debt with respect to four other
Initial Investments) will be junior lien loans. Because of their subordinate
position, subordinate or junior lien loans carry a
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greater credit risk, including a substantially greater risk of non-payment of
interest or principal, than senior lien financing. Where, as part of a
financing structure, the Company has an equity or other unsecured position, the
risk of loss may be materially increased. A decline in the real estate market
where the property underlying the Financing is located could adversely affect
the value of the property such that the aggregate outstanding balances of
senior liens and the Company's Financing may exceed the value of the underlying
property. See "Risk Factors -- Investment Activity Risks -- Real Property
Considerations." In the event of a default on a senior loan, the Company may
elect to make payments, if it has the right to do so, in order to prevent
foreclosure on the senior loan. In the event of such foreclosure, the Company
will only be entitled to share in the proceeds after satisfaction of the
amounts due to senior lienors, which may result in the Company not being able
to recover the full amount or, indeed, any of its investment. It is also
possible that in some cases, a "due on sale" clause included in a senior
mortgage, which accelerates the amount due under the senior mortgage in case of
the sale of the property, may apply to the sale of the property upon
foreclosure by the Company of its Financing, and may accordingly increase the
risk of loss to the Company in the event of a default by the borrower on the
Company's Financing. See "Investment Objectives and Policies -- Certain Legal
Aspects of Real Property Loans and Investments."
When the Company acquires a loan, it may not acquire the right to service
the senior loans. The servicers of the senior loans are responsible to the
holders of such loans, whose interests will likely not coincide with those of
the Company, particularly in the event of a default. Accordingly, the senior
loans may not be serviced in a manner that is most advantageous to the Company.
After the Company acquires senior participations relating to the Initial
Investments, five of the Initial Investments (aggregating 32% of the Initial
Investments, by cost) will not be collateralized by recorded or perfected
liens. Certain of the Company's future Financings may not be collateralized by
such liens. Such loans are subject to many of the same factors that interfere
with or affect the ability of a lender to exercise its remedies against a
borrower with respect to mortgage loans. In addition, such loans generally will
be subject and subordinate not only to existing prior liens encumbering the
underlying property, but also to future judgment liens that may arise from
litigation against a borrower. Furthermore, in a bankruptcy, the holders of
such loans have materially fewer rights than secured creditors and their rights
are subordinate to the lien-like rights of the bankruptcy trustee. Moreover,
enforcement of such loans against the underlying properties generally involves
a longer and more complex legal process than enforcement of a mortgage loan.
For a description of the collateral or other security pertaining to these
loans, see "Investment Objectives and Policies -- Initial Investments." The
Company will endeavor to structure such loans so that they will qualify as
interests in real property or interests in mortgages on real property as
defined in the Code and as interpreted by the Internal Revenue Service.
Financings that would not so qualify will be undertaken only in amounts that
will not jeopardize RAIT's qualification as a REIT. See "Federal Income Tax
Considerations -- Requirements for Qualification."
Investment in Non-Conforming Loans May Involve Increased Risk of Loss. The
Company anticipates that a material portion of its Financings (including all of
the Initial Investments) will consist of loans that do not conform to
conventional loan criteria (see "Investment Objectives and Policies -- General"
for a general description of conforming loans) due to past defaults by
borrowers resulting from complex ownership structures of the entities that own
properties underlying the Financings, lack of a strong operating history for
the properties, historical credit or cash flow problems of the borrowers or
with respect to the underlying properties or other factors. As a result, these
loans may be subject to a higher risk of default and consequent loss to the
Company than conventional loans. Any such loss may reduce distributions to
shareholders or adversely affect the value of the Common Shares.
Interest Rate Changes May Adversely Affect Company's Investments. The fair
market value of loans in the Company's portfolio will be affected by changes in
interest rates. In general, the resale value of a loan will change in inverse
relation to an interest rate change. Accordingly, in a period of rising
interest rates, the fair market value of the loan will decrease. Moreover, in a
period of declining interest rates, real estate loans may benefit less than
other fixed income securities due to prepayments. Interest rate changes will
also affect the Company's return on new loans that it makes. In particular,
during a period of declining rates, the amounts becoming available to the
Company for investment due to repayment of its Financings may be invested at
lower rates than the Company had been able to obtain in prior investments, or
than the rates on the repaid Financings. Also, increases in interest on debt,
if any, incurred by the Company in originating or acquiring Financings or
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Property Interests may not be reflected in increased rates of return on the
Financings or Property Interests funded or acquired through such debt, thereby
adversely affecting the Company's return on such investments. Accordingly,
interest rate changes may materially affect the total return on the Company's
investment portfolio, which will affect amounts available for distribution to
the Company's shareholders.
Limited Number of Investments Will Make Company More Dependent upon
Performance of Individual Investments. The Company anticipates that the total
number of investments it will be able to make will be limited because of the
size of the Offering (approximately $45.8 million of net proceeds), the
acquisition of the Initial Investments and the anticipated size of the
Company's additional investments (between $1 million and $8 million each). As a
result of the anticipated limited number of portfolio investments, the adverse
effect on the financial condition of the Company of a loss with respect to any
one investment will be proportionately greater than a similar loss in a larger
investment portfolio. For a discussion of certain risks pertaining to the
Initial Investments, see "Risk Factors-Investment Activity Risks-Considerations
Relating to Initial Investments."
Lack of Geographic Diversification Exposes Company's Investments to Higher
Risk of Loss Due to Regional Economic Factors. The Company intends to emphasize
Financing with respect to properties located in metropolitan areas of the
United States, and has identified certain areas in which it may concentrate its
investments. In particular, the Company anticipates that a material portion of
its loans will relate to properties located in the Philadelphia, Pennsylvania
metropolitan area (11 of the 12 Initial Investments relate to properties
located in this area) or in the Baltimore/Washington, D.C. corridor (where the
other Initial Investment is located). See "Investment Objectives and Policies
- -- Location of Properties Relating to Financings." The Company does not expect
to set specific limitations on the aggregate percentage of its portfolio
relating to properties located in any one area (whether by state, zip code or
other geographic measure). Any lack of geographic diversification that may
occur could result in the Company's investment portfolio being more sensitive
to, and the Company being less able to respond to, adverse economic
developments of a primarily regional nature, which may result in reduced rates
of return, or higher rates of default, on the Company's Financing than might be
incurred with a more geographically diverse investment portfolio.
Competition for Financing May Inhibit Company's Ability to Achieve
Objectives. The Company may encounter significant competition in seeking to
originate or acquire suitable real estate loans from banks, insurance
companies, savings and loan associations, mortgage bankers, pension funds,
investment bankers and others, including public or private REITs which have
been or may be formed with objectives similar in whole or in part to those of
the Company. This competition could reduce yields obtainable by the Company in
its Financings and adversely affect its ability to obtain participations in the
appreciation in the value of or revenues from properties subject to its
Financings. See "Investment Objectives and Policies -- Types of Financing." It
may also increase the price (and thus reduce potential yields) on discounted
loans the Company seeks to acquire. See "Investment Objectives and
Policies -- Acquisition of Loans at Discount." Many of the Company's
anticipated competitors, including General Electric Capital Corporation,
Goldman Sachs' Whitehall Street Real Estate Fund, BlackRock Capital Finance,
IMH Commercial Holdings and Ocwen Asset Investment Corporation, will have
substantially greater assets than the Company, and thus an ability to make
larger loans to more creditworthy borrowers or have a more diversified loan
portfolio to reduce the risks of loss from any one loan. An increase in the
general availability of funds to lenders, or a decrease in the amount of
borrowing activity, may increase competition for making loans and may further
reduce the yields available thereon or increase the credit risk inherent in the
available loans.
Participations May Reduce Interest Rates Without Resulting in Additional
Returns. In structuring Financings it originates, the Company will seek to
obtain agreements from borrowers to pay, in addition to the specified rate of
interest, additional interest measured by the appreciation of the property
subject to such loan or by increases in such property's revenues. The Company
may, in certain cases, accept a lower minimum interest rate in order to obtain
such a participation and the potentially greater benefit that could result from
a share in the appreciation in value or revenues of the property. The value of
any such participation will depend on the factors inherent in any real estate
investment and, accordingly, there can be no assurance that any benefits will
be realized from participations. See "Risk Factors -- Investment Activity Risks
- -- Real Property Considerations." The Company does not anticipate that amounts
(if any) it may receive as a result of participations will be significant in
the early years of any investment. Moreover, there can be no assurance that the
Company will be able to negotiate participation provisions in any of its loans.
One of the Initial Investments originated by the Company
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(in which RAI will retain a senior interest) provides that, upon sale or
refinancing of the underlying property, the Company will receive 25% of the
first $600,000 of appreciation in value of the underlying property, and 15% of
any additional appreciation, over the current appraised value of the underlying
property (with a minimum $100,000 payment required). See "Investment Objectives
and Policies -- Initial Investments."
There may be uncertainty whether amounts receivable pursuant to
participations can be deemed to be a charge for "interest" for purposes of
determining whether a loan will violate state laws regarding maximum interest
rates that may be charged by lenders ("usury laws"). Accordingly, any such
provisions obtained by the Company in connection with its Financings may
increase the possibility that a loan may be deemed to violate usury laws. See
"Risk Factors -- Investment Activity Risks -- Financing Considerations -- Usury
Statutes May Impose Interest Ceilings and Substantial Penalties for
Violations."
Additionally, as a result of the Company's interest in revenues from or
proceeds of a sale, financing or refinancing of a property underlying a
Financing, a court in a bankruptcy proceeding, arrangement or similar situation
could treat the Company as a partner of, or joint venturer with, the borrower,
and the Company would, accordingly, lose the priority of any security interest
it might otherwise have in such situations.
Loans Secured by Interests in Entities Owning Real Property May Involve
Increased Risk of Loss. The Company may originate or acquire Financings which
are secured by interests in entities that own real properties rather than a
direct security interest in the underlying properties. Although the Company
does not anticipate that it will originate or acquire a material number of
Financings so secured, to the extent it does so, it will be subject to the risk
that the interests pledged as security will be illiquid, or otherwise have
features that may make it difficult for the Company to obtain a return of its
investment in the event of a default on its Financing. See "Risk Factors --
Investment Activity Risks -- Real Property Considerations -- Investments in
Joint Ventures, Partnerships or Other Interests May Result in Less Control by
Company." Loans secured by interests in such entities may also not be deemed to
be "Qualified Interests" for Investment Company Act purposes. Depending upon
the number of interests the Company holds which are not "Qualified Interests,"
the Company may be required to change its method of operations or to register
as an investment company under the Investment Company Act, which could have an
adverse effect on the Company and the market price for its Common Shares. See
"Risk Factors -- Legal and Tax Risks -- Loss of Investment Company Act
Exemption Would Affect Company Adversely." In addition, loans secured by such
interests, to the extent they are not deemed to be controlling interests in
partnerships under the Code, may not be treated as "real estate assets" for
purposes of the Code requirement that 75% of the value of an entity's assets
must be cash items, government securities and real estate assets in order for
it to qualify as a REIT. See "Federal Income Tax Considerations -- Requirements
for Qualification -- Asset Tests."
Usury Statutes May Impose Interest Ceilings and Substantial Penalties for
Violations. Interest charged on loans made by the Company (which may include
amounts received in connection with participations) may be subject to state
usury laws imposing maximum interest rates and penalties for violation,
including restitution of excess interest and unenforceability of debt. The
Company will seek to structure its Financings so as not to violate applicable
usury laws, but uncertainties in determining the legality of rates of interest
and other borrowing charges under some statutes may result in inadvertent
violations which could result in reduced investment returns to the Company or,
possibly, loss on an investment.
Discounted Loans May Have High Rates of Default. The Company anticipates
that it will acquire loans at purchase prices that represent a discount from
both the outstanding balances of principal and accrued interest on the loans,
as well as from the appraised value of the properties underlying the loans.
Typically, discounted loans are in default as to payment under the original
loan terms or other requirements. Of the twelve Initial Investments, eight will
be acquired at a discount to both outstanding balances and appraised values.
Each of the eight loans is in default under its original loan terms but is
current with respect to payments required by and other terms of the related
forbearance agreements. Accordingly, acquiring loans at a discount may involve
a substantially higher degree of risk of collection than loans that conform to
institutional underwriting criteria. The Company does not presently intend to
acquire a loan unless the prior loan holder (or some other party or parties)
has taken material steps toward resolving problems to which the loan, or its
underlying property, is subject. However, there can be no assurance that the
loans or their underlying properties will not be subject to recurrence of
previously existing problems, or that other problems will not arise.
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Construction Financing May Increase Repayment Risk. Although the Company
does not anticipate making construction loans, the Company anticipates making
loans in situations where construction is involved, generally either (i) as
financing that repays a third party's construction loan, or (ii) where the loan
is secured by property with a pre-construction value that is within the
Company's investment guidelines. The Company may depart from its guidelines,
typically where there are other assurances of payment such as personal
guarantees from the developers. See "Investment Objectives and Policies --
Certain Financial Guidelines" and "-- Types of Properties Relating to
Financings." Loans in these situations may involve a higher degree of risk than
other lending, to the extent that repayment is dependent upon successful
completion of the project, or as a result of the lack of an operating history
on the project as constructed or rehabilitated upon which to base a loan's
underwriting, difficulties in estimating construction costs and timing, the
financial strength of guarantors and other reasons.
Real Property Considerations
Value of Company's Property Interests Dependent on Conditions Beyond
Company's Control. Although the Company will emphasize originating or acquiring
Financings, the Company will also acquire Property Interests. See "Investment
Objectives and Policies -- Acquisition of Property Interests." Real property
investments are subject to varying degrees of risk. The yields available from
real properties depend on the amount of income earned and capital appreciation
generated by the properties as well as the expenses incurred in connection
therewith. If the properties do not generate income sufficient to meet
operating expenses, including debt service and capital expenditures, the
ability to make distributions to the Company's shareholders will be adversely
affected. Income from, and the value of, the properties may be adversely
affected by general and local economic conditions, neighborhood values,
competitive overbuilding, weather, casualty losses and other factors beyond the
Company's control. Revenues from, and values of, real properties are also
affected by such factors as the cost of compliance with regulations and the
potential for liability under applicable environmental laws, changes in
interest rates and the availability of financing. Income from a property would
be adversely affected if a significant number of tenants were unable to pay
rent or if available space could not be rented on favorable terms. Certain
significant expenditures associated with an investment in real property (such
as mortgage payments, real estate taxes and maintenance costs) generally are
not reduced when circumstances cause a reduction in income from the investment.
Property Interests Are Illiquid and Value May Decrease. Real estate
investments are relatively illiquid and, therefore, the Company may be limited
in its ability to vary its portfolio of Property Interests quickly in response
to changes in economic or other conditions. As a consequence, the fair market
value of some or all of the Company's Property Interests may decrease in the
future. In addition, provisions in the Code and related regulations impose a
100% tax on gain realized by a REIT with respect to property deemed to be held
primarily for sale in the ordinary course of business. These provisions may
materially adversely affect the Company's ability to sell Property Interests
without adversely affecting distributions to the Company's shareholders. See
"Risk Factors -- Legal and Tax Risks -- Gain on Disposition of Assets Deemed
Held for Sale in Ordinary Course Subject to 100% Tax."
Uninsured and Underinsured Losses May Affect Value of, or Returns from,
Property Interests. The Company intends to maintain (or cause to be maintained)
comprehensive insurance on its Property Interests (as well as on properties
underlying its Financings), including liability and fire with extended
coverage, in amounts sufficient to permit the replacement of the properties in
the event of a total loss, subject to applicable deductibles. There are certain
types of losses, however, generally of a catastrophic nature, such as
earthquakes, floods and hurricanes, that may be uninsurable or not economically
insurable. Inflation, changes in building codes and ordinances, environmental
considerations, and other factors also might make it infeasible to use
insurance proceeds to replace a property if it is damaged or destroyed. Under
such circumstances, the insurance proceeds received by the Company might not be
adequate to restore its economic position with respect to the affected
property. In such a case, the Company's returns from an affected property would
be reduced, or some portion or all of the Company's investment in the property
would be lost.
Investments in Joint Ventures, Partnerships or Other Interests May Result
in Less Control by Company. The Company anticipates that, from time to time,
its investment activities may take the form of an equity interest in entities
which own real property, rather than acquiring or making a real property loan
or acquiring a property
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directly. While the Company anticipates that any equity interest it acquires
will be senior in right of payment to existing and future equity interests, the
Company is not limited as to the kind of equity interests it may acquire, and
it may acquire equity interests which are not senior or preferred interests.
Since an equity interest is subordinate to all creditors, where the Company
purchases equity interests, the Company's risk of loss may be increased.
Moreover, acquisition of equity interests provides certain risks not present in
real property loans or direct property ownership. For example, there is the
possibility that the other equity owners in the entity holding the property
might have economic or business interests or goals which are inconsistent with
the business interests or goals of the Company or be in a position to take
action contrary to the instructions or requests of the Company or contrary to
its policies or objectives. While the Company will seek to obtain sufficient
contractual rights with respect to a property in which it obtains an equity
interest to allow it to protect the value of its interest, there can be no
assurance that any rights obtained will, in fact, enable it to do so. Moreover,
in limited
partnerships, even if the Company is a limited partner, if its rights under the
partnership agreement allow it sufficient control over the partnership or its
property, it might be deemed to be a general partner and, in such a case, could
incur liability for the debts of the partnership beyond the amount of its
investment.
Compliance with Americans with Disabilities Act and Other Governmental
Rules and Regulations Will Decrease Returns on Property Interests. Under the
Americans with Disabilities Act of 1990 (the "ADA"), all public properties are
required to meet certain federal requirements related to access and use by
disabled persons. Properties acquired by the Company (or properties underlying
Financings which may be made or acquired by the Company) may not be in
compliance with the ADA. If a property is not, the Company (or its borrowers)
will be required to make modifications to such property to bring it into
compliance, or face the possibility of an imposition of fines or an award of
damages to private litigants. In addition, changes in other governmental rules
and regulations, including changes to building codes and fire and life-safety
codes, may occur. If the Company (or its borrowers) were required to make
substantial modifications to the properties to comply with the ADA or other
changes in governmental rules and regulations, the Company's ability to make
expected distributions to its shareholders could be adversely affected.
Property Taxes Decrease Returns on Property Interests. All properties
included in the Company's Property Interests or underlying its Financings will
be subject to real, and in some instances, personal property taxes. Such real
and personal property taxes may increase or decrease as property tax rates
change and as the properties are assessed or reassessed by taxing authorities.
An increase in property taxes on these properties could materially adversely
affect the Company's income and ability to make distributions to its
shareholders.
Real Properties with Environmental Problems May Create Liability for the
Company
Contamination of real property by hazardous substances or toxic wastes may
give rise to a lien on that property to assure payment of the cost of
remediation or, in certain circumstances, result in liability of the owners or
operators of, or lenders to, the property for that cost under various federal,
state and local environmental laws. Many of these laws impose liability whether
or not such persons knew of, or were responsible for, the contamination, and
such liability may be substantial. Accordingly, environmental contamination
could materially adversely affect the value of the property and its cash flow.
It is possible that such costs could become a liability of the Company,
reducing the return to the Company and its ability to make distributions to its
shareholders if such remedial costs were incurred or if property vacancy
resulted. See "Investment Objectives and Policies -- Certain Legal Aspects of
Real Property Loans and Investments -- Environmental Matters."
Considerations Relating to Initial Investments
Multifamily and Commercial Loans Included in the Initial Investments
Involve a Greater Risk of Loss than Single Family Loans. The properties
underlying the Initial Investments are secured by existing multifamily or
commercial properties. Multifamily and commercial real property loans are
considered to involve a higher degree of risk than single family residential
lending because of a variety of factors, including generally larger loan
balances, dependency on successful operation of the property and tenants
operating businesses therein for repayment, and (as is the case with the
Initial Investments) loan terms that often require little or no amortization
but, instead, provide for balloon payments at stated maturity. In addition, the
value of multifamily and commercial real estate can be affected significantly
by the supply and demand in the market for that type of property. Market values
may vary as a result of economic events, governmental regulations or other
factors outside
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the control of the borrower or the Company, such as the imposition in the
future of rent control laws in the case of the Initial Investments involving
multifamily properties, which may impact the future cash flow of the underlying
property. See "Risk Factors -- Financing Considerations" and "-- Real Property
Considerations."
The successful operation of a multifamily or commercial real estate
project also generally is dependent on the performance and viability of the
property manager of that project. With the exception of the Initial Originated
Loans, (See "Investment Objectives and Policies -- Initial Investments") the
properties underlying the Initial Investments are managed, or management is
supervised by, Brandywine (an affiliate of RAI, see "Conflicts of Interest").
The property manager is responsible for responding to changes in the local
market, planning and implementing the rental structure, including establishing
appropriate rental rates, and advising the owner so that maintenance and
capital improvements can be carried out in a timely fashion and at an
appropriate cost. There can be no assurance regarding the performance of
Brandywine, or any other managers.
Geographic Concentration of Initial Investments in Pennsylvania May Make
the Company's Performance Subject to Economic Conditions in Pennsylvania.
Eleven of the twelve Initial Investments are with respect to real properties
located in Philadelphia, Pennsylvania. Philadelphia has, in the past, been
subject to adverse economic conditions which have not affected other regions of
the country, or has been disproportionately affected by adverse national or
regional economic conditions, including a decline in its residential
population. The Company's performance and its ability to make distributions to
its shareholders likely will be materially affected by future economic
conditions in Philadelphia. See "Risk Factors -- Investment Activity Risks --
Financing Considerations -- Lack of Geographic Diversification Exposes
Company's Investments to Higher Risk of Loss Due to Regional Economic Factors"
and "-- Limited Number of Investments Will Make Company More Dependent upon
Performance of Individual Investments."
Initial Investments Include Loans in Default Under Original Loan Terms and
Thus May Involve Higher Payment Risks than Performing Loans. Eight of the
twelve Initial Investments involve the acquisition of discounted loans that are
in default with respect to payment of debt service under their original loan
terms. Each such loan is currently subject to, and in compliance with, a
forebearance agreement pursuant to which the loan may not be foreclosed
provided that minimum payment requirements and certain other conditions are
met. See "Investment Objectives and Policies -- Acquisition of Loans at
Discount" and " -- Initial Investments." These Initial Investments may have
greater risk of future defaults and delinquencies as compared to
newly-originated, higher quality loans. Returns on an investment of this type
depend upon the borrower's ability to make required payments under the
forbearance agreements, the ability of the borrower to obtain refinancing or
otherwise pay the loan upon expiration of the forbearance agreement, or the
ability of the Company to foreclose upon or sell the underlying property upon a
default. There can be no assurance that the borrowers will be able to pay such
loans upon termination of the forbearance agreements or, if the Company
forecloses upon and sells the underlying property, that the Company will be
able to do so successfully or in a timely fashion.
Other Investment Activity Risks
Appropriate Investments May Not Be Available and Full Investment of Net
Proceeds May Be Delayed. Other than the Initial Investments (which will be
acquired utilizing approximately 45% of the Offering proceeds, including the
sale of shares to RAI; 40% if the Underwriters exercise their over-allotment
option), the Financing and Property Interests to be originated or acquired by
the Company have not been identified. Investors must rely upon the ability of
Company management to identify appropriate investment opportunities, and will
not have an opportunity to evaluate relevant economic, financial and other
information regarding the Company's future investments at the time they are
made. There can be no assurance that the Company will identify Financing or
Property Interests that meet its investment criteria, or that any such assets,
once acquired, will produce a return on the Company's investment. A delay may
occur between the time the Common Shares are sold in this Offering and the time
the proceeds of this Offering are utilized by the Company, which could result
in a delay in the receipt by a shareholder of the benefits, if any, of an
investment in the Company. Pending investment in Financing and Property
Interests, the Offering proceeds will be held in temporary investments that the
Company believes will have low investment risk but that the Company does not
anticipate will produce substantial investment returns. See "Use of Proceeds."
Newly-Formed Entity; Limited REIT Management Experience of Senior
Management. The Company is a newly-formed entity with no prior operating
history, and its operating strategies and policies are untried. The
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Company will be dependent for the monitoring of its day-to-day operations,
including, but not limited to, the selection, structuring and monitoring of its
investments and associated borrowings, on the diligence and skill of its senior
management, which has limited prior experience in managing a REIT. There can be
no assurance that the Company and its management will be able to implement
successfully the policies and strategies the Company intends to pursue.
Importance of Key Personnel. The Company believes that its future success
will depend to a significant extent upon the continued services of the
Company's senior management (Mrs. Cohen, Mr. Eisner, Mr. Jay Cohen and Ms.
DiStefano). The unexpected loss of the services of any of these persons, could
have a material adverse effect upon the Company. See "The Company -- Trustees
and Executive Officers." While the Company anticipates that it will enter into
employment agreements with its Chairman and Chief Executive Officer, Mrs.
Cohen, and its President and Chief Operating Officer, Mr. Eisner, it will not
maintain key person life insurance on either person, or on any other officer.
Mr. Eisner, Mr. Jay Cohen and Ms. DiStefano will devote all of their business
time to the Company's business. Mrs. Cohen is Chairman and Chief Executive
Officer of JeffBanks and its subsidiary banks, and is a director of two other
public companies, to which she expects to devote substantial amounts of her
time. Mrs. Cohen's obligations to these businesses will limit the amount of
time she has available to devote to the Company's business.
Leverage Can Reduce Income Available for Distribution and Cause Losses.
The Company is permitted to leverage its portfolio through borrowings although,
in general (except with respect to certain Initial Investments as to which it
will acquire senior debt interests), it will not do so unless it does not have
immediately available capital sufficient to make a particular investment. If
and when used, the Company's leverage ratio will vary depending on the
Company's estimate of the stability of the portfolio's cash flow. To the extent
that changes in market conditions cause the cost of such financing to increase
relative to the income that can be derived from the investments acquired, the
Company may reduce the amount of leverage it utilizes. The Company may also
borrow to the extent necessary to meet REIT distribution requirements imposed
by the Code. See "Federal Income Tax Considerations --Requirements for
Qualification -- Distribution Requirements" and "Risk Factors -- Legal and Tax
Risks -- 'Phantom Income' May Require Company to Borrow or Sell Assets to Meet
REIT Distribution Requirements." In general, the Company expects that the ratio
of the Company's overall indebtedness to its equity will not exceed 0.5 to 1.
See "Investment Objectives and Policies -- Leverage." However, the Company's
Declaration of Trust does not limit the amount of indebtedness the Company can
incur, and the Board of Trustees has the discretion to deviate from or change
this indebtedness policy at any time, without consent from or notice to the
Company's shareholders. Utilizing leverage to acquire investments creates an
opportunity for increased net income, but at the same time creates risks. For
example, leverage can reduce the net income available for distributions to
shareholders in periods of rising interest rates where the increase in rates
paid by the Company on its borrowings is not matched by corresponding increases
in the rates of return on its investments. The Company will leverage assets to
acquire investments only when there is an expectation that the use of leverage
will enhance returns, although there can be no assurance that the Company's use
of leverage will prove to be beneficial. The Company may be required to
mortgage or otherwise pledge some portion or all of its assets as collateral
security in order to obtain debt financing. There can be no assurance that the
Company will be able to meet its debt service obligations on any debt financing
so secured and, to the extent that it cannot, the Company risks the loss of
some or all of its assets.
Legal and Tax Risks
Failure to Maintain REIT Status Would Result in Company Being Taxed as a
Regular Corporation. The Company intends to operate in a manner that permits it
to qualify as a REIT for federal income tax purposes. Although the Company does
not intend to request a ruling from the Service as to its REIT status, it has
received an opinion of counsel that, based on certain assumptions and
representations, it so qualifies. Investors should be aware, however, that
opinions of counsel are not binding on the Service or any court. The opinion
only
represents the view of counsel based on counsel's review and analysis of
existing law. Furthermore, both the validity of the opinion and the continued
qualification of the Company as a REIT will depend on the Company's
satisfaction of certain asset, income, organizational, distribution and
shareholder ownership requirements on a continuing basis. If the Company were
to fail to qualify as a REIT in any taxable year, it would be subject to
federal income tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate rates, and distributions to shareholders
would not be deductible by the Company in computing its taxable
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income. Any such corporate tax liability could be substantial and would reduce
the amount of cash available for distribution to shareholders, which in turn
could have an adverse impact on the value of, and trading prices for, the
Common Shares. Unless entitled to relief under certain Code provisions, the
Company also would be disqualified from taxation as a REIT for the four taxable
years following the year during which it ceased to qualify as a REIT.
"Phantom Income" May Require Company to Borrow or Sell Assets to Meet REIT
Distribution Requirements. The Company must distribute at least 95% of its
annual net taxable income (excluding any net capital gain or retained capital
gain) in order to avoid corporate income taxation of the earnings that it
distributes. In addition, the Company will be subject to a 4% nondeductible
excise tax on the amount, if any, by which certain distributions paid by it
with respect to any calendar year are less than the sum of (i) 85% of its
ordinary income for that year, (ii) 95% of its capital gain net income for that
year, and (iii) 100% of its undistributed taxable income from prior years. The
Company intends to make distributions to its shareholders to comply with the
95% distribution requirement and to avoid the nondeductible excise tax.
However, the Company may originate or acquire Financings that will be deemed to
have original issue discount ("OID") for federal income tax purposes, which is
generally equal to the difference between an obligation's issue price and its
redemption price. For example, mortgages with participation features sometimes
will be considered to have OID and, if so, will accrue OID at a rate based on
the expected overall yield on the mortgage, which generally will exceed the
stated interest rate. The income generated by such investments for federal
income tax purposes will consist of amortization of the OID and the coupon
interest associated with the investments. The Company will be required to
recognize as income in each year the portion of the OID that accrues during
that year, which will increase the amount that the Company must distribute to
its shareholders in order to avoid corporate income tax for that year,
notwithstanding the fact that there may be no corresponding contemporaneous
receipt of cash by the Company. The Company may also be required to accrue
interest at a rate greater than the rate at which it is receiving interest. In
particular, this may happen where there has been a default with respect to the
loan.
In addition, the Company may acquire or originate wraparound loans
pursuant to which it will receive payments of principal and interest that do
not coincide with the payments of principal and interest on underlying senior
liens. Even if, as expected, there is positive cash flow to the Company from
the transaction, it may be that the amount of principal the Company is required
to pay on the senior obligations will exceed the amount of principal it
receives from the obligor on the wraparound loan, and that the amount of
interest it receives from the obligor will exceed the amount of interest it
pays on the senior obligations. This could create a situation where the
Company's taxable income exceeds the Company's retained cash flow from the
investments. REIT taxable income in excess of cash received may also arise in
certain property sales and where a "significant" modification is made to a
loan. See "Federal Income Tax Considerations -- Requirements for Qualification
- -- Distribution Requirements." The occurrence of any such situation could have
the effect of requiring the Company, in order to avoid corporate income tax and
the nondeductible excise tax, (i) to borrow funds, (ii) to sell assets at times
which may not be advantageous to the Company, (iii) to distribute amounts that
represent a return of capital, or (iv) to distribute amounts that would
otherwise be spent on future acquisitions, unanticipated capital expenditures,
or repayment of debt. To offset these risks, the Company intends, as
appropriate, to invest in Property Interests so that the non-cash depreciation
deductions associated with Property Interest investments may help offset any
non-cash income.
Origination Fees Which May Be Received by the Company Will Not Be REIT
Qualifying Income. Although the Company does not now anticipate receiving
origination fees in connection with its mortgage loans, any origination fees
received by the Company will not be qualifying income for purposes of the 75%
or 95% gross income tests of the Code. See "Federal Income Tax Considerations
- -- Requirements for Qualification -- Income Tests." Failure of the Company to
satisfy these tests as a result of origination fees received (or for any other
reason) could cause the Company not to qualify as a REIT. See "Risk Factors --
Legal and Tax Risks -- Failure to Maintain REIT Status Would Result in Company
Being Taxed as a Regular Corporation."
Income from Wraparound Loans May Not Be REIT Qualifying Income in Some
Instances. It is contemplated that the Company may purchase and originate
wraparound or similar loans that are only indirectly secured by real property.
In situations where a senior loan prevents a junior lender from recording a
mortgage against the property or otherwise substantially restricts the junior
lender from exercising its rights as a junior secured lender,
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it is possible that the Service would conclude that interest on the junior
lender's loan does not constitute interest "secured by mortgages on real
property or on interests in real property," so that such interest would not
qualify for purposes of the 75% gross income test. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Income Tests." With respect
to the two wraparound loans included as part of the Initial Investments,
because the Company will have, upon any default, foreclosure rights directly
exercisable by the Company, Counsel is of the opinion that interest income from
such loans will constitute qualifying income.
Gain on Disposition of Assets Deemed Held for Sale in Ordinary Course
Subject to 100% Tax. With respect to any sale of assets by the Company, there
is risk that the sale will be deemed to be the disposition of an asset held
primarily for sale to customers in the ordinary course of a trade or business.
Gain from the sale of any asset so characterized generally will be subject to a
100% tax. Whether an asset is held "primarily for sale to customers in the
ordinary course of a trade or business" depends on the facts and circumstances
in effect from time to time, including those related to a particular asset.
Nevertheless, the Company will attempt to comply with the terms of safe-harbor
provisions in the Code prescribing when asset sales will not be so
characterized. Complete assurance cannot be given, however, that the Company
can comply with the safe-harbor provisions of the Code or avoid owning property
that may be characterized as property held "primarily for sale to customers in
the ordinary course of a trade or business." See "Federal Income Tax
Considerations -- Requirements for Qualification -- Income Tests."
Loss of Investment Company Act Exemption Would Affect the Company
Adversely. The Company believes that it will not be, and intends to conduct its
operations so as not to become, regulated as an investment company under the
Investment Company Act. The Investment Company Act exempts entities that,
directly or through majority-owned subsidiaries, are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualified Interests"). Under current
interpretations by the Securities and Exchange Commission (the "Commission"),
in order to qualify for a "no action" position by the Commission with respect
to the availability of the exemption, the Company, among other things, must
maintain at least 55% of its assets in Qualifying Interests and also may be
required to maintain an additional 25% in Qualifying Interests or other assets
related to real property. The assets that the Company may acquire, therefore,
may be limited by the provisions of the Investment Company Act. In connection
with its origination or acquisition of Financing, the Company will seek, where
appropriate, to obtain foreclosure rights with respect to the underlying
property, although there can be no assurance that it will be able to do so on
acceptable terms. If the Company does not obtain such rights, the Financing may
not constitute a Qualifying Interest for the purpose of the Investment Company
Act. If the Company obtains such rights, the Company believes that the
Financing will constitute a Qualifying Interest for the purpose of the
Investment Company Act. The Company does not intend, however, to seek an
exemptive order, no-action letter or other form of interpretive guidance from
the Commission on this position. If the Commission were to take a different
position with respect to whether any such Financing constitutes a Qualifying
Interest, the Company could, among other things, be required either (a) to
change the manner in which it conducts its operations to avoid being required
to register as an investment company under the Investment Company Act or (b) to
register as an investment company, either of which could have an adverse effect
on the Company and the market price for the Common Shares.
Investment in Common Stock by Certain Benefit Plans May Give Rise to
Prohibited Transaction under ERISA and the Code. The Employee Retirement Income
Security Act of 1974, as amended ("ERISA"), and section 4975 of the Code
prohibit certain transactions that involve (i) certain pension, profit-sharing,
employee benefit, or retirement plans or individual retirement accounts (each a
"Plan") and (ii) the assets of a Plan. A "party in interest" or "disqualified
person" with respect to a Plan will be subject to (x) an initial 15% excise tax
on the amount involved in any prohibited transaction involving the assets of
the Plan and (y) an excise tax equal to 100% of the amount involved if any
prohibited transaction is not corrected. Consequently, the fiduciary of a Plan
contemplating an investment in the Common Shares should consider whether the
Company, any other person associated with the issuance of the Common Shares, or
any affiliate of the foregoing is or might become a "party in interest" or
"disqualified person" with respect to the Plan. In such a case, the acquisition
or holding of Common Shares by or on behalf of the Plan could be considered to
give rise to a prohibited transaction under ERISA and the Code. See "Benefit
Plan Considerations -- Employee Benefit Plans, Tax Qualified Retirement Plans
and IRAs."
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Board of Trustees May Change Policies Without Shareholder Consent. The
policies of the Company, including its investment policy and other policies
with respect to acquisition, financing, growth, operations, debt and
distributions, are determined by its Board of Trustees. The Board of Trustees
may amend or revise these and other policies, or approve transactions that
deviate from these policies, from time to time, without a vote of the
shareholders. The effect of any such changes may be positive or negative. The
Company cannot change its policy of seeking to maintain its qualification as a
REIT without the approval of the holders of two-thirds of the outstanding
Common Shares.
Limitation of Liability of Officers and Trustees. The Declaration of Trust
of the Company contains a provision which, subject to certain exceptions,
eliminates the liability of a trustee or officer to the Company or its
shareholders for monetary damages for any breach of duty as a trustee or
officer. This provision does not eliminate the liability of a trustee to the
extent that it is proved that the trustee actually received an improper benefit
in money, property or services or engaged in active and deliberate dishonesty
established by a final judgment as being material to the cause of action. The
Company will also enter into indemnification agreements with its trustees and
executive officers containing similar provisions. See "Certain Provisions of
Maryland Law and of the Company's Declaration of Trust and Bylaws."
Conflicts of Interest in the Business of the Company. There are
relationships between the Company, RAI, Brandywine and their affiliates
resulting from affiliations among their respective managements, RAI's
anticipated ownership of 15% of the Common Shares and RAI's affiliation with
Brandywine. As a result of these relationships, there is a risk that conflicts
of interest may arise among the Company, RAI, Brandywine and their affiliates
in connection with the price and terms at which investments are sold or
services provided to the Company by RAI, Brandywine and their affiliates. For a
more detailed discussion of these relationships, see "Conflicts of Interest."
Failure to Develop Active Market for Common Shares May Result in Decreased
Market Price. Prior to this Offering, there has been no public market for the
Common Shares offered hereby. The initial public offering price will be
determined by the Company and Friedman, Billings, Ramsey & Co., Inc., as the
representative of the Underwriters (the "Representative"). There can be no
assurance that the price at which the Common Shares will sell in the public
market after the Offering will not be lower than the price at which they are
sold by the Underwriters. Application has been made to list the Common Shares
on the Amex. There can be no assurance that such application will be approved
or that if approved, an active market will develop for the Common Shares.
Ownership Limitation May Restrict Business Combination Opportunities. In
order for the Company to maintain its qualification as a REIT, not more than
50% in value of its outstanding capital shares may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year, other than the
Company's taxable year ending December 31, 1997. For the purpose of preserving
the Company's REIT qualification, the Declaration of Trust generally prohibits
direct or indirect ownership of more than 8.3% (or, with respect to RAI, 15%)
of the outstanding Common Shares (the "Ownership Limitation"). The Ownership
Limitation will likely have the effect of discouraging a takeover or other
transaction in which holders of some, or a majority, of the Common Shares might
receive a premium for their Common Shares over the then prevailing market price
or which such holders might believe to be otherwise desirable. See "Description
of Shares of Beneficial Interest -- Restrictions on Ownership and Transfer" and
"Federal Income Tax Considerations -- Requirements for Qualification."
Preferred Shares May Prevent Change in Control. The Company's Declaration
of Trust authorizes the Board of Trustees to issue preferred shares ("Preferred
Shares"), to establish the preferences and rights of any Preferred Shares
issued, to classify any unissued Preferred Shares and reclassify any previously
classified but unissued Preferred Shares. Although the Company has no current
intention to issue any series of Preferred Shares in the foreseeable future,
the issuance of any series of Preferred Shares could have the effect of
delaying or preventing a change in control of the Company (apart from the
Ownership Limitation) even if a majority of the Company's shareholders believe
such change of control is desirable. See "Description of Shares of Beneficial
Interest -- Preferred Shares."
Maryland Anti-Takeover Statutes May Restrict Business Combination
Opportunities. As a Maryland real estate investment trust, the Company is
subject to various provisions of Maryland law which impose certain
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restrictions and require certain procedures with respect to certain takeover
offers and business combinations, including, but not limited to, combinations
with interested holders and share repurchases from certain holders. While the
Company has elected to "opt out" of these provisions, the Board of Trustees has
the right to rescind such election at any time without notice to the
shareholders. See "Certain Provisions of Maryland Law and the Company's
Declaration of Trust and Bylaws -- Business Combinations" and "-- Control Share
Acquisitions."
Future Offerings of Capital Stock May Result in Dilution of the Book Value
per Common Share. The Company may issue additional Common Shares, securities
convertible into Common Shares or Preferred Shares in the future to finance its
capital needs. To the extent such securities are issued for cash or property
having a net tangible book value less than the net tangible book value of the
Common Shares on the date of issuance, holders will realize an immediate
dilution in the net tangible book value of their Common Shares. The actual or
perceived effect of such sales of securities may result in the reduction of the
market price of the Common Shares.
CONFLICTS OF INTEREST
The relationships among the Company, RAI, Brandywine and their affiliates
may give rise to conflicts of interest. RAI will own 15% of the Company's
Common Shares at the completion of the Offering (assuming the Underwriters do
not exercise their overallotment option). RAI will have the right to nominate
one person for election to the Company's Board of Trustees until such time as
its ownership of outstanding Common Shares is less than 5%. Jonathan Z. Cohen
is RAI's nominee to the Board of Trustees. Mr. Cohen is the son of Betsy Z.
Cohen, the Chairman and Chief Executive Officer of the Company, and Edward E.
Cohen, the Chairman, Chief Executive Officer and a principal shareholder of
RAI. RAI is advancing funds to the Company for legal, accounting and filing
fees and expenses, salaries of the Company's executive officers, rent and other
organizational expenses (which are estimated to be $526,900) and for the
expenses incurred by RAI in sponsoring the Company, including an allocation of
compensation of RAI employees (which are estimated to be $562,000). These
advances are without interest and will be repaid from the proceeds of this
Offering. See "Use of Proceeds."
Of the Initial Investments 88% will be purchased by the Company from RAI.
Two of the Initial Investments (28% of the Initial Investments, by cost) were
originated by the Company and will be acquired from RAI at RAI's cost. See
"Investment Objectives and Policies -- Initial Investments." RAI will retain a
$2.5 million senior secured interest with respect to one of such investments.
The Company anticipates that, subject to the limitations referred to below, it
will purchase additional investments from RAI. The Company may from time to
time retain RAI to perform due diligence investigations on properties subject
to Financings (other than Financings being acquired from RAI) or on Property
Interests that the Company is considering for acquisition. Brandywine, an
affiliate of RAI, may provide real estate management and/or management
supervisory services for properties that the Company owns or for which it has
provided Financing. Brandywine currently manages, or supervises the management
of nine of the properties underlying the Initial Investments.
The Company has instituted certain procedures to mitigate the effects of
any such conflicts, including (i) requiring that a majority of its trustees be
Independent Trustees, (ii) requiring that the acquisition price of any
investments acquired from RAI (or in which an officer or trustee of the
Company, including Mrs. Cohen, has an interest) be determined based upon
independent appraisal of the underlying property, (iii) limiting the
investments that may be acquired from RAI to a maximum of 30% of the Company's
investments (excluding the Initial Investments), based upon the Company's
investment cost (the amount of the investment plus legal, filing and other
related fees and expenses), (iv) requiring that any fees for services performed
by RAI, Brandywine or their affiliates be no greater than prevailing fees in
the area for similar services provided by unrelated third parties, (v)
requiring that any service arrangements with an affiliated entity provide that
services will be rendered only as and to the extent requested by the Company
from time to time and that, in any event, the arrangements be cancelable by the
Company, without penalty, on no more than 30 days' notice, (vi) requiring that
any investment acquisition or services arrangement, and every transaction with
RAI, Brandywine and their affiliates, or relating to any property in which any
such person has an interest, receive the prior approval of a majority of the
Independent Trustees (who, in giving such approval, may rely upon information
supplied by RAI, Brandywine or their affiliates), and (vii) with respect to
real estate management or management supervisory services performed
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by Brandywine, requiring that the aggregate of the fee received by Brandywine
and the manager being supervised may not exceed the normal and customary fee
for similar property management services with respect to similar properties in
the same area. The Company will not, however, be required to obtain the
approval of the Independent Trustees to retain RAI to perform a due diligence
investigation of a property where the amount of the fee for such services will
not exceed the lesser of 1% of the property's appraised value or $10,000. The
non-Independent Trustees are Betsy Z. Cohen and Jonathan Z. Cohen. The
Independent Trustees are Jerome S. Goodman, Joel R. Mesznik, Daniel Promislo
and Jack L. Wolgin, who currently constitute two-thirds of the Company's
Trustees.
The Company anticipates that it will have customary banking relationships
with the bank affiliates of JeffBanks, which may also refer to the Company
financing proposals that are not within JeffBanks' normal underwriting
criteria. The Company anticipates that it may (subject to the approval of a
majority of the Independent Trustees) sublease office space from JeffBanks.
Furthermore, Mr. and Mrs. Cohen are principal stockholders of JeffBanks, Mrs.
Cohen is the Chairman and Chief Executive Officer of JeffBanks and Mr. Cohen is
Chairman of its Executive Committee.
Since each of the Company, RAI and JeffBanks seeks to originate or, in the
case of the Company and RAI, acquire mortgage loans, there may be conflicts of
interest among the Company, RAI and JeffBanks regarding the allocation of loan
opportunities. The Company believes, however, that these conflicts are
substantially mitigated since there are significant differences between the
investment objectives of the Company, RAI and JeffBanks. RAI has advised the
Company that it seeks to acquire loans which are either in default, or at risk
of imminent default, requiring active intervention by RAI in the workout
process. The Company, however, seeks to acquire loans where the workout process
has already been initiated and there is no need for its active
intervention. JeffBanks has advised the Company that, with respect to real
estate loans, it seeks to provide customary commercial lending services
emphasizing first lien financing that is subject to specified underwriting
standards. The Company seeks to provide Financing that does not conform to
JeffBanks' underwriting standards. The Company believes that conflicts will be
further mitigated because the anticipated sources of the Company's loan
referrals will be different from those of RAI and JeffBanks.
To further limit conflicts between the Company and RAI, the Company and
RAI have agreed that, for two years following the completion of the Offering,
(i) RAI will not sponsor another REIT with investment objectives and policies
which are the same as, or substantially similar to, those of the Company; (ii)
if RAI proposes to provide new wraparound or other junior lien or subordinated
Financing with respect to multifamily, office or other commercial properties to
a borrower (other than to a borrower with an existing loan from RAI), RAI must
first offer the opportunity to the Company; and (iii) if RAI desires to sell
any loan it has acquired that conforms to the Company's investment objectives
and policies with respect to acquired loans, it must first offer to sell it to
the Company. RAI has also agreed that if, after expiration of the two year
period, RAI sponsors a REIT with investment objectives similar to those of the
Company, RAI's representative on the Board of Trustees (should RAI have a
representative on the Board at that time) will recuse himself from considering
or voting upon matters relating to Financings which may be deemed to be within
the lending guidelines of both the Company and the REIT sponsored by RAI.
Subject only to the limitations referred to above, to the extent that an
investment opportunity is presented to one entity which may be deemed
appropriate for either entity, the entity to which the opportunity is presented
may invest in such opportunity without offering the other entity the right to
participate. However, each entity reserves the right, in its sole discretion,
to refer to the other appropriate investment opportunities, or to offer a
participation to the other entity in investments that may be deemed appropriate
for both.
Ledgewood Law Firm, P.C., which has acted as counsel to the Company in
connection with its organization and the Offering, previously has acted as
counsel to RAI, Brandywine, JeffBanks and their affiliates (including Messrs.
Jonathan Z. and Edward E. Cohen and Mrs. Cohen) and anticipates that it will
continue to do so in the future. Until April 1996, Edward E. Cohen was Of
Counsel to the firm, of which he was previously a member, and receives certain
debt service payments from the firm in connection with his withdrawal from the
firm as a member and its redemption of his interest in the firm. The interests
of the Company, RAI, Brandywine, JeffBanks or their affiliates could become
adverse in the future. In the event that a dispute were to arise between the
Company and any of such entities, either the Company or such entity (or both),
as appropriate, will retain separate counsel for such matters.
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USE OF PROCEEDS
The Company has contracted (subject to the consent of the Independent
Trustees) to acquire the Initial Investments upon completion of this Offering
for an investment cost of approximately $20.6 million, which is equal to
approximately 45% of the net proceeds of this Offering and the sale of shares
to RAI (40% if the Underwriters exercise their overallotment option). The
Initial Investments will consist of those Financings described at "Investment
Objectives and Policies -- Initial Investments." Of the Initial Investments,
$18.1 million will be acquired from RAI; $2.5 million will be acquired from
third parties, as described in the next paragraph. Two of the Initial
Investments were originated by the Company and will be purchased from RAI at
cost. RAI will retain a $2.5 million senior secured interest in one such
investment. The purchase price for each of the Initial Investments (except for
the two Initial Investments to be acquired at cost) was negotiated based upon
the appraised value of the property underlying the loan, current yield, lien
position of the loan and the Company's analysis of the long-term prospects for
the property. In addition, the Company will reimburse RAI for legal, accounting
and filing fees and expenses, salaries of the Company's executive officers,
rent and other organizational expenses (which are estimated to be $526,900) and
for the expenses incurred by RAI in sponsoring the Company, including an
allocation of the compensation of RAI employees (which are estimated to be
$562,000).
At the time of their acquisition, the Initial Investments being acquired
from RAI will be subject to $20.4 million of loan participation interests or
other debt that is senior to the loan interests acquired from RAI. The Company
anticipates acquiring $2.5 million of such senior lien interests from the
proceeds of this Offering. However, the Company also anticipates that,
following acquisition, the Company will seek to borrow against the loans as to
which it has acquired the prior senior lien interests or that borrowers may
seek to refinance some portion of the loans and, accordingly, that the Company
will obtain the return of some portion or all of the funds utilized to acquire
the senior lien interests. There can be no assurance, however, that any such
borrowings or refinancings will occur. For certain information concerning the
senior interests to be acquired (including interest rate and maturity date) see
"Investment Objectives and Policies -- Initial Investments."
The balance of the Offering proceeds (including any funds obtained from
borrowings against or refinancings of loans as referred to above) will be
invested in the manner described in "Investment Objectives and
Policies." It is anticipated that the investment process will take up to six
months after the Offering has been completed, although there can be no
assurance that the process will not be longer. Pending such investment, the
balance of the net proceeds will be invested in readily marketable,
interest-bearing securities which, following the expiration of the one year
investment period provided by the Code, will be limited to those securities
allowing the Company to continue to qualify as a REIT. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Asset Tests."
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INVESTMENT OBJECTIVES AND POLICIES
General
The Company's principal business activity will be to acquire or provide
loans secured by mortgages on real property (or interests in such loans) in
situations that, generally, do not conform to the underwriting standards of
institutional lenders or sources that provide financing through securitization.
The Company's Financings will consist of direct loans to borrowers and the
acquisition of existing loans. The Company anticipates that it also will
acquire Property Interests. The Company will seek to generate income for
distribution to its shareholders from a combination of interest, rents,
distributions in respect of rents (where the Company owns an equity interest in
a real property), proceeds from refinancings and proceeds from the sale of
portfolio investments. The Company does not anticipate that it will seek or
receive origination fees in connection with its loans. See "Risk Factors --
Legal and Tax Risks -- Origination Fees Which May Be Received by the Company
Will Not Be REIT Qualifying Income."
The Company believes that, under current market conditions, institutional
lenders and lending sources that provide financing through securitization
(which the Company believes are currently the principal sources of real
property financing), require that loans made by them satisfy certain standard
criteria. Typically, these lenders will require that the requested loan be
within the institution's size parameters and bear a specified relation to the
appraised value of the property securing the loan, that the property have
historical operating results demonstrating a ratio of cash flow to projected
debt service meeting standards established by the institution and that the loan
be secured by a first lien on the property. These lenders frequently restrict
the ability of the borrower to incur junior lien loans on the property without
the lender's consent and impose substantial penalties on loan prepayment.
Lenders may also establish guidelines with respect to type of property, type
and amount of insurance, uses of funds, appraisals and loan documentation. The
Company believes that borrowers or properties needing attention to specific or
unique situations are frequently unable to obtain financing from these sources,
or cannot obtain financing adapted to their particular needs, providing the
Company with a niche market with substantial growth potential. The Company also
believes that the recent trend towards consolidation among regulated financial
service providers has enhanced the opportunity for unregulated financial
service providers, such as the Company, to compete in this niche.
The Company believes that its tax and corporate structure as a REIT will
provide it with an advantage over certain other financial institutions and
commercial mortgage originators. As a REIT, the Company generally will be able
to pass through earnings as dividends to shareholders without payment of
corporate level federal income tax. Thus, the Company expects to be able to pay
higher dividends than traditional commercial mortgage lending institutions,
which are subject to corporate level federal income tax. In addition,
management believes that the Company, as an unregulated company, provides a
more attractive method of investing in loans than regulated financial
institutions, and more flexibility in pursuing investment opportunities,
because the Company will not be subject to the costs and restrictions
associated with federal and state regulations imposed upon insured financial
institutions.
Types of Financing
The Company will emphasize wraparound mortgage loans and, to a lesser
extent, other forms of junior lien and subordinated financing. The Company is
not, however, limited as to the types of financing it may provide, and it may
also acquire or provide first lien financing. In originating new Financing, the
Company will endeavor to adapt the terms of its financing to the needs of its
borrowers, utilizing a variety of financing techniques such as staged payments,
event specific loan advances, different rates of interest payment and interest
accrual, deferred (or "balloon") principal payments and similar techniques. The
Company will also from time to time provide subordinated financing through a
direct purchase of a Property Interest. See "Investment Objectives and
Policies -- Acquisition of Property Interests." It is not anticipated that the
Company's Financings will be insured by the Federal Housing Administration or
guaranteed by the Veterans Administration or otherwise guaranteed (except by
borrowers or their affiliates, in certain cases) or insured.
Wraparound and other junior lien loans and subordinated financing
generally will be secured by mortgages on properties already subject to the
liens of other mortgage loans. A wraparound loan is a junior lien loan having a
principal amount equal to the sum of the outstanding principal balances of
senior loans plus the net amount
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advanced by the wraparound lender. From payments it receives on the wraparound
loan, the wraparound lender pays principal and interest to the holders of the
senior loans, but ordinarily only to the extent that payments are received from
the borrower. Wraparound loans (and other junior loans) offer the potential for
higher yields than yields ordinarily obtained in senior lien financing (and, in
the case of wraparound loans, the possibility of increasing yields as the
principal amounts of senior loans are amortized). However, such loans carry
greater credit risk, including substantially greater risk of non-payment of
interest or principal, than senior lien financing. See "Risk
Factors -- Investment Activity Risks -- Financing Considerations -- Investment
In Subordinate Financing May Involve Increased Risk of Loss."
The Company anticipates acquiring some loans that are not collateralized
by recorded or perfected liens, including five of the Initial Investments
(after the Company's acquisition of senior debt with respect to four of the
other Initial Investments). It is not anticipated that these loans will
constitute more than 15% of the Company's assets. See "Risk
Factors -- Investment Activity Risks -- Financing Considerations." Management
believes that, with respect to any such loans (including the Initial
Investments), the following matters serve to mitigate the Company's risks as an
unsecured lender. First, the tenants of the underlying properties generally
will pay their rents directly to a lockbox controlled by the Company. Second,
future liens encumbering the underlying properties are generally prohibited by
the lenders of existing senior lien loans on these properties. Finally, the
Company generally will hold a deed-in-lieu of foreclosure that may enable it to
enforce its rights against the underlying property in an expedited fashion.
However, none of these factors will assure that these loans are collected.
Moreover, filing a deed-in-lieu of foreclosure with respect to these loans may
(and, with respect to the applicable Initial Investments, will) constitute an
event of default under related senior debt. Any such default would require the
Company to acquire or pay off the senior debt in order to protect its
investment.
The Company will seek to originate or acquire Financing that not only has
current cash returns higher than those obtained in typical first lien
institutional financing but that also has various features designed to increase
the return over the term of the Financing. In particular, the Company will seek
to obtain participations. These participations typically will be one of two
types, as follows: (i) a grant of an interest in the appreciated value of the
financed real property (that is, an interest in the value of the property,
typically determined by sales price, refinancing amount or appraisal, which
exceeds a specified amount, usually the appraised value of the property at the
time of the Company's Financing or the principal amount of the Financing),
payable at the maturity of the loan or the time the property is sold or
refinanced, or (ii) a grant of an interest in the revenues from the property,
usually in excess of a specified amount. The Company typically will seek not
less than a 25% participation rate, and may seek to obtain either or both types
of participations. The Company believes that obtaining participations may be
advantageous to it since the Company will thus have the opportunity of
participating in the growth in value of the real property being financed (and,
therefore, the opportunity of gaining additional compensation). However,
obtaining participations may limit or, possibly, reduce the amount of interest
which the Company might otherwise be able to obtain on a loan. There can be no
assurance that the Company will be able to obtain participations in any loan,
or as to the final terms (including the participation rate) under which they
may be granted. Moreover, since participations are more usually associated with
subordinated loans to compensate the lender for its subordinated position, the
Company may not be able to find borrowers willing to give participations in
first mortgage loans (to the extent acquired by the Company) on terms
acceptable to the Company.
Loan Origination Sources
To generate loan originations, the Company will rely primarily upon the
relationships senior management has developed as a result of its background in
the banking, real estate and real estate finance industries with developers,
commercial real estate brokers, mortgage bankers, real estate investors and
other direct borrowers or referral sources. See "The Company -- Trustees and
Executive Officers." For sources of loans for acquisition (in addition to RAI),
the Company will focus on institutional holders (primarily banks and insurance
companies) who may wish to dispose of underperforming loans in their existing
portfolios that meet the Company's Financing criteria. The Company's focus on
smaller loans makes it a niche buyer for loans held by these institutions as
the Company believes that others seeking to purchase subordinated loan
positions typically will focus on large size loans or pools of loans. These
institutional lenders may also refer to the Company loan opportunities
presented to them that they do not wish to underwrite.
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Certain Financial Guidelines
The Company has established financial guidelines for use in evaluating
financing proposals subsequent to the Initial Investments. The Company may
depart from one or more of the guidelines in underwriting any particular
Financing, provided that the Company's Financing portfolio, in the aggregate,
is in compliance. The guidelines provide as follows: (i) the property
underlying the Financing will have a current appraised value of not less than
25% below the Company's estimate of the property's replacement cost, (ii) the
size of the Financing will be between $1 million and $8 million, (iii) the
ratio of current cash flow to debt service on senior lien loans with respect to
the underlying property will be at least 1.25 to 1, (iv) the ratio of current
cash flow to debt service on both senior loans and the Company's Financing will
be at least 1.1 to 1, (v) the cash flow from the underlying property will be
sufficient to yield a current return on the Company's investment of no less
than 10% per year, (vi) the aggregate of all outstanding senior debt may not
exceed 75% of the appraised value of the underlying property, and (vii) the
aggregate of outstanding senior debt plus the amount of the Company's Financing
may not exceed 90% of the appraised value of the underlying property. The
"appraised value" of a property for purposes of the guidelines would be the
estimate by an independent real estate appraiser of the fair market value of
the property, taking into account standard valuation methodologies. The
Company's estimate as to replacement cost will be based upon information
developed by the Company from developers, contractors and other persons
regarding construction costs both generally and with respect to similar
properties in the area.
In departing from a particular guideline for any Financing, the Company
will typically consider factors that would cause the underlying property to be
in compliance with the guideline within a reasonable time following initial
funding of the Financing. For example, the Company may depart from the cash
flow guidelines where the borrower can demonstrate (through new lease
placements or otherwise) that historical cash flow will not be representative
of cash flow during the term of the loan, and may depart from loan-to-value
guidelines where the borrower can demonstrate that the application of the loan
proceeds will result in an increase in property value. Notwithstanding the
foregoing, these guidelines may be changed by the Board of Trustees of the
Company without notice to or approval by the shareholders.
Location of Properties Relating to Financings
The Company intends to finance properties located in metropolitan areas of
the United States where there is a significant amount of small, multi-family
residential, office and other commercial properties. Initially, the Company
anticipates that it will focus its financing activities in Philadelphia,
Pennsylvania and the Baltimore/Washington corridor, with a particular emphasis
on the Philadelphia metropolitan area. Of the 12 loans included within the
Company's Initial Investments, 11 relate to properties located in the
Philadelphia metropolitan area, and one is located in the Washington, D.C.
metropolitan area. See "Investment Objectives and Policies -- Initial
Investments." The Company is not, however, limited as to the geographic areas
in which it may provide Financing. Accordingly, it may provide Financing in
metropolitan areas other than Philadelphia and the Baltimore/Washington
corridor, in metropolitan areas that do not readily fit the Company's targeted
characteristics, or in geographic areas that are outside of metropolitan areas,
as appropriate opportunities are identified. These Financings may (although it
is not currently anticipated that they will) constitute a material portion of
the Company's investment portfolio.
Types of Properties Relating to Financings
The Company will focus its financing activities on multi-family
residential, office and other commercial properties with property values
generally between $2 million and $20 million. The Company may, in appropriate
circumstances as determined by the Board of Trustees, provide financing to
properties with values outside this range, as is the case with one of the loans
included within the Company's Initial Investments. See "Investment Objectives
and Policies -- Initial Investments." It is not anticipated, however, that a
significant number of properties will be outside the targeted range. The
Company will not normally finance undeveloped property or make loans in
situations where construction is involved except where the underlying property
(and any additional real property collateral that the Company may require as
security) meets the Company's loan-to-value guidelines. See "Investment
Objectives and Policies -- Certain Financial Guidelines" and "Risk
Factors -- Investment
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Activity Risks -- Financing Considerations -- Construction Financing May
Increase Repayment Risk." In situations where an underlying property does not
meet the Company's cash flow guidelines, the Company will typically require
that the developers and their controlling persons personally guarantee the
Financing, and that some or all of such persons have net worth sufficient to
repay the Financing in the event of default. Any such Financing may also
condition funding of the Financing upon the satisfaction of certain property
income or occupancy criteria. The Company is not limited in the amount or
percentage of its assets it may lend against any category of property. In
general, however, the Company will not make loans or investments (including
Property Interest investments) that, in the aggregate, will exceed (i) with
respect to any one property, 5% of the Company's total assets, or (ii) with
respect to any one person or his or its affiliates, 10% of the Company's total
assets. Two of the Initial Investments (loans 108 and 111) exceed such
limitations; each will constitute approximately 9.9% of the Company's total
assets, by cost, upon completion of this Offering (assuming the Underwriters do
not exercise their over-allotment option).
Acquisition of Loans at Discount
In acquiring existing Financing, the Company will focus on Financing that,
because of one or more past defaults under the original loan terms (due to
complex structures of the entities that own the underlying property, lack of a
strong operating history for the underlying property, historical credit or cash
flow problems of the borrower or with respect to the underlying property, or
other factors) can be acquired at a discount to its outstanding balance and the
appraised value of its underlying property. The Company will not acquire any
such loan, however, unless the prior loanholder, property owner or some other
party or parties have taken material steps to resolve the problems to which the
loan and its underlying property have been subject and where completion of the
resolution process will not involve active intervention by the Company. The
Company will seek to acquire loans for which completion of the resolution
process will enhance the Company's total return through increased yields or
realization of some portion or all of the discount at which they were acquired.
The Company anticipates that a substantial portion of the discounted loans
it acquires will be obtained from RAI, the Company's sponsor, which specializes
in acquiring and resolving mortgage loans. However, the investments that may be
acquired from RAI are limited to a maximum of 30% of the Company's investments
based upon the Company's cost (excluding the Initial Investments, of which
$18.1 million, by cost, will be acquired from RAI). See "Conflicts of
Interest," "Use of Proceeds" and "Investment Objectives and Policies -- Initial
Investments."
Lending Procedures
Prior to making or acquiring any Financing, the Company will conduct an
acquisition review. The value of the underlying property will be estimated by
the Company based upon a recent independent appraisal obtained by the borrower,
an independent appraisal obtained by the Company, or upon valuation information
obtained by the Company and thereafter confirmed by an independent appraisal.
The Company will make an on-site inspection of the property and, where
appropriate, the Company will require further inspections by engineers,
architects or property management consultants. The Company may also retain
environmental consultants to review potential environmental issues. See "Risk
Factors -- Real Properties with Environmental Problems May Create Liability for
the Company." The Company will obtain and review available rental, expense,
maintenance and other operational information regarding the property and
prepare cash flow and debt service analyses. For acquired loans, the Company
will also evaluate the adequacy of the loan documentation (for example, the
existence and adequacy of notes, mortgages, collateral assignments of rents and
leases, and title policies insuring lien positions) and other available
information (such as credit and collateral files), and will evaluate the status
and efficacy of programs to resolve problems to which the loan or its
underlying property may have been subject. The amount which the Company is
willing to lend, or the amount of the Company's offer to purchase, will be
based upon the foregoing evaluations and analyses. The Company may modify these
procedures as it deems appropriate in particular situations.
After originating or acquiring any Financing, the Company will follow
specified procedures to monitor Financing performance and compliance. On
performing Financing originated by the Company, the borrower will be required
to supply monthly operating statements and yearly certification of compliance
with the terms of the loan. With respect to acquired loans, or non-performing
Company-originated Financing (and in addition to the above procedures), the
Company generally will require that all revenues from the underlying property
be paid
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into an operating account on which the Company is the sole signatory. All
expenditures with respect to a property (including debt service, taxes,
operational expenses and maintenance costs) will be paid from that account and
will be subject to review and approval by the Company prior to payment. The
Company may also require that its approval be obtained before any material
contract or commercial lease with respect to the property is executed and that
the borrower prepare a budget for the property not less than sixty days prior
to the beginning of a year, which must be reviewed and approved by the Company.
Acquisition of Property Interests
As appropriate, either as part of the Company's investment strategy or for
tax planning purposes, the Company may acquire Property Interests. The Company
believes that acquiring Property Interests will be advantageous for three
primary reasons. First, it gives the Company flexibility in addressing the
financial needs and tax situations of borrowers in situations where debt
financing may not be appropriate. Second, it will provide the Company with the
possibility of capital appreciation in addition to the current income realized
from its loan portfolio. Third, it will assist the Company in its tax planning.
It is anticipated that certain of the Financings made by the Company may result
in timing differences between (i) the actual receipt of income and the actual
payment of deductible expenses and (ii) the inclusion of that income and
deduction of such expenses in arriving at its REIT taxable income. This may
increase the amount that the Company must distribute to its shareholders to
avoid corporate income tax in such year, although there may be no
contemporaneous corresponding receipt of cash by the Company. Depreciation
deductions associated with the Company's investments in Property Interests,
however, should help offset such adverse tax effects. See "Federal Income Tax
Considerations -- Requirements for Qualification -- Distribution
Requirements."
The Company is not limited in the amount it may invest in Property
Interests. In general, however, the Company will not make loans or investments
(including Financings) that, in the aggregate, will exceed (i) with respect to
any one property, 5% of the Company's total assets, or (ii) with respect to any
one person or his or its affiliates, 10% of the Company's total assets. Two of
the Initial Investments (loans 108 and 111) exceed such limitations; each will
constitute approximately 9.9% of the Company's total assets, by cost, upon
completion of this Offering (assuming that the Underwriters do not exercise
their over-allotment option). See "Investment Objectives and Policies --
Initial Investments."
Each acquisition of a Property Interest will be supported by an appraisal
prepared by an independent appraiser. Prior to acquisition, the Company will
require satisfactory evidence (generally in the form of title insurance) that
the Company (if the Company is acquiring the Property Interest directly), or
the entity owning the property in which the Company is acquiring an interest,
has or will acquire good and marketable title to the property subject only to
such encumbrances as are acceptable to the Company.
The Company intends to acquire Property Interests primarily in
Philadelphia, Pennsylvania and the Baltimore/Washington corridor. The Property
Interests will involve the same types of properties as those for which the
Company intends to provide financing. See "Investment Objectives and
Policies -- Types of Properties Relating to Financings." The Company will not
manage any of its Property Interests, but will retain the services of
third-party management companies, including (subject to approval by a majority
of the Company's Independent Trustees) Brandywine, an affiliate of RAI. See
"Conflicts of Interest." Brandywine may also be retained by the Company to
supervise a local property manager. In instances where Brandywine is managing a
property or supervising a local manager, the fees paid to Brandywine and the
local manager, in the aggregate, may not exceed the amount customarily charged
by property managers in the area for management of comparable properties.
In addition to acquiring a property directly, the Company may also acquire
interests in the entity that owns the property, typically in the form of an
interest in a partnership, joint venture or limited liability company owning
the property. The Company anticipates that any such interests would be acquired
either to provide Financing in situations where further debt financing cannot
be used, where further debt financing is inappropriate (as, for example, where
senior lienors have imposed covenants against further borrowing or against the
imposition of junior liens), or where the Company is seeking an equity interest
in a property (similar to a participation) as part of a financing package. The
Company will typically require that its interests in any property or entity be
preferred over the interests of other owners both as to current distributions
and repayment of invested capital.
31
<PAGE>
The Company will also typically require that the owners incur no further debt
and issue no equity interest of equal rank with or senior to the Company's
interest without the Company's consent. However, the Company is not limited in
the kinds of equity interests that it may acquire and can, accordingly, acquire
interests that are not preferred or permit co-owners of the properties to incur
further debt without the Company's consent. See "Risk Factors -- Real Property
Considerations -- Investments in Joint Ventures, Partnerships or Other
Interests May Result in Less Control by the Company." The Company will endeavor
to structure such investments so that they qualify as real estate assets within
the meaning of the Code and the income therefrom qualifies as income from
interests in real estate within the meaning of the Code. The Company will
closely monitor any such investment that does not qualify as a real estate
asset so that the Company's qualification as a REIT will not be jeopardized.
See "Federal Income Tax Considerations -- Requirements for Qualification."
Leverage
The Company intends to finance its investment activity with the proceeds
of this Offering and future equity offerings. Although the Company is permitted
to incur debt to originate Financing or acquire Property Interests (including
seller or purchase money debt for both acquired loans and Property Interests),
the Company generally will not do so unless it does not have immediately
available capital sufficient to enable it to acquire a particular investment.
The Company may also incur debt in order to prevent default under loans senior
to the Company's Financing or to discharge senior loans entirely if this
becomes necessary to protect the Company's Financing. This may occur if
foreclosure proceedings are instituted by the holder of a mortgage interest
which is senior to the Company's Financing. The Company may incur indebtedness
in order to assist in the operation of any property financed by the Company and
as to which the Company has subsequently taken over operations as a result of
default, or to protect its Financing. The Company may also borrow to the extent
the Company deems it necessary to meet REIT distribution requirements imposed
by the Code. See "Federal Income Tax Considerations Requirements for
Qualification -- Distribution Requirements." Debt incurred by the Company may
be collateralized by some or all of the Company's assets. The Company
anticipates that, in normal operations, it will not exceed a debt to equity
ratio of 0.5:1. For purposes of calculating this ratio, the Company's
indebtedness will include all indebtedness of the Company, whether or not with
recourse to the Company, and equity will be equal to the value of the Company's
portfolio based upon the most recent appraised value of the properties
underlying the portfolio. The Company is not limited as to the amount of debt
that it may incur, and may have a debt to equity ratio that may from time to
time vary substantially from 0.5 to 1, if appropriate investment opportunities
are presented. See "Risk Factors -- Other Investment Activity Considerations --
Leverage Can Reduce Income Available for Distribution and Cause Losses." The
Company currently has no arrangements for loans or lines of credit.
Portfolio Turnover
The Company will not purchase investments with the intention of engaging
in short-term trading. The Company may, however, sell any particular investment
and reinvest proceeds (subject to distribution requirements and limitations on
asset sales imposed on a REIT by the Code; see "Federal Income Tax
Considerations" and "Risk Factors -- Legal and Tax Risks -- Gain on Disposition
of Assets Deemed Held for Sale in Ordinary Course Subject to 100% Tax") when it
is deemed prudent by the Company's management, regardless of the length of the
holding period.
Other Policies
The Company will not invest in the securities of other issuers for the
purpose of exercising control, except to the extent set forth in "Investment
Objectives and Policies -- Acquisition of Property Interests," nor will it
underwrite securities of other issuers. The Company will not repurchase or
otherwise reacquire its Common Shares or other securities, except to the extent
set forth in "Description of Shares of Beneficial Interest -- Restrictions on
Ownership and Transfer" with respect to certain transfers in violation of the
Ownership Limitation. These policies may be changed by majority vote of the
Board of Trustees, including a majority of the Independent Trustees. The
Company, however, does not currently anticipate any such changes.
32
<PAGE>
Initial Investments
The Company will enter into an agreement with RAI to purchase the Initial
Investments at an aggregate cost of approximately $18.1 million and will
purchase senior debt in the amount of $2.5 million held by third parties with
respect to four of the loans included in the Initial Investments. Had the
Company purchased the Initial Investments as of October 31, 1997, RAI would
have realized a gain on sale of approximately $3.2 million.
The Company anticipates that the Initial Investments will be accounted for
as loans and recorded at cost. Interest on these loans will be recognized as
revenue when earned according to the terms of the loans. Additionally, the
Company will amortize into income over the estimated life of the loans the
difference between its cost basis in them and the future cash collections, if
any, that are both reasonably estimatable and probable, using the constant
interest method. Also, any changes in the amortization of discount as a result
of changes in anticipated cash flows will be adjusted currently and treated as
a change in estimate.
The Company is acquiring (i) eight loans purchased at discounts of between
18.8% and 55.8% from the Company's share of the outstanding loan receivable
balances, and at ratios of between 38% to 97% of investment cost to appraised
values of the underlying properties (the "Discounted Loans"), (ii) two loans
purchased at no discount to the outstanding loan receivable balance (the
"Non-Discounted Loans") and (iii) two loans originated by the Company, which
will be purchased from RAI at RAI's cost ($5.8 million) (the "Initial
Originated Loans"). The Discounted Loans are subject to an aggregate of
approximately $13.8 million of senior financing ($2.5 million of senior lien
interests that the Company intends to purchase, and which are included in the
Initial Investments; and $11.3 million of senior lien interests with respect to
the underlying properties that the Company does not intend to purchase and to
which the Company's loans are subordinate), as set forth in the table below.
Each of the Discounted Loans is in default with respect to its terms as
originally underwritten, but is subject to a forbearance agreement pursuant to
which the holder of the loan (the Company, upon acquisition) has agreed not to
foreclose provided that the borrower pays (subject to a stated minimum) all
revenues from the underlying property (after operating expenses) to the
Company. The Company will receive all the increase, if any, in the revenues
from the underlying properties, after payment of operating expenses, to a
maximum aggregate amount equal to the then outstanding balance of the loan as
originally underwritten, together with accrued interest and penalties (except
for loan 108 in which it will receive a share proportionate to its
participation interest). In addition, these loans (except for loan 108) permit
the Company to capture (upon a sale or refinancing of the property) any
increase in the value of the underlying property to a maximum amount equal to
the then outstanding balance of the loan as originally underwritten and accrued
interest. For loan 108, the Company will receive increases in revenues and
value pursuant to the terms of the participation. Since debt service based on
the original terms of these loans is in excess of payments currently being
made, the Company anticipates that the outstanding balances, as originally
underwritten, will increase.
The Non-Discounted Loans consist of two subordinated loans, each with a
current return of 18% (based upon the Company's cash investment). The
Non-Discounted Loans are subordinate to an aggregate of approximately $4.1
million of senior debt held by third parties that is secured by the underlying
properties, as set forth in the table below. There are no senior loan
participation interests in either Non-Discounted Loan.
The aggregate outstanding loan receivable balance of the Discounted and
Non-Discounted Loans, as of October 31, 1997, was $78.7 million of which $72.4
million (or approximately 92%) represented the aggregate outstanding balance of
Discounted Loans. The appraised value of the properties underlying the
Discounted and Non-Discounted Loans is $54.1 million.
The Initial Originated Loans consist of loans on two separate properties.
The loans on the first property are a first mortgage loan in the amount of $6.1
million requiring interest only payments at 9.7%, and a second participating
mortgage loan in the amount of $1.3 million requiring interest only payments at
11%. The first mortgage loan, which will be acquired for $3.6 million, will be
subject to a $2.5 million senior secured interest to be retained by RAI. The
second participating mortgage loan also provides for the holder to receive a
participation of the greater of $100,000 or the increase in value of the
property over the current appraised value equal to 25% of the first $600,000 of
such appreciation and 15% of any additional appreciation. The loan on the
second property is a first mortgage loan in the amount of $900,000 requiring
interest only payments of 10.7%.
33
<PAGE>
The following table sets forth certain information regarding each of the
Initial Investments as of October 31, 1997:
<TABLE>
<CAPTION>
Maturity of
Loan/Expiration
of Forbearance Type of
Loan Number(1) Agreement(2) Property Location
- ---------------- ----------------- --------------- ------------------
<S> <C> <C> <C>
Discounted Loans:
101 10/31/03 Multifamily Philadelphia, PA
102 10/31/03 Multifamily Philadelphia, PA
103 12/31/04 Office Arlington, VA
104 08/31/01 Multifamily Philadelphia, PA
105 09/02/99 Multifamily Philadelphia, PA
106 12/02/99 Multifamily Philadelphia, PA
107 03/28/01 Multifamily Philadelphia, PA
108 01/01/02 Office Philadelphia, PA
Total Discounted Loans
Non-Discounted Loans:
109 10/31/99 Multifamily Philadelphia, PA
110 12/29/00 Multifamily Philadelphia, PA
Total Non-Discounted Loans
Total Discounted and Non-Discounted Loans
Initial Originated Loans:
111 12/31/02 Retail/Office Philadelphia, PA
112 12/31/02 Retail Philadelphia, PA
Total Initial Originated Loans
Total Initial Investments
<CAPTION>
Cost of Investment
to Company
Outstanding Including Amount of
Loan Number(1) Loan Receivable(3) Senior Debt(4) Senior Debt(5)
- ---------------- -------------------- ------------------- ---------------
<S> <C> <C> <C>
Discounted Loans:
101 $ 1,563,222 $ 786,000 $ 600,000
102 1,483,290 1,140,000 896,000
103 5,781,753 2,555,000 878,706
104 5,402,669 3,075,000 1,101,275
105 1,586,891 735,000 600,000
106 3,046,887 2,008,000 1,258,072
107 713,559 580,000 448,523
108 52,779,919 12,895,097 7,995,097
----------- ----------- -----------
Total Discounted Loans 72,358,230 23,774,097 13,777,673
----------- ----------- -----------
Non-Discounted Loans:
109 1,639,614 1,639,614 886,996
110 4,711,741 4,711,741 3,182,642
----------- ----------- -----------
Total Non-Discounted Loans 6,351,355 6,351,355 4,069,638
----------- ----------- -----------
Total Discounted and Non-Discounted Loans 78,709,585 30,125,452
----------- ----------- -
17,847,311
----------
Initial Originated Loans:
111 7,530,000 7,380,000 2,500,000
112 900,000 900,000 --
----------- ----------- -----------
Total Initial Originated Loans 8,430,000 8,280,000
----------- ----------- --
2,500,000
---------
Total Initial Investments $87,139,585 $38,405,452
=========== ===========
$20,347,311
===========
</TABLE>
<PAGE>
- ------------
(1) Loans 111 and 112 were funded by RAI on September 30, 1997.
(2) Loans 101 through 108 are subject to forbearance agreements which expire
on the specified dates or, with respect to loans 101 through 104, will be
modified to expire on such dates prior to acquisition by the Company.
Pursuant to these forbearance agreements (i) the lender (the Company once
it has acquired the loans) has agreed, subject to receiving specified
minimum monthly payments, to defer exercise of existing rights to proceed
on the loan (which is in default relative to its initial underwriting),
including the right of foreclosure, (ii) the Company directly receives
rents from the underlying property and (iii) the borrower has agreed to
retain a property management company acceptable to the Company. Brandywine
currently acts as the property manager for each such property. Loans 109
through 112 are not subject to forbearance agreements; the dates specified
are the maturity dates of the loans.
(3) Consists of the outstanding principal balance of the obligations plus (i)
accrued interest and penalties, and (ii) the outstanding balance of senior
indebtedness relating to the underlying property, each as of October 31,
1997.
(4) Consists of the purchase price to be paid by the Company plus the
outstanding balance, as of October 31, 1997, of senior indebtedness
relating to the underlying property. Does not include costs and expenses
relating to the acquisition or origination of the loan, and related
professional fees, estimated at $75,000 for such loans in the aggregate.
(5) Outstanding balance of all senior indebtedness relating to the underlying
property as of October 31, 1997.
34
<PAGE>
<TABLE>
<CAPTION>
Ratio of Senior
Debt to Appraised Monthly
Ratio of Company's Value After Revenues from Ratio of
Appraised Value Investment Plus Certain Senior Operations Cash Flow to
of Underlying Senior Debt to Debt Acquisitions Company's Net or Monthly Senior Debt
Property(6) Appraised Value(7) by the Company(8) Investment(9) Debt Service(10) Service(11)
- ----------------- -------------------- ------------------- --------------- ------------------ -------------
<S> <C> <C> <C> <C> <C>
$ 900,000 87% 0% $ 786,000 $ 6,700 n/a
1,200,000 95% 0% 1,140,000 9,600 n/a
2,800,000 91% 31% 1,676,294 16,800 2.98
3,200,000 96% 34% 1,973,725 14,800 2.29
800,000 92% 0% 735,000 6,800 n/a
2,200,000 91% 57% 749,928 8,200 1.73
600,000 97% 0% 580,000 5,700 n/a
34,000,000 38% 24% 4,900,000 55,895 3.19
----------- ----------- --------
45,700,000 52% 25% 12,540,947 124,585
----------- ----------- --------
2,700,000 61% 33% 752,618 11,289 3.02
5,725,000 82% 56% 1,529,099 22,936 1.84
----------- ----------- --------
8,425,000 75% 48% 2,281,717 34,225
----------- ----------- --------
54,125,000 56% 28% 14,822,664 158,810
----------- ----------- --------
8,400,000 88% 30% 4,880,000 40,378 3.09
2,200,000 41% 0% 900,000 7,950 n/a
----------- ----------- --------
10,600,000 78% 24% 5,780,000 48,328
----------- ----------- --------
$64,725,000 59% 28% $20,602,664 $207,138 3.05
=========== =========== ========
</TABLE>
(6) The Company retained independent appraisal firms (Joseph Dennis
Pasquarella & Co. with respect to loans 101, 102, 104, 107, 109 and 110;
Johnson, McClellan, Sullins & Page with respect to loan 103; M. Richard
Cohen with respect to loans 105, 106 and 108; and Louis A. Iatarola Realty
Appraisal Group, Ltd. with respect to loans 111 and 112) to appraise the
properties underlying the Initial Investments. The purpose of the
appraisals was to develop an estimate of the fair market value of each of
the properties appraised. The appraisals were conducted in February, July,
August, September and October 1997. The appraised values generally were
developed based on consideration of the cost, sales comparison and income
valuation approaches. The cost approach determines a value based upon the
market value of the land plus the depreciated replacement cost of the
improvements. The sales comparison approach analyzes sales of other
going-concern properties in comparison to the subject properties and
assumes that purchaser and seller are willing, knowledgeable and
uncoerced, and that a reasonable time is allowed for exposure of the
property in the market. The income approach develops a going-concern value
of the subject properties by determining projected operating income from
historical revenue and expense data, and multiplying that income by a
factor determined by the appraiser as representing a rate of return on
investment that the current market would find acceptable in investments of
a like kind, adjusted for such factors as returns on other investment
media, liquidity risk and similar matters. After determining value
estimates using the three different approaches, the appraisers analyze the
estimates in light of information regarding the property, which may
include such factors as property location, age, use and condition
(interior and exterior), leasing information, highest and best use (that
is, the use of the property which is physically possible, appropriately
supported, financially feasible and which results in the highest value)
and other factors, and reconcile the valuation estimates into a final
valuation opinion. Operating data, financial data and legal descriptions
of the properties provided to the appraisers by the Company or the prior
or current owners thereof were assumed by the appraisers to be accurate
and correct. The appraisers also assumed that (i) legal title to the
properties is good and marketable, (ii) the improvements on the properties
do not encroach on adjacent land, (iii) economic conditions existing at
the time of the appraisals will continue, (iv) the properties are managed
competently and are in the hands of responsible ownership and (v) that
there are no hidden conditions or environmental problems. As a consequence
of the foregoing, caution should be exercised in evaluating appraisal
results. An appraisal is only an estimate of value and should not be
relied upon as a precise measure of realizable value.
35
<PAGE>
(7) The purchase price paid by RAI for each loan acquired from RAI, and RAI's
cost basis as of October 31, 1997 in each loan, are as follows:
Loan No. RAI's Cost Basis RAI's Purchase Price
- ------------------- ------------------ ---------------------
101 $ 785,295 $ 569,513
102 1,134,958 859,547
103 2,549,375 2,325,558
104 2,238,616 1,614,174
105 733,073 456,356
106 2,005,723 1,299,780
107 577,165 474,064
108 11,232,054 7,300,165
109 1,489,489 1,362,884
110 4,154,877 3,757,701
111 7,380,000 7,380,000
112 900,000 900,000
----------- -----------
Total $35,180,625 $28,299,472
=========== ===========
For purposes of this table, (i) "RAI's Cost Basis" consists of the cost of
the investment as carried on the books and records of RAI (after allocation
of gains from the sale of a participation in the loan, or borrower
refinancing of the underlying property), plus senior debt, and including
(a) all acquisition costs and expenses, (b) subsequent advances, if any,
made by RAI in connection with its acquisition of the loan, and (c) amounts
representing accretion of discount by RAI; and (ii) "RAI's Purchase Price"
consists of the original cost of the investment to RAI, plus the amounts
referred to in clauses (i) (a) and (b), above, plus the amount, as of the
date of RAI's acquisition of the loan, of any senior indebtedness to which
the underlying property was subject. With respect to loans 111 and 112, the
amount is stated net of principal repayments of $200,000 and $100,000,
respectively, in October 1997. Accretion of discount by RAI subsequent to
October 31, 1997 will increase RAI's cost basis in, and thus decrease RAI's
book profit from the sale of, the loans to the Company. RAI's gain from the
sale of the loans to the Company would also be reduced to the extent of any
gain realized upon a sale of a participation in a loan prior to sale to the
Company. With respect to loan 108, the amounts represent an allocation to
the interest being acquired by the Company.
(8) The Company will acquire senior lien interests previously sold by RAI in
connection with loans 101, 102, 105 and 107. See "Use of Proceeds." In
connection with the sale of these senior lien interests, RAI had
subordinated its interests in the loans to the interests of the senior
lienor. After acquisition of the senior lien interests, the Company will
hold the entire lender's interest in each such loan.
(9) The Company's net investment is calculated as the difference between the
amount set forth in the column "Cost of Investment to Company Including
Senior Debt," less the amount set forth in the column "Amount of Senior
Debt," except for loans 101, 102, 105 and 107 where, because the Company
anticipates acquiring the senior indebtedness (see note (8), above), the
amount is that set forth in the column "Cost of Investment to Company
Including Senior Debt" only.
(10) Amounts set forth with respect to loans 101 through 107 represent the
monthly revenues from operations for the underlying properties. Amounts
set forth for loans 108 through 112 represent the monthly debt service
required to be paid on the loans. With respect to loans 108 through 112,
the monthly revenues from operations with respect to the underlying
properties are $174,800, $15,400, $23,200, $44,000 and $12,500,
respectively. For purposes of this table, (i) "Monthly Revenues from
Operations" consist of the monthly rent roll as of October 31, 1997 with
respect to the underlying property less operating expenses, including real
estate and other taxes pertaining to the underlying property and its
operation and less interest on senior debt (to the extent not being
acquired by the Company), but before depreciation, amortization and
capital expenditures; and (ii) "Monthly Debt Service" is the stated amount
of interest and principal payable monthly under the terms of the loan.
Monthly revenues from operations are set forth where, pursuant to
36
<PAGE>
forbearance agreements or the terms of the loan documents, the holder of
the loan has the right to receive all net cash flow from the underlying
properties as payment of debt service on the loans while monthly debt
service is set forth where the stated monthly debt service under the terms
of the loan is less than monthly revenues from operations.
(11) Consists of monthly revenues from operations before interest on the senior
indebtedness divided by the monthly payment of principal and interest
required under the senior indebtedness.
The following is a description of certain of the material terms of the
loans included in the Initial Investments, and assumes the acquisition by the
Company of all senior loan participation interests as set forth in Note 8 to
the above table:
Loan 101. Loan evidenced by a note in the original principal amount of
$1,080,000, secured by a first mortgage on multi-family residential property
located in Philadelphia, Pennsylvania, bearing interest at 12% per year. The
loan was in default under its original terms at the time it was acquired by RAI
in June, 1992. The forbearance agreement with respect to this loan will
terminate (upon its extension, which will occur prior to the Company's
acquisition of the loan) on October 31, 2003 when all principal, accrued
interest and other amounts become due and payable. The loan documents provide
that the holder of the loan (the Company, upon loan acquisition) (i) holds a
deed-in-lieu of foreclosure, which may be recorded upon default by the
borrower, and (ii) may replace the manager of the property. Tenants at the
property currently pay rents directly to the holder of this loan. The Company
will acquire the senior participation interest in this loan following the close
of the Offering.
Loan 102. Loan evidenced by a note in the original principal amount of
$1,312,000, secured by a first mortgage on multi-family residential property
located in Philadelphia, Pennsylvania, bearing interest at an annual rate of
2.5% over the monthly national median annualized cost of funds for SAIF-insured
institutions as announced by the Federal Deposit Insurance Corporation with a
minimum rate of 8.5% (which, as of October 31, 1997, resulted in an interest
rate of 8.5%). The loan was in default under its original terms at the time it
was acquired by RAI in March, 1993. The forbearance agreement with respect to
this loan will terminate (upon its extension, which will occur prior to the
Company's acquisition of the loan) on October 31, 2003 when all principal,
accrued interest and other amounts become due and payable. The loan documents
provide that the holder of the loan (the Company, upon loan acquisition) (i)
holds a deed-in-lieu of foreclosure, which may be recorded upon default by the
borrower, and (ii) may replace the manager of the property. Tenants at the
property currently pay rents directly to the holder of this loan. The Company
will acquire the senior participation interest in this loan following the close
of the Offering.
Loan 103. Loan evidenced by a note in the original principal amount of
$4,812,000, bearing interest at an annual rate of 0.5% over the Maryland
National Bank prime rate (which, as of October 31, 1997, resulted in an
interest rate of 9.0%). The loan was in default under its original terms at the
time it was acquired by RAI in December, 1994. The forbearance agreement with
respect to this loan will terminate (upon its extension, which will occur prior
to the Company's acquisition of the loan) on December 31, 2004 when all
principal, accrued interest and other amounts become due and payable. The loan
is subject to senior indebtedness held by an unaffiliated third party in the
form of a first mortgage loan on an office property located in Arlington,
Virginia, in the amount of $878,706. The loan documents provide that the holder
of the loan (the Company, upon loan acquisition) (i) holds a deed-in-lieu of
foreclosure with respect to the property, which may be recorded upon default by
the borrower, and (ii) may replace the manager of the property. Moreover, the
terms of the senior indebtedness restrict the borrower from incurring any other
indebtedness (except trade indebtedness) or placing any encumbrances upon the
Property without the consent of the senior lender. Tenants of the property
currently pay rents directly to the holder of this loan.
Loan 104. Loan evidenced by a note in the original principal amount of
$3,559,000, bearing interest at an annual rate of 2% over the yield of one-year
United States Treasury Securities (which, as of October 31, 1997, resulted in
an interest rate of 7.5%). The loan was in default under its original terms at
the time it was acquired by RAI in July, 1994. The forbearance agreement with
respect to this loan will terminate (upon its extension, which will occur prior
to the Company's acquisition of the loan) on August 31, 2004 when all
principal, accrued interest and other amounts become due and payable. The loan
is subject to senior indebtedness held by an unaffiliated third party in the
form of a first mortgage loan on a multi-family residential property located in
Philadelphia, Pennsylvania, in the amount of $1,101,275. The loan documents
provide that the holder of the loan (the
37
<PAGE>
Company, upon loan acquisition) (i) holds a deed-in-lieu of foreclosure with
respect to the property, which may be recorded upon default by the borrower,
and (ii) may replace the manager of the property. Moreover, the terms of the
senior indebtedness restrict the borrower from incurring any other indebtedness
(except trade indebtedness) or encumbrances upon the Property without the
consent of the senior lender. Tenants of the property currently pay rents
directly to the holder of this loan.
Loan 105. Loan evidenced by a note in the original principal amount of
$1,211,000, secured by a first mortgage on a multi-family residential property
located in Philadelphia, Pennsylvania, bearing interest at an annual rate of
12.5%. The loan was in default under its original terms at the time it was
acquired by RAI in September, 1994. The forbearance agreement with respect to
this loan terminates on September 2, 1999 when all principal, accrued interest
and other amounts become due and payable. In addition, the loan documents
provide that the holder of the loan (the Company, upon loan acquisition) (i)
holds a deed-in-lieu of foreclosure with respect to the underlying property,
which may be recorded upon default by the borrower, and (ii) may replace the
manager of the property. Tenants at the property currently pay rents directly
to the holder of this loan. The Company will acquire the senior participation
interest in this loan following the close of this Offering.
Loan 106. Loan evidenced by notes in the original aggregate principal
amount of $1,695,000, bearing interest at varying annual rates ranging from 12%
to 14% per year. The loan was in default under its original terms at the time
it was acquired by RAI in December, 1994. The forbearance agreement with
respect to this loan terminates on December 2, 1999 when all principal, accrued
interest and other amounts become due and payable. The loan is subject to
senior indebtedness held by an unaffiliated third party in the form of a first
mortgage loan on a multi-family residential property located in Philadelphia,
Pennsylvania, in the amount of $1,258,072. The loan documents provide that the
holder of the loan (the Company, upon loan acquisition) (i) holds a
deed-in-lieu of foreclosure with respect to the property, which may be recorded
upon default by the borrower, and (ii) may replace the manager of the property.
Moreover, the terms of the senior indebtedness restrict the borrower from
incurring any other indebtedness (except trade indebtedness) or placing any
encumbrances upon the Property without the consent of the Senior Lender.
Tenants of the property currently pay rents directly to the holder of this
loan.
Loan 107. Loan evidenced by a note in the original principal amount of
$600,000, secured by a first mortgage on a multi-family residential property
located in Philadelphia, Pennsylvania, bearing interest at an annual rate of
12%. The loan was in default under its original terms at the time it was
acquired by RAI in March, 1996. The forbearance agreement with respect to this
loan terminates on March 28, 2001 when all principal, accrued interest and
other amounts become due and payable. The loan documents provide that the
holder of the loan (the Company, upon loan acquisition) (i) holds a
deed-in-lieu of foreclosure, which may be recorded upon default by the
borrower, and (ii) may replace the manager of the property. Tenants at the
property currently pay rents directly to the holder of this loan. The Company
will acquire the senior participation interest in this loan following the close
of this Offering.
Loan 108. Wraparound participation in the amount of $4.9 million in a loan
evidenced by notes in the original aggregate principal amount of $40,906,000
bearing interest at an annual rate of 8% and secured by a first mortgage on an
office property located in Philadelphia, Pennsylvania. The participation
provides that, from payments made on the loan, interest is payable to the
participant at an annual rate of 11.1% and also provides that it is subject to
a senior participation held by an unaffiliated third party in the amount of $8
million, with interest at an annual rate of 9.5%. The loan was in default under
its original terms at the time it was acquired by RAI in December, 1996. The
forbearance agreement with respect to this loan terminates on January 1, 2002
(or January 1, 2009 if the borrower exercises an option to extend) when all
principal, accrued interest and other amounts become due and payable. The loan
documents provide that (i) the holder of the loan (the Company, upon loan
acquisition) may record a deed to the property, which is held in escrow, on the
occurrence of certain defaults, (ii) the holder of the loan may assume
operating control of the property under certain conditions and (iii) certain
principals of the borrower may be subject to limited personal recourse under
certain circumstances. The loan may be paid in full by the borrower by (i)
payment to the holder of a specified amount of cash (currently $27 million but
increasing in 1998 and thereafter) and giving the holder a preferred
partnership interest entitling the holder to all net cash flow from the
property to specified limits (currently $10 million, but increasing in 1998 and
thereafter).
Loan 109 Loan evidenced by a note in the original principal amount of
$765,000, bearing interest at an annual rate of 18% until October 31, 1999 when
all principal, accrued interest and other amounts become due
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and payable. The loan is subject to senior indebtedness held by an unaffiliated
third party in the form of a first mortgage loan on a multi-family residential
property located in Philadelphia, Pennsylvania, in the amount of $886,996. The
loan documents provide that the holder of the loan (the Company, upon loan
acquisition) (i) holds a deed-in-lieu of foreclosure with respect to the
property, which may be recorded upon default by the borrower, and (ii) may
replace the manager of the property. Moreover, the terms of the senior
indebtedness restrict the borrower from incurring any other indebtedness
(except trade indebtedness) or encumbrances upon the property without the
consent of the senior lender. Tenants of the property currently pay rents
directly to the holder of this loan.
Loan 110. Loan evidenced by a note in the original principal amount of
$4,627,000, bearing interest at an annual rate of 7.75% until December 29, 2000
when all principal, accrued interest and other amounts become due and payable.
The loan is subject to senior indebtedness held by an unaffiliated third party
in the form of a first mortgage loan on a multi-family residential property
located in Philadelphia, Pennsylvania in the amount of $3,182.642. The loan
documents provide that the holder of the loan (the Company, upon loan
acquisition) (i) holds a deed-in-lieu of foreclosure with respect to the
property, which may be recorded upon default by the borrower, and (ii) may
replace the manager of the property. Moreover, the terms of the senior
indebtedness restrict the borrower from incurring any other indebtedness
(except trade indebtedness) or placing any encumbrances upon the property
without consent of the senior lender. Tenants of the property currently pay
rents directly to the holder of this loan.
Loan 111. Participation in the amount of $4,880,000 in loans evidenced by
notes in the original principal amount of $7,380,000 bearing interest at annual
rates of 9.7% with respect to the original principal amount of $6,080,000 and
11% with respect to the original principal amount of $1,300,000. The
participation interest is subject to the senior secured interest retained by
RAI in the amount of $2.5 million. RAI will be entitled to receive, from
payments made on the loan, interest at an annual rate of 10%. The Company may,
at any time, purchase RAI's senior retained interest for its then outstanding
principal balance, plus accrued interest thereon, if any. The notes are secured
by first and second mortgages on a retail/office property in Philadelphia,
Pennsylvania and mature December 31, 2002. With respect to the $1,300,000 note,
the borrower must make an additional interest payment of $50,000 at the time
the loan is repaid. In addition, the loan provides for the holder to receive a
participation of the greater of $100,000 or the increase in value of the
property over the current appraised value equal to 25% of the first $600,000 of
such appreciation and 15% of any additional appreciation, payable on the sale
or refinancing of the underlying property or at maturity of the loan. The loan
documents provide that the holder of the loan holds a deed-in-lieu of
foreclosure which may be recorded upon default by the borrower. All tenants of
the property pay rents directly to the holder of the loan.
Loan 112. Loan evidenced by a note in the original principal amount of
$900,000 bearing interest at an annual rate of 10.6%. The note is secured by a
first mortgage on four retail properties in Philadelphia, Pennsylvania and
matures December 31, 2002. The loan documents provide that the holder of the
loan holds a deed-in-lieu of foreclosure which may be recorded upon default by
the borrower. All tenants of the property pay rents directly to the holder of
the loan.
Certain Legal Aspects of Real Property Loans and Investments
The Company intends primarily to originate or acquire Financings
(including wraparound and other forms of junior lien or subordinated financing)
and, to a lesser extent, Property Interests. There are a number of legal
considerations involved in the origination and acquisition of Financings and
Property Interests or the foreclosure and sale of defaulted Financing. The
following discussion provides general summaries of certain legal aspects of
real estate loans and real property. Because such legal aspects are governed by
applicable state law (which laws vary from state to state), the summaries do
not purport to be complete, to reflect the laws of any particular state, or to
encompass the laws of all states. The summaries are not based upon opinions of
counsel, either as to the general content thereof or as to the laws of any
particular state. Accordingly, the summaries are qualified in their entirety by
reference to the applicable laws of the states where the property is located.
General. Each Financing will be evidenced by a note or bond and typically
will be collateralized by an instrument granting a security interest in real
property, which may be a mortgage, deed of trust, deed to secure debt or
similar instrument, depending upon the prevailing practice and law in the state
in which the underlying
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property is located. Mortgages, deeds of trust, deeds to secure debt and
similar instruments are herein collectively referred to as "mortgages." Of the
Initial Investments, seven are (or, after the intended acquisition of senior
lien interests, will be) secured by mortgages. A mortgage creates a lien upon,
or grants a title interest in, the real property covered thereby, and
represents the security for the repayment of the indebtedness customarily
evidenced by a promissory note. The priority of the lien created or interest
granted will depend on the terms of the mortgage and, in some cases, on the
terms of separate subordination agreements or intercreditor agreement with
others that hold interests in the real property, the knowledge of the parties
to the mortgage and, generally, the order of recordation of the mortgage in the
appropriate public recording office. However, the lien of a recorded mortgage
will generally be subordinate to later-arising liens for real estate taxes and
assessments and other charges imposed under governmental police powers. After
the acquisition of senior interests, five of the Company's mortgage-secured
Financings will be first lien mortgages and two will be junior lien mortgages.
With respect to Financings which may be acquired by the Company, it is possible
that the Company will not record its mortgage until a default occurs (as a
result of provisions in the instruments held by senior lienors or otherwise),
at which time there may be intervening or prior liens, or injunctions or stays
delaying or precluding such recordation or the exercise of any rights under
such mortgages. See "Investment Objectives and Policies -- Certain Legal
Aspects of Real Property Loans and Investments -- Foreclosure" and "--
Bankruptcy Laws."
Types of Mortgage Instruments. There are two parties to a mortgage: a
mortgagor (the borrower and usually the owner of the subject property) and a
mortgagee (the lender). In contrast, a deed of trust is a three-party
instrument, among a trustor (the equivalent of a borrower), a trustee to whom
the real property is conveyed, and a beneficiary (the lender) for whose benefit
the conveyance is made. Under a deed of trust, the trustor grants the property,
irrevocably until the debt is paid, in trust and generally with a power of
sale, to the trustee to secure repayment of the indebtedness evidenced by the
related note. A deed to secure debt typically has two parties. The grantor (the
borrower) conveys title to the real property to the grantee (the lender),
generally with a power of sale, until such time as the debt is repaid. The
mortgagee's authority under a mortgage, the trustee's authority under a deed of
trust and the grantee's authority under a deed to secure debt are governed by
the express provisions of the related instrument, the law of the state in which
the real property is located, certain federal laws and, in some deed of trust
transactions, the directions of the beneficiary. None of the Initial
Investments involves a deed of trust or deed to secure debt.
Leases and Rents. Mortgages that encumber income-producing property often
contain an assignment of rents and leases, pursuant to which the borrower
assigns to the lender the borrower's right, title and interest as landlord
under each lease and the income derived therefrom, while (unless rents are to
be paid directly to the lender) retaining a revocable license to collect the
rents so long as there is no default. If the borrower defaults, the license
terminates and the lender is entitled to collect the rents. Local law may
require that the lender take possession of the property and/or obtain a
court-appointed receiver before becoming entitled to collect the rents. Each of
the mortgage secured Initial Investments has an assignment of rents and leases.
In addition, each of the Initial Investments (except for loans 108, 111 and
112) requires that all income from the underlying property be paid to the
lender.
The potential payments from a property may be less than the periodic
payments due under the mortgage. For example, the net income that would
otherwise be generated from the property may be less than amount that would be
needed to service the debt if the leases on the property are at below-market
rents, the market rents have fallen since the original financing, vacancies
have increased, or as a result of excessive or increased maintenance, repair or
other obligations to which a lender succeeds as landlord. The properties
underlying the Discounted Loans included as part of the Initial Investments are
not currently generating income sufficient to pay the debt service requirements
under the original loan terms. However, each of such properties is generating
revenues to sufficient to pay debt service required under the forbearance
agreements relating to the loans.
Condemnation and Insurance. The form of the mortgage or deed of trust used
by many lenders confers on the mortgagee or beneficiary the right both to
receive all proceeds collected under any hazard insurance policy and all awards
made in connection with any condemnation proceedings, and to apply such
proceeds and awards to any indebtedness secured by the mortgage or deed of
trust, in such order as the mortgagee or beneficiary may determine. Thus, in
the event improvements on the property are damaged or destroyed by fire or
other casualty, or in the event the property is taken by condemnation, the
mortgagee or beneficiary under the senior
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mortgage or deed of trust will have the prior right to collect any insurance
proceeds payable under a hazard insurance policy and any award of damages in
connection with the condemnation and to apply the same to the indebtedness
secured by the senior mortgage or deed of trust. Proceeds in excess of the
amount of senior mortgage indebtedness will, in most cases, be applied to the
indebtedness of a junior mortgage or trust deed to the extent the junior
mortgage or deed of trust so provides (subject, however, to any inter-creditor
agreements). Each of the mortgage-secured Initial Investments contains
provisions allowing the holder to collect proceeds and condemnation awards. The
laws of certain states may limit the ability of mortgagees or beneficiaries to
apply the proceeds of hazard insurance and partial condemnation awards to the
secured indebtedness. In such states, the mortgagor or trustor must be allowed
to use the proceeds of hazard insurance to repair the damage unless the
security of the mortgage or beneficiary has been impaired. Similarly, in
certain states, the mortgagee or beneficiary is entitled to the award for a
partial condemnation of the real property security only to the extent that its
security is impaired. The laws of the states in which the properties securing
the Initial Investments are located do not contain these limitations.
Foreclosure. Foreclosure is a legal procedure that allows the lender to
recover its mortgage debt by enforcing its rights and available legal remedies
under the mortgage. If the borrower defaults in payment or performance of its
obligations under the note or mortgage, the lender has the right to institute
foreclosure proceedings to sell the real property at public auction to satisfy
the indebtedness.
Two primary methods of foreclosing a mortgage are judicial foreclosure
(which is the method applicable to the mortgage secured Initial Investments),
involving court proceedings, and non-judicial foreclosure pursuant to a power
of sale granted in the mortgage instrument. Other foreclosure procedures are
available in some states, such as strict foreclosure, but they are either
infrequently used or available only in limited circumstances.
A judicial foreclosure proceeding is conducted in a court having
jurisdiction over the mortgaged property. Generally, the action is initiated by
the service of legal pleadings upon the property owner and all parties having a
subordinate interest of record in the real property and all parties in
possession of the property, under leases or otherwise, whose interests are
subordinate to the mortgage. A foreclosure action may be subject to most of the
delays and expenses of other lawsuits if defenses are available and are raised
or counterclaims are interposed. When the lender's right to foreclose is
contested, the legal proceedings can be time-consuming. Upon successful
completion of a judicial foreclosure proceeding, the court generally issues a
judgment of foreclosure and appoints a referee or other officer to conduct a
public sale of the mortgaged property, the proceeds of which are used to
satisfy the judgment. Such sales are made in accordance with procedures that
vary from state to state.
Foreclosure of a deed of trust is generally accomplished by a non-judicial
trustee's sale pursuant to a power of sale typically granted in the deed of
trust. A power of sale may also be contained in any other type of mortgage
instrument if applicable law so permits. A power of sale under a deed of trust
allows a non-judicial public sale to be conducted generally following a request
from the beneficiary/lender to the trustee to sell the property upon default by
the borrower and after notice of sale is given in accordance with the terms of
the mortgage and applicable state law. The borrower or junior lienholder may
then have the right, during a reinstatement period required in some states, to
cure the default by paying the entire actual amount in arrears (without regard
to the acceleration of the indebtedness), plus the lender' expenses incurred in
enforcing the obligation. In other states, the borrower or the junior
lienholder is not provided a period to reinstate the loan, but has only the
right to pay off the entire debt to prevent the foreclosure sale. Generally,
state law governs the procedure for public sale, the parties entitled to
notice, the method of giving notice and the applicable time periods. An action
to halt a non-judicial foreclosure might be brought if valid defenses to such
foreclosure exist.
United States courts have often imposed general equitable principles to
limit the remedies available to lenders in foreclosure actions. These
principles are generally designed to relieve borrowers from the effects of
mortgage defaults perceived as harsh or unfair. Relying on such principles, a
court may alter the specific terms of a loan to the extent it considers
necessary to prevent or remedy an injustice, undue oppression or overreaching,
or may require the lender to undertake affirmative actions to determine the
cause of the borrower's default and the likelihood that the borrower will be
able to reinstate the loan. In some cases, courts have substituted their
judgment for the lenders' and have required that lenders reinstate loans or
recast payment schedules in order to accommodate borrowers who are suffering
from a temporary financial disability. In other cases, courts have
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limited the right of the lender to foreclosure in the case of a non-monetary
default, such as a failure to adequately maintain the mortgaged property or an
impermissible further encumbrance of the mortgaged property. However, there can
be no assurance that these principles will be applied.
In a majority of states (excluding Pennsylvania with respect to mortgages
on properties of the type underlying the Initial Investments), after sale
pursuant to a deed of trust or foreclosure of a mortgage, the borrower and
foreclosed junior lienors are given a statutory period in which to redeem the
property. In some states, statutory redemption may occur only upon payment of
the foreclosure sale price. In other states, redemption may be permitted if the
former borrower pays only a portion of the sums due. In some states, the
borrower retains possession of the property during the statutory redemption
period. The effect of a statutory right of redemption is to diminish the
ability of the lender to sell the foreclosed property because the exercise of a
right of redemption would defeat the title of any purchaser through a
foreclosure. Consequently, the practical effect of the redemption right is to
force the lender to maintain the property and pay the expenses of ownership
until the redemption period has expired. In some states, a post-sale statutory
right of redemption may exist following a judicial foreclosure, but not
following a trustee's sale under a deed of trust.
Many loans acquired by the Company (including the Initial Investments) are
likely to be nonrecourse loans, as to which recourse in the case of default
will be limited to the property and such other assets, if any, that were
pledged to secure the mortgage loan. However, even if a mortgage loan by its
terms provides for recourse to the borrower's other assets, a lender's ability
to realize upon those assets may be limited by state law. For example, in some
states a lender cannot obtain a deficiency judgment against the borrower. In
certain other states, the lender has the option of bringing a personal action
against the borrower. In certain other states, the lender has the option of
bringing a personal action against the borrowing on the debt without first
exhausting such security; however, in some of those states, the lender,
following judgment on such personal action, may be deemed to have elected a
remedy and thus may be precluded from foreclosing upon the security.
Consequently, lenders in those states where such an election of remedy
provision exists may choose to proceed first against the security. Finally,
other statutory provisions, designed to protect borrowers from exposure to
large deficiency judgments that might result from bidding at below-market
values at the foreclosure sale, limit any deficiency judgment to the excess of
the outstanding debt over the fair market value of the property at the time of
the sale.
Bankruptcy Laws. Operation of the Bankruptcy Code and related state laws
may interfere with or affect the ability of a lender to realize upon collateral
or to enforce a deficiency judgment. For example, under the Bankruptcy Code,
virtually all actions (including foreclosure actions and deficiency judgment
proceedings) to collect a debt are automatically stayed upon the filing of the
bankruptcy petition and, often, no interest or principal payments are made
during the course of the bankruptcy case. The delay and the consequences
thereof caused by such automatic stay can be significant. Also, under the
Bankruptcy Code, the filing of a petition in bankruptcy by or on behalf of a
junior lienor may stay the senior lender from taking action to foreclose out
such junior lien.
Under the Bankruptcy Code, provided certain substantive and procedural
safeguards protective of the lender are met, the amount and terms of a mortgage
loan secured by a lien on property of the debtor may be modified under certain
circumstances. For example, the outstanding amount of the loan may be reduced
to the then-current value of the property (with a corresponding partial
reduction of the amount of lender's security interest) pursuant to a confirmed
plan or lien avoidance proceeding, thus leaving the lender a general unsecured
creditor for the difference between such value and the outstanding balance of
the loan. Under certain circumstances, a plan can be confirmed which provides
for little or no payment for the unsecured claim for deficiency. Other
modifications may include a reduction in the amount of each scheduled payment,
by means of a reduction in the rate of interest or alteration of the repayment
schedule (with or without affecting the unpaid principal balance of the loan),
and by an extension (or shortening) of the term to maturity.
Federal bankruptcy law may also have the effect of interfering with or
affecting the ability of the secured lender to enforce the borrower's
assignment of rents and leases related to the mortgaged property. Under section
362 of the Bankruptcy Code, the lender will be stayed from enforcing the
assignment, and the legal proceedings necessary to resolve the issue could be
time-consuming, with resulting delays in the lender's receipt of the rents. In
addition, the Bankruptcy Code has been amended to provide that a lender's
perfected pre-petition security interest in leases, rents and hotel revenues
continues in the post-petition leases, rents and hotel revenues, unless a
bankruptcy court orders to the contrary "based on the equities of the case."
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In a bankruptcy or similar proceeding, action may be taken seeking the
recovery as a preferential transfer of any payments made by the mortgagor under
the related mortgage loan to the owner of such mortgage loan. Payments on
long-term debt may be protected from recovery as preferences to the extent the
lender is oversecured or if they are payments in the ordinary course of
business made on debts incurred in the ordinary course of business. Whether any
particular payment would be protected depends upon the facts specific to a
particular transaction.
A trustee in bankruptcy, in some cases, may be entitled to collect its
costs and expenses in preserving or selling the mortgaged property ahead of
payment to the lender. In certain circumstances, a debtor in bankruptcy may
also have the power to grant liens senior to the lien of a mortgage, and
analogous state statutes and general principles of equity may also provide a
mortgagor with means to halt a foreclosure proceeding or sale and to force a
restructuring of a mortgage loan on terms a lender would not otherwise accept.
Moreover, the laws of certain states also give priority to certain tax liens
over the lien of a mortgage or deed of trust. Under the Bankruptcy Code, in
unusual circumstances, if the court finds that actions of the mortgagee have
been harmful to the unsecured creditors and are in bad faith or highly
unreasonable, the lien of the related mortgage may be subordinated to the
claims of unsecured creditors.
The Company's acquisition of Property Interests may be affected by many of
the considerations applicable to mortgage lending. For example, the Company's
ability to derive income from real property will generally be dependent on its
receipt of rent payments under leases of the related property. The ability to
collect rents may be impaired by the commencement of a bankruptcy proceeding
relating to a lessee under such lease. Under the Bankruptcy Code, the filing of
a petition in bankruptcy by or on behalf of a lessee results in a stay in
bankruptcy against the commencement or continuation of any state court
proceeding for past due rent, for accelerated rent, for damages or for a
summary eviction order with respect to a default under the lease that occurred
prior to the filing of the lessee's petition. In addition, the Bankruptcy Code
generally provides that a trustee or debtor-in-possession may, subject to
approval of the court, (i) assume the lease and retain it or assign it to a
third party or (ii) reject the lease. If the lease is assumed, the trustee or
debtor-in-possession (or assignee, if applicable) must cure any default under
the lease, compensate the lessor for its losses and provide the lessor with
"adequate assurance" of future performance. Such remedies may be insufficient,
and any assurances provided to the lessor may, in fact, be inadequate. If the
lease is rejected, the lessor will be treated as an unsecured creditor with
respect to its claim for damages for termination of the lease. The Bankruptcy
Code also limits a lessor's damages for lease rejection to the rent reserved by
the lease (without regard to acceleration) for the greater of one year, or 15%,
not to exceed three years, of the remaining term of the lease. Efforts to eject
a debtor/lessee are usually costly and time-consuming.
Default Interest and Limitations on Prepayments. Notes and mortgages may
contain provisions that obligate the borrower to pay a late charge or
additional interest if payments are not timely made, and in some circumstances,
may prohibit prepayments for a specified period or condition prepayments upon
the borrower's payment of prepayment fees or yield maintenance penalties. The
notes and mortgages in the Initial Investments include such provisions. In
certain states, there are or may be specific limitations upon the late charges
that a lender may collect from a borrower for delinquent payments. Certain
states also limit the amounts that a lender may collect from a borrower as an
additional charge if the loan is prepaid. In addition, the enforceability of
provisions that provide for prepayment fees or penalties upon an involuntary
prepayment is unclear under the laws of many states.
Forfeitures in Drug and RICO Proceedings. Federal law provides that
property owned by persons convicted of drug-related crimes or of criminal
violations of the Racketeer Influenced and Corrupt Organizations ("RICO")
statute can be seized by the government if the property was used in, or
purchased with the proceeds of, such crimes. Under procedures contained in the
Comprehensive Crime Control Act of 1984 (the "Crime Control Act"), the
government may seize the property even before conviction. The government must
publish notice of the forfeiture proceeding and may give notice to all parties
"known to have an alleged interest in the property," including the holders of
mortgage loans.
A lender may avoid forfeiture of its interest in the property if it
establishes that: (i) its mortgage was executed and recorded before commission
of the crime upon which the forfeiture is based, or (ii) the lender was, at the
time of execution of the mortgage, "reasonably without cause to believe" that
the property was used in, or purchased with the proceeds of, illegal drug or
RICO activities.
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Environmental Matters. The Company may risk environmental liabilities
when it takes a security interest in real property, as well as when it acquires
any real property. See "Risk Factors -- Real Properties with Environmental
Problems May Create Liability for the Company." Of particular concern are
properties that are or have been used for industrial, manufacturing, military
or disposal activity. Such environmental risks include the risk of the
diminution of the value of a contaminated property or, as discussed below,
liability for the costs of compliance with environmental regulatory
requirements or the costs of any remedial actions. These compliance or
remediation costs could exceed the value of the property or the amount of the
lender's loan. In certain circumstances, a lender could determine to abandon a
contaminated mortgaged property as collateral for its loan rather than
foreclose and risk liability for compliance or remediation costs.
The federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980, as amended ("CERCLA"), imposes strict liability on
present and past "owners" and "operators" of contaminated real property for the
costs of site assessment and remediation. A secured lender may be liable as an
"owner" or "operator" of a contaminated mortgaged property if agents or
employees of the lender have become sufficiently involved in the management of
such mortgaged property or the operations of the borrower. Such liability may
exist even if the lender did not cause or contribute to the contamination, and
whether the lender has actually taken possession of a mortgaged property
through foreclosure, deed in lieu of foreclosure or otherwise. The magnitude of
the CERCLA liability at any given contaminated site is a function of the
actions required to address adequately the risks to human health and the
environment posed by the particular conditions at the site. As a result, such
liability is not constrained by the value of the property or the amount of the
original or unamortized principal balance of any loans secured by the property.
Moreover, under certain circumstances, liability under CERCLA may be joint and
several; any liable party may be obligated to pay the entire remediation cost
regardless of its relative contribution to the contamination.
The Asset Conservation, Lender Liability and Deposit Insurance Act of 1996
(the "1996 Lender Liability Act") provides a safe harbor for a secured lender
from CERCLA liability even though the lender forecloses and sells the real
estate securing the loan, provided the secured lender sells "at the earliest
practicable, commercially reasonable time, at commercially reasonable terms,
taking into account market conditions and legal and regulatory requirements."
Although the 1996 Lender Liability Act appears to provide significant
protection to secured lenders, it has not yet been construed by the courts and
there are circumstances in which actions taken could expose a secured lender to
CERCLA liability. Further, the transferee from the secured lender is not
entitled to the protections enjoyed by a secured lender. Accordingly, the
marketability of any contaminated real property cannot be assured.
Many states have environmental clean-up statutes similar to CERCLA, and
not all those statutes provide for a secured creditor exemption. In addition,
underground storage tanks ("USTs") commonly are found at a wide variety of
commercial and industrial properties. Federal and state laws impose liability
on the owners and operators for any remediation that may be required as a
result of releases from USTs. These laws also impose certain compliance
obligations on the UST owners and operators, such as regular monitoring for
leaks and upgrading of older USTs. The Company may become a UST owner or
operator and subject to compliance obligations and potential remediation
liabilities, either as a result of becoming involved in the management of a
site at which a UST is located or, more commonly, by taking title to such a
property. Federal and state laws also obligate property owners and operators to
maintain and, under some circumstances, to remove asbestos-containing building
materials and lead-based paint. As a result, the presence of these materials
can increase the cost of operating a property and thus diminish its value. In a
few states, transfers of some types of properties are conditioned upon
remediation of contamination prior to transfer. In these cases, a lender that
becomes the owner of a property through foreclosure, deed in lieu of
foreclosure or otherwise, may be required to remedy the contamination before
selling or otherwise transferring the property.
Beyond statute-based environmental liability, there exist common law
causes of action (for example, actions based on nuisance or on toxic tort
resulting in death, personal injury or damage to property) related to hazardous
environmental conditions on a property.
Under many states' laws, contamination of a property may give rise to a
lien on the property for remediation costs. In several states, such a lien has
priority over all existing liens, including those of existing mortgages. In
these states, the lien of a mortgage may lose its priority to such a
"superlien."
44
<PAGE>
The cost of remediating environmental contamination at a property can be
substantial. To reduce the likelihood of exposure to such losses, the Company
will neither acquire title to a property, whether directly or through
foreclosure, nor take over its operation unless, based on an environmental site
assessment prepared by a qualified environmental consultant, the Company has
determined that the acquisition is appropriate. The Company intends to consider
all of its options, including the organization of a special purpose subsidiary,
if it determines it appropriate to acquire any environmentally contaminated
real property.
Environmental site assessments can be a valuable tool in anticipating,
managing and minimizing risks from environmental conditions. They are commonly
performed in many commercial real estate transactions. The Company will require
that a recent "Phase I" environmental site assessment report be obtained or
available for properties underlying any Financing or Property Interest. The
purpose of Phase I environmental assessments is to identify potential
environmental contamination that is made apparent from historical reviews of
the properties, reviews of certain public records, preliminary investigations
of the sites and surrounding properties, and screening for the presence of
hazardous substances, toxic substances and underground storage tanks.
Environmental site assessments vary considerably in their content and quality.
Even when adhering to good professional practices, environmental consultants
sometimes do not detect significant environmental problems. Accordingly, these
reports may not reveal all environmental liabilities. Nevertheless, in
assessing and addressing environmental risks in connection with commercial real
estate (including multifamily properties) it is generally helpful to conduct an
environmental site assessment of a property because it enables anticipation of
environmental problems and, if agreements are structured appropriately, can
allow a party to decline to go forward with a transaction. Depending on what
the Phase I assessment discloses, a Phase II environmental site assessment may
be performed.
Where a property has been the subject of a recent Phase I assessment
report which is addressed to the borrower, owner or another person, the Company
may accept such assessment report in lieu of requiring that another assessment
be performed. The Company will normally require that the assessment report be
updated and addressed to the Company. The Company may waive either requirement
if management believes, based upon its review of the assessment report and the
property, that environmental risk is minimal.
Applicability of Usury Laws. Title V of the Depository Institutions
Deregulation and Monetary Control Act of 1980 ("Title V") provides that state
usury limitations shall not apply to certain types of residential (including
multifamily) first mortgage loans originated by certain lenders after March 31,
1980. Title V authorized any state to reimpose interest rate limits by
adopting, before April 1, 1983, a law or constitutional provision that
expressly rejects application of the federal law. In addition, even where Title
V is not so rejected, any state is authorized by the law to adopt a provision
limiting discount points or other charges on mortgage loans covered by Title V.
Certain states have taken action to reimpose interest rate limits and/or to
limit discount points or other charges. In Pennsylvania and Virginia (the
states in which the properties securing the Initial Investments are located),
loans with respect to properties such as those included in the Initial
Investments are not so limited.
Americans With Disabilities Act. Under Title III of the ADA, in order to
protect individuals with disabilities, public accommodations (such as hotels,
restaurants, shopping centers, hospitals, schools and social service center
establishments) must remove architectural and communication barriers to
disabled individuals that are structural in nature from existing places of
public accommodation to the extent "readily achievable." In addition, under the
ADA, alterations to a place of public accommodation or a commercial facility
are to be made so that, to the maximum extent feasible, such altered portions
are readily accessible to and usable by disabled individuals. The "readily
achievable" standard takes into account, among other factors, the financial
resources of the affected site, owner, landlord, or other applicable persons.
In addition to imposing a possible financial burden on the borrower in its
capacity as owner or landlord, the ADA may also impose such requirements on a
foreclosing lender who succeeds to the interest of the borrower, owner or
landlord. Furthermore, since the "readily achievable" standard may vary
depending on the financial condition of the owner or landlord, a foreclosing
lender who is financially more capable than the borrower of complying with the
requirements of the ADA may be subject to more stringent requirements that
those to which the borrower is subject.
45
<PAGE>
THE COMPANY
RAIT was formed as a real estate investment trust in the State of Maryland
in August 1997 and will elect to be taxed as a REIT under the Code. The
principal executive offices of the Company are located at 1521 Locust Street,
10th Floor, Philadelphia, Pennsylvania 19102. The Company's telephone number is
(215) 546-5119.
Management
The Company will be self-administered and self-managed with respect to its
investments in Financings and Property Interests. While the Company will
supervise the management of the properties underlying its Financings and
Property Interests, leasing, operational and tenant improvement services will
be provided by third-party managers, including Brandywine, an affiliate of RAI.
The Company will internally service its Financing, although it has the right to
retain third-party servicers, including affiliates. The Company may also
utilize property due diligence investigation services provided by RAI. See
"Conflicts of Interest."
Trustees and Executive Officers
The following sets forth certain information regarding the trustees and
executive officers of the Company:
<TABLE>
<CAPTION>
Name Age Position with the Company
- -------------------- ----- -------------------------------------------------
<S> <C> <C>
Betsy Z. Cohen 55 Chairman, Chief Executive Officer and Trustee
Jay J. Eisner 40 President, Chief Operating Officer and Secretary
Jay R. Cohen 56 Executive Vice President
Ellen J. DiStefano 32 Chief Financial Officer
Jonathan Z. Cohen 27 Trustee*
Jerome S. Goodman 62 Trustee**
Joel R. Mesznik 51 Trustee**
Daniel Promislo 64 Trustee**
Jack L. Wolgin 81 Trustee**
</TABLE>
- ------------
* Trustee nominated by RAI
** Independent Trustee
Betsy Z. Cohen was elected in August 1997 to serve as Chairman, Chief
Executive Officer and trustee of the Company. Mrs. Cohen has served as
Chairman, Chief Executive Officer and a director of JeffBanks, a bank holding
company with $1.2 billion in total assets as of September 30, 1997, since its
founding in 1981, and of its subsidiaries Jefferson Bank (since its founding in
1974) and Jefferson Bank of New Jersey (since its founding in 1988). Mrs. Cohen
is also a director of Aetna, Inc. and Life Technologies, Inc. Mrs. Cohen is
married to Edward E. Cohen, Chairman, Chief Executive Officer and President of
RAI. Jonathan Z. Cohen, a trustee of the Company, is Mrs. Cohen's son, and Jay
Cohen, Executive Vice President of the Company, is a cousin of Mrs. Cohen.
Jay J. Eisner, a certified public accountant, was elected in August 1997
to serve as President, Chief Operating Officer and Secretary of the Company.
From December 1994 to March 1997, Mr. Eisner was Chief Financial Officer of
Washington Capital Corporation, Philadelphia, Pennsylvania (a private
investment firm providing non-conforming mortgage loan financing to real estate
developers and others) and, from 1987 to December 1994, was Chief Financial
Officer of Asbell & Associates, L.P., Philadelphia, Pennsylvania, (a private
real estate development, investment and financing firm). From 1983 through
1987, Mr. Eisner was Vice President and Controller of Ascott Investment
Corporation, a national real estate syndication and investment company and from
1979 through November 1983 was a Supervisor with Touche Ross & Company,
certified public accountants.
Jay R. Cohen was elected in October 1997 to serve as Executive Vice
President of the Company. From 1995 through September 1997, Mr. Cohen was
Executive Vice President and Treasurer of CRIIMI MAE, Inc., Rockville,
Maryland, a REIT investing in mortgage loans. Prior thereto, from 1983 he
served in various executive
46
<PAGE>
capacities with predecessor REITs to CRIIMI MAE, including service as Executive
Vice President and Treasurer of CRI Insured Mortgage Association, Inc., CRI
Liquidating REIT, Inc. and Capital Housing and Mortgage Partners, Inc. During
such period, Mr. Cohen also served as President of Crico Mortgage Company,
Inc., a manager of REITs and master limited partnerships. Mr. Cohen is a cousin
of Mrs. Cohen.
Ellen J. DiStefano, a certified public accountant, was elected in October
1997 to serve as Chief Financial Officer of the Company. From 1992 to August
1997, Ms. DiStefano was Chief Financial Officer of Brandywine, a Philadelphia,
Pennsylvania based national manager and developer of commercial, multifamily,
office and hotel properties, and an affiliate of RAI. From 1987 to 1992, Ms.
DiStefano was a Senior Associate at Coopers & Lybrand, certified public
accountants.
Jonathan Z. Cohen was elected in September 1997 to serve as a trustee of
the Company, and is the nominee of RAI. From 1994 to present, Mr. Cohen has
been a founder and the Chief Executive Officer of Blue Guitar Films, Inc., a
New York based feature film production company. Mr. Cohen received his J.D.
from the American University with honors in May 1995 and his B.A. from the
University of Pennsylvania. From 1989 to 1991, Mr. Cohen was President and
founder of a group of neighborhood advertising supplements/magazines called "In
Walking Distance." Mr. Cohen is the son of Betsy Z. Cohen.
Jerome S. Goodman was elected in August 1997 to serve as a trustee of the
Company. Mr. Goodman has been Chairman of Travel One (a commercial travel
management company) since 1971, and was the sole stockholder of Travel One from
1971 to 1994. Mr. Goodman was a member of the New Jersey Sports Exposition
Authority from 1991 to 1994, and its Chairman from 1992 to 1994. He has also
served as Chairman, President and Chief Executive Officer of First Peoples
Financial Corporation (a bank holding company) from 1987 to 1992 and President
and Chief Executive Officer of First Peoples Bank of NJ from 1983 to 1987. He
was a member of the Board of Directors of GBC Technologies, Inc. from 1992 to
1995. Mr. Goodman is a director of Aetna, Inc.
Joel R. Mesznik was elected in August 1997 to serve as a trustee of the
Company. From 1990 to date, Mr. Mesznik has been President of Mesco Ltd., New
York, New York (a corporate financial advisory firm). From 1976 to 1990, Mr
Mesznik was affiliated with Drexel Burnham Lambert, Inc. including, from 1976
to 1987, service as head of its Public Finance Department. Mr. Mesznik is the
general partner of several private limited partnerships which have acquired
real estate assets from the Resolution Trust Corporation, the Federal Deposit
Insurance Corporation and institutional lenders.
Daniel Promislo was elected in August 1997 to serve as a trustee of the
Company. Mr. Promislo is the Managing Director of Wolf, Block, Schorr and
Solis-Cohen, a Philadelphia, Pennsylvania law firm (with which he was Of
Counsel from 1994 to October 1997, and a partner from 1977 to 1994, principally
involved in corporate and real estate finance matters). He currently is also
President and a director of Historic Documents Co. and Historical Souvenir Co.
(of which he is also a founder), which manufacture souvenirs of American
history, and a director of U.S. Physicians, Inc., a physicians' practice
management company. From 1994 to date he has been a director, and from 1996 to
October 1997, Chairman of the Board of Directors, of WHYY, Inc., the principal
public television station in the Philadelphia metropolitan area.
Jack L. Wolgin was elected in August 1997 to serve as a trustee of the
Company. For over 50 years, Mr. Wolgin has been extensively involved in the
development and financing of real estate, as a founder and director of
Industrial Valley Bank (where he was a member of the Executive, Audit and Real
Estate Loan Committees), founder, Chairman, President and Chief Executive
Officer of Atlas Credit Corporation (a Philadelphia home improvement lender)
and Colonial Mortgage Company (a mortgage origination and servicing company), a
founder of the Pennsylvania Real Estate Investment Trust, a past director and
member of the Executive Committee of the board of directors of Brooks Harvey
Realty Investors (a REIT sponsored by Morgan Stanley & Co.) and as a developer,
for his own account, of in excess of $340 million of commercial, multifamily
residential, office and other properties.
All trustees (except trustees appointed to fill vacancies) will be elected
at each annual meeting of shareholders for a term of one year, and will hold
office until their successors are elected and qualified. All officers
47
<PAGE>
serve at the discretion of the Board of Trustees. The Company will pay an
annual trustee's fee to each Independent Trustee equal to $10,000 plus $1,000
for each meeting of the Board of Trustees, and $500 for each meeting of a
committee thereof attended in person. Chairmen of committees will receive an
additional $500 for each meeting of a committee attended in person. All
trustees will be reimbursed for their costs and expenses in attending all
meetings of the Board of Trustees and any committee thereof. Affiliated
trustees will not be separately compensated by the Company.
The following table sets forth certain information concerning the
compensation that will be paid to the Company's Chief Executive Officer and
each of the Company's other most highly compensated executive officers whose
aggregate compensation will exceed $100,000 in the Company's first full fiscal
year:
Summary Compensation Table
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
-------------------- -----------------------------------------
Securities
Name and Principal Underlying LTIP
Position Salary Bonus Options Payouts All Other
- ------------------------- ---------- ------- ------------ --------- --------------
<S> <C> <C> <C> <C> <C>
Betsy Z. Cohen $250,000 (1) 225,000 -- $ --
Chairman and Chief
Executive Officer(1)
Jay J. Eisner 150,000 (1) 75,000 -- --
President, Chief
Operating Officer and
Secretary(1)
Jay R. Cohen 200,000 (1) 50,000 -- 4,200(2)
Executive Vice
President
Ellen J. DiStefano 125,000 (1) 35,000 -- 8,800(2)
Chief Financial Officer
</TABLE>
- ------------
(1) Bonuses may be paid in the discretion of the Board of Trustees. No such
bonuses have been provided for as of the date hereof.
(2) Automobile allowance.
Except for Mrs. Cohen, all executive officers of the Company are required
to devote substantially all of their business time to the Company's operations.
Mrs. Cohen is required to devote only so much of her time as may be required
for the effective discharge of her duties. Mrs. Cohen currently has substantial
business interests apart from the Company which the Company anticipates will
require a material amount of her time. The trustees and officers (subject to
the requirement that the officers, with the exception of Mrs. Cohen, devote
substantially all of their business time to the Company's operations) generally
are not limited or restricted from engaging in any business or rendering
services of any kind to any other person, including the acquisition or
origination of real properties or loans that meet the Company's investment
objectives and policies. Except as set forth in "Conflicts of Interest," the
trustees and officers of the Company and their affiliates may not be
participants in the Company's investments.
The Company's Declaration of Trust provides that, except in the case of a
vacancy, a majority of the members of the Board of Trustees, and of any
committee of the Board of Trustees, will at all times be Independent Trustees.
Vacancies occurring on the Board of Trustees among the Independent Trustees
will be filled by the vote of a majority of the trustees, including a majority
of the Independent Trustees.
Option Plan
The Company intends to adopt a share option plan on or before the
completion of this Offering (the "Option Plan"), which will provide for both
incentive and non-qualified options to purchase Common Shares. The maximum
aggregate number of Common Shares that may be issued pursuant to options
granted under the Option Plan is 450,000. The purpose of the Option Plan is to
provide a means of performance-based compensation in order to provide
incentives for the Company's key employees.
48
<PAGE>
It is anticipated that the Option Plan will provide for an option exercise
price equal to the price of the shares in the Offering, a term of ten years,
and vesting of options in equal increments over the four years following the
date of grant. The Company has agreed, once the Option Plan has been
established, to issue options to acquire Common Shares as follows: Betsy Z.
Cohen -- 225,000 shares; Jay J. Eisner -- 75,000 shares; Jay R. Cohen -- 50,000
shares and Ellen J. DiStefano -- 35,000 shares. In addition, the Company
intends to issue options to acquire 500 shares under the Option Plan upon the
foregoing terms to each of the trustees other than Mrs. Cohen.
Employment Agreements
At the close of the Offering, the Company will enter into employment
agreements with Betsy Z. Cohen, its Chairman and Chief Executive Officer, and
Jay J. Eisner, its President and Chief Operating Officer, providing for
compensation and the grant of options as set forth in "The Company -- Trustees
and Executive Officers -- Summary Compensation Table" and "-- Option Plan."
Other material terms of these agreements are described below.
The agreement with Mrs. Cohen will provide that she will devote only such
time to the Company as is reasonably required to fulfill her duties. The
agreement will have a term of one year which is automatically extended so that,
on any day that the agreement is in effect, it will have a then current term of
one year. The automatic extensions cease upon notice by the Company of its
election to terminate the agreement at the end of the one year period then in
effect or upon 90 days notice by Mrs. Cohen after the initial one year term.
The agreement terminates upon Mrs. Cohen's death, and may be terminated by the
Company for cause (material and willful misconduct, conduct that would result
in material injury to the reputation of the Company or continued deliberate
negligent performance or non-performance of duties) or disability of Mrs. Cohen
for more than an aggregate of 180 days during any 365 day period. The agreement
may be terminated by Mrs. Cohen upon 45 days notice for "good reason"
(generally, relocation of the Company out of the Philadelphia area, a change in
control of the Company, a substantial change in Mrs. Cohen's duties, the
Company's failure to continue coverage under benefit plans or a material breach
of the agreement by the Company), subject to a 30-day cure period. In the event
of a termination other than for cause, Mrs. Cohen (or her estate) will receive
a lump sum benefit equal to her "average compensation." As used in the
agreement, "average compensation" means the average of Mrs. Cohen's
compensation (including the annualized current year's compensation) in the
three most highly compensated years during the previous five years, except that
if she has been employed for less than three years, it means the highest annual
compensation received during the period. In addition, upon termination, all
options to acquire Common Shares held by Mrs. Cohen vest on the later of the
effective date of termination or six months after the options were granted.
Except as to compensation, number of option shares, and the requirement
that Mr. Eisner devote his full-time services to the business and affairs of
the Company, Mr. Eisner's employment agreement, including the formula for
calculating the termination benefit, is substantially similar to that of Mrs.
Cohen.
Indemnification of Trustees and Executive Officers
The Company's Declaration of Trust provides for the indemnification of the
trustees and officers of the Company to the full extent permitted by Maryland
law. The Declaration of Trust also provides that the personal liability of any
trustee or officer of the Company to the Company or its shareholders for money
damages is limited to the fullest extent allowed by Maryland law. In addition,
the Company will enter into indemnification agreements with its trustees and
officers containing similar provisions. See "Certain Provisions of Maryland Law
and of the Company's Declaration of Trust and Bylaws -- Indemnification;
Limitation of Trustees' and Officers' Liability" and "-- Indemnification
Agreements."
49
<PAGE>
DISTRIBUTION POLICY
In order to avoid corporate income taxation of the earnings that it
distributes, the Company must distribute to its shareholders an amount at least
equal to (i) 95% of its REIT taxable income (determined before the deduction
for dividends paid and excluding any net capital gain) plus (ii) 95% of the
excess of its net income from foreclosure property over the tax imposed on such
income by the Code less (iii) any excess non-cash income (as determined under
the Code). See "Federal Income Tax Considerations." The actual amount and
timing of distributions, however, will be at the discretion of the Board of
Trustees and will depend upon the financial condition of the Company in
addition to the requirements of the Code. It is anticipated that the first
distribution will be made after the first fiscal quarter following the
completion of this Offering.
Subject to the distribution requirements referred to in the immediately
preceding paragraph, the Company intends, to the extent practicable, to invest
substantially all of the principal from repayments, sales and refinancings of
the Company's assets in Financings and Property Interests. The Company may,
however, under certain circumstances, make a distribution of principal. Such
distributions, if any, will be made at the discretion of the Board of Trustees.
It is anticipated that distributions generally will be taxable as ordinary
income or return on capital, although (as referred to in the previous
paragraph) a portion of such distributions may constitute long-term capital
gain or a return of capital. The Company will furnish annually to each of its
shareholders a statement setting forth distributions paid during the preceding
year and their federal income tax status. For a discussion of the federal
income tax treatment of distributions by the Company, see "Federal Income Tax
Considerations -- Taxation of RAIT" and "-- Taxation of Taxable U.S.
Shareholders Generally."
CAPITALIZATION
The capitalization of the Company, as of October 31, 1997, and as adjusted
to reflect the sale of the Common Shares offered hereby, is as follows:
<TABLE>
<CAPTION>
Actual As Adjusted(1)
-------- ---------------
<S> <C> <C>
Preferred Shares, par value $.01; 25,000,000 shares authorized; no shares
outstanding, actual; no shares outstanding, as adjusted ............... $ -- $ --
Common Shares, par value $.01; 200,000,000 shares authorized; 100 shares
outstanding, actual; 3,333,434 shares outstanding, as adjusted(1)(2) ... 1 33,334
Additional paid-in capital ............................................. 999 45,753,675
------ -----------
Total ............................................................... $1,000 $45,787,009
====== ===========
</TABLE>
- ------------
(1) Includes 500,000 Common Shares to be purchased by RAI, and up to 125,000
Common Shares which may be purchased by directors, trustees and officers
of the Company, RAI and Brandywine, together with members of their
respective families and relatives, at the initial public offering price,
less underwriting discounts and commissions, and is stated after deducting
Offering expenses, estimated to be $714,000, payable by the Company.
(2) Assumes no exercise of the Underwriters' over-allotment option to purchase
up to an additional 425,000 Common Shares, and excludes 141,667 Common
Shares issuable pursuant to warrants granted to the Representative and
450,000 Common Shares reserved for issuance to executive officers of the
Company in connection with future grants of employee options.
50
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION
The Company has been organized and will elect to qualify as a REIT under
the Code and, as such, anticipates distributing annually at least 95% of its
taxable income, subject to certain adjustments. Cash for such distributions is
expected to be generated from the Company's operations, although the Company
also may borrow funds to make distributions. The Company's revenues will be
derived from interest paid on Financings, rents received from Property
Interests, the proceeds from any sales of loans or properties (see "Risk
Factors -- Legal and Tax Risks -- Gain on Disposition of Assets Deemed Held for
Sale in Ordinary Course Subject to 100% Tax"), proceeds from any participations
and borrowings (see "Investment Objectives and Policies -- Leverage") and
interest and revenues from other (generally short-term) investments.
The principal sources of the Company's funds will be the proceeds of this
Offering, proceeds from borrowings and proceeds from future equity offerings.
From the net proceeds of this Offering, approximately $20.6 million will be
used to purchase the Initial Investments.
The Company anticipates that the Initial Investments will be accounted for
as loans and recorded at cost. Interest on these loans will be recognized as
revenue when earned according to the terms of the loans. Additionally, with
respect to mortgage loans it acquires at a discount, the Company will amortize
into income over the estimated life of the loans the difference between its
cost basis in them and the future cash collections, if any, that are both
reasonably estimatable and probable, using the constant interest method. Also,
any changes in the amortization of discount as a result of changes in
anticipated cash flows will be adjusted currently and treated as a change in
estimate.
Each of the Discounted Loans is in default with respect to its terms as
originally underwritten, but is subject to a forbearance agreement pursuant to
which the holder of the loan (currently RAI and, upon acquisition, the
Company), has agreed not to foreclose provided the borrower pays (subject to a
stated minimum) all revenues from the underlying property (after operating
expenses) to the holder of the loan. Accordingly, the Company, once it acquires
these loans, will receive the increase, (or, with respect to loan 108 in which
it will acquire a partial interest, a share of the increase) if any, in the
revenue from the underlying properties, after payment of operating expenses, to
a maximum aggregate amount equal to the required payments on the loan as
originally underwritten.
In addition, these loans will permit the Company to capture, upon a sale
or refinancing of the underlying properties, some or all of the increase in the
value of the underlying property to a maximum amount equal to the then
outstanding balance of the loan as originally underwritten, together with
accrued interest (except for loan 108, in which the Company will receive
amounts attributable to its proportionate interest in the loan). Since, based
on the original terms of these loans, debt service is in excess of payments
currently being made, the Company anticipates that the outstanding balances, as
originally underwritten, will increase.
Although the debt service required under the original terms of the
Discounted Loans and Non-Discounted Loans is in excess of payments currently
being made by the borrowers, following the acquisition of the Discounted Loans
and Non-Discounted Loans by RAI the borrowers have made all required payments
under their forbearance agreements and any senior indebtedness to which the
property is subject. The primary risks to the Company's investment in these
loans are (i) a decrease in property cash flow, which would reduce the yield to
the Company; (ii) a decrease in the value of the property, which, if the value
decreased below the Company's cost, would require the Company to recognize a
loss on its investment; and (iii) a default on any senior indebtedness to which
the property is subject, which could require the Company to satisfy the senior
indebtedness or risk losing its investment. The Company does not believe that
there is a substantial risk of default on the senior indebtedness to which the
properties underlying the Discounted and Non-Discounted Loans are subject since
the cash flow from the properties, both individually and in the aggregate, is
substantially in excess of debt service on such senior indebtedness. See
"Investment Objectives and Policies -- Initial Investments."
The Initial Investments comprise approximately 45% of the assets to be
purchased with the net proceeds of the Offering and the sale of shares to RAI
(40% if the Underwriters exercise their over-allotment option) and most of the
net proceeds of the offering initially will be invested in readily marketable
securities. Accordingly, the Company does not anticipate a need to sell the
Initial Investments for liquidity purposes. The Company
51
<PAGE>
intends to establish working capital reserves to a maximum of 3% of the
Offering proceeds. These funds, together with funds derived from operations
representing a return of principal, are anticipated to be sufficient to satisfy
liquidity requirements. Liquidity may be adversely affected by costs of
operating the Company and administering its portfolio investments. To the
extent that working capital reserves and cash from operations are insufficient
to satisfy the Company's cash requirements, the Company will be required to
obtain financing from third parties or raise additional capital. There can be
no assurance that any such financing or capital will be available when needed.
DESCRIPTION OF SHARES OF BENEFICIAL INTEREST
General
The Declaration of Trust provides that the Company may issue up to
200,000,000 Common Shares, $.01 par value per share, and 25,000,000 Preferred
Shares, $.01 par value per share. Upon completion of this Offering, 3,333,434
Common Shares will be issued and outstanding (3,758,434 Common Shares if the
Underwriters exercise their over-allotment option) and no Preferred Shares will
be issued and outstanding. An additional 591,667 Common Shares will be reserved
for issuance in connection with the warrants to be issued to the Representative
and the proposed management option plan.
Common Shares
Each outstanding Common Share will entitle the holder to one vote on all
matters presented to shareholders for a vote, including the election of
trustees. Except as otherwise required by law or as provided in any resolution
adopted by the Board of Trustees with respect to any other class or series of
shares establishing the designation, powers, preferences and relative,
participating, optional or other special rights and powers of such series, the
holders of such shares will possess the exclusive voting power, subject to the
provisions of the Company's Declaration of Trust regarding the ownership of
Common Shares in excess of the Ownership Limitation or as otherwise may be
permitted by the Board of Trustees, as described below. Holders of Common
Shares will have no conversion, exchange, sinking fund, redemption or appraisal
rights and have no preemptive rights to subscribe for any securities of the
Company or cumulative voting rights in the election of trustees. All Common
Shares to be issued and outstanding following the completion of the Offering
will be duly authorized, fully paid and non-assessable. Subject to the
preferential rights of any other shares or series of shares and to the
provisions of the Declaration of Trust regarding ownership of Common Shares in
excess of the Ownership Limitation or as otherwise may be permitted by the
Board of Trustees, as described below, distributions may be paid to the holders
of Common Shares if and when authorized and declared by the Board of Trustees
out of funds legally available therefor. The Company intends to make quarterly
distributions, beginning with distributions for the first full quarter
following the consummation of the Offering. See "Distribution Policy."
Under Maryland law, shareholders of a business trust are generally not
liable for the Company's debts or obligations. If the Company is liquidated,
subject to the right of any holders of Preferred Shares to receive preferential
distributions, each outstanding Common Share will be entitled to participate
pro rata in the assets remaining after payment of, or adequate provision for,
all known debts and liabilities of the Company.
Subject to the provisions of the Declaration of Trust regarding the
ownership of Common Shares in excess of the Ownership Limitation or as
otherwise permitted by the Board of Trustees, as described below, all Common
Shares will have equal distribution, liquidation and voting rights, and will
have no preference or exchange rights.
Under the Declaration of Trust, the Company cannot dissolve, amend its
trust agreement (except as described in this paragraph), merge, consolidate or
sell, lease, exchange or otherwise transfer all or substantially all of its
assets, unless approved by the affirmative vote of shareholders holding at
least two-thirds of the shares entitled to vote on the matter. As permitted
under Maryland law, the Company's Declaration of Trust permits the Board of
Trustees, without any action by the shareholders of the Company, to (i) amend
the Declaration of Trust by a two-thirds vote to allow the Company to qualify,
or continue its qualification, as a REIT under the Code or Maryland law and
(ii) amend the Declaration of Trust by a majority vote to increase or decrease
the aggregate number of shares of beneficial interest or the number of shares
of any class of shares of beneficial interest that the Company has the
authority to issue.
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The Declaration of Trust authorizes the Board of Trustees to reclassify
any unissued Common Shares into other classes or series of classes of shares
and to establish the number of shares in each class or series and to set the
preferences, conversion and other rights, voting powers, restrictions,
limitations and restrictions on ownership, limitations as to dividends or other
distributions, qualifications and terms or conditions of redemption for each
such class or series.
Preferred Shares
Preferred Shares may be issued from time to time, in one or more series,
as authorized by the Board of Trustees. No Preferred Shares are currently
issued or outstanding. Prior to the issuance of shares of each series, the
Board of Trustees is required to fix for each series the terms, preferences,
conversion or other rights, voting powers, restrictions, limitations as to
distributions, qualifications and terms or conditions of redemption, as
permitted by Maryland law. Because the Board of Trustees has the power to
establish the preferences, powers and rights of each series of Preferred
Shares, it may afford the holders of any series of Preferred Shares
preferences, powers and rights, voting or otherwise, senior to the rights of
holders of Common Shares. Apart from the effect of the Ownership Limitation
(see "Description of Shares of Beneficial Interest -- Restrictions on Ownership
and Transfer"), the issuance of Preferred Shares could have the effect of
delaying or preventing a change of control of the Company that might involve a
premium price for holders of Common Shares or that they otherwise may deem to
be desirable. The Board of Trustees has no present plans to issue any Preferred
Shares.
Restrictions on Ownership and Transfer
For the Company to qualify as a REIT under the Code, no more than 50% in
value of its outstanding shares of beneficial interest may be owned, actually
or constructively, by five or fewer individuals (as defined in the Code to
include certain entities) at any time during the last half of a taxable year
(other than the first year for which an election to be treated as a REIT has
been made). In addition, if the Company, or an owner of 10% or more of the
Company's shares, actually or constructively owns 10% or more of a tenant of
the Company (or a tenant of any partnership in which the Company is a partner),
the rent received by the Company (either directly or through any such
partnership) from such tenant will not be qualifying income for purposes of the
REIT gross income tests of the Code. The Company's shares must also be
beneficially owned by 100 or more persons during at least 335 days of a taxable
year of twelve months or during a proportionate part of a shorter taxable year
(other than the first year for which an election to be treated as a REIT has
been made).
Because the Company believes it to be essential to qualify as a REIT, the
Declaration of Trust, subject to certain exceptions described below, contains
restrictions on the ownership and transfer of Common and Preferred Shares which
are intended to assist the Company in complying with these requirements. The
ownership limitation set forth in the Company's Declaration of Trust provides
that, subject to certain specified exceptions, no person or entity may own, or
be deemed to own by virtue of the applicable constructive ownership provisions
of the Code, (i) more than 8.3% of the number of outstanding Common Shares,
except for RAI which may own up to 15% of the number of outstanding Common
Shares (and which will own 15% of the outstanding Common Shares at the
conclusion of the Offering, assuming the Underwriters do not exercise their
over-allotment option), or (ii) more than 9.8% of the number of outstanding
Preferred Shares of any class or series (the "Ownership Limitation"). The
constructive ownership rules are complex, and may cause shares owned actually
or constructively by a group of related individuals and/or entities to be owned
constructively by one individual or entity. As a result, the acquisition or
ownership of less than 8.3% of the Common Shares or 9.8% of the Preferred
Shares (or the acquisition of an interest in an entity that owns, actually or
constructively, Common or Preferred Shares) by an individual or entity, could
nevertheless cause that individual or entity, or another individual or entity,
to own constructively in excess of 8.3% of the outstanding Common Shares or
9.8% of the Preferred Shares, and thus violate the Ownership Limitation, or
such other limit as provided in the Company's Declaration of Trust or as
otherwise established by the Board of Trustees. The Board of Trustees may, but
in no event will be required to, waive the Ownership Limitation with respect to
a particular shareholder if it determines that such ownership will not
jeopardize the Company's status as a REIT and the Board of Trustees otherwise
decides such action would be in the best interest of the Company. As a
condition of such waiver, the Board of Trustees may require an opinion of
counsel satisfactory to it or undertakings or representations from the
applicant with respect to preserving the REIT status of the Company. No such
waiver or opinion has been required with respect to RAI's ownership rights,
which are established as part of the Declaration of Trust.
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The Company's Declaration of Trust further prohibits any person from
actually or constructively owning Common or Preferred Shares that would (i)
cause the Company to be "closely held" under Section 856(h) of the Code, (ii)
cause the Company to own constructively 10% or more of the ownership interests
in a tenant of the Company's real property (within the meaning of Code section
856(d)(2)(B)), or (iii) cause the Company's shares to be owned by fewer than
100 persons. Any person, including RAI, who acquires or attempts or intends to
acquire actual or constructive ownership of the Company's shares that will or
may violate any of the foregoing restrictions on transferability and ownership
is required to give notice immediately to the Company and provide the Company
with such other information as the Company may request in order to determine
the effect of the transfer on the Company's status as a REIT. The foregoing
restrictions on transferability and ownership will not apply if the Board of
Trustees determines that it is no longer in the best interest of the Company to
attempt to qualify, or to continue to qualify, as a REIT. Except as otherwise
described above, the Ownership Limitation can only be changed by an amendment
to the Declaration of Trust requiring the affirmative vote of two-thirds of the
outstanding shares entitled to vote.
Pursuant to the Declaration of Trust, if any purported transfer of Common
or Preferred Shares (including transfers by RAI) or any other event would (i)
result in any person violating the Ownership Limitation or such other limit as
provided in the Declaration of Trust, or as otherwise permitted by the Board of
Trustees, (ii) result in the Company being "closely held," (iii) result in the
Common Shares being owned by fewer than 100 persons, or (iv) cause the Company
to own constructively 10% or more of the ownership interests in a tenant of its
real property, the transfer will be void and of no force or effect with respect
to the purported transferee (the "Prohibited Transferee") as to that number of
shares in excess of the Ownership Limitation or such other limit, and the
Prohibited Transferee will acquire no right or interest (or, in the case of any
event other than a purported transfer, the person or entity holding record
title to any such excess shares (the "Prohibited Owner") shall cease to own any
right or interest) in the excess shares. Excess shares will be transferred
automatically, by operation of law, to a trust, the beneficiary of which will
be a qualified charitable organization selected by the Company (the
"Beneficiary"). The automatic transfer will be deemed to be effective as of the
close of business on the business day prior to the date of the violative
transfer. The trustee of the trust (who shall be designated by the Company and
be unaffiliated with the Company and any Prohibited Transferee or Prohibited
Owner) will be required to sell the excess shares to a person who could own the
shares without violating the Ownership Limitation, or such other limit as
provided in the Company's Declaration of Trust or as otherwise permitted by the
Board of Trustees, and distribute to the Prohibited Owner the sales proceeds
received by the trust for such excess shares. Where excess shares result from
an event other than a transfer, or from a transfer for no consideration (such
as a gift), the trustee will be required to sell the excess shares to a
qualified person and distribute to the Prohibited Owner an amount equal to the
lesser of the Market Price (as defined in the Company's Declaration of Trust)
of the excess shares as of the date of such event or the sales proceeds
received by the trust for the excess shares. In either case, any proceeds in
excess of the amount distributable to the Prohibited Transferee or Prohibited
Owner, as applicable, will be distributed to the Beneficiary. Prior to sale,
the trustee will be entitled to receive, in trust for the Beneficiary, all
dividends and other distributions paid by the Company with respect to the
excess shares, and also will be entitled to exercise all voting rights with
respect to the excess shares. Subject to Maryland law, effective as of the date
that the shares have been transferred to the trust, the trustee has the right
(i) to rescind any vote cast by a Prohibited Transferee or Prohibited Owner
prior to the discovery by the Company that such shares have been transferred to
the trust and (ii) thereafter to vote the shares at its discretion. However, if
the Company has already taken irreversible corporate action, then the trustee
shall not have the authority to rescind and revote such vote. Any dividend or
other distribution paid to the Prohibited Transferee or Prohibited Owner (prior
to the discovery by the Company that such shares had been automatically
transferred to a trust as described above) will be required to be repaid to the
trustee, upon demand, for distribution to the Beneficiary. In the event that
transfer to the trust as described above is not automatically effective (for
any reason) to prevent violation of the Ownership Limitation or such other
limit as provided in the Company's Declaration of Trust or as otherwise
permitted by the Board of Trustees, then the Declaration of Trust provides that
the transfer of the excess shares will be void.
In addition, Common Shares held in the trust shall be deemed to have been
offered for sale to the Company, or its designee, at a price per share equal to
the lesser of (i) the price per share in the transaction that resulted in such
transfer to the trust (or, in the case of a gift, the Market Price at the time
of gift) and (ii) the
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Market Price on the date the Company, or its designee, accepts such offer. The
Company may accept the offer until the trustee has sold the shares. Upon that
sale, the interest of the Beneficiary in the shares terminates and the trustee
must distribute the net sale proceeds to the Prohibited Transferee or
Prohibited Owner.
All certificates evidencing Common Shares will bear a legend referring to
the restrictions described above. The foregoing ownership limitations could
delay, defer or prevent a transaction or a change in control of the Company
that might involve a premium price for the Common Shares or otherwise be
desired by shareholders.
Under the Declaration of Trust, every owner of a specified percentage (or
more) of the outstanding Common Shares (including RAI) must file a completed
questionnaire with the Company containing information regarding his ownership
of such shares, as set forth in the Treasury Regulations. Under current
Treasury Regulations, the percentage will be set between 0.5% and 5.0%,
depending upon the number of record holders of the Common Shares. In addition,
each shareholder shall, upon demand, be required to disclose to the Company in
writing such information as the Company may request in order to determine the
effect, if any, of such shareholder's actual and constructive ownership of
Common Shares on the Company's status as a REIT and to ensure compliance with
the Ownership Limitation, or such other limit as provided in the Company's
Declaration of Trust or as otherwise permitted by the Board of Trustees.
Dividend Reinvestment Plan
The Company intends to implement a dividend reinvestment plan whereby
shareholders may automatically reinvest their dividends in the Common Shares.
Details about any such plan will be sent to the Company's shareholders
following adoption thereof by the Board of Trustees.
Reports to Shareholders
The Company will furnish its shareholders with annual reports containing
audited financial statements certified by independent public accountants and
distribute quarterly reports containing unaudited financial information for
each of the three remaining quarters of the year.
Transfer Agent and Registrar
The transfer agent and registrar for the Common Shares will be American
Stock Transfer & Trust Company.
CERTAIN PROVISIONS OF MARYLAND LAW AND OF
THE COMPANY'S DECLARATION OF TRUST AND BYLAWS
The following paragraphs summarize certain provisions of Maryland law
relating to REITs and of the Company's Declaration of Trust and Bylaws. The
summary does not purport to be complete and is subject to and qualified in its
entirety by reference to Maryland law and to the Declaration of Trust and
Bylaws of the Company.
Board of Trustees
The Declaration of Trust provides that the number of trustees of the
Company may be established by the Board of Trustees but may not be fewer than
three nor more than nine. There are currently six trustees. The trustees may
increase or decrease the number of trustees by a majority vote of the Board of
Trustees, provided that (i) the number of trustees may be increased above nine
or decreased below three only by a vote of at least 75% of the trustees then in
office, and (ii) the tenure of office of a trustee shall not be affected by any
decrease in the number of trustees. Any vacancy will be filled, including any
vacancy created by an increase in the number of trustees, at any regular
meeting or at any special meeting called for that purpose, by a majority of the
remaining trustees, provided that Independent Trustees shall nominate
replacements for vacancies in Independent Trustee positions.
The Company's Declaration of Trust provides that a trustee may be removed
with or without cause by the affirmative vote of at least two-thirds of the
votes entitled to be cast in the election of trustees. This provision,
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when coupled with the provision in the Bylaws authorizing the Board of Trustees
to fill vacant trusteeships, precludes the Company's shareholders, as a
practical matter, from removing incumbent trustees and filling the vacancies
created by such removal with their own nominees.
Business Combinations
Under the Maryland General Corporation Law ("MGCL"), as applicable to
REITs, certain "business combinations" (including a merger, consolidation,
share exchange, or, in certain circumstances, an asset transfer or issuance or
reclassification of equity securities) between the Company and any person who
beneficially owns, directly or indirectly, 10% or more of the voting power of
the Company's shares, or an affiliate of the Company who, at any time within
the previous two years was the beneficial owner of 10% or more of the voting
power of the Company's then outstanding shares (an "Interested Shareholder") or
an affiliate of an Interested Shareholder are prohibited for five years after
the most recent date on which the Interested Shareholder became an Interested
Shareholder. Thereafter, a proposed business combination must be recommended by
the Board of Trustees and approved by the affirmative vote of at least (i) 80%
of the votes entitled to be cast by holders of outstanding voting shares and
(ii) two-thirds of the votes entitled to be cast by holders of outstanding
voting shares excluding shares held by the Interested Shareholder unless, among
other conditions, the Company's shareholders receive a minimum price (as
defined in the MGCL) for their shares and the consideration is received in cash
or in the same form as previously paid by the Interested Shareholder for its
shares. These provisions of the MGCL do not apply, however, to business
combinations that are approved or exempted by the Board of Trustees prior to
the time that the Interested Shareholder becomes an Interested Shareholder.
Under the MGCL, RAI would be deemed to be an Interested Shareholder. It is
anticipated, however, that the Company's Board of Trustees will resolve to "opt
out" of the business combination provisions of the MGCL.
Control Share Acquisitions
The MGCL, as applicable to REITs, provides that control shares (as defined
below) of the Company acquired in a control share acquisition (as defined
below) have no voting rights except to the extent approved by a vote of
two-thirds of the votes entitled to be cast on the matter, excluding shares
owned by the acquiror or by officers or trustees who are employees of the
Company. "Control Shares" are voting shares which, if aggregated with all other
such shares previously acquired by the acquiror, or in respect of which the
acquiror is able to exercise or direct the exercise of voting power (except
solely by revocable proxy), would entitle the acquiror to exercise voting power
in electing trustees within one of the following ranges of voting power: (i)
one-fifth or more but less than one-third; (ii) one-third or more but less than
a majority; or (iii) a majority of all voting power. Control Shares do not
include shares the acquiring person is then entitled to vote as a result of
having previously obtained shareholder approval. A "Control Share Acquisition"
means the acquisition of Control Shares, subject to certain exceptions. Since
RAI can hold no more than 15% of the Common Shares, its shares would not be
deemed to be Control Shares under the MGCL.
A person who has made or proposes to make a Control Share Acquisition,
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Trustees to call a special meeting of
shareholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the Company may itself
present the question at any shareholders' meeting.
If voting rights are not approved at the shareholders' meeting or if the
acquiring person does not deliver an acquiring person statement as required by
the MGCL, then, subject to certain conditions and limitations, the Company may
redeem any or all of the Control Shares (except those for which voting rights
have previously been approved) for fair value determined, without regard to the
absence of voting rights for the Control Shares, as of the date of the last
Control Share Acquisition by the acquiror or of any meeting of shareholders at
which the voting rights of such shares are considered and not approved. If
voting rights for Control Shares are approved at a shareholders' meeting and
the acquiror becomes entitled to vote a majority of the shares entitled to
vote, all other shareholders may exercise appraisal rights. The fair value of
the shares as determined for purposes of such
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appraisal rights may not be less than the highest price per share paid by the
acquiror in the Control Share Acquisition. The Control Share Acquisition
statute does not apply to shares acquired in a merger, consolidation or share
exchange if the Company is a party to the transaction or to acquisitions
approved or exempted by the Declaration of Trust or Bylaws. Under the MGCL the
Company may "opt out" of the control share provisions. The Bylaws of the
Company contain a provision exempting from the Control Share Acquisition
statute any and all acquisitions by any person of the Company's Common or
Preferred Shares. There can be no assurance that such provision will not be
amended or eliminated at any time in the future.
Amendment of Declaration of Trust and Bylaws
The Company's Declaration of Trust may not be amended without the
affirmative vote of at least a majority of the shares entitled to vote on the
matter except that the sections of the Declaration of Trust relating to the
trustees, the Ownership Limitation, amendments to the Declaration of Trust and
the duration and termination of the Company may not be amended without the
affirmative vote of two-thirds of the shares entitled to vote on the matter. In
addition, the Declaration of Trust may be amended by a two-thirds vote of the
Board of Trustees, without any action by the shareholders of the Company, to
allow the Company to qualify, or continue its qualification, as a REIT under
the Code or Maryland law and, by a majority vote of the Board of Trustees, to
increase or decrease the aggregate number of shares of beneficial interest or
the number of shares of any class of shares of beneficial interest that the
Company has the authority to issue. See "Description of Shares of Beneficial
Interest -- Common Shares." The Company's Bylaws may be amended or altered only
by the Board of Trustees.
Meetings of Shareholders
The Company's Declaration of Trust provides for annual meetings of
shareholders, commencing in 1998, to elect the Board of Trustees and transact
such other business as may properly be brought before the meeting. Special
meetings of shareholders may be called by the Chairman, the Chief Executive
Officer, the President or the Board of Trustees and shall be called at the
request in writing of the holders of 50% or more of the outstanding shares
entitled to vote.
Advance Notice of Trustees' Nominations and New Business
The Company's Declaration of Trust provides that (i) with respect to any
meeting of shareholders, the nomination of persons for election to the Board of
Trustees and the proposal of business to be considered by shareholders may be
made only (a) by the Board of Trustees or (b) by a shareholder who is entitled
to vote at the meeting and has complied with the advance notice procedures set
forth in the Bylaws, and (ii) with respect to a special meeting of
shareholders, only the business specified in the Company's notice of meeting
may be brought before the meeting.
Dissolution of the Company
Pursuant to the Company's Declaration of Trust, and subject to any
restrictions imposed by the terms of any class or series of shares of
beneficial interest of the Company then outstanding, the shareholders of the
Company may dissolve the Company by the affirmative vote of the holders of
two-thirds of all of the votes entitled to be cast on the matter.
Indemnification; Limitation of Trustees' and Officers' Liability
Maryland law permits a Maryland REIT to include in its declaration of
trust, and the Company's Declaration of Trust includes, a provision limiting
the liability of its trustees and officers to the trust and its shareholders
for money damages except for liability resulting from (a) actual receipt of an
improper benefit or profit in money, property or services or (b) a final
judgment based upon a finding of active and deliberate dishonesty by the
Trustee that was material to the cause of action adjudicated.
The Declaration of Trust authorizes the Company, to the maximum extent
permitted by Maryland law, to obligate itself to indemnify and to pay or
reimburse reasonable expenses in advance of final disposition of a proceeding
to (a) any present or former shareholder, trustee or officer or (b) any
individual who, while a trustee of
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the Company and at the request of the Company, serves or has served another
corporation, partnership, joint venture, trust, employee benefit plan or any
other enterprise as a trustee, director, officer, partner or otherwise, from
and against any claim or liability to which such person may become subject or
which such person may incur by reason thereof. The Bylaws require the Company
to indemnify each trustee or officer who has been successful, on the merits or
otherwise, in the defense of any proceeding to which he is made a party by
reason of his service in the foregoing capacities.
Maryland law permits a Maryland REIT to indemnify and advance expenses to
its trustees, officers, employees and agents to the same extent as permitted by
the MGCL for directors and officers of Maryland corporations. The MGCL permits
a corporation to indemnify its present and former directors and officers, among
others, against judgments, penalties, fines, settlements and reasonable
expenses actually incurred by them in connection with any proceeding to which
they may be made a party by reason of their service in those or other
capacities unless it is established that (a) the act or omission of the
director or officer was material to the matter giving rise to the proceeding
and (i) was committed in bad faith or (ii) was the result of active and
deliberate dishonesty, (b) the director or officer actually received an
improper personal benefit in money, property or services or (c) in the case of
any criminal proceeding, the director or officer had reasonable cause to
believe that the act or omission was unlawful. However, a Maryland corporation
may not indemnify for an adverse judgment in a suit by or in the right of the
corporation. In accordance with the MGCL, the Bylaws of the Company require it,
as a condition to advancing expenses, to obtain (i) a written affirmation by
the trustee or officer of his good faith belief that he has met the standard of
conduct necessary for indemnification by the Company as authorized by the
Bylaws and (ii) a written statement by or on his behalf to repay the amount
paid or reimbursed by the Company if it shall ultimately be determined that the
standard of conduct was not met.
Indemnification Agreements
The Company will enter into indemnification agreements with each of its
officers and trustees. The indemnification agreements will require, among other
matters, that the Company indemnify its officers and trustees to the fullest
extent permitted by law and advance to the officers and trustees all related
expenses, subject to reimbursement if it is subsequently determined that
indemnification is not permitted. Under the agreements, the Company must also
indemnify and advance all expenses incurred by officers and trustees seeking to
enforce their rights under the indemnification agreements and may cover
officers and trustees under any trustees' and officers' liability insurance.
Although the form of indemnification agreement offers substantially the same
scope of coverage afforded by the Declaration of Trust, Bylaws and applicable
Maryland law, it provides greater assurance to trustees and officers that
indemnification will be available, because, as a contract, it cannot be
modified unilaterally in the future by the Board of Trustees or the
shareholders to eliminate the rights it provides.
Possible Anti-takeover Effect of Certain Provisions of Maryland Law and of
Declaration of Trust and Bylaws
The provisions of the Declaration of Trust regarding the removal of
Trustees and the restrictions on the transfer of shares, and the advance notice
provisions of the Bylaws, could have the effect of delaying, deferring or
preventing a transaction or a change in control of the Company that might
involve a premium price for holders of Common Shares or that they otherwise may
believe to be desirable. Also, if the resolution of the Board of Trustees
opting out of the business combination statute or the provisions of the Bylaws
electing not to be governed by the control share acquisition statute are
rescinded, such statutes could have a similar effect.
Maryland Asset Requirements
To maintain its qualification as a Maryland real estate investment trust,
Maryland law requires at least 75% of the value of the Company's assets to be
held, directly or through other entities, in real estate assets, mortgages or
mortgage related securities, government securities, cash and cash equivalent
items, including high-grade short term securities and receivables. Maryland law
also prohibits the Company from using or applying land for farming,
agricultural, horticultural or similar purposes.
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COMMON SHARES AVAILABLE FOR FUTURE SALE
Upon the completion of the Offering, the Company will have outstanding
3,333,434 Common Shares (3,758,434 Common Shares if the Underwriters exercise
their over-allotment option). Of the outstanding shares, 2,708,334 (3,133,334
if the Underwriters exercise their over-allotment option) will be freely
tradeable without restriction or further registration under the Securities Act
unless purchased by "affiliates" of the Company as that term is defined in Rule
144 under the Securities Act. Of the remaining shares, 125,000 shares will
become eligible for future sale commencing 180 days following conclusion of the
Offering (the date of the expiration of the period the holders of these shares
will agree with the Underwriters not to offer, sell or otherwise dispose of
their shares).
Common Shares issued to holders of units of limited partnership interest
in the Operating Partnership ("Units") upon exercise of the Redemption Rights
(see "Operating Partnership Agreement -- Redemption Rights") will be
"restricted" securities under the meaning of Rule 144 promulgated under the
Securities Act ("Rule 144") and may not be sold in the absence of registration
under the Securities Act unless an exemption from registration is available,
including exemptions contained in Rule 144.
In general, under Rule 144 as currently in effect, if one year has elapsed
since the later of the date of acquisition of restricted shares from the
Company or any "affiliate" of the Company, as that term is defined under the
Securities Act, the acquiror or subsequent holder thereof is entitled to sell
within any three-month period a number of shares that does not exceed the
greater of 1% of the then outstanding Common Shares or the average weekly
trading volume of the Common Shares during the four calendar weeks preceding
the date on which notice of the sale is filed with the Commission. Sales under
Rule 144 also are subject to certain manner of sale provisions, notice
requirements and the availability of current public information about the
Company. If two years have elapsed since the date of acquisition of restricted
shares from the Company or from any affiliate of the Company, and the acquiror
or subsequent holder thereof is deemed not to have been an affiliate of the
Company at any time during the three months preceding a sale, such person would
be entitled to sell such shares in the public market under Rule 144(k) without
regard to the volume limitations, manner of sale provisions, public information
requirements or notice requirements.
Additionally, upon the conclusion of this Offering, there will be
outstanding warrants and options that will be granted at the initial public
offering price to the Representative and to executive officers, directors and
employees of the Company, none of which will be exercisable until one year from
the date of grant. The number of shares to be subject to such warrants and
options will be 529,167 shares.
No prediction can be made as to the effect, if any, that future sales of
Common Shares, or the availability of Common Shares for future sale, will have
on the market price prevailing from time to time. Sales of substantial amounts
of Common Shares, or the perception that such sales could occur, may affect
adversely prevailing market prices of the Common Shares.
OPERATING PARTNERSHIP AGREEMENT
The Operating Partnership has been organized as a Delaware limited
partnership, the general partner of which is RAIT General, Inc., and the
initial limited partner of which is RAIT Limited, Inc., each of which is a
wholly-owned subsidiary of RAIT. Because RAIT indirectly owns 100% of the
partnership interests in the Operating Partnership, the Operating Partnership
will be disregarded as a separate entity from RAIT for federal income tax
purposes until a third party is admitted as a partner of the Operating
Partnership. The Company organized the Operating Partnership in order to
provide future sellers of assets with the opportunity to transfer those assets
to the Company in a tax-deferred exchange.
General
Pursuant to the Operating Partnership Agreement, the General Partner, as
the sole general partner of the Operating Partnership, will have full,
exclusive and complete responsibility and discretion in the management and
control of the Operating Partnership. The limited partners of the operating
partnership (the "Limited Partners") will have no authority in their capacity
as Limited Partners to transact business for, or participate in the
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management activities or decisions of, the Operating Partnership except as
required by applicable law. Consequently, RAIT, as a result of its ownership of
the General Partner, will control the assets and business of the Operating
Partnership. However, any amendment to the Operating Partnership Agreement that
would (i) convert a Limited Partner's interest in the Operating Partnership
into a General Partner interest; (ii) increase the liability of a Limited
Partner under the Operating Partnership Agreement; (iii) alter a Partner's
rights to distributions; (iv) alter or modify any aspect of a Partners' rights
with respect to redemption of his interest; (v) cause the early termination of
the Operating Partnership (other than as set forth in the Operating Partnership
Agreement) or (vi) modify the provisions of the Operating Partnership Agreement
addressing amendments thereto, will require the consent of the Limited Partners
affected thereby.
General Partner Not to Withdraw
The General Partner may not voluntarily withdraw from the Operating
Partnership or transfer or assign its interest in the Operating Partnership.
Upon the involuntary withdrawal of the General Partner, the Operating
Partnership will dissolve unless, within ninety days after such involuntary
withdrawal, a majority in interest of the remaining Partners agree in writing
to the continuation of the Partnership and the appointment of a successor
General Partner.
Capital Contribution
RAIT will contribute, through the General Partner and the Initial Limited
Partner, all of the net proceeds of the Offering to the Operating Partnership.
The General Partner will hold a 1% general partnership interest in the
Operating Partnership, and the Initial Limited Partner will hold a 99% limited
partnership interest in the Operating Partnership.
After the completion of the Offering, RAIT will have issued a total of
3,333,434 Common Shares (3,758,434 shares if the Underwriters exercise their
over-allotment option) and will own, through the General Partner and the
Initial Limited Partner, 100% of the Units in the Operating Partnership.
Although the Operating Partnership will receive the net proceeds of the
Offering, the Initial Limited Partner and the General Partner will be deemed to
have made a capital contribution to the Operating Partnership in the aggregate
amount of the gross proceeds of the Offering and the Operating Partnership will
be deemed simultaneously to have paid the underwriter's discount and other
expenses paid or incurred in connection with the Offering.
It is anticipated that the Operating Partnership Agreement will provide
that if the Operating Partnership requires additional funds at any time or from
time to time in excess of funds available to the Operating Partnership from
borrowing or capital contributions, the General Partner may borrow such funds
from a financial institution or other lender and lend such funds to the
Operating Partnership on the same terms and conditions as are applicable to the
General Partner's borrowing of such funds. Moreover, the Operating Partnership
Agreement authorizes the General Partner to cause the Operating Partnership to
issue Units for less than fair market value if the Company has concluded in
good faith that such issuance is in the best interest of the Company and the
Operating Partnership. Under the Operating Partnership Agreement, each of the
General Partner and the Initial Limited Partner is obligated to contribute the
net proceeds of any future share offering by RAIT as additional capital to the
Operating Partnership in exchange for additional Units. Upon such contribution,
the General Partner's and the Initial Limited Partner's percentage interests in
the Operating Partnership would be increased on a proportionate basis based
upon the amount of such additional capital contributions. The percentage
interest of the Limited Partners (other than the Initial Limited Partner) would
be decreased on a proportionate basis in the event of additional capital
contributions by the General Partner and the Initial Limited Partner. In
addition, if the General Partner and the Initial Limited Partner were to
contribute additional capital to the Operating Partnership, the General Partner
would revalue the property of the Operating Partnership to its fair market
value (as determined by the General Partner) and the capital accounts of the
Partners would be adjusted to reflect the manner in which the unrealized gain
or loss inherent in such property (that has not been reflected in the capital
accounts previously) would be allocated among the partners under the terms of
the Operating Partnership Agreement as if there were a taxable disposition of
such property for such fair market value on the date of the revaluation.
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Redemption Rights
Limited Partners (other than the Initial Limited Partner) have the right
(the "Redemption Right") to cause the Operating Partnership to redeem their
Units. Redemptions may be either for cash or, at the election of the General
Partner, for Common Shares on the basis of one Common Share for each Unit
redeemed. Notwithstanding the right of the General Partner to redeem Units for
Common Shares, the redemption price will be paid in cash in the event that the
issuance of Common Shares to the redeeming Limited Partner would (i) result in
any person owning, directly or indirectly, Common Shares in excess of the
Ownership Limitation, (ii) result in capital shares of the Company being owned
by fewer than 100 persons (determined without reference to any rules of
attribution), (iii) result in the Company being "closely held" within the
meaning of section 856(h) of the Code, (iv) cause the Company to own, actually
or constructively, 10% or more of the ownership interests in a tenant of the
Company's or the Operating Partnership's real property, within the meaning of
section 856(d)(2)(B) of the Code, or (v) cause the acquisition of Common Shares
by such redeeming Limited Partner to be "integrated" with any other
distribution of Common Shares for purposes of complying with the Securities
Act.
Operations
The Operating Partnership Agreement requires that the Operating
Partnership be operated in a manner that will enable RAIT to satisfy the
requirements for being classified as a REIT for federal tax purposes, to avoid
any federal income or excise tax liability imposed by the Code, and to ensure
that the Operating Partnership will be not classified as a "publicly traded
partnership" for purposes of section 7704 of the Code.
In addition to the administrative and operating costs and expenses
incurred by the Operating Partnership, the Operating Partnership will pay all
general, operating and administrative expenses of the Company, the General
Partner and the Initial Limited Partner (collectively, the "Company Expenses")
and the Company Expenses will be treated as expenses of the Operating
Partnership. The Company Expenses generally will include (i) all expenses
relating to the organization and continuation of the Company, the General
Partner and the Initial Limited Partner, (ii) all expenses relating to the
public offering and registration of securities by the Company, (iii) all
expenses associated with the preparation and filing of any periodic reports by
the Company under federal, state or local laws or regulations, (iv) all
expenses associated with compliance by the Company, the General Partner and the
Initial Limited Partner with laws, rules and regulations promulgated by any
regulatory body and (v) all other general, operating and administrative costs
of the Company, the General Partner and the Initial Limited Partner incurred in
the ordinary course of their business on behalf of the Operating Partnership.
Distributions
The Operating Partnership Agreement provides that the Operating
Partnership will distribute cash from operations (including net sale or
refinancing proceeds, but excluding net proceeds from the sale of the Operating
Partnership's property in connection with the liquidation of the Operating
Partnership) on a quarterly (or, at the election of the General Partner, more
frequent) basis, in amounts determined by the General Partner in its sole
discretion, to the partners in accordance with their respective percentage
interests in the Operating Partnership. Upon liquidation of the Operating
Partnership, after payment of, or adequate provision for, debts and obligations
of the Operating Partnership, including partner loans, it is anticipated that
any remaining assets of the Operating Partnership will be distributed to all
partners with positive capital accounts in accordance with their respective
positive capital account balances. If the General Partner has a negative
balance in its capital account following a liquidation of the Operating
Partnership, it will be obligated to contribute cash to the Operating
Partnership equal to the negative balance in its capital account.
Allocations
Income, gain and loss of the Operating Partnership for each fiscal year
generally will be allocated among the partners in accordance with their
respective interests in the Operating Partnership, subject to compliance with
the provisions of Code sections 702 and 704 and Treasury regulations ("Treasury
Regulations") promulgated thereunder.
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Term
The Operating Partnership shall continue until December 31, 2050, or until
sooner terminated as provided in the Operating Partnership Agreement or by
operation of law.
Tax Matters
Pursuant to the Operating Partnership Agreement, the General Partner is
the tax matters partner of the Operating Partnership and, as such, has
authority to handle tax audits and to make tax elections under the Code on
behalf of the Operating Partnership.
FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of Common Shares. Ledgewood Law
Firm, P.C. ("Counsel") has acted as counsel to the Company, has reviewed this
summary and has rendered an opinion that the descriptions of the law and the
legal conclusions contained herein are correct in all material respects, and
that the discussions hereunder fairly summarize the federal income tax
considerations that are likely to be material to the Company and a holder of
the Common Shares. This discussion does not purport to address all aspects of
taxation that may be relevant to particular shareholders (including insurance
companies, tax-exempt organizations (except to the extent discussed below),
financial institutions or broker-dealers and, except to the extent discussed
below, foreign corporations and persons who are not citizens or residents of
the United States) subject to special treatment under the federal income tax
laws.
The statements in this discussion and the opinion of Counsel are based on
current provisions of the Code, existing, temporary and currently proposed
Treasury Regulations promulgated under the Code, the legislative history of the
Code, existing administrative rulings and practices of the Services, and
judicial decisions. No assurance can be given that future legislative, judicial
or administrative actions or decisions, which may be retroactive in effect,
will not affect the accuracy of any statements in this Prospectus with respect
to the transactions entered into or contemplated prior to the effective date of
such changes.
EACH PROSPECTIVE PURCHASER SHOULD CONSULT HIS OR HER OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OR HER OF THE PURCHASE,
OWNERSHIP AND SALE OF THE COMMON SHARES AND OF RAIT'S ELECTION TO BE TAXED AS A
REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES
OF SUCH PURCHASE, OWNERSHIP, SALE AND ELECTION, AND OF POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
Taxation of RAIT
RAIT plans to make an election to be taxed as a REIT under Sections 856
through 860 of the Code, commencing with its taxable year ending December 31,
1997. RAIT will be organized and has represented that it will operate in such a
manner as to qualify for taxation as a REIT under the Code, but no assurance
can be given that RAIT actually will operate in a manner so as to qualify or
remain qualified as a REIT.
The sections of the Code and the corresponding Treasury Regulations
relating to qualification and operation as a REIT are highly technical and
complex. The following discussion sets forth the material aspects of the Code
sections that govern the federal income tax treatment of a REIT and its
shareholders. The discussion is qualified in its entirety by the applicable
Code provisions, Treasury Regulations promulgated thereunder, and
administrative and judicial interpretations thereof, all of which are subject
to change prospectively or retroactively.
Counsel has acted as counsel to RAIT in connection with the Offering and
RAIT's election to be taxed as a REIT. In the opinion of Counsel, assuming that
the elections and other procedural steps described in this discussion are
completed by RAIT in a timely fashion, RAIT will qualify to be taxed as a REIT
under the Code, and RAIT's organization and proposed method of operation will
enable it to continue to meet the requirements for qualification and taxation
as a REIT under the Code. Investors should be aware, however, that opinions of
counsel are not binding upon the Service or any court. It must be emphasized
that Counsel's opinion is based
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on various assumptions and is conditioned upon certain representations made by
the Company as to factual matters, including representations regarding its
business, assets and future operations, as set forth below in this discussion.
Moreover, such qualification and taxation as a REIT depends upon RAIT's ability
to meet on a continuing basis, through actual annual operating results,
distribution levels, and diversity of share ownership, the various
qualification tests imposed under the Code discussed below, the results of
which will not be reviewed by Counsel. Accordingly, no assurance can be given
that the actual results of RAIT's operations for any particular taxable year
will satisfy such requirements. For a discussion of the tax consequences of
failure to qualify as a REIT, see "Federal Income Tax Considerations -- Failure
to Qualify."
If RAIT qualifies for taxation as a REIT, it generally will not be subject
to federal corporate income tax on its net income that is distributed currently
to its shareholders. That treatment substantially eliminates the "double
taxation" (i.e., taxation at both the corporate and shareholder levels) that
generally results from an investment in a regular corporation. However, RAIT
will be subject to federal income tax in the following circumstances. First,
RAIT will be taxed at regular corporate rates on any undistributed REIT taxable
income, including undistributed net capital gains. Second, under certain
circumstances, RAIT may be subject to the "alternative minimum tax" on its
undistributed items of tax preference, if any. Third, if RAIT has (i) net
income from the sale or other disposition of "foreclosure property" (defined
generally as property acquired by RAIT through foreclosure or otherwise after a
default on a loan secured by the property or a lease of the property; see
"Federal Income Tax Considerations -- Requirements for Qualification -- Income
Tests") that is held primarily for sale to customers in the ordinary course of
business or (ii) other nonqualifying income from foreclosure property, it will
be subject to tax at the highest corporate rate on such income. Fourth, if RAIT
has net income from prohibited transactions (which are, in general, certain
sales or other dispositions of property (other than foreclosure property or
property that has been involuntarily converted) held primarily for sale to
customers in the ordinary course of business), such income will be subject to a
100% tax. Fifth, if RAIT should fail to satisfy the 75% gross income test or
the 95% gross income test (as discussed below), and nonetheless has maintained
its qualification as a REIT because certain other requirements have been met,
it will be subject to a 100% tax on an amount equal to (i) the gross income
attributable to the greater of the amount by which RAIT fails the 75% or 95%
gross income test, multiplied by (ii) a fraction intended to reflect RAIT's
profitability. Sixth, if RAIT should fail to distribute during each calendar
year at least the sum of (i) 85% of its REIT ordinary income for such year,
(ii) 95% of its REIT capital gain net income for such year, and (iii) any
undistributed taxable income from prior periods, RAIT would be subject to a 4%
excise tax on the excess of such required distribution over the amounts
actually distributed. Seventh, RAIT may elect to retain and pay income tax on
its net long-term capital gains. Finally, if RAIT acquires any asset from a C
corporation (i.e., a corporation generally subject to full corporate-level tax)
in a merger or other transaction in which the basis of the asset in RAIT's
hands is determined by reference to the basis of the asset (or any other asset)
in the hands of the C corporation and RAIT recognizes gain on the disposition
of such asset during the 10-year period beginning on the date on which it
acquired such asset, then to the extent of such asset's "built-in-gain" (i.e.,
the excess of the fair market value of such asset at the time of acquisition by
RAIT over the adjusted basis in such asset at such time), RAIT will be subject
to tax at the highest regular corporate rate applicable (as provided in
Treasury Regulations that have not yet been promulgated). The results described
above with respect to the tax on "built-in-gain" assume that RAIT will elect
pursuant to IRS Notice 88-19 to be subject to the rules described in the
preceding sentence if it were to make any such acquisition.
Requirements for Qualification
The Code defines a REIT as a corporation, trust or association (i) that is
managed by one or more trustees or directors, (ii) the beneficial ownership of
which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year other than its
first taxable year (the "5/50 Rule"); (vii) that makes an election to be a REIT
(or has made such election for a previous taxable year) and satisfies all
relevant filing and other administrative requirements established by the
Service that must be met in order to elect and maintain REIT status; (viii)
that uses a calendar year for federal
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income tax purposes and complies with the recordkeeping requirements of the
Code and Treasury Regulations promulgated thereunder; and (ix) that meets
certain other tests, described below, regarding the nature of its income and
assets. The Code provides that conditions (i) to (iv), inclusive, must be met
during the entire taxable year and that condition (v) must be met during at
least 335 days of a taxable year of 12 months, or during a proportionate part
of a taxable year of less than 12 months. Conditions (v) and (vi) will not
apply until after the first taxable year for which an election is made by RAIT
to be taxed as a REIT. For purposes of determining share ownership under the
5/50 Rule, a supplemental unemployment compensation benefits plan, a private
foundation, or a portion of a trust permanently set aside or used exclusively
for charitable purposes generally is considered an individual. A trust that is
a qualified trust under Code section 401(a), however, generally is not
considered an individual and beneficiaries of such trust are treated as holding
shares of a REIT in proportion to their actuarial interests in such trust for
purposes of the 5/50 Rule. In addition, a REIT that (i) complies with certain
Treasury regulations discussed in "Federal Income Tax Considerations --
Requirements for Qualification -- Recordkeeping Requirements" and (ii) does not
know, or have reason to know, that it is closely held so as to violate the 5/50
Rule, is treated as having satisfied the 5/50 Rule.
Prior to the consummation of the Offering, RAIT will not satisfy
conditions (v) and (vi) in the preceding paragraph. RAIT anticipates issuing
sufficient Common Shares with sufficient diversity of ownership pursuant to the
Offering to allow it to satisfy the share ownership requirements described in
clauses (v) and (vi) above. In addition, RAIT's Declaration of Trust provides
for restrictions regarding the transfer of the Common Shares that are intended
to assist RAIT in continuing to satisfy the share ownership requirements
described in clauses (v) and (vi) above. See "Description of Shares of
Beneficial Interest -- Restrictions on Ownership and Transfer." These
restrictions, however, may not ensure that RAIT will, in all cases, be able to
satisfy the share ownership requirements described above. Failure to do so will
result in termination of RAIT's status as a REIT. See "Federal Income Tax
Considerations -- Failure to Qualify."
RAIT currently has two corporate subsidiaries, the General Partner and the
Initial Limited Partner, and may have additional corporate subsidiaries in the
future. Code section 856(i) provides that a corporation that is a "qualified
REIT subsidiary" shall not be treated as a separate corporation, and all
assets, liabilities and items of income, deduction and credit of a "qualified
REIT subsidiary" shall be treated as assets, liabilities and items of income,
deduction and credit of the REIT. A "qualified REIT subsidiary" is a
corporation, all of the capital stock of which is owned by the REIT. Thus, in
applying the requirements described herein, any "qualified REIT subsidiaries"
of RAIT will be ignored, and all assets, liabilities and items of income,
deduction and credit of such "qualified REIT subsidiaries" will be treated as
assets, liabilities and items of income, deduction and credit of RAIT. The
General Partner and the Initial Limited Partner are "qualified REIT
subsidiaries." Accordingly, the General Partner and the Initial Limited Partner
will not be subject to federal income taxation, although they may be subject to
state and local taxation.
Pursuant to Treasury Regulations relating to entity classification (the
"Check-the-Box Regulations"), an unincorporated entity that has a single owner
is disregarded as an entity separate from its owner for federal income tax
purposes. Because RAIT will be deemed to own 100% of the partnership interests
in the Operating Partnership for federal income tax purposes, the Operating
Partnership will be disregarded as an entity separate from RAIT under the
Check-the- Box Regulations during the period when its only partners are the
General Partner and the Initial Limited Partner.
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT for purposes of section 856 of the Code, including satisfying the
gross income and asset tests described below. When the Operating Partnership
admits a partner other than RAIT or a qualified REIT subsidiary of RAIT, a
proportionate share of the assets and gross income of the Operating Partnership
will be treated as assets and gross income of RAIT for purposes of applying the
requirements described herein.
Income Tests
In order for RAIT to qualify and to maintain its qualification as a REIT,
two requirements relating to RAIT's gross income must be satisfied annually.
First, at least 75% of RAIT's gross income (excluding gross income from
prohibited transactions) for each taxable year must consist of defined types of
income derived
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directly or indirectly from investments relating to real property or mortgages
on real property (including "rents from real property" and interest on
obligations secured by mortgages on real property or on interests in real
property) or temporary investment income. Second, at least 95% of RAIT's gross
income (excluding gross income from prohibited transactions) for each taxable
year must be derived from such real property, mortgages on real property, or
temporary investments, and from dividends, other types of interest, hedges that
reduce the interest rate risk of RAIT's liabilities, and gain from the sale or
disposition of stock or securities, or from any combination of the foregoing.
Income deriving from origination fees does not qualify for inclusion under
either such test; see "Risk Factors -- Legal and Tax Risks -- Origination Fees
Which May Be Received by the Company Will Not Be REIT Qualifying Income". The
specific application of these tests to the Company is discussed below.
There may be circumstances in which the principal amount of mortgages on a
property exceed its fair market value. In such a situation, the Service may
contend that the lender is actually the owner of the property for tax purposes.
Since RAIT may acquire loans the face amount of which exceeds the fair market
value of the underlying property, such recharacterization may occur although
the existence of a forbearance or other workout arrangement would make it less
likely. If RAIT is found to be the owner of real property rather than a
mortgagee, its income would consist of the rent from the property rather than
interest on the debt. RAIT would generally be entitled to deductions for
operating expenses of the property as well as for depreciation. Consequently,
as long as the rent qualifies as "rents from real property," it is unlikely
that such recharacterization would adversely affect RAIT's qualification under
the asset tests, income tests or distribution requirements, except as discussed
below.
The term "interest," as defined for purposes of the 75% and 95% gross
income tests, generally does not include any amount received or accrued
(directly or indirectly) if the determination of such amount depends in whole
or in part on the income or profits of any person. However, an amount received
or accrued generally will not be excluded from the term "interest" solely by
reason of being based on a fixed percentage or percentages of receipts or
sales. In addition, an amount received or accrued generally will not be
excluded from the term "interest" solely by reason of being based on the income
or profits of a debtor if the debtor derives substantially all of its gross
income from the related property through the leasing of substantially all of
its interests in the property, to the extent the amounts received by the debtor
would be characterized as rents from real property if received by a REIT.
Furthermore, to the extent that interest from a loan that is based on the cash
proceeds from the sale of the property securing the loan constitutes a "shared
appreciation provision" (as defined in the Code), income attributable to such
participation feature will be treated as gain from the sale of the secured
property, which generally is qualifying income for purposes of the 75% and 95%
gross income tests. In addition, if RAIT receives interest income with respect
to a mortgage loan that is secured by both real property and other property and
the highest principal amount of the loan outstanding during the taxable year
exceeds the fair market value of the real property on the date RAIT purchased
the mortgage loan, the interest income will be apportioned between the real
property and the other property, which apportionment may cause RAIT to
recognize income that is not qualifying income for purposes of the 75% gross
income test.
Counsel is of the opinion that the interest, OID and market discount
income that RAIT derives from its investments in loans generally will be
qualifying interest income for purposes of both the 75% and 95% gross income
tests. In some cases, however, the highest principal amount of a loan
outstanding during the taxable year may exceed the fair market value of the
real property securing the loan as of the time that the loan was acquired,
which will result in a portion of the income from the loan being classified as
qualifying income for purposes of the 95% gross income test, but not for
purposes of the 75% gross income test. It is also possible that, in some
instances, the interest income from a loan may be based in part on the
borrower's profits or net income, which generally will disqualify the income
from the loan for purposes of both the 75% and 95% gross income tests. In
addition, it is contemplated that RAIT may purchase and originate wraparound or
similar loans that are only indirectly secured by real estate. In situations
where a senior loan prevents a junior lender from recording a mortgage against
the property (or otherwise substantially restricts the junior lender from
exercising its rights as a junior secured lender), a junior note held by RAIT
may be collateralized by an unrecorded mortgage, a deed-in-lieu of foreclosure,
a pledge of equity interests of the borrower, a purchase option or some other
arrangements that RAIT believes will enable it to obtain an interest in the
underlying property upon default. It is possible that the Service would
conclude that interest on such a note does not constitute interest "secured by
mortgages on
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real property or on interests in real property," so that such interest would
not qualify for purposes of the 75% gross income test. RAIT will take steps to
ensure that it will always have sufficient qualifying income to meet the 75%
and 95% gross income tests. With respect to the two wraparound loans included
as part of the Initial Investments, because the Company will have, upon any
default, foreclosure rights directly exercisable by the Company, Counsel is of
the opinion that interest income from such loans will constitute qualifying
income.
In the case of wraparound loans made or acquired by a REIT, there is
authority for the position that only the interest attributable to the amounts
advanced by the REIT (or the person from whom it acquired the wraparound loan)
will constitute income to it. Under this interpretation, amounts received by
the REIT from the borrower that are used to pay debt service on the underlying
senior debt would be treated as having been paid directly by the borrower to
the senior lender and thus excluded from the REIT's gross income. The effect
would be to reduce the amount of the REIT's gross income for purposes of the
75% and 95% gross income tests.
RAIT may originate or acquire mortgage loans that have shared appreciation
provisions. RAIT may be required to recognize income from a shared appreciation
provision over the term of the related loan using the constant yield method
pursuant to certain Treasury Regulations. This method generally will result in
RAIT recognizing at least some taxable income in advance of the related cash
flow.
RAIT may receive income not described above that is not qualifying income
for purposes of the 75% and 95% gross income tests. For example, certain fees
for services which may be rendered by RAIT will not be qualifying income for
purposes of the gross income tests. It is not anticipated that RAIT will
receive a significant amount of such fees. RAIT will monitor the amount of
nonqualifying income produced by its assets and has represented that it will
manage its portfolio in order to comply at all times with the gross income
tests.
The rent received by RAIT from the tenants of its real properties will
qualify as "rents from real property" in satisfying the gross income tests for
a REIT described above only if several conditions are met. First, the amount of
rent must not be based, in whole or in part, on the income or profits of any
person. However, an amount received or accrued generally will not be excluded
from the term "rents from real property" solely by reason of being based on a
fixed percentage or percentages of receipts or sales. Second, the Code provides
that rents received from a tenant will not qualify as "rents from real
property" in satisfying the gross income tests if RAIT, or a direct or indirect
owner of 10% or more of RAIT, owns 10% or more of such tenant, taking into
account both direct and constructive ownership (under constructive ownership
rules found in Section 856(d)(5) of the Code, as modified by the 1997 tax law)
(a "Related Party Tenant"). Third, if rent attributable to personal property,
leased in connection with a lease of real property, is greater than 15% of the
total rent received under the lease, then the portion of rent attributable to
such personal property will not qualify as "rents from real property." Finally,
for rents received to qualify as "rents from real property," RAIT generally
must not operate or manage the real property or furnish or render services to
the tenants of such real property other than through an "independent
contractor" who is adequately compensated and from whom RAIT derives no
revenue. The "independent contractor" requirement, however, does not apply to
the extent the services provided by RAIT are "usually or customarily rendered"
in connection with the rental of space for occupancy only and are not otherwise
considered "rendered to the occupant." Moreover, RAIT may render a de minimis
amount (no more than 1% of the gross income from a property) of otherwise
impermissible services to tenants or in connection with the management of such
property, while still treating amounts received with respect to such property
(other than amounts attributable to such services) as rent. For these purposes,
the services may not be valued at less than 150% of RAIT's direct costs for the
services.
RAIT has represented that it will not charge rent for any portion of any
Property Interest that is based, in whole or in part, on the income or profits
of any person (except by reason of being based on a fixed percentage or
percentages of receipts of sales, as described above) to the extent that the
receipt of such rent would jeopardize RAIT's status as a REIT. In addition,
RAIT has represented that, to the extent that it receives rent from a Related
Party Tenant, such rent will not cause RAIT to fail to satisfy either the 75%
or 95% gross income test. RAIT also has represented that it will not allow the
rent attributable to personal property leased in connection with any lease of
real property to exceed 15% of the total rent received under the lease, if the
receipt of such rent would cause RAIT to fail to satisfy either the 75% or 95%
gross income test. Finally, RAIT has represented that it will not operate or
manage its Property Interests or furnish or render noncustomary services to the
tenants of its Property Interests other than through an "independent
contractor," to the extent that such operation or the provision of such
services would jeopardize RAIT's status as a REIT.
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REITs generally are subject to tax at the maximum corporate rate on any
income from foreclosure property (other than income that would be qualifying
income for purposes of the 75% gross income test), less expenses directly
connected with the production of such income. "Foreclosure property" is defined
as any real property (including interests in real property) and any personal
property incident to such real property (i) that is acquired by a REIT as the
result of such REIT having bid in such property at foreclosure, or having
otherwise reduced such property to ownership or possession by agreement or
process of law, after there was a default (or default was imminent) on a lease
of such property or on an indebtedness owed to the REIT that such property
secured, (ii) for which the related loan was acquired by the REIT at a time
when default was not imminent or anticipated, and (iii) for which the REIT
makes a proper election to treat the property as foreclosure property. A
property generally may be treated as foreclosure property until the last day of
the third full taxable year following the election, although the IRS may grant
one extension of the period for treating the property as foreclosure property
if RAIT establishes that an extension is necessary for the orderly liquidation
of RAIT's interest in the property. Such extension may not extend the treatment
as foreclosure property beyond six years from the date the property is acquired
by RAIT. RAIT does not anticipate that it will receive any income from
foreclosure property that is not qualifying income for purposes of the 75%
gross income test, but, if RAIT does receive any such income, RAIT will make an
election to treat the related property as foreclosure property.
If property is not eligible for treatment as foreclosure property
("Ineligible Property") because the related loan was acquired by the REIT at a
time when default was imminent or anticipated, income received with respect to
such Ineligible Property may not be qualifying income for purposes of the 75%
or 95% gross income test. RAIT anticipates that any income it receives with
respect to Ineligible Property will be qualifying income for purposes of the
75% and 95% gross income tests.
The net income from a prohibited transaction is subject to a 100% tax. The
term "prohibited transaction" generally includes a sale or other disposition of
property (other than foreclosure property) that is held primarily for sale to
customers in the ordinary course of a trade or business. The Company believes
that no asset owned by RAIT will be held for sale to customers and that a sale
of any such asset will not be in the ordinary course of RAIT's business.
Whether an asset is held "primarily for sale to customers in the ordinary
course of a trade or business" depends, however, on the facts and circumstances
in effect from time to time, including those related to a particular asset.
Nevertheless, RAIT will attempt to comply with the terms of safe-harbor
provisions in the Code prescribing when asset sales will not be characterized
as prohibited transactions. Complete assurance cannot be given, however, that
RAIT can comply with the safe-harbor provisions of the Code or avoid owning
property that may be characterized as property held "primarily for sale to
customers in the ordinary course of a trade or business."
If RAIT fails to satisfy one or both of the 75% or 95% gross income tests
for any taxable year, it nevertheless may qualify as a REIT for such year if it
is entitled to relief under certain provisions of the Code. Those relief
provisions generally will be available if RAIT's failure to meet such tests is
due to reasonable cause and not due to willful neglect, RAIT attaches a
schedule of the sources of its income to its federal income tax return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances RAIT
would be entitled to the benefit of those relief provisions. As discussed above
in "Federal Income Tax Considerations -- Taxation of RAIT," even if those
relief provisions apply, a 100% tax would be imposed on an amount equal to (i)
the gross income attributable to the greater of the amount by which RAIT fails
the 75% or 95% gross income test, multiplied by (ii) a fraction intended to
reflect RAIT's profitability.
Asset Tests
At the close of each quarter of each taxable year, RAIT must satisfy two
tests relating to the nature of its assets. First, at least 75% of the value of
RAIT's total assets must be represented by cash or cash items (including
certain receivables), government securities, "real estate assets," or, in cases
where RAIT raises new capital through offerings of shares or long-term (at
least five-year) debt, temporary investments in stock or debt instruments
during the one-year period following RAIT's receipt of such capital. The term
"real estate assets" includes interests in real property, interests in
mortgages on real property to the extent the principal balance of a mortgage
does not exceed the fair market value of the associated real property, and
shares of other REITs. For purposes of the 75% asset test, the term "interest
in real property" includes an interest in mortgage loans or land
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and improvements thereon, such as buildings or other inherently permanent
structures (including items that are structural components of such buildings or
structures), a leasehold of real property, and an option to acquire real
property (or a leasehold of real property). To the extent that the fair market
value of the real property securing a mortgage loan equals or exceeds the
outstanding principal balance of the loan, the loan will qualify as a real
estate asset. However, if the outstanding principal balance of a mortgage loan
exceeds the fair market value of the real property securing the loan, such loan
may not be a qualifying real estate asset to the extent that the loan amount
exceeds the value of the associated real property, although the matter is not
free from doubt. An "interest in real property" also generally includes certain
interests in loans secured by controlling equity interests in entities treated
as partnerships for federal income tax purposes that own real property, to the
extent that the principal balances of the loans do not exceed the fair market
value of the real property that is allocable to the equity interest. Second, of
the investments not included in the 75% asset class, the value of any one
issuer's securities owned by RAIT may not exceed 5% of the value of RAIT's
total assets, and RAIT may not own more than 10% of any one issuer's
outstanding voting securities (except for its interests in the General and
Initial Limited Partners, the Operating Partnership, and any other qualified
REIT subsidiary).
RAIT expects that any loans, real properties and temporary investments
that it acquires generally will be qualifying assets for purposes of the 75%
asset test, except to the extent that the principal balance of any loan exceeds
the value of the associated real property, or to the extent the asset is a loan
that is not deemed to be an interest in real property. In the case of
wraparound loans, it is uncertain whether the entire wraparound mortgage amount
or only the amount of RAIT's investment that is in excess of the principal
amount of the underlying loans will be considered an asset of RAIT. RAIT will
monitor the status of the assets that it acquires for purposes of the various
asset tests and has represented that it will manage its portfolio in order to
comply at all times with such tests. If RAIT should fail to satisfy the asset
tests at the end of a calendar quarter, such a failure would not cause it to
lose its REIT status if (i) it satisfied the asset tests at the close of the
preceding calendar quarter and (ii) the discrepancy between the value of RAIT's
assets and the asset test requirements arose from changes in the market values
of its assets and was not wholly or partly caused by the acquisition of one or
more non-qualifying assets. If the condition described in clause (ii) of the
preceding sentence were not satisfied, RAIT still could avoid disqualification
by eliminating any discrepancy within 30 days after the close of the calendar
quarter in which it arose. RAIT intends to maintain accurate records of the
value of its assets to ensure compliance with the assets tests and to take such
other actions within 30 days after the close of any quarter as may be required
to cure any noncompliance.
Distribution Requirements
In order to qualify as a REIT, RAIT is required to distribute with respect
to each taxable year dividends (other than capital gain dividends and retained
capital gains) to its shareholders in an aggregate amount at least equal to (i)
the sum of (A) 95% of its "REIT taxable income" (computed without regard to the
dividends paid deduction and its net capital gain) and (B) 95% of the net
income (after tax), if any, from foreclosure property, minus (ii) the sum of
certain items of noncash income. Such distributions must be paid in the taxable
year to which they relate, or in the following taxable year if declared before
RAIT timely files its federal income tax return for such year and if paid on or
before the first regular dividend payment date after such declaration. To the
extent that RAIT does not distribute all of its net capital gain or distributes
at least 95%, but less than 100%, of its "REIT taxable income," as adjusted, it
will be subject to tax thereon at regular ordinary and capital gains corporate
tax rates (see "Federal Income Tax Considerations -- Taxation of Taxable U.S.
Shareholders Generally" for a discussion of an election RAIT may make to retain
and pay income tax on its net long-term capital gains, in which case it will be
deemed to have distributed such amount). Furthermore, if RAIT should fail to
distribute during each calendar year (or, in the case of a distribution with
declaration and record dates falling in the last three months of the calendar
year, by the end of the January immediately following such year) at least the
sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain income for such year, and (iii) any undistributed taxable income
from prior periods, RAIT would be subject to a 4% nondeductible excise tax on
the excess of such required distribution over the amounts actually distributed.
If RAIT makes the election to retain and pay income tax on its net long-term
capital gains (see "Federal Income Tax Considerations -- Taxation of Taxable
U.S. Shareholders Generally"), such amounts will be treated as distributed for
purposes of the 4% excise tax. RAIT intends to make timely distributions
sufficient to satisfy the annual distribution requirements.
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It is possible that, from time to time, RAIT may experience timing
differences between (i) the actual receipt of income and actual payment of
deductible expenses and (ii) the inclusion of that income and deduction of such
expenses in arriving at its REIT taxable income. For example, RAIT will
recognize taxable income in excess of its cash receipts when OID accrues with
respect to its loans. OID generally will be accrued using a constant yield
methodology that takes into account projected prepayments but that does not
allow credit losses to be reflected until they are actually incurred. Moreover,
pursuant to Treasury Regulations, RAIT may be required to recognize the amount
of any payment projected to be made pursuant to a participation provision in a
loan over the term of the loan using the constant yield method. In addition,
RAIT may recognize taxable market discount income upon the receipt of proceeds
from the disposition of, or principal payments on, loans that are "market
discount bonds" (i.e., obligations with a stated redemption price at maturity
that is greater than RAIT's tax basis in such obligations), although such
proceeds often will be used to make non-deductible principal payments on
related borrowings. RAIT also may be required to accrue interest at a rate
greater than the rate at which it is receiving interest with respect to
defaulted loans. RAIT may also recognize income in excess of cash receipts if
it makes wraparound loans where the payments of nondeductible principal it must
make on the underlying loans exceed the amount of nontaxable principal it is
receiving from the borrower. There is authority, however, for the position that
only the interest on the amount advanced by the wraparound lender is included
in the income of a REIT making such a loan; this would reduce or limit the
possibility of mismatching. It also is possible that, from time to time, RAIT
may recognize net capital gain attributable to the sale of depreciated property
that exceeds its cash receipts from the sale. RAIT also may recognize taxable
income without receiving a corresponding cash distribution if it forecloses on
or makes a "significant modification" (as defined in Regulations Section
1.1001-3(e)) to a loan, to the extent that the fair market value of the
underlying property or the principal amount of the modified loan, as
applicable, exceeds RAIT's basis in the original loan. Finally, capital losses
recognized by RAIT may not be deducted from its REIT taxable income. Therefore,
RAIT may have less cash than is necessary to meet its annual 95% distribution
requirement or, because OID is not taken into account in determining whether
RAIT satisfies the 95% distribution requirement, to distribute all of its
taxable income and thereby avoid corporate income tax or the excise tax imposed
on certain undistributed income. In such a situation, RAIT may find it
necessary to arrange for short-term (or possibly long-term) borrowings or to
raise funds through the issuance of Preferred Shares or additional Common
Shares.
Under certain circumstances, RAIT may be able to rectify a failure to meet
the distribution requirements for a year by paying "deficiency dividends" to
its shareholders in a later year, which may be included in RAIT's deduction for
dividends paid for the earlier year. Although RAIT may be able to avoid being
taxed on amounts distributed as deficiency dividends, it will be required to
pay to the Service interest based upon the amount of any deduction taken for
deficiency dividends.
Recordkeeping Requirements
Pursuant to applicable Treasury Regulations, RAIT must maintain certain
records and request on an annual basis certain information from its
shareholders designed to disclose the actual ownership of its outstanding
shares. Failure to request such information from shareholders in a taxable year
could subject RAIT to a penalty of $25,000 ($50,000 for intentional
violations).
Failure to Qualify
If RAIT fails to qualify for taxation as a REIT in any taxable year, and
the relief provisions do not apply, RAIT will be subject to tax (including any
applicable alternative minimum tax) on its taxable income at regular corporate
rates. Distributions to RAIT's shareholders in any year in which RAIT fails to
qualify will not be deductible by RAIT nor will they be required to be made. In
such event, to the extent of RAIT's current and accumulated earnings and
profits, all distributions to shareholders will be taxable as ordinary income
and, subject to certain limitations of the Code, corporate distributees may be
eligible for the dividends received deduction. Unless entitled to relief under
specific statutory provisions, RAIT also will be disqualified from taxation as
a REIT for the four taxable years following the year during which RAIT ceased
to qualify as a REIT. It is not possible to state whether in all circumstances
RAIT would be entitled to such statutory relief.
Taxation of Taxable U.S. Shareholders Generally
As long as RAIT qualifies as a REIT, distributions made to RAIT's taxable
U.S. shareholders out of current or accumulated earnings and profits (and not
designated as capital gain dividends) will be taken into account
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by such U.S. shareholders as ordinary income and will not be eligible for the
dividends received deduction generally available to corporations. As used
herein, the term "U.S. shareholder" means a holder of Common Shares that for
United States federal income tax purposes is (i) a citizen or resident of the
United States, (ii) a corporation, partnership, or other entity created or
organized in or under the laws of the United States or of any political
subdivision thereof, (iii) an estate whose income from sources without the
United States is includible in gross income for United States federal income
tax purposes regardless of its connection with the conduct of a trade or
business within the United States, or (iv) any trust with respect to which (A)
a United States court is able to exercise primary supervision over the
administration of such trust and (B) one or more United States fiduciaries have
the authority to control all substantial decisions of the trust. Distributions
that are designated as capital gain dividends will be taxed as long-term
capital gains (to the extent they do not exceed RAIT's actual net capital gain
for the taxable year) without regard to the period for which the shareholder
has held his Common Shares. However, corporate shareholders may be required to
treat up to 20% of certain capital gain dividends as ordinary income. RAIT may
elect to retain and pay income tax on net long-term capital gains it receives
during the taxable year. If RAIT makes this election, (i) its shareholders
would include in their income as long-term capital gains their proportionate
share of the undistributed long-term capital gains as designated by RAIT, (ii)
each shareholder would be deemed to have paid the shareholder's share of the
tax paid by RAIT, which would be credited or refunded to the shareholder, and
(iii) the basis of each shareholder's shares would be increased by the amount
of the undistributed long-term capital gains (less the amount of capital gains
tax paid by RAIT) included in the shareholder's long-term capital gains.
Distributions in excess of current and accumulated earnings and profits will
not be taxable to a shareholder to the extent that they do not exceed the
adjusted basis of the shareholder's Common Shares, but rather will reduce the
adjusted basis of such shares. To the extent that these distributions exceed
the adjusted basis of a shareholder's Common Shares, such distributions will be
included in income as long-term capital gain (or short-term capital gain if the
Common Shares had been held for one year or less), assuming the Common Shares
are a capital asset in the hands of the shareholder. In addition, any
distribution declared by RAIT in October, November, or December of any year and
payable to a shareholder of record on a specified date in any such month shall
be treated as both paid by RAIT and received by the shareholder on December 31
of such year, provided that the distribution is actually paid by RAIT during
January of the following calendar year.
Shareholders may not include in their individual income tax returns any
net operating losses or capital losses of RAIT. Instead, any such losses are
carried over by RAIT for potential offset against its future income (subject to
certain limitations). Taxable distributions from RAIT and gain from the
disposition of the Common Shares will not be treated as passive activity income
and, therefore, shareholders generally will not be able to apply any "passive
activity losses" (such as losses from certain types of limited partnerships in
which a shareholder is a limited partner) against such income. In addition,
taxable distributions from RAIT generally will be treated as investment income
for purposes of the investment interest limitations. Capital gains from the
disposition of Common Shares (or distributions treated as such), however, will
be treated as investment income only if the shareholder so elects, in which
case such capital gains will be taxed at ordinary income rates. RAIT will
notify shareholders after the close of RAIT's taxable year as to the portions
of the distributions attributable to that year that constitute ordinary income
or capital gain dividends.
RAIT's investments may cause it under certain circumstances to recognize
taxable income in excess of its economic income ("phantom income") and to
experience an offsetting excess of economic income over its taxable income in
later years. As a result, shareholders may from time to time be required to pay
federal income tax on distributions that economically represent a return of
capital, rather than a dividend. Such distributions would be offset in later
years by distributions representing economic income that would be treated as
returns of capital for federal income tax purposes. Accordingly, if RAIT
receives phantom income, its shareholders may be required to pay federal income
tax with respect to such income on an accelerated basis, i.e., before such
income is realized by the shareholders in an economic sense. Taking into
account the time value of money, such an acceleration of federal income tax
liabilities would cause shareholders to receive an after-tax rate of return on
an investment in RAIT that would be less than the after-tax rate of return on
an investment with an identical before-tax rate of return that did not generate
phantom income. For example, if an investor subject to an effective income tax
rate of 30% purchased a bond (other than a tax-exempt bond) with an annual
interest rate of 10% for its face value, his before-tax return on his
investment would be 10%, and his after-tax return would be 7%. However, if the
same investor purchased shares of RAIT at a time when the before-tax rate of
return was
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10%, his after-tax rate of return on his shares might be somewhat less than 7%
as a result of RAIT's phantom income. In general, as the ratio of RAIT's
phantom income to its total income increases, the after-tax rate of return
received by a taxable shareholder of RAIT will decrease. RAIT will consider the
potential effects of phantom income on its taxable shareholders in managing its
investments.
Taxation of Shareholders on the Disposition of Common Shares
In general, any gain or loss realized upon a taxable disposition of the
Common Shares by a shareholder who is not a dealer in securities will be
treated as long-term capital gain or loss if the Common Shares have been held
for more than 12 months and otherwise as short-term capital gain or loss.
However, any loss upon a sale or exchange of Common Shares by a shareholder who
has held such shares for six months or less (after applying certain holding
period rules) will be treated as a long-term capital loss to the extent of
distributions from RAIT required to be treated by such shareholder as long-term
capital gain. All or a portion of any loss realized upon a taxable disposition
of the Common Shares may be disallowed if other Common Shares are purchased
within 30 days before or after the disposition.
Capital Gains and Losses
A capital asset generally must be held for more than one year in order for
gain or loss derived from its sale or exchange to be treated as long-term
capital gain or loss. The highest marginal individual income tax rate is 39.6%.
The maximum tax rate on long-term capital gains applicable to non-corporate
taxpayers is 28% for assets held for more than one year but not more than 18
months, and 20% for assets held for more than 18 months. Thus, the tax rate
differential between capital gain and ordinary income for non-corporate
taxpayers may be significant. In addition, the characterization of income as
capital gain or ordinary income may affect the deductibility of capital losses.
Capital losses not offset by capital gains may be deducted against an
individual's ordinary income only up to a maximum annual amount of $3,000.
Unused capital losses may be carried forward indefinitely by individuals. All
net capital gain of a corporate taxpayer is subject to tax at ordinary
corporate rates. A corporate taxpayer can deduct capital losses only to the
extent of capital gains, with unused losses being carried back three years and
forward five years.
Information Reporting Requirements and Backup Withholding
RAIT will report to its U.S. shareholders and to the Service the amount of
distributions paid during each calendar year, and the amount of tax withheld,
if any. Under the backup withholding rules, a shareholder may be subject to
backup withholding at the rate of 31% with respect to distributions paid unless
such holder (i) is a corporation or comes within certain other exempt
categories and, when required, demonstrates this fact or (ii) provides a
taxpayer identification number, certifies as to no loss of exemption from
backup withholding, and otherwise complies with the applicable requirements of
the backup withholding rules. A shareholder who does not provide RAIT with his
correct taxpayer identification number also may be subject to penalties imposed
by the Service. Any amount paid as backup withholding will be creditable
against the shareholder's income tax liability. In addition, RAIT may be
required to withhold a portion of capital gain distributions to any
shareholders who fail to certify their nonforeign status to RAIT. The Treasury
Department issued proposed regulations in April 1996 regarding the backup
withholding rules as applied to Non-U.S. Shareholders. These regulations were
issued in final form on October 6, 1997 and will be effective for payments made
after December 31, 1998. The new regulations have eased certain of the
recordkeeping and bookkeeping requirements pertaining to backup withholding.
See "Federal Income Tax Considerations -- Taxation of Non-U.S. Shareholders."
Taxation of Tax-Exempt Shareholders
Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts ("Exempt Organizations"),
generally are exempt from federal income taxation. However, they are subject to
taxation on their unrelated business taxable income ("UBTI"). While many
investments in real estate generate UBTI, in a published ruling the Service
stated that dividend distributions from a REIT to an exempt employee pension
trust do not constitute UBTI, provided that the shares of the REIT are not
otherwise used in an unrelated trade or business of the exempt employee pension
trust. Based on that ruling, amounts distributed
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by RAIT to Exempt Organizations generally should not constitute UBTI. However,
if an Exempt Organization finances its acquisition of the Common Shares with
debt, a portion of its income from RAIT will constitute UBTI pursuant to the
"debt-financed property" rules. Furthermore, social clubs, voluntary employee
benefit associations, supplemental unemployment benefit trusts, and qualified
group legal services plans that are exempt from taxation under paragraphs (7),
(9), (17), and (20), respectively, of Code section 501(c) are subject to
different UBTI rules, which generally will require them to characterize
distributions from RAIT as UBTI. In addition, in certain circumstances, a
pension trust that owns more than 10% of RAIT's shares is required to treat a
percentage of the dividends from RAIT as UBTI (the "UBTI Percentage"). The UBTI
Percentage is the gross income derived by RAIT from an unrelated trade or
business (determined as if RAIT were a pension trust) divided by the gross
income of RAIT for the year in which the dividends are paid. The UBTI rule
applies to a pension trust holding more than 10% of RAIT's shares only if (i)
the UBTI Percentage is at least 5%, (ii) RAIT qualifies as a REIT by reason of
the modification of the 5/50 Rule that allows the beneficiaries of the pension
trust to be treated as holding shares of RAIT in proportion to their actuarial
interests in the pension trust, and (iii) RAIT is a "pension-held REIT" (that
is, either (A) one pension trust owns more than 25% of the value of RAIT's
shares or (B) a group of pension trusts individually holding more than 10% of
the value of RAIT's shares collectively owns more than 50% of the value of
RAIT's shares). Because the Ownership Limitation prohibits any shareholder from
owning (i) more than 8.3% of the number of outstanding Common Shares (other
than RAI, which may own no more than 15% of the number of outstanding Common
Shares or (ii) more than 9.8% of the number of outstanding Preferred Shares of
any series, RAIT should not be a pension-held REIT and, accordingly, no pension
trust should be required to treat a percentage of the dividends from RAIT as
UBTI.
Taxation of Non-U.S. Shareholders
The rules governing United States federal income taxation of nonresident
alien individuals, foreign corporations, foreign partnerships, and other
foreign shareholders (collectively, "Non-U.S. Shareholders") are complex. The
following discussion provides only a summary of such rules. PROSPECTIVE
NON-U.S. SHAREHOLDERS SHOULD CONSULT WITH THEIR OWN TAX ADVISORS TO DETERMINE
THE IMPACT OF FEDERAL, STATE, AND LOCAL INCOME TAX LAWS WITH REGARD TO AN
INVESTMENT IN THE COMMON SHARES, INCLUDING ANY REPORTING REQUIREMENTS.
Distributions to Non-U.S. Shareholders that are not attributable to gain
from sales or exchanges by RAIT of United States real property interests and
are not designated by RAIT as capital gains dividends will be treated as
dividends of ordinary income to the extent that they are made out of current or
accumulated earnings and profits of RAIT. Such distributions ordinarily will be
subject to a withholding tax equal to 30% of the gross amount of the
distribution unless an applicable tax treaty reduces or eliminates that tax.
However, if income from the investment in the Common Shares is treated as
effectively connected with the Non-U.S. Shareholder's conduct of a United
States trade or business, the Non-U.S. Shareholder generally will be subject to
federal income tax at graduated rates, in the same manner as U.S. Shareholders
are taxed with respect to such distributions (and also may be subject to the
30% branch profits tax in the case of a Non-U.S. Shareholder that is a non-U.S.
corporation). RAIT expects to withhold United States income tax at the rate of
30% on the gross amount of any such distributions made to a Non-U.S.
Shareholder unless (i) a lower treaty rate applies and any required form
evidencing eligibility for that reduced rate is filed with RAIT or (ii) the
Non-U.S. Shareholder files an IRS Form 4224 with RAIT claiming that the
distribution is effectively connected income. The Treasury Department issued
final regulations in October 1997 that, for payments made after December 31,
1998, modify the manner in which RAIT complies with the withholding
requirements.
Distributions in excess of current and accumulated earnings and profits of
RAIT will not be taxable to a shareholder to the extent that such distributions
do not exceed the adjusted basis of the shareholder's Common Shares, but rather
will reduce the adjusted basis of such shares. To the extent that distributions
in excess of current and accumulated earnings and profits exceed the adjusted
basis of a Non-U.S. Shareholder's Common Shares, such distributions will give
rise to tax liability if the Non-U.S. Shareholder would otherwise be subject to
tax on any gain from the sale or disposition of his Common Shares as described
above. Because it generally cannot be determined at the time a distribution is
made whether or not such distribution will be in excess of current and
accumulated earnings and profits, the entire amount of any distribution
normally will be subject to withholding at the same rate as a dividend.
However, amounts so withheld are refundable to the extent it is
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determined subsequently that such distribution was, in fact, in excess of
current and accumulated earnings and profits of RAIT. In August 1996, the U.S.
Congress passed the Small Business Job Protection Act of 1996, which requires
RAIT to withhold 10% of any distribution in excess of RAIT's current and
accumulated earnings and profits. Consequently, although RAIT intends to
withhold at a rate of 30% on the entire amount of any distribution, to the
extent that RAIT does not do so, any portion of a distribution not subject to
withholding at a rate of 30% will be subject to withholding at a rate of 10%.
For any year in which RAIT qualifies as a REIT, distributions that are
attributable to gain from sales or exchanges by RAIT of United States real
property interests will be taxed to a Non- U.S. Shareholder under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Under FIRPTA, distributions attributable to gain from sales of
United States real property interests are taxed to a Non-U.S. Shareholder as if
such gain were effectively connected with a United States business. Non-U.S.
Shareholders thus would be taxed at the normal capital gain rates applicable to
U.S. Shareholders (subject to applicable alternative minimum tax and a special
alternative minimum tax in the case of nonresident alien individuals).
Distributions subject to FIRPTA also may be subject to the 30% branch profits
tax in the hands of a non-U.S. corporate shareholder not entitled to treaty
relief or exemption. RAIT is required to withhold 35% of any distribution that
is designated by RAIT as a capital gains dividend. The amount withheld is
creditable against the Non-U.S. Shareholder's FIRPTA tax liability.
Gain recognized by a Non-U.S. Shareholder upon a sale of his Common Shares
generally will not be taxed under FIRPTA if RAIT is a "domestically controlled
REIT," defined generally as a REIT in which at all times during a specified
testing period less than 50% in value of the shares was held directly or
indirectly by Non-U.S. persons. However, because the Common Shares will be
publicly traded, no assurance can be given that RAIT will be a "domestically
controlled REIT." In addition, a Non-U.S. Shareholder that owns, actually or
constructively, no more than 5% of RAIT's shares throughout a specified
"look-back" period will not recognize gain on the sale of his shares taxable
under FIRPTA, if the shares are traded on an established securities market.
Furthermore, gain not subject to FIRPTA will be taxable to a Non-U.S.
Shareholder if (i) investment in the Common Shares is effectively connected
with the Non-U.S. Shareholder's U.S. trade or business, in which case the
Non-U.S. Shareholder will be subject to the same treatment as United States
shareholders with respect to such gain, or (ii) the Non-U.S. Shareholder is a
nonresident alien individual who was present in the United States for 183 days
or more during the taxable year and certain other conditions apply, in which
case the nonresident alien individual will be subject to a 30% tax on the
individual's capital gains. If the gain on the sale of the Common Shares were
to be subject to taxation under FIRPTA, the Non-U.S. Shareholder would be
subject to the same treatment as U.S. Shareholders with respect to such gain
(subject to applicable alternative minimum tax, a special alternative minimum
tax in the case of nonresident alien individuals, and the possible application
of the 30% branch profits tax in the case of non-U.S. corporations).
State and Local Taxes
RAIT, the General Partner, the Initial Limited Partner, the Operating
Partnership and RAIT's shareholders may be subject to state and local tax in
various states and localities, including those states and localities in which
they transact business, own property, or reside. The state and local tax
treatment of RAIT and its shareholders in such jurisdictions may differ from
the federal income tax treatment described above. Consequently, prospective
shareholders should consult their own tax advisors regarding the effect of
state and local tax laws upon an investment in the Common Shares.
Sale of RAIT's Property
Any gain realized by RAIT on the sale of any property held as inventory or
other property held primarily for sale to customers in the ordinary course of
its trade or business will be treated as income from a prohibited transaction
that is subject to a 100% penalty tax. Such prohibited transaction income also
may have an adverse effect upon RAIT's ability to satisfy the income tests for
REIT status. See "Federal Income Tax Considerations--Requirements for
Qualification -- Income Tests" above. RAIT, however, does not presently intend
to acquire or hold a material amount of property that represents inventory or
other property held primarily for sale to customers in the ordinary course of
its trade or business.
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<PAGE>
BENEFIT PLAN CONSIDERATIONS
The following summary of material considerations arising under the
Employee Retirement Income Security Act of 1974, as amended, and the prohibited
transaction provisions of section 4975 of the Code, does not purport to deal
with all aspects of ERISA or section 4975 of the Code that may be relevant to
particular shareholders (including plans subject to Title I of ERISA, other
retirement plans and individual retirement accounts ("IRAs") subject to the
prohibited transaction provisions of section 4975 of the Code, and governmental
plans or church plans that are exempt from ERISA and section 4975 of the Code
but that may be subject to state law requirements) in light of their particular
circumstances.
The discussion is based on current provisions of ERISA and the Code,
existing and currently proposed regulations under ERISA and the Code, the
legislative history of ERISA and the Code, existing administrative rulings of
the Department of Labor ("DOL") and reported judicial decisions. No assurance
can be given that legislative, judicial or administrative changes will not
affect the accuracy of any statements herein with respect to transactions
entered into or contemplated prior to the effective date of such changes.
A FIDUCIARY MAKING THE DECISION TO INVEST IN THE COMMON SHARES ON BEHALF
OF A PROSPECTIVE PURCHASER THAT IS AN EMPLOYEE BENEFIT PLAN, A TAX-QUALIFIED
RETIREMENT PLAN, OR AN IRA SHOULD CONSULT ITS OWN LEGAL ADVISOR REGARDING THE
SPECIFIC CONSIDERATIONS ARISING UNDER ERISA, SECTION 4975 OF THE CODE AND STATE
LAW WITH RESPECT TO THE PURCHASE, OWNERSHIP OR SALE OF THE COMMON SHARES BY
SUCH PLAN OR IRA.
Employee Benefit Plans, Tax-Qualified Retirement Plans and IRAs
Each fiduciary of a pension, profit-sharing or other employee benefit plan
(a "Plan") subject to Title I of ERISA should consider carefully whether an
investment in the Common Shares is consistent with such fiduciary's
responsibilities under ERISA. In particular, the fiduciary requirements of Part
4 of Title I of ERISA require a Plan's investment to be (i) prudent and in the
best interests of the Plan, its participants and its beneficiaries, (ii)
diversified in order to minimize the risk of large losses, unless it is clearly
prudent not to do so, and (iii) authorized under the terms of the Plan's
governing documents (provided the documents are consistent with ERISA). In
determining whether an investment in the Common Shares is prudent for purposes
of ERISA, the appropriate fiduciary of a Plan should consider all of the facts
and circumstances, including whether the investment is reasonably designed, as
a part of the Plan's portfolio for which the fiduciary has investment
responsibility, to meet the objectives of the Plan, taking into consideration
the risk of loss and opportunity for gain (or other return) from the
investment, the diversification of portfolio investments and the cash flow
requirements of the Plan.
A fiduciary of an IRA or of an employee benefit plan that is not subject
to Title I of ERISA because it is a governmental or church plan or because it
does not cover common law employees (a "Non-ERISA Plan") should consider that
such an IRA or Non-ERISA Plan may only make investments that are authorized by
the appropriate governing documents and under applicable law.
Fiduciaries of Plans and persons making investment decisions for an IRA or
other Non-ERISA Plan also should consider the application of the prohibited
transaction provisions of ERISA and the Code in making their investment
decision. A "disqualified person" (within the meaning of section 4975 of the
Code) with respect to a Plan, or an IRA subject to Code section 4975, is
subject to (i) an initial 15% excise tax on the amount involved in any
prohibited transaction involving the assets of the Plan or IRA and (ii) an
excise tax equal to 100% of the amount involved if any prohibited transaction
is not corrected. In general, if the disqualified person who engages in the
transaction is the individual on behalf of whom an IRA is established (or his
beneficiary), the IRA will lose its tax-exempt status and its assets will be
deemed to have been distributed to such individual in a taxable distribution
(and no excise tax will be imposed) on account of the prohibited transaction.
In addition, a fiduciary who permits a Plan to engage in a transaction that the
fiduciary knows or should know is a prohibited transaction may, among other
things, be liable to the Plan for any loss the Plan incurs as a result of the
transaction or for any profits earned by the fiduciary in the transaction.
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<PAGE>
Status of the Company under ERISA's Plan Asset Rules
Regulations of the DOL defining "plan assets" (the "Plan Asset
Regulations") generally provide that when a Plan, Non-ERISA Plan or IRA subject
to section 406 of ERISA or section 4975 of the Code acquires a security that is
an equity interest in an entity and the security is neither a "publicly-offered
security" nor a security issued by an investment company registered under the
Investment Company Act, the Plan's or Non-ERISA Plan's or IRA's assets include
both the equity interest and an undivided interest in each of the underlying
assets of the issuer of such equity interest, unless one or more exceptions
specified in the Plan Asset Regulations are satisfied.
The Plan Asset Regulations define a publicly-offered security as a
security that is "widely-held," "freely-transferable," and either part of a
class of securities registered under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), or sold pursuant to an effective registration
statement under the Securities Act (provided the securities are registered
under the Exchange Act within 120 days after the end of the fiscal year of the
issuer during which the offering occurred). The Common Shares are being sold in
an offering registered under the Securities Act and will be registered under
the Exchange Act within the required 120 day period. The Plan Asset Regulations
provide that a security is "widely held" only if it is part of a class of
securities that is owned by 100 or more investors independent of the issuer and
of one another. A security will not fail to be widely held because the number
of independent investors falls below 100 subsequent to the initial public
offering as a result of events beyond the issuer's control. The Company
anticipates that upon completion of this Offering, the Common Shares will be
"widely held."
The Plan Asset Regulations provide that whether a security is "freely
transferable" is a factual question to be determined on the basis of all
relevant facts and circumstances. The Plan Asset Regulations further provide
that where a security is part of an offering in which the minimum investment is
$10,000 or less (as is the case with this offering), certain restrictions
ordinarily will not, alone or in combination, affect a finding that such
securities are freely transferable. The restrictions on transfer enumerated in
the Plan Asset Regulations as ordinarily not affecting that finding include:
(i) any restriction on or prohibition against any transfer or assignment that
would result in the termination or reclassification of an entity for federal or
state tax purposes, or that otherwise would violate any federal or state law or
court order, (ii) any requirement that advance notice of a transfer or
assignment be given to the issuer, (iii) any administrative procedure that
establishes an effective date, or an event (such as completion of an offering),
prior to which a transfer or assignment will not be effective, and (iv) any
limitation or restriction on transfer or assignment that is not imposed by the
issuer or a person acting on behalf of the issuer. The Company believes that
the restrictions imposed under the Declaration of Trust on the transfer of the
Company's Common Shares will not result in the failure of the Common Shares to
be "freely transferable." The Company also is not aware of any other facts or
circumstances limiting the transferability of the Common Shares that are not
identified in the Plan Asset Regulations as factors that ordinarily do not
adversely affect a finding that securities are freely transferable. However, no
complete assurances can be given that the DOL or the Treasury Department would
not reach a contrary conclusion.
Assuming that the Common Shares will be "widely held" and that no other
facts and circumstances other than those referred to in the preceding paragraph
exist that restrict transferability of the Common Shares, the Common Shares
should be publicly offered securities and the assets of the Company should not
be deemed to be "plan assets" of any Plan, IRA or Non-ERISA Plan that invests
in the Common Shares. However, no assurances can be given that the Company's
assets will not be deemed to be plan assets.
If the assets of the Company were to be deemed to be "plan assets" under
ERISA, (i) the prudence standards and other provisions of Part 4 of Title I of
ERISA would be applicable to any transactions involving the Company's assets,
(ii) persons who exercise any authority over the Company's assets, or who
provide investment advice to the Company, would (for purposes of the fiduciary
responsibility provisions of ERISA) be fiduciaries of each Plan that acquires
Common Shares, (iii) a fiduciary exercising his investment discretion over the
assets of a Plan to cause it to acquire or hold the Common Shares could be held
liable under Part 4 of Title I of ERISA for transactions entered into by the
Company that do not conform to ERISA standards of prudence and fiduciary
responsibility, and (iv) certain transactions that the Company might enter into
in the ordinary course of its business and operations might constitute
"prohibited transactions" under ERISA and the Code.
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<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting
Agreement, the Company has agreed to sell to each of the Underwriters named
below and each of the Underwriters, for whom Friedman, Billings, Ramsey & Co.,
Inc. is acting as Representative, has severally agreed to purchase, the number
of Common Shares offered hereby set forth below opposite its name.
Underwriter Number of Shares
- ---------------------------------------------- -----------------
Friedman, Billings, Ramsey & Co., Inc. ...... 2,233,334
Advest, Inc. ................................. 40,000
Brean Murray, Foster Securities Inc. ......... 40,000
Equitable Securities Corporation ............ 40,000
Fahnestock & Co. Inc. ........................ 40,000
Ferris, Baker Watts, Inc. .................. 40,000
Gruntal & Co., L.L.C. ........................ 40,000
Janney Montgomery Scott Inc. ............... 40,000
Ladenburg Thalmann & Co. Inc. ............... 40,000
Legg Mason Wood Walker, Incorporated ......... 40,000
McDonald & Company Securities, Inc. ......... 40,000
Parker/Hunter Incorporated .................. 40,000
Piper Jaffray Inc. ........................... 40,000
Scott & Stringfellow, Inc. .................. 40,000
Sutro & Co. Incorporated ..................... 40,000
Tucker Anthony Incorporated .................. 40,000
---------
Total .................................... 2,833,334
=========
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to purchase all the Common Shares offered hereby if
any are purchased.
The Underwriters propose initially to offer the Common Shares directly to
the public at the public offering price set forth on the cover page of this
Prospectus and to certain dealers at such offering price less a concession not
to exceed $0.63 per Common Share. The Underwriters may allow and such dealers
may reallow a concession not to exceed $0.10 per Common Share to certain other
dealers. After the Common Shares are released for sale to the public, the
offering price and other selling terms may be changed by the Underwriters.
At the request of the Company, the Underwriters have reserved up to
125,000 Common Shares for sale to officers, directors and trustees of the
Company, RAI and Brandywine, together with members of their respective families
and relatives, at the initial public offering price net of any underwriting
discounts or commissions. The number of shares of Common Stock available for
sale to the general public will be reduced to the extent persons purchase such
reserved shares. Any reserved shares which are not so purchased will be offered
by the Underwriters to the general public on the same basis as the other shares
offered hereby.
The Company has granted to the Underwriters an option exercisable during a
30-day period after the date hereof to purchase, at the initial offering price
less underwriting discounts and commissions, up to an additional 425,000 Common
Shares for the sole purpose of covering over-allotments, if any. To the extent
that the Underwriters exercise such option, each Underwriter will be committed,
subject to certain conditions, to purchase that number of additional Common
Shares which is proportionate to such Underwriter's initial commitment.
The Company has agreed to issue, at the completion of the Offering, to the
Representative and/or its designees, warrants to purchase up to 141,667 Common
Shares (representing 5% of the Common Shares issued in the Offering, excluding
shares issuable pursuant to the Underwriters' overallotment option) at an
exercise price equal to the initial offering price per share. The warrants may
not be sold, transferred, assigned or hypothecated for one year following the
effective date of the Offering, except to officers of the Representative. The
warrants are exercisable one year from the effective date of the Offering and
have a term of five years from the effective date of the Offering (the "Warrant
Exercise Term"). The Company has also registered the Common Shares underlying
the Warrants. During the Warrant Exercise Term, the Representative is given the
opportunity to profit
76
<PAGE>
from a rise in market price of the Common Shares. To the extent that the
warrants are exercised, dilution to the interest of the holders of the Common
Shares may occur. In addition, the terms upon which the Company will be able to
obtain additional equity capital may be adversely affected because the holders
of the warrants can be expected to exercise them at a time when the Company
likely would be able to obtain any needed capital on terms more favorable to
the Company than those provided in the warrants.
The Company has agreed to reimburse the Underwriters for up to $100,000 of
their out-of-pocket expenses, including fees and expenses of counsel to the
Underwriters.
The Company has granted to the Representative preferential rights for two
years from the date of the registration statement, assuming completion of the
Offering, to act as the exclusive underwriter for, or advisor to, the Company
in specified transactions or offerings.
In connection with this Offering, certain Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Shares. Specifically, the Underwriters may overallot this Offering,
creating a syndicate short position. In addition, the Underwriters may bid for
and purchase Common Shares in the open market to cover syndicate short
positions or to stabilize the price of the Common Shares. Finally, the
underwriting syndicate may reclaim selling concessions from syndicate members
if the syndicate repurchases previously distributed Common Shares in syndicate
covering transactions, in stabilization transactions or otherwise. Any of these
activities may stabilize or maintain the market price of the Common Shares
above independent market levels. The Underwriters are not required to engage in
these activities and may end any of these activities at any time.
The Company has agreed to indemnify the several Underwriters against
certain civil liabilities under the Securities Act, or to contribute to
payments the Underwriters may be required to make in respect thereof.
Prior to this Offering, there has been no public market for the Common
Shares. The initial public offering price has been determined by negotiation
between the Company and the representative of the Underwriters. Among the
factors considered in making such determination were the history of, and the
prospects for, the industry in which the Company will compete, an assessment of
the Initial Investments and the Company's prospects for future earnings, the
general conditions of the economy and the securities markets and the prices of
offerings by similar issuers. There can, however, be no assurance that the
price at which the Common Shares will sell in the public market after this
Offering will not be lower than the price at which they have been sold by the
Underwriters.
The Representative has informed the Company that the Underwriters do not
intend to confirm sales of the Common Shares offered hereby to any accounts
over which they exercise discretionary authority.
RAI and the other persons purchasing the reserved Common Shares described
above have agreed not to offer, sell or contract to sell or otherwise dispose
of those shares without the prior consent of the Representative for a period of
180 days following the conclusion of the Offering.
Entities associated with the Representative are the beneficial owners of
314,005 shares of RAI's common stock, representing 6.7% of all common shares
issued and outstanding. The Representative currently makes a market in RAI's
common stock and in RAI's 12% Senior Notes.
LEGAL MATTERS
Certain legal matters will be passed upon for the Company by Ledgewood Law
Firm, P.C., Philadelphia, Pennsylvania and for the Underwriters by Hunton &
Williams, Richmond, Virginia. Certain matters regarding formation of the
Company and Maryland law will be passed upon for the Company by Arnold &
Porter, Washington, D.C. For certain relationships between Ledgewood Law Firm,
P.C. and the Company, see "Conflicts of Interest."
EXPERTS
The financial statement of the Company as of October 31, 1997 included in
this Prospectus or in the Registration Statement of which this Prospectus forms
a part, have been audited by Grant Thornton LLP, independent certified public
accountants, whose report thereon appears herein and elsewhere in this
Registration Statement. Such financial statement is included in reliance upon
the report of Grant Thornton LLP, given upon the authority of such firm as
experts in accounting and auditing.
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<PAGE>
The appraised values of properties underlying the Initial Investments have
been included herein in reliance upon the reports of Johnson, McClellan,
Sullins & Page, Joseph Dennis Pasquarella & Co., M. Richard Cohen and Louis A.
Iatarola Realty Appraisal Group, Ltd. as experts in appraising real properties.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement (of
which this Prospectus forms a part) on Form S-11 under the Securities Act with
respect to the Common Shares. This Prospectus contains summaries of the
material terms of the documents referred to herein and therein, but does not
contain all of the information set forth in the Registration Statement pursuant
to the rules and regulations of the Commission. For further information,
reference is made to such Registration Statement and the exhibits thereto. Such
Registration Statement and exhibits filed by the Company can be inspected
without charge and copied at prescribed rates at the public reference
facilities maintained by the Commission at the Public Reference Section of the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and at its Regional
Offices located as follows: Chicago Regional Office, Citicorp Center, Suite
1400, 500 West Madison Street, Chicago, Illinois 60661-2511; and New York
Regional Office, Seven World Trade Center, Suite 1300, New York, New York
10048. In addition, copies of such documents may be obtained at the
Commission's Internet address at http://www.sec.gov.
Statements contained in this Prospectus as to the contents of any contract
or other document that is filed as an exhibit to the Registration Statement are
not necessarily complete, and each such statement is qualified in its entirety
by reference to the full text of such contract or document.
The Company will be required to file reports and other information with
the Commission pursuant to the Securities Exchange Act of 1934. In addition to
applicable legal requirements, if any, holders of Common Shares will receive
annual reports containing audited financial statements with a report thereon by
the Company's independent certified public accountants, and quarterly reports
containing unaudited financial information for each of the first three quarters
of each fiscal year.
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<PAGE>
GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"ADA" shall mean the Americans with Disabilities Act of 1990, as amended.
"Bankruptcy Code" shall mean Title 11 of the United States Code, as
amended.
"Beneficiary" shall mean a charitable organization selected by the Company
to which shares in excess of the Ownership Limitation may be donated under the
circumstances set forth in "Description of Shares of Beneficial Interest --
Restrictions on Ownership and Transfer."
"Board of Trustees" shall means the Board of Trustees of RAIT.
"Brandywine" shall mean Brandywine Construction & Management, Inc.
"Bylaws" shall mean the Bylaws of RAIT.
"CERCLA" shall mean the Comprehensive Environmental Response, Compensation
and Liability Act of 1980, as amended.
"Code" shall mean the Internal Revenue Code of 1986, as amended.
"Commission" shall mean the Securities and Exchange Commission.
"Common Shares" shall mean the common shares of beneficial interest, par
value $0.01 per share, of RAIT.
"Company" shall mean Resource Asset Investment Trust, a Maryland real
estate investment trust, together with its subsidiaries, unless the context
indicates otherwise.
"Company Expenses" shall mean all administrative costs and expenses of the
Company and the General Partner.
"Control Share Acquisitions" shall mean transactions causing the voting
strength of any person acquiring beneficial ownership of shares to meet or
exceed certain threshold percentages (20%, 33 1/3% or 50%) of the total votes
entitled to be cast for the election of trustees.
"Counsel" shall mean Ledgewood Law Firm, P.C., counsel to the Company.
"Declaration of Trust" shall mean the Declaration of Trust of RAIT.
"DOL" shall mean the Department of Labor.
"ERISA" shall mean the Employee Retirement Income Security Act of 1974, as
amended.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as amended.
"Exempt Organizations" shall mean tax-exempt entities, including, but not
limited to, charitable organizations, qualified employee pension and profit
sharing trusts and individual retirement accounts.
"Financings" shall mean any one or more of the mortgage obligations the
Company will originate or acquire for its investment portfolio.
"5/50 Rule" shall mean the requirement under the Code that not more than
50% in value of the outstanding shares of a REIT be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year after the REIT's
first taxable year.
"FIRPTA" shall mean the Foreign Investment in Real Property Tax Act of
1980.
"General Partner" shall mean RAIT General, Inc., as the sole general
partner of the Operating Partnership.
"Independent Trustee" shall mean a trustee who, within the last two years,
has not (i) been an Affiliate of RAI, Brandywine or their Affiliates, (ii) been
an officer of the Company, or (iii) had any material business or professional
relationship with the Company, RAI, Brandywine or their affiliates.
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<PAGE>
"Initial Investments" shall mean the Financings acquired or originated by
the Company as set forth in "Investments Objectives and Policies -- Initial
Investments."
"Initial Limited Partner" shall mean RAIT Limited, Inc., as limited
partner of the Operating Partnership.
"Interested Shareholder" shall mean any holder of more than 10% of any
class of outstanding voting shares of the Company.
"Investment Company Act" shall mean the Investment Company Act of 1940.
"IRA" shall mean an individual retirement account.
"JeffBanks" shall mean JeffBanks, Inc.
"Limited Partners" shall mean the Initial Limited Partner and any
additional persons admitted as limited partners of the Operating Partnership.
"MGCL" shall mean the Maryland General Corporation Law.
"1996 Lender Liability Act" shall mean the Asset Conversion, Lender
Liability and Deposit Insurance Act of 1996.
"Non-ERISA Plan" shall mean a plan that does not cover common law
employees.
"Non-U.S. Shareholder" shall mean alien individuals, foreign corporations,
foreign partnerships and other foreign shareholders that are not resident in
the United States.
"Offering" shall mean the offering of Common Shares made pursuant to this
Prospectus.
"OID" shall mean original issue discount.
"Operating Partnership" shall mean RAIT Partnership, L.P.
"Operating Partnership Agreement" shall mean the agreement of limited
partnership of the Operating Partnership, as amended from time to time.
"Option Plan" shall mean the qualified share option plan that the Company
intends to adopt to provide options to officers and trustees of the Company.
"Ownership Limitation" shall mean the restriction on ownership (or deemed
ownership by virtue of the attribution provisions of the Code) of (a) more than
8.3% of the outstanding Common Shares by any shareholder other than RAI, (b)
more than 15% of the outstanding Common Shares by RAI, or (c) more than 9.8% of
the outstanding Preferred Shares of any series by any shareholder.
"Plan" shall mean a pension, profit-sharing or other employee benefit
plan.
"Plan Asset Regulations" shall mean DOL regulations that define "plan
assets."
"Preferred Shares" shall mean the preferred shares of beneficial interest,
par value $0.01 per share, of the Company.
"Prohibited Transferee" shall mean a person to whom a transfer of Common
Shares has been made which is in excess of the Ownership Limitation.
"Property Interest" shall mean any direct or indirect interest in a
property acquired by the Company, including an interest in a partnership, joint
venture or limited liability company owning real property as all or
substantially all of its assets.
"Qualified Interests" shall mean mortgages and other liens on and
interests in real estate, within the meaning of the Investment Company Act.
"RAI" shall mean Resource America, Inc. or its subsidiaries.
"RAIT" shall mean Resource Asset Investment Trust.
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<PAGE>
"Redemption Rights" shall mean the rights that it is anticipated the
Limited Partners (other than the Initial Limited Partner) will have pursuant to
the Operating Partnership Agreement to redeem all or a portion of their
interests in the Operating Partnership for cash or, at the option of the
General Partner, Common Shares on a one-for-one basis.
"REIT" shall mean a real estate investment trust, as defined in section
856 of the Code.
"Representative" shall mean Friedman, Billings, Ramsey & Co., Inc., as
representative of the Underwriters.
"RICO" shall mean the Racketeer Influenced and Corrupt Organizations Act.
"Rule 144" shall mean the rule promulgated under the Securities Act that
permits holders of restricted securities as well as affiliates of an issuer of
securities, pursuant to certain conditions and subject to certain restrictions,
to sell their securities publicly without registration under the Securities
Act.
"Securities Act" shall mean the Securities Act of 1933, as amended.
"Service" shall mean the Internal Revenue Service.
"Title V" shall mean Title V of the Depository Institutions Deregulation
and Monetary Control Act of 1980.
"Treasury Regulations" shall mean the income tax regulations promulgated
under the Code.
"Trustee" shall mean a trustee of RAIT.
"UBTI" shall mean unrelated business taxable income as defined in the
Code.
"UBTI Percentage" shall mean the gross income derived by the Company in
any year from an unrelated trade or business divided by the gross income of the
Company for that year.
"Underwriters" shall mean Friedman, Billings, Ramsey & Co., Inc. and each
of the underwriters for whom Friedman, Billings, Ramsey & Co., Inc. is acting
as representative.
"Underwriting Agreement" shall mean the agreement pursuant to which the
Underwriters will underwrite the Common Stock.
"Units" shall mean units of limited partnership interest in the Operating
Partnership.
"UST" shall mean an underground storage tank.
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Report of Independent Certified Public Accountants
Board of Trustees
Resource Asset Investment Trust
We have audited the accompanying consolidated balance sheet of Resource
Asset Investment Trust as of October 31, 1997. This financial statement is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statement referred to above presents fairly,
in all material respects, the consolidated financial position of Resource Asset
Investment Trust as of October 31, 1997 in conformity with generally accepted
accounting principles.
/s/ Grant Thornton LLP
- -------------------------------------
GRANT THORNTON LLP
Philadelphia, Pennsylvania
October 31, 1997
F-1
<PAGE>
RESOURCE ASSET INVESTMENT TRUST
Consolidated Balance Sheet
October 31, 1997
<TABLE>
<S> <C>
ASSETS
Cash ........................................................................ $ 1,000
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Shareholder's equity
Preferred shares -- par value $0.01; authorized, 25,000,000 shares ......... $ --
Common shares -- par value $0.01; authorized, 200,000,000 shares; issued and
outstanding, 100 shares ................................................... 1
Additional paid-in-capital ................................................ 999
-------
$ 1,000
=======
</TABLE>
The accompanying notes are an integral part of this statement.
F-2
<PAGE>
RESOURCE ASSET INVESTMENT TRUST
Notes to Consolidated Balance Sheet
October 31, 1997
NOTE A - FORMATION AND STRUCTURE OF THE COMPANY
Resource Asset Investment Trust (RAIT or the Company), together with its
subsidiaries--RAIT Partnership, L.P. (the Operating Partnership); RAIT General,
Inc. (the General Partner), the General Partner of the Operating Partnership;
and RAIT Limited, Inc. (the Initial Limited Partner), the Initial Limited
Partner of the Operating Partnership--were each formed in August 1997. The
Company, the General Partner and the Initial Limited Partner were incorporated
in Maryland, and the Operating Partnership was organized as a Delaware limited
partnership.
The General Partner and the Initial Limited Partner will capitalize the
Operating Partnership. The General Partner initially owns a 1% general
partnership interest, and the Initial Limited Partner initially owns a 99%
limited partnership interest in the Operating Partnership.
RAIT was initially capitalized through the sale of 100 common shares of
beneficial interest (Common Shares) for $1,000.
RAIT's principal business activity will be to provide mortgage or other
debt financing (Financing) in situations that do not conform to the
underwriting standards of institutional lenders or sources that provide
financing through securitization. The Company intends to purchase or originate
Financing relating to multifamily residential, office and other commercial
properties. The Company will emphasize wraparound loans and, to a lesser
extent, other forms of junior lien and subordinated financing with principal
amounts generally between $1 million and $8 million. The Company also
anticipates the acquisition of real properties, or interests therein. The
Operating Partnership will undertake the business of the Company, including the
origination and acquisition of Financing and the acquisition of property
interests.
The Company's sole activity through October 31, 1997 consisted of the
organization and start-up of the Company. Accordingly, no consolidated
statement of operations is presented.
NOTE B - FEDERAL INCOME TAXES
The Company intends to qualify and will elect to be taxed as a Real Estate
Investment Trust (REIT) under Sections 856 through 860 of the Internal Revenue
Code of 1986, as amended, commencing with its taxable year ending December 31,
1997. If the Company qualifies for taxation as a REIT, it generally will not be
subject to federal corporate income tax on its taxable income that is
distributed to its shareholders. A REIT is subject to a number of
organizational and operational requirements, including a requirement that it
currently distribute at least 95% of its annual taxable income.
NOTE C - TRANSACTIONS WITH AFFILIATES
Resource America, Inc. (RAI), which is the sponsor of the Company, will
own 15% of the outstanding Common Shares upon consummation of an offering of
Common Shares proposed to be made by the Company (assuming that the
underwriters for such offering do not exercise their over-allotment option).
RAI, until such time as its ownership of outstanding Common Shares is less than
5%, has the right to nominate one member of the Board of Trustees. The Chairman
and Chief Executive Officer of the Company is the spouse of the Chairman, Chief
Executive Officer and President of RAI. A trustee of the Company is their son.
A material portion of the Initial Investments will be purchased by the Company
from RAI, and the Company anticipates that, subject to specified limitations,
it will purchase additional investments from RAI. The Company may also from
time to time (but is not obligated to) retain RAI to perform due diligence
investigations on properties underlying proposed investments (except
investments acquired from RAI). Brandywine Construction and Management, Inc.
(Brandywine), an affiliate of RAI, may provide real estate management or
management supervisory services to properties underlying the Company's
investments. Accordingly, the Company's relationship with RAI, Brandywine and
their affiliates will be subject to various potential conflicts of interest,
including conflicts over the price at which investments are sold or services
rendered to the Company by those entities.
F-3
<PAGE>
RESOURCE ASSET INVESTMENT TRUST
Notes to Consolidated Balance Sheet -- (Continued)
October 31, 1997
NOTE C - TRANSACTIONS WITH AFFILIATES -- (Continued)
The Company has instituted certain procedures to mitigate the effects of
any such conflicts, including (i) requiring that a majority of its Trustees be
independent Trustees, (ii) requiring that the acquisition price of any
investments acquired from RAI, or in which an officer or trustee of the Company
has an interest be determined based upon independent appraisal of the
underlying property, (iii) limiting the investments which may be acquired from
RAI to a maximum of 30% of the Company's investments (excluding the Initial
Investments), based upon the Company's investment cost (the amount of the
investment plus legal, filing and other related fees and expenses), (iv)
requiring that any fees for services performed by RAI, Brandywine or their
affiliates be no greater than prevailing fees in the area for similar services
provided by unrelated third parties, (v) requiring that any service
arrangements with an affiliated entity provide that services will be rendered
only as and to the extent requested by the Company from time to time and that,
in any event, the arrangements be cancelable by the Company, without penalty,
on no more than 30 days' notice, (vi) requiring that any investment acquisition
or services arrangement, and every transaction with RAI, Brandywine and their
affiliates, or relating to any property in which any such persons has an
interest, receive the prior approval of a majority of the Independent Trustees
(who, in giving such approval, may rely upon information provided by RAI,
Brandywine or their affiliates), and (vii) with respect to real estate
management or management supervisory services performed by Brandywine,
requiring that the aggregate of the fee received by Brandywine and the manager
being supervised may not exceed the normal and customary fee for similar
property management services with respect to similar properties in the same
area. The Company will not, however, be required to obtain the approval of the
Independent Trustees to retain RAI to perform a due diligence investigation of
a property where the amount of the fee for such services will not exceed the
lesser of 1% of the property's appraised value or $10,000.
NOTE D - OPTION PLAN
The Company intends to adopt a qualified share option plan (the Option
Plan), which provides for options to purchase Common Shares. The maximum
aggregate number of Common Shares that may be issued pursuant to options
granted under the Option Plan is 450,000. The purpose of the Option Plan is to
provide a means of performance-based compensation in order to provide incentive
for the Company's key employees.
Upon completion of the offering of the Company's Common Shares (the
Closing Date), the Company will grant to certain officers of the Company
options to acquire Common Shares at an exercise price per share equal to the
initial offering price of the Common Shares. The options are not exercisable
immediately; rather, 25% of each option becomes exercisable on each of the
first four anniversaries of the Closing Date. The options will terminate on the
tenth anniversary of the Closing Date. In addition, the Company will grant to
the Trustees of the Company options to acquire Common Shares under terms
described above.
The Company has adopted Financial Accounting Standards (FAS) No. 123,
Accounting for Stock-Based Compensation, on August 20, 1997. FAS No. 123
contains a fair value-based method for valuing stock-based compensation that
entities may use, which measures compensation cost at the grant date based on
the fair value of the award. Compensation is then recognized over the service
period, which is usually the vesting period. Alternatively, the standard
permits entities to continue accounting for employee stock options and similar
equity instruments under Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees. Entities that continue to account for
stock options using APB Opinion No. 25 are required to make pro forma
disclosures of net income and net income per share, as if the fair value-based
method of accounting defined in FAS No. 123 had been applied. The Company's
stock option plans will be accounted for under APB Opinion No. 25.
NOTE E - PUBLIC OFFERING OF COMMON SHARES
The Company has filed a Registration Statement for sale of its Common
Shares. Contingent upon the consummation of the public offering, the Company
will be liable for organization and offering expenses in connection with the
sale of the Common Shares offered. Prior thereto, RAI has paid such expenses,
subject to reimbursement therefor, at the closing date.
F-4
<PAGE>
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No person is authorized to give any information or to make any representation
not contained in this Prospectus and any information or representation not
contained herein must not be relied upon as having been authorized by the
Company or any Underwriter. This Prospectus does not constitute an offer of any
securities other than the securities to which it relates or an offer to any
person in any jurisdiction where such an offer would be unlawful. Neither the
delivery of this Prospectus nor any sale made hereunder shall, under any
circumstances, create any implication that there has been no change in the
affairs of the Company since the date hereof.
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TABLE OF CONTENTS
Page
Prospectus Summary ............... 5
Formation and Structure ............ 12
Risk Factors ..................... 13
Conflicts of Interest ............ 24
Use of Proceeds .................. 26
Investment Objectives and Policies 27
The Company ........................ 46
Distribution Policy ............... 50
Capitalization ..................... 50
Management's Discussion and
Analysis of Financial Condition 51
Description of Shares of Beneficial
Interest ........................ 52
Certain Provisions of Maryland
Law and of the Company's Dec-
laration of Trust and Bylaws 55
Common Shares Available for
Future Sale ..................... 59
Operating Partnership Agreement . 59
Federal Income Tax Considerations 62
Benefit Plan Considerations ...... 74
Underwriting ..................... 76
Legal Matters ..................... 77
Experts ........................... 77
Additional Information ............ 78
Glossary ........................... 79
Consolidated Financial Statement . F-2
--------------------------
Until February 2, 1998, all dealers effecting transactions in the registered
securities, whether or not participating in this distribution, may be required
to deliver a Prospectus. This is in addition to the obligation of dealers to
deliver a Prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.
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<PAGE>
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2,833,334 Shares
RESOURCE ASSET
INVESTMENT TRUST
Common Shares
-----------------------------------
PROSPECTUS
-----------------------------------
FRIEDMAN, BILLINGS, RAMSEY
& CO., INC.
January 8, 1998
