<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 21, 1998
REGISTRATION NO. 333-52117
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
PRE-EFFECTIVE AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 6513 47-0810842
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of organization) Classification Number) Identification
No.)
</TABLE>
SUITE 400, 1004 FARNAM STREET
OMAHA, NEBRASKA 68102
(402) 444-1130
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
PAUL L. ABBOTT
SUITE 400, 1004 FARNAM STREET
OMAHA, NEBRASKA 68102
(402) 444-1130
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------------------
WITH COPIES TO:
PAUL E. BELITZ, ESQ.
BRIAN V. CAID, ESQ.
Kutak Rock
717 17th Street, Suite 2900
Denver, Colorado 80202
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF THE PROPOSED SALE TO THE PUBLIC: AS
SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE AND
AFTER CONDITIONS IN THE MERGER AGREEMENT HAVE BEEN SATISFIED.
--------------------------
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this Form is post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
--------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED PROPOSED AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT MAXIMUM OFFERING MAXIMUM AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED TO BE REGISTERED PRICE PER UNIT(1) OFFERING PRICE(1) FEE(1)
<S> <C> <C> <C> <C>
Common Stock, $.001 par value per share..... 3,354,887(2) $25 $83,872,175 $24,742.29(3)
Variable Rate Junior Notes and Promissory
Notes...................................... N/A(4) N/A(4) $40,000,000(4) $0(4)
</TABLE>
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(f), promulgated under the Securities Act of 1933, as
amended.
(2) Represents the maximum number of shares of Common Stock (the "Shares")
issuable upon consummation of the transactions described herein.
(3) The fee was paid with the filing of the registration statement on May 7,
1998.
(4) The maximum principal amount of the Variable Rate Junior Notes Callable On
or After the Date of Issuance and any Promissory Notes that may be issued in
lieu of fractional Notes (the "Notes") that will be issued is $40 million.
Investors whose securities are exchanged or cancelled will receive Shares or
Notes. To the extent Notes are issued in lieu of Shares, the proposed
maximum aggregate offering price of the Shares will be proportionately
reduced. Accordingly, no further fee is due for the registration of the
Notes.
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
CROSS REFERENCE SHEET
FURNISHED PURSUANT TO ITEM 1 OF FORM S-4 AND ITEM 501(b) OF REGULATION S-K
<TABLE>
<CAPTION>
CAPTION IN OR PART OF
ITEM OF S-4 PROSPECTUS/CONSENT SOLICITATION STATEMENT
- -------------------------------------------------------------------- ---------------------------------------------------------
<S> <C> <C> <C>
A. Information about the Transaction
1. Forepart of Registration Statement and Outside
Front Cover Page of Prospectus.............. Front Cover Page of the Registration Statement; Outside
Front Cover Page of the Prospectus/ Consent
Solicitation Statement
2. Inside Front and Outside Back Cover Pages of
Prospectus.................................. Inside Front Cover Page of the Prospectus/Consent
Solicitation Statement; Available Information; Outside
Back Cover Page of the Prospectus/ Consent Solicitation
Statement
3. Risk Factors, Ratio of Earnings to Fixed
Charges and Other Information............... Summary; Risk Factors; Selected Financial Data of the
Partnerships; Voting
4. Terms of the Transaction...................... Summary; Risk Factors; The Transaction; The Company;
Description of Capital Stock; Federal Income Tax
Consequences
5. Pro Forma Financial Information............... Pro Forma Financial Information
6. Material Contacts of the Partnerships Being
Acquired.................................... The Transaction; The Partnerships
7. Additional Information Required for Reoffering
by Persons and Parties Deemed to be
Underwriters................................ *
8. Interest of Named Experts and Counsel......... *
9. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities................................. *
B. Information about the Registrant
10. Information with Respect to S-3 Registrants... *
11. Incorporation of Certain Information by
Reference................................... *
12. Information with Respect to S-2 or S-3
Registrants................................. *
13. Incorporation of Certain Information by
Reference................................... *
14. Information with Respect to Registrants Other
than S-3 or S-2 Registrants................. Available Information; Summary; Risk Factors; The
Transaction; The Company; Federal Income Tax
Consequences
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
CAPTION IN OR PART OF
ITEM OF S-4 PROSPECTUS/CONSENT SOLICITATION STATEMENT
- -------------------------------------------------------------------- ---------------------------------------------------------
<S> <C> <C> <C>
C. Information about the Partnerships Being Merged
15. Information with Respect to S-3
Partnerships................................ *
16. Information with Respect to S-2 or S-3
Partnerships................................ *
17. Information with Respect to Partnerships other
than S-3 or S-2 Partnerships................ Available Information; Summary; Benefits of, and
Background and Reasons for, the Transaction; The
Transaction; The Partnerships; Selected Financial Data
of the Partnerships; see Index to Financial Statements
D. Voting and Management Information
18. Information if Proxies, Consents or
Authorizations are to be Solicited.......... Available Information; Summary; The Transaction; The
Company; Voting
19. Information if Proxies, Consents or
Authorizations are not to be Solicited or in
an Exchange Offer........................... *
</TABLE>
<PAGE>
SUBJECT TO COMPLETION
DATED JULY 20, 1998
THIS PROSPECTUS AND THE INFORMATION CONTAINED HEREIN ARE SUBJECT TO COMPLETION
OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE
SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION
STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO
SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY
SUCH STATE.
<PAGE>
CONSENT SOLICITATION STATEMENT OF
CAPITAL SOURCE L.P. AND CAPITAL SOURCE II L.P.--A
------------------------
THIS CONSENT SOLICITATION STATEMENT ALSO SERVES AS
THE PROSPECTUS OF AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
3,354,887 SHARES OF COMMON STOCK AND
VARIABLE RATE JUNIOR NOTES CALLABLE ON OR AFTER THE DATE OF ISSUANCE
This Prospectus/Consent Solicitation Statement relates to the proposed
merger (the "Transaction") of Capital Source L.P., a Delaware limited
partnership ("Cap Source I"), and Capital Source II L.P.--A, a Delaware limited
partnership ("Cap Source II", and together with Cap Source I, the
"Partnerships"), and the general partners of the Partnerships (the "General
Partners"), with and into America First Real Estate Investment Company, Inc., a
newly organized Delaware corporation (the "Company"). As a result of the
Transaction, the Company will issue securities to the Partnerships in exchange
for their assets, and the separate existence of the Partnerships will cease.
After the Transaction, the Company's primary business objective will be to make
real estate investments through the direct acquisition, rehabilitation,
development, financing and management of real property, including the
acquisition of equity securities of entities engaged in similar real estate
businesses.
The holders (the "Investors") of beneficial assignment certificates
representing assigned limited partnership interests in the Partnerships (the
"Units") are being asked to approve the Transaction as described in this
Prospectus/Consent Solicitation Statement. Upon completion of the Transaction,
Investors will receive, at their election and subject to certain limitations,
either shares of the Company's $.001 par value common stock (the "Shares") or
the Company's Variable Rate Junior Notes Callable On or After the Date of
Issuance (the "Notes"). See "THE NOTES--Notes--INTEREST" for the interest rate
calculation for the Notes. The common stock of the Company (the "Common Stock")
will be listed on the New York Stock Exchange ("NYSE"), subject to official
notice of issuance.
Consummation of the Transaction is subject to certain conditions and will
not occur unless, among other things: (i) both Partnerships participate in the
Transaction, and (ii) Investors who vote against the Transaction ("Dissenting
Investors") do not elect to receive more than the maximum amount of Notes
issuable in connection with the Transaction. Participation in the Transaction
requires the approval of a majority in interest of Investors in each
Partnership. The maximum amount of Notes that may be issued in the Transaction
(the "Maximum Note Limitation") is $40.0 million. The Company may, at its
option, pay cash in lieu of issuing Notes.
THIS TRANSACTION INVOLVES MATERIAL RISKS THAT SHOULD BE CONSIDERED BY THE
INVESTORS. SEE "RISK FACTORS" BEGINNING ON PAGE 21. IN PARTICULAR, INVESTORS
SHOULD CONSIDER THE FOLLOWING:
- The Common Stock may trade at prices substantially below the estimated
liquidation value of the Company's assets and the value assigned to the
Shares for purposes of the Transaction. A public market for the Notes is not
expected to develop. If the Notes are sold, they may sell at prices
substantially below their issuance price.
- The general partners of the Partnerships (the "General Partners") initiated
and participated in the structuring of the Transaction and have certain
conflicts of interest with respect to its completion. In particular, the
General Partners will receive an aggregate of 33,549 Shares, which could
have an approximate value of $838,725 based on an assumed value of $25 per
Share. In addition, the Company's advisor (the "Advisor"), a subsidiary of
the entity that controls the General Partners, will be entitled to receive
management fees from the Company following the Transaction.
- The Transaction involves a fundamental change in the nature of the
Investors' investment. If the Transaction is completed, Investors will not
receive a return on their investment in the form of liquidation proceeds
through sales of Partnership assets. Instead, Investors who receive Shares
("Shareholders") will be able to liquidate their investments only by selling
their Shares on the NYSE or in private transactions. An Investor's share of
liquidation proceeds could be higher than the amount realized from the sale
of the Company's Shares or payments on the Notes.
- There can be no guarantee with respect to the level of the Company's future
cash dividends, and regardless of the initial level of such dividends, they
could decline so that some Shareholders would receive lower distributions
than they received from the Partnership prior to the Transaction.
(CONTINUED ON FOLLOWING PAGE)
THIS SOLICITATION OF CONSENTS EXPIRES AT 5:00 P.M., CENTRAL TIME
ON , 1998, UNLESS EXTENDED.
------------------------
THE DATE OF THE PROSPECTUS/CONSENT SOLICITATION STATEMENT IS , 1998.
<PAGE>
(COVER PAGE CONTINUED)
- The Company is newly formed and has no operating history.
- The investment strategy and operating policies of the Company will be
materially different from those of the Partnerships and may be modified or
altered by the Board of Directors of the Company without the consent of the
Shareholders.
- Dissenting Investors are not entitled to any appraisal or other dissenters'
rights under Delaware law and none will be offered in the Transaction.
- There are alternatives to the Transaction. By approving the Transaction,
Investors will effectively preclude the pursuit of certain alternatives.
- The external management structure of the Company creates certain conflicts
of interest. In particular, the Advisor may also manage other entities with
similar investment objectives to those of the Company.
- To the extent Notes are issued, the Partnerships will be required to
recognize taxable gain which would be allocated to all Investors in
proportion to their ownership of Units.
- The Company intends to use debt financing to increase its real estate asset
portfolio. An increase in debt may increase the possibility of default on
the Company's obligations, which could adversely affect the Company's
earnings and its ability to pay expected dividends to Shareholders.
- Approval of a majority in interest of the Investors in a Partnership with
respect to the Transaction will bind all Investors in that Partnership,
including Dissenting Investors and Investors who abstained from voting with
respect to the Transaction.
- Investors who receive Notes ("Noteholders") will not hold an equity interest
in the Company and therefore will not be able to participate in the
Company's growth or benefit from any increases in the value of the Shares.
The Notes will be unsecured obligations of the Company and may be redeemed
prior to maturity at the Company's option.
See "GLOSSARY" for definitions of certain key terms used in this
Prospectus/Consent Solicitation Statement.
This Prospectus/Consent Solicitation Statement is being furnished to
Investors in connection with the solicitation of consents by the General
Partners. Approval by a majority in interest of the Investors of each
Partnership is required for the Partnership to approve the Transaction. The
established record date for voting the Units is , 1998 (the "Record
Date"). In order to be valid, the enclosed form of consent (the "Consent Card")
must be received by Service Data Corporation by 5:00 p.m. Central Time on
, 1998. INVESTORS ARE URGED TO COMPLETE, DATE AND SIGN THE CONSENT
CARD AND RETURN IT IN THE ENCLOSED POSTAGE-PREPAID ENVELOPE. This
Prospectus/Consent Solicitation Statement and the accompanying Consent Card are
first being mailed to Investors on or about , 1998.
THE GENERAL PARTNERS RECOMMEND THAT ALL INVESTORS VOTE "YES" IN FAVOR OF THE
TRANSACTION.
------------------------
NEITHER THIS TRANSACTION NOR THESE SECURITIES HAVE 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 FAIRNESS OR MERITS OF THIS TRANSACTION OR
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/ CONSENT SOLICITATION
STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
ALL QUESTIONS AND INQUIRIES SHOULD BE DIRECTED TO ,
INFORMATION AGENT, , OR BY TELEPHONE AT (800) .
<PAGE>
AVAILABLE INFORMATION
The Partnerships are subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith file reports, proxy and information statements and other
information with the Securities and Exchange Commission (the "SEC" or
"Commission"). In addition, the Company has filed with the Commission a
Registration Statement on Form S-4 of which this Prospectus/Consent Solicitation
Statement forms a part (including all amendments, exhibits, annexes and
schedules thereto, the "Registration Statement") pursuant to the Securities Act
of 1933, as amended (the "Securities Act") and the rules and regulations
promulgated thereunder, with respect to the Shares and Notes offered pursuant to
this Prospectus/Consent Solicitation Statement. This Prospectus/ Consent
Solicitation Statement, which is part of the Registration Statement, does not
contain all of the information set forth in the Registration Statement and the
exhibits and financial schedules thereto. For further information with respect
to the Partnerships and the Company, reference is made to the reports of the
Partnerships filed under the Exchange Act and the Company's Registration
Statement and such exhibits and schedules, copies of which may be examined
without charge or obtained upon payment of prescribed fees at the public
reference facilities maintained by the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549, and at the regional offices of
the Commission at 7 World Trade Center, New York, New York 10048 and Northwest
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The
Commission maintains a site in the World Wide Web at http://www.sec.gov that
contains reports, proxy and other information statements and other information
regarding registrants that file electronically with the Commission, including
the electronic filings of the Partnerships and the Company.
Statements contained in this Prospectus/Consent Solicitation Statement as to
the contents of any contract, agreement or other document are not necessarily
complete, and in each instance, reference is made to the copy of such contract,
agreement or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference. The
information in this Prospectus/Consent Solicitation Statement concerning the
Company, Cap Source I and Cap Source II has been furnished by the Company, Cap
Source I and Cap Source II, respectively. For further information with respect
to the Company, the Partnerships and the Shares and Notes offered hereby,
reference is made to the Registration Statement.
A separate supplement to this Prospectus/Consent Solicitation Statement has
been prepared for each Partnership and will be delivered to each Investor of the
Partnership covered thereby. Upon receipt of a written request by an Investor or
representative so designated in writing, the General Partners of the Investor's
Partnership will send a copy of any supplement without charge. All requests
should be directed to Service Data Corporation, 2424 South 130th Circle, Omaha,
Nebraska 68144.
Upon consummation of the Transaction, the Company will be required to file
reports and other information with the Commission pursuant to the Exchange Act.
Shareholders and Noteholders will receive annual reports containing audited
financial statements with a report thereon by the Company's independent public
accountants, and quarterly reports containing unaudited financial information
for each of the first three quarters of each fiscal year. If the Transaction is
not consummated, the Partnerships will continue to file reports and other
information with the Commission as required by law.
i
<PAGE>
TABLE OF CONTENTS
<TABLE>
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PAGE
---------
<S> <C>
SUMMARY.................................................................................................... 3
The Transaction.......................................................................................... 3
Summary Risk Factors..................................................................................... 4
Benefits of the Transaction.............................................................................. 6
Fairness................................................................................................. 6
Fairness Opinion......................................................................................... 7
Bringdown Fairness Opinion............................................................................... 7
Recommendation of the General Partners and the Special Committee; Fairness
Determination.......................................................................................... 8
Appraisals............................................................................................... 8
Contacts Regarding Fairness Opinions, Valuations and Other Reports....................................... 8
The Shares............................................................................................... 8
The Notes................................................................................................ 8
Voting Procedures........................................................................................ 9
Communicating With Other Investors....................................................................... 10
No Dissenters' Rights.................................................................................... 10
The Company.............................................................................................. 10
The Advisor.............................................................................................. 11
Background and Reasons for the Transaction............................................................... 11
Exchange Value........................................................................................... 12
Consideration of Alternatives............................................................................ 12
Conflicts of Interest and Benefits to Insiders........................................................... 14
Compensation, Reimbursements and Distributions to the General Partners................................... 15
Dividend Policy.......................................................................................... 16
Federal Income Tax Consequences.......................................................................... 16
Accounting Treatment..................................................................................... 16
Ratio of Earnings to Fixed Charges....................................................................... 17
Organizational Structure................................................................................. 17
Comparison of Units and Shares........................................................................... 20
RISK FACTORS............................................................................................... 21
Risks Associated with the Transaction.................................................................... 21
No Prior Market for the Shares; Market Price May Decrease After the Transaction........................ 21
No Prior Market for the Notes; Price May Decrease After the Transaction................................ 21
Conflicts of Interest of the General Partners.......................................................... 21
Fundamental Change in the Nature of Investment......................................................... 21
Possible Lower Distributions........................................................................... 22
Lack of Operating History.............................................................................. 22
Significant Change in Business Operations.............................................................. 22
No Dissenters' Rights.................................................................................. 22
Possible Alternatives to the Transaction Will Not Be Pursued........................................... 22
Conflicts of Interest Created by External Management Structure......................................... 23
Federal Income Tax Consequences........................................................................ 23
A Majority in Interest Will Bind All Investors in Each Partnership..................................... 23
Notes are Unsecured Obligations of the Company......................................................... 23
Contingent or Undisclosed Liabilities.................................................................. 23
Investors Who Elect to Receive Notes Could Receive Shares.............................................. 24
Risks Associated with the Company's Business............................................................. 24
</TABLE>
ii
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<TABLE>
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PAGE
---------
<S> <C>
Leveraging Strategy.................................................................................... 24
No Assurance of Successful Implementation of New Business Plan......................................... 24
Real Estate Investments................................................................................ 24
Investments in Assets Located Outside the United States................................................ 25
Dependence on Available Investments.................................................................... 25
Competition............................................................................................ 25
Illiquidity of Real Estate............................................................................. 25
Unspecified Acquisitions............................................................................... 25
Investment Strategy of the Company..................................................................... 25
Title Defects.......................................................................................... 26
Environmental Laws May Impose Additional Liability..................................................... 26
Board of Directors May Change Policies Without Shareholder Approval.................................... 26
Registration Under the Investment Company Act.......................................................... 26
Potential Liability Under the Americans With Disabilities Act.......................................... 26
Regulatory and Legislative Risks......................................................................... 27
BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION............................................... 27
History of the Partnerships.............................................................................. 27
The Decision to Pursue the Transaction................................................................... 30
Preparation for and Chronology of Events Leading to the Transaction...................................... 30
Alternatives Considered.................................................................................. 32
Reasons for, and Benefits of, the Transaction............................................................ 35
Consequences if Transaction Not Completed................................................................ 36
THE TRANSACTION............................................................................................ 36
General.................................................................................................. 36
Terms of the Merger Agreement............................................................................ 36
Issuance of Shares and Notes of the Company.............................................................. 37
No Fractional Shares..................................................................................... 38
Fractional Notes......................................................................................... 38
Transaction Expenses..................................................................................... 38
Accounting Treatment..................................................................................... 39
Regulatory Matters....................................................................................... 39
The Special Committee.................................................................................... 39
Recommendation of the General Partners and the Special Committee......................................... 40
Effect of the Transaction on Dissenting Investors........................................................ 41
Effective Time........................................................................................... 41
Conflicts of Interest and Benefits to Insiders........................................................... 41
FAIRNESS................................................................................................... 41
Belief as to Fairness.................................................................................... 41
Material Factors Underlying Belief as to Fairness........................................................ 42
Certain Alternatives to the Transaction.................................................................. 44
Comparison of Certain Alternatives to the Transaction.................................................... 47
The General Partners' Analysis for the Transaction....................................................... 49
FAIRNESS OPINION AND APPRAISALS............................................................................ 50
Fairness Opinion......................................................................................... 50
Bringdown Fairness Opinion............................................................................... 53
Appraisals............................................................................................... 54
Compensation and Material Relationships.................................................................. 59
EXCHANGE VALUES............................................................................................ 59
COMPARISON OF LIMITED PARTNERSHIP AND CORPORATE STRUCTURE.................................................. 62
Form of Organization..................................................................................... 62
</TABLE>
iii
<PAGE>
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Business................................................................................................. 62
Duration of Existence.................................................................................... 63
Investment Objectives and Policies....................................................................... 63
Borrowing Policies....................................................................................... 64
Management............................................................................................... 64
Fees and Expenses........................................................................................ 65
Voting Rights............................................................................................ 66
Anti-Takeover Provisions................................................................................. 67
Review of Investor Lists................................................................................. 67
Nature of Investment..................................................................................... 68
Potential Dilution of Payments Rights.................................................................... 69
Expected Distributions and Payments...................................................................... 69
Liquidity and Transferability............................................................................ 70
Taxation of Taxable Investors............................................................................ 70
THE COMPANY................................................................................................ 71
Overview................................................................................................. 71
The Advisor.............................................................................................. 72
Investment Strategy...................................................................................... 72
Financing Strategies..................................................................................... 73
ConAm Agreement.......................................................................................... 73
Risk Control............................................................................................. 73
Affiliated REIT.......................................................................................... 73
Operating Restrictions................................................................................... 74
Dividend Policy.......................................................................................... 74
Legal Proceedings........................................................................................ 74
MANAGEMENT OF THE COMPANY.................................................................................. 76
Directors and Executive Officers of the Company.......................................................... 76
Board of Directors Compensation.......................................................................... 79
Committees of the Directors.............................................................................. 79
Compensation of Executive Officers....................................................................... 79
Stock Option Plan........................................................................................ 80
Limitation of Directors' Liability....................................................................... 80
Indemnification.......................................................................................... 81
The Advisor.............................................................................................. 81
VOTING..................................................................................................... 84
Solicitation by the General Partners..................................................................... 84
Voting Procedures........................................................................................ 84
Record Date and Outstanding Units........................................................................ 85
Solicitation of Votes; Solicitation Expenses............................................................. 85
Revocability of Consent.................................................................................. 86
Communicating With Other Investors....................................................................... 86
No Right of Appraisal.................................................................................... 86
FIDUCIARY RESPONSIBILITIES................................................................................. 86
PRO FORMA FINANCIAL INFORMATION............................................................................ 87
THE PARTNERSHIPS........................................................................................... 105
Cap Source I............................................................................................. 105
Cap Source II............................................................................................ 107
SECONDARY MARKET AND OWNERSHIP OF PARTNERSHIP UNITS........................................................ 110
Sale Prices of Units..................................................................................... 110
Unitholders.............................................................................................. 113
</TABLE>
iv
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<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Partnership Distributions................................................................................ 113
Third Party Tender Offers................................................................................ 114
SELECTED FINANCIAL DATA OF THE PARTNERSHIPS................................................................ 115
DESCRIPTION OF CAPITAL STOCK............................................................................... 118
General.................................................................................................. 118
Common Stock............................................................................................. 118
Preferred Stock.......................................................................................... 119
Shares Eligible for Future Sale.......................................................................... 120
THE NOTES.................................................................................................. 120
General.................................................................................................. 120
Allocation of Notes...................................................................................... 120
Notes.................................................................................................... 121
CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS................................ 125
FEDERAL INCOME TAX CONSEQUENCES............................................................................ 127
General.................................................................................................. 127
Opinions of Counsel...................................................................................... 127
Certain Tax Differences Between the Ownership of Units and the Shares.................................... 128
Tax Treatment of the Transaction......................................................................... 128
Taxation of the Company.................................................................................. 130
Taxation of Shareholders................................................................................. 130
Taxation of Non-U.S. Shareholders........................................................................ 131
Tax Issues Associated with Notes......................................................................... 133
Considerations for Tax-Exempt Shareholders............................................................... 135
General Partner Liabilities.............................................................................. 136
Termination of Trade Processing.......................................................................... 136
EMPLOYEE RETIREMENT INCOME SECURITY ACT.................................................................... 136
INDEPENDENT PUBLIC ACCOUNTANTS............................................................................. 137
LEGAL MATTERS.............................................................................................. 137
GLOSSARY................................................................................................... 138
INDEX TO FINANCIAL STATEMENTS.............................................................................. FS-1
LIST OF APPENDICES
APPENDIX A--Form of Agreement and Plan of Merger........................................................... A-1
APPENDIX B--Fairness Opinion............................................................................... B-1
APPENDIX C--Bringdown Fairness Opinion..................................................................... C-1
</TABLE>
FINANCIAL STATEMENTS--The Financial Statements of the Partnerships are included
in a separate volume to this Prospectus/Consent Solicitation Statement. Such
Financial Statements constitute an integral part of this Prospectus/Consent
Solicitation Statement and should be reviewed in conjunction with this material
and the accompanying Prospectus Supplement.
v
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY DOES NOT PURPORT TO BE COMPLETE AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO THE MORE DETAILED INFORMATION APPEARING ELSEWHERE
IN THIS PROSPECTUS/CONSENT SOLICITATION STATEMENT AND THE APPENDICES AND
SUPPLEMENTS HERETO. SEE "GLOSSARY" FOR CERTAIN CAPITALIZED TERMS USED IN THIS
PROSPECTUS/ CONSENT SOLICITATION STATEMENT.
THE TRANSACTION
This Prospectus/Consent Solicitation Statement relates to the proposed
merger (the "Transaction") of Capital Source L.P., a Delaware limited
partnership ("Cap Source I"), and Capital Source II L.P.-A, a Delaware limited
partnership ("Cap Source II," and together with Cap Source I, the
"Partnerships"), and the general partners of the Partnerships (the "General
Partners"), with and into America First Real Estate Investment Company, Inc., a
newly organized Delaware corporation (the "Company"). The Company was organized
to implement a new growth-oriented business strategy for the Partnerships upon
completion of the Transaction. The Transaction is being proposed in accordance
with an Agreement and Plan of Merger among the Partnerships, the General
Partners and the Company (the "Merger Agreement"). The form of the Merger
Agreement is attached to this Prospectus/Consent Solicitation Statement as
Appendix A. In connection with the Transaction, the Company will distribute the
securities described below to the Partnerships in exchange for the assets of the
Partnerships. The Partnerships in turn will distribute the securities to their
respective holders (the "Investors") of beneficial assignment certificates
representing assigned limited partner interests in the Partnerships (the
"Units") based upon the number of Units held by each Investor, and to the
General Partners in exchange for the transfer of the General Partners' assets to
the Company pursuant to the Merger Agreement. Upon completion of the
Transaction, the separate existence of the Partnerships will cease.
Investors are being asked to approve the Transaction as described in this
Prospectus/Consent Solicitation Statement. Upon completion of the Transaction,
Investors will receive, at their election and subject to certain limitations,
shares of the Company's $.001 par value common stock (the "Shares") or the
Company's Variable Rate Junior Notes Callable On or After the Date of Issuance
(the "Notes"). The Company may, at its option, pay cash in lieu of issuing
Notes. See "THE NOTES." The General Partners will receive 33,549 shares in
connection with the Transaction. The common stock of the Company (the "Common
Stock") will be listed on the New York Stock Exchange ("NYSE"), subject to
official notice of issuance, under the symbol "AFE."
The General Partners are Insured Mortgage Equities, Inc. and America First
Capital Source I, L.L.C. (together, the "Cap Source I General Partners"), and
Insured Mortgage Equities II L.P. and America First Capital Source II, L.L.C.
(together, the "Cap Source II General Partners"). The Transaction is being
proposed by the General Partners in an effort to increase the value of the
investments held by the Investors while offering substantially enhanced
liquidity. To achieve these objectives, the General Partners are proposing to
restructure the business of the Partnerships by merging the Partnerships and the
General Partners with and into the Company in accordance with the Merger
Agreement. After the Transaction, the Company's primary business objective will
be to provide Investors who receive Shares ("Shareholders") with long term
after-tax returns that are greater than those available from real estate
investment trusts ("REITs") and other similar publicly traded real estate
companies. The Company expects to achieve this objective by investing in assets
and using investment and management strategies not generally permitted to or
used by REITs. Such strategies may include investing in real estate operating
companies, in underperforming real estate assets such as office buildings and
apartment complexes with the objective of renovating and repositioning them to
increase values, and in underperforming markets and foreign markets that the
Company expects will show significant improvement. See "THE COMPANY." There can
be no assurance, however, that the Company's business objectives will be met.
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The Transaction is subject to certain conditions and will not occur unless,
among other things: (i) both Partnerships participate in the Transaction, and
(ii) Investors who vote against the Transaction ("Dissenting Investors") do not
elect to receive more than the maximum amount of Notes issuable in connection
with the Transaction. Participation in the Transaction requires approval of a
majority in interest of Investors in each Partnership. The maximum amount of
Notes that may be issued in the Transaction (the "Maximum Note Limitation") is
$40.0 million. If the Transaction is not consummated, the Partnerships will
continue to operate as separate legal entities with their own assets and
liabilities, and their respective investment objectives, policies and
restrictions will not change.
SUMMARY RISK FACTORS
The following is a summary of the potential disadvantages, adverse
consequences and risks of the Transaction. This summary is qualified in its
entirety by the more detailed discussion in the section entitled "RISK FACTORS"
contained in this Prospectus/Consent Solicitation Statement.
- There is substantial uncertainty as to the prices at which the Common
Stock will trade after the Transaction. The price of the Shares may
decrease after the Transaction due to the potentially large number of
Shares that may be sold immediately by Shareholders. Thus, the Common
Stock may trade at prices substantially below the estimated liquidation
value of the Company's assets and the value assigned to the Shares for
purposes of the Transaction.
- A public market for the Notes is not expected to develop. If the Notes are
sold, they may sell at prices substantially below their issuance price.
Investors who receive Notes ("Noteholders") are likely to receive the full
face amount of the Notes only if they hold the Notes to maturity, which is
approximately eight years after the Transaction, or if the Company repays
or refinances the Notes at or prior to maturity.
- The General Partners initiated and participated in the structuring of the
Transaction and have certain conflicts of interests with respect to its
completion. The General Partners will receive certain economic benefits as
a result of the Transaction, including an aggregate of 33,549 shares,
which could have an approximate value of $838,725 based on an assumed
value of $25 per Share. In addition, the Company's advisor (the
"Advisor"), a subsidiary of American First Companies L.L.C. ("America
First Companies"), which controls the General Partners, will be entitled
to receive management fees from the Company following the Transaction. See
"THE TRANSACTION-- Conflicts of Interest and Benefits to Insiders" and
"MANAGEMENT OF THE COMPANY--The Advisor."
- The Transaction involves a fundamental change in the nature of the
Investors' investment from an investment in a finite-life entity in which
Investors will receive a distribution upon liquidation based on the net
proceeds from the sale of the entity's assets, to an investment in an
infinite-life entity in which Shareholders will be able to liquidate their
investments only by selling their Shares on the NYSE or in private
transactions. Retaining the finite life feature of the Partnerships would
allow Investors eventually to receive liquidation proceeds from the
disposition of the Partnership assets, and an Investor's share of these
proceeds could be higher than the amount realized from the sale of the
Company's Shares or payments on the Notes.
- There can be no guarantee with respect to the level of the Company's
future dividends, and regardless of the initial level of such dividends,
they could decline in the future so that some Shareholders would receive
dividends that are lower than the distributions they received as Investors
prior to the Transaction. The Company may also reinvest cash generated by
the sale of existing assets or from operations to acquire additional
assets, potentially causing cash dividends to be lower than the
distributions made by the Partnerships in certain cases.
- The Company has only recently been organized and has no operating history.
As a result, there can be no assurance that any of the Company's planned
future activities will be successful.
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- There is a material difference between the investment strategies and
operating policies of the Partnerships and those of the Company. The
Company's investment objectives will be to identify and pursue
growth-oriented real estate investments, which will create a greater
degree of risk for Investors than the investments of the Partnerships. The
Company's investment strategies and operating policies are determined by,
and may be modified or altered by, the Board of Directors of the Company
(the "Board of Directors") without the consent of the Shareholders.
- Dissenting Investors are not entitled to receive cash based on an
appraisal of their Units or other dissenters' rights under Delaware law,
and no such rights will be afforded by the Partnerships. Dissenting
Investors will only have the right to exchange their Units for Notes if
they so elect, subject to certain limitations. See "THE NOTES."
- There are alternatives to the Transaction. By approving the Transaction,
Investors will effectively preclude the pursuit of certain alternatives.
See "BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE
TRANSACTION--Alternatives Considered."
- The external management structure of the Company creates certain conflicts
of interest. In particular, the Company's advisor may also manage other
entities with similar investments, objectives and goals, and may be
required to resolve conflicts between the entities it manages from time to
time.
- To the extent Notes are issued, the Partnerships will be required to
recognize gain and include such gain in income. Each Investor, regardless
of whether such Investor chooses Shares or Notes, would be allocated a
portion of such gain based on his ownership of Units. The amount of such
gain could be material if the maximum amount of Notes is chosen.
- The Company intends to use debt financing to increase its real estate
asset portfolio. Although the Notes will be issued under an indenture (the
"Indenture") which creates certain debt limitations, the Company's
organizational documents do not limit the amount of debt the Company may
incur. The Company may therefore be more leveraged than either of the
Partnerships. The Company's use of debt financing may increase the
possibility of default on the Company's obligations, which could adversely
affect the Company's earnings and its ability to pay expected dividends to
Shareholders.
- Approval of the Transaction by Investors holding a majority of outstanding
Units of a Partnership may cause the Partnership to be merged with and
into the Company, and such approval will bind all Investors in such
Partnership, including Dissenting Investors and Investors who abstained
from voting with respect to the Transaction.
- The Notes, which will be prepayable at any time, are unsecured obligations
of the Company and, as a practical matter, will be junior to all other
debt of the Company. The Notes will bear interest at a variable rate that
may be lower than rates on other variable rate debt instruments that may
be perceived as having comparable or lower risks than the Notes.
Noteholders will not hold an equity interest in the Company and therefore
will not be able to participate in the Company's growth or benefit from
any increases in the value of the Shares.
- The Company may be liable for unknown, undisclosed or contingent
liabilities of the Partnerships, which could adversely affect the
liquidity of the Company and its ability to pay expected dividends to
Shareholders.
- If Dissenting Investors elect to receive Notes in excess of the Maximum
Note Limitation, the Transaction will not be consummated. If this does not
occur, but the total amount of Notes allocable to all Investors who elect
to receive Notes exceeds the Maximum Note Limitation, Notes will be
allocated first to Dissenting Investors who elected to receive Notes and
then, on a pro rata basis, to Investors who abstained from voting or who
voted "YES" in favor of the Transaction ("Consenting Investors"). Thus, an
Investor could choose Notes but receive Shares instead. To be assured of
receiving Notes, an Investor must vote "NO" with respect to the
Transaction and elect to receive Notes.
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BENEFITS OF THE TRANSACTION
The following is a summary of the principal benefits of the Transaction.
This summary is qualified in its entirety by the more detailed discussion in the
section titled "BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION"
contained in this Prospectus/Consent Solicitation Statement:
- The Transaction creates the potential for substantially enhanced liquidity
of investment due to conversion of limited partnership interests into
publicly traded Shares of the Company. There is no established public
trading market for the Units, and secondary sales activity for the Units
has been limited and sporadic at prices which the General Partners believe
are generally below fair value. The Transaction offers Shareholders
liquidity through the public trading expected to result from the listing
of the Common Stock on the NYSE.
- The Company will be afforded significant growth and profit opportunities
due to new real estate investments. The Company will expand the investment
objectives and policies of the Partnerships and will have the potential
for enhanced access to and flexibility in obtaining additional equity and
debt financing. In particular, the Company will have the ability to fund
future portfolio growth through the issuance of additional publicly traded
securities and the raising of funds from borrowing under secured and
unsecured debt obligations.
- If the Transaction is completed, affiliates of the Cap Source I General
Partners have agreed to permanently waive amounts which may be payable to
such affiliates by certain Operating Partnerships (as defined herein)
pursuant to the terms of the respective partnership agreements of such
Operating Partnerships. As of March 31, 1998, such amounts total
$3,416,295, as reflected in the financial statements of Cap Source I.
- By combining the Partnerships into a single ownership entity, the
Transaction will create an investment portfolio larger and more
diversified than the portfolio of an individual Partnership. The
diversification of assets to be held by the Company is expected to limit
the effect of adverse developments and reduce Shareholder risks associated
with investments concentrated in any particular asset type. The increased
size and the resulting combination of operations spreads the risk of the
investment over a broader group of assets and reduces the dependence of
Investors' investment upon the performance of any particular asset or
group of assets.
- The Transaction will provide a capital and operating structure that will
allow the Company to respond more efficiently to, and to anticipate the
occurrence of, changing conditions in the U.S. equity markets, thereby
potentially reducing the adverse effects of such changes.
- The Transaction will result in simplified federal and state tax reporting
for Investors. Shareholders and Noteholders will receive Form 1099 rather
than the more complicated Schedule K-1 and will no longer be subject to
state tax withholding or be required to file individual state tax returns
(other than in their state of residence) solely as a result of an
investment in the Company.
For a discussion of the potential benefits of the alternatives to the
Transaction and the reasons such alternatives were rejected by the General
Partners, see "BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE
TRANSACTION--Alternatives Considered," below, and "FAIRNESS--Comparison of
Alternatives to the Transaction." The Transaction will require Investors to
forego certain alternatives to the Transaction.
FAIRNESS
The General Partners reasonably believe the terms of the Transaction are
fair as a whole, to each of the Partnerships and to the Investors in each of the
Partnerships. The General Partners have based their determination as to the
fairness of the Transaction on the following material factors: (i) the process
of arm's-length negotiation of the terms and conditions of the Transaction, with
a committee (the "Special Committee") representing the interests of the
Partnerships and Investors; (ii) the opportunity for each
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Investor to object to the Transaction and the requirement that the Transaction
be approved by Investors holding a majority in interest in each of the
Partnerships' outstanding Units; (iii) the form and amount of consideration
offered to the Investors; (iv) the method of allocating the Shares and Notes
among the Partnerships and the General Partners in the Transaction and the
Exchange Values used in connection with this allocation (the "Exchange Values");
(v) the fairness opinion dated May 7, 1998 (the "Fairness Opinion"), and written
confirmatory opinion dated , 1998 (the "Bringdown Fairness Opinion"),
rendered by Sutro & Co., Inc. ("Sutro & Co."); (vi) the independent appraisals
(the "Appraisals") prepared by Valuation Research Corporation ("Valuation
Research"), which were used in part in the determination of the Exchange Values;
(vii) the lack of material differences with respect to the assets of the
Partnerships and the consistent valuation methodology applied to the assets; and
(viii) the fact that all Investors, including Dissenting Investors, will be
given the opportunity to elect to receive Notes, subject to certain limitations.
For a more detailed discussion of the General Partners' belief as to the
fairness of the Transaction, see "FAIRNESS."
The General Partners arranged for the organization of the Special Committee
to represent the interests of the Partnerships and Investors in negotiating
terms and conditions of the Transaction. The Special Committee reviewed and
approved the Exchange Values attributable to each of the Partnerships and
General Partners and negotiated the fees to be paid by the Company to America
First Real Estate Advisors LLC, a Delaware limited liability company (the
"Advisor"), following the Transaction. The Special Committee also concluded that
the terms of the Transaction are fair as a whole, to the Partnerships and to the
Investors in each of the Partnerships. The Special Committee was retained
without conditions or restrictions.
The members of the Special Committee are Messrs. Martin A. Massengale and
George J. Kubat. Since the organization of the Special Committee, it has met in
person on four occasions and has had six additional telephonic meetings, and
numerous telephone conferences for the purpose of considering the proposed
Transaction. As part of its analysis of the Transaction, the Special Committee
engaged its own legal counsel and also engaged Sutro & Co. to render the
Fairness Opinion with regard to the Transaction. See "FAIRNESS OPINION AND
APPRAISALS."
Messrs. Massengale and Kubat are outside members of the Board of Managers of
America First Companies, which controls the General Partners; however, neither
is an officer or employee of America First Companies and neither owns an equity
interest in America First Companies. Furthermore, neither member of the Special
Committee will receive an economic benefit which is contingent upon the
completion of the Transaction.
FAIRNESS OPINION
The Special Committee retained Sutro & Co. to render the Fairness Opinion as
to the fairness, from a financial point of view, of the Transaction. Based on
the analysis described under "FAIRNESS OPINION AND APPRAISALS--Fairness
Opinion," and subject to the assumptions, limitations and qualifications noted
in the Fairness Opinion, Sutro & Co. concluded that the aggregate consideration
to be received by the Investors and General Partners, collectively, the
allocation of such consideration among the Investors and General Partners, and
the principal allocation of the Notes, in the Transaction, is fair to the
Investors and the General Partners from a financial point of view.
The full text of the Fairness Opinion and the assumptions and qualifications
made, matters considered and limitations imposed on the review and analysis, is
set forth at Appendix B attached hereto and should be read in its entirety.
BRINGDOWN FAIRNESS OPINION
Sutro & Co. subsequently delivered its Bringdown Fairness Opinion, that the
Transaction continues to be fair from a financial point of view. The full text
of the Bringdown Fairness Opinion, which contains a description of the
assumptions and qualifications made, matters considered and limitations imposed
on the
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review and analysis, is set forth in Appendix C and should be read in its
entirety. See "FAIRNESS OPINION AND APPRAISALS--Bringdown Fairness Opinion."
RECOMMENDATION OF THE GENERAL PARTNERS AND THE SPECIAL COMMITTEE; FAIRNESS
DETERMINATION
The General Partners, together with the Special Committee, have determined
that the Transaction is in the best interests of the Investors and that it is
fair to the Partnerships, to the Investors in each of the Partnerships and as a
whole. Accordingly, the General Partners have approved the Transaction and the
Merger Agreement, and the General Partners and the Special Committee recommend
that Investors vote "YES" in favor of the Transaction and the adoption of the
Merger Agreement. The General Partners believe the Transaction is the most
attractive alternative for providing Investors with the possibility of
increasing the value of their investments while offering substantially enhanced
liquidity. See "THE TRANSACTION--Recommendation of the General Partners and the
Special Committee" and "FAIRNESS."
APPRAISALS
In connection with the Transaction, Valuation Research, an independent full
service appraisal firm, rendered its opinion as to the fair market value of the
real estate held by the Operating Partnerships (the "Properties"). In its
appraisal of the Properties, Valuation Research considered the cost approach,
the direct sales comparison approach and the income approach to market value,
and relied upon the income approach as its primary appraisal technique, using
the direct sales comparison approach as a basis for checking the reasonableness
of the results obtained using the income approach. See "FAIRNESS OPINION AND
APPRAISALS--Appraisals."
CONTACTS REGARDING FAIRNESS OPINIONS, VALUATIONS AND OTHER REPORTS
In addition to Sutro & Co., the Special Committee conducted interviews with
three other firms regarding the possibility of advising the Special Committee
with respect to the Transaction and issuing a fairness opinion for the
Transaction. The three other firms were Valuation Research, J.C. Bradford & Co.
and Schroders. The Special Committee selected Sutro & Co. over these firms based
on Sutro & Co.'s experience in similar transactions and its research
capabilities, reputation, resources and more competitive fee structure. Prior to
organizing the Special Committee, representatives of the General Partners
contacted Robert A. Stanger & Co., Inc. regarding a fairness opinion for the
Transaction. The representatives of the General Partners did not pursue these
discussions after it was decided that the Special Committee would select the
fairness opinion provider. Other than Valuation Research and Robert A. Stanger &
Co., Inc., the General Partners did not make any other contacts with outside
parties regarding the valuation of the Properties or other Partnership assets or
commission any other report with respect to the Transaction. See "BENEFITS OF,
AND BACKGROUND AND REASONS FOR, THE TRANSACTION--Preparation for and Chronology
of Events Leading to the Transaction."
THE SHARES
In connection with the Transaction, the Company will issue to the
Partnerships up to an aggregate of 3,354,887 Shares. Of these Shares, the
General Partners will receive an aggregate of 33,549 Shares in exchange for
transferring their assets to the Company in connection with the Transaction. The
total number of Shares allocated to the Partnerships and the General Partners
was based upon the Exchange Value for each Partnership and was derived by
dividing such Exchange Value by $25, an arbitrary price per Share chosen by the
General Partners for the sole purpose of allocating the Shares.
THE NOTES
All Investors, including Dissenting Investors, will be given the opportunity
to elect to receive Notes instead of Shares, subject to the limitations
discussed below. The Notes will be Variable Rate Junior Notes Callable On or
After the Date of Issuance and will be unsecured obligations of the Company. The
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Company may issue additional senior debt, which may be secured, in compliance
with the covenants of the Notes for the issuance of senior debt.
The Notes will bear interest at a floating rate equal to 120% of the annual
applicable federal rate for debt instruments with a term of not over three years
as determined under the Internal Revenue Code of 1986, as amended (the "Code")
and applicable regulations thereunder. The interest rate on the Notes will be
adjusted and paid annually. The Notes will mature on , 2006 and are
subject to optional redemption by the Company at any time. This optional
redemption may prevent the sale of the Notes at a premium and limit the term the
Notes will be outstanding. See "THE NOTES."
The Company may, at its option, pay cash in lieu of issuing the Notes. If
the Company elects to pay cash to Investors otherwise entitled to receive Notes,
it will pay such Investors an amount equal to the principal amount of Notes such
Investors would have received plus interest accrued to the date of payment at a
rate determined as set forth above.
The total amount of Notes to be issued is subject to the Maximum Note
Limitation, which is equal to $40.0 million. See "THE NOTES."
VOTING PROCEDURES
Each Investor is being asked by the General Partners to consider the
following elections with respect to the Transaction:
"YES," I approve of my Partnership's participation in the Transaction.
or
"NO," I do not approve of my Partnership's participation in the Transaction.
Investors may also abstain from voting.
Each Unit entitles the holder thereof to one vote. An Investor will receive
Shares unless the Investor elects to receive Notes. An Investor may elect to
receive Notes regardless of whether he votes "YES" or "NO" with respect to the
Transaction. An otherwise valid consent card will be deemed to grant consent to
the Transaction if it is not marked "NO" or to abstain. See "VOTING."
The General Partners will not hold a meeting of the Investors to consider
the Transaction, but instead are seeking the written consent of the Investors as
provided in Article X of the respective limited partnership agreements of the
Partnerships (the "Partnership Agreements"). Only Investors holding Units as of
, 1998 (the "Record Date") will be entitled to vote with respect to the
Transaction. A consent card (the "Consent Card") is included with this
Prospectus/Consent Solicitation Statement and Investors are asked to complete,
date and sign the Consent Card and return it to Service Data Corporation in the
enclosed envelope as soon as possible. In order to be valid, consents must be
received by Service Data Corporation by 5:00 p.m. Central Time on ,
1998, unless such date is extended by the General Partners in their sole
discretion (the "Approval Date"). See "VOTING."
An Investor who does not wish to approve his Partnership's participation in
the Transaction may either (i) vote "NO" or (ii) abstain from voting. An
Investor who votes "NO" will receive Shares if the Transaction is completed,
unless such Investor elects to receive Notes as indicated on the Consent Card.
An Investor who abstains from voting with respect to the Transaction by
indicating his abstention on the Consent Card will also receive Shares if the
Transaction is completed, unless such Investor elects to receive Notes as
indicated on the Consent Card. An Investor who does not return the Consent Card
will receive Shares if the Transaction is completed. Investors may withdraw or
revoke their consent at any time prior to the Approval Date. See
"VOTING--Revocability of Consent."
THE GENERAL PARTNERS BELIEVE THAT THE TERMS OF THE TRANSACTION ARE FAIR AND
IN THE BEST INTERESTS OF THE PARTNERSHIPS AND THE INVESTORS AND RECOMMEND THAT
INVESTORS VOTE "YES" IN FAVOR OF THE TRANSACTION.
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COMMUNICATING WITH OTHER INVESTORS
Under Rule 14a-7 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), each Partnership, upon written request from an Investor, will
deliver to such Investor (i) a statement of the approximate number of Investors
of the Partnership and (ii) the estimated cost of mailing proxy materials or
similar communications to the Investors of such Partnership. In addition, under
such rule, an Investor has the right, at his or her option, to have his or her
Partnership (i) mail (at the Investor's expense) any such materials which the
Investor desires to deliver to the other Investors of the Partnership in
connection with the Transaction or (ii) to have the Partnership deliver, within
five business days of the receipt of the request, a reasonably current list of
the names and addresses of the Investors of the Partnership as of the Record
Date. The Partnerships may require a requesting Investor to pay the reasonable
cost of duplicating and mailing such Investor list. Any such requests should be
sent to Maurice Cox, Suite 400, 1004 Farnam Street, Omaha, Nebraska, 68102.
NO DISSENTERS' RIGHTS
Dissenting Investors are not entitled to receive cash based on an appraisal
of their Units or other dissenters' or appraisal rights under the Partnership
Agreements or Delaware law, nor will such rights be provided by the Partnerships
or the Company. Dissenting Investors do, however, have the right to elect to
exchange their Units for Notes rather than Shares. If a Dissenting Investor
votes against the Transaction but does not elect to receive Notes, the
Dissenting Investor will receive Shares. See "VOTING--No Right of Appraisal."
THE COMPANY
The Company was organized under the laws of the State of Delaware on
February 5, 1998, to facilitate the Transaction. As a result of the Transaction,
the Company will acquire the assets and liabilities of the Partnerships and
General Partners.
Following the Transaction, the Company's primary business objective will be
to provide Shareholders with long term after-tax returns that are greater than
those available from REITs and other similar publicly traded real estate
companies. The Company expects to achieve this objective by investing in assets
and using investment and management strategies not generally permitted to or
employed by REITs. There can be no assurance, however, that the Company's
business objectives will be met.
In furtherance of its business objectives, the Company intends to focus
initially on investments in four distinct aspects of the real estate business.
The Company will seek to acquire underperforming real estate assets such as
office, residential and other commercial properties and attempt to improve their
value by renovation, redevelopment, and/or releasing and by acquiring over time
groups of similar assets that have a value as a portfolio greater than their
individual values. The Company will also seek investments in real estate
operating companies. Such operating companies include brokers, developers,
partnerships and general partners thereof which own real estate, and other
similar companies. In addition, the Company plans to consider investments in
foreign or foreign-controlled real estate. The Company will also maintain
ownership in the Operating Partnerships and plans to conduct a detailed
evaluation of each of the Properties in order to determine the best strategy to
maximize their value to the Company.
The Company's investment strategy will be funded initially from available
cash and short-term investments and from borrowing against the mortgage-backed
securities (the "GNMA Certificates") guaranteed as to principal and interest by
the United States Government National Mortgage Association ("GNMA") and first
mortgage loans on multifamily housing properties (the "FHA Loans") insured as to
principal and interest by the United States Federal Housing Authority (the
"FHA"), which the Company will acquire from the Partnerships in connection with
the Transaction. The Company also plans to seek additional sources of financing,
both debt and equity, to further its business objectives and investment
strategies.
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The Company currently does not intend to qualify as a REIT under the Code.
Consequently, the Company will have the flexibility to respond quickly to
opportunities without the structural limitations imposed by the Code on REITs
and to operate, when deemed advantageous by management, on a more highly
leveraged basis than most REITs. By not qualifying as a REIT under the Code
(which would require the Company to distribute each year at least 95% of its net
taxable income, excluding capital gains), the Company will have the ability to
retain cash flow generated from operations, to retain proceeds from sales of
properties for reinvestment and to sell properties without the substantial
income tax penalties which may be imposed on REITs from certain prohibited
transactions.
In addition, the Company differs from real estate opportunity funds that are
typically structured as private partnerships. Such private partnerships
typically have a finite life which limits their ability to grow and may limit
their ability to maximize value. Furthermore, investment in such private
partnerships are generally limited to large, institutional investors. Unlike
investors in such private partnerships, the Company's Shareholders are expected
to have enhanced liquidity through their ability to sell or margin their Shares.
However, unlike private partnerships and in most cases REITs, the Company will
be subject to corporate level taxation.
The Company will enter into an advisory agreement (the "Advisory Agreement")
with the Advisor to manage the assets held by the Company and to provide other
services to the Company. See "MANAGEMENT OF THE COMPANY--The Advisor" below. The
principal executive offices of the Company are located at 399 Park Avenue, New
York, New York 10022, and its telephone number is (212) 935-8760.
THE ADVISOR
Under the terms of the Advisory Agreement, the Advisor will manage the
investments of the Company, formulate investment criteria, represent the Company
in connection with the acquisition and disposition of real estate assets,
recommend strategies to improve the performance of the Company's investments,
administer the day-to-day operation of the Company, communicate with and
maintain relations with the investors of the Company, and perform such other
services as set forth in the Advisory Agreement and as directed from
time-to-time by the Board of Directors. An external advisor is being used by the
Company in place of full time employees. The General Partners believe that the
Company is not of sufficient size to economically employ on a full time basis
all necessary management or employees with the requisite expertise for managing
the Company's assets.
The Advisory Agreement will have an initial term of three years (subject to
earlier termination as provided therein), and will automatically renew for one
year terms unless written notice of termination is delivered 180 days prior to
the expiration of any term. The Advisor will bear all costs of providing
services to the Company, except for the costs of services provided by third
parties, certain limited office expenses and travel expenses on behalf of the
Company. Pursuant to the terms of the Advisory Agreement, the Advisor will
receive compensation (the "Advisor Fees") in the form of an Acquisition Fee, an
Asset Management Fee and an Incentive Fee on New Assets, as more particularly
described under "MANAGEMENT OF THE COMPANY--The Advisor--THE ADVISORY
AGREEMENT." The Advisor Fees were negotiated with the Advisor by the Special
Committee. The Company may engage affiliates of the Advisor to provide other
services if approved by, and upon the terms approved by, the Independent
Directors (as defined herein) of the Company. See "MANAGEMENT OF THE COMPANY."
The Advisor is indirectly owned by America First Companies, an affiliate of the
General Partners. In addition, four of the directors and/or officers of the
Company are directors and/or officers of the Advisor. See "MANAGEMENT OF THE
COMPANY--Directors and Executive Officers of the Company" and "--Directors and
Executive Officers of the Advisor."
BACKGROUND AND REASONS FOR THE TRANSACTION
Cap Source I was formed in 1985 and Cap Source II was formed in 1986. Both
Partnerships were formed to make debt and equity investments in multifamily
rental complexes (the "Complexes"). The
11
<PAGE>
Partnerships were organized and sponsored by persons not affiliated with the
Company, the Advisor or their affiliates. The current General Partners acquired
ownership of the General Partner entities in 1991 and 1997.
The General Partners have proposed the Transaction in an effort to, among
other things, increase the value of the investments held by the Investors while
offering substantially enhanced liquidity, provide a capital and operating
structure that will be able to respond more efficiently to changing conditions
in the U.S. equity markets, and simplify federal and state tax reporting for
Investors. To achieve these objectives, the General Partners are proposing to
restructure the business of the Partnerships by merging them with and into
Company, which will pursue new business objectives and will list its Common
Stock on the NYSE. See "THE COMPANY" and "BENEFITS OF, AND BACKGROUND AND
REASONS FOR, THE TRANSACTION."
EXCHANGE VALUE
Investors will receive Shares or Notes based upon the exchange values (the
"Exchange Values") set forth in the table below. In connection with the
Transaction, the General Partners will receive an aggregate of 33,549 Shares, or
approximately 1% of all Shares outstanding following the completion of the
Transaction assuming no Notes are issued, in exchange for all of their tangible
and intangible assets. Approximately 89% of the Partnerships' combined assets
are in the form of (i) cash, (ii) the GNMA Certificates, which are
collateralized by first mortgage loans on multifamily housing properties, and
(iii) the FHA Loans. The Exchange Values, which were initially determined by the
General Partners and subsequently reviewed and approved by the Special
Committee, are based on (i) the principal amount of GNMA Certificates and the
FHA Loans as set forth in the Partnerships' audited financial statements for the
period ended December 31, 1997, (ii) the value of the Partnerships' limited
partnership interests in the Operating Partnerships, and (iii) the market value
of the Partnerships' remaining net assets as set forth in the Partnerships'
audited financial statements for the period ended December 31, 1997. See
"EXCHANGE VALUES."
The following table sets forth the Exchange Values attributable to the
Partnerships for purposes of the Transaction.
EXCHANGE VALUE
<TABLE>
<CAPTION>
EXCHANGE VALUE PER $1,000
TOTAL EXCHANGE ORIGINAL INVESTMENT
PARTNERSHIP VALUE BY INVESTORS(1)
- ---------------------------------------------- ------------------- ---------------------------
<S> <C> <C>
Cap Source I.................................. $ 50,991,970 $ 748
Cap Source II................................. 32,880,190 406
-------------------
Total....................................... $ 83,872,160
-------------------
-------------------
</TABLE>
- ------------------------
(1) Since the initial investment by Investors, per $1,000 original investment,
the Cap Source I Investors have received a return of capital of $83 and the
Cap Source II Investors have received a return of capital of $381.
CONSIDERATION OF ALTERNATIVES
In addition to the proposed Transaction, the General Partners considered the
following options: (i) continued management of the Partnerships as currently
structured, (ii) listing the Units of each Partnership on a national securities
exchange or automated quotation system; (iii) merging the Partnerships into a
single publicly traded partnership and listing the resulting partnership
interests on a national securities exchange or automated quotation system; (iv)
merging the Partnerships together to form a single REIT; (v) qualifying each
Partnership as an individual REIT; and (vi) liquidating the Partnerships through
12
<PAGE>
entire portfolio sales or sales of individual properties. For the reasons set
forth under "BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE
TRANSACTION--Alternatives Considered," the General Partners rejected each of the
alternatives in favor of the Transaction.
CONTINUATION OF THE PARTNERSHIPS. An alternative to the Transaction would
be to continue each of the Partnerships in accordance with its respective
existing business plan and the Partnership Agreements. Continuing the
Partnerships without change would have the following benefits: (i) each
Partnership would remain a separate entity, with its own assets and liabilities,
and would remain under an obligation to pursue its original investment
objectives, consistent with the Partnership Agreement; (ii) the Partnership's
performance would not be affected by the performance of the other Partnership,
including the investment objectives, interests and intentions of the Investors
in the other Partnership; (iii) the Partnerships would not incur any expenses in
connection with the Transaction; (iv) the Partnerships would avoid the risks
inherent in the Transaction; and (v) the Partnerships would continue their tax
advantaged status and not be subject to federal income tax. See "RISK FACTORS."
However, maintaining the Partnerships as separate entities would have the
following disadvantages, among others: (i) illiquidity of investment on a
current basis due to the lack of a large and established secondary market; (ii)
inability to raise new capital or make new investments, thus limiting growth of
the Partnerships' capital to that inherent in the existing Partnership
investments; (iii) less flexibility and control in actively managing the
portfolio; (iv) duplication among the Partnerships in reporting, filing and
other costly administrative services; (v) continued complicated tax filings for
Investors; and (vi) the declining value of the mortgage investments due to
amortization and subsequent distribution of such amounts.
LISTING THE PARTNERSHIP UNITS. Another alternative to the Transaction would
be to list the Units of each Partnership on a national securities exchange or an
automated quotation system in an attempt to increase the liquidity of the Units.
However, the General Partners believe that limited partnership units generally
do not trade well on such exchanges or automated quotation systems and that
meaningful liquidity would not be achieved. Furthermore, the General Partners
believe that the market tends to view common stock more favorably than limited
partnership units and that pursuing this alternative would substantially
diminish the Partnerships' ability to grow compared to the Transaction. As a
publicly traded company with a base of assets greater than a single Partnership,
the Company expects to be able to issue additional debt and equity securities
with greater ease and on more attractive terms than would be available to a
Partnership individually. The General Partners therefore concluded that the
potential negatives of this alternative outweigh any advantages it may have over
the Transaction.
MERGER RESULTING IN A SINGLE PUBLICLY TRADED LIMITED PARTNERSHIP. Instead
of participating in the Transaction, the Partnerships could be merged together
to form a single publicly traded limited partnership with the partnership units
of the new partnership listed on a national securities exchange or quoted on an
automated quotation system. For the reasons discussed above with respect to
listing the Units of each individual Partnership, the General Partners
determined that this alternative is less advantageous to the Investors than the
Transaction.
SINGLE REIT. The General Partners considered merging the two Partnerships
into a single entity which would elect REIT status but determined that it was a
less attractive alternative to the Transaction. The General Partners concluded
that the resulting REIT would be too small in terms of total capitalization to
compete with existing REITs having similar investment objectives. Specifically,
the initial capitalization of the new company would be less than $85 million, in
contrast to over 85 publicly traded REITS with total current capitalization in
excess of $500 million each, placing the new company at a significant
disadvantage. For example, many investment opportunities available to the
competition would be foreclosed to the new company because of its small size and
resulting difficulty in attracting capital at competitive pricing. As such,
growth prospects would be constrained by the new company's unfavorable
competitive position. Furthermore, due to restrictions in the Code relating to
distributions of net taxable income and limitations on sales of assets, as a
REIT, the new company would not be able to pursue the business plan described
13
<PAGE>
herein which involves the ability to retain cash flow for investment purposes
and to sell assets regularly after the achievement of goals set for those
assets.
INDIVIDUAL REIT. The General Partners considered converting each
Partnership into an individual REIT, but determined that it was a less
attractive alternative than the Transaction for the same reasons discussed above
for the single REIT alternative. The issues cited above as reasons for the lack
of attractiveness of a new company as a single REIT would be magnified when
applied to each Partnership as an individual REIT due to the significantly
smaller size of each Partnership as a stand alone entity.
LIQUIDATION. Although the investment objectives and policies of the
Partnerships do not contemplate the commencement of the liquidation of the
Partnerships at any specific time, the General Partners assessed the possibility
of commencing the orderly liquidation of the Partnerships and distributing the
net proceeds from such liquidation to the Investors and General Partners. The
General Partners concluded that liquidation would be costly and time-consuming
and would not be as beneficial to Investors as the Transaction.
The General Partners determined that an attempt to liquidate the
Partnerships' investments at the current time would likely result in the
Investors not achieving the full potential benefits from an investment in the
Partnerships. They concluded that liquidation would not be the best option to
realize the optimum return on an investment in the Partnerships because although
the Partnerships' investments in mortgage loans could likely be sold at or
slightly above their face value, most of the Partnerships equity positions in
the Operating Partnerships are not attractive to buyers due to restrictions in
the various partnership documents. Liquidation of most of the equity positions
would require either (i) a protracted period of negotiations with the various
general partners of the Operating Partnerships which could potentially create
both substantial transaction costs and additional costs to the Partnerships of
continuing operations during the negotiation period, and/or (ii) the
Partnerships' accepting substantial discounts in value. In addition, there may
be additional costs associated with representations, warranties, and
indemnifications that purchasers generally require and which may result in
additional escrow costs and a delay in final distributions to Investors.
Furthermore, the liquidation of the Partnerships would involve certain
transaction costs, such as legal fees and various other closing costs, which
would further reduce the amount of net proceeds available for distribution.
On the other hand, in a liquidation of the Partnerships, Investors would
benefit by avoiding the risks of continuing their ownership of the Partnerships
and those associated with the Transaction. Liquidation would provide for the
final liquidation of the Investors' investments and a likely substantial
distribution of cash equal to net liquidation proceeds, though not in an amount
that would allow Investors to realize their original investment. In addition,
the Investors would have the potential to reinvest the net proceeds received in
the liquidation in similar or different investments.
CONFLICTS OF INTERESTS AND BENEFITS TO INSIDERS
The General Partners have participated in the initiation and structuring of
the Transaction and are expected to receive certain benefits as a result of its
completion. First, in connection with the Transaction, the General Partners will
receive an aggregate of 33,549 Shares in exchange for their assets. These Shares
could have an approximate value of $838,725 based on an assumed value of $25 per
Share. In addition, the Advisor, a subsidiary of America First Companies, which
is the entity that controls the General Partners, will serve as the advisor to
the Company and will be entitled to receive management fees from the Company
pursuant to the Advisory Agreement. See "MANAGEMENT OF THE COMPANY--The
Advisor." Further, Michael B. Yanney, who is a member and manager of America
First Companies, will also serve as Chairman of the Board of the Company and the
Advisor. As such, he will be entitled to receive stock options under the
Company's 1998 Stock Option Plan. See "MANAGEMENT OF THE COMPANY--Compensation
of Executive Officers" and "THE TRANSACTION--Conflicts of Interests and Benefits
to Insiders."
14
<PAGE>
COMPENSATION, REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNERS
The following table sets forth the cash distributions, fees and
reimbursements the General Partners currently receive from the Partnerships and
the fees that the Advisor, an Affiliate of the General Partners, would have
received from the Company had the Transaction occurred prior to the periods
indicated.
COMPARISON OF COMPENSATION,
REIMBURSEMENTS AND DISTRIBUTIONS TO
GENERAL PARTNERS
<TABLE>
<CAPTION>
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
ACTUAL AMOUNTS PAID TO GENERAL PARTNERS
Capital Source I
- -----------------------------------------------------------------------------
1% Share of Cash Distributions(1)........................................ $ 34,424 $ 34,424 $ 34,424
Asset Management and Partnership Administrative Fee(2)................... 0 0 0
Reimbursements(3)........................................................ 138,857 193,822 240,759
---------- ---------- ----------
Subtotal............................................................... $ 173,281 $ 228,246 $ 275,183
---------- ---------- ----------
Capital Source II
- -----------------------------------------------------------------------------
1% Share of Cash Distributions(1)........................................ $ 32,818 $ 32,818 $ 32,818
Asset Management and Partnership Administrative Fee(4)................... 166,000 166,000 166,000
Reimbursements(3)........................................................ 128,754 165,424 211,845
---------- ---------- ----------
Subtotal............................................................... $ 327,572 $ 364,242 $ 410,663
---------- ---------- ----------
Total.................................................................... $ 500,853 $ 592,488 $ 685,846
---------- ---------- ----------
---------- ---------- ----------
COMPANY--FEES PAYABLE TO THE ADVISOR
Acquisition Fee(5)......................................................... $ 0 $ 0 $ 0
Asset Management Fee(6).................................................... 431,790 429,968 433,014
Incentive Fee(7)........................................................... 0 0 0
---------- ---------- ----------
Total.................................................................... $ 431,790 $ 429,968 $ 433,014
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
(1) The respective Partnership Agreements provide that 1% of cash available for
distribution will be allocated to the General Partners.
(2) The General Partners are entitled to receive an asset management and
partnership administrative fee equal to 0.5% of invested assets per annum,
payable only during such years that an 8% return has been paid to investors
on a noncumulative basis. Any unpaid amounts will accrue and be payable only
after a 13% annual return to investors has been paid on a cumulative basis
and the investors have received the return of their capital contributions.
(3) The General Partners are paid or reimbursed for certain costs and expenses
incurred in connection with the operation of the Partnership. The increase
in historical reimbursements to the General Partners from 1995 to 1997 is
primarily the result of an increase in salaries and related expenses.
Starting in 1996, additional management time was incurred in exploring
various options available to the Partnerships to improve total returns. The
pro forma compensation to the Advisor does not reflect this increase because
the Advisor's fees are based on asset values, not specific reimbursements.
For a description of the fee structure of the Advisor, see "MANAGEMENT OF
THE COMPANY--The Advisor--THE ADVISORY AGREEMENT."
(4) The General Partners are entitled to receive an asset management and
partnership administrative fee equal to 0.5% of invested assets per annum,
the first $50,000 of which shall be paid each year with the balance payable
only during such years that a 6.5% annual return has been paid to investors
on a noncumulative basis. An additional fee of 0.5% of invested assets will
be paid in those years that an 11.5% annual return has been paid to
investors on a cumulative basis. Any unpaid amounts will accrue
15
<PAGE>
and be payable only after an 11.5% annual return to investors has been paid
on a cumulative basis and the investors have received the return of their
capital contributions.
(5) No acquisition fees would have been paid because no new assets were
purchased or permitted to be purchased in the years 1995 to 1997.
(6) Calculated based on the Advisor fees described in more detail under
"MANAGEMENT OF THE COMPANY--The Advisor".
(7) No incentive fee would have been paid because no new assets were owned which
would have qualified for such a fee if sold.
DIVIDEND POLICY
The Company intends to pay regular quarterly dividends to its Shareholders,
beginning with the first full fiscal quarter following the completion of the
Transaction, subject to the discretion of, and in amounts determined by, the
Board of Directors. The Company intends to distribute substantially all of its
net cash flow from operations, after giving effect to any reasonable reserves,
as dividends with respect to the Company's first four complete quarters of
operations. In addition, the Company intends to distribute with respect to the
first two complete quarters of operations an amount which is the greater of (i)
substantially all of its net cash flow from operations as described above, or
(ii) the cash distributions which would have been distributed to Cap Source I
investors if the Transaction had not occurred and distributions were made at the
same quarterly rates as were made in 1997 for the Cap Source I Partnership, or
(iii) cash distributions which would have been distributed to Cap Source II
investors if the Transaction had not occurred and distributions were made on the
basis of actual net cash from operations of Cap Source II. The Company
anticipates that the amount resulting from the application of (ii) and (iii)
above will be $.42 per share per quarter.
FEDERAL INCOME TAX CONSEQUENCES
The Company will not recognize any gain or loss as a result of the
Transaction. In addition, the Partnerships will not recognize gain as a result
of the Transaction except to the extent of the fair market value of any Notes
received in the Transaction subject to the assumptions and other matters
discussed in this Prospectus/Consent Solicitation Statement under "FEDERAL
INCOME TAX CONSEQUENCES-- Tax Treatment of the Transaction." The Company will be
characterized as a corporation for federal income tax purposes. Therefore, the
Company's income and gains are subject to federal corporate income taxation and
do not pass through to the Shareholders. In addition, all items of losses,
deductions and credits must be used to offset the Company's income and thus are
not passed through to the Shareholders. See "FEDERAL INCOME TAX
CONSEQUENCES--Taxation of the Company." Distributions by the Company to
Shareholders will generally be characterized as dividends and taken into account
by Shareholders as ordinary income. Dividends by the Company will be treated as
portfolio income to the Shareholders and, thus, will not be available to offset
passive losses from any other source. See "FEDERAL INCOME TAX
CONSEQUENCES--Taxation of Shareholders."
Dividends by the Company will not constitute unrelated business taxable
income to tax-exempt Shareholders unless Shares are "debt-financed property."
Shares will generally be deemed "debt-financed property" in the hands of a
tax-exempt Shareholder if such Shares are subject to debt. See "FEDERAL INCOME
TAX CONSEQUENCES--Considerations for Tax-Exempt Shareholders."
ACCOUNTING TREATMENT
The Transaction will be accounted for using the purchase method of
accounting in accordance with generally accepted accounting principles ("GAAP").
Cap Source I will be deemed to be the acquirer of Cap Source II under the
purchase method because its Unitholders will be allocated the largest number of
Shares. Accordingly, the Transaction will result, for financial accounting
purposes, in the effective purchase by Cap Source I of all of the Units of Cap
Source II. As the surviving entity for financial accounting
16
<PAGE>
purposes, the assets and liabilities of Cap Source I will be recorded by the
Company at their historical cost and the assets and liabilities of Cap Source II
will be recorded at their estimated fair values.
RATIO OF EARNINGS TO FIXED CHARGES
The ratio of earnings to fixed charges for Cap Source I for the last five
fiscal years beginning December 31, 1993 and ending December 31, 1997 were 5.4,
9.6, 6.0, 5.7 and 5.3, respectively. The ratio was 4.8 for the quarter ended
March 31, 1998. The ratio of earnings to fixed charges for Cap Source II was 0.0
for the last five fiscal years ending December 31, 1997, and the quarter ended
March 31, 1998, because Cap Source II had no fixed charges for these periods.
ORGANIZATIONAL STRUCTURE
The following diagrams set forth the current organizational structure of the
Partnerships.
Chart depicting the organizational structure of Cap Source I before the
Transaction, including the General Partners.
17
<PAGE>
Chart depicting the organizational structure of Cap Source II before the
Transaction, including the General Partners.
18
<PAGE>
The following diagram sets forth the organizational structure of the Company
after the Transaction. The total number and percent of Shares refer to the
Shares issued in connection with the Transaction assuming no Notes are issued.
Chart depicting the organizational structure of the Company after completion of
the Transaction, including the Advisor.
*The Shareholders are the various limited partners who own a 30.6% equity
interest in Insured Mortgage Equities II L.P.
**Affiliates of America First Companies own a 1% General Partner interest in
these Operating Partnerships.
19
<PAGE>
COMPARISON OF UNITS AND SHARES
The following is a summary of certain attributes of the ownership of Units
and the ownership of Shares. The following descriptions are qualified in their
entirety by reference to the Company's Second Amended and Restated Certificate
of Incorporation (the "Certificate of Incorporation") and Bylaws (the "Bylaws,"
and together with the Certificate of Incorporation, the "Organizational
Documents") and to each Partnership's Partnership Agreement. The descriptions
are summaries and do not purport to be complete discussions of these matters.
Investors are encouraged to review carefully the more detailed comparison
regarding the Units, the Shares and the Notes discussed in "COMPARISON OF
LIMITED PARTNERSHIP AND CORPORATE STRUCTURE" and this Prospectus/Consent
Solicitation Statement for additional comparisons.
<TABLE>
<CAPTION>
CHARACTERISTICS INVESTORS SHAREHOLDERS
- ---------------------------------------- ----------------------------------- -----------------------------------
<S> <C> <C>
Business -Equity and debt investments in -Equity and debt investments in
multifamily rental complexes real estate and real estate
related activities
Liquidity -Illiquid - no established market -Traded on NYSE
-Transfers are subject to -Freely transferable
limitations
Property Portfolio -Static portfolio -Investment flexibility
-More diversification and ability
to grow
-Larger portfolio
Duration -40 to 49 years from formation -Perpetual
Federal Taxation -The Partnerships are not subject -The Company is subject to federal
to federal tax tax as a C corporation
State Tax Withholding -Some states require withholding on -Generally, no withholding
partnership distributions
Tax Characterization of Income -Passive income -Portfolio income
Tax Reporting -Schedule K-1, generally mailed by -Form 1099-DIV must be mailed by
March 15 of each year January 31 of each year
Borrowing -New borrowing generally not -Generally permitted
permitted
Management -Vested in two General Partners -Vested in Board of Directors
elected by Shareholders
Voting -Voting is based on Investor's -One vote per Share
ownership interest in a
Partnership; voting is generally
permitted only for significant
actions
</TABLE>
20
<PAGE>
RISK FACTORS
The Transaction involves certain risks and other adverse factors. Each
material risk relating to the Company and the Transaction is described below.
Investors should read this entire Prospectus/Consent Solicitation Statement,
including all appendices and supplements hereto, and consider carefully the
following factors in evaluating the Transaction, the Company and its business
before completing the accompanying Consent Card. The risks described below are
materially the same for the Investors of each of the Partnerships.
RISKS ASSOCIATED WITH THE TRANSACTION
NO PRIOR MARKET FOR THE SHARES; MARKET PRICE MAY DECREASE AFTER THE
TRANSACTION. Prior to the Transaction, there has been no public market for the
Shares, and there can be no assurance that an active trading market will develop
or be sustained. There is substantial uncertainty as to the prices at which the
Shares will trade, and the possibility exists that the trading price of the
Shares may be lower than the proportionate Exchange Value estimated for each
Share. The price of the Shares may decrease after the Transaction due to the
potentially large number of Shares that may be sold immediately by Investors who
elect to receive Shares. The market value of the Shares could also be
substantially affected by numerous factors such as: governmental regulatory
action; changes in tax laws; the market's perception of the Company and its
ability to maintain or increase dividend levels; the size of the Company in
terms of assets and market capitalization; the degree to which the management's
interests are perceived to be aligned with the interests of Shareholders; the
degree to which leverage is used in the Company's capital structure; the
historical performance of the Partnerships; external factors such as market
interest rates and conditions of the mortgage investment and stock markets; and
technical factors relating to the supply and demand for Shares.
NO PRIOR MARKET FOR THE NOTES; PRICE MAY DECREASE AFTER THE
TRANSACTION. The Notes will not be listed on a national securities exchange or
quoted on an automated quotation system. Therefore, the Company does not expect
that an orderly and active trading market for the Notes will develop, and there
is substantial uncertainty as to the prices at which the Notes will trade
following the Transaction. Since the Notes may be redeemed at any time by the
Company without premium for an amount equal to the outstanding principal balance
thereon plus accrued interest, the Notes may never trade at a premium.
Noteholders are likely to receive the full face amount of the Notes only if they
hold the Notes to maturity, which is eight years after the Transaction, unless
the Notes are redeemed earlier by the Company. See "THE NOTES--Notes." There can
be no guaranty, however, that the Company will not default on the Notes prior to
maturity.
CONFLICTS OF INTEREST OF THE GENERAL PARTNERS. The General Partners
initiated and participated in the structuring of the Transaction and have
certain conflicts of interest with respect to its completion. The General
Partners will receive certain economic benefits as a result of the Transaction,
including an aggregate of 33,549 Shares, or approximately 1% of the Shares
outstanding upon completion of the Transaction assuming no Notes are issued.
These Shares could have an approximate value of $838,725 based on an assumed
value of $25 per Share. In addition, the Advisor will be entitled to receive
management fees from the Company following the Transaction pursuant to the
Advisory Agreement. The Advisor is a subsidiary of America First Companies, the
entity that controls the General Partners. Further, Michael B. Yanney, who is a
member and manager of America First Companies, will also serve as the Chairman
of the Board of the Company and the Advisor. As such, he will be entitled to
receive stock options under the Company's 1998 Stock Option Plan. See "THE
TRANSACTION--Conflicts of Interest and Benefits to Insiders."
FUNDAMENTAL CHANGE IN NATURE OF INVESTMENT. Investors who become
Shareholders or Noteholders will have fundamentally changed the nature of their
investment, and their rights will be different from their rights as Investors of
a Partnership. Each Partnership was formed as a finite-life entity with certain
characteristics, including: (i) Investors who expected to receive regular cash
distributions from the
21
<PAGE>
Partnership's cash flow and special distributions upon liquidation of the
Partnership's investments; (ii) any net proceeds from the sale or other
disposition of any Partnership assets would be distributed to Investors to the
extent such proceeds exceed the Partnership's other cash requirements, rather
than reinvested; and (iii) upon liquidation, the Investors would realize the
market value of the Partnerships' investments, less expenses of liquidation and
liquidation fees, if any, payable to the General Partners.
By contrast, the Company has no specific intention to liquidate or to sell a
substantial amount of property, and it plans to continue operations
indefinitely. If the Transaction is completed, Shareholders will not receive
liquidation proceeds through property sales but may liquidate their investment
by selling their Shares on the NYSE or in private transactions. In this regard,
the market value of the Common Stock may never reflect the full fair market
value of the Company's assets and, consequently, Shareholders may not realize
the full fair market value of such assets by selling their Shares at prices
which will be determined by trading on the NYSE. Noteholders will not hold an
equity interest in the Company and therefore will not be able to participate in
the Company's growth or benefit from any increases in the value of the Shares.
See "COMPARISON OF LIMITED PARTNERSHIP AND CORPORATE STRUCTURE."
POSSIBLE LOWER DISTRIBUTIONS. There is no guarantee with respect to the
level of the Company's future cash dividends. Regardless of the initial level of
such dividends, they could decline in the future to a level at which some
Shareholders would receive dividends lower than the distributions they received
as Investors prior to the Transaction. The Company may also reinvest cash
generated by the sale of existing assets or from operations to acquire
additional assets, potentially causing cash dividends to be lower than the
distributions made by the Partnerships in certain cases. See "THE
COMPANY--Dividend Policy."
LACK OF OPERATING HISTORY. The Company is newly organized and has no
operating history. The Company's results of operations, financial condition and
liquidity depend, to a material extent, on the ability of the Company to obtain
long term after-tax returns that are greater than those available from REITs and
other similar publicly traded real estate companies. Therefore, the failure to
invest in real estate investments generating such returns will have a material
adverse effect upon the Company's results of operations and financial condition.
There can be no assurance that any of the Company's business objectives or
planned future activities will be successful.
SIGNIFICANT CHANGE IN BUSINESS OPERATIONS. The investment strategy of the
Company will be materially different from that of the Partnerships. The
investment strategy of the Partnerships was to originate, acquire, hold, sell,
dispose of and otherwise deal with insured mortgages on multifamily rental
housing complexes and to acquire, hold, sell, dispose of and otherwise deal with
limited partnership interests in the Operating Partnerships which construct and
operate multifamily rental housing complexes. The Company's investment
strategies may include investing in real estate operating companies,
underperforming real estate assets such as office buildings and apartment
complexes with the objective of renovating and repositioning them to increase
values, and underperforming markets and foreign markets that the Company expects
will show significant improvement. The Company expects to make both equity and
debt investments, both directly and by the purchase of partnership interests and
other securities of issuers owning such assets. There can be no assurance that
the Company will be able to achieve its investment strategy as a result of the
change in business. These investments will have substantially higher risk than
the current assets of the Partnerships.
NO DISSENTERS' RIGHTS. Under Delaware law, Investors will have no
appraisal, dissenters' or similar rights in connection with the Transaction, and
no such rights will be afforded by the Partnerships of the Company. Therefore,
Investors will not be entitled to receive cash payment for the fair value of
their Units if they do not vote in favor of the Transaction and the Transaction
is approved and consummated.
POSSIBLE ALTERNATIVES TO THE TRANSACTION WILL NOT BE PURSUED. Alternatives
to the Transaction include (i) continued management of the Partnerships as
currently structured, (ii) listing the Units of each
22
<PAGE>
Partnership on a national securities exchange or automated quotation system;
(iii) merging the Partnerships into a single publicly traded partnership and
listing the partnership units on a national securities exchange or automated
quotation system; (iv) merging the Partnerships together to form a single REIT;
(v) qualifying each Partnership as an individual REIT; and (vi) liquidating the
Partnerships through entire portfolio sales or sales of individual properties.
While the consummation of the Transaction does not preclude the Company from
electing REIT status in the future, it does effectively preclude the pursuit of
the other alternatives listed above.
CONFLICTS OF INTEREST CREATED BY EXTERNAL MANAGEMENT STRUCTURE. The Company
will be managed externally by the Advisor. This external management structure
has certain conflicts of interest. In particular, the Advisor may manage other
entities with investments, investment objectives and business goals similar to
those of the Company. The Advisor may be required from time to time to resolve
conflicts between the different entities it manages and the investment choices
it makes for each entity. Also, the Advisor may make investments for the Company
in other entities managed by the Advisor.
FEDERAL INCOME TAX CONSEQUENCES. To the extent the Company issues Notes in
connection with the Transaction, the Partnerships will be required to recognize
gain. In the event the maximum amount of Notes are chosen, the resulting gain
would be approximately $26,000,000 for both Partnerships. The gain for Cap
Source I is approximately $5.12 per Unit and the gain for Cap Source II is
approximately $2.20 per Unit. In general, such gain will be determined by
allocating the value of the Notes among the assets of each Partnership on the
basis of their relative fair market values. The amount of gain recognized will
not exceed the amount of value of the Notes allocable to each asset. The
character of any recognized gain would be the same as would be the case if each
Partnership had sold its assets. Each Investor would be required to include in
income a share of such gain even if such Investor did not vote in favor of the
Transaction and/or did not choose Notes. The Company does not expect to
distribute cash to Investors which would correspond to the income recognized as
a result of the issuance of the Notes.
A MAJORITY IN INTEREST WILL BIND ALL INVESTORS IN EACH PARTNERSHIP. Under
the Partnership Agreements and the requirements of the Delaware Revised Uniform
Limited Partnership Act (the "Delaware Partnership Law"), a Partnership may
participate in the Transaction if a majority in interest of its Investors
consent to the Transaction. If the Transaction is approved by such majority, all
Investors in that Partnership will be bound by the decision of the majority,
including Dissenting Investors and Investors who abstained from voting with
respect to the Transaction.
NOTES ARE UNSECURED OBLIGATIONS OF THE COMPANY. The Notes, which will be
prepayable at any time, are junior unsecured obligations of the Company and, as
a practical matter, will be junior to all other debt (other than trade payables)
of the Company. The Notes will bear interest at a variable rate that may be
lower than rates on other variable rate debt instruments that may be perceived
as having comparable or lower risks than the Notes. In addition, there is no
guarantee that the Company will not default on the Notes. See "THE NOTES."
CONTINGENT OR UNDISCLOSED LIABILITIES. Under the Merger Agreement, the
Company will, as of the effective date of the Transaction (the "Effective
Date"), acquire all assets and liabilities of the Partnerships and General
Partners. Each of the Partnerships will deliver to the Company financial
statements for such entity disclosing all known material liabilities and
reserves, if any, set aside for contingent liabilities as of the Effective Date.
The General Partners will represent and warrant that, to the best of their
knowledge, the financial statements fairly present the financial position of
each Partnership, as if there is no liability or obligation to be set forth or
reserved against in the financial statements based upon generally accepted
accounting principles. The accuracy and completeness of these representations
are conditions to the closing of the Transaction and if, on or prior to the
Effective Date, these representations and warranties are shown to be inaccurate,
there may be adjustments to the consideration paid by the Company or the Company
may elect not to proceed to close the Transaction.
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INVESTORS WHO ELECT TO RECEIVE NOTES COULD RECEIVE SHARES. If Dissenting
Investors elect to receive Notes in excess of the Maximum Note Limitation, the
Transaction will not be consummated. If this does not occur, and the total
amount of Notes allocable to all Investors electing to receive Notes would
exceed the Maximum Note Limitation, then Notes will be allocated among those who
elected to receive Notes, based on how they voted with respect to the
Transaction, in the following order of priority: first to Dissenting Investors
who elected to receive Notes and then, on a pro rata basis, to Investors who
mark "ABSTAIN" on their Consent Card and Consenting Investors. Thus, it is
possible that a Consenting Investor who elects to receive Notes may receive
Shares instead of Notes. In order to be assured of receiving Notes, an Investor
must vote "NO" with respect to the Transaction and elect to receive Notes. See
"THE NOTES-- Allocation of Notes."
RISKS ASSOCIATED WITH THE COMPANY'S BUSINESS
LEVERAGING STRATEGY. The Company will employ a strategy to increase the
size of its real estate asset portfolio by bank borrowing or other credit
arrangements used to finance the acquisition of growth-oriented real estate
investments. Therefore, such assets may not be available to the Shareholders in
the event of the liquidation of the Company except to the extent that the market
value thereof exceeds the amounts due to creditors. The Organizational Documents
of the Company do not limit the amount of debt the Company can incur.
Substantial leverage incurred by the Company will be subject to the
following risks: (a) the Company could lose its interests in assets given as
collateral for secured borrowing if the required principal and interest payments
are not made when due; (b) the Company's cash flow from operations may not be
sufficient to retire these obligations as they mature, making it necessary for
the Company to either refinance these obligations prior to maturity or to raise
additional debt and/or equity for the Company or dispose of some of the
Company's assets to retire the obligations, which could have an adverse effect
on the amount of funds available for dividends to Shareholders; (c) no assurance
can be given as to the availability, or the terms and conditions, of any
financing needed by the Company to refinance borrowing; and (d) debt incurred by
the Company may be at interest rates that adjust based on prevailing market
interest rates, and an increase in the prevailing market interest rates would
adversely affect the Company's earnings and could reduce the amount of funds
available for dividends to Shareholders.
NO ASSURANCE OF SUCCESSFUL IMPLEMENTATION OF NEW BUSINESS PLAN. The
profitability of the Company depends on the successful development and
implementation of the Company's new business plan. To achieve its objective, the
Company will need to develop effective investment and operating policies and
strategies in connection with the implementation of its business plan. There can
be no assurance that the Company will be successful in developing the necessary
investment and operating policies or that it will be able to effectively
implement its business plan.
REAL ESTATE INVESTMENTS. The ultimate performance of the Company's proposed
investments under its new business plan will be subject to the varying degrees
of risk generally incident to the ownership and operation of the underlying real
property. The ultimate value of the Company's security in the underlying real
property depends upon the owners' ability to operate the real property in a
manner sufficient to maintain or increase revenues in excess of operating
expenses and debt service or, in the case of real property leased to a single
lessee, the ability of the lessee to make rental payments. Revenues may be
adversely affected by adverse changes in national economic conditions, adverse
changes in local market conditions due to changes in general or local economic
conditions and neighborhood characteristics, competition from other properties
offering the same or similar services, changes in interest rates and in the
availability, cost and terms of mortgage funds, the impact of present or future
environmental legislation and compliance with environmental laws, the ongoing
need for capital improvements (particularly in older structures), changes in
real estate tax rates and other operating expenses, adverse changes in
governmental rules and fiscal policies, civil unrest, acts of God, including
earthquakes, hurricanes and other natural disasters (which may result in
uninsured losses), acts of war, adverse changes in zoning laws, and other
24
<PAGE>
factors which are beyond the control of the real property owners and the
Company. In the event that any of the properties underlying the Company's
investments experience any of the foregoing events or occurrences, the value of
and return on such investments would be negatively impacted.
INVESTMENTS IN ASSETS LOCATED OUTSIDE THE UNITED STATES. The Company may
make investments outside the United States. These investments may have
substantially greater risks than investments in the United States. These risks
include uncertain or unknown local and regional market conditions, differences
in governmental regulation, differences in laws relating to the ownership and
operation of real estate and changes in the value of the local currency in
relationship to the value of the United States dollar. Other risks include
application of local tax laws relating to investment by foreign investors.
DEPENDENCE ON AVAILABLE INVESTMENTS. The results of the Company's future
operations under the new business plan will be dependent upon the availability
of, as well as management's ability to identify, complete and realize, real
estate investment opportunities. It may take considerable time for the Company
to find and consummate appropriate investments. In general, the availability of
desirable investment opportunities and the results of the Company's operations
will be affected by the level and volatility of interest rates, by conditions in
the financial markets, and general economic conditions. No assurances can be
given that the Company will be successful in finding and then acquiring
economically desirable assets or that the assets, once acquired, will maintain
their economic desirability.
COMPETITION. The Company is engaged in a highly competitive business. The
Company will be competing for investments with many recent entrants into the
business, including numerous public and private real estate investment vehicles,
including financial institutions (such as mortgage banks, pension funds and
REITs) and other institutional investors, as well as individuals. In addition,
the Company's competitors may seek to establish relationships with the financial
institutions and other firms from whom the Company intends to purchase such
assets. Many of the Company's anticipated competitors are significantly larger
than the Company, have established operating histories and procedures, may have
access to greater capital and other resources, may have management personnel
with more experience than the officers of the Company, and may have other
advantages over the Company in conducting certain businesses and providing
certain services.
ILLIQUIDITY OF REAL ESTATE. Real estate investments are relatively
illiquid. Such illiquidity limits the ability of the Company to vary its
portfolio of proposed and current investments in response to changes in economic
and other conditions. Illiquidity may result from the absence of an established
market for investments as well as the legal or contractual restrictions on their
resale by the Company. In addition, illiquidity may result from the decline in
value of a property securing an investment by the Company. No assurances can be
given that the fair market value of any of the real property serving as security
will not decrease in the future leaving the Company's investment
under-collateralized or not collateralized at all. It would be difficult to sell
an under-collateralized investment, and if the Company needed to do so, assuming
it were even able to do so given its typically subordinated lien position, it is
likely that such investment would be sold at a loss.
UNSPECIFIED ACQUISITIONS. Any decision to pursue real estate acquisition
opportunities will be in the discretion of the Company's management and may be
consummated without prior notice or Shareholder approval. In such instances,
Shareholders will be relying on the Company's management to assess the relative
benefits and risks associated with any such acquisition.
INVESTMENT STRATEGY OF THE COMPANY. As discussed under "THE
COMPANY--Investment Strategy," the Company intends to focus initially in aspects
of the real estate business which have particular risks. These aspects include
(i) underperforming commercial properties, (ii) real estate operating companies
and (iii) foreign or foreign-controlled real estate. Underperforming commercial
properties are subject to risks associated with the redevelopment and leasing of
these properties. These risks included a lack of or limited cash flow from
operations of the properties during redevelopment, unanticipated redevelopment
costs and
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<PAGE>
delays in leasing and commercial activities. Real estate operating companies are
subject to risks associated with the ownership of a company involved in various
real estate activities. These risks include the inability of the Company to
exercise control over all activities of the operating company, reliance upon
management of the operating company and the ability of the operating company to
make appropriate investments in the future. Foreign or foreign-controlled real
estate risks are described under "--Investments in Assets Located Outside the
United States," above.
TITLE DEFECTS. At the time the Properties were developed or acquired by the
Operating Partnerships, each of the Operating Partnerships obtained title
insurance policies under which a successor in interest by operation of law to
the Operating Partnerships will become the insured under such policies. The
General Partners are generally not aware of any exceptions to title that may
have been created by third parties during the Operating Partnerships' ownership
of the Properties. Management of the Company has no actual knowledge of any
actions or liens of third parties which would have a material adverse effect
upon the Transaction or the financial condition of the Company.
ENVIRONMENTAL LAWS MAY IMPOSE ADDITIONAL LIABILITY. Under various federal,
state, and local environmental laws, ordinances, and regulations, a current or
previous owner or operator of real property may be liable for the costs of
removal or remediation of hazardous or toxic substances on, under, or in such
property. Such laws often impose liability whether or not the owner or operator
knew of, or was responsible for, the presence of such hazardous or toxic
substances. In addition, the presence of hazardous or toxic substances, or the
failure to properly remediate such property, may adversely affect the owner's
ability to borrow using such real property as collateral. Certain environmental
laws impose liability for release of asbestos-containing materials ("ACMs") into
the air, and third parties may seek recovery from owners or operators of real
properties for personal injury associated with ACMs. In connection with the
ownership (direct or indirect), operation, management, and development of real
properties, the Company may be liable for removal or remediation costs, as well
as certain other potential costs which could relate to such hazardous or toxic
substances or ACMs (including governmental fines and injuries to persons and
property).
BOARD OF DIRECTORS MAY CHANGE POLICIES WITHOUT SHAREHOLDER APPROVAL. The
Company's operating and financial policies, including its policies with respect
to acquisitions, growth, operations, indebtedness, capitalization and dividends,
will be determined by the Board of Directors. Although it has no present
intention to amend or revise these or other policies as described herein, the
Board of Directors generally may do so, from time to time, without Shareholder
approval. Accordingly, Shareholders will have little direct control over changes
in the Company's policies. Changes in the Company's policies could adversely
affect the Company's financial condition and results of operations.
REGISTRATION UNDER THE INVESTMENT COMPANY ACT. The Company at all times
intends to conduct its business so as not to become regulated as an investment
company under the Investment Company Act of 1940, as amended (the "Investment
Company Act"). The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate" ("Qualifying Interests"). Under current
interpretation of the staff of the Securities and Exchange Commission (the "SEC"
or "Commission"), in order to quality for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. If the
Company fails to qualify for exemption from registration as an investment
company, its use of leverage would be substantially reduced, and it would be
unable to conduct its business as described herein. Such a failure to qualify
could have a material adverse effect on the Company.
POTENTIAL LIABILITY UNDER THE AMERICANS WITH DISABILITIES ACT. All of the
Properties were required to be in compliance with the Americans With
Disabilities Act (the "ADA"). The ADA generally requires that places of public
accommodation be made accessible to people with disabilities to the extent
readily achievable. Compliance with the ADA requirements could require removal
of access barriers, and non-compliance could result in imposition of fines by
the federal government, an award of damages to private
26
<PAGE>
litigants and/or a court order to remove access barriers. Because of the limited
history of the ADA, the impact of its application to the Company's properties,
including the extent and timing of required renovations, is uncertain.
Consequently, the Company will be required to cover the costs associated with
such compliance, if any, with funds from operations, established reserves or
bank borrowings.
REGULATORY AND LEGISLATIVE RISKS
The Company's business is subject to numerous federal, state and consumer
laws and regulations, which among other things: (a) require the Company to
obtain and maintain certain licenses, certifications, registrations and
qualifications; (b) require the Company to post a bond in certain states; (c)
limit the interest rates, fees and other charges the Company is allowed to
charge; (d) limit or prescribe certain other terms and conditions of the
Company's contracts; and (e) require the Company to provide specified
disclosures.
The Company's business is subject to regulation, supervision and licensing
by the federal, state and local government authorities and is subject to various
laws and judicial administrative decisions imposing requirements and
restrictions on a substantial portion of its operations. Failure to comply with
these requirements can cause the termination or suspension of certain rights of
recision for mortgage loans, class action law suits and administrative
enforcement actions. Although the Company believes that it has systems and
procedures to facilitate compliance with these requirements and believes that it
is in compliance with all material aspects with applicable local, state and
federal laws, rules and regulations, there can be no assurance that more
restrictive laws, regulations or rules will not be adopted in the future that
could make compliance more difficult or expensive.
BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION
HISTORY OF THE PARTNERSHIPS
FORMATION. Cap Source I was formed in 1985, and Cap Source II was formed
1986. Both Partnerships were formed to make debt and equity investments in
multifamily rental complexes (the "Complexes"). The Partnerships' combined debt
and equity investments are intended to provide Investors with regular
distribution of cash derived from principal and interest payments on insured
mortgages, as well as the benefits of ownership of the Complexes, including any
tax losses and income from operations.
CAP SOURCE I GENERAL PARTNERS' MANAGEMENT OF CAP SOURCE I. Cap Source I's
original general partners were TIG Insured Mortgage Equities Inc. (the "TIG
General Partner") and Hutton Insured Mortgage Equities Inc. (the "Hutton General
Partner"). All of the issued and outstanding stock of the TIG General Partner
was purchased by TIG I Holdings, Inc. ("TIG Holdings") pursuant to a stock
purchase agreement dated June 10, 1991. Thereafter, TIG Holdings merged into the
TIG General Partner with the TIG General Partner being the surviving
corporation. The TIG General Partner subsequently changed its name to America
First Capital Source I, Inc. All of the issued and outstanding capital stock of
America First Capital Source I, Inc. was transferred to America First Companies
as of March 1, 1994. America First Capital Source I, Inc. was subsequently
converted from a Delaware corporation to a Delaware limited liability company
and changed its name to America First Capital Source I, L.L.C.
Lehman Brothers, Inc. ("Lehman"), the successor to E.F. Hutton & Co.,
acquired all of the interests in the Hutton General Partner. The Hutton General
Partner changed its name to Insured Mortgage Equities Inc. Subsequently, on May
16, 1997, Lehman sold all of the shares of capital stock of Insured Mortgage
Equities Inc. to America First Companies.
Thus, Insured Mortgage Equities Inc. and America First Capital Source I,
L.L.C. are the current Cap Source I General Partners. The Cap Source I General
Partners are both wholly owned by America First Companies.
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<PAGE>
Pursuant to the Cap Source I Partnership Agreement, the Cap Source I General
Partners manage Cap Source I and are entitled to receive management fees and
certain reimbursements from Cap Source I and 1% of distributions from Cap Source
I.
CAP SOURCE II GENERAL PARTNERS' MANAGEMENT OF CAP SOURCE II. Cap Source
II's original general partners were TIG Insured Mortgage Equities II Inc. (the
"TIG II General Partner") and Hutton Insured Mortgage Equities II L.P. (the
"Hutton II General Partner"). All of the issued and outstanding stock of the TIG
II General Partner was purchased by TIG II Holdings, Inc. ("TIG II Holdings")
pursuant to a stock purchase agreement dated June 10, 1991. Thereafter, TIG II
Holdings merged into the TIG II General Partner with the TIG II General Partner
being the surviving corporation. The TIG II General Partner subsequently changed
its name to America First Capital Source II, Inc. All of the issued and
outstanding capital stock of America First Capital Source II, Inc. was
transferred to America First Companies as of March 1, 1994. America First
Capital Source II, Inc. was subsequently converted from a Delaware corporation
to a Delaware limited liability company and changed its name to America First
Capital Source II, L.L.C.
The sole general partner of the Hutton II General Partner was CS Housing II
Inc. Lehman, the successor to E.F. Hutton & Co., acquired all of the interests
in CS Housing II Inc. The Hutton II General Partner changed its name to Insured
Mortgage Equities II L.P. Subsequently, on May 16, 1997, Lehman sold all of the
shares of capital stock of CS Housing II Inc. to America First Companies.
Thus, Insured Mortgage Equities II L.P. and America First Capital Source II,
L.L.C. are the current Cap Source II General Partners. The Cap Source II General
Partners are both controlled by America First Companies. America First Companies
owns 100% of America First Capital Source II L.L.C. and owns 100% of CS Housing
II Inc., the sole general partner of Insured Mortgage Equities II L.P.
Pursuant to the Cap Source II Partnership Agreement, the Cap Source II
General Partners manage Cap Source II and are entitled to receive management
fees from Cap Source II and 1% of distributions from Cap Source II.
HISTORICAL INFORMATION AND ACHIEVEMENT OF OBJECTIVES. Cap Source I and Cap
Source II have paid quarterly distributions at the same level since March 31,
1993, and June 30, 1993, respectively. As of March 31, 1998, Cap Source I has
distributed to its Investors an aggregate of approximately $54,498,982, and Cap
Source II has distributed to its Investors an aggregate of approximately
$55,980,182.
The table set forth below provides a comparison of the capital raised and
distributions made by the Partnerships as of March 31, 1998:
HISTORICAL INFORMATION CONCERNING THE PARTNERSHIPS
<TABLE>
<CAPTION>
DATE OF
DISTRIBUTIONS DISTRIBUTIONS TO LAST
TO INVESTORS INVESTORS IN ADMISSION
TOTAL INVESTOR THROUGH MOST OF ORIGINAL
PARTNERSHIP CAPITAL RAISED 3/31/98 RECENT QUARTER INVESTORS
- ----------------------------- -------------- -------------- ---------------- -----------
<S> <C> <C> <C> <C>
Cap Source I................. $ 67,484,440 $ 54,498,982 $ 851,991 5/13/86
Cap Source II................ 62,372,621(1) 55,980,182 812,247 1/04/88
-------------- -------------- ----------------
Total...................... $ 129,857,061 $ 108,814,926 $ 1,664,238
-------------- -------------- ----------------
-------------- -------------- ----------------
</TABLE>
- ------------------------
(1) Total capital contributions for Cap Source II were $80,222,020, of which
$62,372,621 was invested in accordance with the Partnership's original
investment objectives, and the remaining $17,849,399 was returned to
Investors as a return of capital.
To the best knowledge of the General Partners, 100% of the net proceeds of
the original offerings of Cap Source I was invested in accordance with the
Partnership's original investment objectives. To the best knowledge of the
General Partners, 77.75% of the net proceeds of the original offerings of Cap
Source II was invested in accordance with the Partnership's original investment
objectives.
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The following information sets forth the original objectives of Cap Source I
and Cap Source II and the extent to which the General Partners believe such
objectives have been met.
CAP SOURCE I. The original investment objectives of Cap Source I are to:
(a) achieve long-term capital appreciation through increases in the value of Cap
Source I's equity investments in the Cap Source I Operating Partnerships (as
defined below); (b) provide quarterly cash distributions to Cap Source I
Investors; (c) provide Cap Source I Investors with federal income tax deductions
that may offset, in part, taxable cash distributions subsequent to two years
after the initial closing on Cap Source I Units purchased by Cap Source I
Investors; (d) provide the potential for increases in cash distributions from
income from the Cap Source I Operating Partnerships and sale of the Complexes;
and (e) preserve and protect Cap Source I's capital. Cap Source I originally
intended to qualify its Units for quotation on the National Association of
Securities Dealers Automated Quotation System ("NASDAQ") within 24 to 36 months
after it commenced operations in order to make the Units freely transferable.
However, at a Special Meeting of Investors on May 17, 1990, an amendment to the
Cap Source I Partnership Agreement was approved to only allow limited
transferability of Units to preserve the tax status of the Partnership as a
partnership under the Code and avoid being designated as a "publicly traded
partnership." Based upon the original capital raised from the Cap Source I
Investors of $67,484,440, distributions of $54,498,982 as of March 31, 1998, and
a net asset value of $50,991,970, the Cap Source I General Partners believe that
objectives (b), (c) and (e) above were substantially met and objectives (a) and
(d) were not met.
The Cap Source I Operating Partnerships are Bluff Ridge Associates Limited
Partnership, Waters Edge Limited Partnership, Interstate Limited Partnership
(a/k/a Highland Park), Cypress Landings II, Ltd. (a/k/a Misty Springs), Oyster
Cove Limited Partnership (a/k/a Waterman's Crossing), Fox Hollow, Ltd. and Ponds
at Georgetown Limited Partnership (the "Cap Source I Operating Partnerships").
CAP SOURCE II. The original investment objectives of Cap Source II are to:
(a) preserve and protect Cap Source II's capital by investing in Federally
Insured Mortgages and Cap Source II Operating Partnership interests; (b) provide
quarterly cash distributions to Cap Source II Investors from income from
Federally Insured Mortgages; and (c) achieve increasing current income and
long-term capital appreciation through increases in the income from Cap Source
II's equity investments in the Cap Source II Operating Partnerships (as defined
below). Originally, there was a fourth investment objective which was to make
the Cap Source II Units freely transferable 24 to 36 months after the
Partnership commenced operations by qualifying the Units for quotation on
NASDAQ. However, at a Special Meeting of Cap Source II Investors on December 17,
1990, amendments to the Cap Source II Partnership Agreement were approved to
allow limited transferability of Units to preserve the tax status of the
Partnership as a partnership under the Code and avoid being designated as a
"publicly traded partnership." Based upon the original capital raised from the
Cap Source II Investors of $62,372,621 (net of capital returned), distributions
of $55,980,182 as of March 31, 1998, and a net asset value of $32,880,190, the
Cap Source II General Partners believe that objective (a) and (b) above were
substantially met and that objective (c) above was not met.
The Cap Source II Operating Partnerships are Crane's Landing Partners, Ltd.,
Delta Crossing Limited Partnership, Centrum Monticello Limited Partnership and
Ponds at Georgetown Limited Partnership (the "Cap Source II Operating
Partnerships," and together with the Cap Source I Operating Partnerships, the
"Operating Partnerships").
The following table sets forth, with respect to each Partnership, the age of
the Partnership relative to the original term of the Partnership as set forth in
the applicable Partnership Agreement:
LEGAL LIFE OF THE PARTNERSHIPS
<TABLE>
<CAPTION>
COMMENCED LEGAL ORIGINAL REMAINING
OPERATIONS TERMINATION DURATION LIFE
PARTNERSHIP (MO./YR.) (MO./YR.) (YEARS) (YEARS)
- -------------------------------------------- --------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C>
Cap Source I................................ 8/85 12/30 45 32
Cap Source II............................... 8/86 12/35 49 37
</TABLE>
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<PAGE>
THE DECISION TO PURSUE THE TRANSACTION
As the General Partners reviewed the original investment objectives of the
Partnerships and began to explore options to increase the value of the
investments made by Investors in the Partnerships, the General Partners
concluded that the Partnerships had failed to achieve two of their original
investment objectives, namely liquidity and growth.
The General Partners have been concerned about the lack of meaningful
liquidity available for Investors in the Partnerships. The lack of a formal
secondary market for the Units limits the ability of Investors to increase or
decrease their investment in the Partnerships in response to changing personal
circumstances or the performance of the Partnerships. This concern has recently
increased as unrelated third parties have made tender offers and other offers to
purchase the Units at prices which the General Partners believe do not fairly
represent the underlying value of the Units. Liquidity was further decreased by
the suspension of trading of partnership interests on the Chicago Partnership
Board by action of the SEC. The General Partners concluded that it was in the
best interest of Investors to develop a transaction which would provide
substantially better liquidity and will permit Investors the opportunity to
increase or decrease their individual investment at prices more directly related
to their underlying value.
The operations of the Partnerships were adversely affected in their early
years by weaknesses in the real estate markets throughout the United States.
This adversely impacted the operating results of the Partnerships' real estate
investments and led to decreases in distributions to Investors. However, in
recent years, the real estate markets nationwide have generally improved, in
some cases significantly, and the General Partners have been concerned with the
failure of those national trends to translate into improved operating results
for the Partnerships, and hence increased distributions to their Investors. In
analyzing this situation, the General Partners decided that there were two
primary reasons for the lack of improvement in the operations of the
Partnerships. First, the Partnerships' portfolios have been fixed since original
acquisition. Therefore, the Partnerships have been unable to acquire new
investments irrespective of potential investment return, have been unable to
trade poorly performing assets for assets with better profit potential, and have
been unable to increase the overall size of their portfolios to take advantage
of improving markets. Second, the majority of the Partnerships' assets are fixed
income GNMA securities or FHA insured loans, which by their nature do not
participate in improvements in the real estate markets. Consequently, the
General Partners decided that the best way to improve total returns to the
Investors was to develop a transaction that would broaden the investment
limitations of the current Partnerships so as to allow more flexibility in the
type of assets acquired and their investment management and to allow overall
portfolio growth as market conditions warrant.
The General Partners evaluated a number of alternative transactions to
achieve these objectives. Each of these alternatives appeared to have some
advantages and disadvantages, and might be in the best interest of some
Investors but not others. The General Partners consequently concluded that on
balance the proposed Transaction was the best of the alternatives for the
Investors of each Partnership and as a whole.
PREPARATION FOR AND CHRONOLOGY OF EVENTS LEADING TO THE TRANSACTION
The events leading to the Transaction may be divided into two general
phases, which overlapped somewhat: (a) general investigation and consideration
of alternate transactions; and (b) events directly leading to the structuring
and implementation of the Transaction.
GENERAL INVESTIGATION AND CONSIDERATION OF ALTERNATE TRANSACTIONS. Since
assuming management of each of the Partnerships, the General Partners have been
evaluating each Partnership's business prospects, especially with respect to the
feasibility of providing liquidity to the Investors and increasing distributions
to Investors. As the General Partners reviewed the original investment
objectives of the Partnerships and began to explore options, the General
Partners concluded that the Partnerships had failed to achieve two of their
original investment objectives, which were liquidity and growth. The General
Partners thus began
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<PAGE>
to explore options such as the Transaction and certain alternatives to the
Transaction. See "--The Decision to Pursue the Transaction" above.
STRUCTURING AND IMPLEMENTATION OF THE TRANSACTION. In September 1997,
representatives of the General Partners contacted the law firm of Kutak Rock in
Omaha, Nebraska and Denver, Colorado to discuss legal issues relating to the
Transaction. On September 12, 1997, representatives of the General Partners
initiated a conference call with representatives of Kutak Rock in Denver, and
representatives of the law firm of Skadden, Arps, Slate, Meagher & Flom
("Skadden Arps") in New York, New York to discuss preliminary issues relating to
the Transaction and the preparation of a preliminary discussion draft of a
prospectus/ consent solicitation statement and a registration statement on Form
S-4 (the "Registration Statement"). During the conference call representatives
of the General Partners authorized Kutak Rock to begin preparing the preliminary
discussion draft of the Registration Statement and related documents describing
the Transaction as a merger of the Partnerships into a publicly traded limited
partnership. In September, 1997, representatives of the General Partners signed
a formal engagement letter retaining Kutak Rock to perform the legal services in
connection with the Transaction. Another conference call with the same parties
was held on September 29, 1997, to discuss tax issues and other matters
potentially relating to the Transaction.
In September, 1997, representatives of the General Partners contacted
representatives of Sutro & Co. in Los Angeles regarding the possibility of Sutro
& Co. rendering a fairness opinion in connection with the Transaction.
Representatives of the General Partners also contacted representatives of Robert
A. Stanger & Co., Inc. in New Jersey regarding valuations and fairness opinions
for the Transaction.
On October 4, 1997, Kutak Rock circulated a preliminary discussion draft of
the Registration Statement to representatives of the General Partners. On
October 8 and 9, 1997, a meeting was held in the offices of Skadden Arps in New
York to discuss the draft and other preliminary issues relating to the
Transaction. In attendance were representatives of the General Partners, Kutak
Rock, Skadden Arps, E&Y Kenneth Leventhal Real Estate Group and a representative
of a national investment banking firm. At the time, the possibility of forming
the Company as various different types of entities was discussed. During these
discussions, the alternative of a merger of the Partnerships into a publicly
traded limited partnership was discussed further. However, it was determined
that limited partnership units do not trade well on securities exchanges, that
the market tends to view common stock more favorably than limited partnerships
units and that pursuing this alternative would substantially diminish the
Partnerships' ability to grow, making this alternative less advantageous to
Investors.
In October, 1997, representatives of the General Partners contacted
Valuation Research regarding the possibility of Valuation Research rendering
valuations and fairness opinions in connection with the Transaction. In
November, 1997, Valuation Research was retained to provide the Appraisals of the
real estate of the Operating Partnerships in which the Partnerships have limited
partner interests.
At various times during the month of October, representatives of the General
Partners contacted representatives of Kutak Rock by telephone to discuss legal
issues relating to the Transaction and the disclosure in the Registration
Statement.
In November, 1997, the Transaction was selected as the most favorable
alternative considered by the General Partners.
In November, 1997, representatives of America First Companies contacted
George J. Kubat, Mariann Byerwalter and Martin A. Massengale to see if they
would be willing to serve on the Special Committee. All three agreed to serve on
the Special Committee. Ms. Byerwalter subsequently resigned from the Special
Committee because of a potential conflict of interest. See "THE TRANSACTION--The
Special Committee"
On December 15, 1997, the Special Committee met in Denver, Colorado at the
offices of Kutak Rock for an organizational meeting to review the outline of the
proposed Transaction and to interview law firms
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<PAGE>
to represent the Special Committee. At the meeting the Special Committee
selected Holland & Hart LLP to serve as counsel to the Special Committee. At
this meeting, the Special Committee also interviewed Valuation Research as a
potential advisor to the Special Committee and as a potential fairness opinion
provider with respect to the Transaction. Valuation Research was also
interviewed with respect to the Appraisals it had already been retained to
conduct.
At a meeting of the Special Committee held in Denver, Colorado on January
19, 1998, Sutro & Co., J.C. Bradford & Co. and Schroders were each interviewed
as potential advisors to the Special Committee and as potential providers of a
fairness opinion with respect to the Transaction. At the meeting, Sutro & Co.
was selected by the Special Committee to serve as the fairness opinion provider.
At a meeting of the Special Committee held February 6, 1998 in San
Francisco, Sutro & Co. was formally retained to render the Fairness Opinion in
connection with the Transaction. Sutro & Co. then made a presentation discussing
the current status, business strategy and future business plan and goals of the
Partnerships, alternatives to the Transaction, an analysis of a pro forma
trading range of the Common Stock of the Company, an analysis of proposed
management contracts and an analysis of the Fairness Opinion to be issued by
Sutro & Co.
At a meeting of the Special Committee held March 5, 1998 in Denver, Sutro &
Co. made a presentation discussing an analysis of Exchange Values and Exchange
Value percentage allocation of Shares to the Partnerships, pro forma estimated
trading valuation of the Partnerships, peer groups of the Partnerships and an
analysis of proposed management contracts.
At a telephonic meeting of the Special Committee held on May 4, 1998 the
Special Committee concluded that the Transaction was fair as a whole to, and in
the best interests of, the Investors, and recommended that the General Partners
and the Investors approve the Transaction.
Between December 15, 1997 and May 4, 1998, the Special Committee
participated in numerous telephone conversations, many of which included
representatives from Holland & Hart LLP and/or Sutro & Co., in which various
issues raised during meetings of the Special Committee were discussed further.
The Board of Managers of America First Companies met on May 5, 1998 to
consider and approve the Transaction. At the May 5, 1998 meeting, the Special
Committee summarized the actions it had taken in connection with the proposed
Transaction, the conclusions it had reached regarding the fairness of the
Transaction and the recommendations it had made to the General Partners and to
the Investors that the Transaction be approved. Following a discussion of these
matters, the Board of Managers approved the Transaction.
On May 7, 1998, the Company filed the Registration Statement on Form S-4
with the Commission.
On July 20, 1998 the Company filed with the Commission Pre-Effective
Amendment No. 1 to the Registration Statement on Form S-4 in response to
comments issued by the Commission with respect to the Registration Statement.
ALTERNATIVES CONSIDERED
Before deciding to recommend the Transaction, the General Partners
considered alternatives to the proposed Transaction in an effort to achieve
maximum Investor return and substantially enhanced liquidity. The alternatives
were also considered by the Special Committee in connection with its review of
the fairness of the Transaction. In addition to the proposed Transaction, the
General Partners and the Special Committee each considered the following
options: (i) continued management of the Partnerships as currently structured,
(ii) listing the Units of each Partnership on a national securities exchange or
automated quotation system; (iii) merging the Partnerships into a single
publicly traded partnership and listing the resulting partnership interests on a
national securities exchange or automated quotation system; (iv) merging the
Partnerships together to form a single REIT; (v) qualifying each Partnership as
an individual REIT; and (vi) liquidating the Partnerships through entire
portfolio sales or sales of individual properties. For a quantitative comparison
of the alternatives to the Transaction, see "FAIRNESS."
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<PAGE>
CONTINUATION OF PARTNERSHIPS. An alternative to the Transaction would be to
continue each of the Partnerships in accordance with its existing business plan.
If the Partnerships were to continue in their current form, they would remain
separate legal entities governed by their respective Partnership Agreements,
with their own assets and liabilities. Investors in favor of this option should
consider voting against the Transaction. Continuing the Partnerships without
change has a number of benefits, including the following:
- each Partnership would remain a separate entity, with its own assets,
liabilities and original investment objectives, consistent with the
guidelines, restrictions and safeguards in its Partnership Agreement;
- there would be no change in the nature of the Investors' investments or
relative voting rights, and the Partnership's performance would not be
affected by the performance of the other Partnership, including the
investment objectives, interests and intentions of the Investors in the
other Partnership;
- the Partnerships would not incur any expenses in connection with the
Transaction;
- the Partnerships would avoid the risks inherent in the Transaction; and
- the Partnerships would continue their tax advantaged status and not be
subject to federal income tax.
Maintaining the Partnerships as separate entities may have the following
potentially negative results when compared with the benefits the General
Partners believe may be derived from the Transaction:
- illiquidity of investment on a current basis due to the lack of a large
and established secondary market;
- inability to raise new capital or make new investments, thus limiting
growth of the Partnerships' capital to that inherent in the existing
Partnership investments;
- no flexibility or control in actively managing the portfolio in response
to changing conditions in national and international real estate markets;
- the declining value of the mortgage investments due to amortization of
principal and subsequent distributions of such amounts;
- duplication among the Partnerships in reporting, filing and other costly
administrative services; and
- continued complicated tax filings for Investors.
LISTING PARTNERSHIP UNITS. Another alternative to the Transaction would be
to list the Units of each Partnership on a national securities exchange or on an
automated quotation system in an attempt to increase the liquidity of the Units.
However, the General Partners believe that limited partnership units generally
do not trade well on such exchanges or automated quotation systems and that
consequently meaningful liquidity would not be achieved. Furthermore, the
General Partners believe that the market tends to view common stock more
favorably than limited partnership units and that pursuing this alternative
would substantially diminish the Partnerships' ability to grow compared to the
Transaction. As a publicly traded company with a base of assets greater than a
single Partnership, the Company expects to be able to issue additional debt and
equity securities with greater ease and on more attractive terms than would be
available to a Partnership individually. For the reasons described above, as
well as for some of the reasons set forth above with respect to continuation of
the Partnerships, the General Partners concluded that the potential negatives of
this alternative outweigh any advantages it may have over the Transaction.
MERGER RESULTING IN A SINGLE PUBLICLY TRADED LIMITED PARTNERSHIP. Instead
of participating in the Transaction, the Partnerships could be merged together
to form a single publicly traded limited partnership with
33
<PAGE>
the units of the new limited partnership listed on a national securities
exchange or automated quotation system. For the reasons discussed above with
respect to listing the Units of each individual Partnership, the General
Partners determined that this alternative is less advantageous to the Investors
than the Transaction.
SINGLE REIT. The General Partners considered merging the two Partnerships
into a single entity which would elect REIT status but determined that it was a
less attractive alternative to the Transaction. The General Partners concluded
that the resulting REIT would be too small in terms of total capitalization to
compete with existing REITs having similar investment objectives. Specifically,
the initial capitalization of the new company would be less than $85 million, in
contrast to the more than 85 REITs with total current capitalization in excess
of $500 million each, placing the new company at a significant disadvantage. For
example, many investment opportunities available to the competition would be
foreclosed to the new company because of its small size and resulting difficulty
in attracting capital at competitive pricing. As such, growth prospects would be
constrained by the new company's unfavorable competitive position. Furthermore,
due to restrictions in the Code relating to distributions of net taxable income
and limitations on sales of assets, as a REIT the Company would not be able to
pursue the business plan described herein which involves the ability to retain
cash flow for investment purposes and to sell assets regularly after the
achievement of goals set for those assets.
INDIVIDUAL REITS. The General Partners considered converting each
Partnership into an individual REIT, but determined that it was a less
attractive alternative than the Transaction for the same reasons discussed above
for the single REIT alternative. The issues cited above as reasons for the lack
of attractiveness of a new company as a single REIT would be magnified when
applied to each Partnership as an individual REIT due to the significantly
smaller size of each Partnership as a stand alone entity.
LIQUIDATION. Although the investment objectives and policies of the
Partnerships do not contemplate the commencement of the liquidation of the
Partnerships at any specific time, the General Partners assessed the possibility
of commencing the orderly liquidation of the Partnerships and distributing the
net proceeds from such liquidation to the Investors and General Partners. The
General Partners concluded that liquidation would be costly and time consuming
and would not be as beneficial to Investors as the Transaction.
The General Partners determined that an attempt to liquidate the
Partnerships' investments at the current time would likely result in the
Investors not achieving the full potential benefits from an investment in the
Partnerships. They concluded that liquidation would not be the best option to
realize the optimum return on an investment in the Partnerships because although
the Partnerships' investments in mortgage loans could likely be sold at or
slightly above their face value, most of the Partnerships equity positions in
the Operating Partnerships are not attractive to buyers due to restrictions in
the various Operating Partnership documents. Liquidation of most of the equity
positions would require either (i) a protracted period of negotiations with the
various general partners of the Operating Partnerships which could potentially
create both substantial transaction costs and additional costs to the
Partnerships of continuing operations during the negotiation period, and/or (ii)
the Partnerships' accepting substantial discounts in value. In addition, there
may be additional costs associated with representations, warranties, and
indemnifications that purchasers generally require and which may result in
additional escrow costs. In addition to reviewing the liquidation of the
Partnerships' assets through methods outlined by the General Partners, the
Special Committee separately considered the viability of liquidating the
Partnerships through a potential sale of the Partnerships' assets to a REIT. The
Special Committee concluded that this was not a viable option due to various
restrictions in the Operating Partnership partnership agreements. Furthermore,
the liquidation of the Partnerships would involve certain transaction costs,
such as legal fees and various other closing costs, which would further reduce
the amount of net proceeds available for distribution.
On the other hand, in a liquidation of the Partnerships, Investors would
benefit by avoiding the risks of continuing their ownership of the Partnerships
and those associated with the Transaction. Liquidation
34
<PAGE>
would provide for the final liquidation of the Investors' investments and a
likely substantial distribution of cash equal to net liquidation proceeds,
though not at a level that would allow Investors to realize their original
investment. In addition, the Investors would have the potential to reinvest the
net proceeds received in the liquidation in similar or different investments.
REASONS FOR, AND BENEFITS OF, THE TRANSACTION
In deciding whether to recommend the Transaction to the Investors, and in
structuring its terms, the General Partners considered the benefits to be
derived as a result of the Transaction. The following is a brief discussion of
the primary benefits the Transaction is expected to generate for the Investors.
SUBSTANTIALLY ENHANCED LIQUIDITY POTENTIAL. The Units are not currently
listed or regularly traded on a national securities exchange or quoted in the
automated quotation system of any registered securities association or other
over-the-counter market. Following the Transaction, the anticipated listing of
the Common Stock on the NYSE and the Company's larger equity market
capitalization and growth strategy should enhance the liquidity of investments
held by Investors. The General Partners therefore believe the Transaction offers
Investors a faster and more efficient means of liquidating their investment than
if the Partnership were to attempt to liquidate their portfolios through
conventional property sales.
POTENTIAL FOR COMPANY GROWTH; ENHANCED ACCESS TO CAPITAL. The Company will
expand the investment objectives and policies of the Partnerships. Following the
Transaction, the Company will have the potential for enhanced access to and
flexibility in obtaining additional equity and debt financing. In particular,
the Company will have the ability to fund future portfolio growth through the
issuance of additional publicly traded securities and the raising of funds from
borrowing under secured and unsecured debt obligations. The Partnerships are
currently limited under their respective Partnership Agreements in their ability
to raise additional capital. Following the Transaction, the Company will not be
subject to the same capital-raising limitations. In addition, the size and
structure of the Company should provide financing alternatives presently not
available to the Partnerships. The General Partners believe that the larger
total market capitalization of the Company, as compared to those of the
individual Partnerships, will encourage additional and continuing investment, in
many cases by institutional investors (which tend to favor companies with large
market capitalizations), which may over time lead to an increase in the trading
multiple and share price of the Company.
WAIVER BY AFFILIATES OF THE CAP SOURCE I GENERAL PARTNERS OF AMOUNTS PAYABLE
BY CERTAIN CAP SOURCE I OPERATING PARTNERSHIPS. If the Transaction is
completed, affiliates of the Cap Source I General Partners have agreed to
permanently waive amounts which may be payable by certain Cap Source I Operating
Partnerships to such affiliates. As of March 31, 1998, such amounts totaled
$3,416,295, as reflected in the financial statements of Cap Source I. These
amounts are payable pursuant to the terms of the partnership agreements for the
Cap Source I Operating Partnerships.
DIVERSIFICATION OF ASSETS. By combining the Partnerships into a single
ownership entity, the Transaction will create an investment portfolio
substantially larger and more diversified than the portfolio of an individual
Partnership. This increased size and the resulting combination of operations
spreads the risk of the investment over a broader group of assets and reduces
the dependence of Investors' investment upon the performance of any particular
asset or group of assets, any specific geographic area or industry, or any
particular large tenant or tenants.
SIMPLIFIED REPORTING REQUIREMENTS. The Transaction will result in
simplified federal and state tax reporting for Investors. Shareholders and
Noteholders will receive Form 1099 rather than the more complicated Schedule K-1
and will no longer be subject to state tax withholding or be required to file
individual state tax returns (other than in their state of residence) solely as
a result of an investment in the Company.
The General Partners also considered: (i) that the effects of the
Transaction may differ with each Investor and may be disadvantageous to certain
Investors, depending on their individual circumstances and
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<PAGE>
investment objectives; and (ii) certain negative factors relating to the
Transaction, including; (a) the uncertainty as to the prices at which the Common
Stock will trade and the possibility that the trading price of the Shares may be
lower than the value assigned to them for purposes of the Transaction; (b) the
Company is a newly formed corporation, with no operating history; (c) potential
conflicts facing the Company following the Transaction, including, among other
things, the fees payable to the Advisor under the Advisory Agreement; (d) the
payment of expenses relating to the Transaction will reduce the net worth of the
Company following the Transaction; and (e) there can be no assurance the Company
will be able to achieve the benefits of the Transaction and successfully
implement its business plan as described herein. The General Partners did not
believe that the negative factors were sufficient, either individually or
collectively, to outweigh the advantages of the Transaction. See "RISK FACTORS"
and "THE TRANSACTION--Conflicts of Interest and Benefits to Insiders."
For a discussion of the potential benefits of the alternatives to the
Transaction and the reasons such alternatives were rejected by the General
Partners, see "--Alternatives Considered," above, and "FAIRNESS--Comparison of
Certain Alternative to the Transaction." While the Transaction does not preclude
the Company from electing REIT status in the future, it does effectively
preclude the pursuit of the other alternatives to the Transaction.
CONSEQUENCES IF TRANSACTION NOT COMPLETED
If the Transaction is not completed the Partnerships will continue to
operate as separate legal entities with their own assets and liabilities. There
will be no change in their investment objectives, policies and restrictions.
THE TRANSACTION
GENERAL
The General Partners have proposed the Transaction in which (i) the
Partnerships, the General Partners and the Company will be merged together, (ii)
the separate existence of the Partnerships will cease and the Company will be
the surviving entity and will succeed to all of the assets and liabilities of
the Partnerships and the General Partners, and (iii) Investors will receive, at
their election and subject to certain limitations, either Shares or Notes based
upon the Exchange Value assigned to their respective Partnerships for purposes
of the Transaction. The General Partners will receive 33,549 of the Company's
Shares, or approximately 1% of the Shares that will be outstanding after the
completion of the Transaction assuming no Notes are issued, as consideration for
the transfer of their assets to the Company pursuant to the Merger Agreement.
The Transaction has been proposed by the General Partners in an effort to
increase the value of investments held by Investors while offering substantially
enhanced liquidity.
The Company, the General Partners and the Partnerships have entered into the
Merger Agreement and will consummate the Transaction pursuant to the terms
thereof promptly after the receipt of consents from Investors holding a majority
of the outstanding Units of each of the Partnerships. If the consent of a
majority in interest of the Investors of each of the Partnerships is not
received, or all other conditions to the Transaction are not satisfied, by
, 1998, the Merger Agreement will terminate. In addition, the Merger
Agreement may be terminated by a majority of the Board of Directors before or
after the receipt of consents from Investors at any time prior to the Effective
Date.
TERMS OF THE MERGER AGREEMENT
The following is a summary of the material terms of the Merger Agreement.
This summary does not purport to be complete and is subject to, and qualified in
its entirety by, the terms of the Merger Agreement, a copy of which is attached
as Appendix A of this Prospectus/Consent Solicitation Statement and is
incorporated by reference herein.
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<PAGE>
EFFECT OF THE MERGER. Under the terms of the Merger Agreement (i) the
separate existence of the Partnerships will cease and the Company will be the
surviving entity and will succeed to all of the assets and liabilities of the
Partnerships and General Partners, and (ii) Investors will become Shareholders
or Noteholders of the Company.
CONDITIONS TO CONSUMMATION OF THE TRANSACTION. The closing for the
Transaction will take place promptly after the General Partners have received
the consent to the Transaction from the holders of a majority of the outstanding
Units of each of the Partnerships. The receipt of such consent by no later than
, 1998 (unless such date is extended by the General Partners in their
sole discretion) is a condition to closing the Transaction and if it is not
obtained, or all other conditions to closing are not satisfied or waived, the
Merger Agreement will terminate. Other conditions to closing include (i) the
declaration of effectiveness of the registration statement for the Shares of the
Company under the Securities Act of 1933, as amended (the "Securities Act");
(ii) the delivery of a tax opinion acceptable to the General Partners to the
effect that for federal income tax purposes the Transaction will be an exchange
subject to the nonrecognition provisions of Section 351 of the Code, provided
that for purposes of such opinion the Transaction shall include only the merger
of the Partnerships into the Company and the related transfer of assets by the
Partnerships to the Company; (iii) the absence of any material adverse change in
the overall business of the Partnerships from the date of this
Prospectus/Consent Solicitation Statement to the Effective Date; and (iv) the
approval of the Shares of the Company for listing on NYSE, subject to official
notice of issuance.
TERMINATION OF THE MERGER AGREEMENT. The Merger Agreement may be terminated
by a majority of the Board of Directors before or after the receipt of consents
from Investors at any time prior to the effective time of the Certificate of
Merger filed with the Secretary of State of the State of Delaware relating to
the Transaction.
ISSUANCE OF SHARES AND NOTES OF THE COMPANY
As promptly as practical after the closing of the Transaction, Service Data
Corporation will mail to each Investor of record on the Record Date a letter of
transmittal along with instructions for the exchange of Units for Shares or
Notes of the Company.
INVESTORS SHOULD NOT SEND IN THEIR UNITS WITH THE CONSENT CARD. CERTIFICATES
REPRESENTING UNITS SHOULD ONLY BE RETURNED ALONG WITH THE LETTER OF TRANSMITTAL
FORM FROM SERVICE DATA CORPORATION.
Upon surrender by an Investor to Service Data Corporation of the certificate
for his or her Units in a Partnership together with a properly executed letter
of transmittal and any other required documents, Shares or Notes of the Company
will be issued and mailed to the Investor.
Notwithstanding the failure of an Investor to surrender the certificate for
his or her Units for Shares or Notes of the Company, such Investor will be
recognized as a Shareholder or Noteholder, as the case may be, in the Company
for all purposes and will be entitled to all rights thereof, including the right
to receive dividends. However, there will be no transfers of Units in the
Partnerships recognized after the Effective Date. If certificates for Units are
presented for transfer after the Effective Date of the Transaction, they will be
returned to the presenter together with a form of letter of transmittal and
exchange instructions.
If a certificate for Units has been lost, stolen or destroyed, Shares or
Notes in the Company will be issued only upon receipt of appropriate evidence as
to such loss, theft or destruction, appropriate evidence as to the ownership of
such Units by the claimant and appropriate and customary indemnification
including, when appropriate, the posting of a bond. Neither the Company, the
Partnerships nor Service Data Corporation will be liable to any holder of Units
for any amount properly delivered to any public official pursuant to applicable
abandoned property, escheat or similar laws.
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NO FRACTIONAL SHARES
No fractional Shares will be issued by the Company in the Transaction. Each
Investor who would otherwise be entitled to a fractional Share (which
entitlement will be determined by combining such Investor's allocation of Shares
from each Partnership as to which such Investor is receiving Shares) will
instead receive a cash payment equal to $25 multiplied by the fraction.
FRACTIONAL NOTES
The principal balance of the Notes to which an Investor is entitled is
determined by multiplying the number of the Investor's Units by the Exchange
Value, per $1,000 original investment, assigned to such Investor's Partnerships.
The application of this formula may result in the Investor's being entitled to a
fractional interest in a Note (determined after combining such Investor's
allocation of Notes from each Partnership as to which such Investor is receiving
Notes). The Company will issue to each Investor entitled to such a fractional
interest a promissory note ("Promissory Note") with an original principal
balance equal to that fraction times $1,000, subject to the Company's right, at
its option, to pay cash in lieu of any portion of a Promissory Note. Apart from
its principal balance, this Promissory Note will be identical to the Notes and
will be issued by the Company pursuant to the Indenture. No market is expected
to develop for these Promissory Notes and they will not be listed on any
securities exchange.
TRANSACTION EXPENSES
GENERAL. The term "Transaction Costs" means all costs associated with the
Transaction. Assuming the Transaction is approved, the Transaction Costs are
estimated to be as follows:
SOLICITATION/COMMUNICATION COSTS
<TABLE>
<S> <C>
Information Agent................................................. $ 35,000
Printing, postage and brochure.................................... 225,000
Marketing expenses................................................ 20,000
---------
Subtotal........................................................ $ 280,000
---------
</TABLE>
PRECLOSING TRANSACTION COSTS
<TABLE>
<S> <C>
Legal Fees........................................................ $ 390,000
Special Committee................................................. 40,000
Appraisals (including fee and expenses)........................... 90,000
Fairness Opinion (including fees and expenses).................... 225,000
Registration, Listing and Filing Fees............................. 110,000
Accounting........................................................ 65,000
Contingency....................................................... 35,000
---------
Subtotal........................................................ $ 955,000
---------
</TABLE>
CLOSING TRANSACTION COSTS
<TABLE>
<S> <C>
Transfer Fees, Taxes and Title..................................... $ 50,000
---------
</TABLE>
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<PAGE>
COSTS TO WIND UP AND DISSOLVE PARTNERSHIPS
<TABLE>
<S> <C>
Accounting...................................................... $ 20,000
---------
Total Transaction Costs......................................... $1,305,000
---------
---------
</TABLE>
ALLOCATION OF COSTS. If the Transaction is approved, all Transaction Costs
will be paid by the Partnerships and the Company. If the Transaction is
rejected, the General Partners of each Partnership will bear a percentage of all
Transaction Costs, excluding solicitation/communication costs, equal to the
total number of abstentions and "NO" votes cast by Investors in that Partnership
with respect to the Transaction, divided by the total number of abstentions and
votes cast by Investors in that Partnership. In such event, the Partnerships
will bear the remaining Transaction Costs. The solicitation/communication costs
listed above will be paid by the Partnerships.
ACCOUNTING TREATMENT
The Transaction will be accounted for using the purchase method of
accounting in accordance with GAAP. Cap Source I will be deemed to be the
acquirer of Cap Source II under the purchase method because its Unitholders will
be allocated the largest number of Shares. Accordingly, the Transaction will
result, for financial accounting purposes, in the effective purchase by Cap
Source I of all of the Units of Cap Source II. As the surviving entity for
financial accounting purposes, the assets and liabilities of Cap Source I will
be recorded by the Company at their historical cost and the assets and
liabilities of Cap Source II will be recorded at their estimated fair values.
REGULATORY MATTERS
The Transaction will not be subject to the requirements of the
Hart-Scott-Rodino Antitrust Improvements Act of 1976. However, the Transaction
is subject to the completion or receipt by the General Partners of all necessary
requirements and approvals by the United States Department of Housing and Urban
Development ("HUD"). These requirements include the filing by principals and
affiliates of a certificate regarding their previous participation in HUD
projects and clearance of such certificate by HUD. HUD may also require the
submission of information for a modified review of the Transaction. The General
Partners are not aware of any facts which would cause HUD not to take the
required action or approvals. Other than federal proxy solicitation rules
relating to the solicitation of Investor consents and state and federal
regulations relating to the offering of the Company's Shares and Notes, no other
federal or state regulatory requirements must be complied with and no approval
thereunder must be obtained in connection with the Transaction.
THE SPECIAL COMMITTEE
The General Partners arranged for the organization of the Special Committee
to represent the interests of the Partnerships and Investors in negotiating the
terms and conditions of the Transaction and Advisory Agreement. The Special
Committee also negotiated the fees to be paid to the Advisor under the Advisory
Agreement. The Exchange Values were initially determined by the General Partners
and subsequently reviewed and approved by the Special Committee. The Special
Committee concluded that the terms of the Transaction are fair as a whole, to
the Partnerships and to the Investors in each of the Partnerships. The Special
Committee was retained without conditions or restrictions.
The members of the Special Committee are Messrs. Martin A. Massengale and
George J. Kubat. Since the organization of the Special Committee, it has met in
person on four occasions and has had six additional telephonic meetings and
numerous other telephone conferences for the purpose of considering the proposed
Transaction. As part of its analysis of the Transaction, the Special Committee
engaged its own legal counsel and engaged Sutro & Co. to render the Fairness
Opinion with regard to the Transaction.
39
<PAGE>
See "FAIRNESS OPINION AND APPRAISALS--Fairness Opinion." The Special Committee
originally consisted of three members, including the two current members and Ms.
Mariann Byerwalter. Ms. Byerwalter resigned from the Special Committee on
February 6, 1998 as a result of a potential conflict of interest relating to her
position as the former Chief Financial Officer and director of Eureka Bank, and
as a former director of the holding company of Eureka Bank. Eureka Bank was
owned by America First Financial Fund, which could be considered to be an
affiliate of America First Companies. Eureka Bank was sold in January 1998, and
is no longer an affiliate of America First Companies. Messrs. Massengale and
Kubat were each paid $15,000 plus reasonable out-of-pocket expenses as
compensation for serving as members of the Special Committee.
The members of the Special Committee were selected based on their general
business experience and because they serve as independent managers, for NASDAQ
purposes, of two publicly traded limited partnerships, the general partners of
which are controlled by America First Companies. America First Companies
controls the General Partners. Messrs. Massengale and Kubat, who are members of
the Board of Managers of America First Companies, are not officers or employees
of America First Companies, nor do they own any equity interest in America First
Companies. Neither Mr. Massengale nor Mr. Kubat will receive any economic
benefit which is contingent upon the completion of the Transaction.
The business experience of the members of the Special Committee is as
follows:
George J. Kubat is president and chief executive officer of Phillips
Manufacturing, Inc. of Omaha, Nebraska. From 1969 to 1992, Mr. Kubat was
employed by Coopers & Lybrand, most recently as Tax Partner-in-Charge of the
Omaha office. Mr. Kubat is a director and chairman of the Audit Committee of
American Business Information, Inc.; member of the board of managers and
chairman of the Audit Committee of America First Companies, L.L.C.; and a
director and chairman of the Audit Committee of Sitel Corp. He is active in
numerous civic and charitable organizations including being a director and
treasurer of the Nebraska Game and Parks Foundation and a director of All Our
Kids, Inc. Mr. Kubat holds a degree of Juris Doctorate from Creighton University
and is a Certified Public Accountant.
Martin A. Massengale is a member of the Board of Managers of America First
Companies. Since 1976, Dr. Massengale has been associated with the University of
Nebraska as vice chancellor, chancellor, interim president, president and
currently as president emeritus. Prior to joining the University of Nebraska, he
was a professor and associate dean with the University of Arizona. He serves on
the Board of Directors of IBP, Inc., a meat packing company, and on the Board of
Trustees of Great Plains Funds, a mutual fund. He has served on a number of
professional boards, has received more than 30 awards recognizing his
contributions to agriculture and education and has published more than 70
articles pertaining to agriculture. At the invitation of the Minister of
Education, Dr. Massengale traveled to the People's Republic of China to review
educational programs with the State Commission of Education in Beijing and for
the Shaanxi Providence in Xi'an. He has also provided his expertise to Australia
and New Zealand, Morocco, Indonesia, the Soviet Union, Saudi Arabia, Mexico and
Brazil. He has been recognized by more than 20 publications, both national and
international, for his achievements and leadership in both education and
agriculture.
RECOMMENDATION OF THE GENERAL PARTNERS AND THE SPECIAL COMMITTEE
The General Partners, together with the Special Committee, have determined
that the Transaction is in the best interest of the Investors and that it is
fair to the Partnerships, to the Investors in each of the Partnerships and as a
whole. Accordingly, the General Partners have approved the Transaction and the
Merger Agreement, and the General Partners and the Special Committee recommend
that the Investors vote "YES" in favor of the Transaction and the adoption of
the Merger Agreement. The General Partners believe the Transaction is the most
attractive alternative for providing Investors with the possibility of
increasing the value of their investments while offering substantially enhanced
liquidity. See "FAIRNESS."
40
<PAGE>
EFFECT OF THE TRANSACTION ON DISSENTING INVESTORS
Dissenting Investors and Investors who abstain from voting with respect to
the Transaction do not have a statutory right to elect to be paid the appraised
value of their interests in the Partnership. However, all Investors, including
Dissenting Investors, will be given the opportunity to elect to receive Notes
instead of Shares for their Units as described under "THE NOTES." Noteholders
are entitled to receive only the principal and interest payments required under
the Notes. Unlike Shareholders, Noteholders will have no right to participate in
the Company's earnings in excess of operating expenses, debt service and other
obligations, and will not benefit from growth in Shareholders' equity that might
result from future financial performance of the Company.
EFFECTIVE TIME
The Effective Time of the Transaction will be at the time the Certificates
of Merger with respect to the merger of the Partnerships and the General
Partners with and into the Company are filed with the Secretary of State of
Delaware, or at such later time as may be specified in the Certificates of
Merger. It is anticipated that such filings will be made as promptly as
practicable after the requisite approval of the Investors has been obtained and
the other conditions to the Transaction have been satisfied or waived, if
permitted under the Merger Agreement.
CONFLICTS OF INTEREST AND BENEFITS TO INSIDERS
The General Partners participated in the initiation and structuring of the
Transaction and are expected to receive certain benefits as a result of its
completion. First, in connection with the Transaction, the General Partners will
receive an aggregate of 33,549 Shares, or approximately 1% of the Shares
outstanding upon completion of the Transaction assuming no Notes are issued, in
exchange for their assets. These Shares could have an approximate value of
$838,725 based on an assumed value of $25 per Share. In addition, the Advisor, a
subsidiary of America First Companies, which controls the General Partners, will
serve as the advisor to the Company and will be entitled to receive management
fees from the Company pursuant to the Advisory Agreement. See "MANAGEMENT OF THE
COMPANY--The Advisor." Further, Michael B. Yanney, who is a member and manager
of America First Companies, will also serve as Chairman of the Board of the
Company and the Advisor. As such, he will be entitled to receive stock options
under the Company's 1998 Stock Option Plan. See "MANAGEMENT OF THE COMPANY--
Compensation of Executive Officers". Mr. Yanney will not receive any Shares or
Notes for his .99% interest in two of the General Partners in connection with
the Transaction. In an effort to reduce potential conflicts of interest, the
Partnerships and Investors have been represented by the Special Committee in the
negotiation of the terms and conditions of the Transaction and Advisory
Agreement.
FAIRNESS
BELIEF AS TO FAIRNESS
The General Partners, together with the Special Committee, reasonably
believe that the terms of the Transaction are fair as a whole, to the
Partnerships and to the Investors in each of the Partnerships, regardless of
whether an Investor receives Shares or Notes. The material factors underlying
the beliefs of the General Partners and the Special Committee relating to the
fairness of the Transaction are discussed below under "--Material Factors
Underlying Belief as to Fairness."
The General Partners and the Special Committee based their determinations as
to the fairness of the Transaction on the following material factors: (i) the
process of arm's-length negotiation of the terms and conditions of the
Transaction and Advisory Agreement, with the Special Committee acting on behalf
of the Partnerships and Investors; (ii) the opportunity for each Investor to
object to the Transaction and the requirement that the Transaction be approved
by Investors holding a majority in interest of each of the Partnerships'
outstanding Units; (iii) the form and amount of consideration offered to the
Investors;
41
<PAGE>
(iv) the method of allocating the Shares and Notes between the Partnerships in
the Transaction; (v) the lack of material differences with respect to the assets
of the Partnerships and the consistent valuation methodology applied to the
assets; (vi) the Fairness Opinion rendered by Sutro & Co.; (vii) the independent
Appraisals prepared by Valuation Research, which were used in part in the
determination of the Exchange Values; and (viii) the fact that all Investors,
including Dissenting Investors, will be given the opportunity to elect to
receive Notes, subject to certain limitations.
The General Partners and the Special Committee also considered the potential
benefits of the Transaction compared to the alternatives in reaching their
conclusion as to the fairness of the Transaction. Such potential benefits
include, but are not limited to: (i) enhanced liquidity resulting from the
anticipated listing of the Shares on the NYSE and the Company's larger equity
market capitalization and growth strategy; (ii) the Company's potential for
growth and enhanced access to capital; (iii) a capital and operating structure
that will allow the Company to respond more efficiently to changing conditions
in the U.S. equity markets, thereby potentially reducing the adverse effects of
such changes; and (iv) simplified tax reporting requirements for Investors. See
"BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION."
MATERIAL FACTORS UNDERLYING BELIEF AS TO FAIRNESS
The following is a discussion of the material factors underlying the belief
of the General Partners and the Special Committee that the Transaction is fair
as a whole, to the Partnerships and to the Investors in each of the
Partnerships.
PARTNERSHIP REPRESENTATIVES. The Partnerships and Investors have been
represented by the Special Committee, which participated in arm's-length
negotiations on behalf of the Partnerships with respect to the terms and
conditions of the Transaction and Advisory Agreement. The Special Committee
also negotiated the fees to be paid to the Advisor under the Advisory
Agreement. The Exchange Values were initially determined by the General
Partners and subsequently reviewed and approved by the Special Committee. In
addition, the Special Committee retained Sutro & Co. to render the Fairness
Opinion. The members of the Special Committee are also outside members of
the Board of Managers of America First Companies, which controls the General
Partners; however, neither is an officer or employee of America First
Companies and neither owns an equity interest in America First Companies.
Furthermore, neither member of the Special Committee will receive an
economic benefit which is contingent upon the completion of the Transaction.
VOTING PROCEDURES AND OPPORTUNITY TO ELECT TO RECEIVE NOTES. The
General Partners and the Special Committee believe that the voting process
and alternatives presented to Investors, including Dissenting Investors, are
fair. Each Investor has the opportunity to make an investment decision by
voting "YES," "NO" or "ABSTAIN" with respect to the Transaction, and the
Transaction must be approved by Investors holding a majority in interest of
each Partnership's outstanding Units. See "VOTING." All Investors, including
Dissenting Investors, are also being given the opportunity to elect to
receive Notes instead of Shares in exchange for their Units, subject to
certain limitations. See "THE NOTES."
CONSIDERATION OFFERED. The General Partners and the Special Committee
believe that the Shares and Notes offered to the Investors constitute fair
value. In reaching this conclusion, the General Partners and the Special
Committee considered the fact that Investors will surrender their right to
receive cash proceeds from the liquidation of the Partnerships at some time
in the future. In this regard, the General Partners and the Special
Committee compared the amount of consideration to be received in alternative
transactions, including liquidation, to the anticipated market value of the
Company's Shares. The General Partners and the Special Committee believe the
Exchange Value, which was negotiated in arm's-length negotiations by the
Special Committee and is based in part on the Appraisals, adequately takes
into account the relative values of each of the Partnerships.
42
<PAGE>
METHOD OF ALLOCATION. The General Partners and the Special Committee
believe that it is fair to allocate the Shares and Notes between the
Partnerships in accordance with their respective Exchange Values. In view of
the similarities between the Partnerships in terms of their investment
objectives and policies as well as in their assets, the General Partners and
the Special Committee believe there is no material difference between the
Partnerships with respect to determinations related to the allocation of
Shares and Notes between the Partnerships. A majority of the assets of both
Partnerships are GNMA Certificates, FHA Loans, cash and cash equivalents.
Further, all of the properties owned by the Operating Partnerships are
multifamily apartment complexes. The General Partners and Special Committee
therefore believe that the consistent valuation methodology applied to these
assets and the lack of material difference between assets of each
Partnership support their conclusion that the allocation of the Shares and
principal allocation of Notes to be received by the Investors is fair.
FAIRNESS OPINION. The General Partners and the Special Committee have
relied, in part, upon the Fairness Opinion rendered by Sutro & Co. to
support their conclusion that the Transaction is fair. The preparation and
delivery of the Fairness Opinion was requested by the Special Committee.
Sutro & Co. was retained to render the Fairness Opinion without any
conditions or restrictions. See "FAIRNESS." The qualifications, limitations
and assumptions in the Fairness Opinion did not limit the General Partners'
reliance on the Fairness Opinion.
INDEPENDENT APPRAISALS. The General Partners and the Special Committee
have relied upon the Appraisals prepared by Valuation Research, an
independent appraiser, to establish the fair market value (the "Appraised
Value") of the Properties. Such Appraised Values were utilized, in part, in
determining the Exchange Values of the Partnerships. In preparing the
Appraisals, Valuation Research was not engaged to represent the interests of
the General Partners or any specific group of Investors, but was engaged to
determine the fair market value of the Properties in which the Partnerships
hold an interest without taking into account the specific financial interest
of any person or group. The General Partners and the Special Committee
believe that the use of a single independent appraiser, applying consistent
methodology and criteria in assessing the value of each of the Properties,
increased the likelihood that the value of each such real property would be
determined on a fair, consistent and unbiased basis. Sutro & Co. also
reviewed the Appraisals in connection with its issuance of the Fairness
Opinion, and found the Appraisals to be acceptable. The General Partners and
the Special Committee therefore believe the Appraisals support their
conclusion as to the fairness of the Transaction.
NOTES. The Indenture for the Notes contains specific covenants for the
benefit of Noteholders. These covenants include (i) a limitation on Company
indebtedness, (ii) certain restrictions on the sale or transfer of Company
assets and (iii) certain prohibitions against mergers or transactions
involving the Company. See "THE NOTES." In addition, the Notes are variable
rate obligations. The General Partners believe the use of a variable rate
note, combined with these restrictive covenants, may improve the likelihood
that after the Transaction the price of the Notes will not fall below their
face value upon issuance. Although the aggregate principal amount of Notes
to be issued may not exceed $40 million, the General Partners and the
Special Committee believe this limitation is procedurally fair because the
Notes will be allocated first to Dissenting Investors, who will be able to
receive Notes under any circumstances, whereas an abstaining or Consenting
Investor who wishes to receive Notes will receive Shares if the issuance of
Notes has reached $40 million. See "THE NOTES--Allocation of Notes."
In addition to the foregoing material factors, the General Partners and the
Special Committee considered that the effects of the Transaction may differ with
respect to each Investor and may be disadvantageous to certain Investors,
depending on their individual circumstances and investment objectives. Further,
the General Partners and the Special Committee considered the following negative
factors relating to the Transaction:
43
<PAGE>
UNCERTAIN MARKET PRICE OF COMMON STOCK. There is substantial
uncertainty as to the prices at which the Shares will trade following the
Transaction. Following the Transaction, the market value of the Common Stock
could be substantially affected by numerous factors. Accordingly, the
possibility exists that the trading price of the Shares may be lower than
the value assigned to the Shares for purposes of the Transaction.
LACK OF OPERATING HISTORY. The Company will be a newly formed
corporation, with no operating history.
CONFLICTS OF INTEREST FACING THE GENERAL PARTNERS. There are conflicts
of interest facing the General Partners with respect to the completion of
the Transaction, including, as indicated above, that (i) the Advisor will be
an affiliate of the General Partners and therefore the owners of the General
Partners will benefit from the completion of the Transaction by indirectly
receiving fees pursuant to the Advisory Agreement, and (ii) the General
Partners determined the method of allocation of the Common Stock between
themselves and Investors.
TRANSACTION EXPENSES. The payment of the expenses relating to the
Transaction will reduce the net worth of the Company following the
Transaction.
NO ASSURANCE BENEFITS OF THE TRANSACTION WILL BE REALIZED. Considerable
time and resources will be required to be devoted by the Advisor in order to
implement the business plan of the Company and to achieve the anticipated
benefits of the Transaction. Because the success of the Company will depend
on numerous factors, including the cost of the Company's borrowing, the cost
and effectiveness of the Company's risk management strategies, changing
conditions in the real estate markets, reserve requirements and the
operating expenses of the Company, there can be no assurance the Company
will be able to achieve the benefits of the Transaction and successfully
implement it business plan.
The General Partners and the Special Committee did not believe that these
negative factors were sufficient, either individually or collectively, to
outweigh the advantages of the Transaction.
The foregoing discussion of the information and factors considered by the
General Partners and the Special Committee includes material factors considered
by the General Partners and the Special Committee. The General Partners and the
Special Committee did not assign relative weights to the above factors. A
determination of various weightings would, in the view of the General Partners
and the Special Committee, be impractical. Rather, the determinations and
recommendations of the General Partners and the Special Committee are based on
the totality of the information presented to, and considered by, them.
CERTAIN ALTERNATIVES TO THE TRANSACTION
Prior to concluding that the Transaction should be proposed to Investors and
to evaluate the fairness of the Transaction, the General Partners examined the
estimated values which could be derived from alternatives to the Transaction.
The alternatives examined by the General Partners were: (i) continuation of the
Partnerships, and (ii) liquidation of the Partnerships. To determine whether the
Transaction or one of these alternatives would be more beneficial to Investors,
the General Partners compared the potential benefits and detriments of the
Transaction with the potential benefits and detriments of each of the
alternatives. Each of the Transaction and its alternatives have potential
benefits and detriments not present in the other alternatives. For the reasons
set forth below, the General Partners determined that the Transaction is more
beneficial to Investors than either of the alternatives to the Transaction.
CONTINUATION OF THE PARTNERSHIPS. In assessing the Transaction, the General
Partners and the Special Committee considered the advantages and disadvantages
of keeping the Partnerships intact and continuing to operate them in accordance
with their respective Partnership Agreements and existing business plans. If the
Partnerships were to continue in their current form, they would remain separate
legal entities governed
44
<PAGE>
by their respective Partnership Agreements. In managing the businesses of the
Partnerships, the General Partners would continue to take whatever actions they
deemed were appropriate in satisfying their fiduciary obligations to the
Investors and the Partnerships. Under this alternative, Investors would have
continued to receive cash distributions in the future and, ultimately, a
liquidation distribution.
Continuing the Partnerships without change has a number of benefits,
including (i) the Partnerships would remain separate entities, with their own
assets and liabilities, and their original investment objectives, consistent
with the guidelines, restrictions and safeguards in their Partnership
Agreements; (ii) the Partnership's performance would not be affected by the
performance of the other Partnership, including the investment objectives,
interests and intentions of the Investors in the other Partnership; (iii) there
would be no change in the nature of the Investors' investments; (iv) the
Partnerships would not incur any expenses in connection with the Transaction;
and (v) the Partnerships would avoid the risks inherent in the Transaction. See
"RISK FACTORS."
The General Partners and the Special Committee concluded that maintaining
the Partnerships as separate entities may have the following potentially
negative results when compared with the benefits that the General Partners and
Special Committee believe may be derived from the Transaction: (i) lower
liquidity of investment due to the illiquid nature of the market for Units; (ii)
inability to raise new capital or make new investments, thus limiting growth of
the Partnerships' capital to that inherent in the existing Partnership
investments; (iii) less flexibility and control in actively managing the
portfolio; (iv) duplicative general and administrative expenses; and (v)
continued complicated tax filings.
LIQUIDATION. Although the investment objectives and policies of the
Partnerships do not contemplate the commencement of the liquidation of the
Partnerships at any specific time, the General Partners and the Special
Committee assessed the possibility of commencing the orderly liquidation of the
Partnerships and distributing the net proceeds from such liquidation to the
Investors and General Partners. The General Partners and Special Committee
concluded that liquidation would be costly and time consuming and would not be
as beneficial to Investors as the Transaction.
The General Partners and the Special Committee determined that an attempt to
liquidate the Partnerships' investments at the current time would likely result
in the Investors not achieving the full potential benefits from an investment in
the Partnerships. They concluded that liquidation would not be the best option
to realize the optimum return on an investment in the Partnerships because
although the Partnerships' investments in mortgage loans could likely be sold at
or slightly above their face value, most of the Partnerships equity positions in
the Operating Partnerships are not attractive to buyers due to restrictions in
the various Operating Partnership documents. Liquidation of most of the equity
positions would require either (i) a protracted period of negotiations with the
various general partners of the Operating Partnerships which could potentially
create both substantial transaction costs and additional costs to the
Partnerships of continuing operations during the negotiation period, and/or (ii)
the Partnerships' accepting substantial discounts in value. In addition, there
may be additional costs associated with representations, warranties, and
indemnifications that purchasers generally require and which may result in
additional escrow costs. Furthermore, the liquidation of the Partnerships would
involve certain transaction costs, such as legal fees and various other closing
costs, which would further reduce the amount of net proceeds available for
distribution.
On the other hand, in a liquidation of the Partnerships, Investors would
benefit by avoiding the risks of continuing their ownership of the Partnerships
and those associated with the Transaction. Liquidation would provide for the
final liquidation of the Investors' investments and a likely substantial
distribution of cash equal to net liquidation proceeds, though not at a level
that would allow Investors to realize their original investment. In addition,
the Investors would have the potential to reinvest the net proceeds received in
the liquidation in similar or different investments.
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<PAGE>
Based upon this comparison of the potential benefits and detriments of the
Transaction to the potential benefits and detriments of certain possible
alternatives to the Transaction, the General Partners have concluded that the
Transaction is the more attractive alternative for Investors.
Notwithstanding the belief of the General Partners and the Special Committee
that the assets of the Partnerships cannot be liquidated on favorable terms and
conditions, the following table describes the estimated liquidation values of
the Partnerships.
ESTIMATED LIQUIDATION VALUES
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
GNMA
CERTIFICATES PARTNERSHIP PARTNERSHIP NET OTHER
AND MORTGAGE EQUITY TERMINATION ASSETS AND LIQUIDATION
LOANS(1) INTERESTS(2) COSTS(3) LIABILITIES(4) VALUES
------------- ------------ ----------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Cap Source I............................ $ 35,502,310 $ 2,644,095 $(500,000) $ 10,755,845 $ 48,402,250
Cap Source II........................... $ 27,494,089 $ 1,917,753 $(500,000) $ 1,630,253 $ 30,542,095
</TABLE>
ESTIMATED LIQUIDATION VALUES
AS OF DECEMBER 31, 1997
PER $1000 INVESTMENT*
<TABLE>
<CAPTION>
GNMA
CERTIFICATES PARTNERSHIP PARTNERSHIP NET OTHER
AND MORTGAGE EQUITY TERMINATION ASSETS AND LIQUIDATION
LOANS(1) INTERESTS(2) COSTS(3) LIABILITIES(4) VALUES
--------------- --------------- --------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
Cap Source I................................. $ 521 $ 39 $ (7) $ 157 $ 710
Cap Source II................................ $ 339 $ 24 $ (6) $ 20 $ 377
</TABLE>
- ------------------------
* Totals assume Investors receive 99% of total liquidation value.
(1) GNMA Certificates and FHA Loans are reflected at an average premium over
their current principal balances equivalent to 1.5%, with the exception of
the Ponds at Georgetown ("The Ponds") which is reflected at par due to the
failure of The Ponds to pay principal, interest and property taxes when due.
A proposed settlement agreement with the co-insurer of the mortgage loan on
The Ponds is currently pending. See "THE PARTNERSHIPS--Cap Source I--RECENT
DEVELOPMENTS" and "--Cap Source II--RECENT DEVELOPMENTS." No adjustments
have been made based upon the proposed settlement agreement because the
proposed settlement does not have a material effect on the calculation of
the estimated liquidation values and because the settlement has not been
completed.
(2) Derived by using the arithmetic average of the value of the Properties as
determined by the Appraisals and subtracting repayment of the current
principal balances of the mortgages then allocating the remaining proceeds,
if any, according to the limited partnership agreements. These resulting
equity values were then discounted to reflect, in the cases where the
Operating Partnership remains in the control of a non-affiliated General
Partner, an amount that might be sufficient to acquire that General
Partner's interest plus, for all partnership interests, an additional
amount, 37.5% on average, to reflect the leveraged nature of the limited
partnership interest being sold.
(3) An estimate of costs to terminate the Partnership's business.
(4) Includes cash, cash equivalents, miscellaneous GNMA Certificates, interest
receivables and accounts payable.
46
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COMPARISON OF CERTAIN ALTERNATIVES TO THE TRANSACTION
To assist Investors in evaluating the fairness of the consideration offered
by the Company in the Transaction, the General Partners have compared the
estimated market value of the Shares with: (i) estimates of the value of the
Units on a "going concern" basis, assuming that the Operating Partnerships would
be in existence until December 31, 2002, followed by the immediate liquidation
of all the Operating Partnerships for cash and the immediate distribution of the
available proceeds to the Partnerships for further distribution to the Investors
and General Partners in accordance with the respective Partnership Agreements;
(ii) estimates of the value of the Units under a liquidation scenario, assuming
that the Partnerships' mortgages were sold at their current market value, the
limited partnership interests in the Operating Partnerships were sold at prices
reflecting discounts for the highly leveraged nature of the interests plus
estimated amounts, if any, to gain operating control of the Operating
Partnerships, and that these amounts together with cash, cash equivalents and
other net assets of the Partnership are distributed to Investors and General
Partners in accordance with their respective Partnership Agreements; and (iii)
prices at which the Units have been trading on the illiquid secondary market
over the recent 12-month period ended December 31, 1997 as compiled and reported
to the General Partners by Service Data Corporation. These valuation estimates
are subject to significant uncertainties, since the value of the Shares, as well
as the comparative estimated values are based upon numerous estimates,
variables, assumptions and market conditions. Therefore, no assurance can be
given that the estimated values indicated could be realized, and actual realized
values may be higher or lower than the estimates of such values.
The results of this comparative analysis are summarized in the table
entitled "Summary of Comparative Valuation Alternatives" set forth below.
Investors should consider that the estimated values assigned to the Shares and
alternative forms of consideration are based on a variety of assumptions that
have been made by the General Partners, using information and analysis from
Sutro & Co. as to the estimated market value of the Shares. These assumptions
relate, among other things, to: (i) projections as to the Partnerships' future
income, expenses, cash flow and other significant financial matters; (ii) the
capitalization rates that would likely be used by prospective buyers if the
Partnerships' assets were liquidated; (iii) appropriate discount rates applied
to expected cash flows in computing the present value of the cash flows that may
be received with respect to the Units; and (iv) selling costs and other
expenses, discounts and contingencies attributable to the sales of assets and
liquidation of the Partnerships. In addition, these estimates are based upon
certain information available to the General Partners at the time the estimates
were prepared, and no assurance can be given that the same conditions will exist
at the time of closing of the Transaction. The assumptions have been determined
by the General Partners, using information and analysis from Sutro & Co. as to
the estimated values of the Shares, and where appropriate, are based upon
current historical information regarding the Partnerships and current real
estate markets, and have been highlighted below to the extent material to the
General Partners' conclusions. While the General Partners believe they have a
reasonable basis for the assumptions made, it is unlikely that all of the
assumptions used by the General Partners will prove to be accurate in all
material respects, and some assumptions used by the General Partners as to
future events have been deleted to simplify the analysis and may not approximate
the actual experience of the Partnerships. The estimated values of the Shares
and alternative forms of consideration would have been different had the General
Partners made different assumptions. No assurance can be given that such
consideration would have been realized through any of the alternatives
described.
47
<PAGE>
SUMMARY OF COMPARATIVE VALUATION ALTERNATIVES
PER $1,000 OF ORIGINAL INVESTMENT*
<TABLE>
<CAPTION>
ESTIMATED LIQUIDATION ESTIMATED MARKET
ESTIMATED MARKET VALUE OF UNITS IF ASSETS VALUE OF UNITS
VALUE OF SHARES(1) SOLD AT ADJUSTED NET ASSET BASED ON WEIGHTED
-------------------- ESTIMATED GOING VALUE(3) AVERAGE OF
HIGH CONCERN VALUE OF -------------------------- SECONDARY MARKET
PARTNERSHIP VALUE LOW VALUE UNITS(2) RANGE MIDPOINT TRADES(4)
- ------------------------------------- --------- --------- ----------------- ----------- ------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Cap Source I......................... $ 754 $ 653 $ 747 $700-720 710 $ 510
Cap Source II........................ $ 409 $ 354 $ 373 $371-383 377 $ 354
</TABLE>
- ------------------------
* An Original Investment of $1,000 consists of 50 Units in each of Cap Source
I and Cap Source II.
(1) The General Partners were unable to identify publicly traded companies
directly comparable to the Company. As such, the General Partners were
unable to estimate the market value at which the Shares may initially trade
based upon the trading history of similar companies. However, based upon
methodology used by Sutro & Co. in preparing its Fairness Opinion, the
General Partners have determined the range of estimated market values of the
Company based upon a division of the assets in each Partnership into three
asset types. Asset Type A is the limited partnership interests in the
Operating Partnerships; Asset Type B is the mortgages and Asset Type C is
cash, cash equivalents and other net assets. On the low end of estimated
value, no value was assigned to Asset Type A. On the high end, Funds from
Operations ("FFO") attributable to the limited partnership interests were
valued using an FFO multiple of 10. The FFO multiple of 10 was derived by
taking the average and median 1998 estimated FFO multiple from a peer group
of equity REITs, as identified by Sutro & Co. For both the high and low
estimates, Asset Types B and C were valued at their face values as of
December 31, 1997. Values assigned to Asset Types A, B and C were added
together and divided by the number of shares outstanding after consummation
of the Transaction to determine a per Share value. The Value per original
$1,000 Investment was determined by multiplying the resulting per Share
value by the number of shares allocated per original $1,000 Investment using
the Exchange Value methodology. The General Partners and the Special
Committee recognized that there is substantial uncertainty as to the prices
at which the Shares will trade following the Transaction, and it is possible
that the Shares will trade below the values reflected in this analysis.
(2) These values were derived from a discounted cash flow analysis at the
Partnership level for the period from January 1, 1998 through December 31,
2002. The five-year period was used because it was a time period reasonably
determined by the General Partners to obtain control of the Operating
Partnerships from non-affiliates of the General Partners, thus allowing the
liquidation of the Partnerships' assets on an equivalent fee-simple basis.
Cash flows from mortgages owned by the Partnerships were included at the
fixed monthly amounts described in the respective mortgage documents. To
determine any cash flow to the Partnerships from the limited partnership
interests in the Operating Partnerships, estimated cash flows for 1998 were
taken from the Appraisals prepared by Valuation Research, and revenue and
expenses in subsequent years were increased at the rates set forth in the
Appraisals. From net income in each year, debt service payments and
applicable fees were deducted to arrive at net cash flow available for
distribution by the Operating Partnerships. Such cash is then assumed to be
distributed to the Partners in the Operating Partnerships as prescribed in
the limited partnership agreements for each Operating Partnership; any
shortfalls are assumed to be funded by the Partnerships. (Projections for
The Ponds are based on terms not materially different from the proposed
settlement agreement. For a description of these terms see "THE
PARTNERSHIP--Cap Source I-- RECENT DEVELOPMENTS" and "--Cap Source
II--RECENT DEVELOPMENTS.") Interest income and cash from principal
repayments on miscellaneous GNMA certificates are estimated based on a model
of Partnership level cash flow; that model includes an estimate of annual
administrative and operating expenses which were increased annually by 4%.
At the end of the final year of analysis, the properties were assumed to be
sold at prices derived by capitalizing the following year's net income at a
rate 25 basis points higher than the current year capitalization rate
applied to each property in the Appraisals. Selling costs are assumed to be
3% of proceeds. Net proceeds are first used to repay the then outstanding
principal balance of any mortgage loan, and remaining cash is distributed in
accordance
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with the respective partnership agreements. At the Partnership level at the
end of the final year of analysis, proceeds from repayment of the mortgage
loans, cash received in respect of limited partnership interests in the
operating partnerships, and any other net assets, including cash and cash
equivalents, are then distributed to the Investors and General Partners in
accordance with the Partnership Agreement. Annual distributed cash flows,
inclusive of liquidating proceeds from the assets sales at the end of the
period, are discounted at a rate of 11% to arrive at an estimate of the
present value of each Partnership on a "going concern" basis.
(3) The figures in this column represent the amount that would be available for
distribution to Investors if the Partnerships sold their assets as of
December 31, 1997 based on the following assumptions. Mortgages were sold at
their current market values which on the noted date would have been at
slight premiums to their current principal values. With the exception of the
mortgage on The Ponds which is included at its current principal value due
to the failure of The Ponds to pay principal, interest and property taxes
when due, premiums for the high value are 2% and for the low value are 1%. A
proposed settlement agreement with the co-insurer of the mortgage loan on
The Ponds is currently pending. See "THE PARTNERSHIPS--Cap Source I--RECENT
DEVELOPMENTS" and "--Cap Source II--RECENT DEVELOPMENTS." At December 31,
1997 there was no equity in the mortgage loan on The Ponds. No adjustments
have been made based upon the proposed settlement agreement because the
proposed settlement does not have a material effect on the calculation of
the estimated liquidation values and because the settlement agreement has
not been completed. These estimated premiums reflect, to the best knowledge
of the General Partners, current pricing on similar mortgage instruments
which are generally prepayable with minimal or no penalties. Limited partner
interests in the Operating Partnerships were sold at discounts to the values
derived by using the arithmetic average of the value of the Properties as
determined by the Appraisals and subtracting repayment of the current
principal balance of the mortgages then allocating the remaining proceeds,
if any, according to the limited partnership agreements. Discounts were
determined by the General Partners by taking into account two factors.
First, if the Operating Partnership remains in the control of a
non-affiliated General Partner, an amount was estimated that might be
sufficient to acquire that General Partners' interest and was deducted from
the derived value of the limited partnership interest. Second, discounts
ranging from 25% for the high value and 50% for the low value were taken to
reflect the leveraged nature of the ownership interest being sold, and thus
the higher return requirement of a buyer. Cash and cash equivalents were
included at their current market values, along with any other net assets. A
deduction was made for estimated costs of winding up the Partnerships. The
resulting amount was deemed to be distributed to the Investors and General
Partners in accordance with the Partnership Agreements.
(4) Based on the high and low value of secondary market trades during 1997,
provided to the General Partners by Service Data Corporation. Service Data
Corporation's records may not reflect all trading activity for the Units.
THE GENERAL PARTNERS' ANALYSIS FOR THE TRANSACTION.
The General Partners' analysis for the Transaction was based upon a review
of the alternatives to the Transaction in comparison to the proposed
Transaction. This analysis was based upon the assumptions and calculations for
the alternatives and the proposed Transaction. Except as otherwise described,
there were no limitations for any analysis. In addition, as described under
"FAIRNESS--Material Factors Underlying Belief as to Fairness," no relative
weight was assigned to any one factor.
With respect to the alternative of Continued Management, the assumptions are
set forth under "FAIRNESS--Comparison of Certain Alternatives to the
Transaction" in footnote 2 to the table entitled "Summary of Comparative
Valuation Alternatives." The resulting calculation is set forth in this table.
With respect to the alternative of liquidating the Partnerships, the
assumptions are set forth in the footnotes under tables entitled "Estimated
Liquidation Values as of December 31, 1997" and "Estimated Liquidation Values as
of December 31, 1997 per $1,000 Investment," under "--Comparison of Certain
Alternatives to the Transaction." The resulting calculations are set forth in
these tables.
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Other alternatives considered by the General Partners include (i) listing
the Units of each Partnership on a national securities exchange or automated
quotation system; (ii) merging the Partnerships into a single publicly-traded
limited partnership and listing the resulting limited partnership interests on a
national securities exchange or automated quotation system; (iii) merging the
Partnerships together to form a single REIT; and (iv) qualifying each
Partnership as an individual REIT. The General Partner's analysis did not
quantify any of these alternatives or any assumptions. A quantification of these
alternatives was not done by the General Partners because it involved a
quantification of the future trading prices of the securities described in these
alternatives. The General Partners concluded that using any assumption or group
of assumptions would result in a speculative valuation because of the limited
capitalization, market and trading assumptions.
FAIRNESS OPINION AND APPRAISALS
Sutro & Co. has rendered its opinion that the Consideration (as defined in
the Fairness Opinion, which is attached as Appendix B hereto) to be received by
Investors and the General Partners collectively, the allocation of such
Consideration among the Investors and the General Partners, and the principal
allocation of the Notes (as defined in the Fairness Opinion) in the Transaction,
is fair to the Investors and the General Partners from a financial point of
view.
FAIRNESS OPINION
GENERAL. Sutro & Co. was engaged by the Special Committee to conduct an
analysis of the Transaction and has delivered a written summary of its
determination, based on the review, analysis, scope and limitations described
therein, as to the fairness of the allocation of interests in the Company, from
a financial point of view, pursuant to the Transaction (the "Fairness Opinion").
The full text of the Fairness Opinion, which contains a description of the
assumptions and qualifications made, matters considered and limitations imposed
on the review and analysis, is set forth in Appendix B and should be read in its
entirety. Certain of the material assumptions, qualifications and limitations to
the Fairness Opinion are described below. The summary set forth below does not
purport to be a complete description of the analyses used by Sutro & Co. in
rendering the Fairness Opinion.
Except for certain assumptions described more fully below, which the Special
Committee and the Partnerships advised Sutro & Co. that it would be reasonable
to make, neither the Special Committee nor the Partnerships imposed conditions
or limitations on the scope of Sutro & Co.'s investigation or the methods and
procedures to be followed in rendering the Fairness Opinion. There were no
factors considered by Sutro & Co. that did not support their fairness
determination with respect to the Transaction. The Partnerships have agreed to
indemnify Sutro & Co. against certain liabilities arising out of its engagement
to prepare and deliver the Fairness Opinion. Upon consummation of the
Transaction such indemnity obligations will be obligations of the Company.
EXPERIENCE OF SUTRO & CO. Sutro & Co., as part of its investment banking
business, is regularly engaged in the evaluation of capital structures, the
valuation of businesses and their securities in connection with mergers and
acquisitions, firm commitment underwriting, secondary distributions of listed
and unlisted securities, private placements, financial restructurings and other
financial services. The Special Committee selected Sutro & Co. based on its
experience in similar transactions, its research capabilities, resources and
more competitive fee structure. Sutro & Co. was also selected because of its
reputation in connection with companies involved in real estate activities and
real estate assets.
SUMMARY OF MATERIALS CONSIDERED. Sutro & Co.'s analysis of the Transaction
involved a review of the following: (i) the Registration Statement on Form S-4
of the Company as filed on May 7, 1998, including the Preliminary
Prospectus/Consent Solicitation Statement included therein, (ii) the Appraisals,
(iii) individual Partnership Annual Reports and Form 10-Ks for the years ended
December 31, 1996 and December 31, 1997, (iv) the Prospectus for Cap Source I
dated January 10, 1986, (v) the Prospectus for
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Cap Source II dated February 6, 1987, (vi) the Agreement and Plan of Merger
among the Partnerships, the General Partners and the Company, (vii) certain
other publicly available business, financial and other information concerning
the Partnerships, (viii) certain internal information, primarily financial in
nature (including analytical models, projections, forecasts, estimates and
analyses) prepared by or on behalf of the management of the Partnerships, and
(ix) certain information provided to Sutro & Co. by the General Partners
concerning the distributions on, the trading of, and the trading market for, the
equity securities of the Partnerships.
ANALYSIS AND CONCLUSIONS. Sutro & Co., in conducting its review and
arriving at its opinion, noted that the exchange ratios (the "Exchange Ratios")
for Cap Source I and Cap Source II in the Transaction are based on the
Appraisals and the market values of the Partnerships' remaining assets and
liabilities at December 31, 1997 and before transaction costs or other costs
associated with the Transaction (individually or collectively the "Exchange
Values"). The Exchange Ratios relating to the Exchange Values for Cap Source I
and Cap Source II are used to determine the allocation of Shares to be received
by the investors in Cap Source I and Cap Source II in the Transaction and the
principal allocation of the Notes to be received by Investors in Cap Source I
and Cap Source II in the Transaction. The Exchange Values are used to determine
the amount of the Consideration to be received.
Sutro & Co.'s evaluation of the fairness of the Consideration among the
Partnerships is based, in part, on an analysis of the net book values of the
assets and liabilities of each of the Partnerships. Cash and temporary cash
investments, investments in FHA Loans and GNMA Certificates, interest
receivable, accounts payable and distributions payable were valued at the stated
values shown at December 31, 1997 in the audited Parent Company Only Condensed
Balance Sheets in the Annual Reports on Form 10-Ks for 1997 of each of the
Partnerships. Other assets at December 31, 1997 in the audited Parent Company
Only Condensed Balance Sheets in the Annual Reports on Form 10-K for each of the
Partnerships were deemed to have no value. Values for the investments in the
Operating Partnerships were based on the low and high of the range of appraised
values for the fee simple ownership of the individual real estate properties net
of the outstanding mortgage indebtedness of the real estate properties and other
related property level liabilities at December 31, 1997. Such net book value
evaluations indicated a range of net book values for Cap Source I of $49.4
million to $52.8 million or for Cap Source I Investors a net book value of $725
to $775 per $1,000 of original investment and a range of net book values for Cap
Source II of $31.9 million to $33.3 million or for Cap Source II Investors a net
book value of $394 to $411 per $1,000 of original investment.
In addition, Sutro & Co. based its analysis, in part, on an analysis of the
liquidation values of the assets and liabilities of each of the Partnerships.
Liquidation values were calculated as net book values plus a range of a 1% to 2%
premium on the FHA Loans and GNMA Certificates to reflect pro forma market sale
values for such securities less costs associated with disposing of the
investments in the Operating Partnerships and winding down costs for the
Partnerships. Such liquidation value evaluations indicated a range of
liquidation values for Cap Source I of $46.9 million to $50.5 million or for Cap
Source I Investors a liquidation value of $688 to $740 per $1,000 of original
investment and a range of liquidation values for Cap Source II of $29.7 million
to $31.3 million or for Cap Source II Investors a liquidation value of $367 to
$387 per $1,000 of original investment.
Sutro & Co. also analyzed the going concern values for the Partnerships to
approximate the pro forma values of the Partnerships "as is." A five-year
discounted cash flow analysis was calculated based upon pro forma dividends
projected to be received by the Investors plus a pro forma projected liquidation
of the Partnerships at the end of year five. Such cash flows were discounted at
a range of 11% to 13%. Such pro forma "as is" value evaluations indicated a
range of "as is" values for Cap Source I of $47.0 million to $50.9 million or
for Cap Source I Investors an "as is" value of $690 to $747 per $1,000 of
original investment and a range of "as is" values for Cap Source II of $28.0
million to $30.2 million or for Cap Source II Investors an "as is" value of $346
to $373 per $1,000 of original investment. Pro forma projected dividends were
provided by the General Partners and were based, in part, on five-year pro forma
projected
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income statements and balance sheets derived from property level projections by
Valuation Research and Partnership level projections by the General Partners.
As part of its analysis, Sutro & Co. reviewed a peer group of publicly
traded multifamily REITs with market capitalizations of less than $500 million.
The low, high, median and average stock price to estimated 1998 FFO for this
peer group were 8.5x, 11.3x, 9.9x and 9.9x, respectively. Sutro & Co. reviewed
publicly traded multifamily REITs in valuing the equity investments of the
Partnerships. The following REITs were considered by Sutro & Co. in its peer
group analysis: Ambassador Apartments Inc., Associated Estates Realty, Amli
Residential Properties, Berkshire Realty Co., Grove Property Trust, Home
Properties of New York, Investors Real Estate Trust, Oasis Residential Inc.,
Summit Properties Inc., Cornerstone Realty Income Trust and Town & Country
Trust. Sutro & Co. also reviewed a peer group of publicly traded C corporations
or real estate limited partnerships engaged in, among other things, ownership of
residential properties and development activities with market capitalizations of
less than $200 million. The low, high, median and average stock price to latest
twelve months' per share earnings before interest, taxes, depreciation and
amortization ("EBITDA") multiples were 3.3x, 13.2x, 9.8x and 9.1x.
Sutro & Co. also considered the following financial and other factors it
deemed important under the circumstances: (a) the historical and current
operating results of the Partnerships including, among other things, the cash
flow from the investments in FHA Loans and GNMA Certificates and the cash flow
from the investments in the Operating Partnerships, (b) distributions over the
life of each of the Partnerships including distributions and return of capital
to the Investors, and (c) certain balance sheet items of the Partnerships. Sutro
& Co. also took into account its assessment of general economic, market and
financial conditions and its experience in other transactions, as well as its
experience in the securities industry and knowledge of real estate generally.
Additionally, Sutro & Co. was requested to provide an opinion as to the
fairness, from a financial point of view, of the principal allocation of the
Notes that may be elected by the Investors. As used herein, principal allocation
refers solely to the method of allocation, as determined by Exchange Values, of
the Notes among the investors in the Partnerships. Sutro & Co. in arriving at
its opinion as to the fairness, from a financial point of view, of the
allocation of the consideration to be received by the Investors, and with
respect to each Partnership individually, assumed that the maximum amount of
Notes that may be issued in the Transaction is $40.0 million.
In the course of Sutro & Co.'s engagement, Sutro & Co. held discussions with
the senior management of the Partnerships concerning the historical, current and
projected future operations, business plans, financial conditions and results,
and prospects of the Partnerships. Additionally, Sutro & Co. discussed with
representatives of Valuation Research the results, methodology, and limitations
of the Appraisals. Sutro & Co. did not, however, independently verify the
accuracy or completeness of the Appraisals.
Based on the foregoing, Sutro & Co. concluded that, based upon its analysis
and assumptions, and as of the date of the information considered in the
Fairness Opinion, that the allocation of the Consideration to be received by
Investors and the General Partners collectively, the allocation of such
Consideration among the Investors and the General Partners, and the principal
allocation of the Notes, in the Transaction, is fair to the Investors and the
General Partners from a financial point of view.
ASSUMPTIONS, LIMITATIONS AND QUALIFICATIONS OF FAIRNESS OPINIONS. In
conducting its review, Sutro & Co. relied upon and assumed the accuracy and
completeness of the financial and other information, including the Appraisals,
provided to Sutro & Co. or which were publicly available, without independent
verification. Sutro & Co. relied upon the statements and information provided by
the management of the Partnerships as to the reasonableness and achievability of
the financial and operating forecasts and projections (and the assumptions and
bases therefor) provided to Sutro & Co. Sutro & Co. assumed that the financial
models and the financial projections provided by the General Partners that
project future results of the Partnerships are the best currently available
estimates and good faith judgements of the General Partners as to the future
performance of the Partnerships.
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Sutro & Co.'s Fairness Opinion is based upon conditions as of the date of
the Fairness Opinion and the information made available to Sutro & Co. as of the
date of the Fairness Opinion and the information made available to Sutro & Co.
as of the date such information was prepared.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to a partial analysis or summary description. Sutro &
Co. has advised the Partnerships that its entire analysis must be considered as
a whole and that selecting portions of its analyses and the factors considered
by it, without considering all analyses and factors, could create an incomplete
view of the evaluation process underlying its opinion.
The Fairness Opinion does not constitute a recommendation of the Transaction
over any alternative transactions which may be possible for the Partnerships and
does not address the Partnerships' underlying business decision to effect the
proposed Transaction. Furthermore, the Fairness Opinion did not consider any
other aspect of the proposed Transaction or any agreements or other matters,
which include, but are not limited to, the terms or fairness of the Advisory
Agreement that may be deemed part of the Transaction. However, while Sutro & Co.
did not consider the fairness of the Advisory Agreement on a separate and
individual basis, it did consider the effects of the fees payable under the
Advisory Agreement in determining the fairness of the Consideration to be
received by Investors and the General Partners and the allocation of the Notes
in the Transaction. Sutro & Co. was not asked to opine on and did not express an
opinion as to: (a) the terms of the Transaction, (b) the tax consequences of the
Transaction to the Investors, and (c) the prices at which the Company's
securities may trade at in the future.
BRINGDOWN FAIRNESS OPINION
In connection with its Bringdown Fairness Opinion delivered on ,
1998, Sutro & Co. performed the following procedures to update certain analyses
made in connection with the delivery of the Fairness Opinion:
Sutro & Co., among other things, reviewed; (i) a draft of this
Prospectus/Consent Solicitation Statement; (ii) the Form 10-Q for each
Partnership for the quarter ended March 31, 1998; (iii) pro forma financial
statements of the Company; (iv) a business plan of the Company; (v) certain
information provided to Sutro & Co. by the General Partners concerning the
distributions on, the trading of, and the trading market for, the equity
securities of the Partnerships; and (vi) certain financial and other information
that was publicly available or furnished to Sutro & Co. by the Partnerships, the
General Partners and the Company.
In addition, Sutro & Co. held discussions with representatives of the
Partnerships and the Company concerning the Partnerships' and the Company's
historical and current operations, financial conditions and prospects, reviewed
a peer group of publicly traded multifamily REITs with market capitalizations of
less than $500 million, and conducted such other investigations, financial
analysis and studies, and reviewed such other information and factors as it
deemed appropriate for the purposes of the Bringdown Fairness Opinion.
In rendering the Bringdown Fairness Opinion, Sutro & Co. relied, without
assuming responsibility for independent verification, on the accuracy and
completeness of the information it reviewed. The Bringdown Fairness Opinion is
subject to the same qualifications and limitations as the Fairness Opinion. The
full text of the Bringdown Fairness Opinion, which contains a description of the
assumptions and qualifications made, matters considered and limitations imposed
on the review and analysis, is set forth in Appendix C and should be read in its
entirety.
The Bringdown Fairness Opinion was based solely upon information available
to Sutro & Co. and the economic market and other circumstances that existed as
of the date of the Bringdown Fairness Opinion. Sutro & Co. used historical
financial information through , 1998 for the Partnership's assets and
other liabilities.
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In performing such analysis, Sutro & Co. observed that: (i) that the
liquidation analysis continued to support its fairness determination because of
the relationship between the implied range of values of the Units, assuming they
are converted into shares of Common Stock in the Transaction, and the implied
range of equity values of the Partnerships under the updated liquidation
analysis; and (ii) the continuation analysis continues to support its fairness
determination because the equity value for the Units, assuming the continuation
for the Partnerships under the updated continuation analysis, is within the
implied range of values of the Units in each Partnership assuming they are
converted into Shares in the Transaction for each Partnership.
Based on the foregoing, Sutro & Co. confirmed that, based upon its analysis
and assumptions, and as of the date of the information considered in the
Bringdown Fairness Opinion, that the allocation of the consideration to be
received by Investors and the General Partners, and the principal allocation of
the Notes, in the Transaction, is fair to Investors and the General Partners
from a financial point of view.
If a material amendment is made to the Merger Agreement, a revised Fairness
Opinion will be obtained.
APPRAISALS
GENERAL. Valuation Research was engaged by the Partnerships to appraise the
multi-family apartment complexes owned by the Partnerships through their
interest in the Operating Partnerships (the "Properties") and has delivered a
written summary of its analysis, based upon the review, analysis, scope and
limitations described therein, as to the fair market value of the Properties as
of December 31, 1997 (the "Appraisals"). The Special Committee has relied, in
part, upon these Appraisals to determine the ratios for allocating the Shares
and Notes in the Transaction. Certain of the material assumptions,
qualifications, limitations and methods used in the Appraisals are described
below.
SUMMARY OF METHODOLOGY. Valuation Research evaluated each Property based
primarily upon the income approach to valuation. Appraisers typically use up to
three approaches in valuing real property: the cost approach, the direct sales
comparison approach and the income approach. These approaches are based on the
cost to replace assets, market exchanges for comparable properties and the
capitalization of income.
The Appraisals take into account all three methods of valuation. However,
due to the income-producing nature of the properties and current market
conditions, the Appraisals place more emphasis on the income approach and use
the direct sales comparison approach as a check on the reasonableness of the
results obtained using the income approach.
The scope of the Appraisals included an inspection of each Property in
December 1997, and an analysis of recent comparable sales and rental rates of
similar property in each of the subject's specific area.
The highest and best use of each property was also considered. Valuation of
a property is based on its most profitable likely use. The highest and best use
is arrived at by testing potential uses of the property, both as improved and as
though vacant, to find the use which meets the following criteria: physically
possible--the uses of vacant land which are possible after considering physical
characteristics of the land; legally permitted--uses that are permissible after
considering local, state and federal regulations and private restrictions;
financially feasible--those uses which are physically possible and legally
permitted which produce a positive return beyond operating expenses, financial
obligations, and capital amortization; and maximum productive use--the use that
is physically possible, legally permitted and financially feasible which
produces the highest price or value, which is the highest and best use.
Valuation Research concluded that the highest and best use of the Properties is
for multi-family residential development, which is also the current use of the
Properties.
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THE COST APPROACH. The cost approach is a valuation technique that uses the
concept of replacement as a value indicator. Reproduction or replacement cost is
estimated for the property being appraised and is then adjusted for losses in
value (appraised depreciation) due to a variety of factors. This process
requires valuing the site as if vacant, then adding the replacement cost new of
improvements based upon market derived costs for similarly constructed
properties. Then, accrued depreciation from physical deterioration and
obsolescence of all causes is estimated and subtracted from the replacement cost
new to arrive at the present value.
THE SALES COMPARISON APPROACH. The sales comparison approach is a valuation
technique in which value is estimated on the basis of market prices in actual
transactions. The technique consists of studying available market comparable
information and adjusting for differences. This process is essentially that of
comparison and correlation. Differences always exist between properties even
though they may be almost identical, and therefore adjustments for these
differences must be made. Some adjustments that may prove important are: (i)
conditions of sale, (ii) financing terms, (iii) market conditions (time), (iv)
location, (v) physical characteristics, and (vi) income characteristics. A
minimum of three comparable sales were used to form the basis for estimating the
market value of the subject Properties.
THE INCOME APPROACH. The income approach is a valuation technique that
capitalizes the anticipated income stream from the appraised assets. This
approach is predicated on developing either cash flow or income projections,
which are then discounted for risk and time value. Additionally, the present
value of a projected residual value is estimated and added to the present value
of the income stream to derive a total present value.
The income approach attempts to quantify expected, yet uncertain future
benefits. There are two accepted methods of applying the income approach: direct
capitalization and discounted cash flow analysis.
DIRECT CAPITALIZATION APPROACH
The direct capitalization approach is the determination of a proper rental
or revenue value that one would expect to be able to obtain for the subject
property based on actual historical operations and a study of comparable leased
properties with respect to rent levels, location, and amenities offered.
Adjustments are made for differences between the subject and comparable
properties to derive an estimated current economic rent. A similar analysis of
operating expenses aids in constructing an operating statement. The end result
is a net operating income ("NOI") for the first year income that can be
converted into an indicated property value through the overall capitalization
process.
The direct capitalization approach begins with an estimate of the subject's
market rent potential based on an analysis of comparable properties and their
current rental rates and an analysis of the actual rentals in place on the
subject property. The unit of comparison is typically the rent per unit. From
this is deducted an amount estimated to reflect the operating expenses
attributable to the subject property. This operating expense deduction is based
on published market surveys and actual historical data.
To arrive at an appropriate market rent, Valuation Research analyzed several
similar apartments in the immediate area of each subject. Gross potential rent
was derived from the historical revenue trends of the subject property, as well
as from the market surveys mentioned above. The market area for each subject was
also analyzed with respect to current and future apartment rental trends. This
information, taken together with the historical vacancy and collection loss
experience of the subject property based on discussions with the operating
manager and published data, was used to estimate the appropriate vacancy and
collection loss over the projection period.
Effective gross income for each property was estimated based on the
historical income information provided and the market rental information.
Operating expenses were estimated based upon information published by the
Institute of Real Estate Management ("IREM") along with the actual historical
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experience of the subject property. A management fee of 5% of effective gross
income, including miscellaneous income, is generally charged for properties such
as the subject properties, and was used most often in Valuation Research's
analysis. A reserve for replacement was also included in the analysis.
Net operating income was calculated by taking potential gross rental income,
less vacancy and collection loss, less operating expenses, less a management fee
and less reserves for replacement. The relationship between NOI and value can be
expressed in its overall rate of return, or capitalization rate. Capitalization
rates were abstracted from market surveys conducted by reputable national firms
for each of the major metropolitan areas in which the subject properties are
located, as well as reports by The National Real Estate Index for the Third
Quarter, 1997, KORPACZ REAL ESTATE INVESTOR SURVEY and the American Council of
Life Insurance reports. The indicated value for each property was derived from
the NOI for each property divided by the Capitalization Rate.
DISCOUNTED CASH FLOW METHOD
The discounted cash flow method has two components. The first component
equals the sum of the present value of cash flows over a selected holding
period. Valuation Research used a ten year holding period in its analysis. The
second component, a residual, equals the present value of a perpetuity paying
income equal to net income in year eleven and capitalized with the appropriate
capitalization rate. The residual reflects the property's ongoing potential
after the tenth year.
The income and expense projections for each property were based on
historical operating data, information provided by local lessors, and published
data sources. Income and expense statements, furnished by the building
management, were reviewed and adjusted, where necessary, to reflect more typical
market expenses as reported by IREM. These operating results were cross-checked
for reasonableness with market information obtained from area lessors, leasing
agents and brokers who also provided data relating to current rental rates,
vacancy levels, and typical lease terms.
The anticipated earnings received in the future must be discounted to a
present value using a discount rate derived from current market rates for
alternative investments. To determine the current discount rate applicable for
real estate investment, Valuation Research reviewed market surveys of large
institutional real estate investors. Using this market derived data, and
adjusting it based on the specific risks involved with investing in each of the
subject properties, a unique discount rate was estimated and used to discount
the projected cash flows to determine an estimated present value for each
property.
56
<PAGE>
CONCLUSIONS AS TO VALUE. Based on the valuation methodology described
above, Valuation Research assigned a value to each individual Property as set
forth in the following table:
PROPERTY/VALUE RANGE SCHEDULE
<TABLE>
<CAPTION>
CAPITAL SOURCE I VALUE RANGE
- ------------------------------------------ ----------------------------
<S> <C>
Bluff Ridge (108 Units) $3,250,000 - $3,700,000
Jacksonville, North Carolina
Waterman's Crossing (260 Units) $11,700,000 - $12,500,000
Newport News, Virginia
Water's Edge (108 Units) $5,700,000 - $6,500,000
Lake Villa, Illinois
Highland Park (252 Units) $11,000,000 - $11,350,000
Reynoldsburg, Ohio
Fox Hollow (184 Units) $6,770,000 - $7,550,000
High Point, North Carolina
Misty Springs (128 Units) $4,500,000 - $5,000,000
Daytona Beach, Florida
<CAPTION>
CAPITAL SOURCE II VALUE RANGE
- ------------------------------------------ ----------------------------
<S> <C>
Crane's Landing (252 Units) $12,500,000 - $13,000,000
Winter Park, Florida
Delta Crossing (178 Units) $7,500,000 - $8,300,000
Charlotte, North Carolina
Monticello (106 Units) $5,500,000 - $6,000,000
Southfield, Michigan
<CAPTION>
CAPITAL SOURCE I AND II VALUE RANGE
- ------------------------------------------ ----------------------------
<S> <C>
The Ponds at Georgetown (134 Units) $7,250,000 - $7,375,000
Ann Arbor, Michigan
</TABLE>
ASSUMPTIONS, LIMITATIONS AND QUALIFICATIONS OF APPRAISALS. Valuation
Research utilized certain assumptions to determine the appraised value of the
Properties under the income approach. The Appraisals reflect Valuation
Research's valuation of the Properties as of December 31, 1997 in the context of
information available on such date. Events occurring after December 31, 1997 and
before the Effective Date could affect the Properties or assumptions used in
preparing the Appraisals. Valuation Research will not deliver any additional
written summary of the analysis.
Financial statements and other related information provided by the General
Partners in the course of the investigation was accepted, without further
verification, as fully and correctly reflecting the Partnership's business
conditions and operating results for the respective periods, except as
specifically noted in the report. Public information and industry and
statistical information was obtained from sources Valuation Research deemed to
be reliable; however, Valuation Research made no representation as to the
accuracy or completeness of such information, and accepted the information
without further verification.
The conclusions of value are based upon the assumption that the current
level of management expertise and effectiveness would continue to be maintained
and that the character and integrity of the enterprise through any sale,
reorganization, exchange, or diminution of the owners' participation would not
be materially or significantly changed. Valuation Research did not render any
opinion as to title, which
57
<PAGE>
was assumed by Valuation Research to be marketable. The Company conducted an
independent review of title to the Properties. Valuation Research also assumed
that the Properties will be responsibly owned and properly maintained.
Valuation Research did not make a land survey of the Properties. The
boundaries used in the report were taken from records believed to be accurate.
Valuation Research assumed that there were no hidden or unapparent conditions of
the Properties, subsoil, or structures which would render the properties more or
less valuable. Any information furnished by others and included in the Appraisal
report is from sources deemed by Valuation Research to be reliable and believed
to be true and accurate; however, no responsibility was assumed for its
accuracy.
It was assumed that there was full compliance with all applicable federal,
state, and local environmental regulations and laws unless noncompliance was
stated, defined and considered in the Appraisal report. Valuation Research is
not an environmental consultant or auditor, and it did not take responsibility
for any actual or potential environmental liabilities. Valuation Research did
not conduct or provide environmental assessments. Valuation Research asked the
managers of the apartment complexes whether they were subject to any present or
future liability relating to environmental matters (including but not limited to
CERCLA/Superfund liability). Valuation Research did not determine independently
whether any of the apartment complexes or their owners were subject to any such
liabilities, nor the scope of any such liabilities. The Appraisal did not take
such liabilities into account except as they were reported expressly to
Valuation Research by the managers of the apartment complexes, and then only to
the extent that the liability was reported to Valuation Research in an actual or
estimated dollar amount. Such matters are noted in the report. To the extent
such information was reported, Valuation Research relied on it without
verification and offered no warranty or representation as to its accuracy or
completeness.
It was assumed that all applicable zoning and use regulations and
restrictions were complied with, unless a nonconformity was stated, defined, and
considered in the appraisal report. It was also assumed that all required
licenses, certificates of occupancy, consents, or other legislative or
administrative authority from any local, state, or national government or
private entity or organization was or could be obtained or renewed for any use
on which the value estimate contained in the Appraisal report is based.
Valuation Research did not make a specific compliance survey or analysis of
the subject properties to determine whether they were subject to or in
compliance with the ADA and the opinion did not consider the impact, if any, of
noncompliance in estimating the value of the Property.
SUMMARY OF VALUATION RESEARCH ASSUMPTIONS
<TABLE>
<CAPTION>
REVENUE GROWTH EXPENSE GROWTH CURRENT YEAR
PROPERTY RATE RATE CAPITALIZATION RATE
- ---------------------------------------------- ----------------- ----------------- ---------------------
<S> <C> <C> <C>
Bluff Ridge................................... 3.0% 3.0% 9.50%
Waterman's Crossing........................... 2.5 2.0 9.25
Misty Springs................................. 3.0 2.0 9.00
Waters Edge................................... 2.0 3.0 9.25
Highland Park................................. 3.0 2.0 9.00
Ponds at Georgetown........................... 2.5 2.0 9.50
Crane's Landing............................... 3.0 3.0 9.00
Delta Crossing................................ 2.5 3.0 9.75
Monticello.................................... 2.5 3.0 9.75
Fox Hollow.................................... 2.5 3.0 9.50
</TABLE>
58
<PAGE>
COMPENSATION AND MATERIAL RELATIONSHIPS
Neither Valuation Research, Sutro & Co., nor any of their employees have a
present or intended material financial interest in the Company, the Partnerships
or the Properties, nor has there been a material relationship between Valuation
Research or Sutro & Co. or any of their respective affiliates and the Company,
the Partnerships, the General Partners or any of their respective affiliates
during the past two years.
The Partnerships paid Valuation Research aggregate fees of $80,000 plus
expenses to prepare the Appraisals. Sutro & Co. will receive the following fees
for delivering the Fairness Opinion: (i) a non-refundable retainer of $50,000
paid upon the Partnerships' execution of the engagement letter, plus (ii) a fee
of $50,000 paid upon the mailing of this Prospectus/Consent Solicitation
Statement to the Investors, plus (iii) a fee of $50,000 paid upon the delivery
and presentation of Sutro & Co.'s first analysis to the Special Committee, plus
(iv) a fee of $50,000 payable on the final closing of the Transaction, plus (v)
reimbursement for reasonable fees and disbursements of Sutro & Co.'s counsel and
Sutro & Co.'s reasonable travel and other incidental expenses.
The fees paid to Sutro & Co. in connection with the preparation of the
Fairness Opinion were determined through arm's-length negotiations between Sutro
& Co. and the Special Committee. The fees paid to Valuation Research in
connection with the preparation of the Appraisals were determined through
arm's-length negotiations between Valuation Research and the General Partners. A
copy of the Fairness Opinion and the Bringdown Fairness Opinion are attached as
Appendix B and Appendix C, respectively, to this Prospectus/Consent Solicitation
Statement. Investors may obtain a copy of the Appraisal reports prepared by
Valuation Research upon written request directed to: America First Companies
L.L.C., Attn: Maurice Cox, 1004 Farnam Street, Suite 400, Omaha, Nebraska 68102.
EXCHANGE VALUES
Investors in the Partnerships will receive Shares or Notes based upon an
exchange value (the "Exchange Value") described below. The General Partners will
also receive Shares based upon the Exchange Value. The Exchange Values were
initially determined by the General Partners and reviewed and approved by the
Special Committee, which was retained without any conditions or restrictions.
The Exchange Values are based upon (i) the principal amount of GNMA
Certificates and the FHA Loans as set forth in the Partnership's audited
financial statements for the period ended December 31, 1997, (ii) the value of
the Partnership's limited partner interests in the Operating Partnerships, and
(iii) the market value of the Partnerships' remaining net assets as set forth in
the Partnerships' audited financial statements for the period ended December 31,
1997.
To determine the value of each Partnership's limited partner interest in an
Operating Partnership, the General Partners started with the mean of the range
of values provided by Valuation Research in its Appraisal of the Operating
Partnership's Property. See "FAIRNESS OPINION AND APPRAISALS-- Appraisals." The
liabilities of the Operating Partnership, including amounts required to pay off
the insured mortgage on the Property and amounts owed to the general partner of
the Operating Partnership, were then subtracted from the mean value. The net
amount of other assets of the Operating Partnership was added. The net value
after these adjustments was then apportioned among the general partner and
limited partners of the Operating Partnership according to the Operating
Partnership limited partnership agreement. In valuing the Operating
Partnerships, the General Partners did not take into account amounts that may be
payable by certain Cap Source I Operating Partnerships to affiliates of the Cap
Source I General Partners that will be waived if the Transaction is completed.
See "BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION--Reasons for,
and Benefits of, the Transaction--WAIVER BY AFFILIATES OF THE CAP SOURCE I
GENERAL PARTNERS OF AMOUNTS PAYABLE BY CERTAIN CAP SOURCE I OPERATING
PARTNERSHIPS."
59
<PAGE>
The Exchange Values were determined as of December 31, 1997. As of the date
of this Prospectus/ Consent Solicitation Statement, the General Partners and
management of the Company do not know of any material change in the Partnerships
which would affect the Exchange Value.
The following tables set forth the Exchange Value attributable to the
Partnerships for purposes of the Transaction, as well as the allocation of
Shares based on the Exchange Values. The tables assume that no Notes are issued
in connection with the Transaction.
EXCHANGE VALUES
FOR ALLOCATION OF SHARES
<TABLE>
<CAPTION>
TOTAL TOTAL NUMBER PERCENT OF
EXCHANGE VALUE OF SHARES TOTAL SHARES
-------------- ------------- -------------
<S> <C> <C> <C>
PARTNERSHIPS
Cap Source I................................... $ 50,991,970 2,039,679 60.8%
Cap Source II.................................. 32,880,190 1,315,208 39.2
-------------- ------------- -----
Total........................................ $ 83,872,160 3,354,887 100.0%
-------------- ------------- -----
-------------- ------------- -----
INVESTORS
Cap Source I Investors......................... $ 50,482,050 2,019,282 60.2%
Cap Source II Investors........................ 32,551,388 1,302,056 38.8
-------------- ------------- -----
Total........................................ $ 83,033,438 3,321,338 99.0%
-------------- ------------- -----
-------------- ------------- -----
GENERAL PARTNERS
Cap Source I General Partners.................. $ 509,920 20,397 .6%
Cap Source II General Partners................. 328,802 13,152 .4
-------------- ------------- -----
Total........................................ $ 838,722 33,549 1.0%
-------------- ------------- -----
-------------- ------------- -----
</TABLE>
<TABLE>
<CAPTION>
PER $1,000
ORIGINAL INVESTMENT BY INVESTORS
--------------------------------------
EXCHANGE VALUE NUMBER OF SHARES
----------------- -------------------
<S> <C> <C>
PARTNERSHIPS
Cap Source I.................................. $ 748 29.92
Cap Source II................................. $ 406 16.23
</TABLE>
CALCULATION OF EXCHANGE VALUES. The following table sets forth the
components of the Exchange Value for the Partnerships.
CALCULATION OF EXCHANGE VALUES
<TABLE>
<CAPTION>
GNMA
CERTIFICATES PARTNERSHIP NET OTHER
AND MORTGAGE EQUITY ASSETS AND EXCHANGE
LOANS(1) INTERESTS(2) LIABILITIES VALUE
------------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Cap Source I.......................................... $ 35,010,658 $ 5,225,467 $ 10,755,845 $ 50,991,970
Cap Source II......................................... 27,162,646 4,087,291 1,630,253 32,880,190
</TABLE>
- ------------------------
(1) GNMA Certificates and FHA Loans are included at their outstanding principal
balances as of December 31, 1997.
(2) Partnership Equity Interests are derived by using the arithmetic average of
the value of the properties as determined by the Appraisals, subtracting the
current principal balances of the mortgages then allocating the remaining
proceeds, if any, according to the limited partnership agreements.
60
<PAGE>
NET OTHER ASSETS AND LIABILITIES TABLE. The following table sets forth the
components of net other assets and liabilities.
NET OTHER ASSETS AND LIABILITIES TABLE
FOR PARTNERSHIPS
<TABLE>
<CAPTION>
NET OTHER
CASH & CASH MISC. GNMA ASSETS & DISTRIBUTIONS
EQUIVALENTS CERTIFICATES(1) LIABILITIES(2) PAYABLE TOTAL
------------- ------------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
Cap Source I........................... $ 10,410,564 $ 1,088,526 $ 117,342 $ (860,587) $ 10,755,845
Cap Source II.......................... 1,240,992 1,050,718 (114,489) (546,968) 1,630,253
</TABLE>
- ------------------------
(1) These assets are classified for reporting purposes as "available for sale"
and, as such, are reported at fair value.
(2) Generally, interest receivable less accounts payable.
61
<PAGE>
COMPARISON OF LIMITED PARTNERSHIP AND CORPORATE STRUCTURE
In the Transaction, each Partnership will be deemed to have received Shares
and Notes and to have distributed such property to its Investors. The effect of
the Transaction, therefore, is to convert the Units into Shares and Notes. Due
to the inherent differences in form, the change in structure from a partnership
to a corporation will result in certain differences in the scope and operation
of the Partnerships' current businesses and in the interests of the Investors.
In addition, the Partnerships have certain features and characteristics which
are different from those which will exist in the Company.
The rights of Investors are governed by the Delaware Partnership Law and by
the respective Partnership Agreements of the Partnerships. The rights of the
Company's Shareholders and Noteholders will be governed by the Delaware General
Corporation Law (the "Delaware GCL") and the Organizational Documents of the
Company.
A summary of this comparison is set forth under "SUMMARY."
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
UNITS SHARES
- ------------------------------------------------------------------------------------------
<S> <C>
FORM OF ORGANIZATION
Each Partnership is a limited partnership The Company was organized as a corporation
formed under the Delaware Partnership Law. under the Delaware GCL.
Each Partnership has been treated as a
partnership for federal income tax purposes.
EACH PARTNERSHIP WAS FORMED AS A LIMITED PARTNERSHIP UNDER THE DELAWARE PARTNERSHIP
LAW WHILE THE COMPANY WAS ORGANIZED AS A CORPORATION UNDER THE DELAWARE GCL.
BUSINESS
The Partnership Agreements limit the The Company will invest in real estate and
business of the Partnerships to originating, real estate-related activities, and may
acquiring, holding, selling, disposing of engage in any other business activities
and otherwise dealing with insured mortgages permitted a corporation organized under the
on multi-family rental housing complexes and laws of the State of Delaware. The powers,
to acquiring, holding, selling, disposing of limitations and rights with respect to the
and otherwise dealing with limited part- real estate operations conferred in the
nership interests in operating partnerships Partnership Agreements will not be
which construct and operate multi-family applicable to the business activities of the
rental housing complexes. The Partnership Company. The Company will be able to take
Agreements do not permit the Partnerships to advantage of financing opportunities and may
raise new capital. use forms of financing which the
Partnerships did not use. Additional capital
may be raised through all available sources,
including additional equity financing,
borrowings from banks, institutional
investors, public and private debt markets
or other financing vehicles which will be
dependent upon the equity and debt market
conditions, interest rates and other
factors. Many of these additional forms of
financing also expose the Company to
additional risks which do not exist with
respect to the Partnerships, including the
risk of default and foreclosure on any
security securing debt.
THE COMPANY WILL HAVE BROADER BUSINESS OPPORTUNITIES THAN THE PARTNERSHIPS. IN
ADDITION, THE COMPANY WILL HAVE ACCESS TO ADDITIONAL FINANCING OPPORTUNITIES WHICH ARE
CURRENTLY NOT ACCESSIBLE TO THE PARTNERSHIPS. INHERENT IN SEVERAL OF THE ADDITIONAL
FINANCING OPPORTUNITIES ARE CERTAIN RISKS WHICH DO NOT EXIST IN THE CASE OF THE
PARTNERSHIPS.
</TABLE>
62
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
UNITS SHARES
- ------------------------------------------------------------------------------------------
<S> <C>
DURATION OF EXISTENCE
The Partnership Agreements provide that the In accordance with the Delaware GCL and the
Partnerships may exist for terms ranging Company's Certificate of Incorporation, the
from 40 to 49 years and that the Company will continue in perpetual
Partnerships have a limited existence. In existence. The Company has no present
furtherance of this objective, the Part- intention to sell a substantial number of
nership Agreements generally provide that properties. The Company will have no
the proceeds from the sale, financing, restrictions in reinvesting funds after the
refinancing or other disposition of any sale of an original investment. Therefore,
property owned by the Partnerships will not the Company believes that it will be in a
be reinvested but will be distributed to the position to take advantage of economic
Investors to the extent such proceeds exceed opportunities as they are presented. Because
the Partnerships' other cash requirements. the Company will have no restrictions on the
reinvestment of funds, Shareholders will
assume the risk of such reinvestment and
will not be entitled to an immediate
distribution from sale, financing,
refinancing or disposition proceeds.
THE PARTNERSHIP AGREEMENTS PROVIDE FOR THE DISSOLUTION OF THE PARTNERSHIPS AFTER A
SPECIFIED NUMBER OF YEARS, WHEREAS THE COMPANY'S CERTIFICATE OF INCORPORATION PROVIDES FOR
PERPETUAL EXISTENCE. UPON COMPLETION OF THE TRANSACTION, SHAREHOLDERS WILL NOT BE ENTITLED
TO AN IMMEDIATE DISTRIBUTION OF LIQUIDATION OR DISPOSITION PROCEEDS.
INVESTMENT OBJECTIVES AND POLICIES
The principal investment objectives of the The investment objectives of the Company are
Partnerships are substantially the same: to to provide dividends and the potential for
preserve invested capital, to maximize the capital appreciation as reflected in the
potential for appreciation in property market price of the Common Stock, and to
values and to provide for partially tax expand the capital and asset base of the
deferred cash distributions throughout a Company. The Company's Board of Directors
finite life. may change the investment policies of the
Under the Partnership Agreements, the Company without a vote of the Shareholders.
Partnerships are not permitted to reinvest The Company intends to continue its
cash from sales in new properties, except in operations for an indefinite period of time
limited circumstances. The Partnerships will and is not precluded from raising new
automatically dissolve at varying times capital, including senior securities that
between 2030 and 2035, unless dissolved will have priority over the Common Stock as
earlier. The Partnerships have no present to cash flow, distributions and liquidation
intention to liquidate or to sell or finance proceeds, or from reinvesting cash flow or
their properties. sale or financing proceeds in new
properties. Therefore, Shareholders have the
ability to liquidate their investment only
by selling their Shares in the market, and
the market value of the Shares may never
equal or exceed the market value of the Com-
pany's assets or the net proceeds which may
be available for distribution upon
liquidation if the Company were to
liquidate. The Company has the potential for
increasing assets and stockholder value as
new investments are made.
INVESTORS WHO BECOME SHAREHOLDERS WILL BE ABLE TO LIQUIDATE THEIR INVESTMENT BY
SELLING THEIR SHARES IN THE MARKET. THE INTEREST OF SHAREHOLDERS IN THE COMPANY CAN BE
DILUTED THROUGH THE ISSUANCE OF ADDITIONAL SECURITIES, INCLUDING SECURITIES THAT HAVE
PRIORITY OVER THE COMMON STOCK AS TO CASH FLOW, DISTRIBUTIONS AND
</TABLE>
63
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
UNITS SHARES
- ------------------------------------------------------------------------------------------
<S> <C>
LIQUIDATION PROCEEDS. THE COMPANY'S BOARD OF DIRECTORS MAY CHANGE THE INVESTMENT POLICIES
OF THE COMPANY WITHOUT A VOTE OF THE SHAREHOLDERS.
BORROWING POLICIES
The Partnerships are not authorized to incur The Company has broad powers to borrow in
borrowings or are restricted in the amount furtherance of its investment objectives.
and nature of borrowings. The Partnerships The Company intends to incur both short-term
do not incur borrowings in the ordinary and long- term debt in the future to
course of business. increase its funds available for investment
in real estate. While the ability of the
Company to incur indebtedness provides
additional sources of funds and additional
financing opportunities, there are also
certain risks inherent in incurring
indebtedness, including the risk of default
and foreclosure on any security securing
such debt.
INVESTORS WHO BECOME SHAREHOLDERS WILL HAVE INVESTED IN AN ENTITY THAT INCURS DEBT IN
THE ORDINARY COURSE OF BUSINESS AND THAT REINVESTS PROCEEDS FROM BORROWINGS. THE
INCURRENCE OF DEBT INCREASES THE RISK OF INVESTMENT.
MANAGEMENT
The Partnerships are managed by the General The Company will be managed by a Board of
Partners, which have exclusive authority Directors elected by the Shareholders. Under
over the Partnerships' operations, subject Delaware law, the directors are accountable
to certain limitations provided in the to the Company and its Shareholders as
Partnership Agreements. Under Delaware law, fiduciaries and are required to perform
the General Partners are accountable to the their duties in good faith, in a manner
Partnerships and the limited partners as believed to be in the best interests of the
fiduciaries. The limited partners may not Company and its Shareholders and with such
participate in management of the care, including reasonable inquiry, as an
Partnerships. The General Partners have ordinarily prudent person in a like position
general liability for all partnership would use under similar circumstances. The
obligations. The Partnership Agreements liability of the directors is limited
provide generally that the General Partners pursuant to the provisions of Delaware law
are indemnified from losses relating to acts and the Company's Organizational Documents,
performed or omitted to be performed in good which limit a director's liability for mone-
faith and in the best interests of the tary damages to the Company or its
Partnerships, provided the conduct did not Shareholders for breach of the director's
constitute negligence, misconduct, breach of duty of care, where a director fails to
a fiduciary duty or a breach of obligations exercise sufficient care in carrying out the
under the Partnership Agreements. The responsibilities of his office. Those provi-
General Partners may be removed by a vote of sions would not protect a director from
a majority of partnership interests in the liability for a breach of duty of loyalty,
respective Partnerships. intentional misconduct or knowing violations
of law, unlawful dividend payments or
redemption of stock, or any transaction in
which the director derived an improper
personal benefit, nor would they foreclose
any other remedy which might be available to
the Company or the Shareholders. The Bylaws
require the Company to indemnify its
officers and directors under certain
circumstances for expenses or liability
incurred as a result of litigation. The Com-
pany intends to take full advantage of those
provisions and enter into agreements with
the Company's directors and officers,
indemnifying them to the fullest extent
permitted by Delaware law.
</TABLE>
64
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
UNITS SHARES
- ------------------------------------------------------------------------------------------
<S> <C>
THE RIGHTS OF SHAREHOLDERS AGAINST MANAGEMENT OF THE COMPANY IN CERTAIN CIRCUMSTANCES
ARE MORE LIMITED THAN THE RIGHTS OF INVESTORS AGAINST THE GENERAL PARTNERS.
FEES AND EXPENSES
DISBURSABLE CASH FEE
The Partnership Agreements generally provide
that the General Partners are entitled to an
amount not to exceed 1% of cash
distributions in each year.
ASSET MANAGEMENT COMPENSATION
The Cap Source I General Partners are The Advisor will be paid an Acquisition Fee
entitled to receive an asset management and in an amount equal to 1% of the increase in
partnership administrative fee equal to 0.5% the Company's actual investment in New
of invested assets per annum, payable only Assets, including any costs related to the
during such years that an 8% return has been acquisition or financing of New Assets but
paid to Investors on a noncumulative basis. excluding debt which is incurred or assumed
Any unpaid amounts will accrue and be in connection therewith, payable monthly in
payable only after a 13% annual return to arrears. The Advisor will be paid an Asset
Cap Source I Investors has been paid on a Management Fee each month in an amount equal
cumulative basis and such Investors have to .475%, on an annual basis, of the
received the return of their capital Company's Total Assets. The Advisor will
contributions. The Cap Source II General also receive an Incentive Fee on New Assets,
Partners are entitled to receive an asset equal to 10% of any Capital Gain on New
management and partnership administrative Assets (offset by Capital Losses), payable
fee equal to 0.5% of invested assets per by the Company to the Advisor on an annual
annum, the first $50,000 of which is paid basis in the form of Restricted Stock.
each year with the balance payable only
during such years that a 6.5% annual return
has been paid to Cap Source II Investors on
a noncumulative basis. An additional fee of
0.5% of invested assets will be paid in
years that an 11.5% annual return has been
paid to Cap Source II Investors on a
cumulative basis. Any unpaid amounts will
accrue and be payable only after an 11.5%
annual return to Investors has been paid on
a cumulative basis and the Investors have
received the return of their capital
contributions. The General Partners also
receive 1% of the net proceeds from any sale
of Partnership assets. The General Partners
will receive a termination fee equal to 3%
of all sales proceeds less actual costs
incurred in connection with all sales
transactions, payable only after the
Investors have received a return of their
capital contributions and a 13% annual
return on a cumulative basis with respect to
Cap Source I or an 11.5% annual return on a
cumulative basis with respect to Cap Source
II. The General Partners will also receive a
fee equal to 9.1% of all cash available for
distribution and sales proceeds (after
deducting from cash available or sales
proceeds
</TABLE>
65
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
UNITS SHARES
- ------------------------------------------------------------------------------------------
<S> <C>
any termination fee paid therefrom) after
Investors have received a return of their
capital contributions and a 13% annual
return on a cumulative basis with respect to
Cap Source I or an 11.5% annual return on a
cumulative basis with respect to Cap Source
II.
REIMBURSEMENT OF EXPENSES
The Partnership Agreements provide that all In connection with providing services to the
of the Partnerships' expenses, including Company, the Advisor shall be reimbursed by
legal, auditing and accounting expenses, the Company only for (i) rent, utilities,
will be billed directly to and paid by the capital equipment and related expenses
Partnerships. Under the Partnership associated with any office which is
Agreements, the General Partners are established and maintained by the Advisor
reimbursed for their expenses for services exclusively to provide services to the
performed for the Partnerships, such as Company, (ii) expenses of third parties
legal, accounting, transfer agent, data which derive 25% or less of their gross
processing and duplicating services. revenues from providing services to the
Company, and (iii) travel expenses incurred
by employees of the Advisor in connection
with travel at the request or on behalf of
the Company; provided that the Company's
reimbursement of these expenses shall be
limited to amounts for them in the annual
budget as approved by the Board of
Directors, with any subsequent changes
approved by the Board of Directors.
ONE OF THE BENEFITS OF THE TRANSACTION IS TO ALIGN THE INTERESTS OF THE SHAREHOLDERS
AND MANAGEMENT OF THE COMPANY SO AS TO MINIMIZE THE INHERENT CONFLICTS OF INTEREST
CURRENTLY EXISTING AMONG THE PARTNERSHIPS, THE GENERAL PARTNERS AND THEIR AFFILIATES. THE
TRANSACTION WILL RESULT IN THE PERSONS WHO MANAGE THE COMPANY HAVING A SUBSTANTIAL
FINANCIAL INTEREST IN ITS SUCCESS.
VOTING RIGHTS
The Investors are entitled to vote only as With respect to the rights of the
provided under the Delaware Partnership Law stockholders of a Delaware corporation, in
and the respective Partnership Agreements. general stockholders are entitled to vote on
Generally, an Investor may vote on: (i) any material transactions or actions
material amendments to the Partnership relating to such corporation, and such
Agreement; (ii) the approval of the transactions or actions may not be
disposition of substantially all of the consummated without the approval of the
Partnership's assets; (iii) an election to requisite number of stockholders. These
dissolve the Partnership; (iv) the instances include: (i) the right to elect
determination to remove the General Partner; the board of directors and thus participate
(v) the approval of the Partnership in the management of the corporation; (ii)
incurring material additional amounts of the right to amend the corporation's
indebtedness; (vi) the determination to articles of incorporation and bylaws; (iii)
terminate a contract between the Partnership the determination to dissolve the
and the General Partner or an affiliate corporation; (iv) the determination to merge
thereof; and (vii) the approval of a the corporation with or into another entity;
successor General Partner. Under the (v) the determination to approve or
Delaware Partnership Law and the Partnership disapprove the sale of substantially all of
Agreements, decisions relating to the the corporation's assets; and (vi) any other
operation and management of the Partnerships matters which are properly brought before
are made by the General Partners of each the stockholders. Corporations are also
Partnership. There are no provi- required to hold annual meetings which allow
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sions for annual meetings of Investors in stockholders to vote for the directors of
the Partnership Agreements. If a limited the corporation and to participate in the
partner were granted additional voting corporation's decision-making process.
rights, the possibility exists under the Therefore, stockholders have enhanced voting
Code that the partnership structure and the rights as to both determinations of the
terms of the applicable Partnership parties who will be effectuating policy on
Agreement would be disregarded. In such behalf of the corporation, as well as with
event, the Partnership may be taxed as an respect to all material matters affecting
association for tax purposes and thus would the corporation.
be subject to double taxation similar to a
corporation.
INVESTORS WILL BE ENTITLED TO VOTE ON MORE MATTERS AS SHAREHOLDERS OF THE COMPANY THAN
AS UNITHOLDERS OF A PARTNERSHIP. IN ADDITION, AFFILIATES OF THE COMPANY MAY HAVE VOTING
RIGHTS. ON SUBSTANTIALLY ALL MATTERS ON WHICH INVESTORS CAN VOTE, THE GENERAL PARTNERS
HAVE NO VOTE.
ANTI-TAKEOVER PROVISIONS
While the Units are transferable, subject to The Company has a staggered Board, whereby
certain restrictions, the General Partners the Board is divided into three separate
under the Partnership Agreements may under classes, with the term of each class
certain circumstances refuse to permit expiring in a different year than the other
assignees (who are not permitted to vote on two classes. A vacancy on the Board may only
any partnership matters) to become be filled by a majority of the Board of
substituted Investors. Directors. Shareholder action may only be
taken at an annual or special meeting of
Shareholders, and Shareholders do not have
the power to call a special meeting. The
Organizational Documents contain a
supermajority provision, whereby certain
provisions of such documents may not be
amended without the vote of at least 75% of
the Shareholders entitled to vote. The
Certificate of Incorporation limits the
voting power of certain persons who own a
certain percentage of the voting stock of
the Company. The Certificate of
Incorporation authorizes the Company to
issue preferred stock with disproportionate
voting power. In addition, under Section 203
of the Delaware GCL, certain business
combinations with stockholders owning 15% or
more of the Company's outstanding stock (an
"interested stockholder") are prohibited for
three years after such interested
stockholder becomes an interested
stockholder. This may have the effect of
discouraging attempts to take control of the
Company.
CERTAIN PROVISIONS OF THE ORGANIZATIONAL DOCUMENTS OF THE PARTNERSHIPS AND THE COMPANY
COULD BE USED TO DETER ATTEMPTS TO OBTAIN CONTROL OF THE PARTNERSHIPS AND THE COMPANY IN
TRANSACTIONS NOT APPROVED BY THE GENERAL PARTNERS AND THE BOARD OF DIRECTORS,
RESPECTIVELY. HOWEVER, THERE ARE MORE OPPORTUNITIES FOR SUCH ANTI-TAKEOVER PROVISIONS
AVAILABLE TO THE COMPANY THAN TO THE PARTNERSHIPS.
REVIEW OF INVESTOR LISTS
Under the Partnership Agreements and Under Delaware law, a Shareholder is
applicable law, any Investor is entitled to entitled, upon written demand, to inspect
obtain a list of the Investors in his or her and copy the record of stockholders, at any
Partnership upon reasonable demand for any time during usual business hours, for a
purpose reasonably related to the Investor's purpose reasonably related to his or her
interest as an Investor. interest as a Shareholder.
THE RIGHT OF SHAREHOLDERS TO OBTAIN A STOCKHOLDER LIST IS SIMILAR TO THE CORRESPONDING
RIGHT OF INVESTORS IN THE PARTNERSHIPS.
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The following compares certain of the investment attributes and legal rights
associated with the ownership of Units, Shares and Notes.
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NATURE OF INVESTMENT
The Units of each Partnership The Shares constitute equity The Notes will be junior,
constitute equity interests interests in the Company. unsecured obligations of the
entitling each Investor to Each Shareholder will be Company and will be issued
his pro rata share of cash entitled to his pro rata pursuant to an Indenture
distributions made to the share of the dividends made qualified under the Trust
Investors of the Partner- with respect to the Common Indenture Act of 1939, as
ship. Each Partnership Agree- Stock. The dividends payable amended. The Company may
ment specifies how the cash to the Shareholders are not issue additional debt, which
available for distribution is fixed in amount and are only may be secured, only in
to be shared among the paid when declared by the compliance with the covenants
General Partners and Company's Board of Directors. of the Notes for the issuance
Investors. The distributions of senior debt. The Notes
payable to the Investors are will bear interest at a
not fixed in amount and variable rate and will mature
depend upon the operating as of , 2006.
results and net sale or Prior to maturity, interest
refinancing proceeds only payments will be made to
available from the the Noteholders, on an annual
disposition of the basis, and on ,
Partnerships' assets. 2006, the outstanding
principal balance, plus
interest accruing since the
last payment, will be payable
in full. If the Company sells
or refinances any of the
Designated Assets of the
Partnership, 80% of the net
proceeds must be applied
toward the prepayment of the
Notes.
The Company reserves the
right to redeem the Notes at
any time, in whole or in
part, at par. Failure to make
principal and interest
payments when due constitutes
an event of default under the
Notes, allowing the Trustee
to declare the outstanding
principal, plus accrued but
unpaid interest, to be
immediately due and payable.
BOTH THE UNITS AND SHARES REPRESENT EQUITY INTERESTS ENTITLING THE HOLDERS THEREOF TO
PARTICIPATE IN THE GROWTH OF THE PARTNERSHIPS AND THE COMPANY, RESPECTIVELY. DISTRIBUTIONS
AND DIVIDENDS PAYABLE WITH RESPECT TO THE UNITS AND SHARES DEPEND UPON THE PERFORMANCE OF
THE PARTNERSHIPS AND THE COMPANY, RESPECTIVELY. IN CONTRAST, THE NOTES CONSTITUTE DEBT
OBLIGATIONS OF THE COMPANY PROVIDING FOR ANNUAL PAYMENTS OF PRINCIPAL AND INTEREST.
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POTENTIAL DILUTION OF PAYMENTS RIGHTS
Since the Partnerships are The Board of Directors may, Since the Notes are debt
not authorized to issue in its discretion, issue obligations of the Company,
additional equity securities, additional Shares of Common their payment is not
there can be no dilution of Stock or issue Preferred subordinate to dividends or
distributions to Investors. Stock, with such powers, distributions payable to the
preferences and rights as the Shareholders of the Company.
Board of Directors may at the The Company is obligated to
time designate. The issuance apply 80% of the Net Proceeds
of additional Shares of from Sales or Refinancings of
either Common Stock or Designated Assets of the
Preferred Stock, beyond the Partnerships to prepay the
Shares to be issued in the Notes. Except for the
Transaction, may result in restriction in the preceding
the dilution of the interests sentence, there are no
of the Shareholders. restrictions upon the
Company's authority to grant
mortgages, liens or other
security interests in the
Company's real and personal
property, and such security
interests, if granted, would
permit the holders thereof to
have a priority claim against
such collateral in the event
the secured obligations were
in default.
THE SHAREHOLDERS WILL BE SUBJECT TO POTENTIAL DILUTION IF THE COMPANY ISSUES ADDITIONAL
EQUITY SECURITIES. FURTHERMORE, THE COMPANY MAY ISSUE PREFERRED STOCK WITH PRIORITIES OR
PREFERENCES WITH RESPECT TO DIVIDENDS AND LIQUIDATION PROCEEDS. PAYMENT OF THE NOTES WILL
HAVE PRIORITY OVER DISTRIBUTIONS TO THE SHARES OR ANY CLASS OF EQUITY SECURITIES THAT MIGHT
BE ISSUED BY THE COMPANY; HOWEVER, ANY SENIOR SECURED OBLIGATIONS ISSUED BY THE COMPANY
WOULD HAVE PRIOR CLAIMS AGAINST THE COLLATERAL GIVEN FOR SECURITY IN THE EVENT THE COMPANY
DEFAULTS IN THE PAYMENTS OF THOSE SECURED OBLIGATIONS.
EXPECTED DISTRIBUTIONS AND PAYMENTS
Cap Source I makes quarterly The Company intends to make Noteholders are generally
distributions and Cap Source quarterly dividend payments entitled to receive only the
II makes monthly to its Shareholders, subject principal and interest
distributions. Amounts to the discretion of the payments required under the
distributed to the Investors Board of Directors. The Notes. The Company must apply
are derived from their share amount of such dividends will 80% of Net Proceeds from
of cash flow from operations be established by the Board Sales or Refinancings of
or cash flow from sales or of Directors, taking into Designated Assets of the
financings. The General account the amount of funds Participating Partnerships to
Partners may, under the lawfully available therefor prepay the Notes. Noteholders
Partnership Agreements, and the cash needs of the will have no right to
create reserves which may Company. Unlike the participate in any (a)
decrease cash distributions. Partnerships, the Company is profits derived from opera-
See "SELECTED FINANCIAL DATA not required to distribute tions of any of the Company's
OF THE PARTNERSHIPS" for a net proceeds from the sale or assets, including properties
presentation of the cash refinancing of properties, acquired as part of the
distributions to the except as may be required Transaction from the
Investors of the Partnerships under the terms of the Notes. Partnerships, or (b) profits
over the five most recent derived from the sale or
calendar years. refinancing of properties
other than those acquired as
part of the Transaction.
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UNITS SHARES NOTES
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INVESTORS WHO BECOME SHAREHOLDERS WILL RECEIVE THEIR PRO RATA SHARE OF THE DIVIDENDS
MADE WITH RESPECT TO THE COMPANY'S COMMON STOCK. THE AMOUNT OF SUCH DIVIDENDS WILL DEPEND
UPON THE COMPANY'S OPERATING EXPENSES, DEBT SERVICE PAYMENTS, CAPITAL EXPENDITURES,
RESERVES AND FUNDS SET ASIDE FOR EXPANSION. INTEREST PAYMENTS MADE ON THE NOTES WILL BE
PRIOR TO ANY DISTRIBUTIONS WITH RESPECT TO THE SHARES AND WILL REDUCE THE AMOUNT OTHERWISE
DISTRIBUTABLE TO THE SHAREHOLDERS.
INVESTORS WHO RECEIVE NOTES CONVERT THEIR EQUITY INVESTMENT IN THE PARTNERSHIP INTO A
JUNIOR DEBT OBLIGATION OF THE COMPANY AND ARE ENTITLED TO RECEIVE ONLY PRINCIPAL AND
INTEREST PAYMENTS ONLY UNTIL MATURITY UNDER THE NOTES. IF THE COMPANY SELLS OR REFINANCES
THE PROPERTIES OWNED BY THE OPERATING PARTNERSHIPS, 80% OF THE NET PROCEEDS FROM SALES OR
REFINANCINGS OF DESIGNATED ASSETS MUST BE APPLIED TOWARD PREPAYMENT OF THE NOTES. THE NOTES
MAY BE REDEEMED BY THE COMPANY AT ANY TIME WITHOUT PREMIUM.
LIQUIDITY AND TRANSFERABILITY
While the Units are The market for the Common The Notes will be freely
transferable, the General Stock, which will be traded transferable but will not be
Partners have discretion on the NYSE, should be more listed on a national
under the Partnership active and broader based than securities exchange or quoted
Agreements to refuse to the market for the Units. The on an automated quotation
permit assignees to become Common Stock may trade at a system. The Company does not
substituted Investors and the discount to its book value, expect that an active trading
Partnership Agreements and the market value of the market for the Notes will
contain various other Shares may never equal or develop. The Promissory Notes
restrictions on the transfer- exceed the net proceeds that will not be listed on a
ability of Units. Although might be available if the national securities exchange
limited secondary sales of Company's assets, including and no active trading market
Units have occurred, there is the investments in the for the Promissory Notes is
essentially no established Partnerships, were expected to develop.
public trading market for the liquidated.
Units and none is expected to
develop. The Units are not
marginable. Potential adverse
tax consequences would arise
if a Partnership were to be
considered a publicly traded
partnership.
ONE OF THE PRIMARY OBJECTIVES OF THE TRANSACTION IS TO PROVIDE INCREASED LIQUIDITY TO
THE INVESTORS. THE SHARES WILL BE LISTED ON THE NYSE, SUBJECT TO OFFICIAL NOTICE OF
ISSUANCE, AND THERE IS EXPECTED TO BE A PUBLIC MARKET FOR THE SHARES FOLLOWING THE
TRANSACTION. NEITHER THE NOTES NOR THE PROMISSORY NOTES WILL BE LISTED ON A NATIONAL
SECURITIES EXCHANGE OR QUOTED ON AN AUTOMATED QUOTATION SYSTEM. THE BREADTH OF THE MARKETS
FOR THE SHARES AND NOTES CANNOT YET BE DETERMINED, BUT IT IS EXPECTED THAT THE MARKET FOR
THE NOTES WILL BE LESS ACTIVE THAN THAT FOR THE SHARES. WHILE THERE HAS BEEN A LIMITED
SECONDARY MARKET FOR THE UNITS, TRADING ON THAT MARKET HAS BEEN SPORADIC AND LIMITED.
TAXATION OF TAXABLE INVESTORS
The Partnerships, as Dividends received by Interest payments made on the
partnerships for federal Shareholders from the Company Notes will constitute
income tax purposes, are not generally will constitute portfolio income which cannot
subject to tax, but the portfolio income, which offset passive losses from
Investors report their cannot offset passive losses other investments. During
allocable share of from other investments. January of each year,
partnership income and loss During January of each year, Noteholders will receive from
on their respective tax Shareholders will be mailed the Company Form 1099-INT to
returns. Income from the the less complex Form show the investors' interest
Partnerships generally 1099-DIV used by cor- payments during the
constitutes passive income to porations that pay dividends
the Investors, to
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UNITS SHARES NOTES
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which can generally offset their stockholders. prior calendar year.
passive losses from their Shareholders are not required
other investments. Generally, to file state income tax
by March 15 of each year, returns and/or pay state
Investors receive annual income taxes outside of their
Schedule K-1 forms with state of residence with
respect to information for respect to the Company's
inclusion on their federal operations. The Company will
income tax returns. Investors be required to pay federal
must file state income tax income taxes and state income
returns and incur state taxes in certain states where
income tax in most states in it is qualified to do
which the Partnerships have business.
property.
EACH PARTNERSHIP IS A PASS-THROUGH ENTITY WHOSE INCOME AND LOSS IS NOT TAXED AT THE
ENTITY LEVEL BUT INSTEAD ALLOCATED DIRECTLY TO THE GENERAL PARTNERS AND INVESTORS.
INVESTORS ARE TAXED ON INCOME OR LOSS ALLOCATED TO THEM WHETHER OR NOT CASH DISTRIBUTIONS
ARE MADE TO THE INVESTORS. THE COMPANY'S NET INCOME WILL BE TAXED AT THE COMPANY'S LEVEL AT
THE STANDARD CORPORATE TAX RATES. DIVIDENDS PAID TO SHAREHOLDERS WILL CONSTITUTE PORTFOLIO
INCOME AND NOT PASSIVE INCOME. NOTEHOLDERS WILL RECOGNIZE PORTFOLIO INCOME ON THE INTEREST
PAYMENTS RECEIVED ON THE NOTES.
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THE COMPANY
OVERVIEW
The Company was organized under the laws of the State of Delaware on
February 5, 1998, to facilitate the Transaction. As a result of the Transaction,
the Company will acquire the assets and liabilities of the Partnerships and the
General Partners.
Following the Transaction, the Company's primary business objective will be
to provide Shareholders with long term after-tax returns that are greater than
those available from REITs and other similar publicly traded real estate
companies. The Company expects to achieve this objective by investing in assets
and using investment and management strategies not generally permitted under the
Code or used by REITs. Such strategies may include investing in real estate
operating companies, underperforming real estate assets such as office buildings
and apartment complexes with the objective of renovating and repositioning them
to increase values, and underperforming markets and foreign markets that the
Company expects will show significant improvement.
The Company currently does not intend to qualify as a REIT under the Code.
Consequently, the Company will have the flexibility to respond quickly to
opportunities without the structural limitations imposed by the Code for REITs
and to operate, when deemed advantageous by management, on a more highly
leveraged basis than most REITs. By not qualifying as a REIT under the Code
(which would require the Company to distribute each year at least 95% of its net
taxable income, excluding capital gains), the Company will have the ability to
retain cash flow generated from operations, to retain proceeds from sales of
properties for reinvestment, to sell properties without the substantial income
tax penalties which may be imposed on REITs from certain prohibited
transactions, and to invest in the securities of real estate operating
companies.
In addition, the Company differs from real estate opportunity funds that are
typically structured as private partnerships. Such private partnerships
typically have a finite life which limits their ability to grow and may limit
their ability to maximize value. Furthermore, investment in such private
partnerships is generally limited to large, institutional investors. In
addition, unlike investors in such private partnerships, the Company's
Shareholders are expected to have enhanced liquidity through their ability to
sell or margin their Shares. However, unlike REITs and private partnerships, the
Company will be subject to corporate level taxation.
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The Company will enter into the Advisory Agreement with the Advisor to
manage the assets held by the Company and to provide other services to the
Company. See "--The Advisor" below. The principal executive offices of the
Company are located at 399 Park Avenue, New York, New York 10022, and its
telephone number is (212) 935-8760.
THE ADVISOR
Under the terms of the Advisory Agreement, the Advisor will manage the
investments of the Company, formulate investment criteria, represent the Company
in connection with the acquisition and disposition of real estate assets,
recommend strategies to improve the performance of the Company's investments,
administer the day-to-day operation of the Company, communicate with and
maintain relations with the investors of the Company, and perform such other
services as set forth in the Advisory Agreement and as directed from
time-to-time by the Board of Directors. The Advisory Agreement will have an
initial term of three years (subject to earlier termination as provided
therein), and will automatically renew for one year terms unless written notice
of termination is delivered 180 days prior to the expiration of any term. The
Advisor will bear all costs of providing services to the Company, except for the
costs of services provided by third parties, and certain limited office expenses
and travel expenses on behalf of the Company. Pursuant to the terms of the
Advisory Agreement, the Advisor will receive compensation (the "Advisor Fees")
in the form of an Acquisition Fee, an Asset Management Fee and an Incentive Fee
on New Assets, as more particularly described under "MANAGEMENT OF THE
COMPANY--The Advisor--THE ADVISORY AGREEMENT." The Company may engage affiliates
of the Advisor to provide other services if approved by, and upon the terms
approved by, the Independent Directors of the Company.
INVESTMENT STRATEGY
In furtherance of its business objectives, the Company intends to focus
initially on investments in four distinct aspects of the real estate business.
UNDERPERFORMING COMMERCIAL PROPERTIES. The Company will seek to acquire
underperforming office, residential and other commercial properties; to improve
their value by renovation, redevelopment, and/or releasing and by acquiring over
time groups of similar assets that have a value as a portfolio greater than
their individual values; and to dispose of them at such time as the Company
believes the value to its shareholders is maximized without the need to comply
with limitations on such activities that apply to REITs.
The Company believes that the prices for most Class A, well leased, large
commercial properties in the largest metropolitan areas have increased
drtamatically in the last several years due to aggressive competition among the
REITs and other similar investors. However, the Company believes there are
substantial opportunities available to acquire properties at attractive prices
that are not currently sought by REITs and other similar investors because of
little or no short term cash flow due to the need for substantial investment in
rehabilitation and/or releasing; because the properties are individually too
small or the markets in which they are located are too small to attract the
interest of REITs and other similar investors; and/or because the seller wishes
to sell a portfolio of assets that is not attractive to any single REIT or
similar buyer because of varying asset classes, locations, or quality. The
Company believes that by acquiring properties on this basis and renovating them
and/or repackaging them, it can increase asset value and produce substantial
returns to the Company.
REAL ESTATE OPERATING COMPANIES. The ability of REITs to invest in
operating companies not directly related to the management of the properties
they own is limited by the Code and other factors. Such operating companies
include brokers, developers, partnerships and general partners thereof which own
real estate, and other similar companies. Many of these companies have
significant expertise and good reputations, but have been unable to grow and
increase their profitability due to lack of capital, fragmented control, and so
forth. The Company believes that there are significant opportunities to make
investments in real estate operating companies at attractive prices. The Company
believes that its financial
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position and managerial expertise can allow such companies to grow. It also
believes that some real estate companies may well provide synergistic value to
the Company's other businesses.
FOREIGN OR FOREIGN-CONTROLLED REAL ESTATE. The Company believes that the
liquidity that has returned to the United States real estate markets remains
limited in many foreign markets. Some of the causes of this illiquidity are the
lack of capital; pricing disparities due to poor information flow; and
regulatory or policy constraints on foreign real estate lenders and owners such
as banks and finance companies.
In addition, the Company believes that foreign financial institutions and
other foreign non-real estate corporations will increasingly seek to liquidate
non-strategic businesses and assets such as U.S. and foreign real estate. The
Company believes that the recent turmoil in several Asian economies will
exacerbate this trend as companies in these countries seek to divest themselves
of non-core assets.
EXISTING PROPERTIES. The Company will own limited partnership Interests in
ten partnerships owning multifamily properties. The Company will conduct a
detailed evaluation of each of the properties to determine the best strategy to
maximize their value to the Company. Such strategies could include
rehabilitation, refinancing and disposition. Those efforts may be adversely
impacted by the fact that the Company has limited control over most of the
partnerships. Consequently, the Company will evaluate purchasing the interest of
the existing general partner interests to permit it to control the properties
and maximize their value to the Company.
While the Company has targeted these four areas upon which to focus
initially, the Company intends to pursue other investment opportunities that may
arise that meet the Company's business objective.
FINANCING STRATEGIES
The Company intends to fund its new investments first by using its initial
cash and short-term investments, which are expected to approximate $12.2 million
at the completion of the Transaction. Thereafter the Company intends to borrow
against its GNMA Certificates and FHA Loans by entering into "reverse repo
agreements." The Company anticipates it can borrow up to 90% of the principal
balance of the loans. Since the loans carry interest rates significantly above
the rates the Company will pay on its borrowings, the Company expects to make a
significant positive spread which will contribute to cash flow and earnings.
The Company will also consider selling one or more of its loans or
partnership interests, entering into a line-of-credit or similar corporate
financing agreement, the issuance of additional stock either directly in the
market or to sellers of assets, or other ways to meet its investment objectives.
CONAM AGREEMENT
The Partnerships and the Company have entered into an agreement (the "ConAm
Agreement") with Continental American Properties, Ltd., a California limited
partnership ("ConAm") for real estate project evaluation services and
investment. Pursuant to the ConAm Agreement, ConAm will identify and evaluate
multifamily redevelopment projects for possible investment by the Partnerships
and the Company. If the Partnerships and the Company approve of the multifamily
redevelopment projects presented by ConAm, then ConAm will also participate as
an investor in such projects in a partnership or joint venture or other similar
arrangement with the Company on the terms and subject to the conditions set
forth in the ConAm Agreement. The ConAm Agreement provides that ConAm may act as
the property manager for the redevelopment projects.
Prior to closing upon and acquiring into the newly formed venture any
proposed redevelopment project, additional due diligence shall be conducted as
may be necessary to confirm that there are no environmental problems affecting
the subject property or the improvements thereon, that all improvements are
structurally sound, that all zoning matters have been complied with and that the
redevelopment project, in all other material respects, meets the criteria
established in the ConAm Agreement. Nothing in the ConAm Agreement prevents the
Company from locating evaluating and entering into joint venture,
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partnership or other arrangements for the ownership, development, renovation or
management of any real estate project of whatever nature that the Company
locates on its own or through any third party.
RISK CONTROL
The Company will endeavor to control risks by a variety of strategies. The
Company will use experienced third-parties for construction, redevelopment,
property management and other similar services. The Company also expects to rely
on the expertise of its Advisor and its Advisor's affiliates in foreign
investing, property management and other areas. The Company will also endeavor
to use non-recourse or limited recourse debt when it believes the relationship
between cost and risk is favorable. The Company will also consider controlling
its risk on floating rate debt and any transactions in foreign currencies by
employing swaps, hedges, and other methods of controlling risk. The Company will
not invest in or engage in any such derivative transactions except to control
risks that are attendant to its business objectives.
AFFILIATED REIT
The Company intends to achieve its business objectives by investing in
assets and using investment and management strategies not generally permitted to
or employed by REITs. Occasionally, the Company may acquire as part of a
diversified portfolio or otherwise assets which may be more appropriately owned
by a REIT. Furthermore, the Company expects that its investments in the
renovation of underperforming real estate assets will result in assets that are
attractive candidates for acquisition by REITs.
Should the Company acquire a critical mass of such assets, the Company
intends to consider the formation or acquisition of a subsidiary company which
would qualify as a REIT. In such event, the Company would consider spinning off
the REIT to its Shareholders. If the subsidiary is formed and spun off, the
Company and the new REIT would initially share management and would be able to
take advantage of cost and tax synergies. The Company believes that such
synergies would provide the Company and the new REIT with substantial
competitive advantages in making investments in, managing, and disposing of
assets.
OPERATING RESTRICTIONS
The Board of Directors has established the Company's investment and
financing strategies and, except as otherwise restricted, the Board of Directors
has the power to modify or alter the Company's policies and strategies without
the consent of the Shareholders. Developments in the market which affect the
Company's policies and strategies or which change the Company's assessment of
the market may cause the Board of Directors to revise such policies and
strategies.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. The
Investment Company Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interest in real estate" (such mortgages and liens being referred to herein as
"Qualifying Interests"). Under current interpretation of the staff of the SEC,
in order to qualify for this exemption, the Company must maintain at least 55%
of its assets directly in Qualifying Interests. In addition, unless certain
securities relating to federally insured mortgages ("Mortgage Securities")
represent all the certificates issued with respect to an underlying pool of
mortgages, such Mortgage Securities may be treated as securities separate from
the underlying mortgage loans and, thus, may not be considered Qualifying
Interests for purposes of the 55% requirement. The Company will closely monitor
its compliance with this requirement and intends to maintain its exempt status.
Except as provided under "THE NOTES," the Company will have no restriction
on the ratio of debt to equity investments it holds and expects to use
significant levels of leverage to achieve its objective. Such leverage can be
achieved by a combination of direct borrowings by the Company, borrowings
secured by real estate, and through investing in securities of issuers who
themselves employ leverage.
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DIVIDEND POLICY
The Company intends to pay regular quarterly dividends to its Shareholders,
beginning with the first full fiscal quarter of operations following the
completion of the Transaction, subject to the discretion of, and in amounts
determined by, the Board of Directors. The Company intends to distribute
substantially all of its net cash flow from operations, after giving effect to
any reasonable reserves, as dividends with respect to the Company's first four
complete quarters of operations. In addition, the Company intends to distribute
with respect to the first two complete quarters of operations an amount which is
the greater of (i) substantially all of its net cash flow from operations as
described above or (ii) the cash distributions which would have been distributed
to Cap Source I investors if the Transaction had not occurred and distributions
were made at the same quarterly rates as were made in 1997 for the Cap Source I
Partnership or (iii) cash distributions which would have been distributed to Cap
Source II Investors if the Transaction had not occurred and distributions were
made on the basis of actual net cash from operations of Cap Source II. The
Company anticipates that the amount resulting from the application of (ii) and
(iii) above will be $.42 per share per quarter.
LEGAL PROCEEDINGS
The Company is not presently involved in any litigation nor, to its
knowledge, is any litigation threatened against the Company.
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MANAGEMENT OF THE COMPANY
The Board of Directors is responsible for the management of the Company, its
property and the disposition thereof, and is responsible for the general
policies of the Company and the general supervision of the Company's activities
conducted by its officers, agents, employees, advisors, managers or independent
contractors as may be necessary in the course of the Company's business. At all
meetings of the Board of Directors, a majority of the directors shall constitute
a quorum for the transaction of business, which majority shall include at least
two Independent Directors. The term "Independent Directors" refers to directors
of the Company who are not affiliated with the Company or the Advisor and do not
perform any services for the Company or the Advisor, other than as directors,
and are not officers or employees of the Company, the Advisor or any of their
respective affiliates. Actions to be taken by the Board of Directors will
require approval of a majority of the directors present at any meeting in which
there is a quorum, unless otherwise specified by the Company's Bylaws or by law.
The Board of Directors is divided into three classes and currently consists
of three members. Following the Transaction, the Board of Directors will be
increased to seven, with three directors in Class A, two directors in Class B
and two directors in Class C. The resulting vacancies will be filled by a vote
of the existing directors. Thereafter, the Board of Directors will consist of
not less than five nor more than eleven directors. At least one director in each
class will be an Independent Director. In addition, following the Transaction,
the majority of the Board of Directors will be Independent Directors. In the
election of directors, each holder of Common Stock has one vote for each Share
held.
The term of the initial Class A directors will terminate on the date of the
1999 annual meeting of shareholders; the term of the initial Class B directors
will terminate on the date of the 2000 annual meeting of shareholders; and the
term of the initial Class C directors will terminate on the date of the 2001
annual meeting. At each annual meeting of shareholders, directors of the class
to be elected shall be elected for a three-year term. Directors will hold office
until the annual meeting for the year in which their terms expire and until
their successors shall be elected and qualify.
The Board of Directors expects to hold meetings at least quarterly, and may
take action on behalf of the Company by unanimous written consent without a
meeting. Directors may participate in meetings by conference telephone or
similar communications equipment by means of which all persons participating in
the meeting can hear each other.
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The Company's Board of Directors currently consists of the following
persons:
<TABLE>
<CAPTION>
NAME CLASS AGE POSITION WITH THE COMPANY
- --------------------------------------------- ----- --- ---------------------------------
<S> <C> <C> <C>
Michael B. Yanney............................ B 63 Chairman of the Board
Paul L. Abbott............................... C 52 Director, President and Chief
Executive Officer
George H. Krauss............................. A 56 Director
</TABLE>
The business experience during the past five (5) years of each of the
current directors is as follows:
Michael B. Yanney, Chairman of the Board of Directors of the Company, has
served, since 1984, as the Chairman and Chief Executive Officer of America First
and its predecessors, a financial services firm located in Omaha, Nebraska, that
manages public investment funds which have raised over $1.5 billion. From 1977
until the organization of America First, Mr. Yanney was principally engaged in
the ownership and management of commercial banks. From 1961 to 1977, Mr. Yanney
was employed by Omaha National Bank and Omaha National Corporation (subsequently
merged into FirsTier Financial which has merged into First Bank), where he held
various positions, including the position of Executive Vice President and
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Treasurer of the holding company. Mr. Yanney also serves as a member of the
boards of directors of Burlington Northern Santa Fe Corporation, Forest Oil
Corporation, Lozier Corporation, Freedom Communications, Inc., PKS Information
Services, Inc., Magnum Resources, Inc., Rio Grande Medical Technologies, Inc.,
Level 3 Communications, Inc. and RCN Corporation.
Paul L. Abbott serves as Director, President and Chief Executive Officer of
the Company. Mr. Abbott joined America First in 1997. From 1988 until 1997, Mr.
Abbott was a Managing Director of Lehman Brothers, Inc. ("Lehman Brothers"). At
Lehman Brothers, Mr. Abbott served as chairman and chief executive of over 50
real estate investment funds controlled by Lehman Brothers representing gross
client investments exceeding $2.5 billion. The assets owned by those funds
included 50,000 multifamily units; 5,000 manufactured housing sites; 5 million
square feet of retail; 900,000 feet of self-service storage; and a variety of
other debt and equity real estate investments. His responsibilities included
executive responsibility for acquisitions, financings, planning, investment
management, investor relations and regulatory reporting. In serving as chief
executive of these funds, Mr. Abbott was also responsible for developing and
managing relationships throughout the real estate industry, including regional
and national developers, property managers, brokers, owners and lenders. Mr.
Abbott served on various Lehman Brothers committees responsible for approving a
variety of real estate transactions and was involved in a number of real estate
advisory assignments for Lehman Brothers.
Prior to joining Lehman Brothers, from 1983 until 1988, Mr. Abbott was a
Senior Vice President of Daseke & Co., Inc., a predecessor to Walden
Residential, a NYSE-traded real estate investment trust. At Daseke, Mr. Abbott
was responsible for asset management of 20,000 multifamily units and arranging
over $500 million of financings. From 1979 until 1983, Mr. Abbott was a vice
president of various insurance subsidiaries of Household International.
George H. Krauss serves as a Director of the Company and is a consultant to
America First Companies. From 1972 until the time he became a consultant to
America First Companies, Mr. Krauss was a member of Kutak Rock, a national law
firm with over 200 lawyers in eight states and the District of Columbia. As a
member of Kutak Rock, Mr. Krauss gained extensive experience in the corporate,
merger and acquisition, and regulatory areas of the firm's practice. In addition
to his legal education, Mr. Krauss has a Masters of Business Administration and
is a registered Professional Engineer. Mr. Krauss has served on the board of
directors of numerous companies including Gateway 2000, Inc., a computer
manufacturing and distribution company with over $6 billion in sales in 1997,
which is listed on the NYSE, America First Mortgage Investments, Inc., also a
NYSE member, and Bayview Capital Corporation, which is listed on the NASDAQ.
No later than thirty (30) days after the Transaction, the following persons
will be considered for election to the Board of Directors by the current members
of the Board to serve as Independent Directors:
<TABLE>
<CAPTION>
NAME AGE
- ------------------------------------------------------ ---
<S> <C>
--
- -------------------------------------------
--
- -------------------------------------------
--
- -------------------------------------------
--
- -------------------------------------------
</TABLE>
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The business experience during the past five (5) years of each of the
foregoing individuals is as follows:
Officers of the Company will be elected by and serve at the discretion of
the Board of Directors. The current officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- ------------------------------------------- --- -------------------------------------------
<S> <C> <C>
Michael B. Yanney.......................... 63 Chairman of the Board
Paul L. Abbott............................. 52 President and Chief Executive Officer
Gary Thompson.............................. 55 Chief Financial Officer and Treasurer
Helen L. Poorman........................... 37 Executive Vice President-- Acquisitions
Jack Cassidy............................... 46 Executive Vice President--Asset Management
George H. Krauss........................... 56 Secretary
</TABLE>
Subject to the approval of the Board of Directors, it is anticipated that
the foregoing persons will function as executive officers of the Company after
the Transaction, serving a one-year term and until their successors are elected
and qualified or until their earlier resignation or removal. There are no
arrangements or understandings between or among any of the officers or directors
and any other person pursuant to which any officer or director of the Company
was selected as such. There are no family relationships among any directors and
officers of the Company.
The business experience of Messrs. Yanney, Abbott and Krauss is set forth
above. The business experience for the past five (5) years of each of the other
officers of the Company is as follows:
Gary Thompson serves as Chief Financial Officer of the Company. He currently
serves as financial vice president of America First and is responsible for
financial accounting and tax reporting for all America First Funds. Prior to
1989, Mr. Thompson was an audit partner at KPMG Peat Marwick. He is a certified
public accountant.
Helen L. Poorman serves as Executive Vice President--Acquisitions of the
Company. Ms. Poorman joined America First in 1998 after having completed a
consulting assignment for the Company in 1997. From 1987 through 1996, Ms.
Poorman was with Copley Real Estate Advisors ("Copley") in various Portfolio and
Asset Management positions, most recently as Managing Director. Ms. Poorman was
responsible for the overall management of the account of Copley's largest
client, the real estate equity portfolio of New England Mutual Life Insurance
Company. Her responsibilities included strategic planning, asset management,
financings, workouts, and dispositions, among others. The portfolio included
approximately 200 assets comprising 32 million square feet of office and
industrial property, 2,500 apartment units, 4 hotels and nearly 5,000 acres of
land for development or sale. Her Copley background also includes portfolio
management of other multi-billion dollar portfolios, extensive workout
experience, and management of all commercial property types in various ownership
structures. Prior to joining Copley, Ms. Poorman was a Senior Asset Manager with
Daseke & Co., Inc., overseeing the management of numerous limited partnerships
which owned multi-family and office properties. Ms. Poorman holds an M.B.A. in
Finance from the University of Chicago and a B.A. SUMMA CUM LAUDE, in Economics
and Management from DePauw University.
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Jack Cassidy serves as Executive Vice President--Asset Management of the
Company. Mr. Cassidy co-founded and currently serves as President of America
First Properties Management L.L.C., an affiliate of the Advisor. As President of
America First Properties Management L.L.C., Mr. Cassidy has been responsible for
the management of over 8,000 apartments located in 18 states since the Company's
inception in 1992. Prior to his position with the property management of the
Company, Mr. Cassidy supervised the America First Companies' real estate asset
management team overseeing a portfolio of 45 apartment communities. Before
joining America First, Mr. Cassidy was a Vice President of E.F. Hutton & Co.
involved in the analysis, acquisition and asset management of real estate
investments. Mr. Cassidy holds an M.B.A. in finance from the Columbia University
School of Business and an undergraduate degree from Georgetown University.
BOARD OF DIRECTORS COMPENSATION
The Company intends to pay an annual fee of $20,000 to each Independent
Director of the Company, $10,000 of which will be paid in the form of Common
Stock of the Company and $10,000 will be paid in cash. The Company will
reimburse all directors for travel expenses and other out-of-pocket expenses
incurred in connection with their activities on behalf of the Company.
COMMITTEES OF THE DIRECTORS
Promptly following the consummation of the Transaction, the Board of
Directors will establish the following committees:
AUDIT COMMITTEE. The Audit Committee will consist of three directors, all
of which will be Independent Directors. The Audit Committee will be established
to make recommendations concerning the engagement of independent public
accountants, review with the independent public accountants the plans and
results of the audit engagement, approve professional services provided by the
independent public accountants, review the independence of the independent
public accountants, consider the range of audit and nonaudit fees and review the
adequacy of the Company's internal accounting controls.
EXECUTIVE COMMITTEE. The Executive Committee will consist of three
directors. The Executive Committee will have the authority to acquire, dispose
of and finance investments for the Company and execute contracts and agreements,
including those related to the borrowing of money by the Company, and generally
exercise all other powers of the Board of Directors except for those which
require action by all the directors or the Independent Directors under the
Certificate of Incorporation or the Bylaws of the Company, or under applicable
law.
COMPENSATION COMMITTEE. The Compensation Committee will consist of three
directors, which will advise the Board of Directors on all matters pertaining to
compensation programs and policies and will establish guidelines for employee
incentive and benefits programs which it will review on a continuous basis. All
members of the Compensation Committee will be Independent Directors.
The Board of Directors may from time to time establish other committees to
facilitate the management of the Company. The Board of Directors initially will
not have a nominating committee and the entire Board of Directors will perform
the function of such a committee.
COMPENSATION OF EXECUTIVE OFFICERS
The Company was formed on February 5, 1998. Accordingly, the Company has not
paid any cash compensation to its executive officers for prior years, and no
cash compensation will be paid to the executive officers so long as the Advisory
Agreement is in effect. However, pursuant to the terms of the Company's 1998
Stock Option Plan (the "Plan"), the Compensation Committee of the Board of
Directors may, subject to certain restrictions, grant options to the executive
officers to purchase Common Stock of
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the Company. See "--Stock Option Plan." There are no employment agreements
between the Company and any of its officers, and the Company does not expect to
enter into any such agreements in the future.
STOCK OPTION PLAN
GENERALLY. The Plan is intended to provide incentive to key employees,
officers and directors of the Company and any subsidiary of the Company, to
encourage proprietary interest in the Company, to encourage such key employees
to remain in the employ of the Company, attract new employees with outstanding
qualifications and to afford additional incentive to others to increase their
efforts in providing significant services to the Company. The term of the Plan
is ten years. No grants will be made under the Plan with an exercise price of
less than $25 per share for six months following the Effective Date.
ADMINISTRATION. The Plan will be administered by the compensation committee
appointed by the Board (the "Committee"). No member of the Committee may act as
to matters under the Plan specifically relating to such member.
Any director of the Company who is also appointed to serve on the Committee
and who at the time of his appointment qualifies as a "Non-Employee Director"
under Rule 16b-3(b)(3)(i) promulgated under the Exchange Act and, to the extent
that relief from the limitation of Section 162(m) of the Code is sought, as an
"Outside Director" under Section 1.162-27(e)(3)(i) of the Treasury Regulations
will be granted initial and periodic awards pursuant to the formula set forth in
Section 7(a) of the Plan.
The Plan vests authority in the Board to amend the Plan. However, the Board
may not make any amendment in the Plan that would, if such amendment were not
approved by the holders of the Common Stock, cause the Plan to fail to comply
with any requirement or applicable law or regulation, unless and until the
approval of the holders of such Common Stock is obtained.
ELIGIBILITY. Officers, directors and employees of the Company are eligible
to be granted awards under the Plan.
LIMITATION OF DIRECTORS' LIABILITY
Delaware law authorizes Delaware corporations to limit or eliminate the
personal liability of a director to the corporation and its stockholders for
monetary damages for certain breaches of the director's fiduciary duties as a
director, other than for breach of his duty of loyalty to the corporation and
its stockholders, or for acts or omissions not in good faith or involving
intentional misconduct or knowing violation of the law, or for the unlawful
purchase or redemption of stock or payment of unlawful dividends or the receipt
of improper personal benefits. The Board of Directors believes that such
provisions have become commonplace among major corporations and are beneficial
in attracting and retaining qualified directors, and the Company's Certificate
of Incorporation includes such provisions.
The director's duty of care requires that, when acting on behalf of the
corporation, directors must exercise an informed business judgment based on all
material information reasonably available to them. Absent these limitations,
directors are accountable to corporations and/or their shareholders for monetary
damages for conduct constituting gross negligence in the exercise of their duty
of care. Although this provision of Delaware law does not change directors' duty
of care, it enables corporations to limit available relief to equitable remedies
such as injunction or rescission.
The Company's Certificate of Incorporation limits the liability of directors
of the Company to its shareholders (in their capacity as directors but not in
their capacity as officers) to the fullest extent permitted by Delaware law.
Specifically, directors of the Company will not be personally liable for
monetary damages for breach of a director's fiduciary duty as a director, except
for liability (a) for any breach of the directors' duty of loyalty to the
Company or its shareholders, (b) for acts or omissions not in good faith or that
involve intentional misconduct or a knowing violation of law, (c) for unlawful
payments of dividends or unlawful stock repurchases or redemptions as provided
in Section 174 of the Delaware
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GCL or (d) for any transaction from which the director derived an improper
personal benefit. The inclusion of this provision in the Certificate of
Incorporation may have the effect of reducing the likelihood of derivative
litigation against directors and may discourage or deter shareholders or
management from bringing a lawsuit against directors for breach of their duty of
care, even though the action, if successful, might otherwise benefit the Company
and its shareholders.
INDEMNIFICATION
Subject to applicable law, the Company's Bylaws require the Company to
indemnify its officers and directors against expenses, judgments, settlements
and fines incurred in the defense of any claim, including any claim brought by
or in the right of the Company, to which they were made party by reason of being
or having been officers or directors.
It is anticipated that each of the Company's directors and executive
officers will enter into an indemnity agreement with the Company following the
completion of the Transaction. Pursuant to such agreements, the Company will
agree to indemnify the directors and executive officers against any costs and
expenses, judgments, settlements and fines incurred in connection with any claim
involving a director or executive officer by reason of his position as director
or executive officer that are in excess of the coverage provided by any
insurance if the indemnitee meets certain standards of conduct.
THE ADVISOR
DIRECTORS AND OFFICERS OF THE ADVISOR. The directors and officers of the
Advisor are set forth below. These officers of the Advisor may also provide
services to the Company on behalf of the Advisor.
<TABLE>
<CAPTION>
NAME AGE OFFICES HELD
- ------------------------------------------- --- -------------------------------------------
<S> <C> <C>
Michael B. Yanney.......................... 63 Director
Paul L. Abbott............................. 52 Director, President and Chief Executive
Officer
George H. Krauss........................... 56 Director
Helen L. Poorman........................... 37 Director and Executive Vice President
</TABLE>
Biographical information with respect to the directors and officers of the
Advisor is set forth above under "--Directors and Executive Officers of the
Company."
THE ADVISORY AGREEMENT. The Company will enter into an Advisory Agreement
with the Advisor for an initial term of three years, beginning on the Effective
Date, subject to earlier termination for cause as provided therein. After the
initial term, the Advisory Agreement automatically renews for additional one-
year periods unless written notice is delivered 180 days prior to the expiration
of any term.
The Advisor is entitled to receive compensation in the form of an
Acquisition Fee, an Asset Management Fee and an Incentive Fee on New Assets for
services rendered under the Advisory Agreement. The Acquisition Fee will be
payable each month in arrears and will be an amount equal to 1% of the increase
in the Company's actual investment in all New Assets, including any costs
related to the acquisition or financing of New Assets but excluding debt which
is incurred or assumed in connection therewith. The Asset Management Fee will be
equal to .475%, on an annual basis, of the Company's Total Assets, calculated as
of the last day of each month, payable by the Company to the Advisor on a
monthly basis in arrears. The Incentive Fee on New Assets will be equal to 10%
of any Capital Gain offset by any Capital Loss on New Assets, payable by the
Company to the Advisor on an annual basis in the form of Restricted Stock. The
Advisor Fees were negotiated by the Special Committee.
The Advisor may not sell, transfer or otherwise dispose of the Restricted
Stock until the earlier of: (i) the termination of the Advisory Agreement as
provided therein; and (ii) five years following the
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issuance of the Restricted Stock. Upon the termination of the Advisory Agreement
by the Company without cause, or by the Advisor for cause, the Advisor is
entitled to certain registration rights with respect to the Restricted Stock as
set forth in the Advisory Agreement.
The Company will pay all of its expenses, including all costs associated
with third party services provided to it, and will reimburse the Advisor for
documented expenses of the Advisor incurred on its behalf. The Advisor will pay
all of the costs of providing services to the Company, including personnel
costs. In connection with providing services to the Company, the Advisor will be
reimbursed by the Company only for (i) rent, utilities, capital equipment and
related expenses associated with any office which is established and maintained
by the Advisor exclusively to provide services to the Company, (ii) expenses of
third parties which derive 25% or less of their gross revenues from providing
services to the Company, and (iii) travel expenses incurred by employees of the
Advisor in connection with travel at the request or on behalf of the Company;
provided that the Company's reimbursement of these expenses will be limited to
amounts for them in the annual budget as approved by the Board of Directors,
with any subsequent changes approved by the Board of Directors. In addition, no
reimbursement will be permitted for services for which the Advisor is entitled
to compensation by way of a separate fee.
The Advisor at all times will be subject to the supervision of the Board of
Directors and will only have such functions and authority as the Company may
delegate to it. The Advisor will be responsible for the day-to-day operations of
the Company and will perform such services and activities relating to the assets
and operations of the Company as may be appropriate, including:
(i) serving as the Company's consultant with respect to formulation of
investment criteria and preparation of policy guidelines by the Board of
Directors;
(ii) representing the Company in connection with the acquisition and
disposition of real estate assets;
(iii) representing the Company in monitoring the performance of its
assets and recommending strategies to improve such performance;
(iv) furnishing reports and statistical and economic research to the
Company regarding the investment activities and results of operations of the
Company and the services performed by the Advisor for the Company;
(v) providing the executive and administrative personnel, office space
and services required in rendering services to the Company;
(vi) administering the day-to-day operations of the Company and
performing and supervising the performance of such administrative functions
necessary in the management of the Company as may be agreed upon by the
Advisor and the Board of Directors, including collection of revenues and
payment of the expenses, debts and obligations and maintenance of
appropriate computer services to perform such administrative functions;
(vii) communicating on behalf of the Company with the holders of equity
and debt securities of the Company as required to satisfy the reporting and
other requirements of any governmental or regulatory bodies or agencies and
maintaining effective relations with such holders;
(viii) counseling the Company in connection with policy decisions to be
made by the Board of Directors;
(ix) upon request by, and in accordance with the directions of, the
Board of Directors, investing or reinvesting any money of the Company;
(x) qualifying and causing the Company to qualify to do business in all
applicable jurisdictions;
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(xi) causing the Company to retain qualified accountants and tax experts
to assist in developing appropriate accounting procedures and testing
systems and conducting quarterly compliance reviews;
(xii) maintaining exemption from the Investment Company Act;
(xiii) arranging for the preparation and timely filing of all reports
required to be filed by the Company under the Exchange Act, and under any
other applicable securities laws or regulations;
(xiv) complying with and using its best efforts to cause the Company to
comply with all applicable laws; and
(xv) as approved and directed by the Board of Directors, performing such
other services as may be required from time to time for management and other
activities relating to the assets of the Company and its Subsidiaries as the
Advisor shall deem appropriate under the circumstances.
The Company may enter into separate agreements with the Advisor or
affiliates for additional services to be provided to the Company on terms and
conditions to be negotiated by the parties to such agreements. The fees to be
paid by the Company for such additional services will be negotiated and approved
by the Independent Directors on behalf of the Company. Neither the Company nor
the Advisor may assign the Advisory Agreement without the written consent of the
other party.
The Company may terminate the Advisory Agreement upon 60 days' written
notice of termination from the Board of Directors to the Advisor if the Advisor
(i) materially breaches any provision of the Advisory Agreement and fails to
cure the breach as provided therein; or (ii) engages in fraud or willful
misconduct in connection with the business of the Company. If the Advisory
Agreement is terminated by the Company for cause, the Advisor is not entitled to
receive any additional amounts from the Company.
The Company may terminate the Advisory Agreement without cause at any time
after the third annual anniversary of the Effective Date by delivering 180 days
prior written notice of termination. Any termination without cause or
non-renewal of the Advisory Agreement by the Company must be approved by a
majority vote of the Independent Directors or by a vote of the holders of a
majority of the outstanding shares of the Company's Common Stock. In such event,
the Company shall pay the Advisor a termination fee equal to the sum of: (i) the
amount of the Acquisition Fee and the Asset Management Fee for the previous
twelve-month period, and (ii) the fair value of any Incentive Fee on New Assets
that would be earned on any New Assets owned by the Company on the date of the
termination. Under the terms of the Advisory Agreement, the Company and Advisor
are required to use their best efforts to reach a mutual agreement with respect
to the amount of the Incentive Fee on New Assets under such circumstances. If
the parties are unable to agree upon such amount within 30 days following the
notice of termination, the amount shall be determined by an independent
valuation as provided in the Advisory Agreement.
The Advisor may terminate the Advisory Agreement upon 60 days' written
notice of termination to the Company if the Company (i) materially breaches any
provision of the Advisory Agreement and fails to cure the breach as provided
therein; or (ii) engages in fraud, willful misconduct or gross negligence, other
than as a result of acts or omissions caused by employees of the Advisor. In the
case of termination of the Advisory Agreement by the Advisor with cause, the
Company is required to pay the Advisor a fee equal to the sum of: (i) the amount
of the Acquisition Fee and the Asset Management Fee for the previous twelve-
month period, and (ii) the fair value of any Incentive Fee on New Assets that
would be earned on any New Assets owned by the Company on the date of the
termination. Under the terms of the Advisory Agreement, the Company and Advisor
are required to use their best efforts to reach a mutual agreement with respect
to the amount of the Incentive Fee on New Assets under such circumstances. If
the parties are unable to agree upon such amount within 30 days following the
notice of termination, the amount shall be determined by an independent
valuation as provided in the Advisory Agreement.
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The Advisor may terminate the Advisory Agreement without cause at any time
after the third annual anniversary of the Effective Date by delivering 180 days
prior written notice of termination. In such event, the Advisor is entitled to
receive twenty-five percent of the fair value of any Incentive Fee on New Assets
that would be earned on any New Asset owned by the Company on the date of
termination. All such amounts payable to the Advisor shall be paid on the third
anniversary of the date of termination, provided, however, that if any new Asset
is sold during such three-year period, the Advisor shall be paid, at the time of
sale, twenty-five percent of the Incentive Fee on New Assets which would have
been payable to the Advisor, pursuant to the terms of the Advisory Agreement,
until the Advisor receives the total amount payable as provided therein. The
parties are required to use their best efforts to reach a mutual agreement with
respect to such fee. If the parties are unable to agree upon such amount within
30 days following the notice of termination, the amount shall be determined by
an independent valuation as provided in the Advisory Agreement.
VOTING
THE MATTER TO WHICH THE INVESTORS ARE REQUESTED TO CONSENT IS OF GREAT
IMPORTANCE TO THE PARTNERSHIPS AND THE INVESTORS. ACCORDINGLY, INVESTORS ARE
URGED TO READ AND CAREFULLY CONSIDER THE INFORMATION PRESENTED IN THIS
PROSPECTUS/CONSENT SOLICITATION STATEMENT AND TO COMPLETE, DATE, SIGN AND
PROMPTLY RETURN THE ENCLOSED CONSENT CARD IN THE ENCLOSED POSTAGE-PAID ENVELOPE.
SOLICITATION BY THE GENERAL PARTNERS
The General Partners are seeking the consent of the Investors of the
Partnerships to the Transaction. The General Partners will not hold a meeting of
the Investors to consider the Transaction, but instead are seeking the written
consent of Investors as provided in Article X of the Partnership Agreements.
Under the terms of the Partnership Agreements, the transfer of all the assets of
the Partnerships in a single transaction and the dissolution of the Partnerships
requires the consent of the holders of a majority of the outstanding Units.
Accordingly, the Transaction may not be consummated without the consent of the
holders of a majority of the outstanding Units of each of the Partnerships. This
Prospectus/Consent Solicitation Statement constitutes the solicitation of the
approval of the Investors to the Transaction.
VOTING PROCEDURES
Each Investor is being asked by the General Partners to consider the
following elections with respect to the Transaction:
"YES", I approve of my Partnership's participation in the Transaction.
or
"NO", I do not approve of my Partnership's participation in the Transaction.
Investors may also abstain from voting.
Investors, including Dissenting Investors and Investors who abstain from
voting with respect to the Transaction by indicating their abstention on the
Consent Card, will receive Shares if the Transaction is completed unless such
Investors elect to receive Notes as indicated on the Consent Card. An Investor
may elect to receive Notes regardless of whether he votes "YES" or "NO" with
respect to the Transaction. An Investor who does not return the Consent Card
will receive Shares if the Transaction is completed. If Dissenting Investors
elect to receive Notes in excess of the Maximum Note Limitation, the Transaction
will not be consummated. If this does not occur, but the total amount of Notes
allocable to all Investors who elect to receive Notes exceeds the Maximum Note
Limitation, Notes will be allocated first to Dissenting Investors who elected to
receive Notes and then, on a pro rata basis (in denominations of $1,000), to
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Investors who elected to receive Notes and either abstained from voting or voted
"YES" in favor of the Investors. Thus, an Investor could choose Notes but
receive Shares instead. To be assured of receiving Notes, an Investor must vote
"NO" with respect to the Transaction and elect to receive NOTES. See
"NOTES--Allocation of Notes." An otherwise valid Consent Card will be deemed to
grant consent to the Transaction if it is not marked "NO" or to abstain.
A Consent Card is included with this Prospectus/Consent Solicitation
Statement and Investors are asked to complete, date and sign the Consent Card
and return it to Service Data Corporation in the enclosed envelope as soon as
possible. INVESTORS SHOULD NOT SEND THE CERTIFICATES FOR THEIR UNITS WITH THE
CONSENT CARD.
In order to be valid, consents must be received by Service Data Corporation
by 5:00 p.m. Central Time on , 1998, which date may be extended by
the General Partners in their sole discretion. Consent Cards should be returned
in the enclosed envelope to Service Data Corporation at the following address:
Service Data Corporation
2424 South 130th Circle
Omaha, Nebraska 68144
Abstentions and broker nonvotes will have the same effect as a vote against
the Transaction. Investors who vote against the Transaction or abstain from
voting will have no right to require the Partnerships to purchase their Units or
any other rights similar to those available to dissenting shareholders of
corporations under Delaware law. See "--No Right of Appraisal" below.
The vote of the Investors with respect to the Transaction will be tabulated
by Service Data Corporation of Omaha, Nebraska on , 1998, unless such
date is extended by the General Partners in their sole discretion. Service Data
Corporation currently serves as the transfer agent and registrar for the
Partnerships and for other public limited partnerships sponsored by America
First Companies, but is not otherwise affiliated with the Company or the General
Partners.
THE GENERAL PARTNERS BELIEVE THAT THE TERMS OF THE TRANSACTION ARE FAIR AND
IN THE BEST INTERESTS OF THE PARTNERSHIPS AND ALL OF THE INVESTORS AND
RECOMMENDS THE APPROVAL THEREOF BY THE INVESTORS.
RECORD DATE AND OUTSTANDING UNITS
Only Investors holding Units of record at the close of business on the
Record Date will be entitled to receive this notice and to vote with respect to
the Transaction. Under the terms of the Partnership Agreement, Investors are
entitled to one vote for each Unit they hold as of the Record Date. As of the
Record Date, there was a total of 3,374,222 Cap Source I Units and 4,011,101 Cap
Source II Units outstanding. Therefore, the affirmative vote of the holders of
1,687,112 Cap Source I Units is required to approve the Transaction, and the
affirmative vote of the holders of 2,005,551 Cap Source II Units is required to
approve the Transaction. As of the Record Date, no Units were beneficially owned
by the General Partners, America First Companies or any of the officers or
managers of America First Companies.
SOLICITATION OF VOTES; SOLICITATION EXPENSES
Votes of Investors may be solicited by the management of the General
Partners. Costs of solicitation will be allocated as set forth under "THE
TRANSACTION--Transaction Expenses." Certain officers and employees of the
General Partners and affiliates may solicit consents without additional
compensation therefor other than reimbursement for actual and reasonable
out-of-pocket expenses incurred by such persons in connection with such
solicitation. Brokerage firms, fiduciaries, nominees and others will be
reimbursed for out-of-pocket expenses incurred by them in connection with
forwarding consent materials to beneficial holders of Units held in their names.
In addition to the use of the mails, consents may be
85
<PAGE>
solicited by officers and regular employees of the General Partners and
affiliates, who will not be specifically compensated for such services, by means
of personal calls upon or telephonic communications with Investors or their
representatives. Moreover, the General Partners may engage the services of a
professional proxy solicitation firm in connection with the solicitation of
consents. No party will receive any compensation contingent upon solicitation of
a favorable vote. Proxies voted against the Transaction will not be used by the
General Partners to vote for adjournment of the meeting to solicit more votes
pursuant to discretionary authority.
If any material conditions to the Transaction are waived, the consent of the
Investors to the Transaction will be resolicited.
REVOCABILITY OF CONSENT
Investors may withdraw or revoke their consent at any time prior to the
Approval Date. To be effective, a written, telegraphic or telex notice of
revocation or withdrawal of the Consent Card must be received by Service Data
Corporation no later than the Approval Date, addressed as follows: Service Data
Corporation, 2424 South 130th Circle, Omaha, Nebraska 68114. A notice of
revocation or withdrawal must specify the Investor's name and the name of the
Partnership to which such revocation or withdrawal relates.
COMMUNICATING WITH OTHER INVESTORS
Under Rule 14a-7 of the Exchange Act, each Partnership, upon written request
from an Investor, will deliver to such Investor (i) a statement of the
approximate number of Investors of the Partnership and (ii) the estimated cost
of mailing proxy materials or similar communications to the Investors of such
Partnership. In addition, under such rule, an Investor has the right, at his or
her option, to have his or her Partnership (i) mail (at the Investor's expense)
any such materials which the Investor desires to deliver to the other Investors
of the Partnership in connection with the Transaction or (ii) to have the
Partnership deliver, within five business days of the receipt of the request, a
reasonably current list of the names and addresses of the Investors of the
Partnership as of the Record Date. The Partnerships may require a requesting
Investor to pay the reasonable cost of duplicating and mailing such Investor
list. Any such requests should be sent to Maurice Cox, Suite 400, 1004 Farnam
Street, Omaha, Nebraska, 68102.
NO RIGHT OF APPRAISAL
Neither Dissenting Investors nor Investors who abstain from voting with
respect to the Transaction will be entitled to dissenters' or appraisal rights
under the Partnership Agreements, the Delaware Partnership Law or the Delaware
GCL. Such rights, when they exist, give the holders of securities the right to
surrender such securities for an appraised value in cash if the securityholder
opposes a merger or similar reorganization. No such rights will be provided by
the Partnerships or the Company. Dissenting Investors do, however, have the
right to exchange their Units for Notes rather than Shares. If a Dissenting
Investor votes against the Transaction but does not elect to receive Notes, the
Dissenting Investor will receive Shares.
FIDUCIARY RESPONSIBILITIES
Under the Delaware GCL, the directors and officers of the Company, in
exercising the powers and responsibilities of managing the Company, owe the
Company and its Shareholders a duty of care and a duty of loyalty. However, the
directors and officers of the Company are not liable for errors in judgment or
other acts or omissions made in good faith unless their actions are found to be
grossly negligent. Under Delaware law, the General Partners are accountable to
the Partnership and the Investors as fiduciaries and consequently must exercise
good faith and integrity in handling Partnership affairs. Investors who have
questions concerning the duties of the directors and officers with respect to
the Company or the duties of the General Partners with respect to any of the
Partnerships should consult their counsel.
86
<PAGE>
The liability of the directors is limited pursuant to the provisions of the
Delaware GCL and the Company's Organizational Documents, which limit the
personal liability of a director to the Company or its Shareholders for monetary
damages for breach of fiduciary duty as a director. Those provisions would not
protect a director (i) for any breach of the director's duty of loyalty to the
Company or its Shareholders, (ii) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii) for
any unlawful payment of dividends or unlawful purchase or redemption of the
Company's stock, or (iv) for any transaction from which the director derived an
improper personal benefit. In addition, the Company's Organizational Documents
provide for mandatory indemnification of the directors and officers by the
Company to the full extent permitted under Delaware law. Delaware law generally
authorizes Delaware corporations to indemnify their directors, officers,
employees or agents against liabilities (including litigation costs) incurred as
the result of their service to the corporation if such persons acted in good
faith and in a manner they reasonably believed to be in, or not opposed to, the
best interest of the corporation and, with respect to any criminal action or
proceeding, had no reasonable cause to believe their conduct was unlawful. In
accordance with these provisions, the Company has entered into agreements with
the Company's directors and executive officers indemnifying them to the fullest
extent permitted by Delaware law. To the extent that the foregoing provisions
concerning indemnification apply to actions arising under the Securities Act,
the Company has been advised that, in the opinion of the SEC, such provisions
are contrary to public policy and therefore are not enforceable.
The Partnership Agreements provide for indemnification of the General
Partners for losses arising out of any act or omission, provided that it was
determined in good faith that such conduct was in the best interest of the
Partnership and that such conduct did not constitute negligence, misconduct or a
breach of fiduciary obligations to the Investors.
The rights of Shareholders against management of the Company in certain
circumstances are more limited than the rights of Investors against the General
Partners.
Notwithstanding the indemnification conferred, no director or executive
officer of the Company shall be indemnified with regard to any liability, loss
or damage incurred by them in connection with any claim or settlement involving
allegations that the Securities Act, as amended, or any state securities laws
were violated by the director or executive officer unless: (a) (i) the director
or executive officer seeking indemnification is successful in defending such
action on the merits of each count involving such violation, (ii) such claims
have been dismissed with prejudice on the merits by a court of competent
jurisdiction or (iii) a court of competent jurisdiction approves a settlement of
such claims; and (b) such indemnification is specifically approved by a court of
law which shall have been advised as to the then current position of the SEC
regarding indemnification for violations of securities laws.
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma consolidated statements of operations and
cash flows for the year ended December 31, 1997, and for the three months ended
March 31, 1998 have been prepared to reflect the Transactions and related
adjustments and assumptions described in the accompanying notes as if the
Transactions occurred on January 1, 1997. The pro forma consolidated balance
sheet has been prepared assuming the Transaction occurred on March 31, 1998.
Such pro forma financial information is based on the historical financial
statements of each of the Partnerships and should be read in conjunction with
the financial statements and notes included in the separately bound supplement
delivered with this Prospectus/ Consent Solicitation Statement. In the opinion
of management, all adjustments necessary to reflect the effects of the
Transaction have been made.
To assist Unitholders in analyzing the Transaction, two presentations of pro
forma financial statements have been prepared. The first presentation of pro
forma financial statements assumes the Company will not issue any Notes. The
second presentation of pro forma financial statements assumes the Company will
issue the maximum amount of Notes. Unitholders should bear in mind that the
assumptions regarding the
87
<PAGE>
issuance of Notes to Investors in connection with the Transaction are not
necessarily the Company's or the General Partners' expectations regarding the
outcome of the Transaction.
Since the Transaction will be accounted for using the purchase method of
accounting, the pro forma financial statements have been prepared using this
method. Under the purchase method, Cap Source I will be deemed to be the
acquirer of Cap Source II because its Unitholders will be allocated the largest
number of shares of Common Stock of the Company. As the surviving entity, Cap
Source I's assets and liabilities will be recorded by the Company at their
historical cost, and the assets and liabilities of Cap Source II will be
recorded at their estimated fair market values.
The pro forma financial statements are based upon available information and
upon certain assumptions, as set forth in the notes to the pro forma
consolidated financial statements, that the General Partners believe are
reasonable in the circumstances. The pro forma information is unaudited and is
not necessarily indicative of the results which actually would have occurred if
the Transaction had been consummated on such dates or at the beginning of such
periods, nor does it purport to represent the financial position or results of
operations for future periods.
88
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED BALANCE SHEET
MARCH 31, 1998
(UNAUDITED)
WITHOUT NOTES ISSUED
ASSETS
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
-------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Investment in real estate
Land......................................... $ 3,093,671 $ 2,800,750 $ 705,560(A) $ 6,599,981
Buildings.................................... 35,536,966 23,055,361 4,936,221(A) 63,528,548
Personal property............................ 2,004,746 1,675,557 (1,475,787 (A) 2,204,516
-------------- ------------- -------------- --------------
40,635,383 27,531,668 4,165,994 72,333,045
Less accumulated depreciation................ (11,055,886) (6,496,209) 6,496,209(A) (11,055,886)
-------------- ------------- -------------- --------------
Net investment in real estate................ 29,579,497 21,035,459 10,662,203 61,277,159
-------------- ------------- -------------- --------------
Cash and temporary cash investments, at cost
which approximates market value.............. 10,218,941 638,563 (816,997 (B) 10,040,507
Escrow deposits and property reserves.......... 826,231 1,244,779 -- 2,071,010
Investment in mortgage-backed
securities................................... 1,047,854 998,930 -- 2,046,784
Interest and other receivables................. 190,094 17,060 -- 207,154
Deferred mortgage issuance costs, net of
accumulated amortization..................... 2,064,398 1,561,722 (145,232 (A) 3,480,888
Other assets................................... 882,212 214,679 408,499(B) 1,505,390
-------------- ------------- -------------- --------------
$ 44,809,227 $ 25,711,192 $ 10,108,473 $ 80,628,892
-------------- ------------- -------------- --------------
-------------- ------------- -------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Liabilities
Accounts payable and accrued
expenses................................... $ 1,497,745 $ 1,202,646 $ -- $ 2,700,391
Distribution payable......................... 860,587 546,968 -- 1,407,555
Mortgage loan payable........................ 6,320,076 -- -- 6,320,076
Due to general partners and their
affiliates................................. 4,013,726 961,847 (3,416,495 (M) 1,559,078
-------------- ------------- -------------- --------------
12,692,134 2,711,461 (3,416,495) 11,987,100
-------------- ------------- -------------- --------------
Minority interest.............................. 192,208 205,513 -- 397,721
Stockholders' Equity (Deficit)
General Partners............................. (296,410) (338,516) 634,926(C) --
Limited Partners............................. 32,221,295 23,132,734 10,516,972(A) --
(65,871,001 (C)
Stockholders' Equity......................... -- -- 65,236,075(C) 68,244,071
(408,499 (B)
3,416,495(M)
-------------- ------------- -------------- --------------
31,924,885 22,794,218 13,524,968 68,244,071
-------------- ------------- -------------- --------------
$ 44,809,227 $ 25,711,192 $ 10,108,473 $ 80,628,892
-------------- ------------- -------------- --------------
-------------- ------------- -------------- --------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements.
89
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
WITHOUT NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Income
Rental income................................ $7,555,700 $ 5,105,108 $ -- $ 12,660,808
Mortgage-backed securities income............ 90,320 82,182 -- 172,502
Interest on temporary cash investments....... 583,881 104,411 -- 688,292
Other income................................. 252,057 202,670 -- 454,727
------------ ------------- ------------- -------------
Total Income............................... 8,481,958 5,494,371 -- 13,976,329
------------ ------------- ------------- -------------
Expenses
Real estate operating expenses............... 3,903,102 2,562,636 -- 6,465,738
Depreciation................................. 905,563 666,758 259,711 (D) 1,832,032
Interest expense............................. 558,789 -- -- 558,789
General and administrative expenses
Investor servicing......................... 455,322 411,005 87,000 (E) 350,989
(602,338) (F)
Professional fees.......................... 93,950 156,809 12,300 (G) 263,059
Other expenses............................. 16,135 23,326 58,900 (H) 98,361
Amortization................................. 141,467 111,144 (62,376) (I) 206,668
16,433 (J)
Asset management and partnership
administration fees........................ -- 166,000 (166,000) (F) 433,014
433,014 (K)
------------ ------------- ------------- -------------
6,074,328 4,097,678 36,644 10,208,650
Minority interest in (income) losses of
Operating Partnerships..................... (5,090) 857 -- (4,233)
------------ ------------- ------------- -------------
Income before income taxes................... 2,402,540 1,397,550 (36,644) 3,763,446
Provision for income taxes................... -- -- 1,452,690 (L) 1,452,690
------------ ------------- ------------- -------------
Net income..................................... $2,402,540 $ 1,397,550 $ (1,489,334) $ 2,310,756
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Net income per share........................... $ 0.70 $ 0.34 $ 0.69
------------ ------------- -------------
------------ ------------- -------------
Weighted average number of shares outstanding
during the period............................ 3,374,222 4,011,101 3,354,887
------------ ------------- -------------
------------ ------------- -------------
Ratio of earnings to fixed charges............. 7.74
-------------
-------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
90
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
WITHOUT NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income......................................... $ 2,402,540 $ 1,397,550 $ (1,489,334) $ 2,310,756
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization...................... 1,047,030 777,902 213,768 2,038,700
Amortization of discount on securities............. (2,665) (1,397) (4,062)
Minority interest in (income) losses of operating
partnerships..................................... 5,090 (857) 4,233
Decrease (increase) in interest and other
receivables...................................... (8,428) 3,682 (4,746)
Decrease (increase) in escrow deposits and working
capital reserves................................. 22,810 (333,762) (310,952)
Increase in other assets........................... (156,964) (21,269) (178,233)
Increase in accounts payable and accrued
liabilities...................................... 115,472 244,408 1,275,566 1,635,446
Decrease in due to operating partnerships' general
partners and their affiliates.................... (103,479) (32,396) (135,875)
------------- ------------- ------------- -------------
Net cash provided by operating activities........ 3,321,406 2,033,861 -- 5,355,267
------------- ------------- ------------- -------------
Cash flows from investing activities
Principal payments received on mortgage backed
securities....................................... 243,649 127,727 371,376
Acquisition of real estate......................... (19,652) -- (19,652)
Acquisition of personal property................... (8,971) (69,723) (78,694)
Increase in other assets........................... 78,605 -- 78,605
------------- ------------- ------------- -------------
Net cash provided by investing activities........ 293,631 58,004 -- 351,635
------------- ------------- ------------- -------------
Cash flow used in financing activities...............
Principal payments on mortgage loan payable........ (34,581) -- (34,581)
Distributions...................................... (3,442,389) (3,281,810) (6,724,199)
------------- ------------- ------------- -------------
Net cash used in financing activities............ (3,476,970) (3,281,810) -- (6,758,780)
------------- ------------- ------------- -------------
Net increase (decrease) in cash and temporary
cash investments............................... 138,067 (1,189,945) -- (1,051,878)
Cash and temporary cash investments at beginning of
year............................................... 10,272,497 2,430,937 (1,194,820) 11,508,614
------------- ------------- ------------- -------------
Cash and temporary cash investments at end of year... $ 10,410,564 $ 1,240,992 $ (1,194,820) $ 10,456,736
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Distributions--income................................ $ 2,310,756
Distributions--return of capital..................... 4,413,443
-------------
$ 6,724,199
-------------
-------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
91
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
WITHOUT NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------ ------------- ---------------- ------------
<S> <C> <C> <C> <C>
Income
Rental income..................................... $1,894,782 $ 1,259,898 $ -- $ 3,154,680
Mortgage-backed securities income................. 19,895 18,881 -- 38,776
Interest on temporary cash investments............ 141,288 16,700 -- 157,988
Other income...................................... 77,879 40,254 -- 118,133
------------ ------------- ---------------- ------------
Total income.................................... 2,133,844 1,335,733 -- 3,469,577
------------ ------------- ---------------- ------------
Expenses
Real estate operating expenses.................... 950,856 628,702 -- 1,579,558
Depreciation...................................... 224,686 165,915 $ 64,928(D) 455,529
Property development and management fees.......... -- 701 701
Interest expense.................................. 149,841 -- -- 149,841
General and administrative expenses...............
Investor servicing.............................. 126,562 119,620 26,750(E) 78,906
(194,026)(F)
Professional fees............................... 12,775 196,562 2,800(G) 212,137
Other expenses.................................. 66,596 44,212 7,500(H) 118,308
Amortization...................................... 35,369 27,788 (15,594)(I) 51,671
4,108(J)
Asset management and partnership administration
fees............................................ -- 41,500 (41,500)(F) 108,254
108,254(K)
------------ ------------- ---------------- ------------
1,566,685 1,225,000 (36,780) 2,754,905
Minority interest in losses of Operating
Partnerships.................................... 142 90 -- 232
------------ ------------- ---------------- ------------
Income before income taxes........................ 567,301 110,823 36,780 714,904
Provision for income taxes........................ -- -- 275,953(L) 275,953
------------ ------------- ---------------- ------------
Net income.......................................... $ 567,301 $ 110,823 $ (239,173) $ 438,951
------------ ------------- ---------------- ------------
------------ ------------- ---------------- ------------
Net income per share................................ $ 0.17 $ 0.03 $ 0.13
------------ ------------- ------------
------------ ------------- ------------
Weighted average number of shares outstanding during
the period........................................ 3,374,222 4,011,101 3,354,887
------------ ------------- ------------
------------ ------------- ------------
Ratio of earnings to fixed charges.................. 5.77
------------
------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
92
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
WITHOUT NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------- ------------- ----------- --------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income......................................... $ 567,301 $ 110,823 $(239,173) $ 438,951
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization...................... 260,055 193,703 53,442 507,200
Amortization of discount on securities............. (495) (610) (1,105)
Property development and management fees........... -- 701 701
Minority interest in losses of operating
partnerships..................................... (142) (90) (232)
Decrease (increase) in interest and other
receivables...................................... (119,552) 2,383 (117,169)
Decrease (increase) in escrow deposits and working
capital reserves................................. 68,755 (139,956) (71,201)
Decrease (increase) in other assets................ (115,000) 26,819 (88,181)
Increase (decrease) in accounts payable and accrued
liabilities...................................... (34,457) 83,676 185,731 234,950
Increase (decrease) in due to operating
partnerships' general partners and their
affiliates....................................... 100 (106,167) (106,067)
------------- ------------- ----------- --------------
Net cash provided by operating activities........ 626,565 171,282 -- 797,847
------------- ------------- ----------- --------------
Cash flows from investing activities.................
Principal payments received on mortgage backed
securities....................................... 45,205 55,813 101,018
Acquisition of personal property................... (2,796) (9,072) (11,868)
------------- ------------- ----------- --------------
Net cash provided by investing activities........ 42,409 46,741 -- 89,150
------------- ------------- ----------- --------------
Cash flow used in financing activity.................
Distributions...................................... (860,597) (820,452) (1,681,049)
------------- ------------- ----------- --------------
Net cash used in financing activity.............. (860,597) (820,452) -- (1,681,049)
------------- ------------- ----------- --------------
Net decrease in cash and temporary cash
investments.................................... (191,623) (602,429) -- (794,052)
Cash and temporary cash investments at beginning of
period............................................. 10,410,564 1,240,992 (816,997) 10,834,559
------------- ------------- ----------- --------------
Cash and temporary cash investments at end of
period............................................. $ 10,218,941 $ 638,563 $(816,997) $ 10,040,507
------------- ------------- ----------- --------------
------------- ------------- ----------- --------------
Distributions--income................................ $ 438,951
Distributions--return of capital..................... $ 1,242,098
--------------
--------------
$ 1,681,049
--------------
--------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
93
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
WITHOUT NOTES ISSUED
A The historical balance sheet of Cap Source II has been adjusted to reflect
the impact of applying the purchase method of accounting to this
transaction. The net assets of Cap Source II are being adjusted to their
estimated fair value. The fair value is based on: (i) the Appraised value of
the properties; (ii) the market value of the mortgage-backed securities
based on market prices; (iii) any undistributed cash and other assets; less
(iv) any outstanding liabilities owed by the partnership.
The effect of all this on the balance sheet results in the following
adjustments: (i) land and buildings have been adjusted to their estimated
fair value based on their appraised value; (ii) intangible items have been
eliminated as these items were assigned no value; and (iii) the net effect
of those changes to the assets and liabilities has been applied to the
partners' capital account.
B Represents the following adjustments to record remaining transaction costs
expected to be incurred: (i) a decrease in cash for anticipated transaction
costs remaining to be incurred of $816,997; (ii) goodwill of $408,499
resulting from Cap Source 1's share of the remaining transaction costs; and
(iii) a reduction to stockholders' equity for Cap Source II's share of the
remaining transaction costs. Cap Source II's share of the remaining
transaction costs have been excluded from the pro forma statement of
operations.
C Represents reclassification of the existing general partners' and unit
holders' capital to stockholders' equity.
D Represents additional depreciation that will be incurred as a result of
adjusting Cap Source II's assets to fair value.
E Represents additional incremental costs expected to be incurred in
conjunction with operating the Company. These incremental costs consist of:
(i) liability insurance of $73,000 for the year ended December 31, 1997 and
$20,000 for the quarter ended March 31, 1998, respectively, for the
Company's directors and officers and (ii) an increase of $14,000 for the
year ended December 31, 1997 and $6,750 for the quarter ended March 31,
1998, respectively, in mailing, printing and other miscellaneous costs
associated with operating the new Company.
F Under the terms of the Advisory Agreement, the Advisor is responsible for
certain types of general and administrative expenses, namely compensation of
the Company's officers and other personnel whereas, pursuant to the terms of
each Partnership's partnership agreement, compensation costs and
administrative fees were allocated to the respective Partnership. As such,
general and administrative expenses have been adjusted to reflect the
elimination of these expenses. The Advisor will receive a management fee as
described in footnote K.
G Represents additional incremental legal costs expected to be incurred in
conjunction with operating the Company.
H Represents additional incremental costs expected to be incurred in
conjunction with operating the Company. These incremental costs consist of:
(i) board of directors fees and expenses of $29,200 for the year ended
December 31, 1997 and $7,500 for the quarter ended March 31, 1998 as the
Company will have its own board of directors and (ii) travel costs of
$29,700 for the year ended December 31, 1997 relating to expanding the
Company's real estate portfolio.
I Represents the elimination of historical amortization of the initial
advisory fee for Cap Source II as these items were assigned no value in
adjusting to fair value in applying the purchase method of accounting.
94
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
WITHOUT NOTES ISSUED
J Represents the amortization of goodwill using the straight line method over
a period of 40 years.
K Represents the Asset Management Fee payable to the Advisor pursuant to the
terms of the Advisory Agreement. The Asset Management Fee is .475% per annum
of the Company's Total Assets. The Asset Management Fee will be calculated
and payable monthly. For purposes of the pro forma financial statements, the
Asset Management Fee is based on the pro forma Total Assets as of December
31, 1997 for all periods presented. Expenses incurred by the Advisor and
reimbursed by the Company are included in pro forma general and
administrative expenses.
L Represents estimated income tax expense at a rate of 38.6% resulting from
electing to be taxed as a corporation rather than a partnership.
M Represents the amount that is recorded as payable to affiliates of General
Partners of Capital Source I which will be waived by such affiliates if the
transaction is completed. The gain on forgiveness of the payable has been
excluded from the pro forma statements of operations.
95
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
SUPPLEMENTAL PRO FORMA PER SHARE/UNIT DATA (A)
WITHOUT NOTES ISSUED
<TABLE>
<CAPTION>
DISTRIBUTIONS
BOOK VALUE DISTRIBUTIONS NET INCOME YEAR ENDED NET INCOME
EXCHANGE AS OF 3 MONTHS ENDED 3 MONTHS ENDED DEC. 31, YEAR ENDED
VALUE MAR. 31, 1998 MAR. 31, 1998 MAR. 31, 1998 1997 DEC. 31, 1997
------------- ------------- --------------- ----------------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Pro forma--the Company (Per
Share)....................... $ 25.00 $ 20.34 $ 0.5011 $ 0.13 $ 2.0043 $ 0.69
Historical--Cap Source I (Per
Unit)........................ $ 9.55 $ 0.2525 $ 0.17 $ 1.0100 $ 0.70
Equivalent pro forma-- Cap
Source I (Per Unit).......... $ 14.96 $ 12.17 $ 0.2999 $ 0.08 $ 1.1995 $ 0.41
Historical--Cap Source II (Per
Unit)........................ $ 5.77 $ 0.2025 $ 0.03 $ 0.8100 $ 0.34
Equivalent pro forma-- Cap
Source II (Per Unit)......... $ 8.12 $ 6.60 $ 0.1627 $ 0.04 $ 0.6506 $ 0.22
</TABLE>
- ------------------------
(A) Equivalent pro forma data has been calculated by multiplying the Company pro
forma amounts by the exchange ratio (below) for each participating
partnership, so that the Company per share pro forma amounts are equated to
the respective values for one unit of the respective partnership.
<TABLE>
<S> <C>
Exchange Values
(1 unit = x shares)
Cap Source I...................................................... 0.598444
Cap Source II..................................................... 0.324613
</TABLE>
96
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED BALANCE SHEET
MARCH 31, 1998
(UNAUDITED)
WITH NOTES ISSUED
ASSETS
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
-------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Investment in real estate
Land......................................... $ 3,093,671 $ 2,800,750 $ 705,560(A) $ 6,599,981
Buildings.................................... 35,536,966 23,055,361 4,936,221(A) 63,528,548
Personal property............................ 2,004,746 1,675,557 (1,475,787 (A) 2,204,516
-------------- ------------- -------------- --------------
40,635,383 27,531,668 4,165,994 72,333,045
Less accumulated depreciation................ (11,055,886) (6,496,209) 6,496,209(A) (11,055,886)
-------------- ------------- -------------- --------------
Net investment in real estate................ 29,579,497 21,035,459 10,662,203 61,277,159
-------------- ------------- -------------- --------------
Cash and temporary cash investments, at cost
which approximates market value.............. 10,218,941 638,563 (816,997 (B) 10,040,507
Escrow deposits and property reserves.......... 826,231 1,244,779 -- 2,071,010
Investment in mortgage-backed
securities................................... 1,047,854 998,930 -- 2,046,784
Interest and other receivables................. 190,094 17,060 -- 207,154
Deferred mortgage issuance costs, net of
accumulated amortization..................... 2,064,398 1,561,722 (145,232 (A) 3,480,888
Other assets................................... 882,212 214,679 408,499(B) 1,505,390
-------------- ------------- -------------- --------------
$ 44,809,227 $ 25,711,192 $ 10,108,473 $ 80,628,892
-------------- ------------- -------------- --------------
-------------- ------------- -------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Liabilities
Accounts payable and accrued
expenses................................... $ 1,497,745 $ 1,202,646 $ -- $ 2,700,391
Distribution payable......................... 860,587 546,968 -- 1,407,555
Mortgage loan payable........................ 6,320,076 -- -- 6,320,076
Due to general partners and their
affiliates................................. 4,013,726 961,847 (3,416,495 (O) 1,559,078
Notes payable................................ 40,000,000(C) 40,000,000
-------------- ------------- -------------- --------------
12,692,134 2,711,461 36,583,505 51,987,100
-------------- ------------- -------------- --------------
Minority interest.............................. 192,208 205,513 -- 397,721
Stockholders' Equity (Deficit)
General Partners............................. (296,410) (338,516) 634,926(D) --
Limited Partners............................. 32,221,295 23,132,734 10,516,972(A) --
(65,871,001 (D)
Stockholders' Equity......................... -- -- 65,236,075(D) 28,244,071
(408,499 (B)
3,416,495(O)
(40,000,000 (C)
-------------- ------------- -------------- --------------
31,924,885 22,794,218 (26,475,032) 28,244,071
-------------- ------------- -------------- --------------
$ 44,809,227 $ 25,711,192 $ 10,108,473 $ 80,628,892
-------------- ------------- -------------- --------------
-------------- ------------- -------------- --------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements.
97
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
WITH NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Income
Rental income................................. $7,555,700 $ 5,105,108 $ -- $ 12,660,808
Mortgage-backed securities income............. 90,320 82,182 -- 172,502
Interest on temporary cash investments........ 583,881 104,411 -- 688,292
Other income.................................. 252,057 202,670 -- 454,727
------------ ------------- ------------ ------------
Total Income................................ 8,481,958 5,494,371 -- 13,976,329
------------ ------------- ------------ ------------
Expenses
Real estate operating expenses................ 3,903,102 2,562,636 -- 6,465,738
Depreciation.................................. 905,563 666,758 259,711 (E) 1,832,032
Interest expense.............................. 558,789 -- 2,732,000 (F) 3,290,789
General and administrative expenses
Investor servicing.......................... 455,322 411,005 87,000 (G) 350,989
(602,338) (H)
Professional fees........................... 93,950 156,809 12,300 (I) 263,059
Other expenses.............................. 16,135 23,326 58,900 (J) 98,361
Amortization.................................. 141,467 111,144 (62,376) (K) 206,668
16,433 (L)
Asset management and partnership
administration fees......................... -- 166,000 (166,000) (H) 433,014
433,014 (M)
------------ ------------- ------------ ------------
6,074,328 4,097,678 2,768,644 12,940,650
------------ ------------- ------------ ------------
Minority interest in (income) losses of
Operating Partnerships...................... (5,090) 857 -- (4,233)
------------ ------------- ------------ ------------
Income before income taxes.................... 2,402,540 1,397,550 (2,768,644) 1,031,446
Provision for income taxes.................... -- -- 398,138 (N) 398,138
------------ ------------- ------------ ------------
Net income...................................... $2,402,540 $ 1,397,550 $ (3,166,782) $ 633,308
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
Net income per share............................ $ 0.70 $ 0.34 $ 0.36
------------ ------------- ------------
------------ ------------- ------------
Weighted average number of shares outstanding
during the period............................. 3,374,222 4,011,101 1,754,887
------------ ------------- ------------
------------ ------------- ------------
Ratio of earnings to fixed charges.............. 1.31
------------
------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
98
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
(UNAUDITED)
WITH NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income..................................... $2,402,540 $ 1,397,550 $(3,166,782) $ 633,308
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.................. 1,047,030 777,902 213,768 2,038,700
Amortization of discount on securities......... (2,665) (1,397) (4,062)
Minority interest in (income) losses of
operating partnerships....................... 5,090 (857) 4,233
Decrease (increase) in interest and other
receivables.................................. (8,428) 3,682 (4,746)
Decrease (increase) in escrow deposits and
working capital reserves..................... 22,810 (333,762) (310,952)
Increase in other assets....................... (156,964) (21,269) (178,233)
Increase (decrease) in accounts payable and
accrued liabilities.......................... 115,472 244,408 2,953,014 3,312,894
Decrease in due to operating partnerships'
general partners and their affiliates........ (103,479) (32,396) (135,875)
------------ ------------- ----------- ------------
Net cash provided by operating activities.... 3,321,406 2,033,861 -- 5,355,267
------------ ------------- ----------- ------------
Cash flows from investing activities
Principal payments received on mortgage backed
securities................................... 243,649 127,727 371,376
Acquisition of real estate..................... (19,652) -- (19,652)
Acquisition of personal property............... (8,971) (69,723) (78,694)
Increase in other assets....................... 78,605 -- 78,605
------------ ------------- ----------- ------------
Net cash provided by investing activities...... 293,631 58,004 -- 351,635
------------ ------------- ----------- ------------
Cash flow used in financing activities...........
Principal payments on mortgage loan payable.... (34,581) -- (34,581)
Distributions.................................. (3,442,389) (3,281,810) (6,724,199)
------------ ------------- ----------- ------------
Net cash used in financing activities........ (3,476,970) (3,281,810) -- (6,758,780)
------------ ------------- ----------- ------------
Net increase (decrease) in cash and temporary
cash investments........................... 138,067 (1,189,945) -- (1,051,878)
Cash and temporary cash investments at beginning
of year........................................ 10,272,497 2,430,937 (1,194,820) 11,508,614
------------ ------------- ----------- ------------
Cash and temporary cash investments at end of
year........................................... $10,410,564 $ 1,240,992 $(1,194,820) $ 10,456,736
------------ ------------- ----------- ------------
------------ ------------- ----------- ------------
Distributions--income............................ $ 500,879
Distributions--return of capital................. 6,223,320
------------
$ 6,724,199
------------
------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
99
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
WITH NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------ ------------- ---------------- ------------
<S> <C> <C> <C> <C>
Income
Rental income..................................... $1,894,782 $ 1,259,898 $ -- $ 3,154,680
Mortgage-backed securities income................. 19,895 18,881 -- 38,776
Interest on temporary cash investments............ 141,288 16,700 -- 157,988
Other income...................................... 77,879 40,254 -- 118,133
------------ ------------- ---------------- ------------
Total income.................................... 2,133,844 1,335,733 -- 3,469,577
------------ ------------- ---------------- ------------
Expenses
Real estate operating expenses.................... 950,856 628,702 -- 1,579,558
Depreciation...................................... 224,686 165,915 $ 64,928(E) 455,529
Property development and management fees.......... -- 701 701
Interest expense.................................. 149,841 -- 683,000(F) 832,841
General and administrative expenses...............
Investor servicing.............................. 126,562 119,620 26,750(G) 78,906
(194,026)(H)
Professional fees............................... 12,775 196,562 2,800(I) 212,137
Other expenses.................................. 66,596 44,212 7,500(J) 118,308
Amortization...................................... 35,369 27,788 (15,594)(K) 51,671
4,108(L)
Asset management and partnership administration
fees............................................ -- 41,500 (41,500)(H) 108,254
108,254(M)
------------ ------------- ---------------- ------------
1,566,685 1,225,000 646,220 3,437,905
Minority interest in losses of Operating
Partnerships.................................... 142 90 -- 232
------------ ------------- ---------------- ------------
Income before income taxes........................ 567,301 110,823 (646,220) 31,904
Provision for income taxes........................ -- -- 12,315(N) 12,315
------------ ------------- ---------------- ------------
Net income.......................................... $ 567,301 $ 110,823 $ (656,535) $ 19,589
------------ ------------- ---------------- ------------
------------ ------------- ---------------- ------------
Net income per share................................ $ 0.17 $ 0.03 $ 0.01
------------ ------------- ------------
------------ ------------- ------------
Weighted average number of shares outstanding during
the period........................................ 3,374,222 4,011,101 1,754,687
------------ ------------- ------------
------------ ------------- ------------
Ratio of earnings to fixed charges.................. 1.04
------------
------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
100
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
WITH NOTES ISSUED
<TABLE>
<CAPTION>
CAP SOURCE I CAP SOURCE II PRO FORMA PRO FORMA
(HISTORICAL) (HISTORICAL) ADJUSTMENTS COMBINED
------------- ------------- ----------- --------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income......................................... $ 567,301 $ 110,823 $(658,535) $ 19,589
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization...................... 260,055 193,703 53,442 507,200
Amortization of discount on securities............. (495) (610) (1,105)
Property development and management fees........... 701 701
Minority interest in losses of operating
partnerships..................................... (142) (90) (232)
Decrease (increase) in interest and other
receivables...................................... (119,552) 2,383 (117,169)
Decrease (increase) in escrow deposits and working
capital reserves................................. 68,755 (139,956) (71,201)
Decrease (increase) in other assets................ (115,000) 26,819 (88,181)
Increase (decrease) in accounts payable and accrued
liabilities...................................... (34,457) 83,676 605,093 654,312
Increase (decrease) in due to operating
partnerships' general partners and their
affiliates....................................... 100 (106,167) (106,067)
------------- ------------- ----------- --------------
Net cash provided by operating activities........ 626,565 171,282 -- 797,847
------------- ------------- ----------- --------------
Cash flows from investing activities.................
Principal payments received on mortgage backed
securities....................................... 45,205 55,813 101,018
Acquisition of personal property................... (2,796) (9,072) (11,868)
------------- ------------- ----------- --------------
Net cash provided by investing activities........ 42,409 46,741 -- 89,150
------------- ------------- ----------- --------------
Cash flow used in financing activity.................
Distributions...................................... (860,597) (820,452) (1,681,049)
------------- ------------- ----------- --------------
Net cash used in financing activity.............. (860,597) (820,452) -- (1,681,049)
------------- ------------- ----------- --------------
Net decrease in cash and temporary cash
investments.................................... (191,623) (602,429) -- (794,052)
Cash and temporary cash investments at beginning of
period............................................. 10,410,564 1,240,992 (816,997) 10,834,559
------------- ------------- ----------- --------------
Cash and temporary cash investments at end of
period............................................. $ 10,218,941 $ 638,563 $(816,997) $ 10,040,507
------------- ------------- ----------- --------------
------------- ------------- ----------- --------------
Distributions--income................................ $ 19,589
Distributions--return of capital..................... $ 1,661,460
--------------
--------------
$ 1,681,049
--------------
--------------
</TABLE>
See accompanying Notes to Consolidated Pro Forma Financial Statements
101
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
WITH NOTES ISSUED
A The historical balance sheet of Cap Source II has been adjusted to reflect
the impact of applying the purchase method of accounting to this
transaction. The net assets of Cap Source II are being adjusted to their
estimated fair value. The fair value is based on: (i) the Appraised value of
the properties; (ii) the market value of the mortgage-backed securities
based on market prices; (iii) any undistributed cash and other assets; less
(iv) any outstanding liabilities owed by the partnership.
The effect of all this on the balance sheet results in the following
adjustments: (i) land and buildings have been adjusted to their estimated
fair value based on their appraised value; (ii) intangible items have been
eliminated as these items were assigned no value; and (iii) the net effect
of those changes to the assets and liabilities has been applied to the
partners' capital account.
B Represents the following adjustments to record remaining transaction costs
expected to be incurred: (i) a decrease in cash for anticipated transaction
costs remaining to be incurred of $816,997; (ii) goodwill of $408,499
resulting from Cap Source 1's share of the remaining transaction costs; and
(iii) a reduction to stockholders' equity for Cap Source II's share of the
remaining transaction costs. Cap Source II's share of the remaining
transaction costs have been excluded from the pro forma statement of
operations.
C Represents the issuance of Notes by the Company to Participating Investors
electing to receive Notes. The issuance of the Notes results in an increase
in notes payable and a reduction of stockholders' equity. The Notes mature
on 2006 and bear interest at 120% of the quarterly applicable federal
rate for debt instruments with a term of not over three years (assumed to be
6.83%).
D Represents reclassification of the existing general partners' and unit
holders' capital to stockholders' equity.
E Represents additional depreciation that will be incurred as a result of
adjusting Cap Source II's assets to fair value.
F Represents interest on the Notes at an assumed rate of 6.83%.
G Represents additional incremental costs expected to be incurred in
conjunction with operating the Company. These incremental costs consist of:
(i) liability insurance of $73,000 for the year ended December 31, 1997 and
$20,000 for the quarter ended March 31, 1998, respectively, for the
Company's directors and officers and (ii) an increase of $14,000 for the
year ended December 31, 1997 and $6,750 for the quarter ended March 31,
1998, respectively, in mailing, printing and other miscellaneous costs
associated with operating the new Company.
H Under the terms of the Advisory Agreement, the Advisor is responsible for
certain types of general and administrative expenses, namely compensation of
the Company's officers and other personnel whereas, pursuant to the terms of
each Partnership's partnership agreement, compensation costs and
administrative fees were allocated to the respective Partnership. As such,
general and administrative expenses have been adjusted to reflect the
elimination of these expenses. The Advisor will receive a management fee as
described in footnote M.
I Represents additional incremental legal costs expected to be incurred in
conjunction with operating the Company.
J Represents additional incremental costs expected to be incurred in
conjunction with operating the Company. These incremental costs consist of:
(i) board of directors fees and expenses of $29,200 for the year ended
December 31, 1997 and $7,500 for the quarter ended March 31, 1998 as the
Company
102
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
WITH NOTES ISSUED
will have its own board of directors and (ii) travel costs of $29,700 for
the year ended December 31, 1997 relating to expanding the Company's real
estate portfolio.
K Represents the elimination of historical amortization of the initial advisory
fee for Cap Source II as these items were assigned no value in adjusting to
fair value in applying the purchase method of accounting.
L Represents the amortization of goodwill using the straight line method over a
period of 40 years.
M Represents the Asset Management Fee payable to the Advisor pursuant to the
terms of the Advisory Agreement. The Asset Management Fee is .475% per annum
of the Company's Total Assets. The Asset Management Fee will be calculated
and payable monthly. For purposes of the pro forma financial statements, the
Asset Management Fee is based on the pro forma Total Assets as of December
31,1997 for all periods presented. Expenses incurred by the Advisor and
reimbursed by the Company are included in pro forma general and
administrative expenses.
N Represents estimated income tax expense at a rate of 38.6% resulting from
electing to be taxed as a corporation rather than a partnership.
O Represents the amount that is recorded as payable to affiliates of General
Partners of Capital Source I which will be waived by such affiliates if the
transaction is completed. The gain on forgiveness of the payable has been
excluded from the pro forma statements of operations.
103
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
SUPPLEMENTAL PRO FORMA PER SHARE/UNIT DATA (A)
WITH NOTES ISSUED
<TABLE>
<CAPTION>
DISTRIBUTIONS
BOOK VALUE AS DISTRIBUTIONS NET INCOME YEAR ENDED NET INCOME YEAR
EXCHANGE OF 3 MONTHS ENDED 3 MONTHS ENDED DEC. 31, ENDED DEC. 31,
VALUE MAR. 31, 1998 MAR. 31, 1998 MAR. 31, 1998 1997 1997
------------- ------------- --------------- ----------------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Pro forma--the Company (Per
Share)....................... $ 25.00 $ 15.73 $ 0.9578 $ 0.01 $ 3.8317 $ 0.36
Historical--Cap Source I (Per
Unit)........................ $ 9.55 $ 0.2525 $ 0.17 $ 1.0100 $ 0.70
Equivalent pro forma-- Cap
Source I (Per Unit).......... $ 14.96 $ 9.41 $ 0.5732 $ 0.01 $ 2.2931 $ 0.22
Historical--Cap Source II (Per
Unit)........................ $ 5.77 $ 0.2025 $ 0.03 $ 0.8100 $ 0.34
Equivalent pro forma-- Cap
Source II (Per Unit)......... $ 8.12 $ 5.11 $ 0.3109 $ -- $ 1.2438 $ 0.12
</TABLE>
- ------------------------
(A) Equivalent pro forma data has been calculated by multiplying the Company pro
forma amounts by the exchange ratio (below) for each participating
partnership, so that the Company per share pro forma amounts are equated to
the respective values for one unit of the respective partnership.
<TABLE>
<S> <C>
Exchange Values
(1 unit = x shares)
Cap Source I...................................................... 0.598444
Cap Source II..................................................... 0.324613
</TABLE>
104
<PAGE>
THE PARTNERSHIPS
CAP SOURCE I
HISTORY. Cap Source I, a Delaware limited partnership, was formed August
22, 1985. The General Partners of Cap Source I are Insured Mortgage Equities,
Inc. and America First Capital Source I, L.L.C. The initial limited partner, H/T
Corp., a Delaware corporation wholly owned by the Cap Source I General Partners,
assigned certain of the ownership attributes of the limited partner interest to
the Cap Source I Investors, including rights to a percentage of Cap Source I's
income, gain, losses, deductions, credits and distributions. H/T Corp. has
agreed to vote the limited partner interests as directed by the Cap Source I
Investors. The Cap Source I Investors hold beneficial assignment certificates,
which represent beneficial assignments of the limited partner interest in Cap
Source I.
Cap Source I was formed to invest principally in federally insured mortgages
on multifamily housing property (the "Cap Source I Mortgage Securities") and to
acquire, hold, sell and otherwise deal with limited partnership interests (the
"Cap Source I Partnership Equity Interests") in the Cap Source I Operating
Partnerships. The Cap Source I Partnership Agreement originally provided that
the Units would be listed on NASDAQ for trading. The Investors voted by proxy
not to list the Units on NASDAQ.
Cap Source I's assets originally consisted of debt and equity financing for
eight multifamily rental housing properties. Cap Source I's investments in these
properties consisted of: (a) approximately 85% in the form of permanent
mortgages and/or construction loans, each of which was insured or guaranteed, in
an amount substantially equal to the face amount of the mortgage, by the FHA or
GNMA; and (b) the balance to purchase up to a 99% limited partnership interest
in limited partnerships which developed, constructed, own and operate these
properties.
The original Cap Source I Operating Partnerships were structured with the
developer of the respective property serving as the general partner (the "Cap
Source I Operating General Partner") with a 1% interest, Cap Source I as the
limited partner with a 98.99% interest and CS Properties I, Inc., a corporation
wholly owned by affiliates of the Cap Source I General Partners, as the special
limited partner (the "Cap Source I Special Limited Partner") with a .01%
interest. The Cap Source I Special Limited Partner has the power, among other
things, to remove the Cap Source I Operating General Partners under certain
circumstances and to consent to the sale of the Cap Source I Operating
Partnerships' Assets. In the only exception to the above-described original
structuring, in one of the Cap Source I Operating Partnerships, the Ponds at
Georgetown L.P., Cap Source I is a limited partner with a 30.29% interest and
Cap Source II is a limited partner with a 68.7% interest.
Since inception, Cap Source has been repaid by GNMA on one of its Cap Source
I Mortgage Securities, and, as a result, it no longer holds a Cap Source I
Partnership Equity Interest in the Cap Source I Operating Partnership which
owned the property collateralizing the repaid mortgage (Falcon Point). It has
also been repaid by FHA on another of its Cap Source I Mortgage Securities but
continues to own its Cap Source I Partnership Equity Interest in the Cap Source
I Operating Partnership (Fox Hollow). Three of the Cap Source I Operating
Partnerships (Fox Hollow, Misty Springs and Waterman's Crossing) have been
restructured with CS Properties I, Inc. succeeding to the general partner 1%
interest.
As a result of the foregoing, at December 31, 1997, Cap Source I held debt
and/or equity investments in seven properties. These investments consist of (a)
four mortgage-backed securities guaranteed as to principal and interest by GNMA,
collateralized by first mortgage loans insured as to principal and interest by
FHA on multifamily housing properties located in Virginia, Florida, Illinois and
Michigan; (b) two first mortgage loans insured as to principal and interest by
FHA on multifamily housing properties located in North Carolina and Ohio; (c)
Cap Source I Partnership Equity Interests in seven limited partnerships. Cap
Source I also holds reserve investments in the form of cash and cash equivalents
and investments in certain GNMA securities backed by pools of single family
mortgages (the "Cap Source I Reserve Investments").
105
<PAGE>
The Cap Source I Mortgage Securities provide Cap Source I with monthly
payments of principal and interest which are guaranteed either by GNMA or FHA.
The Cap Source I Partnership Equity Interests were intended to be sufficient to
cover all costs not covered by the Cap Source I Mortgage Securities until the
Cap Source I Operating Partnerships' income was sufficient to cover their
expenses, including debt service on the Cap Source I Mortgage Securities, as
well as a return to Cap Source I on its investment during the period. The
current return to Cap Source I on its Cap Source I Partnership Equity Interests
is a function of the net cash flow generated by the properties and is dependent
on the rental and occupancy rates and on the level of expenses at the
properties.
The FHA Loans and GNMA Certificates owned by Cap Source I are guaranteed as
to principal and interest by FHA and GNMA, respectively. The obligations of FHA
and GNMA are backed by the full faith and credit of the United States
government. The Cap Source I Partnership Equity Interests, however, are not
insured or guaranteed. The value of these investments is a function of the value
of the real estate owned by the Cap Source I Operating Partnerships.
The following FHA Loans and GNMA Certificates associated with the Operating
Partnerships were owned by Cap Source I at December 31, 1997.
<TABLE>
<CAPTION>
GUARANTEED AGGREGATE
OR INTEREST MATURITY PRINCIPAL AMOUNT
PROPERTY NAME INSURED BY RATE DATE OUTSTANDING
- ---------------------------------------------------------- ----------- ----------- ------------ ----------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments.................................... FHA 8.72% 11/15/2028 $ 3,510,035
Highland Park Apartments.................................. FHA 8.75 11/01/2028 9,001,010
Misty Springs Apartments.................................. GNMA 8.75 6/15/2029 4,271,964
The Ponds at Georgetown................................... GNMA 9.00 12/15/2029 2,233,927
Waterman's Crossing....................................... GNMA 10.00 9/15/2028 10,927,185
Water's Edge Apartments................................... GNMA 8.75 12/15/2028 5,066,537
----------------
$ 35,010,658
----------------
----------------
</TABLE>
The following table shows the occupancy levels and effective rental rates of
the properties financed by Cap Source I in 1997:
<TABLE>
<CAPTION>
AVERAGE EFFECTIVE
NUMBER OF PERCENTAGE OF ANNUAL RENTAL
PROPERTY NAME LOCATION UNITS UNITS OCCUPIED RATE PER UNIT
- ---------------------------------------------- ---------------------- ----------- ----------------- -----------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments........................ Jacksonville, NC 108 96% $ 6,258
Fox Hollow Apartments......................... High Point, NC 184 96 6,482
Highland Park Apartments...................... Columbus, OH 252 93 6,333
Misty Springs Apartments...................... Daytona Beach, FL 128 98 6,101
The Ponds at Georgetown....................... Ann Arbor, MI 134 97 9,883
Waterman's Crossing........................... Newport News, VA 260 98 7,207
Water's Edge Apartments....................... Lake Villa, IL 108 96 8,723
-----
1,174
-----
-----
</TABLE>
In the opinion of the Cap Source I General Partners, each of the properties
is adequately covered by insurance.
RECENT DEVELOPMENTS. The mortgage on The Ponds has been in default for
several years because cash flow from the property has been insufficient to fully
fund the property's mortgage obligations. In addition, the property is
approximately $584,000 delinquent on its property taxes as of December 31, 1997.
Despite the default, Cap Source I has continued to receive full payment with
respect to the GNMA Certificate due to the co-insurer's (private mortgage
lender) funding of the deficits. The co-insurer has the option to
106
<PAGE>
suspend its funding of the property's deficits and assign its mortgage to GNMA,
which would result in a return to Cap Source I of the outstanding principal
balance of its GNMA Certificate and the possible loss of the Partnership Equity
Interest in the property. A proposed settlement agreement with the co-insurer to
resolve the property's mortgage loan default is currently pending. Under the
terms of the proposed settlement agreement, the current general partners of The
Ponds, W.S. Smith Company, Woodward S. Smith and Robert J. Goodrich, will
withdraw from the Operating Partnership and be replaced with CS Properties I,
Inc. and CS Properties II, Inc. as substitute general partners. CS Properties I,
Inc. and CS Properties II, Inc. are controlled by America First Companies and
are also the special limited partners of The Ponds. In addition to the change of
general partners, the GNMA Certificate relating to The Ponds will be cancelled
and replaced with a new certificate having a principal amount of $7,511,000 and
a rate of 7.5%. Outstanding interest on the mortgage loan and past due taxes on
the property will also be paid upon completion of the proposed settlement from
the increase in principal balance on the mortgage and from capital contributions
totaling approximately $600,000. Of this amount, Cap Source I will contribute
approximately $183,600 and Cap Source II will contribute approximately $416,400.
It is anticipated that the proposed settlement agreement will be final before
September 30, 1998. However, if settlement is not made with the co-insurer,
there can be no assurance that the co-insurer will not make an election in the
future to suspend funding of the property's deficits. In April 1997, Cap Source
I funded $53,550 from its reserves to assist the property in paying a portion of
its property takes in order to avoid a tax sale of the property.
LEGAL PROCEEDINGS Neither Cap Source I nor America First Capital Source I,
L.L.C., one of the Cap Source I General Partners, are presently involved in any
material litigation nor, to their knowledge, is any material litigation
threatened against Cap Source I, America First Capital Source I, L.L.C. or their
respective properties, other than routine litigation arising in the ordinary
course of business. Insured Mortgage Equities, Inc., the other Cap Source I
General Partner, is not, to its knowledge, involved in any material litigation
other than routine litigation arising in the ordinary course of business, except
as set forth below.
Insured Mortgage Equities, Inc. is currently involved in certain litigation,
unrelated to this Transaction, styled in IN RE LEHMAN BROTHERS LIMITED
PARTNERSHIPS LITIGATION, Consolidated Action No. 14886, pending before the Court
of Chancery for the State of Delaware In and For New Castle County. This class
action litigation was filed in 1996, on behalf of the investors in several
limited partnerships against the general partners of those limited partnerships.
The litigation relates to alleged breach of fiduciary responsibilities,
fraudulent mismanagement and self-dealing on the part of the general partners.
Plaintiffs seek injunctive relief, dissolution of the partnerships if necessary,
compensatory damages, attorney fees and costs. Insured Mortgage Equities, Inc.
and Cap Source I have been fully indemnified with regard to these proceedings by
Lehman Brothers, Inc.
CAP SOURCE II
HISTORY. Cap Source II, a Delaware limited partnership, was formed August
22, 1986. The General Partners of Cap Source II are Insured Mortgage Equities,
II L.P. and America First Capital Source II, L.L.C. The initial limited partner,
H/T Corp. II, a Delaware corporation wholly owned by the Cap Source II General
Partners assigned certain of the ownership attributes of the limited partner
interest to the Cap Source II Investors, including rights to a percentage of Cap
Source II's income, gain, losses, deductions, credits and distributions. H/T
Corp. II has agreed to vote the limited partner interests as directed by the Cap
Source II Investors. The Cap Source II Investors hold beneficial assignment
certificates, which represent beneficial assignments of the limited partner
interest in Cap Source II.
Cap Source II was formed to invest principally in federally insured
mortgages on multifamily housing property (the "Cap Source II Mortgage
Securities") and to acquire, hold, sell and otherwise deal with limited
partnership interests (the "Cap Source II Partnership Equity Interests") in the
Cap Source II Operating Partnerships. The Cap Source II Partnership Agreement
originally provided that the Units would be listed on NASDAQ for trading. The
Investors voted by proxy not to list the Units on NASDAQ.
107
<PAGE>
Cap Source II's assets originally consisted of debt and equity financing for
five multifamily rental housing properties. Cap Source II's investments in these
properties consisted of: (a) approximately 85% in the form of permanent
mortgages and/or construction loans, each of which was insured or guaranteed, in
an amount substantially equal to the face amount of the mortgage, by the FHA or
GNMA; and (b) the balance to purchase up to a 99% limited partnership interest
in limited partnerships which developed, constructed, own and operate these
properties.
The Cap Source II Operating Partnerships were structured with the developer
of the respective property serving as the general partner (the "Cap Source II
Operating General Partner") with a 1% interest, Cap Source II as the limited
partner with a 98.99% interest and CS Properties II, Inc., a corporation wholly
owned by affiliates of the Cap Source II General Partners, as the special
limited partner (the "Cap Source II Special Limited Partner") with a .01%
interest. The Cap Source II Special Limited Partner has the power, among other
things, to remove the Cap Source II Operating General Partners under certain
circumstances and to consent to the sale of the Cap Source II Operating
Partnerships' Assets. In the only exception to the above-described original
structuring, in one of the Cap Source II Operating Partnerships, the Ponds at
Georgetown L.P., Cap Source II is a limited partner with a 68.7% interest and
Cap Source I, is a limited partner with a 30.29% interest.
Since inception, Cap Source II has been repaid by GNMA on one of its Cap
Source II Mortgage Securities, and, as a result, it no longer holds a Cap Source
II Partnership Equity Interest in the Cap Source II Operating Partnership which
owned the property collateralizing the repaid mortgage.
As a result of the foregoing, at December 31, 1997, Cap Source II held debt
and/or equity investments in four properties. These investments consist of (a)
three mortgage-backed securities guaranteed as to principal and interest by
GNMA, collateralized by first mortgage loans insured as to principal and
interest by FHA on multifamily housing properties located in Michigan and
Florida; (b) one first mortgage loan insured as to principal and interest by FHA
on a multifamily housing property located in North Carolina; (c) Cap Source II
Partnership Equity Interests in four limited partnerships. Cap Source II also
holds reserve investments in the form of cash and cash equivalents and
investments in certain GNMA securities backed by pools of single family
mortgages (the "Cap Source II Reserve Investments").
The Cap Source II Mortgage Securities provide Cap Source II with monthly
payments of principal and interest which are guaranteed either by GNMA or FHA.
The Cap Source II Partnership Equity Interests were intended to be sufficient to
cover all costs not covered by the Cap Source II Mortgage Securities until the
Cap Source II Operating Partnerships' income was sufficient to cover their
expenses, including debt service on the Cap Source II Mortgage Securities, as
well as a return to Cap Source II on its investment during the period. The
current return to Cap Source II on its Cap Source II Partnership Equity
Interests is a function of the net cash flow generated by the properties and is
dependent on the rental and occupancy rates and on the level of expenses at the
properties.
The FHA Loan and GNMA Certificates owned by Cap Source II are guaranteed as
to principal and interest by FHA and GNMA, respectively. The obligations of FHA
and GNMA are backed by the full faith and credit of the United States
government. The Cap Source II Partnership Equity Interests, however, are not
insured or guaranteed. The value of these investments is a function of the value
of the real estate owned by the Cap Source II Operating Partnerships.
108
<PAGE>
The following FHA Loan and GNMA Certificates were owned by Cap Source II at
December 31, 1997. Interest income from the FHA Loan and GNMA Certificates is
the primary source of cash available for distribution to Investors.
<TABLE>
<CAPTION>
GUARANTEED AGGREGATE
OR INTEREST MATURITY PRINCIPAL AMOUNT
PROPERTY NAME INSURED BY RATE DATE OUTSTANDING
- ---------------------------------------------------------- ----------- ----------- ------------ ----------------
<S> <C> <C> <C> <C>
Crane's Landing........................................... GNMA 8.75% 12/15/2030 $ 10,229,304
Delta Crossing............................................ FHA 9.10 10/01/2030 6,538,424
Monticello Apartments..................................... GNMA 8.75 11/15/2029 5,328,430
The Ponds at Georgetown................................... GNMA 9.00 12/15/2029 5,066,488
----------------
$ 27,162,646
----------------
----------------
</TABLE>
The following table shows the occupancy levels and effective rental rates of
the properties financed by Cap Source II in 1997:
<TABLE>
<CAPTION>
AVERAGE EFFECTIVE
NUMBER OF PERCENTAGE OF ANNUAL RENTAL
PROPERTY NAME LOCATION UNITS UNITS OCCUPIED RATE PER UNIT
- ------------------------------------------------- ------------------ ----------- ----------------- -----------------
<S> <C> <C> <C> <C>
Crane's Landing.................................. Winter Park, FL 252 96% $ 7,366
Delta Crossing................................... Charlotte, NC 178 93 7,260
Monticello Apartments............................ Southfield, MI 106 97 8,873
The Ponds at Georgetown.......................... Ann Arbor, MI 134 97 9,883
---
670
---
---
</TABLE>
In the opinion of the Cap Source II General Partners, each of the properties
is adequately covered by insurance.
RECENT DEVELOPMENTS. The mortgage on the Ponds at Georgetown has been in
default for several years because cash flow from the property has been
insufficient to fully fund the property's mortgage obligations. In addition, the
property is approximately $584,000 delinquent on its property taxes as of
December 31, 1997. Despite the default, Cap Source II has continued to receive
full payment with respect to the GNMA Note due to the co-insurer's (private
mortgage lender) funding of the deficits. The co-insurer has the option to
suspend its funding of the property's deficits and assign its mortgage to GNMA,
which would result in a return to Cap Source II of the outstanding principal
balance of its GNMA Note and the possible loss of the Partnership Equity
Interest in the property. A proposed settlement agreement with the co-insurer to
resolve the property's mortgage loan default is currently pending. Under the
terms of the proposed settlement agreement, the current general partners of The
Ponds, W.S. Smith Company, Woodward S. Smith and Robert J. Goodrich, will
withdraw from the Operating Partnership and be replaced with CS Properties I,
Inc. and CS Properties II, Inc. as substitute general partners. CS Properties I,
Inc. and CS Properties II, Inc. are controlled by America First Companies and
are also the special limited partners of The Ponds. In addition to the change of
general partners, the GNMA Certificate relating to The Ponds will be cancelled
and replaced with a new certificate having a principal amount of $7,511,000 and
a rate of 7.5%. Outstanding interest on the mortgage loan and past due taxes on
the property will also be paid upon completion of the proposed settlement from
the increase in principal balance on the mortgage and from capital contributions
totaling approximately $600,000. Of this amount, Cap Source I will contribute
approximately $183,600 and Cap Source II will contribute approximately $416,400.
It is anticipated that the proposed settlement agreement will be final before
September 30, 1998. However, if settlement is not made with the co-insurer,
there can be no assurance that the co-insurer will not make an election in the
future to suspend funding of the property's deficits. In April 1997, Cap Source
II funded $124,450 from its reserves to assist the property in paying a portion
of its property taxes in order to avoid a tax sale of the property.
LEGAL PROCEEDINGS. Neither Cap Source II nor America First Capital Source
II, L.L.C., one of the Cap Source II General Partners, are presently involved in
any material litigation nor, to their knowledge, is any material litigation
threatened against Cap Source II, America First Capital Source II, L.L.C. or
their
109
<PAGE>
respective properties, other than routine litigation arising in the ordinary
course of business. Insured Mortgage Equities II L.P., the other Cap Source II
General Partner, is not, to its knowledge, involved in any material litigation
other than routine litigation arising in the ordinary course of business except
as set forth below.
Insured Mortgage Equities II L.P. is currently involved in certain
litigation, unrelated to this transaction, styled in IN RE LEHMAN BROTHERS
LIMITED PARTNERSHIP LITIGATION, Consolidated Action No. 14886, pending before
the Court of Chancery for the State of Delaware In and For New Castle County.
This class action litigation was filed in 1996, on behalf of the investors in
several limited partnerships against the general partners of those limited
partnerships. The litigation relates to alleged breach of fiduciary
responsibilities, fraudulent mismanagement and self-dealing on the part of the
general partners. Plaintiffs seek injunctive relief, dissolution of the
partnerships if necessary, compensatory damages, attorney fees and costs.
Insured Mortgage Equities II L.P. and Cap Source II have been fully indemnified
with regard to these proceedings by Lehman Brothers, Inc.
SECONDARY MARKET AND OWNERSHIP OF PARTNERSHIP UNITS
SALE PRICES OF UNITS
The Units are not listed on any national or regional securities exchange or
quoted on any automated quotation system, and there is no established public
trading market for the Units. Secondary sales activity for the Units has been
limited and sporadic. The General Partners monitor transfers of the Units (a)
because the admission of the transferee as a substitute investor requires the
consent of the General Partners under each of the Partnership Agreements, and
(b) in order to track compliance with safe harbor provisions to avoid treatment
of the Partnerships as "publicly traded partnerships" for federal income tax
purposes.
Set forth in the tables that follow is certain information regarding sale
transactions in the Units. Such information was obtained from the sources
indicated. The transactions reflected in the tables below represent only some of
the sale transactions in the Units. There may have been other secondary sale
transactions in the Units, although specific information regarding such
transactions is not readily available to the General Partners. Because the
information regarding sale transactions in the Units included in the tables
below is provided without verification by the General Partners and because the
information provided does not reflect sufficient activity to cause the prices
shown to be representative of the values of the Units, such information should
not be relied upon as indicative of the ability of Investors to sell their Units
in secondary sale transactions or as to the prices at which such Units may be
sold. Therefore, the information presented should not necessarily be relied upon
by Investors in determining whether or not to tender their Units in the
Transaction.
The General Partners do not believe that the secondary sale prices of the
Units accurately reflect the value of the assets of the Partnerships because
secondary sale prices are adversely affected by a variety of factors unrelated
to the value of the assets of a limited partnership. Limited partner interests
are generally traded on a sporadic basis. Sale prices can vary dramatically
based on the number of interests sold at once or over time. Additionally, the
Tax Reform Act of 1986 contained provisions which eliminated certain federal
income tax advantages associated with investments in limited partnerships and
which caused limited partnerships to place restrictions on transfers of
interests in order to avoid taxation of income at the partnership and partner
levels. Accordingly, limited partnerships have not been well received by
investors and secondary sale prices have been adversely affected.
While the General Partners receive some information regarding the prices of
secondary sales transactions of the Units, the General Partners do not receive
or maintain comprehensive information regarding all activities of all
broker/dealers and others known to facilitate secondary sales of the Units. The
General Partners estimate, based solely on the transfer records of the
Partnerships, that the number of Units transferred in sale transactions (i.e.,
excluding transactions believed to be between related parties, family members or
the same beneficial owner) was as follows:
110
<PAGE>
SECONDARY MARKET PARTNERSHIP NET UNIT PRICES
FROM JANUARY 1, 1996 THROUGH DECEMBER 31, 1996
CAPITAL SOURCE L.P.
<TABLE>
<CAPTION>
ADJUSTED CAPITAL
UNIT SALES PRICE PER ORIGINAL PRICE VERSUS ADJUSTED CAPITAL
PER $1,000 ORIGINAL INVESTMENT $1,000 NUMBER
------------------------------- INVESTMENT --------------------------------- OF
MONTH WEIGHTED HIGH LOW AS OF 12/31/95 WEIGHTED HIGH LOW UNITS
- --------------------------- --------- --------- --------- ---------------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
January.................... $ 575.00 $ 575.00 $ 575.00 $ 917.50 (37.3)% (37.3)% (37.3)% 434
February................... 529.00 540.00 450.00 917.50 (42.3) (41.1) (51.0) 10,980
March...................... N/A N/A N/A 917.50 N/A N/A N/A N/A
April...................... N/A N/A N/A 917.50 N/A N/A N/A N/A
May........................ 522.50 550.50 501.50 917.50 (43.1) (40.0) (45.3) 2,400
June....................... N/A N/A N/A 917.50 N/A N/A N/A N/A
July....................... 523.00 569.50 401.50 917.50 (43.0) (37.9) (56.2) 1,700
August..................... 549.00 587.50 300.00 917.50 (40.2) (36.0) (67.3) 10,820
September.................. 300.50 502.50 300.00 917.50 (67.2) (45.2) (67.3) 101,524
October.................... 494.50 576.00 300.00 917.50 (46.1) (37.2) (67.3) 29,936
November................... 492.50 550.00 300.00 917.50 (46.3) (40.1) (67.3) 2,229
December................... 558.00 562.50 545.00 917.50 (39.2) (38.7) (40.1) 1,188
</TABLE>
SECONDARY MARKET PARTNERSHIP NET UNIT PRICES
FROM JANUARY 1, 1997 THROUGH DECEMBER 31, 1997
CAPITAL SOURCE L.P.
<TABLE>
<CAPTION>
ADJUSTED CAPITAL
UNIT SALES PRICE PER ORIGINAL PRICE VERSUS ADJUSTED CAPITAL
PER $1,000 ORIGINAL INVESTMENT $1,000 NUMBER
------------------------------- INVESTMENT --------------------------------- OF
MONTH WEIGHTED HIGH LOW AS OF 12/31/96 WEIGHTED HIGH LOW UNITS
- --------------------------- --------- --------- --------- ---------------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
January.................... $ 565.00 $ 568.00 $ 563.50 $ 917.50 (38.4)% (38.1)% (38.6)% 1,183
February................... 568.50 583.00 463.00 917.50 (38.0) (36.5) (49.5) 1,602
March...................... 542.00 545.00 529.50 917.50 (40.9) (40.6) (42.3) 2,130
April...................... 541.50 550.00 537.50 917.50 (41.0) (40.1) (41.4) 300
May........................ 476.50 537.50 450.00 917.50 (48.1) (41.4) (51.0) 1,860
June....................... N/A N/A N/A 917.50 N/A N/A N/A N/A
July....................... 410.00 537.50 387.50 917.50 (55.3) (41.4) (57.8) 5,865
August..................... 454.00 537.50 374.50 917.50 (50.5) (41.4) (59.2) 914
September.................. 568.50 606.00 482.50 917.50 (38.0) (34.0) (47.4) 2,740
October.................... 588.50 625.00 512.50 917.50 (35.9) (31.9) (44.1) 6,355
November................... 405.00 405.00 405.00 917.50 (55.9) (55.9) (55.9) 1,875
December................... N/A N/A N/A 917.50 N/A N/A N/A N/A
</TABLE>
111
<PAGE>
SECONDARY MARKET PARTNERSHIP NET UNIT PRICES
FROM JANUARY 1, 1996 THROUGH DECEMBER 31, 1996
CAPITAL SOURCE II L.P.-A
<TABLE>
<CAPTION>
ADJUSTED CAPITAL
UNIT SALES PRICE PER ORIGINAL PRICE VERSUS ADJUSTED CAPITAL
PER $1,000 ORIGINAL INVESTMENT $1,000 NUMBER
------------------------------- INVESTMENT --------------------------------- OF
MONTH WEIGHTED HIGH LOW AS OF 12/31/95 WEIGHTED HIGH LOW UNITS
- -------------------------- --------- --------- --------- ---------------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
January................... $ 350.00 $ 350.00 $ 350.00 $ 619.50 (43.5)% (43.5)% (43.5)% 2,406
February.................. 303.50 315.00 225.50 619.50 (51.0) (49.2) (63.6) 763
March..................... 327.00 350.00 323.00 619.50 (47.2) (43.5) (47.9) 4,250
April..................... 323.00 342.50 275.00 619.50 (47.9) (44.7) (55.6) 7,805
May....................... N/A N/A N/A 619.50 N/A N/A N/A N/A
June...................... 317.50 319.50 310.00 619.50 (48.7) (48.4) (50.0) 2,605
July...................... N/A N/A N/A 619.50 N/A N/A N/A N/A
August.................... 338.50 362.50 200.00 619.50 (45.4) (41.4) (67.7) 2,350
September................. 204.50 348.00 200.00 619.50 (67.0) (43.8) (67.7) 145,086
October................... 252.50 340.00 200.00 619.50 (59.2) (45.1) (67.7) 5,513
November.................. 207.50 361.00 200.00 619.50 (66.5) (41.7) (67.7) 115,275
December.................. 330.00 330.00 330.00 619.50 (46.7) (46.7) (46.7) 2,983
</TABLE>
SECONDARY MARKET PARTNERSHIP NET UNIT PRICES
FROM JANUARY 1, 1997 THROUGH DECEMBER 31, 1997
CAPITAL SOURCE II L.P.-A
<TABLE>
<CAPTION>
ADJUSTED CAPITAL
UNIT SALES PRICE PER ORIGINAL PRICE VERSUS ADJUSTED CAPITAL
PER $1,000 ORIGINAL INVESTMENT $1,000 NUMBER
------------------------------- INVESTMENT --------------------------------- OF
MONTH WEIGHTED HIGH LOW AS OF 12/31/96 WEIGHTED HIGH LOW UNITS
- --------------------------- --------- --------- --------- ---------------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
January.................... $ 333.50 $ 342.50 $ 300.00 $ 619.50 (46.2)% (44.7)% (51.6)% 3,250
February................... 343.00 349.50 337.50 619.50 (44.6) (43.6) (45.5) 3,589
March...................... 329.50 345.00 200.00 619.50 (46.8) (44.3) (67.7) 1,254
April...................... 378.50 387.50 355.00 619.50 (38.9) (37.4) (42.7) 9,160
May........................ 383.50 387.50 307.50 619.50 (38.1) (37.4) (50.4) 16,613
June....................... 359.00 370.00 314.00 619.50 (42.1) (40.3) (49.3) 2,375
July....................... 285.00 364.00 275.00 619.50 (54.0) (41.2) (55.6) 10,339
August..................... 338.50 350.00 334.00 619.50 (45.4) (43.5) (46.1) 850
September.................. 372.00 407.00 362.50 619.50 (40.0) (34.3) (41.5) 4,636
October.................... 363.50 368.00 225.50 619.50 (41.3) (40.6) (63.6) 3,350
November................... 387.50 387.50 387.50 619.50 (37.4) (37.4) (37.4) 1,000
December................... 305.00 305.00 305.00 619.50 (50.8) (50.8) (50.8) 250
</TABLE>
112
<PAGE>
UNITHOLDERS
NUMBER OF UNITHOLDERS. As of the Record Date, Cap Source I had outstanding
3,374,222 Units which were held of record by approximately Investors.
Cap Source II had outstanding 4,011,101 Units which were held of record by
approximately Investors.
BENEFICIAL OWNERS OF MORE THAN 5% OF THE UNITS. There are no Persons known
by the General Partners to be the beneficial owners of more than 5% of the
outstanding Units in either of the Partnerships.
PARTNERSHIP DISTRIBUTIONS
Cap Source I made the following cash distributions per Unit for the two most
recent fiscal years and the interim period ended March 31, 1998:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
MARCH 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------- ------------------ ------------------
<S> <C> <C> <C>
Regular quarterly distributions
Income....................... $ .1664 $ .7049 $ .7767
Return of capital............ .0861 .3051 .2333
------- ------- -------
$ .2525 $ 1.0100 $ 1.0100
------- ------- -------
------- ------- -------
Distributions
Paid out of cash flow........ $ .2525 $ 1.0100 $ 1.0100
------- ------- -------
------- ------- -------
</TABLE>
Cumulative cash distributions as of May 15, 1998 totaled $16.27 and $16.06
per original $20.00 Unit, depending on the initial closing date of the
Investor's investment. These amounts include a $1.65 per Unit special return of
capital distribution paid to Investors in 1993. Accordingly, current cash
distributions are based on an adjusted Unit value of $18.35.
Regular quarterly distributions to Investors consist primarily of interest
on the FHA Loans and GNMA Certificates. Additional cash for distributions is
received from other temporary investments. Cap Source I may draw on reserves to
pay operating expenses or to supplement cash distributions to Investors. Cap
Source I is permitted to replenish reserves with cash flows in excess of
distributions paid. For the quarter ended March 31, 1998, a net amount of
$191,623 was distributed from reserves. The total amount held in reserves at
March 31, 1998, was $10,723,750, of which $1,047,854 was invested in GNMA
Certificates.
Cap Source II made the following cash distributions per Unit for the two
most recent fiscal years and the interim period ended March 31, 1998:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
MARCH 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------- ------------------- -------------------
<S> <C> <C> <C>
Regular monthly distributions
Income....................... $ .0274 $ .3449 $ .2947
Return of capital............ .1751 .4651 .4153
------ ------ ------
$ .2025 $ .8100 $ .8100
------ ------ ------
------ ------ ------
Distributions
Paid out of cash flow........ $ .0799 $ .5172 $ .6019
Paid out of reserves......... .1228 .2928 .2081
------ ------ ------
$ .2025 $ .8100 $ .8100
------ ------ ------
------ ------ ------
</TABLE>
113
<PAGE>
Cumulative cash distributions as of May 15, 1998 totaled $18.71 and $17.74
per original $20.00 Unit, depending on the initial closing date of the
Investor's investment. These amounts include a $7.61 per Unit special return of
capital distribution paid to Investors in 1993. Accordingly, current cash
distributions are based on an adjusted Unit value of $12.39.
Regular monthly distributions to Investors consist primarily of interest on
the FHA Loan, GNMA Certificates and the Cap Source II Reserve Investments.
Additional cash for distributions is received from other temporary investments.
Cap Source II is permitted to replenish reserves with cash flows in excess of
distributions paid. For the quarter ended March 31, 1998, a net amount of
$602,429 was distributed from reserves. The total amount held in reserves at
March 31, 1998, was $1,000,519 of which $998,930 was invested in GNMA
Certificates.
Cap Source II has been supplementing cash flow from operations with
withdrawals from reserves in order to maintain distributions at the current
levels. Cash distributions for the first quarter of 1998 were funded primarily
from reserves, with the remaining amounts being funded from cash flow generated
by Cap Source II's investment in insured or guaranteed mortgages on four
multifamily apartment complexes. Consequently, it is likely that the level of
distributions will be reduced in the future.
Following consummation of the Transaction, Investors may receive a final
distribution from their Partnership for the period commencing on the first day
following the end of the last fiscal quarter for which distributions are made
and ending on the Effective Date.
THIRD PARTY TENDER OFFERS
The General Partners of Cap Source I are aware of eight unsolicited offers
that were made between July 3, 1996 and July 15, 1998, to purchase Units of Cap
Source I by third parties not affiliated with the General Partners. Prices on
these offers ranged from $6.00 to $11.00 per Unit. The General Partners of Cap
Source II are aware of six unsolicited offers that were made between July 3,
1996, and July 15, 1998, to purchase Units of Cap Source II by third parties not
affiliated with the General Partners. Prices on these offers ranged from $4.00
to $6.25 per Unit.
114
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SELECTED FINANCIAL DATA OF THE PARTNERSHIPS
The following selected financial data of the Partnerships has been derived
from, and should be read in conjunction with, the financial statements and
related notes for, and as of, the end of the period indicated, which are
contained in the separately bound supplement delivered with this
Prospectus/Consent Solicitation Statement. The financial statements as of
December 31, 1997 and 1996 and for each of the three years in the period ended
December 31, 1997 have been audited by Coopers & Lybrand L.L.P., independent
public accountants, whose reports thereon are included in the separately bound
supplement. The financial statements as of and for the three months ended March
31, 1997 and 1998 are unaudited.
Reference is made to the Pro Forma Financial Information which reflects the
historical financial statements of the Company and the Partnerships after giving
effect to the Transaction under the assumptions and adjustments set forth in the
accompanying notes to the pro forma financial statements.
115
<PAGE>
SELECTED FINANCIAL DATA
CAPITAL SOURCE L.P.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1993 1994 1995 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Rental income............................................. $ 7,530,940 $ 7,748,867 $ 7,210,114 $ 7,203,323
Interest on temporary cash investments and U.S. government
securities.............................................. 184,042 159,005 225,135 550,599
Mortgage-backed securities income......................... -- 77,012 132,211 112,182
Interest on GNMA securities............................... -- 446,103 519,970 --
Other income.............................................. 202,831 306,903 219,376 270,132
Unusual item--gain on disposition of Falcon Point assets
and related liabilities................................. -- 2,746,326 -- --
Expenses (including depreciation)......................... (5,437,478) (6,167,516) (5,477,264) (5,573,880)
Minority interest in (income) losses of operating
partnerships............................................ 6,889 (19,772) 2,571 2,746
------------- ------------- ------------- -------------
Income before extraordinary item...................... 2,487,224 5,296,928 2,832,113 2,565,102
Extraordinary item--gain from forgiveness of accrued
interest................................................ -- -- -- 82,216
------------- ------------- ------------- -------------
Net income................................................ $ 2,487,224 $ 5,296,928 $ 2,832,113 $ 2,647,318
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Net income per Unit
Income before extraordinary item........................ $ .73 $ 1.55 $ .83 $ .76
Extraordinary item...................................... -- -- -- .02
------------- ------------- ------------- -------------
Net income per Unit....................................... $ .73 $ 1.55 $ .83 $ .78
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Cash distributions per Unit............................... $ 2.6825 $ 1.0100 $ 1.0100 $ 1.0100
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Total assets.............................................. $ 48,098,722 $ 48,103,699 $ 47,193,984 $ 46,223,005
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Mortgage loan payable..................................... $ 6,395,004 $ 6,395,004 $ 6,392,007 $ 6,354,657
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1997 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Rental income............................................. $ 7,555,700 $ 1,827,184 $ 1,894,782
Interest on temporary cash investments and U.S. government
securities.............................................. 583,881 143,363 141,288
Mortgage-backed securities income......................... 90,320 24,245 19,895
Interest on GNMA securities............................... -- -- --
Other income.............................................. 252,057 90,024 77,879
Unusual item--gain on disposition of Falcon Point assets
and related liabilities................................. -- -- --
Expenses (including depreciation)......................... (6,074,328) (1,331,384) (1,566,685)
Minority interest in (income) losses of operating
partnerships............................................ (5,090) 4,849 142
------------- ------------- -------------
Income before extraordinary item...................... 2,402,540 758,281 567,301
Extraordinary item--gain from forgiveness of accrued
interest................................................ -- -- --
------------- ------------- -------------
Net income................................................ $ 2,402,540 $ 758,281 $ 567,301
------------- ------------- -------------
------------- ------------- -------------
Net income per Unit
Income before extraordinary item........................ $ .70 $ .22 $ .17
Extraordinary item...................................... -- -- --
------------- ------------- -------------
Net income per Unit....................................... $ .70 $ .22 $ .17
------------- ------------- -------------
------------- ------------- -------------
Cash distributions per Unit............................... $ 1.0100 $ .2525 $ .2525
------------- ------------- -------------
------------- ------------- -------------
Total assets.............................................. $ 45,132,930 $ 45,996,388 $ 44,809,227
------------- ------------- -------------
------------- ------------- -------------
Mortgage loan payable..................................... $ 6,320,076 $ 6,354,657 $ 6,320,076
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
116
<PAGE>
SELECTED FINANCIAL DATA
CAPITAL SOURCE II L.P.-A
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1993 1994 1995 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Rental income............................................. $ 4,442,657 $ 4,529,975 $ 4,656,371 $ 4,854,898
Mortgage-backed securities income......................... 259,294 78,153 123,033 91,982
Interest on temporary cash investments and U.S. government
securities.............................................. 372,655 195,309 218,077 168,311
Other income.............................................. 254,238 161,039 144,967 161,805
Gain on sale of mortgage-backed securities................ -- -- 15,670 --
Expenses (including depreciation)......................... (3,674,507) (3,526,029) (3,432,024) (3,678,376)
Minority interest in losses of operating partnerships..... 6,243 3,582 2,220 608
------------- ------------- ------------- -------------
Net income................................................ $ 1,660,580 $ 1,442,029 $ 1,728,314 $ 1,599,228
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Net income per Unit....................................... $ .41 $ .36 $ .43 $ .39
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Cash distributions per Unit............................... $ 4.0702 $ .8100 $ .8100 $ .8100
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Total assets.............................................. $ 33,356,335 $ 31,262,819 $ 29,795,170 $ 28,106,422
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Mortgage loan payable..................................... $ -- $ -- $ -- $ --
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1997 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Rental income............................................. $ 5,105,108 $ 1,257,440 $ 1,259,898
Mortgage-backed securities income......................... 82,182 21,484 18,881
Interest on temporary cash investments and U.S. government
securities.............................................. 104,411 29,971 16,700
Other income.............................................. 202,670 44,521 40,254
Gain on sale of mortgage-backed securities................ -- -- --
Expenses (including depreciation)......................... (4,097,678) (858,776) (1,225,000)
Minority interest in losses of operating partnerships..... 857 147 90
------------- ------------- -------------
Net income................................................ $ 1,397,550 $ 494,787 $ 110,823
------------- ------------- -------------
------------- ------------- -------------
Net income per Unit....................................... $ .34 $ .12 $ .03
------------- ------------- -------------
------------- ------------- -------------
Cash distributions per Unit............................... $ 0.8100 $ .2025 $ .2025
------------- ------------- -------------
------------- ------------- -------------
Total assets.............................................. $ 26,439,286 $ 27,746,496 $ 25,711,192
------------- ------------- -------------
------------- ------------- -------------
Mortgage loan payable..................................... $ -- $ -- $ --
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
117
<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
Pursuant to the Second Amended and Restated Certificate of Incorporation
(the "Certificate of Incorporation") of the Company, the total number of shares
of capital stock that the Company has authority to issue is 100,000,000,
consisting of 50,000,000 shares of common stock, par value $.001 per share and
50,000,000 shares of preferred stock, par value $.001 per share. There are
presently 1,000 shares of Common Stock issued and outstanding, all of which are
held by America First Companies L.L.C., who purchased the shares at a price of
$1.00 per share when the Company was organized. Upon consummation of the
Transaction, all such outstanding shares held by America First Companies L.L.C.
will be repurchased by the Company at a price of $1.00 per share. The number of
shares of Common Stock to be issued in connection with the Transaction depends
on the number of Notes issued. Assuming all Investors receive Shares in
connection with the Transaction, 3,354,887 shares of Common Stock will be issued
and outstanding after the Transaction. Under Delaware law, shareholders
generally are not liable for the Company's debts or obligations.
COMMON STOCK
The holders of shares of Common Stock are entitled to one vote per share on
all matters voted on by Shareholders, including election of directors, and,
except as provided in the Certificate of Incorporation in respect of any other
class or series of stock, the holders of such shares exclusively possess all
voting power. The Certificate of Incorporation does not provide for cumulative
voting in the election of directors. Subject to any preferential rights of any
outstanding shares or series of stock, holders of shares of Common Stock are
entitled to receive dividends when and as declared by the Board of Directors,
out of funds legally available therefor. Upon any liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to receive
pro rata all assets of the Company available for distribution to its
Shareholders after payment of, or adequate provisions for, all known debts and
liabilities of the Company. All shares of Common Stock now outstanding are, and
the Shares of Common Stock offered hereby will be when issued, fully paid and
nonassessable. The holders thereof will not have preemptive rights to subscribe
to additional stock or securities issued by the Company at a subsequent date.
The Company may issue additional shares of common stock without further
stockholder approval, up to the maximum authorized number of shares, except as
may be otherwise required by applicable law or stock exchange regulations.
As further described in the Certificate of Incorporation, persons who
acquire beneficial ownership of shares of the Company's Common Stock entitling
such person, in the aggregate, to 15% or more of all voting power of the
Company, will not be able to exercise more than 15% of the Company's total
voting power until such time as such exercise is approved by a vote of at least
75% of the remaining shares of the Company entitled to vote on such matter.
The Certificate of Incorporation authorizes the Board of Directors to
classify or reclassify any unissued shares of stock, to provide for the issuance
of shares in other classes or series, including preferred stock in one or more
series, to establish the number of shares in each class or series and to fix the
preferences, conversion and other rights, voting powers, restrictions,
limitations as to distributions, qualifications or terms or conditions of
redemption of such class or series. The Company has no present intention to
issue shares of any class or series other than Common Stock.
There is currently no established trading market for the Common Stock, and
prior to the Transaction, the Common Stock will not be listed on any national
securities exchange or quoted on an automated quotation system. Therefore, no
sale or bid price information is available with respect to the Common Stock. The
Common Stock has been approved for listing on the NYSE under the symbol "AFE,"
subject to official notice of issuance. The Company will meet the round lot
distribution and market value standards established by the NYSE.
will act as transfer agent and registrar of the Common Stock.
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<PAGE>
PREFERRED STOCK
Pursuant to the Certificate of Incorporation, the Board of Directors may
from time to time issue in one or more series up to 50,000,000 shares of
preferred stock in one or more series (the "Preferred Stock"). The Board of
Directors is authorized, by filing a certificate pursuant to the Delaware GCL
(hereinafter, the "Preferred Stock Designation"), to establish from time to time
the number of shares to be included in each series, and to fix the designations,
voting powers, privileges, preferences, terms and rights, and the limitations,
restrictions and qualifications of the shares of each series. The authority of
the Board of Directors with respect to each series shall include, but not be
limited to, determination of the following:
(a) the designation of the series, which may be by distinguishing
number, letter or title;
(b) the number of shares of the series, which number the Board of
Directors may thereafter (except where otherwise provided in the preferred
stock designation) increase or decrease (but not below the number of shares
thereof then outstanding);
(c) whether dividends, if any, shall be cumulative or noncumulative,
and, in the case of shares of any series having cumulative dividend rights,
the date or dates or method of determining the date or dates from which
dividends on the shares of such series shall be cumulative;
(d) the rate of any dividends (or method of determining such dividends)
payable to the holders of the shares of such series, any conditions upon
which such dividends shall be paid and the date or dates or the method for
determining the date or dates upon which such dividends shall be payable;
(e) the price or prices (or method of determining such price or prices)
at which, the form of payment of such price or prices (which may be cash,
property or rights, including securities of the same or another corporation
or other entity) for which, the period or periods within which and the terms
and conditions upon which the shares of such series may be redeemed or
exchanged, in whole or in part, at the option of the Company or at the
option of the holder or holders thereof or upon the happening of a specified
event or events, if any;
(f) the obligation, if any, of the Company to purchase, exchange or
redeem shares of such series pursuant to a sinking fund or otherwise and the
price or prices at which, the form of payment of such price or prices (which
may be cash, property or rights, including securities of the same or another
corporation or other entity) for which, the period or periods within which
and the terms and conditions upon which the shares of such series shall be
redeemed, exchanged or purchased, in whole or in part, pursuant to such
obligation;
(g) the amount payable out of the assets of the Company to the holders
of shares of the series in the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Company;
(h) provisions, if any, for the conversion or exchange of the shares of
such series, at any time or times at the option of the holder or holders
thereof or at the option of the Company or upon the happening of a specified
event or events, into shares of any other class or classes or any other
series of the same or any other class or classes of stock or any other
security, of the Company, or any other corporation or other entity, and the
price or prices or rate or rates of conversion or exchange and any
adjustments applicable thereto, and all other terms and conditions upon
which such conversion or exchange may be made;
(i) restrictions on the issuance of shares of the same series or
restrictions on the issuance of shares of the same series or of any other
class or series, if any;
(j) the voting powers, if any, of the holders of shares of the series,
which may provide more than one vote per share; and
(k) any other relative rights, preferences and limitations on that
series allowed by Delaware law.
119
<PAGE>
Subject to the express provisions of any other series of Preferred Stock
then outstanding, the Board of Directors may increase or decrease (but not below
the number of shares of such series then outstanding) the number of shares, or
amend the voting powers, designations, preferences and relative, participating,
optional or other rights, if any, or the qualifications, limitations or
restrictions thereof of the shares of any such series of Preferred Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Shares received by Investors in the Transaction will be freely transferable
without restriction or further registration under the Securities, except for
Shares acquired by "affiliates" of the Company, as that term is defined in Rule
144 under the Securities Act, which sales would be subject to certain volume
limitations and other restrictions described below.
In general, under Rule 144 as currently in effect, a person, including a
person who may be deemed an "affiliate" of the Company, who has held restricted
shares for at least one year may sell such shares, subject to certain volume
limitations and other restrictions, without registering them under the
Securities Act. Rule 144 generally also permits sales of restricted shares,
without any volume limitations, by a person who has not been an "affiliate" of
the Company for at least three months preceding the sale of such shares and who
has held those restricted shares for at least two years.
THE NOTES
GENERAL
If the Investors holding a majority of outstanding Units of a Partnership
approve the Transaction and the other conditions to the Transaction are met, the
Transaction will be consummated and such action will bind all Investors in that
Partnership, including those who abstain from voting, fail to return a completed
Consent Card or vote "NO" against the Transaction. All Investors will be given
the opportunity to elect to receive either Shares or Notes. An Investor who
failed to return a completed Consent Card will receive Shares of the Company for
his Units. Each Investor will receive written instructions on the proper
procedures for completing and submitting the Consent Card. See "VOTING." Certain
provisions of the Notes and the Indenture under which they will be issued are
summarized under "--Notes."
Neither the Partnership Agreements nor the Delaware Partnership Law give an
Investor the right to demand any type of dissenter's rights or to elect to
receive the appraised value of his Units in connection with the Transaction. No
such rights will be given to Dissenting Investors by the Partnerships or the
Company in connection with the Transaction. See "VOTING--No Right of Appraisal."
ALLOCATION OF NOTES
The aggregate principal amount of Notes to be issued by the Company may not
exceed the Maximum Note Limitation, which is $40.0 million. If Dissenting
Investors elect to receive Notes in excess of the Maximum Note Limitation, the
Transaction will not be consummated. In the event Dissenting Investors do not
elect to receive Notes in excess of the Maximum Note Limitation, but the total
amount of Notes allocable to all Investors who elect to receive Notes exceeds
such limit, Notes will be allocated first to Dissenting Investors who elected to
receive Notes and any remaining Notes will be allocated on a pro rata basis (in
denominations of $1,000) to those Investors who elected to receive Notes and
either abstained from voting by indicating their abstention on the Consent Card
or voted "YES" in favor of the Transaction. In such event, the abstaining
Investors and Consenting Investors who elected to receive Notes will receive
Shares in an amount equal to the difference between the Exchange Value allocable
to such Investors and the amount of Notes distributed to such Investors.
120
<PAGE>
NOTES
The following summaries describing certain provisions of the Notes do not
purport to be complete and are subject to, and are qualified in their entirety
by reference to, all of the provisions of the Indenture, which is included as an
exhibit to the Registration Statement.
GENERAL. The Notes, if any, will be junior, unsecured obligations of the
Company callable on or after the date of issuance, issued under the Indenture,
to be dated as of the first day of the month in which the Notes are issued, by
and between the Company and U.S. Bank Trust National Association, as Trustee.
The Notes will be limited to $40.0 million aggregate principal amount and will
be designated as Variable Rate Junior Notes.
The Company may issue additional indebtedness, which may be secured, only in
compliance with the covenants of the Notes for the issuance of senior debt.
On , 2006 (the "Maturity Date") the outstanding principal balance
of the Notes, plus accrued but unpaid interest, will be payable in full. The
Notes will be payable as follows:
(a) annual installments of accrued interest, payable on the fifteenth
day of each January (an "Interest Payment Date"), commencing on the first
Interest Payment Date following the issuance of the Notes and continuing
until the entire interest on and principal of each Note is paid in full; and
(b) the unpaid principal balance and accrued but unpaid interest on the
Maturity Date.
Payments under the Notes will be paid to the persons in whose names such Notes
are registered, subject to certain exceptions, at the close of business on the
last day of the month preceding the applicable Interest Payment Date. The Notes
will be issued in registered form without coupons in denominations of $1,000.
FRACTIONAL NOTES. Since the aggregate principal balance of the Notes to
which an Investor is entitled is determined by multiplying the Investor's Units
by the Exchange Value, per $1,000 original investment, assigned to such
Investor's Partnerships, the Investor may be entitled to a fractional interest
in a Note. Rather than issue a fractional interest in a Note, the Company will
issue to each such Investor a promissory note ("Promissory Note") with an
original principal balance equal to the fraction times $1,000, subject to the
Company's right, at its option, to pay cash in lieu of any portion of a
Promissory Note. The Promissory Notes will be issued pursuant to the terms of
the Indenture, but will not be listed on a national securities exchange.
INTEREST. For each period from and including an Interest Payment Date to
and including the day immediately preceding the next Interest Payment Date, the
Notes will bear interest at a rate equal to 120% of the annual applicable
federal rate for debt instruments with a term of not over three years as
determined under the Code and applicable regulations thereunder. As of the date
of this Prospectus/ Consent Solicitation Statement, 120% of the annual
applicable federal rate for debt instruments with a term of not over three years
was %. Therefore, the interest rate on the Notes as of the date of this
Prospectus/Consent Solicitation Statement is %. The interest rate will
remain in effect until the first day of the calendar year following completion
of the Transaction. Interest on the Notes will be adjusted annually and computed
on the basis of a 360-day year for the actual number of days elapsed.
OPTIONAL REDEMPTION. The Company may, at its option, redeem all or any
portion of the Notes or Promissory Notes from time to time by giving written
notice of the proposed redemption to the holders of the Notes or the Promissory
Notes, as the case may be. In the event less than all of the Notes and
Promissory Notes are to be redeemed, the Trustee will select first the
Promissory Notes to be redeemed and then the Notes to be redeemed by lot until
all Notes and Promissory Notes are paid in full and redeemed. The redemption
price will be 100% of the outstanding principal balance of such Notes or the
Promissory Notes, as the case may be, together with accrued interest to the date
fixed for redemption. There will be no sinking fund established to retire the
Notes or the Promissory Notes.
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MANDATORY REDEMPTION. The Indenture requires that the Company use 80% of
the Net Proceeds from Sales or Refinancings of Designated Assets (as defined
herein) to prepay the Notes. Net Proceeds from Sales or Refinancings of
Designated Assets generally means the gross proceeds of all sales, exchanges or
refinancings received with respect to assets acquired by the Company from the
Partnerships in the Transaction, less all costs and expenses incurred by the
Company in connection with such sales, exchanges or refinancings. Upon receipt
by the Company, at least 80% of the Net Proceeds from Sales or Refinancings of
Designated Assets will be deposited into a segregated trust account established
under the Indenture, and when the funds in such account equal or exceed $5
million, the proceeds will be used to redeem the Notes as provided in the
Indenture. In the event less than all of the Notes are to be redeemed pursuant
to this provision, the Trustee will select the Promissory Notes and the Notes to
be redeemed in the same manner as for an optional redemption until all Notes and
Promissory Notes are paid in full and redeemed.
LIMITATION ON INDEBTEDNESS. The Indenture prohibits the Company from
incurring any indebtedness if the new indebtedness would cause the Company's
aggregate principal amount of indebtedness then outstanding to exceed 70% of the
greater of (a) the value which is placed by an independent appraiser on all the
assets of the Company as of the date of the Transaction, and (b) the value
placed by an independent appraiser on all assets of the Company as of the date
of determination.
TRANSACTION, CONVEYANCE OR TRANSFER. The Company will not merge or
consolidate with or into, or sell, assign, transfer, lease or otherwise dispose
of all or substantially all of its properties and assets as an entirety to, any
other entity or entities, and the Company will not permit any of its wholly
owned subsidiaries to enter into any such transaction if, in the aggregate, such
transaction would result in a sale, assignment, transfer, lease or other
disposition of all or substantially all of the properties and assets of the
Company and its subsidiaries on a consolidated basis to any other entity or
entities, unless at the time and after giving effect thereto (a) either (i) if
the transaction is a merger or transaction, the Company shall be the surviving
entity, or (ii) the entity formed by such transaction or into which the Company
or such subsidiary is merged or to which the properties and assets of the
Company or such subsidiary, as the case may be, substantially as an entirety,
are transferred shall be a corporation organized and existing under the laws of
the United States of America, any state thereof or the District of Columbia and
shall expressly assume by a supplemental indenture executed and delivered to the
Trustee, in form satisfactory to the Trustee, all the obligations of the Company
under the Notes and the Indenture, and in each case, the Indenture shall remain
in full force and effect; (b) immediately before and immediately after giving
effect to such transaction on a pro forma basis (including, without limitation,
any indebtedness incurred or anticipated to be incurred in connection with or in
respect of such transaction), no event of default shall have occurred and be
continuing and the Company, or the surviving entity, as the case may be, after
giving effect to such transaction on a pro forma basis, could incur $1.00 of
additional indebtedness under "--LIMITATION ON INDEBTEDNESS" above; and (iii)
immediately after giving effect to such transaction on a pro forma basis, the
consolidated net worth of the Company, or the surviving entity, as the case may
be, is at least equal to the consolidated net worth of the Company immediately
before such transaction.
EVENTS OF DEFAULT. A default will occur under the Indenture with respect to
the Notes if (a) the Company defaults in the payment of the principal of any
Note when the same becomes due and payable at maturity, upon redemption or
otherwise, (b) the Company defaults in the payment of interest on any Note when
the same becomes due and payable and such default continues for a period of 30
days, (c) the Company fails to comply with any of its other agreements contained
in the Indenture or the Notes for a period of 30 days after written notice
thereof, as provided in the Indenture, (d) the Company shall default under any
agreement relating to any other indebtedness of the Company where the
indebtedness exceeds $5 million, or (e) certain events of bankruptcy, insolvency
or reorganization shall have occurred.
If an event of default specified in (a) through (d) above occurs and is
continuing, either the Trustee or the holders of not less than 25% in principal
amount of the Notes then outstanding may declare all unpaid
122
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principal of and interest accrued on the Notes to be immediately due and
payable. In the event of a default specified in (e) above, all unpaid principal
and accrued interest on the Notes shall be immediately due and payable without
any declaration or other act on the part of the Trustee or any Noteholders. Upon
certain conditions such declarations may be annulled by the holders of a
majority in principal amount of the Notes and past defaults may be waived
(except a continuing default in payment of principal of or interest on the
Notes) by the holders of a majority in principal amount of the Notes.
The holders of a majority in principal amount of the outstanding Notes may
direct the time, method and place of conducting any proceeding for any remedy
available to the Trustee or exercising any trust or power conferred on the
Trustee, provided that such direction shall not be in conflict with any rule of
law or the Indenture. Before proceeding to exercise any right or power under the
Indenture at the direction of such holders, the Trustee shall be entitled to
receive from such holders reasonable security or indemnity against the costs,
expenses and liabilities which might be incurred by it in compliance with any
such direction.
The Company will be required to furnish to the Trustee annually a statement
of certain officers of the Company as to their knowledge of the Company's
compliance with all conditions and covenants under the Indenture. The Indenture
requires the Trustee to give to all Noteholders notice of any default by the
Company, unless such default shall have been cured or waived; however, except in
the case of a default in the payment of principal of or interest on any
outstanding Notes, the Trustee is entitled to withhold such notice in the event
that a trust committee of directors or certain officers of the Trustee in good
faith determine that withholding such notice is in the interest of the holders
of the outstanding Notes.
DEFEASANCE AND DISCHARGE. The Indenture provides that the Company will be
discharged from obligations in respect of the Notes under the Indenture
(excluding certain obligations, such as the obligation to pay principal of and
interest on the Notes then outstanding, obligations of the Company in the event
of acceleration following default in the payment of any installment of interest
on and, if applicable, principal of the Notes and obligations to register the
transfer or exchange of the outstanding Notes and to replace stolen, lost or
mutilated certificates), upon the irrevocable deposit, in trust, of cash or
certain U.S. government obligations which through the payment of interest and
principal thereof in accordance with their terms will provide cash in an amount
sufficient to pay any installment of principal of and interest on the
outstanding Notes on the stated maturity of such installments in accordance with
the terms of the Indenture and the outstanding Notes, provided that the Company
has received an opinion of counsel or a favorable ruling of the IRS to the
effect that such a discharge will not be deemed, or result in, a taxable event
with respect to holders of the outstanding Notes and that certain other
conditions are met.
CHANGE IN CONTROL. The Indenture does not contain provisions requiring
redemption of the Notes or Promissory Notes by the Company, or adjustment to any
terms of the Notes or Promissory Notes, upon any change in control of the
Company.
LIMITED PROTECTION AGAINST DECLINE IN CREDIT QUALITY. The Indenture does
not contain any provisions protecting Noteholders against a sudden and dramatic
decline in credit quality of the Notes or Promissory Notes resulting from
takeovers, restructuring, reorganizations or similar transactions involving the
Company.
MODIFICATION OF THE INDENTURE. The Company and the Trustee may amend or
supplement the Indenture or the Notes without the consent of the Noteholders to:
(a) provide for uncertificated Notes in addition to or in place of certificated
Notes, (b) add covenants and events of default for the protection of the
Noteholders, (c) cure any ambiguity, defect or inconsistency in the Indenture or
to make any other change that does not adversely affect the rights of any
Noteholder, and (d) evidence the acceptance of appointment by a successor
trustee.
The Indenture also contains provisions permitting the Company and the
Trustee, with the consent of the holders of not less than a majority in
principal amount of the Notes then outstanding, to add any
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provisions to, or change in any manner or eliminate any of the provisions of,
the Indenture, or modify in any manner the rights of the holders of the Notes,
provided that the Company and the Trustee may not, without the consent of the
holder of each outstanding Note affected thereby, (a) reduce the amount of Notes
whose holders must consent to an amendment, supplement or waiver; (b) reduce the
rate of or change the time for payment of interest on any Note; (c) reduce the
principal of or change the fixed maturity of any Note or alter the redemption
provisions with respect thereto; (d) waive a default in the payment of the
principal of or interest on any Note; or (e) make any Note payable in money
other than that stated in the Note.
GOVERNING LAW. The Notes, the Promissory Notes and the Indenture will be
governed by and construed in accordance with the laws of the State of Delaware.
THE TRUSTEE. U.S. Bank Trust National Association (the "Trustee"), will be
the Trustee under the Indenture. The Trustee does not serve as a trustee under
any other indenture relating to obligations of the Company and has no prior
business relationship with the Company, the General Partners or any of their
Affiliates.
PURCHASE OF NOTES IN SECONDARY MARKET. In addition to making partial
redemption of the Notes, the Company may purchase Notes in the secondary market,
and such purchases may be at discounts from the outstanding principal balance of
the Notes. Such purchases have the effect of retiring the obligations, but do
not obligate the Company to follow the procedures for partial redemption of the
Notes described in the Indenture.
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CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF
INCORPORATION AND BYLAWS
Certain provisions of the Company's Organizational Documents generally have
an anti-takeover effect with respect to the Company, and may deter an offer with
a substantial premium to the then-current trading price of the Company's Common
Stock or hinder a potential transaction that may be attractive to Shareholders.
PURPOSES AND ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS. The Certificate
of Incorporation contains several provisions that will make difficult an
acquisition of control of the Company, by means of a tender offer, open market
purchase, a proxy fight or otherwise, that is not approved by the Company's
Board of Directors. The Bylaws also contain provisions that could have an
anti-takeover effect.
The purposes of the relevant provisions of the Certificate of Incorporation
and Bylaws are to discourage certain types of transactions, described below,
which may involve an actual or threatened change of control of the Company and
to encourage persons seeking to acquire control of the Company to consult first
with the Board of Directors to negotiate the terms of any proposed business
combination or offer. The provisions are designed to reduce the vulnerability of
the Company to an unsolicited proposal for a takeover that does not contemplate
the acquisition of all outstanding shares or is otherwise unfair to stockholders
of the Company or an unsolicited proposal for the restructuring or sale of all
or part of the Company. The Company believes that, as a general rule, such
proposals would not be in the best interests of the Company and its
stockholders.
The Company believes that the imminent threat of removal of the Company's
management or Board of Directors in such situations would severely curtail the
ability of management or the Board of Directors to negotiate effectively with
such purchasers. The management or the Company's Board of Directors would be
deprived of the time and information necessary to evaluate the takeover
proposal, to study alternative proposals and to help ensure that the best price
is obtained in any transaction involving the Company which may ultimately be
undertaken. If the real purpose of a takeover bid were to force the Company to
repurchase an accumulated stock interest at a premium price, management or the
Board of Directors would face the risk that, if it did not repurchase the
purchaser's stock interest, The Company's business and the Company's management
would be disrupted, perhaps irreparably.
Certain provisions of the Certificate of Incorporation and Bylaws, in the
view of the Company, will help ensure that the Company's Board of Directors, if
confronted by a surprise proposal from a third-party which has acquired a block
of stock, will have sufficient time to review the proposal and appropriate
alternatives to the proposal and to act in what it believes to be the best
interests of the stockholders. In addition, certain other provisions of the
Certificate of Incorporation are designed to prevent a purchaser from utilizing
two-tier pricing and similar inequitable tactics in the event of an attempt to
take over the Company.
These provisions, individually and collectively, will make difficult and may
discourage a merger, tender offer or proxy fight, even if such transaction or
occurrence may be favorable to the interests of the stockholders, and may delay
or frustrate the assumption of control by a holder of a large block of the
Company's Common Stock and the removal of incumbent management, even if such
removal might be beneficial to the stockholders. Furthermore, these provisions
may deter or could be utilized to frustrate a future takeover attempt which is
not approved by the incumbent Board of Directors, but which the holders of a
majority of the Company's Common Stock may deem to be in their best interests or
through which stockholders may receive a substantial premium for their stock
over prevailing market prices of such stock. By discouraging takeover attempts,
these provisions may have the incidental effect of inhibiting certain changes in
management (some or all of the members of which might be replaced in the course
of a change of control) and also the temporary fluctuations in the market price
of the stock, should a market develop, which often result from actual or rumored
takeover attempts.
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Set forth below is a description of all such material provisions in the
Certificate of Incorporation and the Bylaws. Such description is intended as a
summary only and is qualified in its entirety by reference to the Certificate of
Incorporation and the Bylaws.
REMOVAL; FILLING VACANCIES. The Certificate of Incorporation generally
provides that only a majority of the Board of Directors then in office shall
have the authority to fill any vacancies on the Board of Directors, including
vacancies created by an increase in the number of directors. Further, a director
may be removed only for cause and then only pursuant to the affirmative vote of
75% of the outstanding shares of stock entitled to vote in the election of
directors. In addition, the Bylaws provide that a new director elected to fill a
vacancy on the Board of Directors will serve for the remainder of the full term
of his or her predecessor and that no decrease in the number of directors shall
shorten the term of an incumbent. These provisions relating to removal and
filling of vacancies on the Board of Directors will preclude stockholders from
enlarging the Board of Directors or removing incumbent directors and filling the
vacancies with their own nominees.
TERMS OF DIRECTORS. Generally, the Certificate of Incorporation provides
that directors shall be classified, with respect to the time for which they hold
office, into three classes as nearly equal in number as possible. One class will
be originally elected for a term expiring at the annual meeting of stockholders
to be held in 1999, another class will be originally elected for a term expiring
at the annual meeting of stockholders to be held in 2000 and the third class
will be originally elected for a term expiring at the annual meeting of
stockholders to be held in 2001. Directors in all classes will hold office until
such person's successor is duly elected and qualified.
LIMITATIONS ON STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The
Certificate of Incorporation and Bylaws provide that stockholder action can be
taken at an annual or special meeting of stockholders. No action of stockholders
may be taken by any consent in writing by the stockholders in lieu of such
meeting. The Certificate of Incorporation and Bylaws also provide that special
meetings of stockholders can be called only by the Chairman of the Board, the
President or the Board of Directors. Any power of stockholders to call a special
meeting is specifically denied by the Certificate of Incorporation.
INTERESTED STOCKHOLDER TRANSACTIONS. The Certificate of Incorporation
specifically provides that the Company will be governed by Section 203 of the
Delaware GCL ("Section 203"). Section 203 generally provides that the Company
may not engage in any business combination with any interested stockholder for a
period of three years following the date such stockholder became an interested
stockholder, unless (i) prior to such date the Board of Directors of the Company
approved either the business combination or the transaction which resulted in
the stockholder becoming an interested stockholder, (ii) upon consummation of
the transaction which resulted in the stockholder becoming an interested
stockholder, the interested stockholder owned at least 85% of the voting stock
of the corporation outstanding at the time the transaction commenced (excluding
for determining the number of shares outstanding (a) shares owned by persons who
are directors and officers and (b) employee stock plans, in certain instances),
or (iii) on or subsequent to such date the business combination is approved by
the Board of Directors and authorized at an annual or special meeting of the
stockholders by at least 66 2/3% of the affirmative voting stock that is not
owned by the interested stockholder. An interested stockholder is defined in
Section 203 as any person who (i) owns, directly or indirectly, 15% or more of
the outstanding voting stock of the Company or (ii) is an affiliate or associate
of the Company and was the owner of 15% or more of the outstanding voting stock
at any time within the three-year period immediately prior to the date on which
it is sought to be determined whether such person is an interested stockholder;
and the affiliates and the associates of such person.
SUPERMAJORITY VOTES. Certain provisions of the Certificate of Incorporation
and the Bylaws may not be amended, or repealed, nor may inconsistent provisions
be adopted, without the affirmative vote of stockholders holding at least 75% of
the stock of the Company entitled to vote.
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CONTROL SHARES. Pursuant to the Certificate of Incorporation, a person
acquiring beneficial ownership of more than 15% of the Company's Common Stock
will not be able to vote more than 15% of the total voting power of the Company
unless approved by the stockholders of the Company. See "DESCRIPTION OF CAPITAL
STOCK."
PREFERRED STOCK. Pursuant to the Certificate of Incorporation, the Board of
Directors is authorized to issue up to 50,000,000 shares of preferred stock in
one or more series. The Board of Directors is also authorized to determine (i)
the number of shares, (ii) the voting power, (iii) the privileges and
preferences, (iv) the terms and rights and (v) the limitations, restrictions and
qualifications with respect to any such series. The preferred stock may be
issued with disproportionate voting power in the discretion of the Board of
Directors. See "DESCRIPTION OF CAPITAL STOCK--Preferred Stock."
ADDITIONAL ANTI-TAKEOVER PROVISIONS. The Board of Directors may, in the
future, consider and adopt future anti-takeover provisions for the Company.
These provisions may include, but are not limited to, rights agreements for
stockholders of the Company which provide for the issuance of securities to
stockholders upon the occurrence of certain events, commonly known as "poison
pills." The purpose of these provisions would be to protect, for the benefit of
the stockholders, unrecognized or unrealized value in investments of the
Company.
FEDERAL INCOME TAX CONSEQUENCES
GENERAL
The following discussion describes the material federal income tax
considerations to the Partnerships, the Investors, the Shareholders and the
Company that may result from the Transaction. This discussion is based upon the
provisions of the Internal Revenue Code of 1986, as amended (the "Code"),
applicable Treasury Department regulations promulgated thereunder (the
"Regulations"), rulings of the Internal Revenue Service (the "Service") and
applicable court decisions.
There is no assurance that provisions of the Code, Regulations or rulings
will not be changed by new legislation, Regulations or rulings, which may or may
not apply retroactively to transactions entered into or completed prior to the
date of the change, or that there will not be differences of opinion as to the
interpretation of provisions of the Code and Regulations and their application
to the Partnerships, the Investors, the Shareholders, the Company and the
holders of the Notes.
This summary is directed primarily to Investors who are individual residents
or citizens of the United States. This summary does not discuss federal income
tax consequences peculiar to nonresident alien individuals and foreign entities,
insurance companies, banking institutions, regulated investment companies, real
estate investment trusts, or other persons or entities to which special rules
apply by virtue of the nature of their specific activities. Specific
consideration is given, however, to entities that are exempt from federal income
taxation in "--Considerations for Tax-Exempt Shareholders" below. In addition,
no representations are made as to state or local tax consequences resulting from
the Transaction or an investment in the Company. In particular, Investors who
are nonresident aliens are urged to contact their tax advisors concerning the
potential effects of the relevant provisions of the Foreign Investment in Real
Property Tax Act of 1980 to the Transaction. ACCORDINGLY, THIS SUMMARY IS NOT
INTENDED AS A SUBSTITUTE FOR CAREFUL TAX PLANNING AND INVESTORS AND IN
PARTICULAR TAX-EXEMPT INVESTORS, SHOULD CONSULT WITH THEIR OWN TAX ADVISORS AS
TO THEIR PARTICULAR CIRCUMSTANCES IN RELATION TO THE TAX CONSIDERATIONS
DESCRIBED HEREIN.
OPINIONS OF COUNSEL
Kutak Rock, counsel to the Company ("Counsel"), will render its opinion (the
"Opinion"), subject to various assumptions and conditioned upon certain
representations as to factual matters, that: (a) subject to
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the limitations described herein, the merger of the Partnerships with and into
the Company and the related transfer of assets by the Partnerships to the
Company under the terms and conditions set forth in the Merger Agreement will be
an exchange subject to the nonrecognition provisions of Section 351 of the Code;
and (b) the discussion that follows fairly summarizes the material federal
income tax considerations associated with the Transaction. It should be noted
that a ruling from the Service will not be requested and that the Opinion,
unlike a ruling by the Service, is not binding on the Service or any court.
Therefore, no assurance can be given that the Service will not challenge any
views expressed in this discussion.
CERTAIN TAX DIFFERENCES BETWEEN THE OWNERSHIP OF UNITS AND THE SHARES
Investors are treated as limited partners of the Partnerships for federal
income tax purposes. The Partnerships are not subject to federal income taxation
and, instead, each Investor is required to take into account his or her share of
income, deductions or loss of the Partnership in which he or she invested,
regardless of whether any cash is distributed. The character of income to each
Investor is dependent upon its character to the Partnership. Upon consummation
of the Transaction, the Investors will, in essence, receive Shares in exchange
for their Units and thereby become shareholders of the Company which is
characterized as a corporation for federal income tax purposes. See "--Tax
Treatment of the Transaction" and "--Taxation of the Company" below.
In contrast to the tax treatment of the Partnerships, the Company is subject
to corporate income taxation. In addition, Shareholders will be taxed based on
the amount of distributions received from the Company. Each Shareholder will
receive a Form 1099-DIV reporting the amount of taxable and nontaxable
distributions paid to him or her during the preceding year. The extent to which
such distributions are taxable depends upon the amount of the Company's earnings
and profits. The character of distributions to the Shareholders is also not
dependant on its character to the Company and is generally characterized as
ordinary dividend income to the Shareholders. In addition, such income is
classified as portfolio income under the passive loss rules. Furthermore,
deductions and losses are not passed through to the Shareholders. See
"--Taxation of the Company" and "--Taxation of Shareholders" below.
TAX TREATMENT OF THE TRANSACTION
OVERVIEW. The Transaction will be consummated as described herein under the
laws of the State of Delaware. The Transaction shall be treated, for federal
income tax purposes, as (a) a contribution by both Cap Source I and Cap Source
II of their respective assets to the Company in exchange for Shares, Notes and
the assumption of any liabilities by the Company; and (b) the liquidation of the
Partnerships and the distribution of the Shares and Notes received in the
Transaction to the Investors.
RECOGNITION OF GAIN OR LOSS AS A RESULT OF THE TRANSACTION. In general,
under Section 351 of the Code, no gain or loss is recognized as a result of a
contribution of property to a corporation, provided that immediately after the
exchange, the contributor is part of a group of contributors who own 80% or more
of each class of voting stock of the corporation and 80% of each other class of
stock. However, gain will be recognized by a contributor to the extent
liabilities on the contributed assets exceed the contributor's aggregate basis
in such assets. Similarly, if a contributor receives property other than stock,
such as the Notes, then gain but not loss on the transfer will be recognized to
the extent of the fair market value of such property.
In addition, Section 351 of the Code will not apply and gain or loss will be
recognized if property is transferred to an investment company. A transfer of
property will be considered to be a transfer to an investment company if the
transfer results directly or indirectly in the diversification of the
transferors' interests and the transferee is a regulated investment company, a
real estate investment trust or a corporation more than 80% of the value of the
assets of which are held for investment and are readily marketable stock or
securities. The Taxpayer Relief Act of 1997 (the "Tax Act") has changed the
definition of an investment company so that it includes certain corporations if
more than 80% of the value of their
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assets (the "80% Test") consists of, among other things, readily marketable
stock or securities, money, stocks and other equity interests in corporations,
evidences of indebtedness, publicly traded partnership interests and interests
in an entity if substantially all of the assets of such entity are assets listed
in this sentence (the "Listed Assets"). The legislative history of the Tax Act
indicates that even though money is treated as a Listed Asset, if pursuant to a
plan, money contributed to a corporation is used to acquire assets, other than
Listed Assets, the 80% Test will be applied immediately after such acquisition.
In this regard, the General Partners have represented that the cash to be
contributed to Company will be used to acquire assets, other than Listed Assets.
Regulations promulgated under Section 351 of the Code provide that where
there are two or more transferors in a Section 351 transaction, a transferor may
have taxable income in the event it receives stock with a value in excess of the
property contributed by it. Thus, a Partnership which receives Shares with a
fair market value in excess of the fair market value of the assets it
contributes to the Company, may recognize income in amounts equal to such
excess. Similarly, in the event the fair market values of the Notes and the
Shares are different from those anticipated by the Company, Investors of each
Partnership could recognize gain as a result of the Transaction.
The Company (a) does not expect that the liabilities of the Partnerships
will exceed their bases in their contributed assets; (b) expects that, in
addition to Shares, the Partnerships will receive, as a result of the
Transaction, Notes, Promissory Notes or cash which will be distributed to
Dissenting Investors or in certain circumstances Investors (see "THE NOTES");
(c) expects that more than 20% of the value of the assets of the Company,
(including for this purpose cash which pursuant to a plan will be invested as
described above) will be attributable to assets, other than Listed Assets; and
(d) expects that the value of the Shares each Partnership receives will not
exceed the value of its assets contributed to the Company. Based on the
foregoing, the Company expects that the Transaction will be treated as an
exchange subject to the nonrecognition provisions of Section 351 of the Code and
that gain will not be recognized except to the extent of the fair market value
of any Notes, Promissory Notes or cash received by the Partnerships.
It should be noted that the Company will not request a ruling from the
Service that the Transaction will be subject to Section 351 of the Code and that
the Opinion is based in part on factual representations of the Company. In
addition, there is little guidance regarding the interpretation of the foregoing
provisions of the Tax Act. Further, the valuation of the assets of the
Partnerships is subject to uncertainty. As a result, there can be no assurance
that the Service will concur with the conclusions set forth herein.
FORMATION OF THE COMPANY. As discussed above, pursuant to the provisions of
Section 351 of the Code, the Company expects that the Partnerships will not
recognize gain or loss as a result of the contribution of assets in exchange for
Shares, except to the extent of the fair market value of any Notes, Promissory
Notes or Cash received. Each Investor would be required to include in income a
share of such gain even if such Investor did not vote in favor of the
Transaction. The Company does not expect to distribute cash to Investors which
would correspond to the income recognized as a result of the issuance of the
Notes. See "RISK FACTORS--Risks Associated with the Transaction--CERTAIN FEDERAL
INCOME TAX RISKS."
Any gain or loss recognized as a result of the Transaction would pass
through the Partnerships and be recognized by the Investors as capital gain or
losses, except for any portion of gain attributable to the Partnerships'
recapture amounts. In general, an individual may only use up to $3,000 of
capital loss in excess of capital gains to offset ordinary income in any taxable
year. The amount of any such gain recognized by an Investor would result in an
increase in his adjusted basis in his Units and a corresponding increase in the
adjusted basis of his Shares.
The basis of the Company in assets acquired from the Partnerships will equal
the Partnerships' bases in such assets immediately prior to the Transaction plus
any gain recognized as a result of the Transaction. The Company's holding period
for assets contributed by the Partnership will include the period during which
such assets were held by the Partnerships.
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LIQUIDATION AND TERMINATION OF THE PARTNERSHIPS. Upon receipt of the Shares
pursuant to the Transaction, the Partnerships will liquidate and distribute to
the Investors the Shares. The taxable year for the Partnerships will end at such
time and the Investors must report, in the taxable year of the Transaction,
their respective share of all income, gain, loss, deduction and credit from the
Partnerships including, if any, their allocable share of gain or loss resulting
from the Transaction. An Investor whose taxable year differs from that of the
Partnership in which he holds Units may have bunching of income from such
Partnership because of the foregoing short taxable year.
As a general matter, a partner will recognize gain as a result of the
liquidation of a partnership only to the extent the amount of distributed cash
exceeds the basis of his or her partnership interest. However, for this purpose,
certain marketable securities are treated as if they were cash. This provision
will not apply to marketable securities received in a nonrecognition transaction
if: (i) the value of the marketable securities and cash exchanged by the
partnership in the nonrecognition transaction is less than 20% of all its assets
transferred in such exchange; and (ii) the partnership distributes the
marketable securities acquired in the nonrecognition transaction within five
years of their acquisition. Consequently, the General Partners do not expect
that the Investors will recognize gain or loss as a result of this provision.
Pursuant to the terms of their respective Partnership Agreements, upon
liquidation of the Partnerships, the General Partners are obligated to restore
any remaining deficient balances in their Capital Account. In addition, each
General Partner will receive 1% of the total number of Shares to be issued in
the Transaction. The remaining deficit balances of the General Partners' Capital
Accounts, are not expected to be material and in that event will be disregarded
in distributing Shares in liquidation of the Partnerships.
TAXATION OF THE COMPANY
The Company will be characterized as a corporation for federal income tax
purposes. The Company's income and gains are subject to federal corporate income
taxation and do not pass through to the Shareholders. In addition, all items of
losses, deductions and credits resulting from a Company's operations must be
used to offset its income and, thus, are not passed through to the Shareholders.
There is no deduction for dividends paid by the Company. See "--Certain Tax
Differences Between the Ownership of Units and the Shares".
The Company's income will be subject to two levels of taxation because a
corporate level tax is imposed on the Company's taxable income and the
Shareholders are taxed on dividends from the Company. See "--Taxation of
Shareholders--DISTRIBUTIONS."
TAXATION OF SHAREHOLDERS
DISTRIBUTIONS. Distributions by the Company to Shareholders will be
characterized as dividends and taken into account by Shareholders as ordinary
income to the extent distributions are paid from the Company's current and
accumulated earnings and profits. Distributions in excess of current and
accumulated earnings and profits will not be taxable to a Shareholder to the
extent that the distributions do not exceed the recipient Shareholder's adjusted
basis in his or her Shares, but rather will reduce their adjusted basis therein.
To the extent such distributions exceed the adjusted basis of a Shareholder's
Shares, the distribution will be included in income as long-term capital gain
assuming the Shares are a capital asset in the hands of the Shareholder and have
been held for more than eighteen months. The Company expects that all
distributions will be made from current or accumulated earnings and profits.
Therefore, the Company's distributions should be characterized as dividends and
be taken into account by Shareholders as ordinary income. Shareholders which are
corporations may be entitled to exclude from gross income a portion of any
dividends received with respect to the Shares.
BACKUP WITHHOLDING FOR SHAREHOLDERS. The Company will report to its
Shareholders and the Service the amount of dividends paid during each calendar
year and the amount of tax withheld, if any, with respect
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thereto. Under the backup withholding rules, a Shareholder may be subject to
backup withholding at the rate of 31% with respect to dividends paid unless such
Shareholder (a) is a corporation or comes within certain exempt categories and,
when required, demonstrates this fact, or (b) provides a taxpayer identification
number, certifies as to no loss of exemption from backup withholding, and
otherwise complies with applicable requirements of the backup withholding rules.
A Shareholder who does not provide the Company with its correct taxpayer
identification number may also be subject to penalties imposed by the Service.
Any amount paid as backup withholding will be creditable against the
Shareholder's income tax liability.
PASSIVE INCOME AND LOSSES. Section 469 of the Code provides that losses or
deductions from passive trade or business activities in excess of income from
all such passive activities may not be deducted against wages, salaries or
portfolio income. Similarly, credits from passive activities are limited to the
tax allocable to such passive activities. Suspended losses and credits may be
carried forward and treated as deductions and credits from passive trade or
business activities in succeeding taxable years. Suspended losses are allowed in
full when the taxpayer disposes of his entire interest in the passive activity
in a taxable transaction to an unrelated party.
Portfolio income, in general, includes interest, dividends, annuities and
royalties. Generally, portfolio income and the expenses which are clearly,
directly and properly allocable to such portfolio income are not treated as
income or expense from passive activity. Therefore, the passive losses or
deductions may not be applied to offset portfolio income.
Dividends of a corporation will be treated as portfolio income and will not
be available to offset passive losses from any other source. The Company will be
characterized as a corporation for federal income tax purposes. Consequently,
dividends received by Shareholders will be characterized as portfolio income and
will not be available to offset passive losses from other sources.
GAIN OR LOSS ON THE SALE OF SHARES. The Tax Act increased the holding
period required to receive long term capital gains treatment on the sale or
exchange of capital assets. In order to receive long term capital gains rates an
individual must now hold capital assets for 18 months. In addition, the Tax Act
reduced the maximum long-term capital gains rate from 28% to 20%. However, an
18% maximum long-term capital gains rate will apply to capital assets held for
more than five years beginning after December 31, 2000. Gain on assets held more
than 12 but less than 18 months will be subject to tax at a rate of 28%. In
general, an individual may only use up to $3,000 of capital loss in excess of
capital gains to offset ordinary income, such as wages and interest income, in
any taxable year. Assuming that a Shareholder holds Shares as a capital asset,
the sale of Shares will result in either capital gain or loss and be subject to
the foregoing rules.
INVESTMENT INTEREST. Investment interest (i.e., interest paid or accrued on
indebtedness incurred or continued to purchase or carry property held for
investment) is deductible by non-corporate taxpayers only to the extent it does
not exceed "net investment income" (i.e., investment income less investment
expenses). Investment interest which is not allowable as a deduction in one year
pursuant to this limitation may be carried over to subsequent years within
certain limits. Investors who borrowed to finance the purchase of their Units
should be aware that interest on such borrowing may constitute investment
interest and would therefore be subject to the above-described limitations
before and after the Transaction.
TAXATION OF NON-U.S. SHAREHOLDERS
GENERAL. The following is a general discussion of certain federal income
tax consequences of the ownership and disposition of Shares by a Shareholder who
is not a United States person (a "Non-U.S. Shareholder"). For this purpose, the
term "United States person" is defined as any person who is a citizen or
resident of the United States, a corporation or a partnership or other entity
created or organized in the United States or under the laws of the United States
or of any state, or an estate or trust whose income is includible in gross
income for federal income tax purposes regardless of source. The rules governing
the
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federal income taxation of Non-U.S. Shareholders are complex, and no attempt
will be made herein to provide more than a limited summary of such rules. Each
Investor that may be characterized as a Non-U.S. Shareholder is advised to
consult a tax advisor with respect to current and possible future federal income
and federal estate tax consequences of acquiring, holding and disposing of
Shares as well as any other tax consequences that may arise under the laws of
any U.S. state, municipality or other taxing jurisdiction including any
information reporting and withholding requirements associated with the
foregoing.
An individual may, subject to certain exceptions, be deemed to be a resident
alien (as opposed to a non-resident alien) by virtue of being present in the
United States for at least 31 days in the calendar year and for an aggregate of
at least 183 days during the three-year period ending in the current calendar
year (counting for such purposes all of the days present in the current year,
one-third of the days present in the immediately preceding year, and one-sixth
of the days present in the second preceding year) (a "Resident Alien"). Resident
Aliens are subject to federal income tax as if they were U.S. citizens.
In general, Non-U.S. Shareholders will be subject to regular federal income
taxation with respect to holding their Shares in the same manner as a U.S.
Shareholder (i.e., at graduated rates on a net basis after deductions) if the
holding of such Shares is "effectively connected" with the conduct of a trade or
business in the United States by such Non-U.S. Shareholder. A Non-U.S.
Shareholder that is a corporation and that receives income with respect to its
investment in Shares that is "effectively connected" with the conduct of a trade
or business in the United States may also be subject to the 30% branch profits
tax imposed under Section 884 of the Code, which is payable in addition to the
regular federal corporate income tax. The following discussion addresses only
the federal income taxation of Non-U.S. Shareholders whose holding of Shares is
not "effectively connected" with the conduct of a trade or business in the
United States. Investors who may be characterized as Non-U.S. Shareholders and
whose holding of Shares may be "effectively connected" with the conduct of a
United States trade or business should consult their own tax advisors as to the
federal income and other tax consequences associated therewith.
DISTRIBUTIONS. The Company expects to make quarterly dividend
distributions. See "THE COMPANY--Dividend Policy." To the extent distributions
of the Company are deemed to be dividends, such dividends paid to Non-U.S.
Shareholders will be subject to withholding of federal income tax on a gross
basis at a 30% rate or such lower rate as may be specified by an applicable
income tax treaty.
Under current Regulations, dividends paid to an address outside the United
States are presumed to be paid to a resident of such country for purposes of the
withholding discussed above (unless the payor has knowledge to the contrary).
Under proposed Regulations not currently in effect, however, a Non-U.S.
Shareholder who wishes to claim the benefit of an applicable treaty rate would
be required to satisfy applicable certification and other requirements. A
Non-U.S. Shareholder eligible for a reduced rate of withholding tax pursuant to
an income tax treaty may obtain a refund of any excess amounts withheld by
filing an appropriate claim for refund with the Service.
GAIN OR LOSS ON SALE OF SHARES. A Non-U.S. Shareholder generally will not
be subject to federal income tax with respect to gain recognized on a sale or
other disposition of Shares unless: (a)(i) the gain is effectively connected
with the conduct of a trade or business in the United States by the Non-U.S.
Shareholder or (ii) if a treaty applies, the gain is attributable to a United
States permanent establishment of the Non-U.S. Shareholder; (b) in the case of a
Non-U.S. Shareholder who is an individual and holds the Shares as a capital
asset, such Shareholder is present in the United States for 183 or more days in
the taxable year of the sale or other disposition and certain other conditions
are met; (c) the Shares are characterized as United States real property
interests ("USRPIs") for federal income tax purposes; or (d) the Non-U.S.
Shareholder is subject to tax pursuant to certain provisions of the Code
applicable to expatriates.
If any class of stock of a corporation is regularly traded on an established
securities market, stock of such class shall be treated as a USRPI only in the
case of a person or entity who, at some time during the shorter of five years or
the period such person or entity held such stock, held more than 5% of such
stock.
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The Company believes that the Shares likely will qualify as being regularly
traded on an established securities market. Therefore, the Company expects that
the Shares will not be characterized as USRPIs except with respect to any
Non-U.S. Shareholder who acquires more than 5% of the Shares.
If an individual Non-U.S. Shareholder falls under clause (b) above, such
individual generally will be subject to a flat 30% tax on the gain derived from
a sale, which may be offset by certain United States capital losses
(notwithstanding the fact that such individual is not considered a Resident
Alien). Thus, Non-U.S. Shareholders who fall or expect to fall in clause (b)
above in the taxable year in which they contemplate a sale of Shares are urged
to consult their tax advisors as to the tax consequences of such sale.
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX. The Company must report
annually to the Service and to each Non-U.S. Shareholder the amount of dividends
paid to such Shareholder and the tax withheld with respect to such dividends.
These information reporting requirements apply even if withholding was not
required because the dividends were effectively connected with the conduct of a
trade or business in the United States by the Non-U.S. Shareholder or
withholding was reduced by an applicable income tax treaty. Copies of the
information returns reporting such dividends and withholding may be made
available to the tax authorities in the country in which the Non-U.S.
Shareholder resides or is established under the provisions of an applicable
income tax treaty or agreement.
United States backup withholding (see "--Taxation of Shareholders--BACKUP
WITHHOLDING FOR SHAREHOLDERS") generally will not apply to dividends paid to
Non-U.S. Shareholders that are either subject to the 30% withholding discussed
above or subject to withholding at a reduced treaty rate.
TAX ISSUES ASSOCIATED WITH NOTES
STATED INTEREST. Under general federal income tax principles, holders of
Notes must include stated interest in income in accordance with their method of
tax accounting. Accordingly, holders of Notes using the accrual method of tax
accounting must include stated interest in income as it accrues and holders of
Notes using the cash method of tax accounting must include stated interest in
income as it is actually or constructively received.
Payments of interest to taxable holders of Notes will constitute portfolio
income for purposes of Section 469 of the Code and not passive activity income.
Accordingly, such income will not be subject to reduction by losses from passive
activities (e.g., any interest in a trade or business held as a limited partner
in which the holders of Notes do not materially participate) of holders of Notes
who are subject to the passive activity loss rules. However, income attributable
to interest payments may be offset by investment expense deductions, subject to
the limitation that individual investors may only deduct miscellaneous itemized
deductions (including investment expenses) to the extent such deductions exceed
two percent of the investor's adjusted gross income.
ORIGINAL ISSUE DISCOUNT. Original issue discount is generally defined as
the excess of a debt instrument's stated redemption price at maturity over its
issue price, subject to a statutorily-defined DE MINIMIS exception (generally,
one-quarter of 1% of the debt instrument's stated redemption price at maturity
multiplied by the number of complete years to maturity from its issue date). The
"stated redemption price at maturity" of a debt instrument is generally the sum
of the debt instrument's stated principal amount plus all other payments
required thereunder, other than payments of "qualified stated interest"
(generally, stated interest that is unconditionally payable in cash or in
property at least annually at a single fixed rate). The "issue price" of a debt
instrument, that is not part of an issue of which a substantial part is sold for
money and is traded on an established securities market, is its fair market
value when issued, or in the case of such a debt instrument that is not so
traded, either (a) its stated principal amount, if the debt instrument provides
for "adequate stated interest" (generally, interest at the applicable federal
rate for the month of issuance) or (b) its "imputed principal amount"
(generally, the sum of the present value of all payments due under the debt
instrument, discounted at the applicable federal rate), if the debt instrument
does not provide for "adequate stated interest."
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The Regulations set forth special rules applicable to debt instruments
providing for variable rates of interest. In general, if a debt instrument
providing for variable rates of interest qualifies as a variable rate debt
instrument, then the debt instrument would generally not be treated as issued
with original issue discount unless the debt instrument is issued at a price
below the debt instrument's stated principal amount, subject to the statutorily
defined DE MINIMIS amount. A debt instrument will qualify as a variable rate
debt instrument under the Regulations if (a) the issue price of the debt
instrument does not exceed the total noncontingent principal payments by more
than a specified amount, (b) the debt instrument provides for stated interest,
paid or compounded at least annually, at current values of (i) one or more
qualified floating rates, (ii) a single fixed rate and one or more qualified
floating rates, (iii) a single objective rate, or (iv) a single fixed rate and a
single objective rate that is a qualified inverse floating rate. A qualified
floating rate is any floating rate where variations in such rate can reasonably
be expected to measure contemporaneous variations in the cost of newly borrowed
funds, including certain rates based on a qualified floating rate. An objective
rate is a rate that is not itself a qualified floating rate but which is
determined using a single formula that is fixed throughout the term of the debt
instrument and which is (A) based upon one or more qualified floating rates, (B)
based upon one or more rates where each rate would be a qualified floating rate
for a debt instrument denominated in a currency other than the currency in which
the debt instrument is denominated, (C) based upon the price of certain types of
actively traded personal property, or (D) a combination of (A), (B) or (C).
The Company believes that the variable rates of interest on the Notes will
be treated as providing for stated interest, paid at least annually, at one or
more qualified floating rates and that, as a result, the Notes should qualify as
variable rate debt instruments under the Regulations. Accordingly, the Notes are
not expected to be issued with original issue discount.
Alternatively, if the Notes qualify as variable rate debt instruments under
the Regulations but the fair market value of the Notes is less than their stated
principal amount by more than the statutorily-defined DE MINIMIS amount, then
the Notes would be issued with original issue discount. In such case, the
holders of Notes would be required to include in gross income on a constant
yield to maturity basis the sum of the daily portions of original issue discount
for the period during the taxable year the holders of Notes held the Notes even
through the holders of Notes may not receive a payment representing the original
issue discount in such year. Any amount or original issue discount included in
income would increase a holders of Notes' tax basis in the Notes.
In addition, if, contrary to the Company's expectations, the Notes do not
qualify as variable rate debt instruments under the Regulations, then the Notes
may be subject to certain contingent payment provisions of the Regulations. In
this event, Noteholders would generally be required to include stated interest
on the Notes in income in the taxable year in which the amount of the interest
payments become fixed, regardless of their method of tax accounting.
BOND PREMIUM AND MARKET DISCOUNT. Holders of Notes should have a basis in
the Notes received in liquidation of their interests in a Partnership equal to
the adjusted basis in their Units, which may be more or less than the face
amount of Notes received. As a result, holders of Notes may have bond premium or
market discount with respect to the Notes.
If the Noteholders' initial adjusted basis in the Notes or their fair market
value immediately after the Transaction, whichever is lower, exceeds the amount
payable at maturity of such Notes (or in certain cases, on an earlier call
date), the Noteholders may be able to elect to deduct such excess using a
constant yield method over the remaining term of the Notes as amortizable bond
premium under Section 171 of the Code provided the Notes are held as a capital
asset. Except as provided in the Regulations, the amortizable bond premium will
be treated as an offset to interest income on the Notes rather than as a
separate deduction item. An election under Code Section 171 generally is binding
once made and applies to all obligations owned or subsequently acquired by the
taxpayer.
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The market discount provisions of the Code generally provide that, subject
to a statutorily-defined DE MINIMIS exception, if a holder of a debt instrument
acquires it at a market discount and thereafter recognizes gain on a disposition
of the debt instrument (including a gift), the lesser of such gain or the
portion of the market discount that accrued while the debt instrument was held
by such holder will be treated as ordinary interest income at the time of the
disposition. For this purpose, in the case of a debt instrument not issued with
original issue discount, an acquisition at a market discount includes an
acquisition, other than an acquisition at original issuance, resulting in a
basis in the debt instrument below the debt instrument's stated redemption price
at maturity. The market discount rules also provide that a holder who acquires a
debt instrument at a market discount (and who does not elect to include such
market discount in income on a current basis) may be required to defer a portion
of any interest incurred or maintained to purchase or carry such debt instrument
until the holder disposes of the debt instrument in a taxable transaction.
The Notes provide that they may be redeemed, in whole or in part, before
maturity. If some or all of the Note are redeemed, each holder of a Note
acquired at a market discount would be required to treat the principal payment
as ordinary interest income to the extent of any accrued market discount on such
Notes.
A holder of a debt instrument may elect to have market discount accrue on a
constant interest rate basis (as opposed to a straight line basis). The current
inclusion election, once made, applies to all market discount obligations
acquired by such holder on or after the first day of the first taxable year to
which the election applies and may not be revoked without the consent of the
Service. If a Noteholder elects to include market discount in income in
accordance with the preceding sentence, the foregoing rules with respect to the
recognition of ordinary income on a sale or certain other dispositions of a Note
and the deferral of interest deduction on indebtedness related to such Note will
not apply.
DISPOSITION OF NOTES. In general, a holder of Notes will recognize gain or
loss upon the sale, exchange, redemption or other taxable disposition of a Note
measured by the difference between (a) the amount of cash and the fair market
value of property received (except, for cash method taxpayers, to the extent
attributable to the payment of accrued interest) and (b) such holder's adjusted
basis in the Note (as increased by any original issue discount or market
discount previously included in income by such holder and decreased by any cash
payments received, other than payments constituting qualified stated interest,
and any amortizable bond premium deducted over the term of the Note). Subject to
the market discount and bond premium rules discussed above, any such gain or
loss will generally be long-term capital gain or loss, provided the Note was a
capital asset in the hands of the holder and was held for more than one year.
CONSIDERATIONS FOR TAX-EXEMPT SHAREHOLDERS
Shareholders that are tax-exempt entities, including charitable
corporations, pension, profit sharing or stock bonus plans, Keogh Plans,
Individual Retirement Accounts and certain other employee benefit plans are
subject to federal income tax on unrelated business taxable income (i.e., net
income derived from the conduct of a trade or business regularly carried on by a
tax-exempt entity or by a partnership in which it is a partner). A $1,000
special deduction is allowed in determining the amount of unrelated business
taxable income subject to tax. Tax-exempt entities taxed on their unrelated
business taxable income are also subject to the alternative minimum tax for
items of tax preference which enter into the computation of unrelated business
taxable income. Dividends are generally deemed not to constitute unrelated
business taxable income. Therefore, dividends received by tax-exempt
Shareholders should not constitute unrelated business taxable income. However,
unrelated business taxable income may arise from dividends from "debt-financed
property," which may result when a tax-exempt Shareholder incurs debt in
connection with the acquisition of Shares or its Shares are subject to debt
previously incurred in connection with the acquisition of Units.
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GENERAL PARTNER LIABILITIES
Three Cap Source I Operating Partnerships currently have certain contingent
liabilities which might in the future become payable to their respective General
Partners which are affiliates of America First Companies. The contingent
liabilities consist of:
(a) property development and management fees;
(b) asset management and partnership administration fees; and
(c) operating deficit and construction loans.
The affiliates of America First Companies have agreed that the noted
liabilities should be waived if the Transaction is completed. The General
Partners believe that the forgiveness of these liabilities should not give rise
to any material amount of discharge of indebtedness income for federal income
tax purposes because of certain conditions precedent to their payment. If the
forgiveness of these liabilities were characterized as discharge of indebtedness
income, however, the Partnerships and the Operating Partnerships would be
required to recognize corresponding amounts of income. If such income were
recognized, no additional funds would be received by the Partnerships and
distributed to the Unitholders.
TERMINATION OF TRADE PROCESSING
In the event the General Partners have reason to believe that a requested
sale, transfer or assignment of Units would cause Cap Source I or Cap Source II
to be characterized as a publicly traded partnership for federal income tax
purposes, the General Partners will, pursuant to their powers under Section 5.09
of the Partnership Agreement, refuse to process such requested sale, transfer or
assignment unless the General Partners receive an unqualified opinion of Counsel
to the effect that such sale, transfer or assignment of Units, in conjunction
with all other reasonably expected sales, transfers or assignments of Units,
would not cause the Partnership to be characterized as a publicly traded
partnership for federal income tax purposes. Neither the General Partner nor the
Partnership may be held liable for any losses resulting to a holder of Units or
a purchaser of Units as a result of a requested sale, transfer or assignment of
Units not being processed due to these limitations.
The foregoing restrictions are intended to prevent the trading volume of
Units from reaching a level that would cause the Partnership to be characterized
as a publicly traded partnership under Section 7704 of the Code. In the event
the Partnership were characterized as a publicly traded partnership, the
Partnership could be subject to entity level taxation. In such event, amounts
otherwise distributable to holders of Units would be used to satisfy federal
income tax liabilities of the Partnership and, thus, amounts received by holders
of Units would be less than anticipated.
EMPLOYEE RETIREMENT INCOME SECURITY ACT
The Employee Retirement Income Security Act of 1974, as amended ("ERISA")
applies to investments by pension, profit sharing, stock bonus, Keogh and other
employee benefit plans, and by IRAs (collectively referred to as "Benefit
Plans"). ERISA does not prohibit Benefit Plans from investing in any specific
type of investment but does require that plan fiduciaries give appropriate
consideration to the facts and circumstances relevant to a particular
investment, including whether the investment is reasonably designed, as part of
the investment portfolio, to further the purposes of the Benefit Plan, taking
into consideration risk of loss and opportunity for gain. ERISA also requires
fiduciaries to take into account factors such as composition of the portfolio
with regard to diversification, liquidity, current return relative to
anticipated cash flow requirements and projected return relative to funding
objectives, and the need to value plan assets annually. ERISA prohibits certain
transactions between a Benefit Plan and a "party in interest" as defined by
ERISA. Section 4975 of the Code imposes a 5% excise tax on any fiduciary or
"disqualified person" (as defined therein) who engages in certain transactions
similar to those transactions prohibited under ERISA. The excise tax may
increase to 100% if violations are not timely corrected after notice. A
corporation, such as the Company, will be subject to the foregoing rules
restrictions and penalties if its assets are deemed to be the assets of a
Benefit Plan under ERISA. Whether or not assets of the
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Company will be deemed to be assets of a Benefit Plan for purposes of ERISA or
Section 4975 of the Code will be determined in accordance with the "plan asset"
regulations discussed below. It should be noted that Benefit Plan fiduciaries
should carefully consider whether an investment in the Company is consistent
with their responsibilities under ERISA.
Under the Department of Labor plan assets regulations, the assets of a
pooled investment vehicle, the definition of which may include the Company, will
not be plan assets of a Benefit Plan for ERISA purposes (and will not be subject
to requirements regarding fiduciary responsibility and the holding of plan
assets in trust) if the issuer is an "operating company" (i.e., "an entity that
is primarily engaged in the production or sale of a product or service other
than the investment of capital") or if equity participation in the entity by
Benefit Plans is not significant (i.e., less than 25% of the value of any class
of equity interests in an entity is held by Benefit Plan investors). The Company
believes that it may be an operating company and anticipates that ownership of
Shares by Benefit Plans will be less than 25%. There can be no absolute
assurance, however, that the Company will meet the operating company exception
or 25% test.
Alternatively, the plan assets regulations further provide that assets of a
corporation will not be treated as plan assets if equity interests in such
corporation are "publicly offered securities" (i.e., a security that is widely
held, freely transferable, not offered primarily to tax-exempt limited partners,
either registered under the Exchange Act or sold pursuant to a registration
statement under the Securities Act and the class of securities is registered
under the Exchange Act within 120 days after the end of the issuer's fiscal year
during which the public offering occurred). In general, the regulations provide
that securities are "widely held" only if they are part of a class of securities
purchased and held by 100 or more persons who are independent of the issuer and
of one another. The Company expects that (a) it will have significantly more
than 100 Shareholders independent from it and one another; (b) the Shares will
not be offered primarily to tax-exempt investors; (c) the Shares will be freely
transferrable; (d) the Shares are being offered pursuant to a registration
statement under the Securities Act; and (e) the Company will be registered under
Section 12(g) of the Exchange Act within the applicable period because it will
have more than 500 Shareholders and total assets exceeding $5,000,000. Based on
these facts, the Company believes that the Shares satisfy all criteria for the
"publicly offered securities exception." Accordingly, based on all the facts and
circumstances described above, the Shares will be characterized as "publicly
offered securities" and the assets of the Company will not be plan assets for
ERISA purposes.
INDEPENDENT PUBLIC ACCOUNTANTS
The audited financial statements of the Company and the Partnerships
included in the Prospectus/ Consent Solicitation Statement have been audited by
Coopers & Lybrand L.L.P., independent public accountants, as indicated in their
respective reports thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
LEGAL MATTERS
Kutak Rock, a national law firm, will deliver an opinion to the effect that
the Shares offered by this Prospectus/Consent Solicitation Statement will be
validly issued, and that the Notes offered by this Prospectus/Consent
Solicitation Statement will be binding obligations of the Company. Kutak Rock
has relied on Richards, Layton & Finger as to certain matters of Delaware law.
In addition, Kutak Rock will deliver an opinion to the effect that the
discussion under "FEDERAL INCOME TAX CONSEQUENCES" fairly summarizes all of the
material federal income tax considerations for a holder of Units who exchanges
such Units for Shares or Notes. Kutak Rock has previously performed certain
legal services on behalf of the Partnerships, the General Partners, the Company
and their Affiliates.
The opinions of Kutak Rock are not attached as appendices to this
Prospectus/Consent Solicitation Statement; however, upon receipt of a written
request by an Investor or representative so designated in writing, a copy of
such opinions will be sent by the General Partners. All requests should be
directed to Maurice Cox, Suite 400, 1004 Farnam Street, Omaha, Nebraska, 68102.
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GLOSSARY
Certain capitalized terms used in this Prospectus/Consent Solicitation
Statement shall have the following meanings unless the context otherwise
requires.
"ACMS" means asbestos-containing materials.
"ACQUISITION FEE" means an amount equal to 1% of the increase in the
Company's actual investment in all New Assets including any costs related to the
acquisition or financing of New Assets but excluding debt which is incurred or
assumed in connection therewith, payable by the Company to the Advisor on a
monthly basis as provided in the Advisory Agreement.
"ADA" means the Americans with Disabilities Act, as amended.
"ADJUSTED NEW ASSET VALUE" means, with respect to each individual New Asset
owned by the Company, the Beginning New Asset Value increased by additional
investments in such New Asset (which investments may be made from any
borrowings, additional equity or any other source available to the Company) and
decreased by Returns of Capital; provided, however, this Value shall not be
decreased below zero by Returns of Capital; provided, further, if, after the
final sale of a New Asset, the Adjusted New Asset Value is greater than zero,
such value shall be zero.
"ADJUSTED ORIGINAL ASSET VALUE" means, with respect to each individual
Original Asset owned by the Company, (i) for each Equity Interest in an
Operating Partnership, the amount set forth in Exhibit A to the Advisory
Agreement which represents an equity interest in an Operating Partnership
reduced to zero upon the sale or redesignation as a New Asset of such asset or
(ii) for each GNMA as set forth in Exhibit A to the Advisory Agreement, the
aggregate outstanding principal amount of such GNMA decreased by (A) borrowings
which are directly or indirectly secured by such GNMA and (B) principal
repayments with respect to such GNMA.
"ADVISOR" means America First Real Estate Advisors LLC, a Delaware limited
liability company.
"ADVISORY AGREEMENT" means the agreement between the Company and the Advisor
whereby the Advisor is to manage the assets of the Company as directed by the
Board of Directors of the Company.
"ADVISOR FEES" means the Acquisition Fee, Asset Management Fee and Incentive
Fee on New Assets as set forth in the Advisory Agreement.
"AFFILIATE" means, with respect to a Person, or any other Person directly or
indirectly controlling, controlled by or under common control with such Person,
or any other Person owning or controlling 10% or more of the outstanding voting
securities of such Person.
"APPRAISALS" means the independent appraisals of the real estate assets of
each of the Operating Partnerships prepared by Valuation Research to show the
fair market value of such assets as of December 31, 1997.
"APPROVAL DATE" means , 1998, which is the date by which each
Investor must inform the General Partners as to whether the Investor wishes to
vote in favor of or against the Transaction, and the date on which the vote of
the Investors will be tabulated, unless extended.
"ASSET MANAGEMENT FEE" means an amount equal to .475% on an annual basis, of
the Company's Total Assets, calculated as of the last day of each month, payable
by the Company to the Advisor each month in arrears.
"BEGINNING NEW ASSET VALUE" means with respect to each individual New Asset
owned by the Company, (a) with respect to any asset directly owned by the
Company, the total consideration paid by the Company for such asset, including
all payments made in respect of equity and all debt incurred or assumed with
respect to such asset, plus any costs related to the acquisition or financing of
such asset or (b) with respect to any asset indirectly owned by the Company
through an interest in a joint venture, partnership or similar
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entity, the total consideration paid by the Company for such interest, including
all payments in respect of such interest and all debt incurred, assumed or
allocated with respect to such interest, plus any costs related to the
acquisition or financing of such interest.
"BRINGDOWN FAIRNESS OPINION" means the written confirmatory opinion rendered
by Sutro & Co. regarding the fairness of the Transaction.
"BYLAWS" means the Bylaws of the Company, as in effect from time to time.
"CAPITAL GAIN" means with respect to each individual New Asset owned by the
Company, the excess, if any, of (i) the net proceeds, net of all closing costs
(including without limitation any real estate or selling commissions), but
without deduction for any applicable mortgage indebtedness, from any partial
sale or a whole sale received by the Company upon the sale of a New Asset over
(ii) the Adjusted New Asset Value of such New Asset prior to such sale.
"CAPITAL LOSS" means with respect to each individual New Asset owned by the
Company, the deficit, if any, upon the occurrence of final sale of such Asset of
(i) the net proceeds, net of all closing costs (including without limitation any
real estate or selling commissions), but without deduction for any applicable
mortgage indebtedness, from any partial sale or a whole sale received by the
Company upon the sale of a New Asset over (ii) the Adjusted New Asset Value of
such New Asset prior to such sale.
"CAP SOURCE I" means Capital Source L.P., a Delaware limited partnership.
"CAP SOURCE I GENERAL PARTNERS" means Insured Mortgage Equities Inc. and
America First Capital Source I, L.L.C.
"CAP SOURCE I MORTGAGE SECURITIES" means securities relating to federally
insured mortgages on multifamily housing properties owned by Cap Source I.
"CAP SOURCE I OPERATING PARTNERSHIPS" means Bluff Ridge Associates Limited
Partnership, Waters Edge Limited Partnership, Interstate Limited Partnership
(a/k/a Highland Park), Cypress Landings II, Ltd. (a/k/a Misty Springs), Oyster
Cove Limited Partnership (a/k/a Waterman's Crossing), Fox Hollow, Ltd. and Ponds
at Georgetown Limited Partnership.
"CAP SOURCE I PARTNERSHIP EQUITY INTERESTS" means the limited partnership
interests in the Cap Source I Operating Partnerships.
"CAP SOURCE I SPECIAL LIMITED PARTNER" means CS Properties I, Inc.
"CAP SOURCE II" means Capital Source II L.P.-A, a Delaware limited
partnership.
"CAP SOURCE II GENERAL PARTNERS" means Insured Mortgage Equities II L.P. and
America First Capital Source II, L.L.C.
"CAP SOURCE II MORTGAGE SECURITIES" means the federally insured mortgages on
multifamily housing properties owned by Cap Source II.
"CAP SOURCE II OPERATING PARTNERSHIPS" means Crane's Landing Partners, Ltd.,
Delta Crossing Limited Partnership, Centrum Monticello Limited Partnership and
Ponds at Georgetown Limited Partnership.
"CAP SOURCE II PARTNERSHIP EQUITY INTERESTS" means the limited partnership
interests in the Cap Source II Operating Partnerships.
"CAP SOURCE II SPECIAL LIMITED PARTNER" means CS Properties II, Inc.
"CASH" means cash and cash equivalents and amounts invested on a short-term
basis by the Company.
"CERTIFICATE OF INCORPORATION" means the Second Amended and Restated
Certificate of Incorporation of the Company, as amended from time to time.
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"CERTIFICATE OF MERGER" means the Certificate of Merger to be filed with the
Delaware Secretary of State with respect to the merger of the Partnerships and
the Company under the terms and conditions set forth in the Merger Agreement.
"CODE" means the Internal Revenue Code of 1986, as amended, including
successor statutes thereto.
"COMMISSION" means the United States Securities and Exchange Commission,
also sometimes referred to as the "SEC."
"COMMON STOCK" means the $.001 par value common stock of the Company.
"COMPANY" means America First Real Estate Investment Company, Inc., a newly
organized Delaware corporation.
"CONSENT CARD" means the consent card accompanying the Prospectus/Consent
Solicitation Statement which includes a ballot on which the Investor may vote in
favor of or against his Partnerships's participation in the Transaction or
abstain from voting with respect thereto.
"CONSENTING INVESTORS" means Investors who vote "YES" in favor of the
Transaction.
"COUNSEL" means Kutak Rock, a partnership including professional
corporations, which has served as counsel to the Company in the preparation of
the Transaction.
"DELAWARE GCL" means the Delaware General Corporation Law, as may be amended
from time to time.
"DELAWARE PARTNERSHIP LAW" means the Delaware Revised Uniform Limited
Partnership Act, as may be amended from time to time.
"DESIGNATED ASSETS" means assets of the Company which were owned by a
Partnership prior to the Transaction.
"DISSENTING INVESTOR" means an Investor who votes "NO" against the
Transaction.
"EFFECTIVE DATE" means the time at which the Partnerships will be merged
with and into the Company in accordance with the Merger Agreement and the
Transaction will be consummated.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and
all rules and regulations promulgated thereunder.
"EXCHANGE VALUE" means the value attributable to the Partnerships for
purposes of the Transaction.
"FAIRNESS OPINION" means the opinion rendered by Sutro & Co., Inc. that the
consideration (as defined therein) to be received by Investors and the General
Partners collectively, and with respect to each Partnership individually, the
allocation of such consideration among the Investors and the General Partners,
and the principal allocation of the Notes in the Transaction, is fair from a
financial point of view.
"FFO" or "FUNDS FROM OPERATIONS" means net income determined in accordance
with GAAP, excluding gains (or losses) from debt restructuring and sales of
property, plus depreciation.
"FHA" means the United States Federal Housing Administration.
"FHA LOANS" means the first mortgage loans insured as to principal and
interest by the FHA on certain multifamily housing properties owned by the
Operating Partnerships.
"GAAP" means generally accepted accounting principles.
"GENERAL PARTNERS" means the Cap Source I General Partners and the Cap
Source II General Partners.
"GNMA" means the United States Government National Mortgage Association.
140
<PAGE>
"GNMA CERTIFICATES" means the mortgage-backed securities guaranteed as to
principal and interest by GNMA and collateralized by first mortgage loans on
multifamily housing properties owned by the Operating Partnerships.
"INCENTIVE FEE" means an annual amount equal to 10% of any Capital Gain on
New Assets, offset by any Capital Loss, payable by the Company to the Advisor on
an annual basis in the form of Restricted Stock as provided in the Advisory
Agreement.
"INDENTURE" means the indenture dated as of the first day of the month in
which the Notes are issued, between the Company and the Trustee, pursuant to
which the Notes and the Promissory Notes are to be issued.
"INDEPENDENT DIRECTORS" means the directors of the Company who are not
affiliated with the Company or the Advisor and do not perform any services for
the Company or the Advisor, other than as directors, and who are not officers or
employees of the Company, the Advisor or any of their respective affiliates.
"INTEREST PAYMENT DATE" means the fifteenth day of each January, commencing
on the first Interest Payment Date following the issuance of the Notes, until
the principal and interest on all Notes and Promissory Notes have been paid in
full.
"INVESTMENT COMPANY ACT" means the Investment Company Act of 1940, as
amended, and the rules and regulations promulgated thereunder.
"INVESTOR" means the holder of one or more beneficial assignment certificate
representing limited partner interests in a Partnership as of the Record Date.
"IRS" means the United States Internal Revenue Service, also referred to
sometimes as the "SERVICE."
"MATURITY DATE" means the date on which the outstanding principal balance of
the Notes, plus accrued but unpaid interest thereon, will be payable in full,
which date shall be , 2006.
"MAXIMUM NOTE LIMITATION" means $40 million, the maximum aggregate dollar
amount of Notes that the Company may issue in connection with the Transaction.
"MERGER AGREEMENT" means the Agreement and Plan of Merger among the
Partnerships and the Company pursuant to which the Transaction is to be
consummated.
"MORTGAGE SECURITIES" means securities relating to federally insured
mortgages on multifamily housing property.
"NASDAQ" means the National Association of Securities Dealers Automated
Quotations System.
"NET PROCEEDS FROM SALES OR REFINANCINGS OF DESIGNATED ASSETS" means the
gross proceeds of all sales, exchanges or refinancings received in connection
with Designated Assets, less any and all costs and expenses incurred by the
Company in connection with such sales, exchanges or refinancings.
"NEW ASSETS" means any and all assets acquired by the Company after the
Effective Date and prior to the termination of the Advisory Agreement, and any
Original Asset designated by the Board of Directors as a redevelopment project.
"NOTEHOLDERS" means Investors who receive Notes in connection with the
Transaction.
"NOTES" means the Company's Variable Rate Junior Notes Callable On or After
the Date of Issuance issued pursuant to the Indenture.
"NYSE" means the New York Stock Exchange.
"OPERATING PARTNERSHIPS" means the Cap Source I Operating Partnerships and
the Cap Source II Operating Partnerships, collectively.
141
<PAGE>
"ORGANIZATIONAL DOCUMENTS" means the Second Amended and Restated Certificate
of Incorporation and Bylaws of the Company.
"ORIGINAL ASSET" means the assets contributed to the Company on the
Effective Date as set forth in Exhibit A to the Advisory Agreement, excluding
any Original Asset that is subsequently classified as a New Asset because of its
classification as a redevelopment project.
"PARTNERSHIP AGREEMENTS" means the limited partnership agreements of the
Partnerships, as amended.
"PARTNERSHIP EQUITY INTERESTS" means the Cap Source I Partnership Equity
Interests together with the Cap Source II Partnership Equity Interests.
"PARTNERSHIPS" means Cap Source I and Cap Source II, together.
"PERSON" means an individual, partnership, corporation, trust or other
entity.
"PROMISSORY NOTE" means a promissory note issued by the Company in
connection with the Transaction to Investors entitled to a fractional interest
in a Note.
"PROPERTIES" means the real estate held by the Operating Partnerships.
"PROSPECTUS/CONSENT SOLICITATION STATEMENT" means this Prospectus/Consent
Solicitation Statement, together with the supplements and appendices thereto,
filed with the SEC as it may be further supplemented or amended from time to
time.
"PROSPECTUS SUPPLEMENT" means, with respect to each Partnership, the
Supplement to this Prospectus/ Consent Solicitation Statement prepared
specifically for the Investors of that Partnership.
"REAL ESTATE ASSETS" means the real estate and real estate related
investments of the Company, including New Assets.
"RECORD DATE" means , 1998.
"REGISTRATION STATEMENT" means the Registration Statement on Form S-4,
Registration No. 333- , as filed with the SEC by the Company under the
Securities Act to register the offering and sale of Shares and Notes pursuant to
the Transaction, as the same may be amended or supplemented from time to time.
"REGULATIONS" means the Treasury Department regulations promulgated under
the Code.
"REIT" means the classification for federal tax purposes as a real estate
investment trust pursuant to Part II, Subchapter M of Chapter 1 of Subtitle A of
the Code, as now enacted or hereafter amended, including successor statutes and
regulations promulgated thereunder.
"RESERVE INVESTMENTS" means amounts held in each Partnership's reserve
account invested in certain GNMA securities backed by pools of single-family
mortgages.
"RESTRICTED STOCK" means Common Stock issued to the Advisor for the
Incentive Fee on New Assets, which contains the restrictions described in the
Advisory Agreement.
"RETURNS OF CAPITAL" means net proceeds, net of all closing costs (including
without limitation any real estate or selling commissions) but without deduction
for any applicable mortgage indebtedness, from any partial sale or a whole sale
of any asset, and principal repayments on debt obligations; provided, however,
this amount shall not be greater than the Adjusted New Asset Value with respect
to such assets.
"SEC" means the United States Securities and Exchange Commission, also
sometimes referred to as the "Commission."
"SECURITIES ACT" means the Securities Act of 1933, as amended, and all rules
and regulations promulgated thereunder.
"SERVICE" means the United States Internal Revenue Service, also referred to
sometimes as the "IRS."
142
<PAGE>
"SHAREHOLDER" means a holder of Shares.
"SHARES" means shares of the Company's $.001 par value Common Stock proposed
to be issued in connection with the Transaction.
"SPECIAL COMMITTEE" means the committee organized to represent the interests
of the Partnerships and Investors in negotiating the structure terms and
conditions of the Transaction.
"STATE" means any state of the United States of America, and the District of
Columbia.
"SUTRO & CO." means Sutro & Co., Inc.
"TAX ACT" means the Taxpayer Relief Act of 1997, as may be amended from time
to time.
"THE PONDS" means Ponds at Georgetown Limited Partnership.
"TOTAL ASSETS" means the sum of (a) Adjusted Original Asset Value, (b)
Adjusted New Asset Value, and (c) Cash, less any allowance or adjustment for the
permanent impairment of assets as reflected on the financial statements of the
Company.
"TRANSACTION" means the merger of Cap Source I and Cap Source II with and
into the Company pursuant to the terms and conditions set forth in the Merger
Agreement, as more fully described in the Prospectus/Consent Solicitation
Statement.
"TRANSACTION COSTS" means, with respect to the Transaction, the cost of
mailing and printing the Prospectus/Consent Solicitation Statement, any
supplement thereto or other documents related to the Transaction, legal fees not
related to the solicitation of consents, financial advisory fees, investment
fees, appraisal fees, accounting fees, Special Committee expenses, travel
expenses and all other fees related to the preparatory work of the Transaction,
but not including costs that would have otherwise been incurred by the
Partnerships in the ordinary course of business.
"TRUSTEE" means U.S. Bank Trust National Association, as trustee under the
Indenture.
"UNIT" means the ownership interest of an Investor in a Partnership
representing an assigned limited partner interest in a Partnership.
"VALUATION RESEARCH" means Valuation Research Corporation.
143
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
INDEX TO FINANCIAL STATEMENTS OF
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
Report of Independent Public Accountants................................................................... FS-2
Balance Sheet at April 16, 1998............................................................................ FS-3
Notes to Balance Sheet..................................................................................... FS-4
</TABLE>
INDEX TO FINANCIAL STATEMENTS OF THE PARTNERSHIPS
Financial statements and related notes for each of the Partnerships are
included in a separately bound volume provided with this Prospectus/Consent
Solicitation Statement. The index to such financial statements is set forth in
the separately bound volume.
FS-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders
America First Real Estate Investment Company, Inc.
We have audited the accompanying balance sheet of America First Real Estate
Investment Company, Inc. as of April 16, 1998. 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 balance sheet referred to above presents fairly, in all
material respects, the financial position of America First Real Estate
Investment Company, Inc. as of April 16, 1998 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Omaha, Nebraska
April 22, 1998
FS-2
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
BALANCE SHEET
APRIL 16, 1998
<TABLE>
<S> <C>
Asset
Cash.............................................................................. $ 1,000
---------
---------
Stockholders' Equity
Common stock, $.001 par value;
50,000,000 shares authorized
1,000 shares issued and outstanding............................................. $ 1
Preferred stock $.001 par value;
50,000,000 shares authorized
No shares issued or outstanding................................................. --
Additional Paid-In Capital.......................................................... 999
---------
Total Stockholders' Equity...................................................... $ 1,000
---------
---------
</TABLE>
The accompanying notes are an integral part of the balance sheet.
FS-3
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
NOTES TO BALANCE SHEET
APRIL 16, 1998
1. ORGANIZATION
America First Real Estate Investment Company, Inc. (the "Company") was
incorporated in Delaware on February 5, 1998. The Company has not yet commenced
operations.
The Company has issued 1,000 shares of common stock for consideration of
$1,000 to America First Companies L.L.C., an affiliate of the general partners
of Capital Source L.P. and Capital Source II L.P.-A (collectively referred to as
the "Capital Source Funds"). The Company intends to issue up to 3,354,387 shares
of common stock in the ratio of 1% to America First Companies L.L.C. and 99% to
holders of Beneficial Assignment Certificates (BACs) of the Capital Source
Funds.
2. RELATED PARTY TRANSACTIONS
America First Real Estate Advisors L.L.C. (the "Advisor") will manage the
operations and investments of the Company and perform administrative services
for the Company. The Advisor is entitled to receive compensation in the form of
an Acquisition Fee, an Asset Management Fee and an Incentive Fee on New assets
for services rendered under the Advisory Agreement. The Acquisition Fee will be
payable each month in arrears and will be an amount equal to 1% of the increase
in the Company's actual investment in all New Assets, including any costs
related to the acquisition or financing of New Assets but excluding debt which
is incurred or assumed in connection therewith. The Asset Management Fee will be
equal to .475%, on an annual basis, of the Company's Total Assets, calculated as
of the last day of each month, payable by the Company to the Advisor on a
monthly basis. The Incentive Fee on New Assets will be equal to 10% of any
Capital Gain offset by any Capital Loss on New Assets, payable by the Company to
the Advisor on an annual basis in the form of Restricted Stock.
America First Properties Management Company L.L.C. (the "Manager"), will
provide property management services for certain of the multifamily properties
to be obtained by the Company. The Manager will receive a management fee equal
to a stated percentage of the gross revenues generated by the property under
management.
FS-4
<PAGE>
APPENDIX A
FORM OF AGREEMENT AND PLAN OF MERGER
AMONG THE COMPANY, THE GENERAL PARTNERS AND
THE PARTNERSHIPS
This Agreement and Plan of Merger (this "Agreement") dated as of
, 1998, is by and among America First Real Estate Investment
Company, Inc., a Delaware corporation (the "Company"); Capital Source L.P., a
Delaware limited partnership ("Cap Source I"); Capital Source II L.P.-A, a
Delaware limited partnership ("Cap Source II" and together with Cap Source I the
"Partnerships" and individually, a "Partnership"); America First Capital Source
I L.L.C., a Delaware limited liability company; Insured Mortgage Equities, Inc.,
a Delaware corporation (together with America First Capital Source I L.L.C. the
"Cap Source I General Partners"); America First Capital Source II L.L.C.; and
Insured Mortgage Equities II L.P. (together with America First Capital Source II
L.L.C. the "Cap Source II General Partners" and collectively with the Cap Source
I General Partners the "General Partners").
W I T N E S S E T H:
WHEREAS, the Company, the General Partners and the Partnerships desire to
merge the Partnerships and the General Partners with and into the Company,
pursuant to Delaware law, with the Company being the surviving entity (the
"Merger"), as part of the merger by consolidation of the Partnerships and the
Company. The Company has filed a registration statement on Form S-4, No.
333-52117, including all amendments thereto (the "Registration Statement"), with
the Securities and Exchange Commission (the "SEC") pursuant to the Securities
Act of 1933, as amended (the "Act") relating to the Transaction, of which the
Prospectus/Consent Solicitation Statement of the Company (the
"Prospectus/Consent Solicitation Statement") is a part; and
WHEREAS, Section 263 of the General Corporation Law of the State of
Delaware, 8 DEL.C. Section 101 ET SEQ. (the "DGCL") and Section 17-211 of the
Delaware Revised Uniform Limited Partnership Act (the "Partnership Act")
authorize the merger of a Delaware corporation and Delaware limited
partnerships; and
WHEREAS, Section 251 of the DGCL authorizes the merger of Delaware
Corporations; and
WHEREAS, Section 264 of the DGCL and Section 18-209 of the Delaware Limited
Liability Company Act (the "LLC Act") authorize the merger of a Delaware
corporation with Delaware limited liability companies; and
WHEREAS, the Company's Certificate of Incorporation and Bylaws permit, and
resolutions adopted by the Company's Board of Directors authorize, this
Agreement and the consummation of the Merger.
NOW, THEREFORE, for good and valuable consideration, the receipt of which is
hereby acknowledged, the parties to this Agreement covenant and agree as
follows:
ARTICLE I
THE MERGER
Section 1.01. THE MERGER; SURVIVING CORPORATION. Subject to the terms and
conditions set forth in this Agreement, at the Effective Time (as defined in
Section 1.02 below), the Partnerships and the General Partners shall each be
merged with and into the Company, pursuant to Section 17-211(e) of the
Partnership Act, Sections 263, 264, 251 and 103 of the DGCL and Section 18-209
of the LLC Act, and the separate existence of each of the Partnerships and the
General Partners shall cease. The Company shall be the surviving entity (the
"Surviving Corporation") and shall continue to be governed by the DGCL.
A-1
<PAGE>
Section 1.02. EFFECTIVE TIME. In accordance with Section 17-211(e) of the
Partnership Act and Sections 263, 264, 251 and 103 of the DGCL and Section
18-209 of the LLC Act, the Merger shall become effective (the "Effective Time")
upon the filing of the certificate of merger (the "Certificate of Merger") with
the Secretary of State of the State of Delaware, or at such later time, not
later than five business days thereafter, as may be specified in the Certificate
of Merger. All other filings or recordings required by Delaware law in
connection with the Merger shall also be made.
Section 1.03. EFFECT OF THE MERGER. The Merger shall have the effects set
forth in Section 17-211 of the Partnership Act, Section 251, 263, and 264 of the
DGCL and Section 18-209 of the LLC Act.
ARTICLE II
THE SURVIVING CORPORATION
Section 2.01. NAME. The name of the Surviving Corporation shall be America
First Real Estate Investment Company, Inc.
Section 2.02. CERTIFICATE OF INCORPORATION AND BYLAWS. The Certificate of
Incorporation and Bylaws of the Company as in effect immediately prior to the
Effective Time shall be the Certificate of Incorporation and Bylaws of the
Surviving Corporation unless and until amended in accordance with their terms
and applicable law.
Section 2.03. OFFICERS AND DIRECTORS. The officers of the Company
immediately prior to the Effective Time shall continue as officers of the
Surviving Corporation and remain officers until their successors are duly
appointed or their prior resignation, removal or death. The directors of the
Company immediately prior to the Effective Time shall continue as directors of
the Surviving Corporation and shall remain directors until their successors are
duly elected and qualified or their prior resignation, removal or death.
ARTICLE III
CONVERSION OF PARTNERSHIP INTERESTS
Section 3.01. CONVERSION OF LIMITED PARTNER INTERESTS.
(a) At the Effective Time, as a result of the Merger each limited
partner interest ("Unit") in each of the Partnerships shall be converted, in
accordance with the capital accounts of each limited partner of the
Partnerships (the "Investor") and pursuant to the terms of each respective
Partnership's Partnership Agreement (individually, a "Partnership Agreement"
and collectively, the "Partnership Agreements"), into the number of shares
of the Company's Common Stock, $.001 par value per share (the "Common
Stock"), as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF
PARTNERSHIP COMMON STOCK PER UNIT
- ---------------------------------------------------------------------- -----------------------
<S> <C>
Cap Source I.......................................................... .5984
Cap Source II......................................................... .3246
</TABLE>
Each of the Partnerships has one class of Units and all such Units are
held by the Investors.
The number of shares of Common Stock to be issued as a result of the
conversion of Units shall first be multiplied by the number of Units held by
an Investor on the Record Date, as defined in the Prospectus/Consent
Solicitation Statement. No fractional shares of Common Stock will be issued.
Each Investor who would otherwise be entitled to a fractional share (which
entitlement will be determined by combining such Investor's allocation of
shares of Common Stock from each Partnership as to which such Investor is
receiving shares) of Common Stock will instead receive cash equal to $25
multiplied by the fraction.
A-2
<PAGE>
(b) Notwithstanding subparagraph (a) above and subject to the
limitations described herein, Investors who, in connection with the
Transaction, elected to receive the Company's Variable Rate Junior Notes
Callable On or After the Date of Issuance ("Notes"), will, except as
hereinafter provided, receive Notes. In the event Investors elect to receive
Notes in the aggregate principal amount which exceeds $40 million, the Notes
will be allocated first to such Investors who voted against the Transaction,
and any remaining Notes will be allocated on a pro rata basis (in
denominations of $1,000) to those Investors who elected to receive Notes and
either abstained from voting by indicating their abstention on the Consent
Card or voted "YES" in favor of the Transaction. In such event, the
Investors who voted for the Transaction or abstained from voting and who
elected to receive Notes will receive shares of Common Stock in an amount
equal to the difference between the Exchange Value allocable to such an
Investor and the amount of Notes distributed to such an Investor. Subject to
the foregoing limitations, each Unit held by an Investor who elected to
receive Notes shall be converted into the Notes.
Section 3.02. CONSIDERATION TO GENERAL PARTNERS. At the Effective Time,
the Company shall issue 20,397 shares of Common Stock to the Cap Source I
General Partners and 13,152 shares of Common Stock to the Cap Source II General
Partners as consideration for the transfer of all of the assets of the General
Partners, including, but not limited to, such valuable systems, lists, processes
and know-how held by the General Partners, and not as consideration in relation
to any interest in Cap Source I or Cap Source II held or relinquished by any of
the General Partners. Such shares shall be initially issued to Cap Source I and
Cap Source II for the benefit of the General Partners. Upon receipt of the
shares, Cap Source I and Cap Source II shall immediately effectuate a transfer
of the shares to the General Partners as consideration for entering this
Agreement and the transfers described above. The Shares are to be issued to the
General Partners as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES
GENERAL PARTNER OF COMMON STOCK
- --------------------------------------------------------------------------- -----------------
<S> <C>
America First Capital Source I L.L.C....................................... 10,198.5
Insured Mortgage Equities, Inc............................................. 10,198.5
America First Capital Source II L.L.C...................................... 6,576
Insured Mortgage Equities II L.P........................................... 6,576
</TABLE>
No fractional shares of Common Stock will be issued. The General Partners
that would otherwise be entitled to a fractional share of Common Stock will
instead receive cash equal to $25 multiplied by the fraction.
Section 3.03. TAX ASPECTS. For federal income tax purposes, the conversion
of the Units pursuant to Section 3.01(a) of this Agreement shall be deemed a
transfer of the assets of each Partnership to the Company in exchange for the
Common Stock and Notes and a distribution of such Common Stock and Notes in
liquidation of each of the Partnerships pursuant to the terms of each respective
Partnership Agreement in accordance with the provisions of the Partnership
Agreements. The issuance of Common Stock set forth in Section 3.02 of this
Agreement shall be deemed, for federal income tax purposes, transfers of the
assets of the General Partners to the Company in exchange for the Common Stock
listed in Section 3.02 with such Common Stock initially being issued to Cap
Source I and Cap Source II for the benefit of the General Partners.
As to the transfers by the Cap Source II General Partners and America First
Capital Source I L.L.C., the parties intend that transfer of assets by such
persons be an integral part of the organizational plan of the Company and as an
exchange subject to the provisions of Section 351 of the Internal Revenue Code
of 1986, as amended (the "Code"). As to the transfer by Insured Mortgage
Equities, Inc., the parties hereto intend that the transfer of its assets be an
integral part of the organizational plan of the Company and as a transaction
described in Section 368(a)(1)(A) of the Code.
A-3
<PAGE>
Section 3.04. ISSUANCE OF SHARES.
(a) The Company shall designate an exchange agent (the "Exchange Agent")
to act as such in connection with the issuance of certificates representing
Common Stock and Notes pursuant to this Agreement.
(b) As soon as practicable after the Effective Time, the Company shall
cause the Exchange Agent to distribute to each Investor who, in connection
with the Transaction, elected to receive shares of Common Stock, or who made
no election with respect to Common Stock or Notes, and to the General
Partners, certificates representing the number of shares of Common Stock to
which such Investor and the General Partners are entitled pursuant to
Section 3.01(a) and Section 3.02 of this Agreement.
Section 3.05. ISSUANCE OF NOTES. As soon as practicable after the
Effective Time, the Company shall cause the Exchange Agent to distribute to each
Investor who elected to receive Notes in connection with the Transaction, Notes
to which such Investor is entitled pursuant to, and subject to the limitations
set forth in, Section 3.01(b) of this Agreement.
ARTICLE IV
TRANSFER AND CONVEYANCE OF ASSETS AND ASSUMPTION OF LIABILITIES
Section 4.01. TRANSFER, CONVEYANCE AND ASSUMPTION. At the Effective Time,
the Company shall continue in existence as the Surviving Corporation and without
further transfer, succeed to and possess all the rights, privileges and powers
of the General Partners and the Partnerships, and all the assets and property of
whatever kind and character of the General Partners and the Partnerships shall
vest in the Company without further act or deed. Thereafter, the Company, as the
Surviving Corporation, shall be liable for all of the liabilities and
obligations of the General Partners and the Partnerships, and any claim or
judgement against the Partnerships may be enforced against the Company, as the
Surviving Corporation, in accordance with Section 17-211 of the Partnership Act
and Sections 263, 264, 259 and 103 of the DGCL and Section 18-209 of the LLC
Act.
Section 4.02. FURTHER ASSURANCES. If at any time the Company shall
consider or be advised that any further assignment, conveyance or assurance is
necessary or advisable to vest, perfect or confirm of record in the Surviving
Corporation the title to any property or right of the Partnerships, or
otherwise, to carry out the provisions hereof, the proper representatives of the
General Partners and the Partnerships as of the Effective Time shall execute and
deliver any and all proper deeds, assignments and assurances, and do all things
necessary and proper to vest, perfect or convey title to such property or right
in the Surviving Corporation and otherwise to carry out the provisions hereof.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF THE PARTNERSHIPS
The Partnerships each severally represent and warrant to the Company and to
each other (with respect only to the Partnership making the representation and
warranty) as follows:
Section 5.01. VALIDITY OF ACTIONS. Each Partnership (a) is a limited
partnership duly formed, validly existing and in good standing under the laws of
the State of Delaware, (b) has the authority to conduct its business as
currently conducted and to own and operate the properties which it now owns and
operates, (c) is qualified to do business in all jurisdictions in which such
qualification is necessary, and (d) has full power and authority to enter into
this Agreement and to carry out all acts contemplated by it. This Agreement has
been duly executed and delivered on behalf of the Partnerships, and has received
all necessary authorization and is a legal, valid and binding obligation of the
Partnerships, enforceable against the Partnerships in accordance with its terms.
The execution and delivery of this Agreement and
A-4
<PAGE>
consummation of the transactions contemplated by it will not violate any
provision of the Partnership Agreements nor violate, conflict with or result in
any breach of any of the terms, provisions or conditions of, or constitute a
default or cause acceleration of, any indebtedness under any agreement or
instrument to which any of the Partnerships are a party or by which they or
their assets may be bound, or cause a breach of any applicable federal or state
law or governmental regulation, or any applicable order, judgment, writ, award,
injunction or decree of any court or governmental instrumentality.
Section 5.02. PARTNERSHIPS' FINANCIAL STATEMENTS. The financial statements
and schedules of the Partnerships, together with related notes (the "Financial
Statements"), set forth in the Registration Statement of the Company, fairly
present, on the basis stated in the Registration Statement, the financial
position of the Partnerships at the date or for the periods specified in the
Registration Statement. The Financial Statements have been prepared in
accordance with generally accepted accounting principles applied on a consistent
basis ("GAAP"), except to the extent stated therein.
Section 5.03. NO MISSTATEMENTS. The representations of the Partnerships
contained in this Agreement and the information supplied by the Partnerships for
inclusion in the Registration Statement and the Prospectus/Consent Solicitation
Statement do not contain any untrue statement of a material fact or omit to
state any fact necessary to make such representations or information not
materially misleading.
Section 5.04. NO MATERIAL ADVERSE CHANGE. Since the respective dates as to
which information is given in the Registration Statement and the
Prospectus/Consent Solicitation Statement with respect to the Partnerships, and
except as described in the Registration Statement or the Prospectus/Consent
Solicitation Statement, there have been no changes in the business, operations,
properties, assets or the prospects or condition, financial or otherwise, of the
Partnerships which would, in the aggregate, have a material adverse effect on
the business, properties, prospects, profitability, assets or financial
condition of the Partnerships.
Section 5.05. TITLE TO ASSETS. Each Partnership has good and marketable
title to the assets reflected in the most recent balance sheet (the "Balance
Sheet") included in the Financial Statements with respect to such Partnership,
and will hold good and marketable title to such assets, and any assets acquired
by the Partnership prior to the Effective Time, as of the Effective Time, except
for assets disposed of in the ordinary course of business. Such assets, together
with the related goodwill and rights of each Partnership as a going concern,
tangible and intangible, are collectively referred to as the "Assets." Except as
otherwise disclosed in the Balance Sheet or related notes accompanying it, all
of the Assets are owned free and clear of any and all adverse claims, security
interests, charges or other encumbrances or restrictions of every nature, except
liens for current taxes not yet due and payable or landlords' liens as provided
for in the relevant leases or by applicable law.
Section 5.06. LIABILITIES OF THE PARTNERSHIPS. The Partnerships have no
material liabilities, including, without limitation, liabilities for state or
federal income, withholding or other taxes, except to the extent reflected,
reserved against, or provided for in the Balance Sheet, and except for any
material liabilities disclosed in the Prospectus/Consent Solicitation Statement
or any other obligations incurred after , 1998 in the ordinary course
of business which subsequently incurred obligations are of an amount and nature
as to be capable of being discharged from the operations of the Partnerships
without requiring additional equity or borrowing.
Section 5.07. REPRESENTATIONS AND WARRANTIES PERTAINING TO REAL
PROPERTY. For purposes of the following representations and warranties, "Real
Property" shall mean those parcels of real property of a Partnership as listed
in the Prospectus/Consent Solicitation Statement and "Improvements" shall mean
any building, structure or other improvements situated on the Real Property.
Each Partnership makes the following representations and warranties only with
respect to the Real Property owned by it as specified in the Prospectus/Consent
Solicitation Statement.
(a) To the best knowledge of each Partnership, all assumptions of the
appraisers of the Real Property (the "Appraisers") used by the Appraisers in
preparing the appraisals of the Real Property,
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as the same may have been revised (the "Appraisals"), are reasonable
assumptions. All information provided by each Partnership to the Appraisers
with respect to the Real Property was true and correct as of the date given.
(b) To the best knowledge of each Partnership, there is at present no
material violation of any law, ordinance, rule, requirement, resolution,
policy statement or regulation (including, without limitation, those
relating to land use, subdivision, zoning, environmental, occupational
health and safety, water, and building and fire codes) of any governmental
authority (collectively, "Governmental Regulations") applicable to the
construction, alteration, rehabilitation, maintenance, use, operation or
sale of any of the Real Property, which violation would have a material
adverse impact on the use of the Real Property or the Improvements. None of
the Partnerships have received notice or have knowledge that any
governmental authority, or any employee or agent thereof, considers the
operations, use or ownership of any of the Improvements to violate or have
violated in a material manner any Governmental Regulation, or that any
investigation has been commenced or is contemplated regarding such possible
violation.
(c) To the best knowledge of each Partnership, such Partnership has
neither received notice nor has knowledge of any plan or study of any
governmental authority which would materially adversely affect the use of
the Real Property or the Improvements for their intended uses, or result in
any public improvements which will result in any material charge being
levied against, or any material lien assessed upon, all or any portion of
such Real Property or Improvements.
(d) To the best knowledge of each Partnership, such Partnership has good
and marketable title to the Real Property and Improvements owned by it, free
and clear of all liens, encumbrances, claims, covenants, conditions and
restrictions, easements, rights of way, charges and any other exceptions to
or defects of title ("Encumbrances"), except for (i) those matters disclosed
in the Prospectus/Consent Solicitation Statement or the Title Insurance
Policy issued to each Partnership with respect to each Real Property
(collectively, the "Title Policies"), and (ii) those matters created by
third parties which are the liability of the lessee of such Real Property
and Improvements, or, in the absence of acceptance of responsibility by such
lessee, have been or will be resolved by the Partnership.
(e) Except as disclosed in the Prospectus/Consent Solicitation Statement
or the Title Policies, to the best knowledge of each Partnership, there are
no delinquent taxes, assessments, charges, debts, liabilities, claims or
obligations arising from the construction, design, development, ownership,
maintenance or operation of, or otherwise relating to, the Real Property or
the Improvements, which matters could give rise to any mechanic's or
materialmen's or other statutory or common law lien against such Real
Property or Improvements or any part thereof which, individually or in the
aggregate, would have a material adverse impact on the value of such Real
Property and Improvements.
(f) Except as disclosed in the Prospectus/Consent Solicitation
Statement, to the best knowledge of each Partnership, none of the Real
Property, which for purposes of this paragraph shall include, without
limitation, subsurface soil and ground water, contains any substance,
including, without limitation, any asbestos, formaldehyde, radioactive
substance, hydrocarbons, industrial solvents, flammables, explosives, and
any hazardous substance or toxic material, which could presently or at any
time in the future cause a material detriment to or materially impair the
value or beneficial use of the Real Property, or constitute or cause a
health, safety or environmental hazard on or relating to the Real Property
or to any person who may enter on the Real Property or require remediation
at the behest of any governmental agency (collectively, "Hazardous
Materials"). Except as disclosed in the Prospectus/Consent Solicitation
Statement, none of the Partnerships have received notice that the ownership,
operation, use and condition of any of the Real Property is in violation of
any federal, state or local law, ordinance or regulation pertaining to
industrial hygiene, Hazardous Materials or environmental protection. Except
as disclosed in the Prospectus/Consent Solicitation Statement, to the best
knowledge of each Partnership, there is no proceeding or action pending or,
to its actual
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knowledge, threatened by any person or governmental agency regarding the
environmental condition of any of the Real Property.
Section 5.08. INSURANCE. Either each Partnership, or, in the absence of
each Partnership so doing, the respective tenants of the Real Property and
Improvements owned by each Partnership, or, where applicable, each borrower from
each Partnership which holds a loan secured by real property owned by such
borrower, carries, to the extent deemed reasonable by the General Partners under
the circumstances, comprehensive liability, fire, extended coverage and rental
loss insurance with respect to the Partnerships' properties with policy
specifications and insured limits customarily carried for similar properties.
All such policies are currently in effect and will remain in effect after the
Merger.
Section 5.09. TAXES. Each Partnership has filed timely all federal, state
and local tax returns which it is required to file, has provided to its
Investors all required Form K-1's and such other tax forms as may be required by
federal, state or local authorities, and has no outstanding liability for any
federal, state or local taxes or interest or penalties thereon, whether disputed
or not, except taxes not yet payable which have been provided for in accordance
with GAAP and are disclosed in the Financial Statements.
Section 5.10. ACTIONS PENDING. Except as disclosed in the
Prospectus/Consent Solicitation Statement: (a) there are no actions, suits,
proceedings or claims pending or threatened against the Partnerships or the
general partner of the Partnerships which, if determined adversely to such
Partnerships, could (i) have a material adverse effect on the Partnerships, the
Assets or the business of the Partnerships when taken as a whole, or (ii)
prevent or delay the consummation of any of the transactions contemplated by
this Agreement; (b) no Partnership, to the best of its knowledge, is the subject
of any pending or threatened investigation relating to any aspect of such
Partnership's operations by any federal, state or local governmental agency or
authority; and (c) each Partnership, to the best of its knowledge, is not and
has not been the subject of any formal or informal complaint, investigation or
inspection under the Equal Employment Opportunity Act or the Occupational Safety
and Health Act (or their state or local counterparts) or by any other federal,
state or local authority.
Section 5.11. APPRAISAL OF PARTNERSHIPS. To the best knowledge of each
Partnership, the information furnished by such Partnership to the appraisers
named in the Prospectus/Consent Solicitation Statement for the purposes of
determining the appraised value of the Partnerships is accurate and complete in
all material respects.
ARTICLE VI
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to the Partnerships as follows:
Section 6.01. VALIDITY OF ACTIONS. The Company (a) is duly organized,
validly existing and in good standing under the laws of the State of Delaware,
(b) has the authority to conduct its business as currently conducted, (c) is
qualified to do business in all jurisdictions in which such qualification is
necessary, and (d) has full power and authority to enter into this Agreement and
to carry out all acts contemplated by it, and (e) has no commitment to sell or
otherwise transfer any of its assets except as contemplated under Section 6.04
and except in the ordinary course of business. This Agreement has been duly
executed and delivered on behalf of the Company, has received all necessary
authorization and is a legal, valid and binding obligation of the Company,
enforceable against the Company in accordance with its terms. The execution and
delivery of this Agreement and consummation of the transactions contemplated by
it will not violate any provision of the Certificate of Incorporation or Bylaws
of the Company nor violate, conflict with or result in any breach of any of the
terms, provisions or conditions of, or constitute a default or cause
acceleration of, any indebtedness under any agreement or instrument to which the
Company is a party or by which it or its assets may be bound, or cause a breach
of any applicable federal or state law or regulation, or any applicable order,
judgment, writ, award, injunction or decree of any court or governmental
instrumentality.
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Section 6.02. CAPITAL STOCK OF THE COMPANY. The authorized capital stock
of the Company consists of 100,000,000 shares of capital stock, of which there
are 50,000,000 shares of Common Stock and 50,000,000 shares of Preferred Stock
authorized. One thousand shares of Common Stock, having an aggregate par value
of $1.00, are issued and outstanding as of the date of this Agreement, and such
shares of Common Stock constitute all of the issued and outstanding capital
stock of the Company outstanding as of the date hereof. The shares of Common
Stock of the Company to be delivered to the Investors pursuant to this Agreement
have been duly and validly authorized, and when issued and delivered, will be
fully paid and nonassessable. As of the date hereof, the Company has no binding
commitment to issue any capital stock, except as otherwise required pursuant to
the terms of the [Merger Agreement] and [Asset Transfer Agreement].
Section 6.03. MISSTATEMENTS. The representations of the Company contained
in this Agreement and the information regarding the Company contained in the
Registration Statement and the Prospectus/ Consent Solicitation Statement do not
contain any untrue statement of a material fact or omit to state any fact
necessary to make such representations or information not materially misleading.
Section 6.04. INVESTMENT OF CASH. Upon consummation of the Merger, the
Company will invest the cash it receives from the Partnerships so that not more
than 80% of the Company's assets will consist of assets listed under Section
351(e)(1) of the Code.
ARTICLE VII
COVENANTS OF THE PARTIES
Section 7.01. PROHIBITED ACTS. Pending consummation of the Merger or prior
to termination of this Agreement, the Partnerships agree that, without prior
written consent of the Company, given in a letter which specifically refers to
this Section of the Agreement, the Partnerships shall:
(a) use their reasonable efforts so as not to perform any act, or omit
to take any action that would make any of their representations made above
or any information pertaining to them in the Registration Statement or the
Prospectus/Consent Solicitation Statement inaccurate or materially
misleading as of the Effective Time;
(b) not enter into any commitment, contract or other transaction in any
way affecting any of the Partnerships' business, except to carry out its
business in the ordinary course, and as contemplated by this Agreement or in
the Prospectus/Consent Solicitation Statement;
(c) not make any loans or advances to, or investments in, any other
corporation, partnership or other legal entity or to any other persons
except in the ordinary course of business;
(d) not borrow money for any purpose or agree to become contingently
liable, by guaranty or otherwise, for the obligations or indebtedness of any
other person other than in the ordinary course of business; and
(e) not mortgage, pledge, encumber, sell, lease or transfer any of the
Assets other than in the ordinary course of business.
Section 7.02. NOTICE. Pending the consummation of the Merger or prior to
termination of this Agreement, each party agrees that it will promptly advise
the other of the occurrence of any condition or event which would make any of
its representations contained in this Agreement or the Prospectus/Consent
Solicitation Statement inaccurate, incorrect, or materially misleading.
Section 7.03. ADDITIONAL DOCUMENTS. At the request of any party, each
party will execute and deliver any additional documents and perform in good
faith such acts as reasonably may be required in order to consummate the
transactions contemplated by this Agreement.
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ARTICLE VIII
CONDITIONS TO THE MERGER
The obligation of the Company, on the one hand, and each Partnership on the
other hand, to consummate the Merger shall be subject to compliance with or
satisfaction of the following conditions:
Section 8.01. BRING DOWN. The representations and warranties set forth in
this Agreement shall be true and correct in all material respects at and as of
the Effective Time as if then made (except for those representations and
warranties made as of a given date, which shall continue to be true and correct
as of such given date), as evidenced by a certificate made by the General
Partners of each Partnership and the President, Chief Executive Officer or Chief
Operating Officer of the Company, as of the Effective Time.
Section 8.02. COMPLIANCE. The Company, each of the General Partners and
each Partnership shall have complied with all of the covenants and agreements in
this Agreement on its part to be complied with as of or prior to the Effective
Time.
Section 8.03. PARTNERSHIP APPROVALS. The Investors holding a majority of
outstanding Units of Cap Source I and Cap Source II shall have approved the
Transaction and the Dissenting Investors of the Partnerships have not elected to
receive Notes exceeding $40,000,000 in principal amount.
Section 8.04. STOCK EXCHANGE LISTING. At or before the Effective Time, the
Common Stock to be issued in the Merger shall be approved for listing on the New
York Stock Exchange, subject to official notice of issuance.
Section 8.05. CONSENTS OBTAINED. All necessary consents, waivers,
approvals, authorizations or orders required to be obtained, and the making of
all filings required to be made by any party to the Merger for the
authorization, execution and delivery of this Agreement and the Certificate and
Plan of Merger between the Company, the General Partners and the Partnerships,
and the consummation of the transactions contemplated thereby on or before (and
remain in effect at) the Effective Time shall have been obtained or made.
Section 8.06. NO MATERIAL ADVERSE CHANGE. Since the respective dates as to
which information is given in the Registration Statement and the
Prospectus/Consent Solicitation Statement, there shall not have occurred or been
threatened any material adverse changes in the overall business or prospects of
the Partnerships or in the tax or other regulatory provisions applicable to the
Partnerships, the General Partners or the Company, and the Company shall not
have become aware of any facts that, in the sole judgment of the Company and the
General Partners, have or may have a material effect, whether adverse or
otherwise, on the Partnerships, taken as a whole, the Transaction, or the value
to the Company of the properties of the Partnerships, taken as a whole.
Section 8.07. OPINIONS AND LETTERS. The Company shall have received, on or
prior to the Effective Time, an opinion of counsel, which shall not have been
withdrawn as of the Effective Time, to the effect that for federal income tax
purposes the Merger will be an exchange subject to the nonrecognition provisions
of Section 351 of the Code; provided, however, that for purposes of this Section
8.07, the Merger shall include only the merger of the Partnerships into the
Company and the related transfer of assets by the Partnerships to the Company.
Section 8.08. NO STATUTE, RULE OR REGULATION AFFECTING CONSUMMATION. At
the Effective Time, there shall be no statute, rule, regulation, injunction or
court order enacted or issued by the United States or any State, or by a court,
which prohibits or challenges the consummation of the Transaction.
Section 8.09. NO DECLARATIONS. At the Effective Time, there shall be no
declaration of suspension of trading in, or limitation on prices for, securities
generally on the New York Stock Exchange, declaration of a banking moratorium by
federal or state authorities or any suspension of payments by banks in the
United States (whether mandatory or not) or of the extension of credit by
lending institutions in the United States, or commencement of war, armed
hostility, or other international or national calamity directly or indirectly
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involving the United States, which war, hostility or calamity, in the sole
judgment of the Company, would have a material adverse effect on the business
objectives of the Company, or, in the case of any of the foregoing existing on
the date of the Prospectus/Consent Solicitation Statement, any material
acceleration or worsening thereof.
Section 8.10. EFFECTIVENESS OF REGISTRATION STATEMENT. At or prior to the
Effective Time, the Registration Statement shall have been declared effective,
no stop order suspending the effectiveness of the Registration Statement shall
have been issued, no proceedings for such purpose shall have been initiated, and
all necessary approvals under state securities or blue sky laws shall have been
received.
ARTICLE IX
OTHER AGREEMENTS
Section 9.01. WAIVER BY GENERAL PARTNERS. Immediately prior to the
Effective Time, the General Partners of the Partnerships shall waive all rights
to any fees not accrued to the Effective Time. The General Partners each further
acknowledge that they have no rights to additional distributions of fees or
proceeds of sale or liquidation by the Partnerships.
Section 9.02. INDEMNIFICATION.
(a) To the fullest extent permitted by law, the Partnerships and the
General Partners (the "Indemnifying Parties"), jointly and severally, agree
to defend, indemnify and hold harmless the Company and its directors,
officers, employees and agents (the "Indemnified Parties") from and against
any losses, claims, damages or liabilities (including, without limitation,
attorneys' fees and disbursements) to which such Indemnified Party may
become subject under the Act, the Securities Exchange Act of 1934, as
amended, or otherwise, insofar as such losses, claims, damages or
liabilities (or actions with respect thereof arise out of or are based upon
an untrue statement or an alleged untrue statement of a material fact
contained in the Registration Statement, the Prospectus/Consent Solicitation
Statement, or any amendment or supplement to such documents, or arise out of
or are based upon the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the
statements therein not misleading, or to the extent that such losses,
claims, damages or liabilities (including, without limitation, attorneys'
fees and disbursements) result from a breach by an Indemnifying Party of the
representations and warranties of the Partnerships contained in Article V of
this Agreement.
(b) The Indemnified Parties shall give (or cause to be given) to the
Indemnifying Parties notice of claim or matter for which indemnity is (or
will be) sought under this Section 9.02; such notice shall be given promptly
after the Indemnified Parties receive actual notice or knowledge of the
claim or matter that is subject to indemnification. With respect to any
claim asserted by a third party against any Indemnified Parties for which
indemnity is sought, the relevant Indemnifying Party shall have the right to
employ counsel reasonably acceptable to the relevant Indemnified Parties to
defend against such assertion, and such Indemnifying Parties shall have the
right to compromise or otherwise settle any such action or claim only with
the prior written consent of the relevant Indemnified Party, which shall not
be unreasonably withheld.
(c) This Section 9.02 shall survive the Merger for a period of three (3)
years from the Effective Time.
ARTICLE X
TERMINATION; AMENDMENT; WAIVER
Section 10.01. TERMINATION. This Agreement and the transactions
contemplated hereby may be terminated at any time prior to the filing of the
Certificate of Merger with the Secretary of State of the State of Delaware, (a)
by mutual consent of the Board of Directors of the Company and the General
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Partners of the Partnerships, (b) by action of the Board of Directors of the
Company in the event of a failure of a condition to the obligations of the
Company set forth in Article VIII of this Agreement, (c) by action of the
General Partners of the Partnerships in the event of a failure of a condition to
the obligations of the Partnerships set forth in Article VIII of this Agreement,
or (d) by action of the Board of Directors of the Company or of the General
Partners of the Partnerships in the event that the Merger is not consummated
prior to , 1998 or such later date as the parties shall mutually
agree in writing.
Section 10.02. EFFECT OF TERMINATION. If this Agreement is terminated
pursuant to Section 10.01, this Agreement shall become void and of no effect
with no liability on the part of any party hereto.
Section 10.03. AMENDMENT. The parties hereto may, by written agreement,
amend this Agreement at any time prior to the filing of the Certificate of
Merger with the Delaware Secretary of State, such amendment to be approved by
the parties hereto; provided that, after the approval of the Merger by the
Investors holding a majority of the Units of each Partnership no amendment shall
be made which alters or changes (a) the amount or kind of consideration which
the Investors of each Partnership are entitled to receive upon conversion of the
Units of each Partnership, (b) the Certificate of Incorporation of the Company,
or (c) the terms and conditions of this Agreement if such alteration or change
would have an adverse effect on the Investors of each Partnership or the
shareholders of the Company.
Section 10.04. WAIVER. At any time prior to the Effective Time, any party
to this Agreement may extend the time for the performance of any of the
obligations or other acts of any other party hereto, or waive compliance with
any of the agreements of any other party or with any condition to the
obligations hereunder, in each case only to the extent that such obligations,
agreements and conditions are intended for its benefit.
ARTICLE XI
MISCELLANEOUS
Section 11.01. EXPENSES. The expenses associated with the Merger shall be
paid as set forth in the Prospectus/Consent Solicitation Statement. Any
additional expenses associated with the Asset Transfer shall be paid by the
Company. Notwithstanding the foregoing, the Company shall have no obligation to
pay any personal expense of any beneficial owner of a Transferor or any expense
of a Transferor not a result of transactions contemplated under this Agreement.
Section 11.02. NOTICES. All notices or other communications required or
permitted under the terms of this Agreement by any party shall be made in
writing and shall be delivered by first class mail or by personal delivery,
postage or fees prepaid, to the other parties at America First Companies L.L.C.,
Attn: Paul L. Abbott, 399 Park Avenue, Floor 36, New York, New York 10022, with
a copy to Kutak Rock, 717 17th Street, Suite 2900, Denver, Colorado 80202,
Attention: Paul E. Belitz, or to such other address as any of the parties hereto
may designate by notice to the others.
Section 11.03. NON-ASSIGNABILITY. This Agreement shall not be assignable
by any of the parties to this Agreement.
Section 11.04. ENTIRE AGREEMENT. This Agreement contains the parties'
entire understanding and agreement with respect to its subject matter, and any
and all conflicting or inconsistent discussions, agreements, promises,
representations and statements, if any, between the parties or their
representatives that are not incorporated in this Agreement shall be null and
void and are merged into this Agreement.
Section 11.05. COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall constitute an original, but all of which
together shall constitute a single agreement.
Section 11.06. GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of Delaware, without giving
effect to conflicts of law principles.
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Section 11.07. HEADINGS. The various section headings are inserted for
purposes of reference only and shall not affect the meaning or interpretation of
this Agreement or any provision hereof.
Section 11.08. GENDER; NUMBER. All references to gender or number in this
Agreement shall be deemed interchangeably to have a masculine, feminine, neuter,
singular or plural meaning, as the sense of the context requires.
Section 11.09. SEVERABILITY. The provisions of this Agreement shall be
severable, and any invalidity, unenforceability or illegality of any provision
or provisions of this Agreement shall not affect any other provision or
provisions of this Agreement, and each term and provision of this Agreement
shall be construed to be valid and enforceable to the full extent permitted by
law.
Section 11.10. AUTHORIZATION. The General Partners (a) shall be
authorized, at such time in their full discretion as they deem appropriate, to
execute, acknowledge, verify, deliver, file and record, for and in the name of
the Partnerships and, to the extent necessary, the General Partners and the
Investors, any and all documents and instruments, and (b) shall do and perform
any and all acts required by applicable law or which the General Partners deem
necessary or advisable to effectuate the Merger.
Section 11.11. LIMITATIONS OF REMEDIES. If any party hereto becomes aware,
prior to the closing, of a breach of any representation, warranty or covenant
contained in this Agreement, the sole remedy of the nonbreaching party for such
breach shall be limited to termination of this Agreement.
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IN WITNESS WHEREOF, the undersigned have caused this Agreement to be
executed by an officer duly authorized to do so, all as of the day and year
first above written.
AMERICA FIRST REAL ESTATE
INVESTMENT COMPANY, INC.,
a Delaware corporation
By
--------------------------------------
-----------------------------------------------------------------------------,
President
CAPITAL SOURCE L.P., a Delaware
limited
partnership
By:
--------------------------------------
General Partner
By
-----------------------------------
----------------------------------------------------------------------------,
President
By:
--------------------------------------
General Partner
By
-----------------------------------
----------------------------------------------------------------------------,
President
CAPITAL SOURCE II L.P.-A, a Delaware
limited
partnership
By:
--------------------------------------
General Partner
By
-----------------------------------
----------------------------------------------------------------------------,
President
By:
--------------------------------------
General Partner
By
-----------------------------------
----------------------------------------------------------------------------,
President
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AMERICA FIRST CAPITAL SOURCE I L.L.C.,
a Delaware limited liability company
By
--------------------------------------
-----------------------------------------------------------------------------,
President
INSURED MORTGAGE EQUITIES INC.,
a Delaware corporation
By
--------------------------------------
-----------------------------------------------------------------------------,
President
AMERICA FIRST CAPITAL SOURCE II,
L.L.C.
a Delaware limited liability company
By
--------------------------------------
-----------------------------------------------------------------------------,
President
INSURED MORTGAGE EQUITIES II L.P.,
a Delaware limited partnership
By
--------------------------------------
General Partner
By
------------------------------------
----------------------------------------------------------------------------,
President
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APPENDIX B
FORM OF
FAIRNESS OPINION
May 7, 1998
The Special Committee of
the Board of Managers of America First Companies L.L.C.
Mr. George J. Kubat
4601 South 76th Street
Omaha, NE 68132
Dr. Martin A. Massengale
University of Nebraska
Lincoln, NE 68583
America First Real Estate
Investment Company, Inc.
Suite 400
1004 Farnam Street
Omaha, NE 68102
Capital Source L.P. and
Capital Source II L.P.-A
Suite 400
1004 Farnam Street
Omaha, NE 68102
Ladies and Gentlemen:
You have requested Sutro & Co., Inc.'s ("Sutro & Co.") opinion as investment
bankers as to the fairness, from a financial point of view, of the consideration
to be received by the holders (the "Investors") of beneficial assignment
certificates representing assigned limited partnership interests (the "Units")
in Capital Source L.P. ("Cap Source I") and Capital Source II L.P.-A ("Cap
Source II") (collectively, the "Partnerships"), in connection with the proposed
merger (the "Transaction") of Cap Source I and Cap Source II with and into
America First Real Estate Investment Company, Inc. (the "Company"), a newly
formed Delaware corporation that intends to qualify as a "C" Corporation for
federal income tax purposes.
Sutro & Co. has been advised by the Partnerships and the Company that in
connection with the proposed Transaction, (a) Investors will receive, at their
election and subject to certain limitations, either shares of the Company's
$0.001 par value common stock (the "Shares" or "Consideration") or Variable Rate
Junior Notes Callable On or After the Date of Issuance (the "Notes"), (b) up to
2,019,282 Shares have been allocated to Investors in Cap Source I in exchange
for the Investors' Units and up to 1,302,056 Shares have been allocated to
Investors in Cap Source II in exchange for the Investors' Units, (c) up to
33,549 Shares or 1.00% of the pro forma outstanding Shares immediately following
the consummation of the Transaction have been collectively allocated to Insured
Mortgage Equities, Inc. and America First Capital Source I, LLC (together, the
"Cap Source I General Partners") and Insured Mortgage Equities, Inc. and America
First Capital Source II, LLC (together, the "Cap Source II General Partners" and
collectively with the Cap Source I General Partners, the "General Partners") and
(d) the Company will enter into an advisory agreement (the "Advisory Agreement")
with America First Real Estate Advisors LLC (the "Advisor") to manage the
Company.
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Sutro & Co., in conducting its review and arriving at its opinion, noted
that the exchange ratios (the "Exchange Ratios") for Cap Source I and Cap Source
II in the Transaction are based on (i) the principal amount of the investments
in FHA loans and GNMA certificates at December 31, 1997 in the audited Parent
Company Only Condensed Balance Sheets contained in the Annual Reports on Form
10-K for 1997 for each of the Partnerships, (ii) the value of the Partnerships'
investments in the operating partnerships (that owned the underlying real estate
properties of each of the Partnerships) based on certain appraisals prepared by
Valuation Research dated December 31, 1997 (the "Appraisals"), and (iii) the
market values of the Partnerships' remaining assets and liabilities at December
31, 1997 and before transaction costs or other costs associated with the
Transaction (individually or collectively the "Exchange Values"). The Exchange
Ratios relating to the Exchange Values for Cap Source I and Cap Source II are
used to determine the allocation of Shares to be received by the Investors in
Cap Source I and Cap Source II in the Transaction and the principal allocation
of the Notes to be received by Investors in Cap Source I and Cap Source II in
the Transaction.
Additionally, Sutro & Co. was requested to provide an opinion as to the
fairness, from a financial point of view, of the principal allocation of the
Notes that may be elected by the Investors. As used herein, principal allocation
refers solely to the method of allocation, as determined by the Exchange Values,
of the Notes among the investors in the Partnerships. Sutro & Co. in arriving at
its opinion as to the fairness, from a financial point of view, of the
Consideration to be received by the Investors, assumes that the maximum amount
of Notes that may be issued in the Transaction is $40.0 million.
Based upon and subject to the foregoing and following, Sutro & Co. is of the
opinion, as investment bankers, that, as of the date hereof, the Consideration
to be received by the Investors and the General Partners collectively, the
allocation of such Consideration among the Investors and the General Partners,
and the principal allocation of the Notes, in the Transaction, is fair to the
Investors and the General Partners from a financial point of view.
Sutro & Co., as part of its investment banking business, is regularly
engaged in the evaluation of capital structures, the valuation of businesses and
their securities in connection with mergers and acquisitions, firm commitment
underwritings, secondary distributions of listed and unlisted securities,
private placements, financial restructurings and other financial services. Sutro
& Co. is currently acting as a financial advisor to the Special Committee of the
Board of Managers of America First Companies L.L.C. (the "Special Committee") in
connection with the proposed Transaction and will receive a fee for delivering
this opinion and for performing those advisory services. The Partnerships have
agreed to indemnify Sutro & Co. against certain liabilities arising out of or in
connection with the services rendered by Sutro & Co. under such engagement.
Sutro & Co., in the ordinary course of business, may in the future trade
securities of the Company for its own account or for the accounts of its
customers, and accordingly, may at any time hold a long or short position in
those securities.
Sutro & Co., in arriving at its opinion, reviewed and analyzed, among other
things, the following: (a) the Registration Statement on Form S-4 of the Company
as filed on May 7, 1998, including the Preliminary Prospectus/Consent
Solicitation Statement included therein, (b) the Appraisals, (c) individual
Partnership Annual Reports and Reports on Form 10-K for the years ended December
31, 1996 and December 31, 1997, (d) the Prospectus of Capital Source I dated
January 10, 1986, (e) the Prospectus of Capital Source II dated February 6,
1987, (f) the Agreement and Plan of Merger among the Partnerships, the General
Partners and the Company, (g) certain other publicly available business,
financial and other information concerning the Partnerships, (h) certain
internal information, primarily financial in nature (including analytical
models, projections, forecasts, estimates and analyses) prepared by or on behalf
of the management of the Partnerships, and (i) certain information provided to
us by the management of the Partnerships concerning the distributions on, the
trading of and the trading market for, the equity securities of the
Partnerships.
In the course of Sutro & Co.'s engagement, Sutro & Co. held discussions with
the senior management of the Partnerships concerning the historical, current and
projected future operations, business plans,
B-2
<PAGE>
financial conditions and results, and prospects of the Partnerships.
Additionally, Sutro & Co. has discussed with representatives of Valuation
Research, the results, methodology and limitations of the Appraisals. Sutro &
Co. has not, however, independently verified the accuracy or completeness of the
Appraisals.
In conducting its review, Sutro & Co. has relied upon and assumed the
accuracy and completeness of the financial and other information, including the
Appraisals, provided to Sutro & Co. or which were publicly available and have
not attempted to verify the same. Sutro & Co. has relied upon the statements and
information provided by the management of the Partnerships as to the
reasonableness and achievability of the financial and operating forecasts and
projections (and the assumptions and bases therefor) provided to Sutro & Co.
While the financial models and the financial projections, that were provided by
the management of the Partnerships, that project future results of the
Partnerships are inherently subject to uncertainty, we have assumed that such
forecasts and projections are the best currently available estimates and good
faith judgments of the management of the Partnerships as to the future
performance of the Partnerships.
In rendering its opinion, Sutro & Co. notes that the consummation of the
proposed Transaction is conditioned upon, among other things, the approval of
the majority of both Partnerships. Sutro & Co. is not recommending or
disapproving of any action that may be taken by the Investors, the Partnerships,
the Company, the Advisor or any other person in regard to the Transaction. This
opinion does not constitute a recommendation of the proposed Transaction over
any alternative Transactions which may be possible for the Partnerships and does
not address the Partnerships' underlying business decision to effect the
proposed Transaction. Furthermore, our analysis in this matter has not
considered any other aspect of the proposed Transaction or any agreement or
other matters, which include, but are not limited to, the terms or fairness of
the Advisory Agreement except with respect to the fees payable to the Advisor.
Sutro & Co. was not asked to opine on and is not expressing an opinion as to:
(a) the terms of the Transaction, (b) the tax consequences of the Transaction to
the Investors, and (c) the prices at which the Company's securities may trade at
in the future.
In connection with this opinion, we have assumed that the documents to be
prepared and used to effect the Transaction will do substantially on the terms
set forth in the Agreement and Plan of Merger among the Partnerships, the
General Partners and the Company. Sutro & Co. has not participated in the
negotiation of the Transaction or provided any legal or other advice with
respect to the Transaction except as otherwise described herein or to providing
advice regarding the Advisory Agreement between the Company and the Advisor.
Sutro & Co.'s opinion is necessarily based upon conditions as they exist and
can be evaluated as of the date hereof and the information made available to
Sutro & Co. as of the dates that such information was prepared and based upon.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to a partial analysis or summary description. Sutro &
Co. has advised the Partnerships that its entire analysis must be considered as
a whole and that selecting portions of its analyses and the factors considered
by it, without considering all analyses and factors, could create an incomplete
view of the evaluation process underlying its opinion.
It is understood and agreed that this opinion is provided solely for the use
of the Committee and the Partnerships as one element of their consideration of
the Transaction, and may not be used for any other purpose or any other party,
or otherwise referred to, relied upon, quoted, summarized or circulated, except
with Sutro & Co.'s written consent. This opinion may be reproduced in full in
the Company's Prospectus/ Consent Solicitation Statement pertaining to the
Transaction.
/s/ Sutro & Co., Inc.
Sutro & Co., Inc.
B-3
<PAGE>
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY
OTHER THAN THE EXCHANGE NOTES OFFERED HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO
SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY OF THE EXCHANGE NOTES TO ANY
PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR
SOLICITATION TO SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT
THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE
DATE HEREOF.
UNTIL , 1998 (90 DAYS AFTER COMMENCEMENT OF THE EXCHANGE OFFER),
ALL DEALERS EFFECTING TRANSACTIONS IN THE EXCHANGE NOTES, WHETHER OR NOT
PARTICIPATING IN THE EXCHANGE OFFER, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
<PAGE>
------------------------
FINANCIAL STATEMENT SUPPLEMENT
TO
PROSPECTUS/CONSENT SOLICITATION STATEMENT
---------------
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
CAPITAL SOURCE L.P.
Management's Discussion and Analysis of Financial Condition and Results of Operations as of December 31,
1997..................................................................................................... 1
Report of Independent Public Accountants................................................................... 7
Consolidated Balance Sheets as of December 31, 1997 and 1996............................................... 9
Consolidated Statements of Income for the Years Ended December 31, 1997, 1996, 1995........................ 10
Consolidated Statements of Partners' Capital from December 31, 1994 to December 31, 1997................... 11
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996, and 1995................ 12
Notes to Financial Statements.............................................................................. 13
Schedule III Real Estate and Accumulated Depreciation for the Years Ended December 31, 1997 and 1996....... 22
Management's Discussion and Analysis of Financial Condition and Results of Operations as of March 31,
1998..................................................................................................... 25
Consolidated Balance Sheets as of March 31, 1998 (Unaudited)............................................... 29
Consolidated Statements of Income for the Quarter Ended March 31, 1998 (Unaudited)......................... 30
Consolidated Statements of Partners' Capital for the Quarter Ended
March 31, 1998 (Unaudited)............................................................................... 31
Consolidated Statements of Cash Flows for the Quarter Ended March 31, 1998 (Unaudited)..................... 32
Notes to Financial Statements.............................................................................. 33
CAPITAL SOURCE II L.P.-A
Management's Discussion and Analysis of Financial Condition and Results of Operations as of December 31,
1997..................................................................................................... 41
Report of Independent Public Accountants................................................................... 46
Consolidated Balance Sheets as of December 31, 1997 and 1996............................................... 48
Consolidated Statements of Income for the Years Ended December 31, 1997, 1996, 1995........................ 49
Consolidated Statements of Partners' Capital from December 31, 1994 to December 31, 1997................... 50
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996, and 1995................ 51
Notes to Financial Statements.............................................................................. 52
Schedule III Real Estate and Accumulated Depreciation for the Years Ended December 31, 1997 and 1996....... 60
Management's Discussion and Analysis of Financial Condition and Results of Operations as of March 31,
1998..................................................................................................... 63
Consolidated Balance Sheets as of March 31, 1998 (Unaudited)............................................... 67
Consolidated Statements of Income for the Quarter Ended March 31, 1998 (Unaudited)......................... 68
Consolidated Statements of Partners' Capital for the Quarter Ended
March 31, 1998 (Unaudited)............................................................................... 69
Consolidated Statements of Cash Flows for the Quarter Ended March 31, 1998 (Unaudited)..................... 70
Notes to Financial Statements.............................................................................. 71
</TABLE>
i
<PAGE>
CAPITAL SOURCE L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Capitalized terms not otherwise defined herein shall have the meanings set
forth in the accompanying Prospectus/Consent Solicitation Statement.
LIQUIDITY AND CAPITAL RESOURCES
Capital Source L.P. (the "Partnership") originally acquired: (i) five
mortgage-backed securities guaranteed as to principal and interest by the
Government National Mortgage Association ("GNMA") collateralized by first
mortgage loans on multifamily housing properties located in five states; (ii)
three first mortgage loans insured as to principal and interest by the Federal
Housing Administration ("FHA") on multifamily housing properties located in two
states; and (iii) Partnership Equity Investments in eight limited partnerships
which own the multifamily properties financed by the GNMA Certificates and FHA
Loans. The Partnership subsequently received FHA Debentures in payment of the
FHA Loan on Fox Hollow Apartments which were paid in full in 1993. In 1994,
foreclosure proceedings were initiated on Falcon Point Apartments and,
accordingly, the Partnership no longer holds a Partnership Equity Investment in
this property.
In addition, during 1995, the GNMA Certificate related to Falcon Point
Apartments was paid-in-full to the Partnership. Collectively, the remaining GNMA
Certificates, FHA Loans and Partnership Equity Investments are referred to as
the "Permanent Investments." The Partnership has also invested amounts held in
its reserve account in certain GNMA securities backed by pools of single-family
mortgages ("Reserve Investments"). The obligations of GNMA and FHA are backed by
the full faith and credit of the United States government.
The FHA Loans, GNMA Certificates and Partnership Equity Investments in
Operating Partnerships represent the Partnership's principal assets as shown in
the Parent Company Only Financial Information in Note 6 to the financial
statements. The parent company information is presented using the equity method
of accounting for the investment in Operating Partnerships. Generally accepted
accounting principles, however, require that the Partnership's financial
statements consolidate the Operating Partnerships, since the Partnership holds a
majority ownership in each Operating Partnership and can influence decisions of
the general partners in certain circumstances.
The following FHA Loans and GNMA Certificates were owned by the Partnership
at December 31, 1997.
<TABLE>
<CAPTION>
GUARANTEED
OR INTEREST MATURITY CARRYING
PROPERTY NAME INSURED BY RATE DATE VALUE
- ------------------------------------------------------- ----------- ----------- -------------- -------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments................................. FHA 8.72% 11/15/2028 $ 3,510,035
Highland Park Apartments............................... FHA 8.75 11/01/2028 9,001,010
Misty Springs Apartments............................... GNMA 8.75 06/15/2029 4,271,964
The Ponds at Georgetown................................ GNMA 9.00 12/15/2029 2,233,928
Waterman's Crossing.................................... GNMA 10.00 09/15/2028 10,927,185
Water's Edge Apartments................................ GNMA 8.75 12/15/2028 5,066,537
Pools of Single-Family Mortgages....................... GNMA 7.58(1) 2008 to 2009 539,913
Pools of Single-Family Mortgages....................... GNMA 7.58(1) 2007 to 2008 548,613
-------------
$ 36,099,185
-------------
-------------
</TABLE>
- ------------------------
(1) Represents yield to the Partnership.
1
<PAGE>
DISTRIBUTIONS
Cash distributions paid or accrued per Beneficial Assignment Certificate of
the Partnership (a "BAC") were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
------------------ ------------------ ------------------
<S> <C> <C> <C>
Regular monthly distributions
Income.......................... $ .7049 $ .7767 $ .8309
Return of capital............... .3051 .2333 .1791
------- ------- -------
$ 1.0100 $ 1.0100 $ 1.0100
------- ------- -------
------- ------- -------
Distributions
Paid out of cash flow........... $ 1.0100 $ 1.0100 $ 1.0100
------- ------- -------
------- ------- -------
</TABLE>
Regular quarterly distributions to BAC Holders consist primarily of interest
received on FHA Loans and GNMA Certificates. Additional cash for distributions
is received from other temporary investments. The Partnership may draw on
reserves to pay operating expenses or to supplement cash distributions to BAC
Holders. The Partnership is permitted to replenish reserves with cash flows in
excess of distributions paid. For the year ended December 31, 1997, a net amount
of $189,014 of undistributed cash flow was added to reserves. The total amount
held in reserves at December 31, 1997, was $10,787,058 of which $1,088,526 was
invested in GNMA Certificates.
The Partnership believes that cash provided by operating activities and, if
necessary, withdrawals from the Partnership's reserves will be adequate to meet
its short-term and long-term liquidity requirements, including the payments of
distributions to BAC Holders. Under the terms of its Partnership Agreement, the
Partnership has the authority to enter into short-term and long-term debt
financing arrangements; however, the Partnership currently does not anticipate
entering into such arrangements. The Partnership is not authorized to issue
additional BACs to meet short-term and long-term liquidity requirements.
America First Capital Source I, L.L.C., and Insured Mortgage Equities, Inc.
(referred to as the "General Partners") have conducted a review of their
computer systems to identify those areas that could be affected by the "Year
2000" issue and have developed a plan to resolve the issue. The General Partners
believe the "Year 2000" problem can be resolved without significant operational
difficulties. The Partnership does not maintain its own computer systems and
does not reimburse the General Partners for any capital expenses associated with
computer systems. Therefore, no material effect to the Partnership's results of
operations, financial position or cash flows is anticipated from the "Year 2000"
issue or its resolution.
ASSET QUALITY
The FHA Loans and GNMA Certificates owned by the Partnership are guaranteed
as to principal and interest by FHA and GNMA, respectively. The obligations of
FHA and GNMA are backed by the full faith and credit of the United States
government. The Partnership Equity Investments, however, are not insured or
guaranteed. The value of these investments is a function of the value of the
real estate owned by the Operating Partnerships.
2
<PAGE>
The following table shows the occupancy levels of the properties financed by
the Partnership at December 31, 1997:
<TABLE>
<CAPTION>
NUMBER PERCENTAGE
NUMBER OF UNITS OF UNITS
PROPERTY NAME LOCATION OF UNITS OCCUPIED OCCUPIED
- ------------------------------------- ---------------------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments............... Jacksonville, NC 108 106 98%
Fox Hollow Apartments................ High Point, NC 184 170 92
Highland Park Apartments............. Columbus, OH 252 225 89
Misty Springs Apartments............. Daytona Beach, FL 128 127 99
The Ponds at Georgetown.............. Ann Arbor, MI 134 128 96
Waterman's Crossing.................. Newport News, VA 260 249 96
Water's Edge Apartments.............. Lake Villa, IL 108 104 96
----- ----- --
1,174 1,109 94%
----- ----- --
----- ----- --
</TABLE>
BLUFF RIDGE APARTMENTS. Bluff Ridge Apartments is a 108-unit complex
located in Jacksonville, North Carolina. Average occupancy was 96% in 1997,
compared to 94% in 1996. Operations at Bluff Ridge are heavily dependent on
demand from the local military personnel. The Jacksonville rental market has
remained relatively stable throughout 1997. An increase in operating revenue
resulting from rental rate increases and an increase in average occupancy was
virtually offset by an increase in property operating costs. The increase in
operating costs was largely due to property improvements made during the year.
As a result net cash generated by the property in 1997, excluding interest,
approximated that of 1996. The property was current on its debt service payments
during 1997 and generated cash flow in excess of debt service.
FOX HOLLOW APARTMENTS. Fox Hollow Apartments is a 184-unit apartment
community located in High Point, North Carolina. Average occupancy was 96% in
1997, compared to 95% in 1996. Excluding interest, net cash flow generated by
Fox Hollow Apartments decreased approximately 12% from 1996 to 1997. This
decrease is primarily due to increases of approximately 27% in repairs and
maintenance expenses and property improvements and 18% in property taxes which
were partially offset by a slight increase in operating revenue. Notwithstanding
the decrease in net cash flow, the property remained in compliance with the
terms of the Loan Modification Agreement ("LMA") entered into with a mortgage
holder in 1996. While there can be no assurance that the modified terms of the
Fox Hollow mortgage will enable the property to remain current on its mortgage
obligations, the restructuring allows the Partnership to retain its Partnership
Equity Investment in the Fox Hollow Apartments and improves the property's
ability to make its required mortgage payments from operating cash flow.
HIGHLAND PARK APARTMENTS. Highland Park Apartments contains 252 luxury
garden apartments and is located in Columbus, Ohio. Average occupancy was 93% in
1997, compared to 95% in 1996. Excluding interest, net cash flow generated by
Highland Park Apartments increased approximately 7% from 1996 to 1997. This
increase is due to a 3% increase in operating revenue resulting from rental rate
increases and a 4% decrease in real estate operating expenses, primarily
property improvements. The property remained current on its mortgage obligations
throughout 1997 and generated cash flow in excess of debt service.
MISTY SPRINGS APARTMENTS. Misty Springs Apartments is a 128-unit apartment
community located in Daytona Beach, Florida. Average occupancy was 98% in 1997,
compared to 94% in 1996. The net cash flow generated by the property, excluding
interest, was approximately 22% higher in 1997, compared to 1996, due to an
increase of approximately 9% in operating revenue accompanied by a decrease of
approximately 2% in real estate operating expenses. The increase in operating
revenue was due to the increase in average occupancy and rental rate increases.
Real estate operating expenses were lower primarily due to a decrease in
property taxes.
3
<PAGE>
At December 31, 1997, the Operating Partnership was in compliance with the
terms of a Reinstatement Agreement entered into in 1993. The Operating
Partnership was current on its debt service payments on its mortgage loan during
1997, with a shortfall of $30,000 being funded by Partnership reserves.
THE PONDS AT GEORGETOWN. The Ponds at Georgetown consists of 134 apartments
located in Ann Arbor, Michigan. Average occupancy was 97% in 1997 compared to
95% in 1996. Operating revenue increased approximately 8% in 1997, compared to
1996, primarily due to the increase in average occupancy, rental rate increases
and an increase in corporate unit rentals. Despite the increase in operating
revenue the Operating Partnership remains in default on its mortgage loan and is
delinquent in paying property taxes and insurance. The Partnership continues to
explore a number of alternatives with the mortgage holder to determine the best
course of action to pursue, including a possible restructuring of the mortgage
loan.
WATERMAN'S CROSSING. Waterman's Crossing is a 260-unit apartment community
located in Newport News, Virginia. Average occupancy was 98% in 1997, compared
to 96% in 1996. The Operating Partnership remains current on its mortgage
obligations; however shortfalls of $95,000 were funded by Partnership reserves
in 1997. An increase in operating revenue resulting from an increase in average
occupancy and rental rate increases was virtually offset by an increase in
repairs and maintenance expenses and property improvements. As a result, net
cash flow generated by the property in 1997, excluding interest, approximated
that of 1996.
WATER'S EDGE APARTMENTS. Water's Edge Apartments is a 108-unit apartment
complex located in Lake Villa, Illinois. Average occupancy was 96% in 1997,
compared to 91% in 1996. The property's net cash flow, excluding interest,
increased approximately 5% in 1997 compared to 1996. This increase resulted from
a 7% increase in operating revenue due to the increase in average occupancy and
rental rate increases which was partially offset by a 10% increase in real
estate operating expenses, primarily real estate taxes. The Operating
Partnership remained current on its mortgage obligations in 1997.
4
<PAGE>
RESULTS OF OPERATIONS
The tables below compare the results of operations for each year shown.
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, DEC. 31, DEC. 31,
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Rental income.......................................................... $7,555,700 $7,203,323 $7,210,114
Mortgage-backed securities income...................................... 90,320 112,182 132,211
Interest on GNMA securities............................................ -- -- 519,970
Interest on temporary cash investments and U.S. government
securities........................................................... 583,881 550,599 225,135
Other income........................................................... 252,057 270,132 219,376
------------ ------------ ------------
8,481,958 8,136,236 8,306,806
------------ ------------ ------------
Real estate operating expenses......................................... 3,903,102 3,615,907 3,569,892
Depreciation........................................................... 905,563 897,337 896,420
Interest expense....................................................... 558,789 562,015 571,801
Investor Servicing..................................................... 455,322 301,694 238,667
Professional fees...................................................... 93,950 50,164 53,121
Other expenses......................................................... 16,135 9,966 5,849
Amortization........................................................... 141,467 136,797 141,514
------------ ------------ ------------
6,074,328 5,573,880 5,477,264
------------ ------------ ------------
Minority interest in (income) losses of Operating Partnerships......... (5,090) 2,746 2,571
------------ ------------ ------------
Income before extraordinary item....................................... 2,402,540 2,565,102 2,832,113
Extraordinary item--gain from forgiveness of accrued interest.......... -- 82,216 --
------------ ------------ ------------
Net income............................................................. $2,204,540 $2,647,318 $2,832,113
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
INCREASE INCREASE
(DECREASE) (DECREASE)
FROM 1996 FROM 1995
----------- -----------
<S> <C> <C>
Rental income........................................................................... $ 352,377 $ (6,791)
Mortgage-backed securities income....................................................... (21,862) (20,029)
Interest on GNMA securities............................................................. -- (519,970)
Interest on temporary cash investments and U.S. government securities................... 33,282 325,464
Other income............................................................................ (18,075) 50,756
----------- -----------
345,722 (170,570)
----------- -----------
Real estate operating expenses.......................................................... 287,195 46,015
Depreciation............................................................................ 8,226 917
Interest expense........................................................................ (3,226) (9,786)
Investor servicing...................................................................... 153,628 63,027
Professional fees....................................................................... 43,786 (2,957)
Other expenses.......................................................................... 6,169 4,117
Amortization............................................................................ 4,670 (4,717)
----------- -----------
500,448 96,616
----------- -----------
Minority interest in (income) losses of Operating Partnerships.......................... (7,836) 175
----------- -----------
Income before extraordinary item........................................................ (162,562) (267,011)
Extraordinary item--gain from forgiveness of accrued interest........................... (82,216) 82,216
----------- -----------
Net income.............................................................................. $ (244,778) $ (184,795)
----------- -----------
----------- -----------
</TABLE>
5
<PAGE>
Rental income is recognized net of any vacancy losses and rental concessions
offered. Rental income, net of real estate operating expenses, depreciation and
amortization, increased $52,286 from 1996 to 1997. This increase is due to an
increase in rental income which was partially offset by increases in real estate
operating expenses, primarily repairs and maintenance expenses and property
improvements. The increase in rental income consisted of an increase of
approximately $223,000 due to rental rate increases and approximately $129,000
due to increases in average occupancy at six of the properties.
Rental income, net of real estate operating expenses, depreciation and
amortization decreased $49,006 from 1995 to 1996. The decrease is due to a
slight decrease in rental income accompanied by increases in real estate
operating expenses, primarily repairs and maintenance expenses and property
improvements. The decrease in rental income consisted of a decrease of
approximately $115,000 due to decreases in average occupancy at four of the
properties which was partially offset by an increase in revenue of approximately
$108,000 resulting from rental rate increases.
Mortgage-backed securities income decreased $21,862 from 1997 to 1996 and
$20,029 from 1995 to 1996 due to the continued amortization of the principal
balance of the mortgage-backed securities.
Interest on temporary cash investments and U.S. government securities
increased $33,282 from 1996 to 1997 due to an increase in the Partnership's cash
reserve as additional cash was placed in reserves during 1996 and 1997. Interest
on temporary cash investments and U.S. government securities increased $325,464
from 1995 to 1996. This increase is the result of investing proceeds received
from the payoff of the GNMA Certificate related to Falcon Point Apartments in
November 1995 and to additions made to the Partnership's reserves during 1996.
Other income consists primarily of corporate unit rentals, garage rentals,
washer/dryer and vending income generated by the Partnership's properties.
Income from such sources decreased $18,075 from 1996 to 1997, due primarily to
decreases in corporate unit rentals at Fox Hollow Apartments and Waterman's
Crossing Apartments, partially offset by increases in corporate unit rentals at
Water's Edge Apartments and The Ponds at Georgetown Apartments. Income from such
sources increased $50,756 from 1995 to 1996, due primarily to an increase in
corporate unit rentals at Fox Hollow Apartments.
Investor servicing costs increased $153,628 from 1996 to 1997 and $63,027
from 1995 to 1996. The increase from 1996 to 1997 was due to: (i) an increase of
approximately $137,000 in salaries and related expenses, (ii) an increase of
approximately $6,000 in printing and servicing expenses and (iii) an increase of
approximately $11,000 in other investor servicing expenses. The increase from
1995 to 1996 was due to: (i) an increase of approximately $49,000 in salaries
and related expenses, (ii) an increase of approximately $5,000 in printing and
servicing expenses, (iii) an increase of approximately $3,000 in insurance
expenses and (iv) an increase of approximately $6,000 in other investor
servicing expenses.
Professional fees increased $43,786 from 1996 to 1997, primarily due to
costs incurred in connection with a review of various options available to the
Partnership to improve total investment returns and provide liquidity to the
Partnership's investors. Professional fees decreased $2,957 from 1995 to 1996,
primarily due to a decrease in legal fees.
The Partnership recorded an extraordinary gain of $82,216 in 1996 due to the
forgiveness of accrued interest on the Fox Hollow Apartments mortgage. The
interest was forgiven in conjunction with a Loan Modification Agreement entered
into in January 1996.
This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements that reflect management's
current beliefs and estimates of future economic circumstances, industry
conditions, the Partnership's performance and financial results. All statements,
trend analysis and other information concerning possible or assumed future
results of operations of the Partnership and the real estate investments it has
made constitute forward-looking statements. BAC Holders and others should
understand that these forward looking statements are subject to numerous risks
and uncertainties and a number of factors could affect the future results of the
Partnership and could cause those results to differ materially from those
expressed in the forward-looking statements contained herein.
6
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Partners
Capital Source L.P.:
We have audited the accompanying consolidated balance sheets of Capital
Source L.P. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, partners' capital, and cash flows for each of
the three years in the period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Capital Source L.P. and subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Omaha, Nebraska
March 26, 1998
7
<PAGE>
To the Partners
Capital Source L.P.
Our report on the financial statements of Capital Source L.P. and
subsidiaries is included herein. In connection with our audit of such
consolidated financial statements, we have also audited the related consolidated
financial statement schedule of Real Estate and Accumulated Depreciation.
In our opinion, the consolidated financial statement schedule referred to
above, when considered in relation to the basic financial statements taken as a
whole, present fairly, in all material aspects, the information required to be
included therein.
/s/ Coopers & Lybrand L.L.P
Omaha, Nebraska
March 26, 1998
8
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
<S> <C> <C>
ASSETS
Investment in real estate:
Land..................................................................... $ 3,093,671 $ 3,093,671
Buildings................................................................ 35,536,966 35,517,314
Personal property........................................................ 2,001,950 1,992,979
----------------- -----------------
40,632,587 40,603,964
Less accumulated depreciation.............................................. (10,831,199) (9,925,636)
----------------- -----------------
Net investment in real estate.............................................. 29,801,388 30,678,328
----------------- -----------------
Cash and temporary cash investments, at cost which approximates market
value (Note 5)........................................................... 10,410,564 10,272,497
Escrow deposits and property reserves...................................... 894,986 917,796
Investment in mortgage-backed securities (Note 5).......................... 1,088,526 1,327,396
Interest and other receivables............................................. 70,542 62,114
Deferred mortgage issuance costs, net of accumulated amortization of
$1,503,039 in 1997 and $1,361,572 in 1996................................ 2,099,768 2,241,235
Other assets............................................................... 767,156 723,639
----------------- -----------------
$ 45,132,930 $ 46,223,005
----------------- -----------------
----------------- -----------------
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
Liabilities
Accounts payable and accrued expenses.................................... $ 1,532,202 $ 1,416,730
Distribution payable (Note 3)............................................ 860,587 860,587
Mortgage loan payable (Note 7)........................................... 6,320,076 6,354,657
Due to general partners and their affiliates (Note 4).................... 4,013,626 4,117,105
----------------- -----------------
12,726,491 12,749,079
----------------- -----------------
Minority Interest.......................................................... 192,296 222,048
----------------- -----------------
Partners' Capital (Deficit)
General Partners......................................................... (293,517) (283,139)
Limited Partners ($9.63 per BAC in 1997 and $9.94 in 1996)............... 32,507,660 33,535,017
----------------- -----------------
32,214,143 33,251,878
----------------- -----------------
$ 45,132,930 $ 46,223,005
----------------- -----------------
----------------- -----------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
9
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Income
Rental income......................................... $ 7,555,700 $ 7,203,323 $ 7,210,114
Mortgage-backed securities income..................... 90,320 112,182 132,211
Interest on GNMA securities........................... -- -- 519,970
Interest on temporary cash investments and U.S.
government securities............................... 583,881 550,599 225,135
Other income.......................................... 252,057 270,132 219,376
----------------- ----------------- -----------------
8,481,958 8,136,236 8,306,806
----------------- ----------------- -----------------
Expenses
Real estate operating expenses........................ 3,903,102 3,615,907 3,569,892
Depreciation.......................................... 905,563 897,337 896,420
Interest expense...................................... 558,789 562,015 571,801
General and administrative expenses (Note 4)
Investor servicing.................................. 455,322 301,694 238,667
Professional fees................................... 93,950 50,164 53,121
Other expenses...................................... 16,135 9,966 5,849
Amortization........................................ 141,467 136,797 141,514
----------------- ----------------- -----------------
6,074,328 5,573,880 5,477,264
----------------- ----------------- -----------------
Minority interest in (income) losses of Operating
Partnerships.......................................... (5,090) 2,746 2,571
----------------- ----------------- -----------------
2,402,540 2,565,102 2,832,113
Income before extraordinary item
Extraordinary item--gain from forgiveness of accrued
interest (Note 7)..................................... -- 82,216 --
----------------- ----------------- -----------------
Net income.............................................. $ 2,402,540 $ 2,647,318 $ 2,832,113
----------------- ----------------- -----------------
----------------- ----------------- -----------------
Net Income Allocated to:
General Partners...................................... $ 24,025 $ 26,473 $ 28,321
Limited Partners...................................... 2,378,515 2,620,845 2,803,792
----------------- ----------------- -----------------
$ 2,402,540 $ 2,647,318 $ 2,832,113
----------------- ----------------- -----------------
----------------- ----------------- -----------------
Net Income per BAC
Income Before extraordinary item...................... $ .70 $ .76 $ .83
Extraordinary item.................................... -- .02 --
----------------- ----------------- -----------------
Net income, basic and diluted, per BAC.................. $ .70 $ .78 $ .83
----------------- ----------------- -----------------
----------------- ----------------- -----------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
10
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
FROM DECEMBER 31, 1994 TO DECEMBER 31, 1997
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
----------- ------------- -------------
<S> <C> <C> <C>
Partners' Capital (Deficit)
(excluding net unrealized holding gain)
Balance at December 31, 1994........................................ $ (269,500) $ 34,885,222 $ 34,615,722
Net income.......................................................... 28,321 2,803,792 2,832,113
Cash distributions paid or accrued (Note 3)......................... (34,424) (3,407,964) (3,442,388)
----------- ------------- -------------
Balance at December 31, 1995........................................ (275,603) 34,281,050 34,005,447
Net income.......................................................... 26,473 2,620,845 2,647,318
Cash distributions paid or accrued (Note 3)......................... (34,424) (3,407,965) (3,442,389)
----------- ------------- -------------
Balance at December 31, 1996........................................ (283,554) 33,493,930 33,210,376
Net income.......................................................... 24,025 2,378,515 2,402,540
Cash distributions paid or accrued (Note 3)......................... (34,424) (3,407,965) (3,442,389)
----------- ------------- -------------
(293,953) 32,464,480 32,170,527
----------- ------------- -------------
Net unrealized holding gain
Balance at December 31, 1994........................................ -- -- --
Net change.......................................................... 810 80,196 81,006
----------- ------------- -------------
Balance at December 31, 1995........................................ 810 80,196 81,006
Net change.......................................................... (395) (39,109) (39,504)
----------- ------------- -------------
Balance at December 31, 1996........................................ 415 41,087 41,502
Net change.......................................................... 21 2,093 2,114
----------- ------------- -------------
436 43,180 43,616
----------- ------------- -------------
Balance at December 31, 1997.......................................... $ (293,517) $ 32,507,660 $ 32,214,143
----------- ------------- -------------
----------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
11
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income.............................................. $ 2,402,540 $ 2,647,318 $ 2,832,113
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary item--gain from forgiveness of accrued
interest............................................ -- (82,216) --
Depreciation and amortization......................... 1,047,030 1,034,134 1,037,934
Amortization of discount on mortgage-backed and U.S.
government securities............................... (2,665) (6,700) (11,656)
Minority interest in (income) losses of Operating
Partnerships........................................ 5,090 (2,746) (2,571)
Decrease (increase) in interest and other
receivables......................................... (8,428) 10,879 (44,538)
Decrease in escrow deposits and property reserves..... 22,810 101,533 352,231
Increase in other assets.............................. (156,964) (203,990) (105,999)
Increase in accounts payable and accrued expenses..... 115,472 211,132 61,848
Increase (decrease) in due to general partners and
their affiliates.................................... (103,479) 4,522 (399,530)
Decrease in interest payable.......................... -- (229,746) (37,196)
----------------- ----------------- -----------------
Net cash provided by operating activities............... 3,321,406 3,484,120 3,682,636
----------------- ----------------- -----------------
Cash flows from investing activities
Principal payments received on mortgage-backed and
U.S. government securities.......................... 243,649 322,603 219,865
Acquisition of real estate............................ (19,652) (12,000) --
Acquisition of personal property...................... (8,971) (5,222) (7,211)
Increase in other assets.............................. 78,605 -- --
Maturity of U.S. government securities................ -- 1,000,000 --
Principal payments received on GNMA securities........ -- -- 7,145,554
Acquisition of U.S. government securities............. -- -- (987,578)
----------------- ----------------- -----------------
Net cash provided by investing activities........... 293,631 1,305,381 6,370,630
----------------- ----------------- -----------------
Cash flow used in financing activities
Principal payments on mortgage loan payable........... (34,581) (37,350) --
Distributions......................................... (3,442,389) (3,442,389) (3,442,388)
----------------- ----------------- -----------------
Net cash used in financing activities............... (3,476,970) (3,479,739) (3,442,388)
----------------- ----------------- -----------------
Net increase in cash and temporary cash investments..... 138,067 1,309,762 6,610,878
Cash and temporary cash investments at beginning of
year.................................................. 10,272,497 8,962,735 2,351,857
----------------- ----------------- -----------------
Cash and temporary cash investments at end of year...... $ 10,410,564 $ 10,272,497 $ 8,962,735
----------------- ----------------- -----------------
----------------- ----------------- -----------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.............. $ 558,789 $ 791,761 $ 608,997
----------------- ----------------- -----------------
----------------- ----------------- -----------------
Supplemental disclosure of non-cash investing
activities:
Abandonment of fully depreciated property............. $ -- $ 11,008 $ --
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
12
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION.
Capital Source L.P. (the "Partnership") was formed on August 22, 1985, under
the Delaware Revised Uniform Limited Partnership Act. The General Partners of
the Partnership are insured Mortgage Equities Inc. and America First Capital
Source I, L.L.C. (the "General Partners").
The Partnership provided virtually 100% of the debt and equity financing for
eight multifamily rental housing properties. The Partnership's investment in the
properties consisted of (a) approximately 85% in the form of permanent mortgages
and/or loans to fund construction; and (b) the balance to purchase up to a 99%
limited partnership interest in the Operating Partnerships which developed, own
and operate the properties. Each loan is insured or guaranteed, in an amount
substantially equal to the face amount of the mortgage, by the Federal Housing
Administration ("FHA") or the Government National Mortgage Association ("GNMA").
The Partnership has been repaid by FHA on one of its first mortgage loans. The
Partnership has also been repaid by GNMA on one of its GNMA Certificates. The
Partnership no longer holds a Partnership Equity Investment in the Operating
Partnership which owned the property collateralizing the repaid GNMA
Certificate. The seven remaining Operating Partnerships are geographically
located as follows: (i) two in North Carolina and (ii) one each in Ohio,
Florida, Michigan, Virginia and Illinois.
CS Properties I, Inc., which is owned by affiliates of the General Partners,
serves as the Special Limited Partner for the Operating Partnerships. The
Special Limited Partner has the power, among other things, to remove the general
partners of the Operating Partnerships under certain circumstances and to
consent to the sale of the Operating Partnerships' assets. CS Properties I, Inc.
also serves as the general partner of Misty Springs Apartments, Waterman's
Crossing and Fox Hollow Apartments.
The Partnership will terminate subsequent to the sale of all properties but
in no event will the Partnership continue beyond December 31, 2030.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
(a) FINANCIAL STATEMENT PRESENTATION. The consolidated financial
statements include the accounts of the Partnership and seven subsidiary
Operating Partnerships. The Partnership is a limited partner with an
ownership interest of up to 99% in six of the subsidiary Operating
Partnerships. The Partnership's ownership interest in The Ponds at
Georgetown L.P. is 30.29%. The remaining limited partner interest of 68.70%
is owned by Capital Source II L.P.--A, an affiliate of the General Partners.
All significant intercompany accounts and transactions have been eliminated
in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(b) INVESTMENT IN REAL ESTATE. The Partnership's investment in real
estate is carried at cost less accumulated depreciation. The carrying value
of each property is reviewed for impairment whenever events or circumstances
indicate that the carrying value may not be recoverable. If the sum of the
expected undiscounted future cash flows is less than the carrying amount, an
impairment is recorded based on fair value.
13
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. (CONTINUED)
(c) INVESTMENT IN MORTGAGE-BACKED SECURITIES. Investment securities
are classified as held-to-maturity, available-for-sale or trading.
Investments classified as held-to-maturity are carried at amortized cost.
Investments classified as available-for-sale are reported at fair value with
any unrealized gains or losses excluded from earnings and reflected as a
separate component of partners' capital. Subsequent increases and decreases
in the net unrealized gain/loss on the available-for-sale securities are
reflected as adjustments to the carrying value of the portfolio and
adjustments to the component of partners' capital. The Partnership does not
have investment securities classified as trading.
(d) DEPRECIATION AND AMORTIZATION. Depreciation of real estate is
based on the estimated useful life of the properties using the straight-line
method. Deferred mortgage issuance costs are being amortized using the
effective yield method over the 40-year term of the respective loan.
(e) REVENUE RECOGNITION. The Operating Partnerships lease multifamily
rental units under operating leases with terms of one year or less. Rental
revenue is recognized as earned net of any vacancy losses and rental
concessions offered.
(f) INCOME TAXES. No provision has been made for income taxes since
BAC Holders are required to report their share of the Partnership's income
for federal and state income tax purposes. The tax basis of the
Partnerships' assets and liabilities exceeded the reported amounts by
$4,169,385 and $4,701,874 at December 31, 1997 and December 31, 1996,
respectively.
(g) TEMPORARY CASH INVESTMENTS. Temporary cash investments are
invested in short-term debt securities purchased with original maturities of
three months or less.
(h) NET INCOME PER BENEFICIAL ASSIGNMENT CERTIFICATE ("BAC"). Net
income per BAC is based on the number of BACs outstanding (3,374,222) during
each year presented.
(i) NEW ACCOUNTING PRONOUNCEMENT. The Financial Accounting Standards
Board has issued Financial Accounting Standards No. 128 "Earnings Per Share"
("FAS 128"). FAS 128, which is effective for periods ending after December
15, 1997, did not have an impact on the Partnership's computation,
presentation or disclosure of earnings per BAC as no dilutive common share
equivalents existed at December 31, 1997.
3. PARTNERSHIP INCOME, EXPENSES AND CASH DISTRIBUTIONS.
Profits and losses from normal operations and cash available for
distribution will be allocated 99% to the investors and 1% to the General
Partners. Certain fees payable to the General Partners will not become due until
investors have received certain priority returns. Cash distributions included in
the consolidated financial statements represent the actual cash distributions
made during each year and the cash distributions accrued at the end of each
year.
The General Partners will also receive 1% of the net proceeds from any sale
of Partnership assets. The General Partners will receive a termination fee equal
to 3% of all sales proceeds less actual costs incurred in connection with all
sales transactions, payable only after the investors have received a return of
their capital contributions and a 13% annual return on a cumulative basis. The
General Partners will also receive a fee equal to 9.1% of all cash available for
distribution and sales proceeds (after deducting from cash available or sales
proceeds any termination fee paid therefrom) after investors have received a
return of their capital contributions and a 13% annual return on a cumulative
basis.
14
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
4. TRANSACTIONS WITH RELATED PARTIES.
The General Partners, certain of their affiliates and the Operating
Partnerships' general partners have received or may receive fees, compensation,
income, distributions and payments from the Partnership in connection with the
offering and the investment, management and sale of the Partnership's assets
(other than disclosed elsewhere) as follows.
The Operating Partnerships' general partners provide various on-site
property development and management services. There were no property development
and management fees incurred for the years ended December 31, 1997, 1996 and
1995. Unpaid fees, which are non-interest bearing, are included in amounts due
to general partners and their affiliates on the accompanying consolidated
balance sheets and will be paid in accordance with the terms of the respective
Operating Partnership's limited partnership agreement.
The General Partners are entitled to receive an asset management and
partnership administration fee equal to 0.5% of invested assets per annum,
payable only during such years than an 8% return has been paid to investors on a
noncumulative basis. Any unpaid amounts will accrue and be payable only after a
13% annual return to investors has been paid on a cumulative basis and the
investors have received the return of their capital contributions. For the years
ended December 31, 1997, 1996 and 1995, distributions to investors represented
less than an 8% return; accordingly, no fees were paid or accrued during these
years.
Amounts due to general partners and their affiliates on December 31, 1997
and 1996 are comprised of the following:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Unpaid property development and management fees................... $ 450,073 $ 445,652
Operating deficit loans........................................... 3,563,553 3,671,453
------------ ------------
$ 4,013,626 $ 4,117,105
------------ ------------
------------ ------------
</TABLE>
Substantially all of the Partnership's general and administrative expenses
and certain costs capitalized by the Partnership are paid by a General Partner
or an affiliate and reimbursed by the Partnership. The amount of such expenses
reimbursed to the General Partner was $533,419, $347,522 and $309,826 for the
years ended December 31, 1997, 1996 and 1995, respectively. Reimbursed expenses
are presented on a cash basis and do not reflect accruals made at each year end.
An affiliate of America First Capital Source I, L.L.C. has been retained to
provide property management services for Waterman's Crossing, Misty Springs
Apartments, Fox Hollow Apartments (beginning in June 1995) and The Ponds at
Georgetown (beginning in November 1996). The fees for services provided were
$183,069, $165,721 and $136,529 for 1997, 1996 and 1995, respectively, and
represented the lower of costs incurred in providing management of the property
or customary fees for such services determined on a competitive basis.
15
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
5. PARTNERSHIP RESERVE ACCOUNT.
The Partnership maintains a reserve account which consisted of the following
at December 31, 1997:
<TABLE>
<S> <C>
Cash and temporary cash investments............................ $9,698,532
GNMA Certificates.............................................. 1,088,526
----------
$10,787,058
----------
----------
</TABLE>
The reserve account was established to maintain working capital for the
Partnership and is available for distribution to BAC Holders and for any
contingencies related to Permanent Investments and the operation of the
Partnership. The GNMA Certificates mature between 2007 and 2009.
At December 31, 1997, the total amortized cost, gross unrealized holding
gains and aggregate fair value of available-for-sale securities were $1,044,910,
$43,616 and $1,088,526, respectively. At December 31, 1996, the total amortized
cost, gross unrealized holding gains and aggregate fair value of available-
for-sale securities were $1,285,894, $41,502 and $1,327,396, respectively.
Prior to June 30, 1995, the Partnership classified all investment securities
as held-to-maturity. However, during the quarter ending June 30, 1995, the
Partnership reassessed the appropriateness of the classification of securities
held in the reserve account. The Partnership concluded, given the nature of the
reserve account, it would be more appropriate to classify securities held in the
reserve account as available-for-sale rather than as held-to-maturity.
Accordingly, on June 30, 1995, the Partnership transferred all securities held
in the reserve account from the held-to-maturity classification to the
available-for-sale classification. The total amortized cost, gross unrealized
holding gains and aggregate fair value of the securities transferred were
$2,740,792, $57,052 and $2,797,844, respectively.
6. PARENT COMPANY ONLY FINANCIAL INFORMATION.
Generally accepted accounting principles require that the Partnership's
financial statements consolidate the Operating Partnerships since the
Partnership holds a majority ownership interest and, through CS Properties I,
Inc., can influence the decisions of the general partners in certain
circumstances. In the consolidated financial statements, the Partnership's
investment in FHA Loans and GNMA Certificates is eliminated against the related
mortgage payable recorded by the Operating Partnership. If a mortgage loan goes
into default and is foreclosed upon by FHA or GNMA, the respective agency may,
at their discretion, repay the FHA Loan or the GNMA Certificate. If this occurs,
the Partnership's investment in the Operating Partnership would be eliminated,
resulting in the recognition of a gain on the Partnership's financial
statements. This arises because consolidation accounting does not allow the
Partnership to stop recording losses from the Operating Partnerships when the
net investment is reduced to zero.
The parent company only financial information below represents the condensed
financial information of the Partnership using the equity method of accounting
for the investment in Operating Partnerships, rather than the consolidation of
those partnerships. Under the equity method of accounting, the Partnership's
capital contributions are adjusted to reflect its share of operating partnership
profits or losses and distributions. The investment in Operating Partnerships
represents the Partnership's limited partnership interest in the accumulated
deficits of those Operating Partnerships. The parent company only information is
provided to more clearly present the Partnership's investment in the Operating
Partnerships. Since the Partnership is not a general partner, it is not
obligated to fund the negative balances. If the investments in
16
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. PARENT COMPANY ONLY FINANCIAL INFORMATION. (CONTINUED)
all Operating Partnerships were eliminated at December 31, 1997, Partnership
capital would increase by $13,686,936 ($4.02 per BAC).
The FHA Loans and the GNMA Certificates are collateralized by first mortgage
loans on the properties owned by the Operating Partnerships and are guaranteed
or insured as to principal and interest by FHA or GNMA. The FHA insured mortgage
loans are subject to a 1% assignment fee. The obligations of FHA and GNMA are
backed by the full faith and credit of the United States government.
PARENT COMPANY ONLY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
-------------- --------------
<S> <C> <C>
ASSETS
Cash and temporary cash investments........................... $ 10,410,564 $ 10,272,497
Investment in FHA Loans....................................... 12,511,046 12,585,755
Investment in GNMA Certificates............................... 23,588,139 23,937,795
Investment in Operating Partnerships.......................... (13,686,936) (13,038,255)
Interest receivable........................................... 321,485 321,760
Other assets.................................................. 134,574 130,969
-------------- --------------
$ 33,278,872 $ 34,210,521
-------------- --------------
-------------- --------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
Accounts payable............................................ $ 204,142 $ 98,056
Distributions payable....................................... 860,587 860,587
-------------- --------------
1,064,729 958,643
Partners' Capital............................................. 32,214,143 33,251,878
-------------- --------------
$ 33,278,872 $ 34,210,521
-------------- --------------
-------------- --------------
</TABLE>
17
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. PARENT COMPANY ONLY FINANCIAL INFORMATION. (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE FOR THE
YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
<S> <C> <C>
Income
Mortgage and mortgage-backed securities income....... $ 3,117,407 $ 3,148,565
Interest on temporary cash investments and U.S.
government securities.............................. 554,604 523,636
Interest on mortgage-backed securities............... 90,320 112,182
Equity in losses of Operating Partnerships........... (732,231) (717,501)
Other income......................................... 5,334 9,749
----------------- -----------------
3,035,434 3,076,631
Expenses
Operating and administrative......................... 632,894 429,313
----------------- -----------------
Net income......................................... $ 2,402,540 $ 2,647,318
----------------- -----------------
----------------- -----------------
</TABLE>
18
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. PARENT COMPANY ONLY FINANCIAL INFORMATION. (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FOR THE
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income..................................................... $ 2,402,540 $ 2,647,318
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in losses of Operating Partnerships................. 732,231 717,501
Amortization............................................... 67,488 67,488
Amortization of discount on mortgage-backed and U.S.
government securities.................................... (2,665) (6,700)
Other non-cash adjustments................................. 35,268 12,302
------------- -------------
Net cash provided by operating activities...................... 3,234,862 3,437,909
------------- -------------
Cash flows from investing activities:
FHA Loan and GNMA Certificate principal payments............... 429,144 491,754
Investment in Operating Partnerships........................... (83,550) (254,745)
Maturity of U.S. government securities......................... -- 1,000,000
Distributions received from Operating Partnerships............. -- 77,233
------------- -------------
Net cash provided by investing activities...................... 345,594 1,314,242
------------- -------------
Cash flow used in financing activity
Distributions................................................ (3,442,389) (3,442,389)
------------- -------------
Net increase in cash and temporary cash investments............ 138,067 1,309,762
Cash and temporary cash investments at beginning of year....... 10,272,497 8,962,735
------------- -------------
Cash and temporary cash investments at end of year............. $ 10,410,564 $ 10,272,497
------------- -------------
------------- -------------
</TABLE>
7. MORTGAGE LOAN PAYABLE AND EXTRAORDINARY ITEM.
The mortgage is an 8.86% loan collateralized by Fox Hollow Apartments. Prior
to May 12, 1995 HUD was the mortgage holder, and the Operating Partnership
operated under a Provisional Workout Agreement ("PWA"). A Loan Modification
Agreement ("LMA") dated January 8, 1996, was signed between the Operating
Partnership and the new mortgage holder, dissolving the PWA and modifying
certain terms and conditions of the mortgage payable. The new mortgage holder
agreed to accept $229,745 (of which $161,745 was paid by the Partnership and
$68,000 was paid by the property) as payment of accrued unpaid interest, thereby
forgiving $82,216 of accrued interest. Further, commencing on January 1, 1996,
installments of interest and principal in the amount of $49,947 are due on the
first day of each month, with the balance of principal and accrued interest due
and payable no later than October 1, 2028. The mortgage
19
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
7. MORTGAGE LOAN PAYABLE AND EXTRAORDINARY ITEM. (CONTINUED)
loan payable is recorded on the consolidated balance sheet, since it is no
longer eliminated in consolidation. The mortgage is an obligation of the
Operating Partnership which owns the property. Principal maturities on the
mortgage loan are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
- --------------------------- ------------
<S> <C>
1998....................... $ 41,053
1999....................... 44,841
2000....................... 48,980
2001....................... 53,500
2002....................... 58,437
Thereafter................. 6,073,265
------------
$ 6,320,076
------------
------------
</TABLE>
8. FAIR VALUE OF FINANCIAL INSTRUMENTS.
The following methods and assumptions were used by the Partnership in
estimating the fair value of its financial instruments:
(a) CASH AND TEMPORARY CASH INVESTMENTS. Fair value approximates the
carrying value of such assets.
(b) INVESTMENT IN MORTGAGE-BACKED SECURITIES. Fair values are amounts
obtained from an independent pricing source.
(c) MORTGAGE LOAN PAYABLE. Fair value is not readily determinable as
certain terms of the mortgage loan have recently been revised under a loan
modification agreement.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996
---------------------------- ----------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Cash and temporary cash investments................. $ 10,410,564 $ 10,410,564 $ 10,272,497 $ 10,272,497
Investment in mortgage-backed securities............ 1,088,526 1,088,526 1,327,396 1,327,396
</TABLE>
9. SUMMARY OF UNAUDITED QUARTERLY RESULTS OF OPERATIONS.
<TABLE>
<CAPTION>
FIRST SECOND FOURTH
FROM JANUARY 1, 1997 TO DECEMBER 31, 1997 QUARTER QUARTER THIRD QUARTER QUARTER
- ------------------------------------------------------ ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Total income.......................................... $ 2,084,816 $ 2,101,877 $ 2,183,595 $ 2,111,670
Total expenses........................................ (1,331,384) (1,576,853) (1,550,863) (1,615,228)
Minority interest in (income) losses of operating
partnerships........................................ 4,849 4,653 4,796 (19,388)
------------- ------------- ------------- -------------
Net income............................................ $ 758,281 $ 529,677 $ 637,528 $ 477,054
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Net income, basic and diluted, per BAC................ $ .22 $ .16 $ .18 $ .14
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
20
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
9. SUMMARY OF UNAUDITED QUARTERLY RESULTS OF OPERATIONS. (CONTINUED)
<TABLE>
<CAPTION>
FIRST SECOND FOURTH
FROM JANUARY 1, 1996 TO DECEMBER 31, 1996 QUARTER QUARTER THIRD QUARTER QUARTER
- ------------------------------------------------------ ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Total income.......................................... $ 1,990,066 $ 2,010,934 $ 2,069,863 $ 2,065,373
Total expenses........................................ (1,204,651) (1,486,392) (1,416,101) (1,466,736)
Minority interest in (income) losses of operating
partnerships........................................ 32 668 806 1,240
------------- ------------- ------------- -------------
Income before extraordinary item...................... 785,447 525,210 654,568 599,877
Extraordinary item--gain from forgiveness of accrued
interest.......................................... -- -- -- 82,216
------------- ------------- ------------- -------------
Net income............................................ $ 785,447 $ 525,210 $ 637,568 $ 682,093
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Net income per BAC
Income before extraordinary item.................... $ .23 $ .15 $ .20 $ .18
Extraordinary item.................................. -- -- -- .02
------------- ------------- ------------- -------------
Net income per BAC.................................... $ .23 $ .15 $ .20 $ .20
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
21
<PAGE>
SCHEDULE III
CAPITAL SOURCE L.P.
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1996
<TABLE>
<CAPTION>
COSTS CAPITALIZED
SUBSEQUENT TO
ACQUISITION
INITIAL COST TO ------------------------
DESCRIPTION PARTNERSHIP CARRYING
- ----------------------------------------------------------------------------- ------------------------ COSTS
PROPERTY LOCATION # OF UNITS ENCUMBRANCES LAND PROPERTY IMPROVEMENTS (C)
- --------------------------- -------------------- ----- ------------- ----------- ----------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Waterman's Crossing........ Newport News, VA 260 (a) $ 700,000 $ 893,682 $ 8,894,510 $ 65,190
Fox Hollow................. High Point, NC 184 (b) 272,215 499,365 5,518,162 98,580
Highland Park.............. Columbus, OH 252 (a) 65,799 37,792 8,591,903 69,176
Bluff Ridge................ Jacksonville, NC 108 (a) 196,050 33,281 3,272,492 77,738
Misty Springs.............. Daytona Beach, FL 128 (a) 710,400 351,972 2,840,884 68,679
Water's Edge............... Lake Villa, IL 108 (a) 246,160 24,550 4,805,273 139,440
Ponds at Georgetown........ Ann Arbor, MI 134 (a) 174,879 118,649 1,812,662 24,481
----------- ----------- ------------- ---------
$ 2,365,503 $ 1,959,291 $35,735,886 $ 543,284
----------- ----------- ------------- ---------
----------- ----------- ------------- ---------
</TABLE>
<TABLE>
<CAPTION>
GROSS AMOUNT AT DECEMBER 31, 1996
----------------------------------------
BUILDINGS,
IMPROVEMENTS LIFE ON
AND PERSONAL ACCUMULATED WHICH
LAND PROPERTY TOTAL DEPRECIATION DATE OF DATE DEPRECIATION
PROPERTY (D) (E) (D) AND (E) (F) CONSTRUCTION ACQUIRED IS COMPUTED
- ----------------------------- ----------- ------------- ------------ ------------ --------------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Waterman's Crossing.......... $ 1,122,322 $ 9,431,060 $ 10,553,382 $2,972,902 1987 N/A 5-40 years
Fox Hollow................... 272,215 6,116,107 6,388,322 1,768,704 1988 N/A 5-40 years
Highland Park................ 208,403 8,556,267 8,764,670 1,930,147 1988 N/A 5-40 years
Bluff Ridge.................. 203,050 3,376,511 3,579,561 745,618 1988 N/A 5-40 years
Misty Springs................ 741,587 3,230,348 3,971,935 989,619 1988 N/A 5-40 years
Water's Edge................. 371,215 4,844,208 5,215,423 1,045,121 1988 N/A 5-40 years
Ponds at Georgetown.......... 174,879 1,955,792 2,130,671 473,525 1989 N/A 5-40 years
----------- ------------- ------------ ------------
$ 3,093,671 $37,510,293 $ 40,603,946 $9,925,636
----------- ------------- ------------ ------------
----------- ------------- ------------ ------------
</TABLE>
22
<PAGE>
SCHEDULE III
CAPITAL SOURCE L.P.
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1997
<TABLE>
<CAPTION>
COSTS CAPITALIZED
SUBSEQUENT TO
ACQUISITION
INITIAL COST TO ------------------------
DESCRIPTION PARTNERSHIP CARRYING
- ----------------------------------------------------------------------------- ------------------------ COSTS
PROPERTY LOCATION # OF UNITS ENCUMBRANCES LAND PROPERTY IMPROVEMENTS (C)
- --------------------------- -------------------- ----- ------------- ----------- ----------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Waterman's Crossing........ Newport News, VA 260 (a) $ 700,000 $ 893,682 $ 8,894,510 $ 65,190
Fox Hollow................. High Point, NC 184 (b) 272,215 499,365 5,518,162 98,580
Highland Park.............. Columbus, OH 252 (a) 65,799 37,792 8,591,903 69,176
Bluff Ridge................ Jacksonville, NC 108 (a) 196,050 33,281 3,272,492 77,738
Misty Springs.............. Daytona Beach, FL 128 (a) 710,400 351,972 2,840,884 68,679
Water's Edge............... Lake Villa, IL 108 (a) 246,160 24,550 4,833,896 139,440
Ponds at Georgetown........ Ann Arbor, MI 134 (a) 174,879 118,649 1,812,662 24,481
----------- ----------- ------------- ---------
$ 2,365,503 $ 1,959,291 $35,764,509 $ 543,284
----------- ----------- ------------- ---------
----------- ----------- ------------- ---------
</TABLE>
<TABLE>
<CAPTION>
GROSS AMOUNT AT DECEMBER 31, 1997
----------------------------------------
BUILDINGS,
IMPROVEMENTS LIFE ON
AND PERSONAL ACCUMULATED WHICH
LAND PROPERTY TOTAL DEPRECIATION DATE OF DATE DEPRECIATION
PROPERTY (D) (E) (D) AND (E) (F) CONSTRUCTION ACQUIRED IS COMPUTED
- ----------------------------- ----------- ------------- ------------ ------------ --------------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Waterman's Crossing.......... $ 1,122,322 $ 9,431,060 $ 10,553,382 $ 3,186,337 1987 N/A 5-40 years
Fox Hollow................... 272,215 6,116,107 6,388,322 1,910,707 1988 N/A 5-40 years
Highland Park................ 208,403 8,556,267 8,764,670 2,150,076 1988 N/A 5-40 years
Bluff Ridge.................. 203,050 3,376,511 3,579,561 829,474 1988 N/A 5-40 years
Misty Springs................ 741,587 3,230,348 3,971,935 1,061,578 1988 N/A 5-40 years
Water's Edge................. 371,215 4,872,831 5,244,046 1,173,572 1988 N/A 5-40 years
Ponds at Georgetown.......... 174,879 1,955,792 2,130,671 519,455 1989 N/A 5-40 years
----------- ------------- ------------ ------------
$ 3,093,671 $37,538,916 $ 40,632,587 $ 10,831,199
----------- ------------- ------------ ------------
----------- ------------- ------------ ------------
</TABLE>
23
<PAGE>
SCHEDULE III
CAPITAL SOURCE L.P.
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1997 AND 1996
(a) The Partnership has no encumbrances against this property. Encumbrances
recorded by the operating partnerships are eliminated in the consolidated
financial statements of the Partnership.
(b) The Partnership has a mortgage obligation which totalled $6,320,076 at
December 31, 1997, and $6,354,657 at December 31, 1996. The mortgage
obligation is collateralized solely by this property. Pursuant to the terms
of a Loan Modification Agreement ("LMA") entered into on January 8, 1996,
installments of principal and interest of $49,947 are due monthly with the
balance due and payable no later than October 1, 2028. The mortgage loan
bears interest at 8.86%. The mortgage loan was in compliance with the terms
of the LMA as of December 31, 1997.
(c) Carrying costs include legal fees, appraisal fees, title costs and other
related professional fees.
(d) The aggregate cost for federal income tax purposes is the same as for
financial reporting purposes.
(e) Reconciliation of Real Estate:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Balance--beginning of year..................................... $ 40,603,964 $ 40,597,750
Acquisitions................................................... 19,652 12,000
Improvements................................................... 8,971 5,222
Disposition of personal property............................... -- (11,008)
------------- -------------
Balance--end of year........................................... $ 40,632,587 $ 40,603,964
------------- -------------
------------- -------------
</TABLE>
(f) Reconciliation of Accumulated Depreciation:
<TABLE>
<CAPTION>
1997 1996
------------- ------------
<S> <C> <C>
Balance--beginning of year..................................... $ 9,925,636 $ 9,039,307
Depreciation expense........................................... 905,563 897,337
Disposition of personal property............................... -- (11,008)
------------- ------------
Balance--end of year........................................... $ 10,831,199 $ 9,925,636
------------- ------------
------------- ------------
</TABLE>
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Partnership originally acquired: (i) five mortgage-backed securities
guaranteed as to principal and interest by the Government National Mortgage
Association (GNMA) collateralized by first mortgage loans on multifamily housing
properties located in five states; (ii) three first mortgage loans insured as to
principal and interest by the Federal Housing Administration (FHA) on
multifamily housing properties located in two states; and (iii) Partnership
Equity Investments in eight limited partnerships which own the multifamily
properties financed by the GNMA Certificates and FHA Loans. The Partnership
subsequently received FHA Debentures in payment of the FHA Loan on Fox Hollow
Apartments which were paid in full in 1993. In 1994, foreclosure proceedings
were initiated on Falcon Point Apartments and, accordingly, the Partnership no
longer holds a Partnership Equity Investment in this property. In addition,
during 1995, the GNMA Certificate related to Falcon Point Apartments was
paid-in-full to the Partnership. Collectively, the remaining GNMA Certificates,
FHA Loans and Partnership Equity Investments are referred to as the "Permanent
Investments". The Partnership has also invested amounts held in its reserve
account in certain GNMA securities backed by pools of single-family mortgages
(Reserve Investments). The obligations of GNMA and FHA are backed by the full
faith and credit of the United States government.
The FHA Loans, GNMA Certificates and Partnership Equity Investments in
Operating Partnerships represent the Partnership's principal assets as shown in
the Parent Company Only Financial Information in Note 6 to the financial
statements. The parent company information is presented using the equity method
of accounting for the investment in Operating Partnerships. Generally accepted
accounting principles, however, require that the Partnership's financial
statements consolidate the Operating Partnerships, since the Partnership holds a
majority ownership in each Operating Partnership and can influence decisions of
the general partners in certain circumstances.
The following FHA Loans and GNMA Certificates were owned by the Partnership
at March 31, 1998.
<TABLE>
<CAPTION>
GUARANTEED OR INTEREST CARRYING
PROPERTY NAME INSURED BY RATE MATURITY DATE VALUE
- ------------------------------------------------------ ------------- ----------- -------------- -------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments................................ FHA 8.72% 11-15-2028 $ 3,504,519
Highland Park Apartments.............................. FHA 8.75% 11-01-2028 8,986,802
Misty Springs Apartments.............................. GNMA 8.75% 06-15-2029 4,265,854
The Ponds at Georgetown............................... GNMA 9.00% 12-15-2029 2,231,048
Waterman's Crossing................................... GNMA 10.00% 09-15-2028 10,914,389
Water's Edge Apartments............................... GNMA 8.75% 12-15-2028 5,058,938
Pools of single-family mortgages...................... GNMA 7.58%(1) 2008 to 2009 524,758
Pools of single-family mortgages...................... GNMA 7.58%(1) 2007 to 2008 523,096
-------------
$ 36,009,404
-------------
-------------
</TABLE>
- ------------------------
(1) Represents yield to the Partnership.
25
<PAGE>
DISTRIBUTIONS
Cash distributions paid or accrued per BAC were as follows:
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE QUARTER
ENDED MAR. 31, ENDED MAR. 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Regular monthly distributions................................. $ .1664 $ .2225
Income...................................................... .0861 .0300
------ ------
Return of capital........................................... $ .2525 $ .2525
------ ------
------ ------
Distributions
Paid out of cash flow....................................... $ .2525 $ .2525
------ ------
------ ------
</TABLE>
Regular quarterly distributions to BAC Holders consist primarily of interest
received on FHA Loans and GNMA Certificates. Additional cash for distributions
is received from other temporary investments. The Partnership may draw on
reserves to pay operating expenses or to supplement cash distributions to BAC
Holders. The Partnership is permitted to replenish reserves with cash flows in
excess of distributions paid. For the quarter ended March 31, 1998, a net amount
of $12,596 of undistributed cash flow was withdrawn from reserves. The total
amount held in reserves at March 31, 1998, was $10,723,790 of which $1,047,854
was invested in GNMA Certificates.
The Partnership believes that cash provided by operating activities and, if
necessary, withdrawals from the Partnership's reserves will be adequate to meet
its short-term and long-term liquidity requirements, including the payments of
distributions to BAC Holders. Under the terms of its Partnership Agreement, the
Partnership has the authority to enter into short-term and long-term debt
financing arrangements; however, the Partnership currently does not anticipate
entering into such arrangements. The Partnership is not authorized to issue
additional BACs to meet short-term and long-term liquidity requirements.
ASSET QUALITY
The FHA Loans and GNMA Certificates owned by the Partnership are guaranteed
as to principal and interest by FHA and GNMA, respectively. The obligations of
FHA and GNMA are backed by the full faith and credit of the United States
government. The Partnership Equity Investments, however, are not insured or
guaranteed. The value of these investments is a function of the value of the
real estate owned by the Operating Partnerships.
The overall status of the Partnership's investments has remained relatively
constant since December 31, 1997.
The following table shows the occupancy levels of the properties financed by
the Partnership at March 31, 1998:
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF UNITS PERCENTAGE OF
PROPERTY NAME LOCATION UNITS OCCUPIED UNITS OCCUPIED
- ------------------------------------- ---------------------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
Bluff Ridge Apartments............... Jacksonville, NC 108 104 96%
Fox Hollow Apartments................ High Point, NC 184 173 94%
Highland Park Apartments............. Columbus, OH 252 234 93%
Misty Springs Apartments............. Daytona Beach, FL 128 127 99%
The Ponds at Georgetown.............. Ann Arbor, MI 134 131 98%
Waterman's Crossing.................. Newport News, VA 260 252 97%
Water's Edge Apartments.............. Lake Villa, IL 108 107 99%
--
----- -----
1,174 1,128 96%
--
--
----- -----
----- -----
</TABLE>
26
<PAGE>
RESULTS OF OPERATIONS
The table below compares the results of operations for each period shown.
<TABLE>
<CAPTION>
FOR THE FOR THE INCREASE
QUARTER ENDED QUARTER ENDED (DECREASE)
MARCH 31, 1998 MARCH 31, 1997 FROM 1997
-------------- -------------- -----------
<S> <C> <C> <C>
Rental income....................................................... $ 1,894,782 $ 1,827,184 $ 67,598
Mortgage-backed securities income................................... 19,895 24,245 (4,350)
Interest on temporary cash investments.............................. 141,288 143,363 (2,075)
Other income........................................................ 77,879 90,024 (12,145)
-------------- -------------- -----------
2,133,844 2,084,816 49,028
-------------- -------------- -----------
Real estate operating expenses...................................... 950,856 819,400 131,456
Depreciation........................................................ 224,686 224,392 294
Interest expense.................................................... 149,841 149,841 --
Investor servicing.................................................. 126,562 86,137 40,425
Professional fees................................................... 12,775 15,850 (3,075)
Other expenses...................................................... 66,596 1,565 65,031
Amortization........................................................ 35,369 34,199 1,170
-------------- -------------- -----------
1,566,685 1,331,384 235,301
-------------- -------------- -----------
Minority interest in losses of Operating Partnerships............... 142 4,849 (4,707)
-------------- -------------- -----------
Net income.......................................................... $ 567,301 $ 758,281 $ (190,980)
-------------- -------------- -----------
-------------- -------------- -----------
</TABLE>
Rental income is recognized net of any vacancy losses and rental concessions
offered. Rental income, net of real estate operating expenses, depreciation and
amortization, decreased $65,322 for the quarter ended March 31, 1998, compared
to the same period in 1997. Although rental income increased 3.7% during the
quarter, this increase was more than offset by an increase in real estate
operating expenses and a slight increase in depreciation and amortization. The
increase in rental income was primarily due to an increase in occupancy at
certain properties. The increase in real operating expenses was primarily
attributable to an increase in salaries expense, real estate taxes and property
improvements at certain properties.
Mortgage-backed securities income decreased $4,350 for the quarter ended
March 31, 1998, compared to the same period in 1997 due to the continued
amortization of the principal balance of the mortgage-backed securities.
Other income consists primarily of corporate unit rentals, garage rentals,
washer/dryer, and vending income generated by the Partnership's properties.
Income from such sources decreased $12,145 for the quarter ended March 31, 1998,
compared to the same period in 1997, due primarily to decreases in corporate
unit rentals.
Investor servicing costs increased $40,425 for the quarter ended March 31,
1998, compared to the same period in 1997. This increase is due to an increase
of approximately $46,000 in salaries and related expenses, which were partially
offset by a decrease of approximately $6,000 in other investor servicing
expenses.
Professional fees decreased $3,075 for the quarter ended March 31, 1998,
compared to the same period in 1997, primarily due to a decrease in legal
expenses. Other expenses increased $65,031 for the quarter ending March 31,
1998, compared to the same period in 1997, primarily due to an increase in
consulting fees and travel expenses.
27
<PAGE>
This report contains forward looking statements that reflect management's
current beliefs and estimates of future economic circumstances, industry
conditions, the Partnership's performance and financial results. All statements,
trend analysis and other information concerning possible or assumed future
results of operations of the Partnership and the real estate investments it has
made (including, but not limited to, the information contained in "Management's
Discussion and Analysis of Financial Condition and Results of Operations"),
constitute forward-looking statements. BAC Holders and others should understand
that these forward looking statements are subject to numerous risks and
uncertainties and a number of factors could affect the future results of the
Partnership and could cause those results to differ materially from those
expressed in the forward looking statements contained herein.
28
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
MAR. 31, 1998 DEC. 31, 1997
-------------- --------------
<S> <C> <C>
ASSETS
Investment in real estate:
Land............................................................................ $ 3,093,671 $ 3,093,671
Buildings....................................................................... 35,536,966 35,536,966
Personal property............................................................... 2,004,746 2,001,950
-------------- --------------
40,635,383 40,632,587
Less accumulated depreciation................................................... (11,055,886) (10,831,199)
-------------- --------------
Net investment in real estate................................................... 29,579,497 29,801,388
-------------- --------------
Cash and temporary cash investments, at cost which approximates market value (Note
5).............................................................................. 10,218,941 10,410,564
Escrow deposits and property reserves............................................. 826,231 894,986
Investment in mortgage-backed securities (Note 5)................................. 1,047,854 1,088,526
Interest and other receivables.................................................... 190,094 70,542
Deferred mortgage issuance costs, net of accumulated amortization of $1,538,408 in
1998 and $1,503,039 in 1997..................................................... 2,064,398 2,099,768
Other assets...................................................................... 882,212 767,156
-------------- --------------
$ 44,809,227 45,132,930
-------------- --------------
-------------- --------------
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
Liabilities
Accounts payable and accrued expenses........................................... $ 1,497,745 $ 1,532,202
Distribution payable (Note 3)................................................... 860,587 860,587
Mortgage loan payable (Note 7).................................................. 6,320,076 6,320,076
Due to general partners and their affiliates (Note 4)........................... 4,013,726 4,013,626
-------------- --------------
12,692,134 12,726,491
-------------- --------------
Minority interest................................................................. 192,208 192,296
-------------- --------------
Partners' Capital (Deficit)
General Partners................................................................ (296,410) (293,517)
Limited Partners ($9.55 per BAC in 1998 and $9.63 in 1997)...................... 32,221,295 32,507,660
-------------- --------------
31,924,885 32,214,143
-------------- --------------
$ 44,809,227 $ 45,132,930
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
29
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MAR. 31, 1998 MAR. 31, 1997
-------------- --------------
<S> <C> <C>
Income:
Rental income................................................................... $ 1,894,782 $ 1,827,184
Mortgage-backed securities income............................................... 19,895 24,245
Income on temporary cash investments............................................ 141,288 143,363
Other income.................................................................... 77,879 90,024
-------------- --------------
2,133,844 2,084,816
-------------- --------------
Expenses:
Real estate operating expenses.................................................. 950,856 819,400
Depreciation.................................................................... 224,686 224,392
Interest expense................................................................ 149,841 149,841
General and administrative expenses (Note 4)
Investor servicing............................................................ 126,562 86,137
Professional fees............................................................. 12,775 15,850
Other expenses................................................................ 66,596 1,565
Amortization.................................................................. 35,369 34,199
-------------- --------------
1,566,685 1,331,384
-------------- --------------
Minority interest in losses of Operating Partnerships............................. 142 4,849
-------------- --------------
Net income........................................................................ $ 567,301 $ 758,281
-------------- --------------
-------------- --------------
Net income allocated to:
General Partners................................................................ $ 5,673 $ 7,583
Limited Partners................................................................ 561,628 750,698
-------------- --------------
$ 567,301 $ 758,281
-------------- --------------
-------------- --------------
Net income, basic and diluted, per BAC............................................ $ .17 $ .22
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
30
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
FOR THE QUARTER ENDED MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
----------- ------------- -------------
<S> <C> <C> <C>
Partners' Capital (Deficit)
(excluding net unrealized holding gains)
Balance at December 31, 1997........................................ (293,953) 32,464,480 32,170,527
Net income.......................................................... 5,673 561,628 567,301
Cash distributions paid or accrued (Note 3)......................... (8,606) (851,991) (860,597)
----------- ------------- -------------
(296,886) 32,174,117 31,877,231
----------- ------------- -------------
Net unrealized holding gains
Balance at December 31, 1997........................................ 436 43,180 43,616
Net change.......................................................... 40 3,998 4,038
----------- ------------- -------------
476 47,178 47,654
----------- ------------- -------------
Balance at March 31, 1998............................................. $ (296,410) $ 32,221,295 $ 31,924,885
----------- ------------- -------------
----------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
31
<PAGE>
CAPITAL SOURCE L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MAR. 31, 1998 MAR. 31, 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities
Net income........................................................................ $ 567,301 $ 758,281
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization................................................... 260,055 258,591
Amortization of discount on mortgage-backed securities.......................... (495) (707)
Minority interest in losses of Operating Partnerships........................... (142) (4,849)
Increase in interest and other receivables...................................... (119,552) (169,485)
Decrease in escrow deposits and property reserves............................... 68,755 133,716
Increase in other assets........................................................ (115,000) (16,777)
Decrease in accounts payable and accrued expenses............................... (34,457) (29,047)
Increase (decrease) in due to general partners and their affiliates............. 100 (63,770)
-------------- --------------
Net cash provided by operating activities......................................... 626,565 865,953
-------------- --------------
Cash flows from investing activities
Principal payments received on mortgage-backed securities....................... 45,205 64,640
Acquisition of personal property................................................ (2,796) (2,308)
-------------- --------------
Net cash provided by investing activities..................................... 42,409 62,332
-------------- --------------
Cash flow used in financing activities
Distributions................................................................... (860,597) (860,597)
-------------- --------------
Net increase (decrease) in cash and temporary cash investments.................... (191,623) 67,688
Cash and temporary cash investments at beginning of period........................ $ 10,410,564 $ 10,272,497
-------------- --------------
Cash and temporary cash investments at end of period.............................. $ 10,218,941 $ 10,340,185
-------------- --------------
-------------- --------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest........................................ $ 149,841 $ 149,841
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
32
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
1. ORGANIZATION
Capital Source L.P. (the Partnership) was formed on August 22, 1985, under
the Delaware Revised Uniform Limited Partnership Act. The General Partners of
the Partnership are Insured Mortgage Equities, Inc. and America First Capital
Source I L.L.C. (the General Partners).
The Partnership provided virtually 100% of the debt and equity financing for
eight multifamily rental housing properties. The Partnership's investment in the
properties consisted of: (i) approximately 85% in the form of permanent
mortgages and/or loans to fund construction; and, (ii) the balance to purchase
up to a 99% limited partnership interest in the Operating Partnerships which
developed, own and operate the properties. Each loan is insured or guaranteed,
in an amount substantially equal to the face amount of the mortgage, by the
Federal Housing Administration (FHA) or the Government National Mortgage
Association (GNMA). The Partnership has been repaid by FHA on one of its first
mortgage loans. The Partnership has also been repaid by GNMA on one of its GNMA
Certificates. The Partnership no longer holds a Partnership Equity Investment in
the Operating Partnership which owned the property collateralizing the repaid
GNMA Certificate. The seven remaining Operating Partnerships are geographically
located as follows: (i) two in North Carolina; and, (ii) one each in Ohio,
Florida, Michigan, Virginia and Illinois.
CS Properties I, Inc., which is owned by affiliates of the General Partners,
serves as the Special Limited Partner for the Operating Partnerships. The
Special Limited Partner has the power, among other things, to remove the general
partners of the Operating Partnerships under certain circumstances and to
consent to the sale of the Operating Partnerships' assets. CS Properties I, Inc.
also serves as the general partner of Misty Springs Apartments, Waterman's
Crossing and Fox Hollow Apartments.
The Partnership will terminate subsequent to the sale of all properties but
in no event will the Partnership continue beyond December 31, 2030.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A) FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements include the accounts of the
Partnership and seven subsidiary Operating Partnerships. The Partnership is
a limited partner with an ownership interest of up to 99% in six of the
subsidiary Operating Partnerships. The Partnership's ownership interest in
The Ponds at Georgetown L.P. is 30.29%. The remaining limited partner
interest of 68.70% is owned by Capital Source II L.P.-A, an affiliate of the
General Partners. All significant intercompany accounts and transactions
have been eliminated in consolidation.
The consolidated financial statements are prepared without audit on the
accrual basis of accounting in accordance with generally accepted accounting
principles. The consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Partnership's Annual Report on Form 10-K for the year ended
December 31, 1997. In the opinion of management, all normal and recurring
adjustments necessary to present fairly the financial position at March 31,
1998 and results of operations for all periods presented have been made.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of
33
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
B) INVESTMENT IN REAL ESTATE
The Partnership's investment in real estate is carried at cost less
accumulated depreciation. The carrying value of each property is reviewed
for impairment whenever events or circumstances indicate that the carrying
value may not be recoverable. If the sum of the expected discounted future
cash flows is less than the carrying amount, an impairment is recorded based
on fair value.
C) INVESTMENT IN MORTGAGE-BACKED SECURITIES
Investment securities are classified as held-to-maturity,
available-for-sale or trading. Investments classified as available-for-sale
are reported at fair value with any unrealized gains or losses excluded from
earnings and reflected as a separate component of partners' capital.
Subsequent increases and decreases in the net unrealized gain/loss on the
available-for-sale securities are reflected as adjustments to the carrying
value of the portfolio and adjustments to the component of partners'
capital. The Partnership does not have investment securities classified as
held-to-maturity or trading.
D) DEPRECIATION AND AMORTIZATION
Depreciation of real estate is based on the estimated useful life of the
properties using the straight-line method. Deferred mortgage issuance costs
are amortized using the effective yield method over the 40 year term of the
respective loan.
E) REVENUE RECOGNITION
The Operating Partnerships lease multifamily rental units under
operating leases with terms of one year or less. Rental revenue is
recognized as earned, net of any vacancy losses and rental concessions
offered.
F) INCOME TAXES
No provision has been made for income taxes since BAC Holders are
required to report their share of the Partnership's income for federal and
state income tax purposes.
G) TEMPORARY CASH INVESTMENTS
Temporary cash investments are invested in short-term debt securities
purchased with original maturities of three months or less.
H) NET INCOME PER BENEFICIAL ASSIGNMENT CERTIFICATE (BAC)
Net income per BAC is based on the number of BACs outstanding
(3,374,222) during each period presented.
I) COMPREHENSIVE INCOME
In the first quarter of 1998, the Partnership adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130). SFAS 130 requires the display and
34
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reporting of comprehensive income, which includes all changes in partners'
capital with the exception of additional investments by partners or
distributions to partners. Comprehensive income for the Partnership includes
net income and the change in net unrealized holding gains (losses) on
investments charged or credited to Partners' Capital. Comprehensive income
for the quarters ended March 31, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MAR. 31, 1998 MAR. 31, 1997
-------------- --------------
<S> <C> <C>
Net income.................................................... $ 567,301 $ 758,281
Change in net unrealized holding gains (losses)............... 4,038 (15,847)
-------------- --------------
Comprehensive income.......................................... $ 571,339 $ 742,434
-------------- --------------
-------------- --------------
</TABLE>
3. PARTNERSHIP INCOME, EXPENSES AND CASH DISTRIBUTIONS
Profits and losses from normal operations and cash available for
distribution will be allocated 99% to the Investors and 1% to the General
Partners. Certain fees payable to the General Partners will not become due until
Investors have received certain priority returns. Cash distributions included in
the consolidated financial statements represent the actual cash distributions
made during each period and the cash distributions accrued at the end of each
period.
The General Partners will also receive 1% of the net proceeds from any sale
of Partnership assets. The General Partners will receive a termination fee equal
to 3% of all sales proceeds less actual costs incurred in connection with all
sales transactions, payable only after the Investors have received a return of
their capital contributions and a 13% annual return on a cumulative basis. The
General Partners will also receive a fee equal to 9.1% of all cash available for
distribution and sales proceeds (after deducting from cash available or sales
proceeds any termination fee paid therefrom) after Investors have received a
return of their capital contributions and a 13% annual return on a cumulative
basis.
4. TRANSACTIONS WITH RELATED PARTIES
The General Partners, certain of their affiliates and the Operating
Partnerships' general partners have received or may receive fees, compensation,
income, distributions and payments from the Partnership in connection with the
offering and the investment, management and sale of the Partnership's assets
(other than disclosed elsewhere) as follows.
The Operating Partnerships' general partners provide various on-site
property development and management services. There were no property development
and management fees incurred for the quarter ended March 31, 1998. Unpaid fees,
which are non-interest bearing, are included in amounts due to general partners
and their affiliates on the accompanying consolidated balance sheets and will be
paid in accordance with the terms of the respective Operating Partnership's
limited partnership agreement.
The General Partners are entitled to receive an asset management and
partnership administration fee equal to 0.5% of invested assets per annum,
payable only during such years that an 8% return has been paid to Investors on a
noncumulative basis. Any unpaid amounts will accrue and be payable only after a
35
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
4. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
13% annual return to Investors has been paid on a cumulative basis and the
Investors have received the return of their capital contributions. For the
quarter ended March 31, 1998, distributions to Investors represented less than
an 8% return; accordingly, no fees were paid or accrued during this period.
Amounts due to general partners and their affiliates at March 31, 1998, is
comprised of the following:
<TABLE>
<S> <C>
Unpaid property development and management fees................. $ 450,173
Operating deficit loans......................................... 3,563,553
---------
$4,013,726
---------
---------
</TABLE>
Substantially all of the Partnership's general and administrative expenses
and certain costs capitalized by the Partnership are paid by a General Partner
or an affiliate and reimbursed by the Partnership. The amount of such expenses
and costs reimbursed to the General Partner for 1998 was $363,427. Reimbursed
expenses are presented on a cash basis and do not reflect accruals made at
quarter end.
An affiliate of the General Partners has been retained to provide property
management services for Waterman's Crossing, Misty Springs Apartments, Fox
Hollow Apartments and The Ponds at Georgetown. The fees for services provided in
1998 amounted to $48,616 and represented the lower of costs incurred in
providing management of the property or customary fees for such services
determined on a competitive basis.
5. PARTNERSHIP RESERVE ACCOUNT
The Partnership maintains a reserve account which consisted of the following
at March 31, 1998:
<TABLE>
<S> <C>
Cash and temporary cash investments............................ $9,675,936
GNMA Certificates.............................................. 1,047,854
----------
$10,723,790
----------
----------
</TABLE>
The reserve account was established to maintain working capital for the
Partnership and is available for distribution to BAC Holders and for any
contingencies related to Permanent Investments and the operation of the
Partnership. The GNMA Certificates mature between 2007 and 2009. At March 31,
1998, the total amortized cost, gross unrealized holding gains and aggregate
fair value of available-for-sale securities were $1,000,200, $47,654 and
$1,047,854, respectively.
6. PARENT COMPANY ONLY FINANCIAL INFORMATION
Generally accepted accounting principles require that the Partnership's
financial statements consolidate the Operating Partnerships since the
Partnership holds a majority ownership interest and, through CS Properties I,
Inc. can influence the decisions of the general partners in certain
circumstances. In the consolidated financial statements, the Partnership's
investment in FHA Loans and GNMA Certificates is eliminated against the related
mortgage payable recorded by the Operating Partnership. If a mortgage loan goes
into default and is foreclosed upon by FHA or GNMA, the respective agency may,
at their discretion, repay the FHA Loan or the GNMA Certificate. If this occurs,
the Partnership's investment in the
36
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
6. PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
Operating Partnership would be eliminated, resulting in the recognition of a
gain on the Partnership's financial statements. This arises because
consolidation accounting does not allow the Partnership to stop recording losses
from the Operating Partnerships when the net investment is reduced to zero.
The parent company only financial information below represents the condensed
financial information of the Partnership using the equity method of accounting
for the investment in Operating Partnerships, rather than the consolidation of
those partnerships. Under the equity method of accounting, the Partnership's
capital contributions are adjusted to reflect its share of Operating Partnership
profits or losses and distributions. The investment in Operating Partnerships
represents the Partnership's limited partnership interest in the accumulated
deficits of those Operating Partnerships. The parent company only information is
provided to more clearly present the Partnership's investment in the Operating
Partnerships. Since the Partnership is not a general partner, it is not
obligated to fund the negative balances. If the investments in all Operating
Partnerships were eliminated at March 31, 1998, Partnership capital would
increase by $13,846,450 ($4.06 per BAC).
The FHA Loans and the GNMA Certificates are collateralized by first mortgage
loans on the properties owned by the Operating Partnerships and are guaranteed
or insured as to principal and interest by FHA or GNMA. The FHA insured mortgage
loans are subject to a 1% assignment fee. The obligations of FHA and GNMA are
backed by the full faith and credit of the United States government.
PARENT COMPANY ONLY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
MAR. 31, 1998 DEC. 31, 1997
-------------- --------------
<S> <C> <C>
ASSETS
Cash and temporary cash investments......................... $ 10,218,941 10,410,564
Investment in FHA Loans..................................... 12,491,321 12,511,046
Investment in GNMA Certificates............................. 23,518,083 23,588,139
Investment in Operating Partnerships........................ (13,846,450) (13,686,936)
Interest receivable......................................... 319,311 321,485
Other assets................................................ 285,139 134,574
-------------- --------------
$ 32,986,345 $ 33,278,872
-------------- --------------
-------------- --------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Accounts payable.......................................... $ 200,873 $ 204,142
Distributions payable..................................... 860,587 860,587
-------------- --------------
1,061,460 1,064,729
Partners' Capital......................................... 31,924,885 32,214,143
-------------- --------------
$ 32,986,345 $ 33,278,872
-------------- --------------
-------------- --------------
</TABLE>
37
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
6. PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MAR. 31, 1998 MAR. 31, 1997
-------------- --------------
<S> <C> <C>
Income
Mortgage and mortgage-backed securities income.............. 800,397 794,675
Interest on temporary cash investments...................... 138,177 133,476
Interest on mortgage-backed securities...................... 19,895 24,245
Equity in losses of Operating Partnerships.................. (169,514) (74,392)
Other income................................................ 1,150 700
-------------- --------------
790,105 878,704
Expenses
Operating and administrative................................ 222,804 120,423
-------------- --------------
Net income.................................................... $ 567,301 $ 758,281
-------------- --------------
-------------- --------------
</TABLE>
38
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
6. PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MAR. 31, 1998 MAR. 31, 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities
Net income.................................................... $ 567,301 $ 758,281
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in losses of Operating Partnerships................ 169,514 74,392
Amortization.............................................. 16,872 16,872
Amortization of discount on mortgage-backed securities.... (495) (707)
Other non-cash adjustments................................ (168,532) (4,975)
-------------- --------------
Net cash provided by operating activities..................... 584,660 843,863
-------------- --------------
Cash flows from investing activities
FHA Loan and GNMA Certificate principal payments............ 94,314 109,422
Investment in Operating Partnerships........................ (10,000) (25,000)
-------------- --------------
Net cash provided by investing activities..................... 84,314 84,422
-------------- --------------
Cash flow used in financing activity
Distributions............................................... (860,597) (860,597)
-------------- --------------
Net increase (decrease) in cash and temporary cash
investments................................................. (191,623) 67,688
Cash and temporary cash investments at beginning of period.... 10,410,564 10,272,497
-------------- --------------
Cash and temporary cash investments at end of period.......... $ 10,218,941 $ 10,340,185
-------------- --------------
-------------- --------------
</TABLE>
7. MORTGAGE LOAN PAYABLE
The mortgage collateralized solely by Fox Hollow Apartments provides for
interest at 8.86%. Installments of principal and interest in the amount of
$49,947 are due on the first day of each month with the balance of principal and
interest due and payable no later than October 1, 2028. The mortgage loan
payable of $6,320,076 is recorded on the consolidated balance sheet, since it is
no longer eliminated in consolidation. The mortgage is an obligation of the
Operating Partnership which owns the property.
8. SUBSEQUENT EVENT
On May 7, 1998, a Registration Statement on Form S-4 was filed by America
First Real Estate Investment Company, Inc. (the Company) with the Securities and
Exchange Commission which includes a
39
<PAGE>
CAPITAL SOURCE L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
8. SUBSEQUENT EVENT (CONTINUED)
consent solicitation statement of the Partnership and Capital Source II L.P.-A,
a sister partnership with assets and investment objectives similar to the
Partnership. Upon approval of the proposed plan by Investors in both
Partnerships, the Partnerships will be combined into the Company which will be
engaged in the business of making real estate and related investments. At their
election and subject to certain limitations, Investors in each Partnership will
receive, in exchange for their Partnership Units, Shares of common stock in the
Company (the Common Stock) or variable rate notes (the Notes) of the Company.
The Company intends to list shares of Common Stock issued pursuant to the
planned merger on a national securities exchange.
40
<PAGE>
CAPITAL SOURCE II L.P.-A
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Capitalized terms not otherwise defined herein shall have the meanings set
forth in the accompanying Prospectus/Consent Solicitation Statement.
LIQUIDITY AND CAPITAL RESOURCES
Capital Source II L.P.-A (the "Partnership") originally acquired: (i) four
GNMA Certificates which are guaranteed as to principal and interest by the
Government National Mortgage Association ("GNMA") collateralized by first
mortgage loans on multifamily housing properties located in three states; (ii)
an FHA Loan which is insured as to principal and interest by the Federal Housing
Administration ("FHA") on a multifamily housing property; and (iii) Partnership
Equity Investments in five Operating Partnerships which own the multifamily
properties financed by the GNMA Certificates and the FHA Loan. The Partnership
has been repaid by GNMA on one of the GNMA Certificates and the related property
has been deeded to GNMA in lieu of foreclosure, thus eliminating the Partnership
Equity Investment in this property. Collectively, the remaining GNMA
Certificates, the FHA Loan, and the Partnership Equity Investments are referred
to as the "Permanent Investments." The Partnership has also invested amounts
held in its reserve account in certain GNMA securities backed by pools of
single-family mortgages ("Reserve Investments"). The obligations of GNMA and FHA
are backed by the full faith and credit of the United States government.
The FHA Loan, GNMA Certificates and Partnership Equity Investments in
Operating Partnerships represent the Partnership's principal assets as shown in
the Parent Company Only Financial Information in Note 6 to the financial
statements. The parent company information is presented using the equity method
of accounting for the investment in Operating Partnerships. Generally accepted
accounting principles, however, require that the Partnership's financial
statements consolidate the Operating Partnerships, since the Partnership holds a
majority ownership interest in each Operating Partnership, and can influence
decisions of the general partners in certain circumstances.
The following FHA Loan and GNMA Certificates were owned by the Partnership
at December 31, 1997. Interest income from the FHA Loan and GNMA Certificates is
the primary source of cash available for distribution to investors.
<TABLE>
<CAPTION>
GUARANTEED
OR INTEREST MATURITY CARRYING
PROPERTY NAME INSURED BY RATE DATE VALUE
- ------------------------------------------------------- ----------- ----------- -------------- -------------
<S> <C> <C> <C> <C>
Crane's Landing........................................ GNMA 8.75% 12/15/2030 $ 10,229,304
Delta Crossing......................................... FHA 9.10 10/01/2030 6,538,424
Monticello Apartments.................................. GNMA 8.75 11/15/2029 5,328,430
The Ponds at Georgetown................................ GNMA 9.00 12/15/2029 5,066,488
Pools of Single-Family Properties...................... GNMA 7.58(1) 2008 to 2009 1,050,718
-------------
$ 28,213,364
-------------
-------------
</TABLE>
- ------------------------
(1) Represents yield to the Partnership.
41
<PAGE>
DISTRIBUTIONS
Cash distributions paid or accrued per Beneficial Assignment Certificate of
the Partnership (a "BAC") were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
------------------- ------------------- -------------------
<S> <C> <C> <C>
Regular monthly distributions
Income.......................... $ .3449 $ .3947 $ .4266
Return of capital............... .4651 .4153 .3834
------ ------ ------
$ .8100 $ .8100 $ .8100
------ ------ ------
------ ------ ------
Distributions..................... $ .5172 $ .6019 $ .6497
Paid out of cash flow........... .2928 .2081 .1603
------ ------ ------
Paid out of reserves............ $ .8100 $ .8100 $ .8100
------ ------ ------
------ ------ ------
</TABLE>
Regular monthly distributions to BAC Holders consist primarily of interest
received on the FHA Loan, GNMA Certificates and the Reserve Investments.
Additional cash for distributions is received from other temporary investments.
The Partnership may draw on reserves to pay operating expenses or to supplement
cash distributions to BAC Holders. The Partnership is permitted to replenish
reserves with cash flows in excess of distributions paid. During 1997,
$1,186,163 was withdrawn from reserves to supplement regular monthly cash
distributions. The total amount held in reserves at December 31, 1997, was
$1,550,084 of which $1,050,718 was invested in mortgaged-backed securities.
The Partnership has been supplementing cash flow from operations with
withdrawals from reserves in order to maintain distributions at the current
levels. Consequently, it is likely that the level of distributions will be
reduced in the future. The General Partners will continue to review the level of
distributions each quarter in light of the Partnership's operating results and
financial position.
The Partnership believes that cash provided by operating activities and, if
necessary, withdrawals from the Partnership's reserves will be adequate to meet
its short-term liquidity requirements, including the payments of distributions
to BAC Holders. The Partnership has no other internal or external sources of
liquidity. Under the terms of its Partnership Agreement, the Partnership has the
authority to enter into short-and long-term debt financing arrangements;
however, the Partnership currently does not anticipate entering into such
arrangements. The Partnership is not authorized to issue additional BACs to meet
short-term and long-term liquidity requirements.
ASSET QUALITY
The FHA Loan and GNMA Certificates owned by the Partnership are guaranteed
as to principal and interest by FHA and GNMA, respectively. The obligations of
FHA and GNMA are backed by the full faith and credit of the United States
government. The Partnership Equity Investments, however, are not insured or
guaranteed. The value of these investments is a function of the value of the
real estate owned by the Operating Partnerships.
42
<PAGE>
The following table shows the occupancy levels of the properties financed by
the Partnership as of December 31, 1997:
<TABLE>
<CAPTION>
NUMBER PERCENTAGE
NUMBER OF UNITS OF UNITS
PROPERTY NAME LOCATION OF UNITS OCCUPIED OCCUPIED
- ---------------------------------------- ------------------ ----------- ------------- ---------------
<S> <C> <C> <C> <C>
Crane's Landing......................... Winter Park, FL 252 237 94%
Delta Crossing.......................... Charlotte, NC 178 168 94
Monticello Apartments................... Southfield, MI 106 104 98
The Ponds at Georgetown................. Ann Arbor, MI 134 128 96
--
--- ---
670 637 95%
--
--
--- ---
--- ---
</TABLE>
CRANE'S LANDING. Crane's Landing, located in Winter Park, Florida, is a
252-unit complex with one-, two- and three-bedroom apartments on 14 acres of
land. Average occupancy was 96% during 1997, compared to 94% during 1996. As a
result of the increase in average occupancy and rental rate increases, rental
income increased approximately 9% in 1997, compared to 1996. The increase in
rental income was partially offset by an increase in real estate operating
expenses, primarily an increase of approximately 23% in repairs and maintenance
expenses and 15% in labor expenses. This resulted in an increase of
approximately 4.4% in net cash flow generated by this property, before debt
service, in 1997, compared to 1996. The property generated cash flow in excess
of debt service and was current on its mortgage obligations during 1997.
DELTA CROSSING. Delta Crossing is a 178-unit apartment complex located in
Charlotte, North Carolina. Average occupancy was 93% in 1997, compared to 92% in
1996. As a result of the increase in occupancy and rental rate increases, rental
income increased approximately 2% in 1997, compared to 1996. The increase in
rental income was offset by increases of approximately 11% in repairs and
maintenance expenses and property improvements, 9% in labor expenses and slight
increases in other expenses. Thus, net cash flow generated by this property in
1997 was comparable to 1996. The property generated cash flow in excess of debt
service and was current on its mortgage obligations during 1997.
MONTICELLO APARTMENTS. Monticello Apartments, located in Southfield,
Michigan, contains 106 rental units. Average occupancy was 97% in 1997, compared
to 96% in 1996. As a result, rental income increased slightly in 1997, compared
to 1996. The increase in rental income was more than offset by increases in real
estate operating expenses, primarily an increase of approximately 42% in repairs
and maintenance expenses and property improvements and 13% in labor expenses.
Thus, net cash flow generated by this property, before debt service, decreased
approximately 2.3% in 1997, compared to 1996. Despite the decrease in net cash
flow, the property generated cash flow in excess of debt service and was current
on its mortgage obligations during 1997.
THE PONDS AT GEORGETOWN. The Ponds at Georgetown consists of 134 apartments
located in Ann Arbor, Michigan. Average occupancy was 97% in 1997 compared to
95% in 1996. Operating revenue increased approximately 8% in 1997 compared to
1996, primarily due to the increase in average occupancy, rental rate increases
and an increase in corporate unit rentals. Despite the increase in operating
revenue, the Operating Partnership remains in default on its mortgage loan and
is delinquent in paying property taxes and insurance. The Partnership continues
to explore a number of alternatives with the mortgage holder to determine the
best course of action to pursue, including a possible restructuring of the
mortgage loan.
America First Capital Source II, L.L.C., and Insured Mortgage Equities II
L.P., (referred to as the "General Partners") have conducted a review of their
computer systems to identify those areas that could be affected by the "Year
2000" issue and have developed a plan to resolve the issue. The General Partners
believe the "Year 2000" problem can be resolved without significant operational
difficulties. The Partnership does not maintain its own computer systems and
does not reimburse the General Partners for any capital expenses associated with
computer systems. Therefore, no material effect to the Partnership's results of
operations, financial position or cash flows is anticipated from the "Year 2000"
issue or its resolution.
43
<PAGE>
RESULTS OF OPERATIONS
The tables below compare the results of operations for each year shown.
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, DEC. 31, DEC. 31,
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Rental income.......................................................... $5,105,108 $4,854,898 $4,656,371
Interest on temporary cash investments and U.S. government
securities........................................................... 104,411 168,311 218,077
Mortgage-backed securities income...................................... 82,182 91,982 123,033
Other income........................................................... 202,670 161,805 144,967
Gain on sale of mortgage-backed securities............................. -- -- 15,670
------------ ------------ ------------
5,494,371 5,276,996 5,158,118
------------ ------------ ------------
Real estate operating expenses......................................... 2,562,636 2,384,690 2,134,277
Depreciation........................................................... 666,758 692,383 704,155
Property development and management fees............................... -- 314 28,769
General and administrative expenses
Investor servicing................................................... 411,005 265,836 221,174
Professional fees.................................................... 156,809 38,224 40,234
Other expenses....................................................... 23,326 19,734 10,119
Asset management and partnership administration fees................... 166,000 166,000 166,000
Amortization........................................................... 111,144 111,195 127,296
------------ ------------ ------------
4,097,678 3,678,376 3,432,024
------------ ------------ ------------
Minority interest in losses of Operating Partnerships.................. 857 608 2,220
------------ ------------ ------------
Net income............................................................. $1,397,550 $1,599,228 $1,728,314
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
INCREASE INCREASE
(DECREASE) (DECREASE)
FROM 1996 FROM 1995
----------- -----------
<S> <C> <C>
Rental income........................................................................... $ 250,210 $ 198,527
Interest on temporary cash investments and U.S. government securities................... (63,900) (49,766)
Mortgage-backed securities income....................................................... (9,800) (31,051)
Other income............................................................................ 40,865 16,838
Gain on sale of mortgage-backed securities.............................................. -- (15,670)
----------- -----------
217,375 118,878
----------- -----------
Real estate operating expenses.......................................................... 177,946 250,413
Depreciation............................................................................ (25,625) (11,772)
Property development and management fees................................................ (314) (28,455)
General and administrative expenses
Investor servicing.................................................................... 145,169 44,662
Professional fees..................................................................... 118,585 (2,010)
Other expenses........................................................................ 3,592 9,615
Asset management and partnership administration fees.................................... -- --
Amortization............................................................................ (51) (16,101)
----------- -----------
419,302 246,352
----------- -----------
Minority interest in losses of Operating Partnerships................................... 249 (1,612)
----------- -----------
Net income.............................................................................. $ (201,678) $ (129,086)
----------- -----------
----------- -----------
</TABLE>
44
<PAGE>
Rental income is recognized net of any vacancy losses and rental concessions
offered. Rental income, net of real estate operating expenses, depreciation and
amortization increased $97,940 from 1996 to 1997. The increase was primarily due
to an increase in rental income due to an increase in average occupancy
partially offset by higher repairs and maintenance expenses and labor expenses.
See the discussion of each property in the Asset Quality section for additional
information.
Rental income, net of real estate operating expenses, depreciation, and
amortization, decreased $24,013 from 1995 to 1996. The decrease was due to an
increase in real estate operating expenses resulting from higher repairs and
maintenance expenses, property improvements and administrative expenses. The
increase in real estate operating expenses was partially offset by an increase
in rental income due primarily to an increase in the average occupancy of
Crane's Landing and rental rate increases in certain markets. Also contributing
to the partial offsetting of the increase in real estate operating expenses was
a decrease in depreciation due to certain personal property becoming fully
depreciated and a decrease in amortization due to certain costs becoming fully
amortized.
Interest on temporary cash investments and U.S. government securities
decreased $63,900 from 1996 to 1997 and $49,766 from 1995 to 1996 due to
withdrawals made from the partnership's reserves to supplement distributions to
BAC Holders.
Mortgage-backed securities income decreased $9,800 from 1996 to 1997 and
$31,051 from 1995 to 1996 due to the continued amortization of the principal
balances of the partnership's mortgage-backed securities.
Other income consists of income such as corporate unit rentals, garage
rentals, washer/dryer and vending income earned by the properties. Other income
increased $40,865 from 1996 to 1997 and $16,838 from 1995 to 1996 primarily due
to an increase in corporate unit rentals at The Ponds at Georgetown.
During 1995, the Partnership sold a portion of its mortgage-backed
securities and realized a gain of $15,670 on the sale. There were no such sales
during either 1996 or 1997.
Property development and management fees decreased $314 from 1996 to 1997
and $28,455 from 1995 to 1996 due to a decrease in the amount of such income
earned by the general partners of the Operating Partnerships in accordance with
their respective partnership agreement.
Investor servicing expenses increased $145,169 from 1996 to 1997 and $44,662
from 1995 to 1996 due primarily to an increase in salaries and related expenses.
The Partnership incurred costs of approximately $126,000 during 1997 in
connection with a review of various options available to the Partnership to
improve total investment returns and provide liquidity to the Partnership's
investors. Excluding such costs, professional fees decreased from 1996 to 1997
and 1995 to 1996 due primarily to a decrease in legal fees. Other expenses
increased $3,592 from 1996 to 1997 due to increases in miscellaneous expenses.
Other income increased $9,615 from 1995 to 1996 due to increases in travel and
other miscellaneous expenses.
This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements that reflect management's
current beliefs and estimates of future economic circumstances, industry
conditions, the Partnership's performance and financial results. All statements,
trend analysis and other information concerning possible or assumed future
results of operations of the Partnership and the real estate investments it has
made constitute forward-looking statements. BAC Holders and others should
understand that these forward-looking statements are subject to numerous risks
and uncertainties and a number of factors could affect the future results of the
Partnership and could cause those results to differ materially from those
expressed in the forward-looking statements contained herein.
45
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Partners
Capital Source II L.P.-A:
We have audited the accompanying consolidated balance sheets of Capital
Source II L.P.-A and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, partners' capital and cash flows for
each of the three years in the period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Capital
Source II L.P.-A and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ Coopers & Lybrand L.L.P.
Omaha, Nebraska
March 26, 1998
46
<PAGE>
To the Partners
Capital Source II L.P.-A:
Our report on the consolidated financial statements of Capital Source II
L.P.-A and subsidiaries is included herein. In connection with our audit of such
consolidated financial statements, we have also audited the related consolidated
financial statement schedule of Real Estate and Accumulated Depreciation.
In our opinion, the consolidated financial statement schedule referred to
above, when considered in relation to the basic financial statements taken as a
whole, present fairly, in all material aspects, the information required to be
included therein.
/s/ Coopers & Lybrand L.L.P.
Omaha, Nebraska
March 26, 1998
47
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
<S> <C> <C>
ASSETS
Investments in real estate
Land..................................................................... $ 2,800,750 $ 2,800,750
Buildings................................................................ 23,055,361 23,055,361
Personal property........................................................ 1,666,485 1,597,666
----------------- -----------------
27,522,596 27,453,777
Less accumulated depreciation............................................ (6,330,294) (5,664,440)
----------------- -----------------
Net investment in real estate............................................ 21,192,302 21,789,337
----------------- -----------------
Cash and temporary cash investments, at cost which approximates market
value (Note 5)........................................................... 1,240,992 2,430,937
Escrow deposits and property reserves...................................... 1,104,823 771,061
Investment in mortgage-backed securities (Note 5).......................... 1,050,718 1,171,079
Interest and other receivables............................................. 19,443 23,125
Deferred mortgage issuance costs net of accumulated amortization of
$792,341 in 1997 and $681,197 in 1996.................................... 1,589,510 1,700,654
Other assets............................................................... 241,498 220,229
----------------- -----------------
$ 26,439,286 $ 28,106,422
----------------- -----------------
----------------- -----------------
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
Liabilities
Accounts payable and accrued expenses.................................... $ 1,118,970 $ 874,562
Distribution payable (Note 3)............................................ 546,968 546,968
Due to general partners and their affiliates (Note 4).................... 1,067,313 1,099,709
----------------- -----------------
2,733,251 2,521,239
----------------- -----------------
Minority interest.......................................................... 205,603 206,460
----------------- -----------------
Partners' Capital (Deficit)
General Partners......................................................... (331,453) (312,671)
Limited Partners ($5.94 per BAC in 1997 and $6.41 in 1996)............... 23,831,885 25,691,394
----------------- -----------------
23,500,432 25,378,723
----------------- -----------------
$ 26,439,286 $ 28,106,422
----------------- -----------------
----------------- -----------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
48
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Income:
Rental income......................................................... $ 5,105,108 $ 4,854,898 $ 4,656,371
Interest on temporary cash investments and U.S. government
securities.......................................................... 104,411 168,311 218,077
Mortgage-backed securities income..................................... 82,182 91,982 123,033
Other income.......................................................... 202,670 161,805 144,967
Gain on sale of mortgage-backed securities............................ -- -- 15,670
------------ ------------ ------------
5,494,371 5,276,996 5,158,118
------------ ------------ ------------
Expenses:
Real estate operating expenses........................................ 2,562,636 2,384,690 2,134,277
Depreciation.......................................................... 666,758 692,383 704,155
Property development and management fees (Note 4)..................... -- 314 28,769
General and administrative expenses (Note 4)
Investor servicing.................................................. 411,005 265,836 221,174
Professional fees................................................... 156,809 38,224 40,234
Other expenses...................................................... 23,326 19,734 10,119
Asset management and partnership fees (Note 4)........................ 166,000 166,000 166,000
Amortization.......................................................... 111,144 111,195 127,296
------------ ------------ ------------
4,097,678 3,678,376 3,432,024
------------ ------------ ------------
Minority interest in losses of Operating Partnerships................... 857 608 2,220
------------ ------------ ------------
Net income........................................................ $ 1,397,550 $ 1,599,228 $ 1,728,314
------------ ------------ ------------
------------ ------------ ------------
Net Income Allocated to:
General Partners...................................................... $ 13,976 $ 15,992 $ 17,283
Limited Partners...................................................... 1,383,574 1,583,236 1,711,031
------------ ------------ ------------
$ 1,397,550 $ 1,599,228 $ 1,728,314
------------ ------------ ------------
------------ ------------ ------------
Net income, basic and diluted, per BAC.................................. $ .34 $ .39 $ .43
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
49
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
FROM DECEMBER 31, 1994 TO DECEMBER 31, 1997
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
----------- ------------- -------------
<S> <C> <C> <C>
Partners' Capital (Deficit)
(excluding net unrealized
holding gains)
Balance at December 31, 1994........................................ $ (280,672) $ 28,859,231 $ 28,578,559
Net income.......................................................... 17,283 1,711,031 1,728,314
Cash distributions paid or accrued (Note 3)......................... (32,818) (3,248,992) (3,281,810)
----------- ------------- -------------
Balance at December 31, 1995........................................ (296,207) 27,321,270 27,025,063
Net income.......................................................... 15,992 1,583,236 1,599,228
Cash distributions paid or accrued (Note 3)......................... (32,818) (3,248,992) 3,281,810
----------- ------------- -------------
Balance at December 31, 1996........................................ (313,033) 25,655,514 25,342,481
Net income.......................................................... 13,976 1,383,574 1,397,550
Cash distributions paid or accrued (Note 3)......................... (32,818) (3,248,992) (3,281,810)
----------- ------------- -------------
(331,875) 23,790,096 23,458,221
----------- ------------- -------------
Net unrealized holding gains
Balance at December 31, 1994........................................ -- -- --
Net change.......................................................... 787 77,955 78,742
----------- ------------- -------------
Balance at December 31, 1995........................................ 787 77,955 78,742
Net change.......................................................... (425) (42,075) (42,500)
----------- ------------- -------------
Balance at December 31, 1996........................................ 362 35,880 36,242
Net change.......................................................... 60 5,909 5,969
----------- ------------- -------------
422 41,789 42,211
----------- ------------- -------------
Balance at December 31, 1997.......................................... $ (331,453) $ 23,831,885 $ 23,500,432
----------- ------------- -------------
----------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
50
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income............................................ $ 1,397,550 $ 1,599,228 $ 1,728,314
Adjustments to reconcile net income to net cash from
operating activities
Depreciation and amortization....................... 777,902 803,578 831,451
Amortization of discount on government securities... (1,397) (9,400) (25,076)
Loss on disposition of assets....................... -- 282 --
Property development and management fees............ -- 314 28,769
Minority interest in losses of Operating
Partnerships...................................... (857) (608) (2,220)
Gain on sale of mortgage-backed securities.......... -- -- (15,670)
Decrease (increase) in interest and other
receivables....................................... 3,682 36,242 (27,405)
Decrease (increase) in escrow deposits and property
reserves.......................................... (333,762) 57,409 (12,887)
Increase in other assets............................ (21,269) (21,863) (79,536)
Increase in accounts payable and accrued expenses... 244,408 21,852 119,621
Increase (decrease) in due general partners and
their affiliates.................................. (32,396) 14,776 (139,065)
----------------- ----------------- -----------------
Net cash provided by operating activities............. 2,033,861 2,501,810 2,406,296
----------------- ----------------- -----------------
Cash flows from investing activities
Principal payments received on mortgage-backed
securities.......................................... 127,727 134,435 178,420
Acquisition of buildings and construction in
progress............................................ -- (78,587) (34,527)
Acquisition of personal property...................... (69,723) (102,292) (100,757)
Maturity (acquisition) of U.S. government
securities.......................................... -- 2,500,000 (2,468,945)
Disposition of mortgage-backed securities............. -- -- 470,667
----------------- ----------------- -----------------
Net cash provided by (used in) investing
activities...................................... 58,004 2,453,556 (1,955,142)
----------------- ----------------- -----------------
Cash flow used in financing activity
Distributions......................................... (3,281,810) (3,281,810) (3,281,810)
----------------- ----------------- -----------------
Net increase (decrease) in cash and temporary cash
investments........................................... (1,189,945) 1,673,556 (2,830,656)
Cash and temporary cash investments at beginning of
year.................................................. 2,430,937 757,381 3,588,037
----------------- ----------------- -----------------
Cash and temporary cash investments at end of year...... $ 1,240,992 $ 2,430,937 $ 757,381
----------------- ----------------- -----------------
----------------- ----------------- -----------------
Supplemental disclosure of noncash investing activities
Write-off of fully depreciated assets................. $ 904 $ -- $ --
Disposition of buildings.............................. $ -- $ 17,924 $ --
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
51
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION.
Capital Source II L.P.-A (the "Partnership") was formed on August 22, 1986,
under the Delaware Revised Uniform Limited Partnership Act. The General Partners
of the Partnership are insured Mortgage Equities Inc. II L.P. and America First
Capital Source I, L.L.C. (the "General Partners").
The Partnership provided virtually 100% of the debt and equity financing for
five multifamily rental housing properties. The Partnership's investment in the
properties consisted of (a) approximately 85% in the form of permanent mortgages
and/or loans to fund construction; and (b) the balance to purchase up to a 99%
limited partnership interest in the Operating Partnerships which developed, own
and operate the properties. Each loan is insured or guaranteed, in an amount
substantially equal to the face amount of the mortgage, by the Federal Housing
Administration ("FHA") or the Government National Mortgage Association ("GNMA").
The Partnership has been repaid by GNMA on one of its GNMA Certificates and the
related property has been deeded to GNMA in lieu of foreclosure thus eliminating
the Partnership's Equity Investment. The four remaining Operating Partnerships
are geographically located as follows: (i) two in Michigan and (ii) one each in
Florida and North Carolina.
CS Properties II, Inc., which is owned by affiliates of the General
Partners, serves as the Special Limited Partner for the Operating Partnerships.
The Special Limited Partner has the power, among other things, to remove the
general partners of the Operating Partnerships under certain circumstances and
to consent to the sale of the Operating Partnerships' assets.
The Partnership will terminate subsequent to the sale of all properties but
in no event will the Partnership continue beyond December 31, 2035.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
(a) METHOD OF ACCOUNTING. The consolidated financial statements
include the accounts of the Partnership and four subsidiary Operating
Partnerships. The Partnership is a limited partner with an ownership
interest in three of the subsidiary Operating Partnerships of up to 99%. The
Partnership's ownership interest in The Ponds at Georgetown L.P. is 68.70%.
The remaining limited partner interest of 30.29% is owned by Capital Source
L.P., an affiliate of the General Partners. All significant intercompany
accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(b) INVESTMENT IN REAL ESTATE. The Partnership's investment in real
estate is carried at cost less accumulated depreciation. The carrying value
of each property is reviewed for impairment whenever events or circumstances
indicate that the carrying value may not be recoverable. If the sum of the
expected undiscounted future cash flows is less than the carrying amount, an
impairment is recorded based on fair value.
(c) INVESTMENT IN MORTGAGE-BACKED SECURITIES. Investment securities
are classified as held-to-maturity, available-for-sale or trading.
Investments classified as held-to-maturity are carried at amortized cost.
Investments classified as available-for-sale are reported at fair value with
any unrealized
52
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. (CONTINUED)
gains or losses excluded from earnings and reflected as a separate component
of partners' capital. Subsequent increases and decreases in the net
unrealized gain/loss on the available-for-sale securities are reflected as
adjustments to the carrying value of the portfolio and adjustments to the
component of partners' capital. The Partnership does not have investment
securities classified as trading.
(d) DEPRECIATION AND AMORTIZATION. Depreciation of real estate is
based on the estimated useful life of the properties using the straight-line
method. Deferred mortgage issuance costs are being amortized using the
effective yield method over the 40-year term of the respective loan.
(e) REVENUE RECOGNITION. The Operating Partnerships lease multifamily
rental units under operating leases with terms of one year or less. Rental
revenue is recognized net of any vacancy losses and rental concessions
offered.
(f) INCOME TAXES. No provision has been made for income taxes since
BAC Holders are required to report their share of the Partnership's income
for federal and state income tax purposes. The tax basis of the
Partnerships' assets and liabilities exceeded the reported amounts by
$7,271,784 and $7,345,644 at December 31, 1997, and December 31, 1996,
respectively.
(g) TEMPORARY CASH INVESTMENTS. Temporary cash investments are
invested in short-term debt securities purchased with original maturities of
three months or less.
(h) NET INCOME PER BENEFICIAL ASSIGNMENT CERTIFICATE ("BAC"). Net
income per BAC is based on the number of BACs outstanding (4,011,101) during
each year presented.
(i) NEW ACCOUNTING PRONOUNCEMENT. The Financial Accounting Standards
Board has issued Financial Accounting Standards No. 128 "Earnings Per Share"
("FAS 128"). FAS 128, which is effective for periods ending after December
15, 1997, did not have an impact on the Partnership's computation,
presentation or disclosure of earnings per BAC as no dilutive common share
equivalents existed at December 31, 1997.
3. PARTNERSHIP INCOME, EXPENSES AND CASH DISTRIBUTIONS.
Profits and losses from normal operations and cash available for
distribution will be allocated 99% to the investors and 1% to the General
Partners. Certain fees payable to the General Partners will not become due until
investors have received certain priority returns. Cash distributions included in
the consolidated financial statements represent the actual cash distributions
made during each year and the cash distributions accrued at the end of each
year.
The General Partners will also receive 1% of the net proceeds from any sale
of Partnership assets. The General Partners will receive a termination fee equal
to 3% of all sales proceeds less actual costs incurred in connection with all
sales transactions, payable only after the investors have received a return of
their capital contributions and an 11.5% annual return on a cumulative basis.
The General Partners will also receive a fee equal to 9.1% of all cash available
for distribution and sales proceeds (after deducting from cash available or
sales proceeds any termination fee paid therefrom) after investors have received
a return of their capital contributions and a 11.5% annual return on a
cumulative basis.
53
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
4. TRANSACTIONS WITH RELATED PARTIES.
The General Partners, certain of their affiliates and the Operating
Partnerships' general partners have received or may receive fees, compensation,
income, distributions and payments from the Partnership in connection with the
offering and the investment, management and sale of the Partnership's assets
(other than disclosed elsewhere) as follows.
The Operating Partnerships' general partners provide various on-site
property development and management services. Property development and
management fees for the years ended December 31, 1996 and 1995 amounted to $314
and $28,769, respectively. No such fees were incurred for the year ended
December 31, 1997. Unpaid fees, which are non-interest bearing, are included in
amounts due to general partners and their affiliates on the accompanying
consolidated balance sheets and will be paid in accordance with the terms of the
respective Operating Partnership's limited partnership agreement.
The General Partners are entitled to receive an asset management and
partnership administration fee equal to 0.5% of invested assets per annum, the
first $50,000 of which will be paid each year with the balance payable only
during such years that a 6.5% annual return has been paid to investors on a
noncumulative basis. An additional fee equal to 0.5% of invested assets per
annum will be payable only during those years that an 11.5% annual return has
been paid to investors on a noncumulative basis. Any unpaid amounts will accrue
and be payable only after an 11.5% annual return to investors has been paid on a
cumulative basis and the investors have received the return of their capital
contributions. Asset management and partnership administration fees for the
years ended December 31, 1997, 1996 and 1995 amounted to $166,000 for each year.
Amounts due to general partners and their affiliates on December 31, 1997
and 1996 are comprised of the following:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Unpaid property development and management fees................... $ 111,791 $ 97,015
Operating deficit and construction loans.......................... 849,772 874,194
Unpaid asset management and partnership administrative fees....... 105,750 128,500
------------ ------------
$ 1,067,313 $ 1,099,709
------------ ------------
------------ ------------
</TABLE>
Substantially all of the Partnership's general and administrative expenses
are paid by a General Partner or an affiliate and reimbursed by the Partnership.
The amount of such expenses reimbursed to the General Partner for the years
ended December 31, 1997, 1996 and 1995 amounted to $494,165, $313,049 and
$281,606, respectively. These amounts are presented on a cash basis and do not
reflect accruals made at each year end.
An affiliate of America First Capital Source II, L.L.C. has been retained to
provide property management services for The Ponds at Georgetown beginning in
November 1996. The fees for services provided were $31,924 for 1997 and $4,933
for 1996, respectively, and represented the lower of costs incurred in providing
management of the property or customary fees for such services determined on a
competitive basis.
54
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
5. PARTNERSHIP RESERVE ACCOUNT.
The Partnership maintains a reserve account which consisted of the following
at December 31, 1997:
<TABLE>
<S> <C>
Cash and temporary cash investments............................. $ 499,366
GNMA Certificates............................................... 1,050,718
---------
Balance at end of year.......................................... $1,550,084
---------
---------
</TABLE>
The reserve account was established to maintain working capital for the
Partnership and is available to supplement distributions to investors or for
other contingencies related to the ownership of investments and the operation of
the Partnership. The GNMA Certificates mature between 2008 and 2009.
At December 31, 1997, the total amortized cost, gross unrealized holding
gains and aggregate fair value of available-for-sale securities were $1,008,507,
$42,211 and $1,050,718, respectively. At December 31, 1996, the total amortized
cost, gross unrealized holding gains and aggregate fair value of available-
for-sale securities were $1,134,837, $36,242 and $1,171,079, respectively.
Prior to June 30, 1995, the Partnership classified all investment securities
as held-to-maturity. However, during the quarter ending June 30, 1995, the
Partnership reassessed the appropriateness of the classification of securities
held in the reserve account. The Partnership concluded, given the nature of the
reserve account, it would be more appropriate to classify securities held in the
reserve account as available-for-sale rather than as held-to-maturity.
Accordingly, on June 30, 1995, the Partnership transferred all securities held
in the reserve account from the held-to-maturity classification to the
available-for-sale classification. The total amortized cost, gross unrealized
holding gains and aggregate fair value of the securities transferred were
$4,283,759, $67,199 and $4,350,958, respectively.
During 1995, the Partnership sold a portion of the securities in the
available-for-sale portfolio. The total amortized cost and realized gain for
sales of securities classified as available-for-sale were $454,997 and $15,670,
respectively.
6. PARENT COMPANY ONLY FINANCIAL INFORMATION.
Generally accepted accounting principles require that the Partnership's
financial statements consolidate the Operating Partnerships since the
Partnership holds a majority ownership interest and, through CS Properties II,
Inc., it can influence the decisions of the general partners in certain
circumstances. In the consolidated financial statements, the Partnership's
investment in FHA Loans and GNMA Certificates is eliminated against the related
mortgage payable recorded by the Operating Partnership. If a mortgage loan goes
into default and is foreclosed upon by FHA or GNMA, the respective agency may,
at their discretion, repay the FHA Loan or the GNMA Certificate. If this occurs,
the Partnership's investment in the Operating Partnership would be eliminated,
resulting in the recognition of a gain on the Partnership's financial
statements. This arises because consolidation accounting does not allow the
Partnership to stop recording losses from the Operating Partnerships when the
net investment is reduced to zero.
The parent company only financial information below represents the condensed
financial information of the Partnership using the equity method of accounting
for the investment in Operating Partnerships, rather than the consolidation of
those partnerships. Under the equity method of accounting, the Partnership's
capital contributions are adjusted to reflect its share of operating partnership
profits or losses and
55
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. PARENT COMPANY ONLY FINANCIAL INFORMATION. (CONTINUED)
distributions. The investment in Operating Partnerships represents the
Partnership's limited partnership interest in the accumulated deficits of those
Operating Partnerships. The parent company only information is provided to more
clearly present the Partnership's investment in the Operating Partnerships.
Since the Partnership is not a general partner, it is not obligated to fund the
negative balances. If the investments in all Operating Partnerships were
eliminated at December 31, 1997, Partnership capital would increase by
$5,454,621 ($1.35 per BAC).
The FHA Loan and the GNMA Certificates are collateralized by first mortgage
loans on the properties owned by the Operating Partnerships and are guaranteed
or insured as to principal and interest by FHA or GNMA. The FHA insured mortgage
loan is subject to a 1% assignment fee. The obligations of FHA and GNMA are
backed by the full faith and credit of the United States government.
PARENT COMPANY ONLY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
ASSETS
Cash and temporary cash investments............................ $ 1,240,992 $ 2,430,937
Investment in FHA Loan......................................... 6,538,424 6,568,139
Investment in GNMA Certificates................................ 21,674,940 21,895,675
Investment in Operating Partnerships........................... (5,454,621) (5,198,166)
Interest receivable............................................ 213,024 219,661
Other assets................................................... 162,154 225,743
------------- -------------
$ 24,374,913 $ 26,141,989
------------- -------------
------------- -------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Accounts payable............................................. $ 327,513 $ 216,298
Distribution payable......................................... 546,968 546,968
------------- -------------
874,481 763,266
------------- -------------
Partners' Capital.............................................. 23,500,432 25,378,723
------------- -------------
$ 24,374,913 $ 26,141,989
------------- -------------
------------- -------------
</TABLE>
56
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. PARENT COMPANY ONLY FINANCIAL INFORMATION. (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Income
Mortgage and mortgage-backed securities income.................. $ 2,499,844 $ 2,520,727
Interest on temporary cash investments and U.S. government
securities.................................................... 91,327 147,530
Equity in losses of Operating Partnerships...................... (377,905) (523,809)
Other income.................................................... 3,800 6,950
------------ ------------
2,217,066 2,151,398
Expenses
Operating and administrative.................................... 819,516 552,170
------------ ------------
Net income.................................................... $ 1,397,550 $ 1,599,228
------------ ------------
------------ ------------
</TABLE>
57
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
6. PARENT COMPANY ONLY FINANCIAL INFORMATION. (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities
Net income.................................................... $ 1,397,550 $ 1,599,228
Adjustments to reconcile net income to net cash from
operating activities:
Equity in losses of Operating Partnerships.................. 377,905 523,809
Amortization................................................ 62,376 62,376
Other non-cash adjustments.................................... 117,668 16,695
------------- -------------
Net cash provided by operating activities....................... 1,955,499 2,202,108
------------- -------------
Cash flows from investing activities
FHA Loan and GNMA Certificate principal payments.............. 257,816 253,258
Investment in Operating Partnerships.......................... (121,450) --
Maturity of U.S. government securities........................ -- 2,500,000
------------- -------------
Net cash provided by investing activities..................... 136,366 2,753,258
------------- -------------
Cash flow used in financing activity
Distributions................................................. (3,281,810) (3,281,810)
------------- -------------
Net increase (decrease) in cash and temporary cash
investments................................................... (1,189,945) 1,673,556
Cash and temporary cash investments at beginning of year........ 2,430,937 757,381
------------- -------------
Cash and temporary cash investments at end of year.............. $ 1,240,992 $ 2,430,937
------------- -------------
------------- -------------
</TABLE>
7. FAIR VALUE OF FINANCIAL INSTRUMENTS.
The following methods and assumptions were used by the Partnership in
estimating the fair value of its financial instruments:
(a) CASH AND TEMPORARY CASH INVESTMENTS. Fair value approximates the
carrying value of such assets.
(b) INVESTMENT IN MORTGAGE-BACKED SECURITIES. Fair values are based on
amounts obtained from an independent pricing source.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997 AT DECEMBER 31, 1996
-------------------------- --------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cash and temporary cash investments...................... $ 1,240,992 $ 1,240,992 $ 2,430,937 $ 2,430,937
Investment in mortgage-backed securities................. 1,050,718 1,050,718 1,171,079 1,171,079
</TABLE>
58
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. SUMMARY OF UNAUDITED QUARTERLY RESULTS OF OPERATIONS.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
FROM JANUARY 1, 1997 TO DECEMBER 31, 1997 QUARTER QUARTER QUARTER QUARTER
- -------------------------------------------------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C>
Total income............................................ $ 1,353,416 $ 1,348,345 $ 1,351,644 $ 1,440,966
Total expenses.......................................... (858,776) (954,972) (1,005,215) (1,278,715)
Minority interest in losses of Operating Partnerships... 147 181 369 160
------------ ------------ ------------- -------------
Net income.............................................. $ 494,787 $ 393,554 $ 346,798 $ 162,411
------------ ------------ ------------- -------------
------------ ------------ ------------- -------------
Net income, basic and diluted, per BAC.................. $ .12 $ .10 $ .08 $ .04
------------ ------------ ------------- -------------
------------ ------------ ------------- -------------
</TABLE>
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
FROM JANUARY 1, 1996 TO DECEMBER 31, 1996 QUARTER QUARTER QUARTER QUARTER
- --------------------------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Total income............................................. $ 1,314,149 $ 1,302,210 $ 1,306,100 $ 1,354,537
Total expenses........................................... (794,837) (798,182) (903,409) (1,181,948)*
Minority interest in losses of Operating Partnerships.... 353 144 228 (117)
------------ ------------ ------------ ------------
Net income............................................... $ 519,665 $ 504,172 $ 402,919 $ 172,472
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net income per BAC....................................... $ .13 $ .12 $ .10 $ .04
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
- ------------------------
* Real estate operating expenses were higher during the fourth quarter due to
adjustments made to certain real estate operating expenses.
59
<PAGE>
SCHEDULE III
CAPITAL SOURCE II L.P.-A
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1997
<TABLE>
<CAPTION>
DATE OF DATE
PROPERTY LOCATION # OF UNITS ENCUMBRANCES CONSTRUCTION ACQUIRED
- -------------------------------------------- ----------------- ----- ----------------- --------------- -----------
<S> <C> <C> <C> <C> <C>
Ponds at Georgetown......................... Ann Arbor, MI 134 (a) 1989 N/A
Monticello.................................. Southfield, MI 106 (a) 1989 N/A
Delta Crossing.............................. Charlotte, NC 178 (a) 1989 N/A
Crane's Landing............................. Winter Park, FL 252 (a) 1990 N/A
<CAPTION>
LIFE ON
WHICH
DEPRECIATION
PROPERTY IS COMPUTED
- -------------------------------------------- ------------
<S> <C>
Ponds at Georgetown......................... 5 - 40 years
Monticello.................................. 5 - 40 years
Delta Crossing.............................. 5 - 40 years
Crane's Landing............................. 5 - 40 years
</TABLE>
<TABLE>
<CAPTION>
COSTS CAPITALIZED
SUBSEQUENT TO GROSS AMOUNT AT DECEMBER 31, 1997
----------------------------------------
ACQUISITION BUILDINGS,
INITIAL COST TO ------------------------ IMPROVEMENTS
PARTNERSHIP CARRYING AND PERSONAL ACCUMULATED
------------------------ COSTS LAND PROPERTY TOTAL DEPRECIATION
PROPERTY LAND PROPERTY IMPROVEMENTS (B) (C) (D) (C) AND (D) (E)
- ------------------- ----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ponds at
Georgetown....... $ 261,440 $ 269,094 $ 4,246,230 $ 55,523 $ 396,621 $ 4,435,666 $ 4,832,287 $(1,173,647)
Monticello......... 402,933 363,117 4,683,322 88,306 411,566 5,126,112 5,537,678 (1,595,196)
Delta Crossing..... 700,000 461,011 5,730,514 69,565 960,861 6,000,229 6,961,090 (1,588,441)
Crane's Landing.... 978,902 206,060 8,933,639 72,940 1,031,702 9,159,839 10,191,541 (1,973,010)
----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
$ 2,343,275 $ 1,299,282 $23,593,705 $ 286,334 $ 2,800,750 $24,721,846 $ 27,522,596 $(6,330,294)
----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
</TABLE>
60
<PAGE>
SCHEDULE III
CAPITAL SOURCE II L.P.-A
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1996
<TABLE>
<CAPTION>
DATE OF DATE
PROPERTY LOCATION # OF UNITS ENCUMBRANCES CONSTRUCTION ACQUIRED
- -------------------------------------------- ----------------- ----- ----------------- --------------- -----------
<S> <C> <C> <C> <C> <C>
Ponds at Georgetown......................... Ann Arbor, MI 134 (a) 1989 N/A
Monticello.................................. Southfield, MI 106 (a) 1989 N/A
Delta Crossing.............................. Charlotte, NC 178 (a) 1989 N/A
Crane's Landing............................. Winter Park, FL 252 (a) 1990 N/A
<CAPTION>
LIFE ON
WHICH
DEPRECIATION
PROPERTY IS COMPUTED
- -------------------------------------------- ------------
<S> <C>
Ponds at Georgetown......................... 5 - 40 years
Monticello.................................. 5 - 40 years
Delta Crossing.............................. 5 - 40 years
Crane's Landing............................. 5 - 40 years
</TABLE>
<TABLE>
<CAPTION>
COSTS CAPITALIZED
SUBSEQUENT TO GROSS AMOUNT AT DECEMBER 31, 1996
----------------------------------------
ACQUISITION BUILDINGS,
INITIAL COST TO ------------------------ IMPROVEMENTS
PARTNERSHIP CARRYING AND PERSONAL ACCUMULATED
------------------------ COSTS LAND PROPERTY TOTAL DEPRECIATION
PROPERTY LAND PROPERTY IMPROVEMENTS (B) (C) (D) (C) AND (D) (E)
- ------------------- ----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ponds at
Georgetown....... $ 261,440 $ 269,094 $ 4,246,230 $ 55,523 $ 396,621 $ 4,435,666 $ 4,832,287 $(1,069,482)
Monticello......... 402,933 363,117 4,683,322 88,306 411,566 5,126,112 5,537,678 (1,451,691)
Delta Crossing..... 700,000 461,011 5,687,375 69,565 960,861 5,957,090 6,917,951 (1,418,851)
Crane's Landing.... 978,902 206,060 8,907,959 72,940 1,031,702 9,134,159 10,165,861 (1,724,416)
----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
$ 2,343,275 $ 1,299,282 $23,524,886 $ 286,334 $ 2,800,750 $24,653,027 $ 27,453,777 $(5,664,440)
----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
----------- ----------- ------------- --------- ----------- ------------- ------------ ------------
</TABLE>
61
<PAGE>
SCHEDULE III
CAPITAL SOURCE II L.P.-A
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1997 AND 1996
(a) The Partnership has no encumbrances against this property. Encumbrances
recorded by the Operating Partnerships are eliminated in the consolidated
financial statements of the Partnership.
(b) Carrying costs include legal fees, appraisal fees, title costs and other
related professional fees.
(c) The aggregate cost for federal income tax purposes is the same as for
financial reporting purposes.
(d) Reconciliation of Real Estate:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Balance--beginning of year..................................... $ 27,453,777 $ 27,290,822
Acquisitions................................................... 69,723 180,879
Disposition of personal property............................... (904) (17,924)
------------- -------------
Balance--end of year........................................... $ 27,522,596 $ 27,453,777
------------- -------------
------------- -------------
</TABLE>
(e) Reconciliation of Accumulated Depreciation:
<TABLE>
<CAPTION>
1997 1996
------------- ------------
<S> <C> <C>
Balance--beginning of year..................................... $ 5,664,440 $ 4,989,699
Depreciation expense........................................... 666,758 692,383
Disposition of personal property............................... (904) (17,642)
------------- ------------
Balance--end of year........................................... $ 6,330,294 $ 5,664,440
------------- ------------
------------- ------------
</TABLE>
62
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Partnership originally acquired: (i) four GNMA Certificates which are
guaranteed as to principal and interest by the Government National Mortgage
Association (GNMA) collateralized by first mortgage loans on multifamily housing
properties located in three states; (ii) an FHA Loan which is insured as to
principal and interest by the Federal Housing Administration (FHA) on a
multifamily housing property; and (iii) Partnership Equity Investments in five
Operating Partnerships which own the multifamily properties financed by the GNMA
Certificates and the FHA Loan. The Partnership has been repaid by GNMA on one of
the GNMA Certificates and the related property has been deeded to GNMA in lieu
of foreclosure, thus eliminating the Partnership Equity Investment in such
property. Collectively, the remaining GNMA Certificates, the FHA Loan, and the
Partnership Equity Investments are referred to as the "Permanent Investments."
The Partnership has also invested amounts held in its reserve account in certain
GNMA securities backed by pools of single-family mortgages ("Reserve
Investments"). The obligations of GNMA and FHA are backed by the full faith and
credit of the United States government.
The FHA Loan, GNMA Certificates and Partnership Equity Investments in
Operating Partnerships represent the Partnership's principal assets as shown in
the Parent Company Only Financial Information in Note 6 to the financial
statements. The parent company information is presented using the equity method
of accounting for the investment in Operating Partnerships. Generally accepted
accounting principles, however, require that the Partnership's financial
statements consolidate the Operating Partnerships, since the Partnership holds a
majority ownership interest in each Operating Partnership, and can influence
decisions of the general partners in certain circumstances.
The following FHA Loan and GNMA Certificates were owned by the Partnership
at March 31, 1998. Interest income from the FHA Loan and GNMA Certificates is
the primary source of cash available for distribution to Investors.
<TABLE>
<CAPTION>
GUARANTEED
OR INSURED INTEREST PRINCIPAL
PROPERTY NAME BY RATE MATURITY RATE BALANCE
- ------------------------------------------------------ ------------ ----------- -------------- -------------
<S> <C> <C> <C> <C>
Crane's Landing....................................... GNMA 8.75% 12-15-2030 $ 10,216,616
Delta Crossing........................................ FHA 9.10% 10-01-2030 6,530,560
Monticello Apartments................................. GNMA 8.75% 11-15-2029 5,321,106
The Ponds at Georgetown............................... GNMA 9.00% 12-15-2029 5,059,958
Pools of single-family mortgages...................... GNMA 7.58%(1) 2008 to 2009 998,930
-------------
$ 28,127,170
-------------
-------------
</TABLE>
- ------------------------
(1) Represents yield to the Partnership.
63
<PAGE>
DISTRIBUTIONS
Cash distributions paid or accrued per BAC were as follows:
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE QUARTER
ENDED MARCH 31, ENDED MARCH 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Regular monthly distributions
Income..................................................... $ .0274 $ .1221
Return of capital.......................................... .1751 .0804
------ ------
$ .2025 $ .2025
------ ------
------ ------
Distributions
Paid out of cash flow...................................... $ .0797 $ .1451
Paid out of reserves....................................... .1228 .0574
------ ------
$ .2025 $ .2025
------ ------
------ ------
</TABLE>
Regular monthly distributions to BAC Holders consist primarily of interest
received on the FHA Loan, GNMA Certificates and the Reserve Investments.
Additional cash for distributions is received from other investments. The
Partnership may draw on reserves to pay operating expenses or to supplement cash
distributions to Investors. The Partnership is permitted to replenish reserves
with cash flows in excess of distributions paid. For the quarter ended March 31,
1998, $497,777 was withdrawn from reserves to supplement regular monthly cash
distributions. The total amount held in reserves at March 31, 1998 was
$1,000,519 of which $998,930 was invested in mortgage-backed securities.
The Partnership has been supplementing cash flow from operations with
withdrawals from reserves in order to maintain distributions at the current
level. Consequently, it is likely that the level of distributions will be
reduced in the future. The General Partners will continue to review the level of
distributions each quarter in light of the Partnership's operating results and
financial position.
The Partnership believes that cash provided by operating activities and, if
necessary, withdrawals from the Partnership's reserves will be adequate to meet
its short-term liquidity requirements, including the payments of distributions
to BAC Holders. The Partnership has no other internal or external sources of
liquidity. Under the terms of its Partnership Agreement, the Partnership has the
authority to enter into short- and long-term debt financing arrangements;
however, the Partnership currently does not anticipate entering into such
arrangements. The Partnership is not authorized to issue additional BACs to meet
short-term and long-term liquidity requirements.
ASSET QUALITY
The FHA Loan and GNMA Certificates owned by the Partnership are guaranteed
as to principal and interest by FHA and GNMA, respectively. The obligations of
FHA and GNMA are backed by the full faith and credit of the United States
government. The Partnership Equity Investments, however, are not insured or
guaranteed. The value of these investments is a function of the value of the
real estate owned by the Operating Partnerships.
The overall status of the Partnership's investments has remained relatively
constant since December 31, 1997.
64
<PAGE>
The following table shows the occupancy levels of the properties financed by
the Partnership as of March 31, 1998:
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF UNITS PERCENTAGE OF
PROPERTY NAME LOCATION UNITS OCCUPIED UNITS OCCUPIED
- ------------------------------------------------------------ ------------------ ----------- ------------- ---------------
<S> <C> <C> <C> <C>
Crane's Landing............................................. Winter Park, FL 252 244 97%
Delta Crossing.............................................. Charlotte, NC 178 174 98
Monticello Apartments....................................... Southfield, MI 106 103 97
The Ponds at Georgetown..................................... Ann Arbor, MI 134 131 98
--
--- ---
670 652 97%
--
--
--- ---
--- ---
</TABLE>
RESULTS OF OPERATIONS
The table below compares the results of operations for each period shown.
<TABLE>
<CAPTION>
FOR THE FOR THE INCREASE
QUARTER ENDED QUARTER ENDED (DECREASE)
MARCH 31, 1998 MARCH 31, 1997 FROM 1997
-------------- -------------- -----------
<S> <C> <C> <C>
Rental Income....................................................... $ 1,259,898 $ 1,257,440 $ 2,458
Interest on temporary cash investments.............................. 16,700 29,971 (13,271)
Mortgage-backed securities income................................... 18,881 21,484 (2,603)
Other income........................................................ 40,254 44,521 (4,267)
-------------- -------------- -----------
1,335,733 1,353,416 (17,683)
-------------- -------------- -----------
Real estate operating expenses...................................... 628,702 528,958 99,744
Depreciation........................................................ 165,915 165,982 (67)
Property development and management fees............................ 701 -- 701
Investor servicing.................................................. 119,620 78,360 41,260
Professional fees................................................... 196,562 11,650 184,912
Other expenses...................................................... 44,212 4,526 39,686
Asset management and partnership administration fees................ 41,500 41,500 --
Amortization........................................................ 27,788 27,800 (12)
-------------- -------------- -----------
1,225,000 858,776 366,224
-------------- -------------- -----------
Minority interest in losses of Operating Partnerships............... 90 147 (57)
-------------- -------------- -----------
Net income.......................................................... $ 110,823 $ 494,787 $ (383,964)
-------------- -------------- -----------
-------------- -------------- -----------
</TABLE>
Rental income is recognized net of any vacancy losses and rental concessions
offered. Rental income, net of real estate operating expenses, depreciation, and
amortization, decreased $97,207 for the quarter ended March 31, 1998, compared
to the same period in 1997. Although rental income increased slightly for the
quarter ended March 31, 1998, compared to the same period in 1997, this increase
was more than offset by an increase in real estate operating expenses. The
increase in real estate operating expenses was primarily due to increases in
repairs and maintenance expenses and property improvements at Crane's Landing
and increases in taxes, insurance and other administrative costs at several of
the Partnership's properties.
Interest on temporary cash investments decreased for the quarter ended March
31, 1998, compared to the same period in 1997, due to withdrawals made from the
Partnership's reserves during 1997 and 1998 to supplement distributions to BAC
holders.
65
<PAGE>
Mortgage-backed securities income decreased for the quarter ended March 31,
1998, compared to the same period in 1997, due to the continued amortization of
the principal balances of the Partnership's mortgage-backed securities.
Other income consists primarily of corporate unit rentals, garage rentals,
washer/dryer and vending income generated by the Partnership's properties. Other
income decreased for the quarter ended March 31, 1998, compared to the same
period in 1997, due primarily to a decrease in corporate unit rentals.
Investor servicing expenses increased for the quarter ended March 31, 1998,
compared to the same period in 1997, due primarily to an increase in salaries
and related expenses. The Partnership incurred costs of approximately $186,500
during 1998 in connection with a review of various options available to the
Partnership to improve total investment returns and provide liquidity to the
Partnership's Investors. Excluding such costs, professional fees decreased
$1,600 for the quarter ended March 31, 1998, compared to the same period in
1997, due primarily to a decrease in legal fees. Other expenses increased
$39,686 for the quarter ended March 31, 1998, compared to the same period in
1997, primarily due to an increase in consulting fees and travel expenses.
This report contains forward-looking statements that reflect management's
current beliefs and estimates of future economic circumstances, industry
conditions, the Partnership's performance and financial results. All statements,
trend analysis and other information concerning possible or assumed future
results of operations of the Partnership and the real estate investments it has
made (including, but not limited to, the information contained in "Management's
Discussion and Analysis of Financial Condition and Results of Operations"),
constitute forward-looking statements. BAC Holders and others should understand
that these forward-looking statements are subject to numerous risks and
uncertainties and a number of factors could affect the future results of the
Partnership and could cause those results to differ materially from those
expressed in the forward-looking statements contained herein.
66
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, 1998 DEC. 31, 1997
-------------- -------------
<S> <C> <C>
ASSETS
Investment in real estate:
Land............................................................................ $ 2,800,750 $ 2,800,750
Buildings....................................................................... 23,055,361 23,055,361
Personal property............................................................... 1,675,557 1,666,485
-------------- -------------
27,531,668 27,522,596
Less accumulated depreciation................................................... (6,496,209) (6,330,294)
-------------- -------------
Net investment in real estate................................................... 21,035,459 21,192,302
Cash and temporary cash investments, at cost which approximates market value (Note
5).............................................................................. 638,563 1,240,992
Escrow deposits and property reserves............................................. 1,244,779 1,104,823
Investment in mortgage-backed securities (Note 5)................................. 998,930 1,050,718
Interest and other receivables.................................................... 17,060 19,443
Deferred mortgage issuance costs net of accumulated amortization of $820,129 in
1998 and $792,341 in 1997....................................................... 1,561,722 1,589,510
Other assets...................................................................... 214,679 241,498
-------------- -------------
$ 25,711,192 $ 26,439,286
-------------- -------------
-------------- -------------
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
Liabilities
Accounts payable and accrued expenses........................................... $ 1,202,646 $ 1,118,970
Distribution payable (Note 3)................................................... 546,968 546,968
Due to general partners and their affiliates (Note 4)........................... 961,847 1,067,313
-------------- -------------
2,711,461 2,733,251
Minority Interest................................................................. 205,513 205,603
-------------- -------------
Partners' Capital (Deficit)
General Partners................................................................ (338,516) (331,453)
Limited Partners ($5.77 per BAC in 1998 and $5.94 in 1997)...................... 23,132,734 23,831,885
-------------- -------------
22,794,218 23,500,432
-------------- -------------
$ 25,711,192 $ 26,439,286
-------------- -------------
-------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
67
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MARCH 31, 1998 MARCH 31, 1997
-------------- --------------
<S> <C> <C>
Income:
Rental income.................................................................. $ 1,259,898 $ 1,257,440
Interest on temporary cash investments......................................... 16,700 29,971
Mortgage-backed securities income.............................................. 18,881 21,484
Other income................................................................... 40,254 44,521
-------------- --------------
1,335,733 1,353,416
-------------- --------------
Expenses:
Real estate operating expenses................................................. 628,702 528,958
Depreciation................................................................... 165,915 165,982
Property development and management fees (Note 4).............................. 701 --
General and administrative expenses (Note 4)
Investor servicing........................................................... 119,620 78,360
Professional fees............................................................ 196,562 11,650
Other expenses............................................................... 44,212 4,526
Asset management and partnership administration fees (Note 4).................. 41,500 41,500
Amortization................................................................... 27,788 27,800
-------------- --------------
1,225,000 858,776
-------------- --------------
Minority interest in losses of Operating Partnerships............................ 90 147
-------------- --------------
Net Income..................................................................... $ 110,823 $ 494,787
-------------- --------------
-------------- --------------
Net income allocated to:
General Partners............................................................... $ 1,108 $ 4,948
Limited Partners............................................................... 109,715 489,839
-------------- --------------
$ 110,823 $ 494,787
-------------- --------------
-------------- --------------
Net income, basic and diluted, per BAC........................................... $ .03 $ .12
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
68
<PAGE>
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL (DEFICIT)
FOR THE QUARTER ENDED MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
----------- ------------- -------------
<S> <C> <C> <C>
Partners' Capital (Deficit)
(excluding net unrealized holding gains)
Balance at December 31, 1997........................................ $ (331,875) $ 23,790,096 $ 23,458,221
Net income.......................................................... 1,108 109,715 110,823
Cash distributions paid or accrued (Note 3)......................... (8,205) (812,247) (820,452)
----------- ------------- -------------
(338,972) 23,087,564 22,748,592
----------- ------------- -------------
Net unrealized holding gains
Balance at December 31, 1997........................................ 422 41,789 42,211
Net change.......................................................... 34 3,381 3,415
----------- ------------- -------------
456 45,170 45,626
----------- ------------- -------------
Balance at March 31, 1998............................................. $ (338,516) $ 23,132,734 $ 22,794,218
----------- ------------- -------------
----------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
69
<PAGE>
CAPITAL SOURCE II L.P.-A
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MARCH 31, 1998 MARCH 31, 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities
Net income..................................................................... $ 110,823 $ 494,787
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization................................................ 193,703 193,782
Amortization of discount on government securities............................ (610) (402)
Property development and management fees..................................... 701 --
Minority interest in losses of Operating Partnerships........................ (90) (147)
Decrease in interest and other receivables................................... 2,383 1,955
Increase in escrow deposits and property reserves............................ (139,956) (123,933)
Decrease (increase) in other assets.......................................... 26,819 (16,823)
Increase in accounts payable and accrued expenses............................ 83,676 23,573
Decrease in due to general partners and their affiliates..................... (106,167) (43,478)
-------------- --------------
Net cash provided by operating activities...................................... 171,282 529,314
Cash flows from investing activities
Principal payments on mortgage-backed securities............................... 55,813 36,698
Acquisition of personal property............................................... (9,072) (6,694)
-------------- --------------
Net cash provided by investing activities.................................... 46,741 30,004
Cash flow used in financing activity
Distributions.................................................................. (820,452) (820,452)
-------------- --------------
Net decrease in cash and temporary cash investments.............................. (602,429) (261,134)
Cash and temporary cash investments at beginning of period....................... 1,240,992 2,430,937
-------------- --------------
Cash and temporary cash investments at end of period............................. $ 638,563 $ 2,169,803
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
70
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
1. ORGANIZATION
Capital Source II L.P.-A (the "Partnership") was formed on August 22, 1986,
under the Delaware Revised Uniform Limited Partnership Act. The General Partners
of the Partnership are Insured Mortgage Equities II L.P. and America First
Capital Source II L.L.C. (the "General Partners").
The Partnership provided virtually 100% of the debt and equity financing for
five multifamily rental housing properties. The Partnership's investment in the
properties consisted of: (i) approximately 85% in the form of permanent
mortgages and/or loans to fund construction, and (ii) the balance to purchase up
to a 99% limited partnership interest in the Operating Partnerships which
developed, own and operate the properties. Each loan is insured or guaranteed,
in an amount substantially equal to the face amount of the mortgage, by the
Federal Housing Administration (FHA) or the Government National Mortgage
Association (GNMA). The Partnership has been repaid by GNMA on one of its GNMA
Certificates and the related property has been deeded to GNMA in lieu of
foreclosure thus eliminating the Partnership's Equity Investment. The four
remaining Operating Partnerships are geographically located as follows: (a) two
in Michigan; and, (b) one each in Florida and North Carolina.
CS Properties II, Inc., which is owned by affiliates of the General
Partners, serves as the Special Limited Partner for the Operating Partnerships.
The Special Limited Partner has the power, among other things, to remove the
general partners of the Operating Partnerships under certain circumstances and
to consent to the sale of the Operating Partnerships' assets.
The Partnership will terminate subsequent to the sale of all properties but
in no event will the Partnership continue beyond December 31, 2035.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements include the accounts of the
Partnership and four subsidiary Operating Partnerships. The Partnership is a
limited partner with an ownership interest in three of the subsidiary
Operating Partnerships of up to 99%. The Partnership's ownership interest in
The Ponds at Georgetown L.P. is 68.70%. The remaining limited partner
interest of 30.29% is owned by Capital Source L.P., an affiliate of the
General Partners. All significant intercompany accounts and transactions
have been eliminated in consolidation.
The consolidated financial statements are prepared without audit on the
accrual basis of accounting in accordance with generally accepted accounting
principles. The consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Partnership's Annual Report on Form 10-K for the year ended
December 31, 1997. In the opinion of management, all normal and recurring
adjustments necessary to present fairly the financial position at March 31,
1998, and results of operations for all periods presented have been made.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
71
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(b) INVESTMENT IN REAL ESTATE
The Partnership's investment in real estate is carried at cost less
accumulated depreciation. The carrying value of each property is reviewed
for impairment whenever events or circumstances indicate that the carrying
value may not be recoverable. If the sum of the expected undiscounted future
cash flows is less than the carrying amount, an impairment is recorded based
on fair value.
(c) INVESTMENT IN MORTGAGE-BACKED SECURITIES
Investment securities are classified as held-to-maturity,
available-for-sale or trading. Investments classified as available-for-sale
are reported at fair value with any unrealized gains or losses excluded from
earnings and reflected as a separate component of partners' capital.
Subsequent increases and decreases in the net unrealized gain/loss on the
available-for-sale securities are reflected as adjustments to the carrying
value of the portfolio and adjustments to the component of partners'
capital. The Partnership does not have investment securities classified as
held-to-maturity or trading.
(d) DEPRECIATION AND AMORTIZATION
Depreciation of real estate is based on the estimated useful life of the
properties using the straight-line method. Deferred mortgage issuance costs
are amortized using the effective yield method over the 40 year term of the
respective loan.
(e) REVENUE RECOGNITION
The Operating Partnerships lease multifamily rental units under
operating leases with terms of one year or less. Rental revenue is
recognized as earned, net of any vacancy losses and rental concessions
offered.
(f) INCOME TAXES
No provision has been made for income taxes since BAC Holders are
required to report their share of the Partnership's income for federal and
state income tax purposes.
(g) TEMPORARY CASH INVESTMENTS
Temporary cash investments are invested in short-term debt securities
purchased with original maturities of three months or less.
(h) NET INCOME PER BENEFICIAL ASSIGNMENT CERTIFICATE (BAC)
Net income per BAC was calculated based on the number of BACs
outstanding (4,011,101) during each period presented.
(i) COMPREHENSIVE INCOME
In the first quarter of 1998, the Partnership adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130). SFAS 130 requires the display and reporting of comprehensive
income, which includes all changes in partners' capital with the exception
72
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
of additional investments by partners or distributions to partners.
Comprehensive income for the Partnership includes net income and the change
in net unrealized holding gains (losses) on investments charged or credited
to Partners' Capital. Comprehensive income for the quarters ended March 31,
1998 and 1997 was as follows:
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MAR. 31, 1998 MAR. 31, 1998
-------------- --------------
<S> <C> <C>
Net income.................................................... $ 110,823 $ 494,787
Change in net unrealized holding gains (losses)............... 3,415 (14,209)
-------------- --------------
Comprehensive income.......................................... $ 114,238 $ 480,578
-------------- --------------
-------------- --------------
</TABLE>
3. PARTNERSHIP INCOME, EXPENSES AND CASH DISTRIBUTIONS
Profits and losses from normal operations and cash available for
distribution will be allocated 99% to the Investors and 1% to the General
Partners. Certain fees payable to the General Partners will not become due until
Investors have received certain priority returns. Cash distributions included in
the consolidated financial statements represent the actual cash distributions
made during each period and the cash distributions accrued at the end of each
period.
The General Partners will receive 1% of the net proceeds from any sale of
Partnership assets. The General Partners will receive a termination fee equal to
3% of all sales proceeds less actual costs incurred in connection with all sales
transactions, payable only after the Investors have received a return of their
capital contributions and an 11.5% annual return on a cumulative basis. The
General Partners will also receive a fee equal to 9.1% of all cash available for
distribution and sales proceeds (after deducting from cash available or sales
proceeds any termination fee paid therefrom) after Investors have received a
return of their capital contributions and an 11.5% annual return on a cumulative
basis.
4. TRANSACTIONS WITH RELATED PARTIES
The General Partners, certain of their affiliates and the Operating
Partnerships' general partners have received or may receive fees, compensation,
income, distributions and payments from the Partnership in connection with the
offering and the investment, management and sale of the Partnership's assets
(other than disclosed elsewhere) as follows.
The Operating Partnerships' general partners provide various on-site
property development and management services. Property development and
management fees amounted to $701 in 1998. Unpaid fees, which are non-interest
bearing are included in amounts due to general partners and their affiliates on
the accompanying consolidated balance sheets and will be paid in accordance with
the respective Operating Partnership's limited partnership agreement.
The General Partners are entitled to receive an asset management and
partnership administrative fee equal to 0.5% of invested assets per annum, the
first $50,000 of which will be paid each year with the balance payable only
during such years that a 6.5% annual return has been paid to Investors on a
noncumulative basis. An additional fee equal to 0.5% of invested assets per
annum will be payable only
73
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
4. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
during those years that an 11.5% annual return has been paid to Investors on a
noncumulative basis. Any unpaid amounts will accrue and be payable only after an
11.5% annual return to Investors has been paid on a cumulative basis and the
Investors have received the return of their capital contributions. Asset
management and partnership administration fees of $41,500 were incurred during
1998.
Amounts due to general partners and their affiliates consisted of the
following at March 31, 1998:
<TABLE>
<S> <C>
Unpaid property development and management fees................... $ 112,492
Operating deficit and construction loans.......................... 807,855
Unpaid asset management and partnership administrative fees....... 41,500
---------
$ 961,847
---------
---------
</TABLE>
Substantially all of the Partnership's general and administrative expenses
are paid by a General Partner or an affiliate and reimbursed by the Partnership.
The amount of such expenses reimbursed to the General Partner during 1998 was
$354,820. The reimbursed expenses are presented on a cash basis and do not
reflect accruals made at quarter end.
An affiliate of the General Partners has been retained to provide property
management services for The Ponds at Georgetown. The fees for services provided
were $10,024 for 1998 and represented the lower of costs incurred in providing
management of the property or customary fees for such services determined on a
competitive basis.
5. PARTNERSHIP RESERVE ACCOUNT
The Partnership maintains a reserve account which consisted of the following
at March 31, 1998:
<TABLE>
<S> <C>
Cash and temporary cash investments............................. $ 1,589
GNMA Certificates............................................... 998,930
---------
$1,000,519
---------
---------
</TABLE>
The reserve account was established to maintain working capital for the
Partnership and is available to supplement distributions to Investors or for
other contingencies related to the ownership of investments and the operation of
the Partnership. The GNMA Certificates mature between 2008 and 2009. At March
31, 1998, the total amortized cost, gross unrealized holding gains and aggregate
fair value of available-for-sale securities were $953,304, $45,626 and $998,930,
respectively.
6. PARENT COMPANY ONLY FINANCIAL INFORMATION
Generally accepted accounting principles require that the Partnership's
financial statements consolidate the Operating Partnerships since the
Partnership holds a majority ownership interest and, through CS Properties II,
Inc., it can influence decisions of the general partners in certain
circumstances. In the consolidated financial statements, the Partnership's
investment in FHA Loans and GNMA Certificates is eliminated against the related
mortgage payable recorded by the Operating Partnership. If a mortgage loan goes
into default and is foreclosed upon by FHA or GNMA, the respective agency may,
at their discretion,
74
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
6. PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
repay the FHA Loan or the GNMA Certificate. If this occurs, the Partnership's
investment in the Operating Partnership would be eliminated, resulting in the
recognition of a gain on the Partnership's financial statements. This arises
because consolidation accounting does not allow the Partnership to stop
recording losses from the Operating Partnerships when the net investment is
reduced to zero.
The parent company only financial information below represents the condensed
financial information of the Partnership using the equity method of accounting
for the investment in Operating Partnerships, rather than the consolidation of
those partnerships. Under the equity method of accounting, the Partnership's
capital contributions are adjusted to reflect its share of Operating Partnership
profits or losses and distributions. The investment in Operating Partnerships
represents the Partnership's limited partnership interest in the accumulated
deficits of those Operating Partnerships. The parent company only information is
provided to more clearly present the Partnership's investment in the Operating
Partnerships. Since the Partnership is not a general partner, it is not
obligated to fund the negative balances. If the investments in all Operating
Partnerships were eliminated at March 31, 1998, Partnership capital would
increase by $5,560,660 ($1.37 per BAC).
The FHA Loan and the GNMA Certificates are collateralized by first mortgage
loans on the properties owned by the Operating Partnerships and are guaranteed
or insured as to principal and interest by FHA or GNMA. The FHA insured mortgage
loan is subject to a 1% assignment fee. The obligations of FHA and GNMA are
backed by the full faith and credit of the United States government.
PARENT COMPANY ONLY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, 1998 DEC. 31, 1997
-------------- -------------
<S> <C> <C>
ASSETS
Cash and temporary cash investments......................... $ 638,563 $ 1,240,992
Investment in FHA Loan...................................... 6,530,560 6,538,424
Investment in GNMA Certificates............................. 21,596,610 21,674,940
Investment in Operating Partnerships........................ (5,560,660) (5,454,621)
Interest receivable......................................... 210,045 213,024
Other assets................................................ 145,232 162,154
-------------- -------------
$ 23,560,350 $ 24,374,913
-------------- -------------
-------------- -------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Accounts payable.......................................... $ 219,164 $ 327,513
Distribution payable...................................... 546,968 546,968
-------------- -------------
766,132 874,481
Partners' Capital........................................... 22,794,218 23,500,432
-------------- -------------
$ 23,560,350 $ 24,374,913
-------------- -------------
-------------- -------------
</TABLE>
75
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
6. PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MARCH 31, 1998 MARCH 31, 1997
-------------- --------------
<S> <C> <C>
Income
Mortgage and mortgage-backed securities income............. $ 621,444 $ 626,978
Interest on temporary cash investments..................... 11,756 28,167
Equity in losses of Operating Partnerships................. (106,039) (9,528)
Other income............................................... 1,150 800
-------------- --------------
Expenses..................................................... 528,311 646,417
Operating and administrative............................... 417,488 151,630
-------------- --------------
Net Income................................................... $ 110,823 $ 494,787
-------------- --------------
-------------- --------------
</TABLE>
PARENT COMPANY ONLY
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FOR THE
QUARTER ENDED QUARTER ENDED
MARCH 31, 1998 MARCH 31, 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash from
operating activities................................... $ 110,823 $ 494,787
Equity in losses of Operating Partnerships............... 106,039 9,528
Amortization............................................. 15,594 15,594
Other non-cash adjustments............................... (104,652) (28,715)
-------------- --------------
Net Cash provided by operating activities.................... 127,804 491,194
-------------- --------------
Cash flow provided by investing activity
FHA Loan and GNMA Certificate principal payments........... 90,219 68,124
-------------- --------------
Cash flow used in financing activity
Distributions.............................................. (820,452) (820,452)
-------------- --------------
Net decrease in cash and temporary cash investments.......... (602,429) (261,134)
Cash and temporary cash investments at beginning of period... 1,240,992 2,430,937
-------------- --------------
Cash and temporary cash investments at end of period......... $ 638,563 $ 2,169,803
-------------- --------------
-------------- --------------
</TABLE>
76
<PAGE>
CAPITAL SOURCE II L.P.-A
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
7. SUBSEQUENT EVENT
On May 7, 1998, a Registration Statement on Form S-4 was filed by America
First Real Estate Investment Company, Inc. (the "Company") with the Securities
and Exchange Commission which includes a consent solicitation statement of the
Partnership and Capital Source L.P., a sister partnership with assets and
investment objectives similar to the Partnership. Upon approval of the proposed
plan by Investors in both partnerships, the partnerships will be combined into
the Company which will be engaged in the business of making real estate and
related investments. At their election and subject to certain limitations,
Investors in each partnership will receive, in exchange for their partnership
units, shares of common stock in the Company (the "Common Stock") or variable
rate notes (the "Notes") of the Company. The Company intends to list shares of
Common Stock issued pursuant to the planned merger on a national securities
exchange.
77
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
SUPPLEMENT DATED , 1998
TO
PROSPECTUS/CONSENT SOLICITATION STATEMENT
DATED , 1998
FOR
CAPITAL SOURCE II L.P.-A
On the terms described in the Prospectus/Consent Solicitation Statement
dated , 1998, of which this Supplement (the "Supplement") is a part,
Insured Mortgage Equities, Inc. and America First Capital Source I, L.L.C.
(together, the "Cap Source I General Partners") and Insured Mortgage Equities II
L.P. and America First Capital Source II, L.L.C. (together, the "Cap Source II
General Partners, " and together with the Cap Source I General Partners, the
"General Partners") are proposing the consolidation by merger (the
"Transaction") of Capital Source L.P., a Delaware limited partnership ("Cap
Source I") and Capital Source II L.P.-A, a Delaware limited partnership ("Cap
Source II," or the "Partnership" and together with Cap Source I, the
"Partnerships"), with and into America First Real Estate Investment Company,
Inc., a newly organized Delaware corporation (the "Company"). The Partnerships
are Delaware limited partnerships formed from 1985 through 1986 to invest
principally in federally-insured mortgages on multifamily housing properties and
to acquire, hold, sell, dispose of and otherwise deal with limited partnership
interests ("Partnership Equity Interests") in the limited partnerships (the
"Operating Partnerships") which construct, own and operate these properties.
Upon completion of the Transaction, the Company's primary business objective
will be to make growth-oriented real estate investments through the direct
acquisition, rehabilitation, development, financing and management of real
property, including the acquisition of securities of entities engaged in similar
real estate businesses.
Upon completion of the Transaction, the Partnerships will be merged with and
into the Company. Cap Source I Investors, together with Cap Source II Investors
(collectively, the "Investors"), will receive, at their election, either shares
of the Common Stock of the Company (the "Common Stock" or the "Shares") or
Variable Rate Junior Notes Callable on or After the Date of Issuance (the
"Notes") of the Company, together with promissory notes (the "Promissory Notes")
to each Investor entitled to a fractional interest in the Notes. See
"DESCRIPTION OF CAPITAL STOCK" and "THE NOTES" in the Prospectus/ Consent
Solicitation Statement. The Common Stock will be listed on the New York Stock
Exchange under the symbol " ," subject to official notice of issuance. The
Transaction will not occur unless it is approved by both Partnerships and
Investors who vote against the Transaction ("Dissenting Investors") do not elect
to receive more than the maximum amount of Notes issuable in connection with the
Transaction. The maximum amount of Notes that may be issued in the Transaction
is $40.0 million.
This Supplement has been prepared for the Cap Source II Investors to discuss
the effects and fairness of the Transaction with respect to their beneficial
assignment certificates of the Partnership (the "Units"), and to provide
information on the Partnership. The effects of the Transaction may be different
for Cap Source II Investors than for Cap Source I Investors. A supplement has
also been prepared for Cap Source I Investors. The Supplements are a part of the
Prospectus/Consent Solicitation Statement. Capitalized terms not defined herein
shall have the meaning set forth in the accompanying Prospectus/ Consent
Solicitation Statement.
Copies of any Supplement may be obtained without charge by an Investor or
representative so designated in writing, by giving written notice to the General
Partners of the Investor's respective Partnership. All requests should be
directed to America First Companies L.L.C., Attn: Maurice Cox, 1004 Farnam
Street, Suite 400, Omaha, Nebraska 68102.
SIMILARITIES BETWEEN CAP SOURCE I AND CAP SOURCE II
The investment objectives and the assets held by the Partnerships are
substantially similar in nature and character. Based on the Exchange Values
determined as of December 31, 1997, Cap Source I's assets consisted of 70.8% in
GNMA Certificates and FHA Loans, 19.0% in cash, cash equivalents and net other
<PAGE>
assets and liabilities, and the remaining 10.2% in the Partnership Equity
Interests in the Cap Source I Operating Partnerships. As of December 31, 1997,
Cap Source II's assets consisted of 85.8% in GNMA Certificates and FHA Loans,
1.8% in cash, cash equivalents and net other assets and liabilities, and the
remaining 12.4% in the Partnership Equity Interests in the Cap Source II
Operating Partnerships.
Although there are differences in the geographic area, style of construction
and specific locations for each property owned by the Operating Partnerships,
there are no significant differences in occupancy rates or property types. All
of the properties owned by the Operating Partnerships are multifamily apartment
complexes. In addition, the Operating Partnership interests in the Ponds at
Georgetown Limited Partnership ("The Ponds") are owned by Cap Source I and Cap
Source II.
DIFFERENCES BETWEEN CAP SOURCE I AND CAP SOURCE II
Except for The Ponds, each Partnership Equity Interest is unique to the
Partnership that holds the interest. The style of construction, specific
location and geographic areas for each property owned by the Operating
Partnerships are different. Cap Source I has Partnership Equity Interests in
three Operating Partnerships that have a general partner that is an affiliate of
Cap Source I, which include Waterman's Crossing, Fox Hollow and Misty Springs.
The remaining Cap Source I Operating Partnerships have general partners that are
not affiliated with Cap Source I. All of the Cap Source II Operating
Partnerships have general partners that are not affiliated with Cap Source II.
See "THE PARTNERSHIPS" in the Prospectus/Consent Solicitation Statement.
Although both Partnerships hold a majority of their assets in liquid
investments, the amount of cash and cash equivalents held by each Partnership is
different. Cash, cash equivalents and net other assets and liabilities make up
19% of Cap Source I's assets, whereas only 1.8% of Cap Source II's assets are in
cash, cash equivalents and net other assets and liabilities.
Distributions for both Partnerships are based upon the adjusted Unit value,
which is $20.00 per Unit of original investment, adjusted for returns of capital
to Investors. The adjusted Unit value for Cap Source I is $18.35. The adjusted
Unit value for Cap Source II is $12.39.
In 1997, Cap Source I made distributions at the rate of 5.5% of its adjusted
Unit value, which equaled $1.01 per Unit for the year. Cap Source I made
distributions at an annual rate of 5.5% of its adjusted Unit value, which
equaled $.2525 per Unit for the first quarter of 1998. Cap Source II made
distributions at the rate of 6.5% of its adjusted Unit value, which equaled $.81
per Unit for 1997, $.279 of which was made from reserves. Cap Source II made
distributions at an annual rate of 6.5% of its adjusted Unit value, which
equaled $.2025 per Unit for the first quarter of 1998, $.1228 of which was made
from reserves. Since Cap Source II has been making part of its distributions
from reserves, distributions for Cap Source II are likely to decrease in future
years as reserves are depleted. See "SECONDARY MARKET AND OWNERSHIP OF
PARTNERSHIP UNITS--Partnership Distributions" in the Prospectus/Consent
Solicitation Statement.
The Partnerships have different fee structures for compensating the General
Partners. The Cap Source I General Partners are entitled to receive an asset
management and partnership administrative fee equal to 0.5% of invested assets
per annum, payable only during such years that an 8% return has been paid to
Investors on a noncumulative basis. Any unpaid amounts will accrue and be
payable only after a 13% annual return to Cap Source I Investors has been paid
on a cumulative basis and such Investors have received the return of their
capital contributions.
The Cap Source II General Partners are entitled to receive an asset
management and partnership administrative fee equal to 0.5% of invested assets
per annum, the first $50,000 of which is paid each year with the balance payable
only during such years that a 6.5% annual return has been paid to Cap Source II
Investors on a noncumulative basis. An additional fee of 0.5% of invested assets
will be paid in years that an 11.5% annual return has been paid to Cap Source II
Investors on a cumulative basis. Any unpaid
Cap Source II Supp-2
<PAGE>
amounts will accrue and be payable only after an 11.5% annual return to
investors has been paid on a cumulative basis and the investors have received
the return of their capital contributions.
The General Partners of both Partnerships also receive 1% of the net
proceeds from any sale of Partnership assets. The General Partners of both
Partnerships will receive a termination fee equal to 3% of all sales proceeds
less actual costs incurred in connection with all sales transactions, payable
only after the Investors have received a return of their capital contributions
and a 13% annual return on a cumulative basis with respect to Cap Source I or an
11.5% annual return on a cumulative basis with respect to Cap Source II. The
General Partners of both Partnerships will also receive a fee equal to 9.1% of
all cash available for distribution and sales proceeds (after deducting from
cash available or sales proceeds any termination fee paid therefrom) after
Investors have received a return of their capital contributions and a 13% annual
return on a cumulative basis with respect to Cap Source I or an 11.5% annual
return on a cumulative basis with respect to Cap Source II. However, the
difference in this latter fee is not a material difference since neither
Partnership has achieved such a target level since their inception, and the
General Partners do not anticipate that such a level will be reached in the
foreseeable future.
RISK FACTORS
The Transaction does not involve risks which are more significant to Cap
Source II Investors than to Cap Source I Investors. However, the Transaction
involves certain risks and other adverse factors which are applicable to both
Partnerships, as discussed in detail in the accompanying Prospectus/Consent
Solicitation Statement, of which this Supplement is a part. See "RISK FACTORS"
in the Prospectus/ Consent Solicitation Statement. Because all of the risks and
adverse factors described in the Prospectus/ Consent Solicitation Statement
apply to the effect of the Transaction on both Partnerships, Cap Source II
Investors should carefully review the section entitled "RISK FACTORS" therein.
Except as otherwise stated herein, there are no material differences in the
manner in which Cap Source I or Cap Source II will be affected by any of the
risks or adverse factors discussed in such "RISK FACTORS" section.
For most Investors, the Transaction will not result in a taxable transaction
except to the extent Notes are received in the Transaction. For a more detailed
discussion of the tax consequences of the transaction see "Certain Tax
Differences Between the Ownership of Units and Shares" herein and "CERTAIN
FEDERAL INCOME TAX CONSIDERATIONS" in the Prospectus/Consent Solicitation
Statement.
By participating in the Transaction, Investors in Cap Source II will assume
risks associated with the assets of Cap Source I. Although the majority of the
assets in Cap Source I are substantially similar to those of Cap Source II, the
multifamily apartment complexes in which Cap Source I owns limited partnership
interests are of different construction, geographic area and specific location
than the complexes in which Cap Source II owns interests. Because the market for
real estate may vary from one region of the country to another, the change in
geographic diversity may expose Cap Source II Investors to different and greater
risks than those to which they are presently exposed. For geographic information
regarding the Partnerships' properties, see "THE PARTNERSHIPS" in the
Prospectus/Consent Solicitation Statement. Moreover, because the properties
owned by the Partnerships are not of uniform quality, combining assets and
liabilities of the Partnerships in the Transaction may diminish the overall
asset quality underlying the investments of certain of the Investors by
comparison with their existing Partnership investment.
For a more detailed discussion of the risks associated with the Transaction,
see "RISK FACTORS" in the Prospectus/Consent Solicitation Statement.
EFFECT ON FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Upon completion of the Transaction, the operations and existence of the
Partnerships will cease. See "THE TRANSACTION" in the Prospectus/Consent
Solicitation Statement. If the Transaction is not consummated, the General
Partners do not contemplate liquidation of the Partnerships, which would
Cap Source II Supp-3
<PAGE>
result in an all-cash payment to Investors, in the near future. The Transaction,
however, does not result in an all-cash payment to Investors in liquidation of
their investment. For example, Investors who become Noteholders will have
exchanged their Units for unsecured debt obligations of the Company which may
not be retired in full until , 2006, a date approximately seven years
after the Effective Date. On the other hand, Investors who exchange their Units
for Shares will receive an equity interest in the Company whose marketability
will depend upon the aftermarket that may develop with respect to the Shares.
If the Transaction is approved, all Transaction Costs will be paid by the
Partnerships and the Company. If the Transaction is rejected, the General
Partners of each Partnership will bear a percentage of all Transaction Costs,
excluding solicitation/communication costs, equal to the total number of
abstentions and "NO" votes cast by Investors in that Partnership with respect to
the Transaction, divided by the total number of abstentions and votes cast by
Investors in that Partnership. In such event, the Partnerships will bear the
remaining Transaction Costs. For a more detailed discussion of the Transaction
Costs see "THE TRANSACTION--Transaction Expenses" in the Prospectus/Consent
Solicitation Statement.
EXCHANGE VALUE TABLES
The first table set forth below indicates the Exchange Value as it relates
to the allocation of Shares to Cap Source II in connection with the Transaction.
The second indicates the Exchange Value as it relates to the allocation of
Shares to the Cap Source II General Partners in connection with the Transaction.
The third table sets forth the Exchange Value assigned to Cap Source II, which
is composed of (a) the principal amount of GNMA Certificates and the FHA Loans
as set forth in the Partnership's audited financial statements for the period
ended December 31, 1997, (b) the value of the Partnership's limited partnership
interests in the Cap Source II Operating Partnerships based in part on the
Appraisals, and (c) the market value of the Partnership's remaining net assets
as set forth in the Partnership's audited financial statements for the period
ended December 31, 1997. The Cap Source II General Partners will receive Shares
in an amount equal to 1% of the Exchange Value assigned to Cap Source II upon
consummation of the Transaction. See "--Determination of Exchange Values"
herein, and the tables entitled "Calculation Of Exchange Values" and "Net Other
Assets and Liabilities Table for Partnerships" in the Prospectus/Consent
Solicitation Statement. The fourth table sets forth the specific components of
net other assets and liabilities of Cap Source II.
EXCHANGE VALUE(1)
FOR ALLOCATION OF SHARES TO CAP SOURCE II
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
PER $1,000 ORIGINAL
INVESTMENT
PERCENT OF TOTAL ------------------------
TOTAL EXCHANGE TOTAL NUMBER SHARES EXCHANGE NUMBER OF
VALUE(2) OF SHARES(3) (EXCHANGE RATIO) VALUE SHARES(4)
- ---------------------- ------------- --------------------- ----------- -----------
<S> <C> <C> <C> <C>
$32,880,190 1,315,208 39.2% $ 406 16.23
</TABLE>
- ------------------------
(1) This Exchange Value Table assumes that no Notes will be issued.
(2) See the table entitled "Calculation Of Exchange Values" in the
Prospectus/Consent Solicitation Statement for a determination of the
Exchange Values for each of the Partnerships.
(3) The total number of Shares to be allocated to Cap Source II was calculated
by dividing the Total Exchange Value assigned to the Partnership by $25.
(4) The number of Shares to be issued per $1,000 original investment was
calculated by dividing the Exchange Value per $1,000 original investment by
$25. No fractional Shares will be issued. Each Investor who would otherwise
be entitled to a fractional Share will instead receive a cash payment
Cap Source II Supp-4
<PAGE>
equal to $25 multiplied by the fraction. See "THE TRANSACTION--No Fractional
Shares" in the Prospectus/Consent Solicitation Statement.
EXCHANGE VALUE(1)
FOR ALLOCATION OF SHARES TO CAP SOURCE II GENERAL PARTNERS
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
TOTAL EXCHANGE TOTAL NUMBER PERCENT OF TOTAL SHARES
VALUE(2) OF SHARES(3) (EXCHANGE RATIO)
- ---------------------- ------------- -------------------------
<S> <C> <C>
$328,802 13,152 .4%
</TABLE>
- ------------------------
(1) This Exchange Value Table assumes that no Notes will be issued.
(2) See the table entitled "Calculation Of Exchange Values" in the
Prospectus/Consent Solicitation Statement for a determination of the
Exchange Values for each of the Partnerships.
(3) The total number of Shares to be allocated to the Cap Source II General
Partners was calculated by dividing the Total Exchange Value assigned to the
General Partners by $25.
CALCULATION OF EXCHANGE VALUE
OF CAP SOURCE II
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
LIMITED
GNMA CERTIFICATES AND PARTNERSHIP NET OTHER ASSETS EXCHANGE
MORTGAGE LOANS(1) INTERESTS(2) AND LIABILITIES VALUE
- --------------------- ------------------ ---------------- -------------
<S> <C> <C> <C>
$27,162,646 $ 4,087,291 $ 1,630,253 $ 32,880,190
</TABLE>
- ------------------------
(1) GNMA Certificates and FHA Loans are included at their outstanding principal
balance as of December 31, 1997.
(2) Partnership Equity Interests are derived by using the arithmetic average of
the value of the properties as determined by the Appraisals, subtracting the
current principal balances of the mortgages then allocating the remaining
proceeds, if any, according to the limited partnership agreements.
NET OTHER ASSETS AND LIABILITIES TABLE
FOR CAP SOURCE II
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
MISCELLANEOUS NET OTHER ASSETS
GNMA AND DISTRIBUTIONS
CASH(1) CERTIFICATES(2) LIABILITIES(3) PAYABLE TOTAL
- ------------ ------------- ---------------- ------------ ------------
<S> <C> <C> <C> <C>
$1,240,992 $ 1,050,718 $ (114,489) $ (546,968) $ 1,630,253
</TABLE>
- ------------------------
(1) Cash and cash equivalents.
(2) These assets are classified for reporting purposes as "available for sale"
and, as such, are reported at fair value.
(3) Generally, interest receivable less accounts payable.
DETERMINATION OF EXCHANGE VALUES
GENERAL. Exchange Values, which were determined as of December 31, 1997,
have been assigned to each of the Partnerships solely to establish a consistent
method for allocating Shares and Notes to Investors. The Exchange Values were
initially determined by the General Partners and subsequently
Cap Source II Supp-5
<PAGE>
reviewed and approved by the Special Committee. The Exchange Values are based on
(i) the principal amount of GNMA Certificates and the FHA Loans as set forth in
the Partnerships' audited financial statements for the period ended December 31,
1997, (ii) the value of the Partnerships' limited partnership interests in the
Operating Partnerships, and (iii) the market value of the Partnerships'
remaining net assets as set forth in the Partnerships' audited financial
statements for the period ended December 31, 1997.
To determine the value of each Partnership's limited partner interest in an
Operating Partnership, the General Partners started with the mean of the range
of values provided by Valuation Research in its Appraisal of the Operating
Partnership's Property. See "FAIRNESS OPINION AND APPRAISALS-- Appraisals" in
the Prospectus/Consent Solicitation Statement. The liabilities of the Operating
Partnership, including amounts required to pay off the insured mortgage on the
Property and amounts owed to the general partner of the Operating Partnership,
were then subtracted from the mean value. The net amount of other assets of the
Operating Partnership was added. The net value after these adjustments was then
apportioned among the general partner and limited partners of the Operating
Partnership according to the Operating Partnership limited partnership
agreement. In valuing the Operating Partnerships, the General Partners did not
take into account amounts that may be payable by certain Cap Source I Operating
Partnerships to affiliates of the Cap Source I General Partners that will be
waived if the Transaction is completed. See "BENEFITS OF, AND BACKGROUND AND
REASONS FOR, THE TRANSACTION--Reasons for, and Benefits of, the
Transaction--WAIVER BY AFFILIATES OF THE CAP SOURCE I GENERAL PARTNERS OF
AMOUNTS PAYABLE BY CERTAIN CAP SOURCE I OPERATING PARTNERSHIP" in the
Prospectus/Consent Solicitation Statement.
The Exchange Value assigned to Cap Source II for purposes of the Transaction
is $32,880,190. The aggregate Exchange Value assigned to both Partnerships is
$83,872,160. Based on the assigned Exchange Values, Cap Source II will receive
1,315,208 Shares of Common Stock, or approximately 39.2% of the total 3,354,887
Shares of Common Stock issued in the Transaction, assuming that no Notes are
issued. See "EXCHANGE VALUES" in the Prospectus/Consent Solicitation Statement.
The Exchange Value of Cap Source II does not necessarily reflect the price at
which the assets of the Partnership may be sold, or the price at which Shares or
Notes may be sold after the Transaction.
VALUATION. The value of the Partnership Equity Interests is based in part
upon the Appraisals by Valuation Research. In its appraisal of the Partnership
Properties, Valuation Research considered the cost approach, the direct sales
comparison approach and the income approach to market value, and relied upon the
income approach as its primary appraisal technique, using the direct sales
comparison approach as a basis for checking the reasonableness of the results
obtained using the income approach. See "FAIRNESS OPINION AND
APPRAISALS--Appraisals" in the Prospectus/Consent Solicitation Statement.
CERTAIN TAX DIFFERENCES BETWEEN THE OWNERSHIP OF UNITS AND SHARES
Investors are treated as limited partners of the Partnerships for federal
income tax purposes. The Partnerships are not subject to federal income taxation
and, instead, each Investor is required to take into account his or her share of
income, deductions or loss of the Partnership in which he or she invested,
regardless of whether any cash is distributed. The character of income to each
Investor is dependent upon its character to the Partnership. Upon consummation
of the Transaction, the Investors will, in essence, receive Shares in exchange
for their Units and thereby become shareholders of the Company which is
characterized as a corporation for federal income tax purposes. See "CERTAIN
FEDERAL INCOME TAX CONSIDERATIONS" in the Prospectus/Consent Solicitation
Statement.
In contrast to the tax treatment of the Partnerships, the Company is subject
to corporate income taxation. In addition, Shareholders will be taxed based on
the amount of distributions received from the Company. Each Shareholder will
receive a Form 1099-DIV reporting the amount of taxable and nontaxable
distributions paid to him or her during the preceding year. The extent to which
such distributions are taxable depends upon the amount of the Company's earnings
and profits. The character of distributions to
Cap Source II Supp-6
<PAGE>
the Shareholders is also not dependant on its character to the Company and is
generally characterized as ordinary dividend income to the Shareholders. In
addition, such income is classified as portfolio income under the passive loss
rules. Furthermore, deductions and losses are not passed through to the
Shareholders. See "CERTAIN FEDERAL INCOME TAX CONSIDERATIONS" in the
Prospectus/Consent Solicitation Statement.
FAIRNESS
GENERAL. There are no material differences with respect to the fairness of
the Transaction to the Partnerships, individually, or in the aggregate.
Therefore, the discussion of the fairness of the Transaction set forth below is
intended to summarize briefly the General Partners' belief as to fairness and
the material factors on which such belief is based. In their analysis, the
General Partners did not assign relative weights to these factors. For a more
detailed discussion of the fairness of the Transaction, see the sections
entitled "FAIRNESS" and "FAIRNESS OPINION AND APPRAISALS--Fairness Opinion" in
the Prospectus/ Consent Solicitation Statement.
GENERAL PARTNERS' BELIEF AS TO FAIRNESS. The General Partners, together
with the Special Committee, believe the terms of the Transaction are fair as a
whole, to the Partnerships and to the Investors in each of the Partnerships,
regardless of whether an Investor receives Shares or Notes.
BASIS FOR GENERAL PARTNERS' BELIEF AS TO FAIRNESS. The General Partners and
the Special Committee have based their determination as to the fairness of the
Transaction on the following material factors: (i) the process of arm's-length
negotiation of the terms and conditions of the Transaction and Advisory
Agreement, with the Special Committee acting on behalf of the Partnerships and
Investors; (ii) the opportunity for each Investor to object to the Transaction
and the requirement that the Transaction be approved by Investors holding a
majority in interest of each of the Partnerships' outstanding Units; (iii) the
form and amount of consideration offered to the Investors; (iv) the method of
allocating the Shares and Notes between the Partnerships in the Transaction; (v)
the Fairness Opinion rendered by Sutro & Co.; (vi) the independent Appraisals
prepared by Valuation Research, which were used in part in the determination of
the Exchange Values; (vii) the lack of material differences with respect to the
assets of the Partnerships and the consistent valuation methodology applied to
the assets; and (viii) the fact that all Investors, including Dissenting
Investors, will be given the opportunity to elect to receive Notes, subject to
certain limitations. For a complete discussion of these factors, see
"FAIRNESS--Material Factors Underlying Belief as to Fairness" in the
Prospectus/Consent Solicitation Statement.
The General Partners and the Special Committee also considered the potential
benefits of the Transaction compared to the alternatives in reaching their
conclusion as to the fairness of the Transaction. Such potential benefits
include, but are not limited to: (i) enhanced liquidity resulting from the
anticipated listing of the Shares on the NYSE and the Company's larger equity
market capitalization and growth strategy; (ii) the Company's potential for
growth and enhanced access to capital; (iii) a capital and operating structure
that will allow the Company to respond more efficiently to changing conditions
in the U.S. equity markets, thereby potentially reducing the adverse effects of
such changes; and (iv) simplified tax reporting requirements for Investors. See
"BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION" in the
Prospectus/Consent Solicitation Statement.
COMPENSATION, REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNERS
The following information has been prepared to compare the amounts of
compensation paid, and cash distributions made, by Cap Source II to its General
Partners and their affiliates to the amounts that would have been paid if the
compensation and distribution structure, which will be in effect after the
Transaction, had been in effect during the years presented.
Under Cap Source II's Partnership Agreement, the General Partners are
entitled to receive fees in connection with managing the affairs of the
Partnership. The Partnership Agreement also provides that the
Cap Source II Supp-7
<PAGE>
General Partners are to be reimbursed for expenses for services performed for
the Partnership, such as legal, accounting, transfer agent, data processing and
duplicating services. In addition, the General Partners of Cap Source II have a
1% interest in the Partnership.
During the years ended December 31, 1995, 1996 and 1997, amounts actually
paid by Cap Source II to its General Partners are shown below under "Historical"
and Cap Source II's share of the estimated amounts of compensation that would
have been paid to the Advisor had the Transaction been in effect for the years
presented are shown under "Pro Forma":
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
HISTORICAL:
1% share of Cash Distributions(1)............................................ $ 32,818 $ 32,818 $ 32,818
Asset Management and Partnership Administrative Fee(2)....................... 166,000 166,000 166,000
Reimbursements(3)............................................................ 128,754 165,424 211,845
---------- ---------- ----------
Total historical......................................................... $ 327,572 $ 364,242 $ 410,663
---------- ---------- ----------
---------- ---------- ----------
PRO FORMA:
Acquisition Fee(4)........................................................... $ 0 $ 0 $ 0
Asset Management Fee(5)...................................................... 176,763 174,276 171,882
Incentive Fee(6)............................................................. 0 0 0
---------- ---------- ----------
Total Pro Forma.......................................................... $ 176,763 $ 174,276 $ 171,882
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
(1) The Partnership Agreement provides that 1% of cash available for
distribution will be allocated to the General Partners.
(2) The General Partners are entitled to receive an asset management and
partnership administrative fee equal to 0.5% of invested assets per annum,
the first $50,000 of which shall be paid each year with the balance payable
only during such years that a 6.5% annual return has been paid to investors
on a noncumulative basis. An additional fee of 0.5% of invested assets will
be paid in those years that an 11.5% annual return has been paid to
investors on a cumulative basis. Any unpaid amounts will accrue and be
payable only after an 11.5% annual return to investors has been paid on a
cumulative basis and the investors have received the return of their capital
contributions.
(3) The General Partners are paid or reimbursed for certain costs and expenses
incurred in connection with the operation of the Partnership. The increase
in historical reimbursements to the General Partners from 1995 to 1997 is
primarily the result of an increase in salaries and related expenses.
Starting in 1996, additional management time was incurred in exploring
various options available to the Partnerships to improve total returns. The
pro forma compensation to the Advisor does not reflect this increase because
the Advisor's fees are based on asset values, not specific reimbursements.
For a description of the fee structure of the Advisor, see "MANAGEMENT OF
THE COMPANY--The Advisor--THE ADVISORY AGREEMENT" in the Prospectus/Consent
Solicitation Statement.
(4) No acquisition fees would have been paid because no new assets were
purchased or permitted to be purchased in the years 1995 to 1997.
(5) Calculated based on the Advisor fees described in more detail under "THE
COMPANY--The Advisor" in the Prospectus/Consent Solicitation Statement.
(6) No incentive fee would have been paid because no new assets were owned which
would have qualified for such a fee if sold.
Cap Source II Supp-8
<PAGE>
For purposes of comparing pro forma compensation levels to historical
compensation levels of the General Partners, a pro forma model was developed of
the compensation and distribution structure that the General Partners expect
would have been in place had the Transaction been consummated.
The pro forma model was applied to the years ended December 31, 1995, 1996
and 1997 as shown in the "Pro Forma" table above. Cap Source II's allocation of
the total pro forma cash compensation to the General Partners is set forth
below, using December 31, 1997 amounts for illustrative purposes. The allocation
is based on the ratio that Cap Source II's assigned Exchange Value bears to the
aggregate Exchange Value for both Partnerships:
<TABLE>
<CAPTION>
1997
-------------
<S> <C>
Cap Source II's assigned Exchange Value........................................ $ 32,880,190
Aggregate Exchange Value of both Partnerships.................................. $ 83,872,160
Allocation Ratio............................................................... 39.2%
Aggregate pro forma compensation............................................... $ 433,014
Cap Source II's allocation of pro forma compensation........................... $ 171,882
</TABLE>
CASH DISTRIBUTIONS TO INVESTORS
The information below should be read in conjunction with the information in
the Prospectus/Consent Solicitation Statement under the captions "SECONDARY
MARKET AND OWNERSHIP OF PARTNERSHIP UNITS" and "SELECTED FINANCIAL DATA OF THE
PARTNERSHIPS."
The following table sets forth the distributions paid to Investors in Cap
Source II (per $1,000 original investment) for the periods indicated below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------ QUARTER ENDED
1993 1994 1995 1996 1997 MARCH 31, 1998
---------- --------- --------- --------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Distributions from Income................ $ 20.495 $ 17.795 $ 21.330 $ 19.735 $ 17.245 $ 1.370
Distributions from Return of Capital..... 183.015 22.705 19.170 20.765 23.255 8.755
---------- --------- --------- --------- --------- -------
Total................................ $ 203.510 $ 40.500 $ 40.500 $ 40.500 $ 40.500 $ 10.125
---------- --------- --------- --------- --------- -------
---------- --------- --------- --------- --------- -------
</TABLE>
Cash from operations, defined in the Partnership Agreement as disbursable
cash, is distributed to the Investors. Any variation in the amount of
distributions from operations is due to fluctuations in net cash from operating
activities. Reference is made to "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" in the Financial Statement
Supplement to the Prospectus/Consent Solicitation Statement for a discussion and
analysis of such fluctuations. Cash proceeds from the sale of property may be
distributed separately to the Investors as a return of capital. The Adjusted
Capital Contribution of an Investor is generally the Investor's initial capital
contribution reduced by the cash distributions to the Investor of proceeds from
the sale of Partnership properties. The Adjusted Capital Contribution per Unit
for Investors in Cap Source II, as defined in its Partnership Agreement, was
$12.39 as of March 31, 1998, based on an initial capital contribution of $20 per
unit.
See the information in the Prospectus/Consent Solicitation Statement under
"SELECTED FINANCIAL DATA OF THE PARTNERSHIPS" for more detailed financial
information with respect to the Partnerships and the effects of the Transaction.
Cap Source II Supp-9
<PAGE>
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
SUPPLEMENT DATED , 1998
TO
PROSPECTUS/CONSENT SOLICITATION STATEMENT
DATED , 1998
FOR
CAPITAL SOURCE L.P.
On the terms described in the Prospectus/Consent Solicitation Statement
dated , 1998, of which this Supplement (the "Supplement") is a part,
Insured Mortgage Equities, Inc. and America First Capital Source I, L.L.C.
(together, the "Cap Source I General Partners") and Insured Mortgage Equities II
L.P. and America First Capital Source II, L.L.C. (together, the "Cap Source II
General Partners," and together with the Cap Source I General Partners, the
"General Partners") are proposing the consolidation by merger (the
"Transaction") of Capital Source L.P., a Delaware limited partnership ("Cap
Source I" or the "Partnership") and Capital Source II L.P.-A, a Delaware limited
partnership ("Cap Source II," and together with Cap Source I, the
"Partnerships"), with and into America First Real Estate Investment Company,
Inc., a newly organized Delaware corporation (the "Company"). The Partnerships
are Delaware limited partnerships formed from 1985 through 1986 to invest
principally in federally-insured mortgages on multifamily housing properties and
to acquire, hold, sell, dispose of and otherwise deal with limited partnership
interests ("Partnership Equity Interests") in the limited partnerships (the
"Operating Partnerships") which construct, own and operate these properties.
Upon completion of the Transaction, the Company's primary business objective
will be to make growth-oriented real estate investments through the direct
acquisition, rehabilitation, development, financing and management of real
property, including the acquisition of securities of entities engaged in similar
real estate businesses.
Upon completion of the Transaction, the Partnerships will be merged with and
into the Company. Cap Source I Investors, together with Cap Source II Investors
(collectively, the "Investors"), will receive, at their election, either shares
of the Common Stock of the Company (the "Common Stock" or the "Shares") or
Variable Rate Junior Notes Callable on or After the Date of Issuance (the
"Notes") of the Company, together with promissory notes (the "Promissory Notes")
to each Investor entitled to a fractional interest in the Notes. See
"DESCRIPTION OF CAPITAL STOCK" and "THE NOTES" in the Prospectus/ Consent
Solicitation Statement. The Common Stock will be listed on the New York Stock
Exchange under the symbol " ," subject to official notice of issuance. The
Transaction will not occur unless it is approved by both Partnerships and
Investors who vote against the Transaction ("Dissenting Investors") do not elect
to receive more than the maximum amount of Notes issuable in connection with the
Transaction. The maximum amount of Notes that may be issued in the Transaction
is $40.0 million.
This Supplement has been prepared for the Cap Source I Investors to discuss
the effects and fairness of the Transaction with respect to their beneficial
assignment certificates of the Partnership (the "Units"), and to provide
information on the Partnership. The effects of the Transaction may be different
for Cap Source I Investors than for Cap Source II Investors. A supplement has
also been prepared for Cap Source II Investors. The Supplements are a part of
the Prospectus/Consent Solicitation Statement. Capitalized terms not defined
herein shall have the meaning set forth in the accompanying Prospectus/Consent
Solicitation Statement.
Copies of any Supplement may be obtained without charge by an Investor or
representative so designated in writing, by giving written notice to the General
Partners of the Investor's respective Partnership. All requests should be
directed to America First Companies L.L.C., Attn: Maurice Cox, 1004 Farnam
Street, Suite 400, Omaha, Nebraska 68102.
SIMILARITIES BETWEEN CAP SOURCE I AND CAP SOURCE II
The investment objectives and the assets held by the Partnerships are
substantially similar in nature and character. Based on the Exchange Values
determined as of December 31, 1997, Cap Source I's assets consisted of 70.8% in
GNMA Certificates and FHA Loans, 19.0% in cash, cash equivalents and net other
<PAGE>
assets and liabilities, and the remaining 10.2% in the Partnership Equity
Interests in the Cap Source I Operating Partnerships. As of December 31, 1997,
Cap Source II's assets consisted of 85.8% in GNMA Certificates and FHA Loans,
1.8% in cash, cash equivalents and net other assets and liabilities, and the
remaining 12.4% in the Partnership Equity Interests in the Cap Source II
Operating Partnerships.
Although there are differences in the geographic area, style of construction
and specific locations for each property owned by the Operating Partnerships,
there are no significant differences in occupancy rates or property types. All
of the properties owned by the Operating Partnerships are multifamily apartment
complexes. In addition, the Operating Partnership interests in the Ponds at
Georgetown Limited Partnership ("The Ponds") are owned by Cap Source I and Cap
Source II.
DIFFERENCES BETWEEN CAP SOURCE I AND CAP SOURCE II
Except for The Ponds, each Partnership Equity Interest is unique to the
Partnership that holds the interest. The style of construction, specific
location and geographic areas for each property owned by the Operating
Partnerships are different. Cap Source I has Partnership Equity Interests in
three Operating Partnerships that have a general partner that is an affiliate of
Cap Source I, which include Waterman's Crossing, Fox Hollow and Misty Springs.
The remaining Cap Source I Operating Partnerships have general partners that are
not affiliated with Cap Source I. All of the Cap Source II Operating
Partnerships have general partners that are not affiliated with Cap Source II.
See "THE PARTNERSHIPS" in the Prospectus/Consent Solicitation Statement.
Although both Partnerships hold a majority of their assets in liquid
investments, the amount of cash and cash equivalents held by each Partnership is
different. Cash, cash equivalents and net other assets and liabilities make up
19% of Cap Source I's assets, whereas only 1.8% of Cap Source II's assets are in
cash, cash equivalents and net other assets and liabilities.
Distributions for both Partnerships are based upon the adjusted Unit value,
which is $20.00 per Unit of original investment, adjusted for returns of capital
to Investors. The adjusted Unit value for Cap Source I is $18.35. The adjusted
Unit value for Cap Source II is $12.39.
In 1997, Cap Source I made distributions at the rate of 5.5% of its adjusted
Unit value, which equaled $1.01 per Unit for the year. Cap Source I made
distributions at an annual rate of 5.5% of its adjusted Unit value, which
equaled $.2525 per Unit for the first quarter of 1998. Cap Source II made
distributions at the rate of 6.5% of its adjusted Unit value, which equaled $.81
per Unit for 1997, $.279 of which was made from reserves. Cap Source II made
distributions at an annual rate of 6.5% of its adjusted Unit value, which
equaled $.2025 per Unit for the first quarter of 1998, $.1228 of which was made
from reserves. Since Cap Source II has been making part of its distributions
from reserves, distributions for Cap Source II are likely to decrease in future
years as reserves are depleted. See "SECONDARY MARKET AND OWNERSHIP OF
PARTNERSHIP UNITS--Partnership Distributions" in the Prospectus/Consent
Solicitation Statement.
The Partnerships have different fee structures for compensating the General
Partners. The Cap Source I General Partners are entitled to receive an asset
management and partnership administrative fee equal to 0.5% of invested assets
per annum, payable only during such years that an 8% return has been paid to
Investors on a noncumulative basis. Any unpaid amounts will accrue and be
payable only after a 13% annual return to Cap Source I Investors has been paid
on a cumulative basis and such Investors have received the return of their
capital contributions.
The Cap Source II General Partners are entitled to receive an asset
management and partnership administrative fee equal to 0.5% of invested assets
per annum, the first $50,000 of which is paid each year with the balance payable
only during such years that a 6.5% annual return has been paid to Cap Source II
Investors on a noncumulative basis. An additional fee of 0.5% of invested assets
will be paid in years that an 11.5% annual return has been paid to Cap Source II
Investors on a cumulative basis. Any unpaid
Cap Source I Supp-2
<PAGE>
amounts will accrue and be payable only after an 11.5% annual return to
investors has been paid on a cumulative basis and the investors have received
the return of their capital contributions.
The General Partners of both Partnerships also receive 1% of the net
proceeds from any sale of Partnership assets. The General Partners of both
Partnerships will receive a termination fee equal to 3% of all sales proceeds
less actual costs incurred in connection with all sales transactions, payable
only after the Investors have received a return of their capital contributions
and a 13% annual return on a cumulative basis with respect to Cap Source I or an
11.5% annual return on a cumulative basis with respect to Cap Source II. The
General Partners of both Partnerships will also receive a fee equal to 9.1% of
all cash available for distribution and sales proceeds (after deducting from
cash available or sales proceeds any termination fee paid therefrom) after
Investors have received a return of their capital contributions and a 13% annual
return on a cumulative basis with respect to Cap Source I or an 11.5% annual
return on a cumulative basis with respect to Cap Source II. However, the
difference in this latter fee is not a material difference since neither
Partnership has achieved such a target level since their inception, and the
General Partners do not anticipate that such a level will be reached in the
foreseeable future.
RISK FACTORS
The Transaction does not involve risks which are more significant to Cap
Source I Investors than to Cap Source II Investors. However, the Transaction
involves certain risks and other adverse factors which are applicable to both
Partnerships, as discussed in detail in the accompanying Prospectus/Consent
Solicitation Statement, of which this Supplement is a part. See "RISK FACTORS"
in the Prospectus/ Consent Solicitation Statement. Because all of the risks and
adverse factors described in the Prospectus/ Consent Solicitation Statement
apply to the effect of the Transaction on both Partnerships, Cap Source I
Investors should carefully review the section entitled "RISK FACTORS" therein.
Except as otherwise stated herein, there are no material differences in the
manner in which Cap Source I or Cap Source II will be effected by any of the
risks or adverse factors discussed in such "RISK FACTORS" section.
For most Investors, the Transaction will not result in a taxable transaction
except to the extent Notes are received in the Transaction. For a more detailed
discussion of the tax consequences of the transaction see "Certain Tax
Differences Between the Ownership of Units and Shares" herein and "CERTAIN
FEDERAL INCOME TAX CONSIDERATIONS" in the Prospectus/Consent Solicitation
Statement.
By participating in the Transaction, Investors in Cap Source I will assume
risks associated with the assets of Cap Source II. Although the majority of the
assets in Cap Source II are substantially similar to those of Cap Source I, the
multifamily apartment complexes in which Cap Source II owns limited partnership
interests are of different construction, geographic area and specific location
than the complexes in which Cap Source I owns interests. Because the market for
real estate may vary from one region of the country to another, the change in
geographic diversity may expose Cap Source I Investors to different and greater
risks than those to which they are presently exposed. For geographic information
regarding the Partnerships' properties, see "THE PARTNERSHIPS" in the
Prospectus/Consent Solicitation Statement. Moreover, because the properties
owned by the Partnerships are not of uniform quality, combining assets and
liabilities of the Partnerships in the Transaction may diminish the overall
asset quality underlying the investments of certain of the Investors by
comparison with their existing Partnership investment.
For a more detailed discussion of the risks associated with the Transaction,
see "RISK FACTORS" in the Prospectus/Consent Solicitation Statement.
EFFECTIVE ON FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Upon completion of the Transaction, the operations and existence of the
Partnerships will cease. See "THE TRANSACTION" in the Prospectus/Consent
Solicitation Statement. If the Transaction is not consummated, the General
Partners do not contemplate liquidation of the Partnerships, which would result
in an all-cash payment to Investors, in the near future. The Transaction,
however, does not result in
Cap Source I Supp-3
<PAGE>
an all-cash payment to Investors in liquidation of their investment. For
example, Investors who become Noteholders will have exchanged their Units for
unsecured debt obligations of the Company which may not be retired in full until
, 2006, a date approximately seven years after the Effective Date. On
the other hand, Investors who exchange their Units for Shares will receive an
equity interest in the Company whose marketability will depend upon the
aftermarket that may develop with respect to the Shares.
If the Transaction is approved, all Transaction Costs will be paid by the
Partnerships and the Company. If the Transaction is rejected, the General
Partners of each Partnership will bear a percentage of all Transaction Costs,
excluding solicitation/communication costs, equal to the total number of
abstentions and "NO" votes cast by Investors in that Partnership with respect to
the Transaction, divided by the total number of abstentions and votes cast by
Investors in that Partnership. In such event, the Partnerships will bear the
remaining Transaction Costs. For a more detailed discussion of the Transaction
Costs see "THE TRANSACTION--Transaction Expenses" in the Prospectus/Consent
Solicitation Statement.
EXCHANGE VALUE TABLES
The first table set forth below indicates the Exchange Value as it relates
to the allocation of Shares to Cap Source I in connection with the Transaction.
The second indicates the Exchange Value as it relates to the allocation of
Shares to the Cap Source I General Partners in connection with the Transaction.
The third table sets forth the Exchange Value assigned to Cap Source I, which is
composed of (a) the principal amount of GNMA Certificates and the FHA Loans as
set forth in the Partnership's audited financial statements for the period ended
December 31, 1997, (b) the value of the Partnership's limited partnership
interests in the Cap Source I Operating Partnerships based in part on the
Appraisals, and (c) the market value of the Partnership's remaining net assets
as set forth in the Partnership's audited financial statements for the period
ended December 31, 1997. The Cap Source I General Partners will receive Shares
in an amount equal to 1% of the Exchange Value assigned to Cap Source I upon
consummation of the Transaction. See "--Determination of Exchange Values"
herein, and the tables entitled "Calculation Of Exchange Values" and "Net Other
Assets and Liabilities Table for Partnerships" in the Prospectus/Consent
Solicitation Statement. The fourth table sets forth the specific components of
net other assets and liabilities of Cap Source I.
EXCHANGE VALUE(1)
FOR ALLOCATION OF SHARES TO CAP SOURCE I
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
PER $1,000 ORIGINAL
INVESTMENT
------------------------
TOTAL EXCHANGE TOTAL NUMBER PERCENT OF TOTAL SHARES EXCHANGE NUMBER OF
VALUE(2) OF SHARES(3) (EXCHANGE RATIO) VALUE SHARES(4)
- -------------- ------------- ------------------------- ----------- -----------
<S> <C> <C> <C> <C>
$ 50,991,970 2,039,679 60.8% $ 748 29.92
</TABLE>
- ------------------------
(1) This Exchange Value Table assumes that no Notes will be issued.
(2) See the table entitled "Calculation Of Exchange Values" in the
Prospectus/Consent Solicitation Statement for a determination of the
Exchange Values for each of the Partnerships.
(3) The total number of Shares to be allocated to Cap Source I was calculated by
dividing the Total Exchange Value assigned to the Partnership by $25.
(4) The number of Shares to be issued per $1,000 original investment was
calculated by dividing the Exchange Value per $1,000 original investment by
$25. No fractional Shares will be issued. Each Investor who would otherwise
be entitled to a fractional Share will instead receive a cash payment equal
to $25 multiplied by the fraction. See "THE TRANSACTION--No Fractional
Shares" in the Prospectus/Consent Solicitation Statement.
Cap Source I Supp-4
<PAGE>
EXCHANGE VALUE(1)
FOR ALLOCATION OF SHARES TO CAP SOURCE I GENERAL PARTNERS
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
TOTAL EXCHANGE TOTAL NUMBER PERCENT OF TOTAL SHARES
VALUE(2) OF SHARES(3) (EXCHANGE RATIO)
- -------------- ------------- ---------------------------
<S> <C> <C>
$ 509,920 20,397 .6%
</TABLE>
- ------------------------
(1) This Exchange Value Table assumes that no Notes will be issued.
(2) See the table entitled "Calculation Of Exchange Values" in the
Prospectus/Consent Solicitation Statement for a determination of the
Exchange Values for each of the Partnerships.
(3) The total number of Shares to be allocated to the Cap Source I General
Partners was calculated by dividing the Total Exchange Value assigned to the
General Partners by $25.
CALCULATION OF EXCHANGE VALUE
OF CAP SOURCE I
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
LIMITED
GNMA CERTIFICATES AND PARTNERSHIP NET OTHER ASSETS EXCHANGE
MORTGAGE LOANS(1) INTERESTS(2) AND LIABILITIES VALUE
- --------------------- ------------------ ---------------- -------------
<S> <C> <C> <C>
$ 35,010,658 $ 5,225,467 $ 10,755,845 $ 50,991,970
</TABLE>
- ------------------------
(1) GNMA Certificates and FHA Loans are included at their outstanding principal
balance as of December 31, 1997.
(2) Partnership Equity Interests are derived by using the arithmetic average of
the value of the properties as determined by the Appraisals, subtracting the
current principal balances of the mortgages then allocating the remaining
proceeds, if any, according to the limited partnership agreements.
NET OTHER ASSETS AND LIABILITIES TABLE
FOR CAP SOURCE I
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
MISCELLANEOUS NET OTHER ASSETS
GNMA AND DISTRIBUTIONS
CASH(1) CERTIFICATES(2) LIABILITIES(3) PAYABLE TOTAL
- ------------- ------------- ---------------- ------------ -------------
<S> <C> <C> <C> <C>
$ 10,410,564 $ 1,088,526 $ 117,342 $ (860,587) $ 10,755,845
</TABLE>
- ------------------------
(1) Cash and cash equivalents.
(2) These assets are classified for reporting purposes as "available for sale"
and, as such, are reported at fair value.
(3) Generally, interest receivable less accounts payable.
DETERMINATION OF EXCHANGE VALUES
GENERAL. Exchange Values, which were determined as of December 31, 1997,
have been assigned to each of the Partnerships solely to establish a consistent
method for allocating Shares and Notes to Investors. The Exchange Values were
initially determined by the General Partners and subsequently reviewed and
approved by the Special Committee. The Exchange Values are based on (i) the
principal amount of GNMA Certificates and the FHA Loans as set forth in the
Partnerships' audited financial statements for the period ended December 31,
1997, (ii) the value of the Partnerships' limited partnership interests in the
Operating Partnerships, and (iii) the market value of the Partnerships'
remaining net assets as set forth in the Partnerships' audited financial
statements for the period ended December 31, 1997.
Cap Source I Supp-5
<PAGE>
The Exchange Value assigned to Cap Source I for purposes of the Transaction
is $50,991,970. The aggregate Exchange Value assigned to both Partnerships is
$83,872,160. Based on the assigned Exchange Values, Cap Source I will receive
2,039,679 Shares of Common Stock, or approximately 60.8% of the total 3,354,887
Shares of Common Stock issued in the Transaction, assuming that no Notes are
issued. See "EXCHANGE VALUES" in the Prospectus/Consent Solicitation Statement.
The Exchange Value of Cap Source I does not necessarily reflect the price at
which the assets of the Partnership may be sold, or the price at which Shares or
Notes may be sold after the Transaction.
To determine the value of each Partnership's limited partner interest in an
Operating Partnership, the General Partners started with the mean of the range
of values provided by Valuation Research in its Appraisal of the Operating
Partnership's Property. See "FAIRNESS OPINION AND APPRAISALS-- Appraisals" in
the Prospectus/Consent Solicitation Statement. The liabilities of the Operating
Partnership, including amounts required to pay off the insured mortgage on the
Property and amounts owed to the general partner of the Operating Partnership,
were then subtracted from the mean value. The net amount of other assets of the
Operating Partnership was added. The net value after these adjustments was then
apportioned among the general partner and limited partners of the Operating
Partnership according to the Operating Partnership limited partnership
agreement. In valuing the Operating Partnerships, the General Partners did not
take into account amounts that may be payable by certain Cap Source I Operating
Partnerships to affiliates of the Cap Source I General Partners that will be
waived if the Transaction is completed. See "BENEFITS OF, AND BACKGROUND AND
REASONS FOR, THE TRANSACTION--Reasons for, and Benefits of, the
Transaction--WAIVER BY AFFILIATES OF THE CAP SOURCE I GENERAL PARTNERS OF
AMOUNTS PAYABLE BY CERTAIN CAP SOURCE I OPERATING PARTNERSHIP" in the
Prospectus/Consent Solicitation Statement.
VALUATION. The value of the Partnership Equity Interests is based in part
upon the Appraisals by Valuation Research. In its appraisal of the Partnership
Properties, Valuation Research considered the cost approach, the direct sales
comparison approach and the income approach to market value, and relied upon the
income approach as its primary appraisal technique, using the direct sales
comparison approach as a basis for checking the reasonableness of the results
obtained using the income approach. See "FAIRNESS OPINION AND
APPRAISALS--Appraisals" in the Prospectus/Consent Solicitation Statement.
CERTAIN TAX DIFFERENCES BETWEEN THE OWNERSHIP OF UNITS AND SHARES
Investors are treated as limited partners of the Partnerships for federal
income tax purposes. The Partnerships are not subject to federal income taxation
and, instead, each Investor is required to take into account his or her share of
income, deductions or loss of the Partnership in which he or she invested,
regardless of whether any cash is distributed. The character of income to each
Investor is dependent upon its character to the Partnership. Upon consummation
of the Transaction, the Investors will, in essence, receive Shares in exchange
for their Units and thereby become shareholders of the Company which is
characterized as a corporation for federal income tax purposes. See "CERTAIN
FEDERAL INCOME TAX CONSIDERATIONS" in the Prospectus/Consent Solicitation
Statement.
In contrast to the tax treatment of the Partnerships, the Company is subject
to corporate income taxation. In addition, Shareholders will be taxed based on
the amount of distributions received from the Company. Each Shareholder will
receive a Form 1099-DIV reporting the amount of taxable and nontaxable
distributions paid to him or her during the preceding year. The extent to which
such distributions are taxable depends upon the amount of the Company's earnings
and profits. The character of distributions to the Shareholders is also not
dependant on its character to the Company and is generally characterized as
ordinary dividend income to the Shareholders. In addition, such income is
classified as portfolio income under the passive loss rules. Furthermore,
deductions and losses are not passed through to the Shareholders. See "CERTAIN
FEDERAL INCOME TAX CONSIDERATIONS" in the Prospectus/Consent Solicitation
Statement.
Cap Source I Supp-6
<PAGE>
FAIRNESS
GENERAL. There are no material differences with respect to the fairness of
the Transaction to the Partnerships, individually, or in the aggregate.
Therefore, the discussion of the fairness of the Transaction set forth below is
intended to summarize briefly the General Partners' belief as to fairness and
the material factors on which such belief is based. In their analysis, the
General Partners did not assign relative weights to these factors. For a more
detailed discussion of the fairness of the Transaction, see the sections
entitled "FAIRNESS" and "FAIRNESS OPINION AND APPRAISALS--Fairness Opinion" in
the Prospectus/ Consent Solicitation Statement.
GENERAL PARTNERS' BELIEF AS TO FAIRNESS. The General Partners, together
with the Special Committee, believe the terms of the Transaction are fair as a
whole, to the Partnerships and to the Investors in each of the Partnerships,
regardless of whether an Investor receives Shares or Notes.
BASIS FOR GENERAL PARTNERS' BELIEF AS TO FAIRNESS. The General Partners and
the Special Committee have based their determination as to the fairness of the
Transaction on the following material factors: (i) the process of arm's-length
negotiation of the terms and conditions of the Transaction and Advisory
Agreement, with the Special Committee acting on behalf of the Partnerships and
Investors; (ii) the opportunity for each Investor to object to the Transaction
and the requirement that the Transaction be approved by Investors holding a
majority in interest of each of the Partnerships' outstanding Units; (iii) the
form and amount of consideration offered to the Investors; (iv) the method of
allocating the Shares and Notes between the Partnerships in the Transaction; (v)
the Fairness Opinion rendered by Sutro & Co.; (vi) the independent Appraisals
prepared by Valuation Research, which were used in part in the determination of
the Exchange Values; (vii) the lack of material differences with respect to the
assets of the Partnerships and the consistent valuation methodology applied to
the assets; and (viii) the fact that all Investors, including Dissenting
Investors, will be given the opportunity to elect to receive Notes, subject to
certain limitations. For a complete discussion of these factors, see
"FAIRNESS--Material Factors Underlying Belief as to Fairness" in the
Prospectus/Consent Solicitation Statement.
The General Partners and the Special Committee also considered the potential
benefits of the Transaction compared to the alternatives in reaching their
conclusion as to the fairness of the Transaction. Such potential benefits
include, but are not limited to: (i) enhanced liquidity resulting from the
anticipated listing of the Shares on the NYSE and the Company's larger equity
market capitalization and growth strategy; (ii) the Company's potential for
growth and enhanced access to capital; (iii) a capital and operating structure
that will allow the Company to respond more efficiently to changing conditions
in the U.S. equity markets, thereby potentially reducing the adverse effects of
such changes; and (iv) simplified tax reporting requirements for Investors. See
"BENEFITS OF, AND BACKGROUND AND REASONS FOR, THE TRANSACTION" in the
Prospectus/Consent Solicitation Statement.
COMPENSATION, REIMBURSEMENTS AND DISTRIBUTIONS TO THE GENERAL PARTNERS
The following information has been prepared to compare the amounts of
compensation paid, and cash distributions made, by Cap Source I to its General
Partners and their affiliates to the amounts that would have been paid if the
compensation and distribution structure, which will be in effect after the
Transaction, had been in effect during the years presented.
Under Cap Source I's Partnership Agreement, the General Partners are
entitled to receive fees in connection with managing the affairs of the
Partnership. The Partnership Agreement also provides that the General Partners
are to be reimbursed for expenses for services performed for the Partnership,
such as legal, accounting, transfer agent, data processing and duplicating
services. In addition, the General Partners of Cap Source I have a 1% interest
in the Partnership.
During the years ended December 31, 1995, 1996 and 1997, amounts actually
paid by Cap Source I to its General Partners are shown below under "Historical"
and Cap Source I's share of the estimated
Cap Source I Supp-7
<PAGE>
amounts of compensation that would have been paid to the Advisor had the
Transaction been in effect for the years presented are shown under "Pro Forma":
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
HISTORICAL:
1% share of Cash Distributions(1)............................................ $ 34,424 $ 34,424 $ 34,424
Asset Management and Partnership............................................. 0 0 0
Administrative Fee(2)........................................................
Reimbursements(3)............................................................ 138,857 193,822 240,759
---------- ---------- ----------
Total historical......................................................... $ 173,281 $ 228,246 $ 275,183
---------- ---------- ----------
---------- ---------- ----------
PRO FORMA:
Acquisition Fee(4)........................................................... $ 0 $ 0 $ 0
Asset Management Fee(5)...................................................... 255,027 255,692 261,132
Incentive Fee(6)............................................................. 0 0 0
---------- ---------- ----------
Total Pro Forma.......................................................... $ 255,027 $ 255,692 $ 261,132
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
(1) The Partnership Agreement provides that 1% of cash available for
distribution will be allocated to the General Partners.
(2) The General Partners are entitled to receive an asset management and
partnership administrative fee equal to 0.5% of invested assets per annum,
payable only during such years that an 8% return has been paid to investors
on a noncumulative basis. Any unpaid amounts will accrue and be payable only
after a 13% annual return to investors has been paid on a cumulative basis
and the investors have received the return of their capital contributions.
(3) The General Partners are paid or reimbursed for certain costs and expenses
incurred in connection with the operation of the Partnership. The increase
in historical reimbursements to the General Partners from 1995 to 1997 is
primarily the result of an increase in salaries and related expenses.
Starting in 1996, additional management time was incurred in exploring
various options available to the Partnerships to improve total returns. The
pro forma compensation to the Advisor does not reflect this increase because
the Advisor's fees are based on asset values, not specific reimbursements.
For a description of the fee structure of the Advisor, see "MANAGEMENT OF
THE COMPANY--The Advisor--THE ADVISORY AGREEMENT" in the Prospectus/Consent
Solicitation Statement.
(4) No acquisition fees would have been paid because no new assets were
purchased or permitted to be purchased in the years 1995 to 1997.
(5) Calculated based on the Advisor fees described in more detail under "THE
COMPANY--The Advisor" in the Prospectus/Consent Solicitation Statement.
(6) No incentive fee would have been paid because no new assets were owned which
would have qualified for such a fee if sold.
For purposes of comparing pro forma compensation levels to historical
compensation levels of the General Partners, a pro forma model was developed of
the compensation and distribution structure that the General Partners expect
would have been in place had the Transaction been consummated.
The pro forma model was applied to the years ended December 31, 1995, 1996
and 1997 as shown in the "Pro Forma" table above. Cap Source I's allocation of
the total pro forma cash compensation to the General Partners is set forth
below, using December 31, 1997 amounts for illustrative purposes. The
Cap Source I Supp-8
<PAGE>
allocation is based on the ratio that Cap Source I's assigned Exchange Value
bears to the aggregate Exchange Value for both Partnerships:
<TABLE>
<CAPTION>
1997
-------------
<S> <C>
Cap Source I's assigned Exchange Value............................... $ 50,991,970
Aggregate Exchange Value of both Partnerships........................ $ 83,872,160
Allocation Ratio..................................................... 60.8%
Aggregate pro forma compensation..................................... $ 433,014
Cap Source I's allocation of pro forma compensation.................. $ 261,132
</TABLE>
CASH DISTRIBUTIONS TO INVESTORS
The information below should be read in conjunction with the information in
the Prospectus/Consent Solicitation Statement under the captions "SECONDARY
MARKET AND OWNERSHIP OF PARTNERSHIP UNITS" and "SELECTED FINANCIAL DATA OF THE
PARTNERSHIPS."
The following table sets forth the distributions paid to Investors in Cap
Source I (per $1,000 original investment) for the periods indicated below:
<TABLE>
<CAPTION>
QUARTER ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------------------ --------------
1993 1994 1995 1996 1997 1998
---------- --------- --------- --------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Distributions from Income................ $ 36.490 $ 50.50 $ 41.545 $ 38.835 $ 35.245 $ 8.320
Distributions from Return of Capital..... 97.635 -- 8.955 11.665 15.255 4.305
---------- --------- --------- --------- --------- -------
Total................................ $ 134.125 $ 50.500 $ 50.500 $ 50.500 $ 50.500 $ 12.625
---------- --------- --------- --------- --------- -------
---------- --------- --------- --------- --------- -------
</TABLE>
Cash from operations, defined in the Partnership Agreement as disbursable
cash, is distributed to the Investors. Any variation in the amount of
distributions from operations is due to fluctuations in net cash from operating
activities. Reference is made to "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" in the Financial Statement
Supplement to the Prospectus/Consent Solicitation Statement for a discussion and
analysis of such fluctuations. Cash proceeds from the sale of property may be
distributed separately to the Investors as a return of capital. The Adjusted
Capital Contribution of an Investor is generally the Investor's initial capital
contribution reduced by the cash distributions to the Investor of proceeds from
the sale of Partnership properties. The Adjusted Capital Contribution per Unit
for Investors in Cap Source I, as defined in its Partnership Agreement, was
$18.35 as of March 31, 1998, based on an initial capital contribution of $20 per
unit.
See the information in the Prospectus/Consent Solicitation Statement under
"SELECTED FINANCIAL DATA OF THE PARTNERSHIPS" for more detailed financial
information with respect to the Partnerships and the effects of the Transaction.
Cap Source I Supp-9
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS/CONSENT
SOLICITATION STATEMENT
ITEM 20. INDEMNIFICATION
The General Corporation Law of the State of Delaware permits a Delaware
corporation to indemnify its officers or directors under certain circumstances.
Such statute provides that, in actions in which the corporation is not a party,
a corporation may indemnify its officers or directors for losses incurred by
them if the officer or director acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation. In actions in which the corporation is a party, the statute
provides the same standard but prohibits indemnification if the director or
officer is adjudged liable to the corporation.
The Company has implemented such indemnification provisions in its
Certificate of Incorporation which provides that officers and directors shall be
entitled to be indemnified by the corporation to the fullest extent permitted by
law against expenses (including attorney's fees), judgments, fines and amounts
paid in settlement incurred in connection with any action, suit or proceeding by
reason of the fact that he is or was an officer or director of the Company.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following is a complete list of exhibits filed as part of the
Registration Statement. For electronic filing purposes only, this registration
statement contains Exhibit 27.1, the Financial Data Schedule. Exhibit numbers
correspond to the numbers in the Exhibit Table of Item 601 of Regulation S-K.
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
2.01 Form of Agreement and Plan of Merger to be entered into by and among the
Partnerships, the General Partners and the Company, is incorporated
herein by reference from Appendix A to the Prospectus/Consent
Solicitation Statement.
3.01 Amended and Restated Certificate of Incorporation of the Company.(1)
3.02 Bylaws of the Company.(2)
3.03 Form of Second Amended and Restated Certificate of Incorporation of the
Company.(1)
3.04 Limited Partnership Agreement and Amended Certificate of Limited
Partnership of Capital Source L.P.(1)
3.05 Limited Partnership Agreement and Amended Certificate of Limited
Partnership of Capital Source II L.P.-A.(1)
4.01 The Amended and Restated Certificate of Incorporation and Bylaws of the
Company included as Exhibits 3.01 and 3.02 are incorporated herein by
reference.
4.02 Form of Indenture between the Company and the trustee relating to the
Notes being registered pursuant to this Registration Statement,
including the form of Variable Rate Junior Notes and the form of
Promissory Notes.(1)
4.03 Form of Common Stock Certificate of the Company.(1)
4.04 Form of Variable Rate Junior Notes and Promissory Notes of the Company are
included in Exhibit 4.02.
5.01 Opinion of Kutak Rock as to the legality of the Shares and the validity of
the Notes.(2)
</TABLE>
- ------------------------
(1) Previously filed.
(2) To be filed by amendment.
II-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
8.01 Opinion of Kutak Rock as to certain tax matters.(2)
10.01 Advisory Agreement between the Company and America First Real Estate
Advisors LLC.(1)
10.02 Agreement between Continental American Properties, the Partnerships and
the Company.(2)
23.01 Consent of Independent Accountants.(3)
23.02 Consent of Kutak Rock (included in Exhibits 5.01 and 8.01).
23.03 Consent of Sutro & Co., Inc., to being named in the Registration Statement
and to the inclusion in the Prospectus/Consent Solicitation Statement of
its Fairness Opinion.(3)
23.04 Consent of Valuation Research Corporation to being named in the
Registration Statement.(3)
24.01 The Power of Attorney, included on Page II-5 of the Registration Statement
filed on May 7, 1998, is incorporated herein by reference.
25.01 Statement of Eligibility of Trustee.(2)
27.01 Financial Data Schedule of the Company.(1)
99.01 The Fairness Opinion and Bringdown Fairness Opinion of Sutro & Co., Inc.,
are incorporated herein by reference from Appendix B and Appendix C to
the Prospectus/ Consent Solicitation Statement.
99.02 Market Value Report of Valuation Research Corporation.(1)
99.03 Form of Consent Card for Capital Source I and Capital Source II.(3)
</TABLE>
- ------------------------
(1) Previously filed.
(2) To be filed by amendment.
(3) Filed herewith.
(b) The following financial statement schedule information is furnished as
part of this Registration Statement in a separately bound volume:
<TABLE>
<CAPTION>
SCHEDULE NO. DESCRIPTION
----------------- --------------------------------------------
<S> <C> <C>
Capital Source L.P............... III Real Estate and Accumulated Depreciation for
the Years Ended December 31, 1997 and 1996
</TABLE>
<TABLE>
<CAPTION>
SCHEDULE NO. DESCRIPTION
----------------- --------------------------------------------
<S> <C> <C>
Capital Source II L.P.-A......... III Real Estate and Accumulated Depreciation for
the Years Ended December 31, 1997 and 1996
</TABLE>
(c) The Fairness Opinion of Sutro & Co., Incorporated is included as
Appendix B to the Prospectus/ Consent Solicitation Statement. The Market Value
Report of Valuation Research Corporation is included as Exhibit 99.02 to this
Registration Statement.
ITEM 22. UNDERTAKINGS
A. The Company hereby undertakes the following:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this Registration Statement:
(a) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
II-2
<PAGE>
(b) To reflect in the prospectus any facts or events arising after
the effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the Registration Statement; and
(c) To include any material information with respect to the plan of
distribution not previously disclosed in the Registration Statement or
any material change to such information in the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
B. (1) The undersigned Registrant hereby undertakes as follows: that prior
to any public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this Registration Statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c), the
issuer undertakes that such reoffering prospectus will contain the information
called for by the applicable registration form with respect to reofferings by
persons who may be deemed underwriters, in addition to the information called
for by the other items of the applicable form.
(2) The undersigned Registrant undertakes that every prospectus (i) that is
filed pursuant to paragraph (1) immediately preceding, or (ii) that purports to
meet the requirements of Section 10(a)(3) of the Securities Act of 1933 and is
used in connection with an offering of securities subject to Rule 415, will be
filed as part of an amendment to the registration statement and will not be used
until such amendment is effective, and that, for purposes of determining any
liability under the Securities Act of 1933, each such post-effective amendment
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
C. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
D. The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the Prospectus/Consent
Solicitation Statement pursuant to Items 4, 10(b), 11 or 13 of this Form, within
one business day of receipt of such request, and to send the incorporated
documents by first class mail or other equally prompt means. This includes
information contained in documents filed subsequent to the effective date of
this Registration Statement through the date of responding to the request.
E. The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the Registration Statement when it became effective.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Pre-Effective Amendment No. 1 to the Form S-4
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Omaha, State of Nebraska, on July 20, 1998.
<TABLE>
<S> <C> <C>
AMERICA FIRST REAL ESTATE INVESTMENT
COMPANY, INC.
By: /s/ PAUL L. ABBOTT
-----------------------------------------
Paul L. Abbott,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ PAUL L. ABBOTT
- ------------------------------ Director, President and July 20, 1998
Paul L. Abbott Chief Executive Officer
***
- ------------------------------ Director and Chairman of July 20, 1998
Michael B. Yanney the Board
***
- ------------------------------ Director and Secretary July 20, 1998
George H. Krauss
*** Chief Financial Officer,
- ------------------------------ Treasurer and Principal July 20, 1998
Gary Thompson Accounting Officer
- ------------------------
***By
/s/ PAUL L. ABBOTT
- ------------------------------
Paul L. Abbott,
as attorney-in-fact
II-4
<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 21, 1998
REGISTRATION NO. 333-52117
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
EXHIBITS
TO
PRE-EFFECTIVE
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
(Exact name of registrant as specified in its charter)
SUITE 400, 1004 FARNAM STREET
OMAHA, NEBRASKA 68102
(402) 444-1130
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NO. DESCRIPTION NUMBERED PAGE
- ------------- ------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
2.01 Form of Agreement and Plan of Merger to be entered into by and among the
Partnerships, the General Partners and the Company, is incorporated herein by
reference from Appendix A to the Prospectus/Consent Solicitation Statement.
3.01 Amended and Restated Certificate of Incorporation of the Company.(1)
3.02 Bylaws of the Company.(2)
3.03 Form of Second Amended and Restated Certificate of Incorporation of the Company.(1)
3.04 Limited Partnership Agreement and Amended Certificate of Limited Partnership of
Capital Source L.P.(1)
3.05 Limited Partnership Agreement and Amended Certificate of Limited Partnership of
Capital Source II L.P.-A.(1)
4.01 The Amended and Restated Certificate of Incorporation and Bylaws of the Company
included as Exhibits 3.01 and 3.02 are incorporated herein by reference.
4.02 Form of Indenture between the Company and the trustee relating to the Notes being
registered pursuant to this Registration Statement, including the form of Variable
Rate Junior Notes Callable On or After the Date of Issuance and the form of
Promissory Notes.(1)
4.03 Form of Common Stock Certificate of the Company.(1)
4.04 Form of Variable Rate Junior Notes Callable On or After the Date of Issuance and
Promissory Notes of the Company are included in Exhibit 4.02.
5.01 Opinion of Kutak Rock as to the legality of the Shares and the validity of the
Notes.(2)
8.01 Opinion of Kutak Rock as to certain tax matters.(2)
10.01 Advisory Agreement between the Company and America First Real Estate Advisors LLC.(1)
10.02 Agreement between Continental American Properties, Ltd. and the Company and the
Partnerships.(2)
23.01 Consent of Independent Accountants.(3)
23.02 Consent of Kutak Rock (included in Exhibits 5.01 and 8.01).
23.03 Consent of Sutro & Co., Inc., to being named in the Registration Statement and to the
inclusion in the Prospectus/Consent Solicitation Statement of its Fairness
Opinion.(3)
23.04 Consent of Valuation Research Corporation to being named in the Registration
Statement.(3)
24.01 Power of Attorney, included on Page II-5 of the Registration Statement filed on May
7, 1998, is incorporated herein by reference.
25.01 Statement of Eligibility of Trustee.(2)
27.01 Financial Data Schedule for the Company.(1)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NO. DESCRIPTION NUMBERED PAGE
- ------------- ------------------------------------------------------------------------------------- -----------------
<C> <S> <C>
99.01 The Fairness Opinion and Bringdown Fairness Opinion of Sutro & Co., Inc., are
incorporated herein by reference from Appendix B and Appendix C to the
Prospectus/Consent Solicitation Statement.
99.02 Market Value Report of Valuation Research Corporation.(1)
99.03 Form of Consent Card for Capital Source I and Capital Source II.(3)
</TABLE>
- ------------------------
(1) Previously filed.
(2) To be filed by amendment.
(3) Filed herewith.
<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 21, 1998
REGISTRATION NO. 333-52117
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FINANCIAL STATEMENT SUPPLEMENT
TO
PRE-EFFECTIVE
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
(Exact name of registrant as specified in its charter)
SUITE 400, 1004 FARNAM STREET
OMAHA, NEBRASKA 68102
(402) 444-1130
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 21, 1998
REGISTRATION NO. 333-52117
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
PARTNERSHIP SUPPLEMENTS
TO
PRE-EFFECTIVE
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------
AMERICA FIRST REAL ESTATE INVESTMENT COMPANY, INC.
(Exact name of registrant as specified in its charter)
SUITE 400, 1004 FARNAM STREET
OMAHA, NEBRASKA 68102
(402) 444-1130
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the inclusion in this Registration Statement on Form S-4
of our reports dated March 26, 1998 on our audits of the consolidated
financial statements and consolidated financial statement schedules of
Capital Source L.P. and Capital Source II L.P.-A, as of December 31, 1997 and
1996 and for each of the three years in the period ended December 31, 1997,
and our report dated April 22, 1998 on our audit of the balance sheet of
America First Real Estate Investment Company, Inc. as of April 16, 1998. We
also consent to the references to our firm under the captions "Independent
Public Accountants" and "Selected Financial Data of the Partnerships."
/s/ Price Waterhouse Coopers LLP
Price Waterhouse Coopers LLP
Omaha, Nebraska
July 17, 1998
<PAGE>
EXHIBIT 23.02
Consent of Kutak Rock (included in Exhibits 5.01 and 8.01)
<PAGE>
CONSENT OF SUTRO & CO., INC.
We hereby consent to the use of our Fairness Opinion included in this
Pre-Effective Amendment No. 1 to the Registration Statement and related
Prospectus/Consent Solicitation Statement, and we further consent to all
references to our firm under the headings "FAIRNESS OPINION AND APPRAISALS"
in the Prospectus/Consent Solicitation Statement, and to the use of our name
wherever appearing in this Pre-Effective Amendment No. 1 to the Registration
Statement and the related Prospectus/Consent Solicitation Statement.
Dated: July 20, 1998
SUTRO & CO., INC.
/s/ Scott E. Wendelin
----------------------
Scott E. Wendelin
<PAGE>
CONSENT OF VALUATION RESEARCH CORPORATION
We hereby consent to the use of our name, or to any references to or use
of our reports, wherever appearing, in this Pre-Effective Amendment No. 1 to
the Registration Statement and the related Prospectus/Consent Solicitation
Statement which is a part of this Pre-Effective Amendment No. 1 to the
Registration Statement, and any amendments thereto.
Dated: July 17, 1998 VALUATION RESEARCH CORPORATION
/s/ Robert J. Simpson
---------------------------
Robert J. Simpson
<PAGE>
99.03 Form of Consent Card for Cap Source I and Cap Source II.(1)
<PAGE>
<TABLE>
<S> <C> <C>
MAILING LABEL CONSENT FRONT SIDE
[Includes name of
Partnership]
</TABLE>
THIS CONSENT IS SOLICITED ON BEHALF OF THE GENERAL PARTNERS OF [CAPITAL
SOURCE, L.P.][CAPITAL SOURCE II, L.P.-A]
Reference is made to the Prospectus/Consent Solicitation Statement dated
, 1998, sent with this Consent Card relating to the proposed
consolidation by merger (the "Transaction") of Capital Source L.P. and
Capital Source II, L.P-A (the "Partnerships") and the general partners of the
Partnerships with and into America First Real Estate Investment Company,
Inc., a Delaware corporation (the "Company"). The undersigned hereby votes as
set forth below with respect to all Partnership Units which the undersigned
may be entitled to vote. Please put an "X" in the appropriate box to vote
"YES" in favor of the Transaction, "NO" against the Transaction or to
"ABSTAIN" from voting.
/ / "YES" I approve of my Partnership's participation in the Transaction.
/ / "NO" I do not approve of my Partnership's participation in the
Transaction.
/ / I wish to "ABSTAIN" from voting.
<TABLE>
<S> <C>
- ------------------------------------------------------------------ ---------------------------------------------------------------
Signature of Investor Signature of Co-Owner (if any)
Dated: ------------------------------------------------------------ Dated:
------------------------------------------------------------
</TABLE>
PLEASE DATE; SIGN EXACTLY AS YOUR NAME APPEARS ON THE MAILING LABEL, UNLESS
YOUR NAME IS PRINTED INCORRECTLY; AND MAIL THIS CONSENT CARD IN THE ENVELOPE
PROVIDED. NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES.
THIS CONSENT WHEN PROPERLY EXECUTED, WILL BE VOTED BY THE LIMITED PARTNER IN
THE MANNER DIRECTED HEREIN BY THE UNDERSIGNED. IF NO DIRECTION IS MADE, THIS
CONSENT WILL BE VOTED FOR THE MERGER.
(Continued on reverse side)
<PAGE>
REVERSE SIDE
INVESTORS WILL RECEIVE COMMON STOCK OF THE COMPANY UNLESS THE FOLLOWING ELECTION
IS MARKED:
/ / I wish to receive Variable Rate Senior Notes of the Company as
described in the Prospectus/Consent Solicitation Statement.
If you sign and return this Consent Card without indicating a vote, you will
be deemed to have voted "YES" in favor of the Transaction and you will receive
Common Stock of the Company if the Transaction is consummated.
A Consent Card voted "NO" will not be used to vote for adjournment of the
meeting to solicit more votes pursuant to discretionary authority.
By signing this Consent Card, you hereby acknowledge receipt of the
Prospectus/Consent Solicitation Statement dated , 1998 and furnished
herewith.
IF YOU HAVE ANY QUESTIONS OR NEED ASSISTANCE IN COMPLETING THE CONSENT CARD,
PLEASE CALL , TOLL-FREE AT (800) .
PLEASE MARK, SIGN, DATE AND RETURN THIS CONSENT CARD USING THE ENCLOSED ENVELOPE
SO THAT IT ARRIVES NO LATER THAN 5:00 P.M. CENTRAL TIME ON , 1998.
