<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
Commission File Number 0-9211
NATIONAL INCOME REALTY TRUST
------------------------------------------------------
(Exact name of registrant as specified in its charter)
California 94-2537061
- --------------------------------------------- ----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
280 Park Avenue, East Building, 20th Floor, New York, NY 10017
--------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(212) 949-5000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Shares of Beneficial Interest, No par value 3,635,409
------------------------------------------- ---------------------------------
(Class) (Outstanding at November 6, 1998)
1
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements for the period ended
September 30, 1998, have not been audited by independent certified public
accountants, but, in the opinion of management of National Income Realty Trust
(the "Trust"), all adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of consolidated financial position,
consolidated results of operations, and consolidated cash flows at the dates and
for the periods indicated have been included.
NATIONAL INCOME REALTY TRUST
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
------------- ------------
1998 1997
------------- ------------
<S> <C> <C>
Assets
Real estate held for sale (net of accumulated depreciation
of $20,106 in 1998 and $593 in 1997) .............................................. $ 65,836 $ 5,123
Less - allowance for estimated losses ............................................... (1,194) (1,194)
--------- ---------
64,642 3,929
Real estate held for investment (net of accumulated
depreciation of $31,043 in 1998 and $45,440 in 1997) .............................. 185,497 230,007
Investments in and advances to partnerships ......................................... 33,070 13,839
Cash and cash equivalents ........................................................... 1,195 4,262
Restricted cash ..................................................................... 6,922 4,300
Other assets, net ................................................................... 11,523 9,303
--------- ---------
$ 302,849 $ 265,640
========= =========
Liabilities and Shareholders' Equity
Liabilities
Notes and interest payable .......................................................... $ 218,736 $ 184,126
Other liabilities (including advances from affiliates of
$3,887 in 1998) ................................................................... 19,072 10,423
--------- ---------
237,808 194,549
Commitments and contingencies .......................................................
Shareholders' equity
Shares of beneficial interest, no par value; authorized shares, unlimited;
shares outstanding, 3,697,080 in 1998 and 3,812,404 in 1997 (after deducting
1,058,137 in 1998 and 896,962 in 1997 held in treasury) ........................... 11,100 11,446
Paid-in capital ..................................................................... 279,227 281,638
Accumulated distributions in excess of
accumulated earnings .............................................................. (225,208) (222,126)
Accumulated other comprehensive income (loss) ....................................... (78) 133
--------- ---------
65,041 71,091
--------- ---------
$ 302,849 $ 265,640
========= =========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
2
<PAGE> 3
NATIONAL INCOME REALTY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------- -------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue
Rentals ....................................... $ 14,740 $ 13,126 $ 42,525 $ 37,299
Interest ....................................... 277 88 714 245
Equity in income (loss) of
partnerships ................................. (558) 185 (184) 541
-------- -------- -------- --------
14,459 13,399 43,055 38,085
Expenses
Property operations ............................ 8,436 7,662 23,545 21,114
Interest ....................................... 4,275 3,378 11,901 9,119
Depreciation ................................... 1,591 1,677 5,362 4,770
Advisory fee to affiliate ...................... 212 332 948 1,009
General and administrative ..................... 561 544 1,684 1,561
-------- -------- -------- --------
15,075 13,593 43,440 37,573
-------- -------- -------- --------
Income (loss) before gain on sale of
real estate, gain on sale of
investments, and extraordinary items .......... (616) (194) (385) 512
Gain on sale of real estate ...................... -- 2,774 1,275 4,350
Gain on sale of investments ...................... 6 686 123 686
-------- -------- -------- --------
Income (loss) from continuing
operations .................................... (610) 3,266 1,013 5,548
Extraordinary items .............................. (589) 353 (919) 353
-------- -------- -------- --------
Net income (loss) ................................ $ (1,199) $ 3,619 $ 94 $ 5,901
======== ======== ======== ========
Other comprehensive income (loss):
Unrealized gains (losses) on
marketable equity securities ................ (27) 528 (88) 962
Realized gains on marketable
equity securities ........................... (6) (686) (123) (686)
-------- -------- -------- --------
Net income (loss) recognized in
other comprehensive income .................... (33) (158) (211) 276
-------- -------- -------- --------
Comprehensive income (loss) ...................... $ (1,232) $ 3,461 $ (117) $ 6,177
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
3
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NATIONAL INCOME REALTY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------------- ---------------------------
1998 1997 1998 1997
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Earnings per share
Income (loss) from continuing
operations ................................ $ (.16) $ .85 $ .26 $ 1.43
Extraordinary items ......................... (.16) .09 (.24) .09
---------- ---------- ---------- -----------
Net income (loss) ........................... $ (.32) $ .94 $ .02 $ 1.52
========== ========== ========== ===========
Weighted average shares of
beneficial interest used in
computing earnings per share .............. 3,766,807 3,854,552 3,808,619 3,874,844
========== ========== ========== ===========
Earnings per share - assuming dilution
Income (loss) from continuing
operations ................................ $ (.16) $ .84 $ .26 $ 1.42
Extraordinary items ......................... (.16) .09 (.24) .09
---------- ---------- ---------- -----------
Net income (loss) ........................... $ (.32) $ .93 $ .02 $ 1.51
========== ========== ========== ===========
Weighted average shares of beneficial
interest used in computing earnings
per share - assuming dilution ............. 3,766,807 3,892,054 3,871,328 3,906,071
========== ========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
4
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NATIONAL INCOME REALTY TRUST
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Shares of Distributions Accumulated
Beneficial Interest in Excess of Other
------------------------- Paid-in Accumulated Comprehensive Shareholders'
Shares Amount Capital Earnings Income (Loss) Equity
---------- -------- --------- -------- ------------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1997 ............................ 3,812,404 $ 11,446 $ 281,638 $(222,126) $ 133 $ 71,091
Repurchase of shares
of beneficial interest ......... (161,175) (484) (3,177) -- -- (3,661)
Cash distributions
($0.60 per share) .............. -- -- -- (2,314) -- (2,314)
Share distributions .............. 35,525 107 755 (862) -- --
Share options exercised .......... 10,326 31 11 -- -- 42
Net loss recognized in
other comprehensive
income ......................... -- -- -- -- (211) (211)
Net income ....................... -- -- -- 94 -- 94
---------- -------- --------- --------- ------ --------
Balance, September 30,
1998 ........................... 3,697,080 $ 11,100 $ 279,227 $(225,208) $ (78) $ 65,041
========== ======== ========= ========= ====== ========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
5
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NATIONAL INCOME REALTY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
---------------------
1998 1997
----- -----
<S> <C> <C>
Cash Flows from Operating Activities
Rentals collected .............................................. $ 42,202 $ 37,260
Interest collected ............................................. 151 251
Interest paid .................................................. (11,638) (8,235)
Payments for property operations ............................... (23,635) (22,906)
General and administrative expenses paid ....................... (1,973) (1,544)
Advisory fee paid to affiliate ................................. (954) (1,083)
Organizational costs paid ...................................... (237) --
Deferred financing costs paid .................................. (1,955) (2,009)
-------- --------
Net cash provided by operating activities ................... 1,961 1,734
Cash Flows from Investing Activities
Acquisition of real estate ..................................... (4,145) (14,506)
Real estate improvements ....................................... (11,312) (19,461)
Proceeds from sale of real estate .............................. 968 6,378
Earnest money deposits paid .................................... (1,001) (237)
Note receivable collections .................................... 203 176
Investments in marketable equity securities .................... (81) (2,446)
Proceeds from the sale of marketable equity securities ......... 580 2,231
Net contributions and advances to partnerships ................. (22,651) (3,985)
-------- --------
Net cash (used in) investing activities ..................... (37,439) (31,850)
Cash Flows from Financing Activities
Proceeds from borrowings ....................................... 50,176 51,208
Payments of mortgage notes payable ............................. (21,806) (18,213)
Margin account borrowings, net ................................. 2,419 1,049
Advances from affiliates, net .................................. 3,937 --
Replacement escrow receipts (deposits), net .................... 168 (1,172)
Distribution from partnership's financing activities ........... 3,803 --
Repurchase of shares of beneficial interest .................... (3,661) (748)
Share options exercised ........................................ 42 --
Distributions to shareholders .................................. (2,667) (1,401)
-------- --------
Net cash provided by financing activities ................... 32,411 30,723
-------- --------
Net increase (decrease) in cash and cash equivalents ............. (3,067) 607
Cash and cash equivalents, beginning of period ................... 4,262 3,862
-------- --------
Cash and cash equivalents, end of period ......................... $ 1,195 $ 4,469
======== ========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
6
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NATIONAL INCOME REALTY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Reconciliation of net income to net cash
provided by operating activities:
Net income .............................................................. $ 94 $ 5,901
Extraordinary items ..................................................... 919 (353)
Gain on sale of investments ............................................. (123) (686)
Gain on sale of real estate ............................................. (1,275) (4,350)
Depreciation and amortization ........................................... 6,163 5,389
Equity in (income) loss of partnerships ................................. 184 (541)
Interest on advances to partnerships .................................... (566) --
Changes in other assets and liabilities, net of effects of
noncash investing and financing activities:
Decrease in interest receivable ...................................... 3 5
(Increase) in other assets ........................................... (5,214) (4,890)
Increase in other liabilities ........................................ 2,138 853
Increase (decrease) in interest payable .............................. (362) 406
-------- --------
Net cash provided by operating activities ................................. $ 1,961 $ 1,734
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Changes in assets and liabilities in connection with the
purchase of real estate:
Real estate ............................................................. $ 10,971 $ 30,553
Other assets ............................................................ 764 431
Notes and interest payable .............................................. (7,062) (15,756)
Other liabilities ....................................................... (528) (722)
-------- --------
Cash paid ............................................................ $ 4,145 $ 14,506
======== ========
Assets disposed of and liabilities released in connection
with the sale of real estate:
Real estate ............................................................. $ 676 $ 9,572
Other assets ............................................................ 67 29
Notes and interest payable .............................................. (1,046) (7,493)
Other liabilities ....................................................... (4) (134)
Gain on sale ............................................................ 1,275 4,404
-------- --------
Cash received ........................................................ $ 968 $ 6,378
======== ========
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
7
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NATIONAL INCOME REALTY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
---------------------
1998 1997
---- ----
<S> <C> <C>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
(Continued):
Real estate written off pursuant to condemnation..................... $ - $ 2,209
Note and accrued interest receivable written off..................... $ - $ 977
Note payable written off pursuant to the condemnation of
the collateral property............................................ $ - $ 1,725
Allowances for estimated losses charged off in connection
with the write-off of real estate and note receivable.............. $ - $ 1,462
</TABLE>
The accompanying notes are an integral part of these
Consolidated Financial Statements.
8
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NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Operating results for the nine month period ended September 30,
1998, are not necessarily indicative of the results that may be expected for the
year ending December 31, 1998. For further information, refer to the
Consolidated Financial Statements and Notes thereto included in the Trust's
Annual Report on Form 10-K for the year ended December 31, 1997. Dollar amounts
in tables are in thousands. Certain 1997 balances have been reclassified to
conform to the 1998 presentation.
On January 1, 1998, the Trust adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires the reporting of comprehensive income in addition to net income from
operations. Comprehensive income is a more inclusive financial reporting
methodology that includes disclosure of certain financial information that
historically has not been recognized in the calculation of net income.
Accumulated other comprehensive income (loss) presented in the accompanying
September 30, 1998, Consolidated Balance Sheet and Consolidated Statement of
Shareholders' Equity for the nine months ended September 30, 1998, represents
unrealized holding losses on marketable equity securities.
NOTE 2. REAL ESTATE
In April 1998, the Trust sold Mountain View Shopping Center in Las Vegas,
Nevada, for $2 million, receiving net cash proceeds of $968,000 (after the
payoff of the $1 million mortgage and closing costs) and recognizing a gain on
the sale of $1.3 million.
Also in April 1998, the Trust purchased a 43-acre tract of land adjacent to The
Vistas at Lake Worth in Fort Worth, Texas, for $714,000. The Trust intends to
construct an apartment community to be known as The Observatory on this land.
The Trust paid Tarragon Realty Advisors, Inc. ("Tarragon"), the Trust's advisor
since April 1, 1994, an acquisition fee of $7,000 in connection with this
transaction.
In May 1998, the Trust purchased a 33-acre tract of land in Frisco, Texas, for
$4.9 million, $3 million of which was financed with a mortgage that matures in
March 1999. The Trust plans to build a luxury apartment community to be known as
The Vintage at Legacy Lakes on this land. The Trust paid Tarragon a $45,000
acquisition fee and a $30,000 financing fee in connection with this transaction.
In June 1998, the Trust acquired three properties with a total of 446 apartments
for an aggregate purchase price of $5.4 million, $4.1 million of which was
financed through the assumption of existing government-subsidized, low interest
mortgages. The properties include Desert Winds and Silver Creek each with 152
units located in Jacksonville, Florida, and Palm Grove with 142 units located in
Orlando, Florida. In connection with these acquisitions, the Trust paid Tarragon
acquisition fees totaling $18,753.
In the second quarter of 1998, the Trust identified 12 multifamily properties
with an aggregate 3,406 units and aggregate net carrying value of $56.8 million
that it would pursue marketing for a possible bulk sale and,
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NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
NOTE 2. REAL ESTATE (Continued)
accordingly, reclassified these properties to real estate held for sale. The
Trust ceased depreciating these properties in April 1998. In September 1998, the
Trust removed from consideration for sale two of the properties identified in
April 1998 with an aggregate 320 units and aggregate net carrying value of $5.7
million, and reclassified them to held for investment; depreciation will resume
in October 1998. Also in September 1998, the Trust identified four other
properties that it would pursue marketing for sale, three commercial properties
with total square footage of 216,797 and aggregate net carrying value of $7.6
million and one multifamily property with 136 units and a net carrying value of
$1.6 million. These three properties are classified as held for sale at
September 30, 1998, and depreciation will cease as of October 1, 1998. As the
estimated fair values of these properties exceeded their carrying values at the
time of determination to reclassify, no losses were recognized upon their
reclassification.
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS
Investments in and advances to partnerships, accounted for using the equity
method, consisted of the following at September 30, 1998:
<TABLE>
<S> <C>
Sacramento Nine ....................................... $ 460
Ansonia Apartments, L.P. ("Ansonia") .................. 13,185
Danforth National Apartments, Ltd. ("Danforth") ....... 3,487
801 Pennsylvania Avenue ............................... --
National Omni Associates, L.P. ("Omni") ............... 4,813
Orange National Partners, Ltd. ("Orange") ............. 4,175
RI Windsor, Ltd. ("Windsor") .......................... 2,835
RI Panama City, Ltd. ("Panama City") .................. 1,411
Tarragon Savannah, L.P. ("Savannah") .................. 2,704
-------
$33,070
=======
</TABLE>
In December 1997, the Trust contributed $721,000 to Omni in exchange for a 55%
non-controlling general partner interest in this partnership. In 1998, the Trust
contributed an additional $4.4 million to Omni, which purchased 5600 Collins
Avenue, a 289-unit, high rise apartment building in Miami Beach, Florida, for
$32 million in February 1998. $26 million of the purchase price was financed
through first and second lien mortgages. In connection with this transaction,
Omni paid Tarragon a $150,000 acquisition fee. In accordance with the
partnership agreement, the Trust is to receive a preferred return of 10%
compounded monthly on its contributions. Through December 31, 2001, the Trust
will receive 78% of the partnership's cash distributions from operating net cash
flow, as defined in the partnership agreement, until the preferred return has
been paid and the Trust's contributions have been repaid. The Trust will receive
55% of subsequent cash distributions from the partnership. Any of the preferred
return not paid as of December 31, 2001, is to be paid out of disposition net
cash flow, as defined in the partnership agreement.
In April 1998, the Trust made a capital contribution of $200,000 and received a
1% general partner interest and a 49% limited partner interest in Orange, a
limited partnership formed to construct a 328-unit luxury apartment complex to
be known as The Vineyards at Eagle Harbour in Orange Park, Florida, at an
estimated cost of $20 million. The property is expected to be completed in the
third quarter of 1999. The partnership has obtained a
10
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NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)
$15.8 million loan to finance construction. The Trust also advanced the
partnership $4 million which is to be repaid following completion and lease-up
of the property. Until lease-up of the property, the construction loan is
guaranteed by the other general partner. As the Trust holds a non-controlling
interest in the partnership, it accounts for its investment in the partnership
using the equity method.
During the first nine months of 1998, Ansonia, in which the Trust holds a 70%
non-controlling general partner interest, purchased eight apartment properties
comprising 1,768 units in Connecticut in six separate transactions for an
aggregate purchase price of $60.9 million, $50.9 million of which was financed
with mortgages. The remainder of the purchase price was paid with funds the
Trust contributed to Ansonia. Ansonia paid Tarragon financing and acquisition
fees totaling $54,450 in connection with these transactions.
In June 1998, new first mortgage financing in the amount of $4.2 million secured
by 801 Pennsylvania Avenue was obtained. The Trust received $3.8 million of the
financing proceeds, $2.9 million of which represented the Trust's original
investment, $606,000 of which represented accrued interest, and $267,000 of
which represented the Trust's 50% participation in excess proceeds.
Set forth below are summarized financial data for the partnerships accounted for
using the equity method as of and for the nine months ended September 30, 1998
(unaudited):
<TABLE>
<CAPTION>
Other In
Ansonia Omni Operating Lease-Up Total
------- ---- --------- -------- -----
<S> <C> <C> <C> <C> <C>
Real estate held for investment .................. $ 67,360 $ 32,337 $ 10,142 $ 61,801 $ 171,640
Accumulated depreciation ......................... (302) (433) (3,112) (492) (4,339)
Other assets ..................................... 1,799 1,464 472 1,317 5,052
Notes and interest payable ....................... (54,015) (26,050) (7,994) (47,472) (135,531)
Other liabilities ................................ (1,657) (1,113) (146) (16,006) (18,922)
-------- -------- -------- -------- ---------
Partners' capital ................................ $ 13,185 $ 6,205 $ (638) $ (852) $ 17,900
======== ======== ======== ======== =========
The Trust's proportionate share of capital ....... $ 13,185 $ 4,813 $ 460 $ (628) $ 17,830
Advances ......................................... -- -- -- 15,240 15,240
-------- -------- -------- -------- ---------
Investments in and advances to
partnerships .................................... $ 13,185 $ 4,813 $ 460 $ 14,612 $ 33,070
======== ======== ======== ======== =========
Rental revenue ................................... $ 2,724 $ 2,876 $ 1,693 $ 1,624 $ 8,917
Property operating expenses ...................... (1,320) (1,426) (527) (1,179) (4,452)
Interest expense ................................. (944) (1,424) (365) (1,919) (4,652)
Depreciation expense ............................. (296) (432) (259) (453) (1,440)
-------- -------- -------- -------- ---------
Net income (loss) ................................ $ 164 $ (406) $ 542 $ (1,927) $ (1,627)
======== ======== ======== ======== =========
Equity in income (loss) of
partnerships .................................. $ 164 $ (316) $ 1,286 $ (1,318) $ (184)
======== ======== ======== ======== =========
</TABLE>
11
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NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)
"Other Operating" partnerships include two fully operational partnerships, and
"In Lease-up" partnerships include four partnerships with recently constructed
properties presently in the lease up stage. Orange's property is under
construction and has had no operations to date. The Trust's equity in income of
"Other Operating" partnerships includes $873,000 received from the refinancing
of 801 Pennsylvania Avenue, as described above, representing accrued interest on
the Trust's original investment and additional advances plus a 50% participation
in the excess financing proceeds.
NOTE 4. INVESTMENTS IN MARKETABLE EQUITY SECURITIES
In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," investments in marketable equity securities are carried
at fair value. Investments in marketable equity securities with a cost basis of
$178,000 and a fair value of $100,000 are included in "Other assets" in the
accompanying September 30, 1998 Consolidated Balance Sheet. These investments
are considered available for sale, and unrealized holding gains and losses are
included in other comprehensive income (loss). During the first nine months of
1998, unrealized losses of $88,000 were incurred, and investments with a cost
basis of $457,000 (determined by the average cost method) were sold for
$580,000, resulting in realized gains of $123,000.
NOTE 5. NOTES AND INTEREST PAYABLE
In June 1996, the Trust purchased the $3.1 million Fannie Mae mortgage backed
security ("Fannie Mae MBS") issued by the lender in connection with the
financing of Forest Oaks Apartments at a 1/2% discount and simultaneously
entered into a reverse repurchase agreement with an investment bank. The
investment bank purchased the Fannie Mae MBS from the Trust for 92% of its
value, and the Trust agreed to repurchase the MBS from the investment bank one
month later at the same price plus interest at the London Interbank Offered Rate
("LIBOR") plus 1/2% per annum. In July 1996, the Trust purchased the $16.7
million Government National Mortgage Association mortgage backed security ("GNMA
MBS") issued by the lender in connection with the financing of Heather Hills
Apartments at a 2.7% discount and added this MBS to the reverse repurchase
transaction with the investment bank. As provided for in the agreement, the
Trust and the investment bank extended the repurchase date monthly, and the
repurchase price fluctuated with changes in the values of the MBSs. In January
1997, the Trust entered into a similar repurchase transaction with a government
sponsored enterprise which purchased the MBSs for 97% of their aggregate value,
and the Trust agreed to repurchase them one month later at the same price plus
interest at 5.4% per annum. The Trust and the government sponsored enterprise
extended the repurchase date monthly, establishing a new repurchase price each
month. In November 1997, the Trust purchased the $2.7 million Fannie Mae MBS
issued by the lender in connection with the financing of Cross Creek Apartments
at face value and added this MBS to the reverse repurchase transaction. In July
1998, the Trust renewed the reverse repurchase agreement with the investment
bank. Currently, the repurchase date is December 1998, the repurchase price
is $22.2 million, and the interest rate is 5.4%. The reverse repurchase
transaction has resulted in effective interest rates as of September 30, 1998,
on the Forest Oaks, Heather Hills, and Cross Creek financings of 6.14%, 6.81%,
and 6.96%, respectively.
The Trust is exposed to a demand for additional collateral or, in the
alternative, credit loss in the event the interest rate associated with the
repurchase transaction fluctuates in a manner that is unfavorable to the Trust's
12
<PAGE> 13
NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
NOTE 5. NOTES AND INTEREST PAYABLE (Continued)
interest in the MBSs. However, the Trust intends to either pay off the mortgages
or modify the mortgages to increase the interest rates prior to any significant
credit loss.
In May 1997, the Trust accepted a commitment from GMAC Commercial Mortgage
Corporation ("GMAC") for a $50 million revolving credit facility. Advances under
the facility are available to finance properties currently owned by the Trust as
well as new acquisitions. The outstanding balance is limited to the lesser of
75% of the value of the collateral properties or an amount supported by a debt
service coverage ratio of 1.25. The borrowing base may be increased by adding
new or existing properties to the collateral pool. Advances are limited to the
lesser of 75% of the appraised value of the property as stabilized or 80% of
total acquisition costs which include the purchase price of a newly acquired
property and the cost of improvements incurred between the date of acquisition
and the date that any mortgage secured by that property is recorded. A newly
acquired property is defined as a property owned by the Trust for less than one
year. The outstanding balance under the facility bears interest at the 30 day
LIBOR plus a variable spread of between 2% and 2.5% which is determined based on
the loan-to-value and debt service coverage maintained. Payment terms include
interest only monthly with the outstanding balance due at maturity, which is 36
months from the date of the first advance. The Trust may extend the maturity by
two six-month terms, but no new fundings may occur under the facility during any
extension period. The Trust has obtained fundings under this revolving credit
facility totaling $47.5 million, $42 million of which were obtained in 1997,
secured by first mortgages against nine Trust properties. The Trust received net
cash proceeds of $31.7 million ($26.3 million in 1997) from these fundings after
the payoff of existing mortgages of $13.5 million, establishing escrows for
taxes, insurance, and repairs, and paying the associated closing costs. In
connection with these fundings, the Trust paid Tarragon financing fees totaling
$475,425 ($420,000 in 1997).
In June 1998, the Trust obtained a $35 million revolving credit facility from
GMAC with substantially the same terms as the $50 million revolving credit
facility obtained in 1997. The outstanding balance under the facility bears
interest at the 30-day LIBOR plus 2%. Payment terms include interest only
monthly with the outstanding balance due at maturity, which is June 2001.
Similar to the $50 million facility, the maturity of the $35 million facility
may be extended by two six-month terms, but no new fundings may occur under the
facility during any extension period. In June 1998, the Trust obtained fundings
under this revolving credit facility of $9.5 million secured by first mortgages
on two properties. The Trust received net cash proceeds of $4 million from these
fundings after the payoff of existing mortgages totaling $5.1 million,
establishing escrows for taxes, insurance, and repairs, and paying the
associated closing costs. In connection with these fundings, the Trust paid
Tarragon financing fees totaling $95,000.
In April 1998, the Trust obtained interim financing secured by The Vistas at
Lake Worth of $9.5 million. After closing costs and establishing required
escrows, the Trust received net cash proceeds of $9.1 million. The Trust paid
Tarragon a financing fee of $95,000 in connection with this transaction.
During the first nine months of 1998, the Trust obtained permanent financing
from a government sponsored enterprise at fixed rates between 6.71% and 6.96%
secured by five properties totaling $24.6 million. After the payoff of $15.1
million in existing debt, establishing escrows for taxes, insurance, and
repairs, and closing costs, the Trust received net cash proceeds of $7.4
million. In connection with these financings, the Trust paid Tarragon financing
fees totaling $245,920.
13
<PAGE> 14
NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
NOTE 5. NOTES AND INTEREST PAYABLE (Continued)
During the first nine months of 1998, the Trust recognized $919,000 of
extraordinary expenses resulting from prepayment penalties and the write-off of
deferred financing expenses associated with certain 1998 refinancings.
NOTE 6. ADVANCES FROM AFFILIATES
Other liabilities at September 30, 1998, included $3.9 million advanced by
affiliates of Tarragon during the first nine months of 1998 pursuant to a
two-year $5 million line of credit. Advances under the line of credit bear
interest at LIBOR plus 1% per annum and were made in part to facilitate
acquisitions by the Trust and partnerships in which it holds interests.
NOTE 7. EARNINGS PER SHARE
Earnings per share have been computed based on the weighted average number of
shares of beneficial interest outstanding for the three and nine month periods
ended September 30, 1998 and 1997. 1997 share and per share data have been
restated to give effect to the 10% share distribution paid to shareholders in
September 1997.
Following is a reconciliation of the weighted average shares of beneficial
interest outstanding used in the computation of earnings per share and earnings
per share - assuming dilution. The effect of share options on weighted average
shares of beneficial interest outstanding - assuming dilution for the three
months ended September 30, 1998, is not reflected below because their effect is
anti-dilutive.
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------ ------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average shares of
beneficial interest outstanding ........... 3,766,807 3,854,552 3,808,619 3,874,844
Share options ............................... -- 37,502 62,709 31,227
--------- --------- --------- ---------
Weighted average shares of
beneficial interest outstanding -
assuming dilution ......................... 3,766,807 3,892,054 3,871,328 3,906,071
========= ========= ========= =========
</TABLE>
NOTE 8. INCOME TAXES
No provision has been made for federal income taxes because the Trust's
management believes the Trust has qualified as a Real Estate Investment Trust,
as defined under Sections 856 through 860 of the Internal Revenue Code of 1986
and expects that it will continue to do so.
14
<PAGE> 15
NATIONAL INCOME REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
NOTE 9. COMMITMENTS AND CONTINGENCIES
The Trust is a party to various claims and routine litigation arising in the
ordinary course of business. Management of the Trust does not believe that the
results of these claims and litigation, individually or in the aggregate, will
have a material adverse effect on its business, financial position, or results
of operations.
NOTE 10. SUBSEQUENT EVENTS
In October 1998, the Trust obtained mortgages totaling $10.8 million secured
separately by four properties. The Trust received net proceeds of $4.7 million
after the payoff of existing debt totaling $5.4 million, funding required
escrows, and closing costs. The Trust paid Tarragon financing fees totaling
$107,500 in connection with these transactions.
Also in October 1998, the Trust purchased a 62,500 square foot office building
in Houston, Texas, for $3.5 million, $2 million of which was financed with a
mortgage. The Trust paid Tarragon an acquisition fee of $34,500 in connection
with this transaction.
On October 20, 1998, at a Special Meeting of Shareholders of the Trust, the
shareholders approved by a vote of 94% of the shares voted a proposal to
incorporate the Trust as a California corporation and merge that corporation
into Tarragon Realty Investors, Inc. ("TRI"), with the shares of beneficial
interest of the Trust to be converted into 1.97 shares of Common Stock of TRI.
It is anticipated that the transaction will be consummated in November 1998.
[This space intentionally left blank.]
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the accompanying Notes thereto included
elsewhere in this report.
Introduction
National Income Realty Trust (the "Trust") invests in income-producing real
estate through acquisitions, leases, and partnerships. The Trust was organized
on October 31, 1978, and commenced operations on March 27, 1979. At September
30, 1998, the Trust's real estate portfolio included 65 properties, 21 of which
were held for sale, located throughout the United States, with concentrations in
the Southeast and Southwest. These properties consisted of 43 apartment
complexes, 13 shopping centers, three office buildings, five parcels of land,
and one single-family residence. All of the Trust's real estate, except for ten
properties, is encumbered by mortgages. The Trust's current policy is to fund
mortgage loans only in connection with, and to facilitate, the sale of real
estate. Accordingly, as existing mortgages receivable have been paid off, the
Trust's portfolio of mortgage notes receivable has declined and is expected to
continue to decline.
The Trust also owns through partnerships three office buildings and 16 apartment
communities, three of which are under construction. All of these properties are
encumbered by mortgages.
The Trust's objective is to maximize the long term value of its real estate
portfolio with an emphasis on increasing operating income and future cash
distributions to shareholders. Management focuses on both the appreciation of
the existing real estate portfolio, through intensive management and capital
improvements, and enlarging the portfolio with highly selective and
opportunistic acquisitions concentrated on older, undermanaged, and
underperforming multifamily projects in geographical regions where the Trust
presently owns properties. The Trust also intends to invest increasing amounts
in new construction of apartment communities either directly or through
partnerships. In the first nine months of 1998, the Trust completed construction
of three apartment communities, two of which are owned through partnerships. The
Trust currently has five apartments communities under construction, three of
which are owned through partnerships. To the extent it invests in construction
projects, the Trust is subject to business risks, such as cost overruns and
delays, associated with such higher risk activities. In addition to raising
capital through operating income, the Trust intends to generate capital through
mortgage refinancings and selective disposition of certain assets.
Liquidity and Capital Resources
Cash and cash equivalents aggregated $1.2 million at September 30, 1998,
compared to $4.3 million at December 31, 1997. The Trust's principal sources of
cash have been property operations and external sources, such as property sales
and refinancings. Sources of cash projected through the end of 1998 include net
financing proceeds upon the refinancing of seven properties of $5 million and
proceeds from the sale of three properties totaling $5.8 million. During the
first quarter of 1999, the Trust expects to receive $8 million from the
refinancing of The Mayfaire at Windsor Parke, Harbour Green, and The Club at
Danforth, three properties owned through partnership, and $13 million in net
proceeds from the refinancing of five other properties. The Trust expects these
sources will continue to be sufficient to meet projected cash requirements,
including debt service obligations, property maintenance and improvements, and
continuation of regular cash distributions. For the remainder of 1998, the Trust
expects to invest $2.5 million in capital improvements to its properties
(excluding construction properties), make principal payments (excluding mortgage
payoffs in connection with refinancings) of $400,000, and pay cash distributions
to shareholders totaling $750,000. Additionally, the
16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Trust contemplates funding $2.5 million of costs for the Vintage at Legacy Lakes
(the "Vintage"), an apartment community to be developed in Frisco, Texas. The
Trust has a firm commitment for a $23 million construction loan for the Vintage.
Also, the Trust anticipates purchasing one commercial property in late 1998 for
$9.3 million, the cash portion of which should be $800,000. Although the Trust
expects sources of cash to be more than sufficient to fund planned uses of cash,
there can be no assurance that the expected sales and refinancings of properties
will be consummated when anticipated. If the timing of these transactions is
later than the Trust has projected, certain of the planned uses of cash,
including initial construction costs for the Vintage, will be postponed until
sufficient cash is accumulated.
The Trust purchased five properties during the nine months ended September 30,
1998, for $11 million, $7.1 million of which was financed through first
mortgages. The Trust paid cash totaling $4.1 million at closing of these
purchases.
The Trust sold one shopping center during the nine months ended September 30,
1998, recognizing a gain of $1.3 million and receiving net cash proceeds of
$968,000.
The Trust invested $11.3 million in capital improvements to its properties
during the first nine months of 1998, including $2.9 million on the construction
of The Vistas at Lake Worth, which was completed in the first quarter of 1998.
During the nine months ended September 30, 1998, the Trust contributed $4.4
million to National Omni Associates, L.P., which purchased 5600 Collins Avenue,
a 289-unit, high rise apartment building in Miami Beach, Florida, in February
1998.
During this same period, the Trust contributed or advanced $6.7 million to
Orange National Partners, Ltd., Tarragon Savannah, Ltd., and Danforth National
Apartments, Ltd., each of which is constructing a luxury apartment community
with a construction loan expected to fund remaining construction costs.
Also during this period, the Trust contributed $12 million to Ansonia
Apartments, L.P., which purchased eight Connecticut properties with a total of
over 1,500 apartment units in six separate transactions between April and
August 1998.
During the nine months ended September 30, 1998, the Trust received proceeds
from the sale of marketable equity securities of $580,000 and realized gains on
these sales totaling $123,000.
During the first nine months of 1998, the Trust obtained first mortgage
financing totaling $49.3 million and received net cash proceeds of $26.3 million
after the payoff of existing debt of $20.1 million, funding escrows, and paying
associated closing costs. The Trust made other principal payments totaling $1.7
million during the nine months ended September 30, 1998. Principal payments of
$2.4 million, including balloon payments of $1.9 million, are due during the
remainder of 1998. The Trust intends to either pay off the maturing mortgages or
extend the due dates while seeking to obtain long term refinancing. While
management is confident of its ability to acquire financing as needed, there is
no assurance that the Trust will continue to be successful in its efforts in
this regard.
17
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
The Company received advances from affiliates of Tarragon Realty Advisors, Inc.,
("Tarragon") totaling $3.9 million during the first nine months of 1998 pursuant
to a two-year $5 million line of credit. Advances under the line of credit bear
interest at the London Interbank Offered Rate plus 1% per annum and were made on
a short-term basis in part to facilitate acquisitions by the Trust and
partnerships in which it holds interests.
The Trust received $3.8 million from the refinancing of 801 Pennsylvania Avenue
in June 1998.
During the nine months ended September 30, 1998, the Trust repurchased 161,175
of its shares of beneficial interest at a total cost of $3.7 million. During
1996, the Trust's Board of Trustees (the "Board") authorized the Trust to
repurchase up to an additional 313,092 shares of beneficial interest, all of
which had been purchased as of September 30, 1998. In September 1998, the Board
authorized the Trust to repurchase up to an additional 100,000 shares of
beneficial interest, of which 64,446 had been purchased as of September 30,
1998.
Cash distributions to shareholders totaling $2.7 million, or $0.60 per share,
were paid during the nine month period ended September 30, 1998. The Trust has
paid regular quarterly cash distributions since September 1993.
Results of Operations
The Trust reported a net loss of $1.2 million and net income of $94,000,
respectively, for the three and nine month periods ended September 30, 1998,
compared to net income of $3.6 million and $5.9 million, respectively, for the
three and nine month periods ended September 30, 1997. The major components of
the change in results of operations are discussed in the following paragraphs.
Net rental income (rental revenue less property operating expenses) increased
from $5.5 million and $16.2 million for the three and nine month periods ended
September 30, 1997, to $6.3 million and $19 million for the corresponding
periods in 1998.
Multifamily Properties
The Trust's multifamily portfolio, which represented 81% of the Trust's
real estate and included 8,433 operating apartment units at September 30,
1998, reported increases in net rental income of $826,000, or 20%, and $2.7
million, or 18%, respectively, for the three and nine month periods ended
September 30, 1998, compared to the corresponding periods in 1997. Of these
increases, $110,000 and $1.3 million are related to properties acquired in
1997 and 1998. Decreases of $54,000 and $544,000 resulted from the sale of
three multifamily properties during 1997. The remainder of the increase
comes from higher rents and decreased vacancy losses for multifamily
properties held in both years. Overall, both physical and economic
occupancy levels have increased for multifamily properties held in both
years.
Commercial Properties
The Trust's commercial portfolio included 1.6 million square feet at
September 30, 1998. The sale of Mountain View Shopping Center in April 1998
resulted in decreases in net rental income of $53,000 and
18
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Commercial Properties (Continued)
$79,000, respectively, for the three and nine month periods ended September
30, 1998, compared to the corresponding periods in 1997. The addition of
Mariner Plaza Shopping Center to the Trust's commercial portfolio in August
1997 contributed additional net rental income of $18,000 and $126,000 for
these periods. Overall, commercial properties held in both years reported
an increase in net rental income of $195,000 for the nine months ended
September 30, 1998, compared to the corresponding period in 1997,
principally due to increased rental rates, while net rental income for the
three months ended September 30, 1998, was relatively stable compared to
the corresponding period in 1997. Overall, physical occupancy levels for
commercial properties held in both years were slightly lower than reported
in 1997.
Equity in income (loss) of partnerships decreased $743,000 and $725,000,
respectively, for the three and nine month periods ended September 30, 1998,
compared to the corresponding periods in 1997. Decreases of $664,000 and $1.3
million resulted from the commencement of operations of four partnership
properties with an aggregate 1,062 units which are presently in the lease up
stage and which are either still under construction or only recently completed.
As of November 1, 1998, occupancy at these four properties is as follows:
<TABLE>
<CAPTION>
Partnership Name Property Name Location Number of Units Occupancy
---------------- ------------- -------- --------------- ---------
<S> <C> <C> <C> <C>
RI Windsor, Ltd. Mayfaire at Windsor Parke Jacksonville, FL 324 68%
RI Panama City, Ltd. Harbour Green Panama City, FL 200 65%
Danforth National Apartments, Ltd. The Club at Danforth Jacksonville, FL 288 51%
Tarragon Savannah, L.P. The Links at Georgetown Savannah, GA 250 38%
</TABLE>
Decreases of $149,000 and $316,000 resulted from the operations of 5600 Collins
Avenue, the sole property of National Omni Associates. The decreases for the
nine months ended September 30, 1998, are partially offset by an increase of
$873,000 resulting from the refinancing of 801 Pennsylvania Avenue. $606,000 of
this amount represented accrued interest on the Trust's original investment and
additional advances, and $267,000 represented the Trust's 50% participation in
the excess financing proceeds.
Interest revenue increased for the three and nine month periods ended September
30, 1998, compared to the corresponding periods in 1997, primarily due to
interest on advances to certain partnerships in which the Trust holds
investments accounted for using the equity method.
Interest expense increased from $3.4 million and $9.1 million, respectively,
for the three and nine month periods ended September 30, 1997, to $4.3 million
and $11.9 million, respectively, for the corresponding periods in 1998.
Increases of $416,000 and $1.5 million resulted from the 1997 and 1998
acquisitions. In addition, long term and interim mortgage financing, including
advances under line of credit facilities, obtained in 1997 and 1998 on
properties held in both years increased mortgage loans by $54.3 million. Due
to lower rates on most new loans and advances, the related interest expense
increased by only $317,000 and $2.3 million for these periods. Decreases of
$124,000 and $479,000 resulted from the sale of four properties in 1997 and
1998.
19
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Advisory fees to Tarragon decreased $120,000 and $61,000, respectively, for the
three and nine month periods ended September 30, 1998, compared to the three and
nine month periods ended September 30, 1997. The advisory fee is an incentive
fee equal to 16% per annum of adjusted funds from operations, as defined in the
advisory agreement approved by the Board and shareholders. See "Funds from
Operations" below.
During the first nine months of 1998, the Trust recognized gains totaling
$123,000 relating to sales of investments in marketable equity securities and a
gain on the sale of Mountain View Shopping Center of $1.3 million.
Also, during the first nine months of 1998, the Trust recognized $919,000 in
extraordinary expenses resulting from prepayment penalties and the write-off of
deferred financing expenses associated with certain 1998 refinancings.
During the first nine months of 1997, the Trust recognized gains totaling $4.4
million on the sale of Plaza Hills Apartments, Huntington Green Apartments, and
Pheasant Pointe Apartments and a $54,000 loss related to the sale of a warehouse
owned by Indcon, L.P., in which the Trust held a 40% interest until November
1997.
In August 1997, the Trust recognized an extraordinary gain on debt forgiveness
of $436,000 in connection with the discounted payoff of the mortgage loan
secured by Southgate Shopping Center and $83,000 of extraordinary expenses
resulting from prepayment penalties and the write-off of deferred financing
expenses associated with certain 1997 refinancings.
During the third quarter of 1997, the Trust recognized gains totaling $686,000
related to sales of investments in marketable equity securities.
Funds from Operations
The following information should be read in conjunction with all of the
financial statements and notes thereto included elsewhere in this report and
with the discussion set forth above in "Liquidity and Capital Resources" and
"Results of Operations."
Funds from operations ("FFO") for the three and nine month periods ended
September 30, 1998 and 1997, are as follows (unaudited) (dollars in thousands):
20
<PAGE> 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Funds from Operations (Continued)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------ ------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income (loss) ........................... $(1,199) $ 3,619 $ 94 $ 5,901
Extraordinary items ......................... 589 (353) 919 (353)
Gain on sale of real estate ................. -- (2,774) (1,275) (4,350)
Depreciation and amortization of
real estate assets ........................ 1,635 1,724 5,506 4,902
Depreciation and amortization of
real estate assets of partnerships ........ 660 79 1,093 270
Distributions from partnerships in
excess of the Trust's investments
in the partnerships ....................... (71) (2) (338) (41)
------- ------- ------- -------
Funds from operations ....................... $ 1,614 $ 2,293 $ 5,999 $ 6,329
======= ======= ======= =======
</TABLE>
The Trust generally considers FFO to be an appropriate measure of the
performance of an equity real estate investment trust ("REIT"). FFO, as defined
by the National Association of Real Estate Investment Trusts ("NAREIT"), equals
net income (loss), computed in accordance with generally accepted accounting
principles ("GAAP"), excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation and amortization of real estate assets, and
after adjustments for unconsolidated partnerships and joint ventures.
Adjustments for unconsolidated partnerships and joint ventures are calculated to
reflect FFO on the same basis. The amortization of deferred financing costs is
not added back to net income (loss) in the Trust's calculation. This treatment
is consistent with the Trust's historical calculation of FFO. The Trust believes
that FFO is useful to investors as a measure of the performance of an equity
REIT because, along with cash flows from operating activities, investing
activities, and financing activities, it provides investors an understanding of
the ability of the Trust to incur and service debt and to make capital
expenditures. The Trust believes that in order to facilitate a clear
understanding of its operating results, FFO should be examined in conjunction
with net income (loss) as presented in the financial statements included
elsewhere in this report. FFO does not represent cash generated from operating
activities in accordance with GAAP and therefore should not be considered an
alternative to net income as an indication of the Trust's operating performance
or to cash flow as a measure of liquidity and is not necessarily indicative of
cash available to fund cash needs and cash distributions. The Trust's
calculation of FFO may differ from the methodology for calculating FFO utilized
by other REITs and, accordingly, may not be comparable to such other REITs.
Included in FFO for the three and nine month periods ended September 30, 1998,
are gains totaling $6,000 and $123,000, respectively, resulting from the Trust's
sale of investments in marketable equity securities. Included in FFO for the
three and nine month periods ended September 30, 1997, are gains of $686,000
resulting from the sale of investments in marketable equity securities.
Allowances for Estimated Losses and Provisions for Losses
The Trust's management periodically evaluates the carrying values of the Trust's
properties held for sale. Generally accepted accounting principles require that
the carrying value of a property held for sale cannot
21
<PAGE> 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Allowances for Estimated Losses and Provisions for Losses (Continued)
exceed the lower of its cost or its estimated fair value less estimated costs to
sell. In those instances in which estimates of fair value less estimated selling
costs are less than the carrying values thereof at the time of evaluation, an
allowance for loss is provided by a charge against operations. The evaluation
generally includes selective site inspections, a review of the property's
current rents compared to market rents, a review of the property's expenses, a
review of maintenance requirements, discussions with the property manager, and a
review of the surrounding area. Future evaluations could cause the Trust's
management to adjust current estimates of fair value.
The Trust's management also evaluates the Trust's properties held for investment
for impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. This evaluation generally
consists of a review of the property's cash flow and current and projected
market conditions, as well as any changes in general and local economic
conditions. If an impairment loss exists based on the results of this review, a
loss is recognized by a charge against current earnings and a corresponding
reduction in the respective asset's carrying value. The amount of this
impairment loss is equal to the amount by which the carrying value of the
property exceeds its estimated fair value.
Environmental Matters
Under various federal, state, and local environmental laws, ordinances, and
regulations, the Trust may be potentially liable for removal or remediation
costs, as well as certain other potential costs (including governmental fines
and injuries to persons and property) relating to hazardous or toxic substances
where property-level managers have arranged for the removal, disposal, or
treatment of hazardous or toxic substances. In addition, certain environmental
laws impose liability for release of asbestos-containing materials into the air,
and third parties may seek recovery from the Trust for personal injury
associated with such materials.
The Trust's management is not aware of any environmental liability relating to
the above matters that would have a material adverse effect on the Trust's
business, financial position, or results of operations.
Tax Matters
As more fully discussed in the Trust's Annual Report on Form 10-K for the year
ended December 31, 1997, the Trust has elected and, in the opinion of the
Trust's management, qualified to be taxed as a REIT, as defined under Sections
856 through 860 of the Internal Revenue Code of 1986 (the "Code"). The Code
requires a REIT to distribute at least 95% of its REIT taxable income, plus 95%
of its net income from foreclosure property, as defined in Section 857 of the
Code, on an annual basis to shareholders.
Impact of Year 2000 Issues
The Year 2000 Issue is the result of electronic devices storing the applicable
year as a two-digit field rather than four. Consequently, any of the Trust's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, process invoices,
or engage in similar normal business activities. Following is a discussion of
the status of the Trust's assessment of its exposure to Year 2000 Issues.
22
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Impact of Year 2000 Issues (Continued)
State of Readiness
With regards to the Trust's Information Technology Systems, certain
computer equipment and software of the Trust's properties and Tarragon, the
Trust's advisor which provides accounting and information services to the
Trust, were found not to be Year 2000 compliant. The Trust and Tarragon
have begun to replace the computer equipment with Year 2000 compliant
equipment and to upgrade the software to Year 2000 compliant versions.
These upgrades were planned regardless of Year 2000 Issues, but they were
accelerated in order to ensure compliance. These upgrades are expected
to be completed by the third quarter of 1999. With regard to embedded
technology issues, such as with elevators in commercial buildings, sprinker
systems, security gates, and security alarms, the Trust is currently
assessing the potential risks. The Trust believes that such risks will not
materially affect the Trust's business.
The Trust is currently assessing potential risks related to third parties,
including utility companies, banks, and phone companies. The Trust believes
there is minimal risk that these third parties will not be Year 2000
compliant.
Costs to Address the Year 2000 Issues
To date, Tarragon has incurred $20,000 for replacing noncompliant hardware
and $25,000 for purchasing upgraded accounting software. Of these costs,
approximately $20,000 has been charged back to the Trust through expense
reimbursements. The Trust is also upgrading the rent software at its
properties. This upgraded software is being provided free of charge by the
software manufacturer. Expected remaining costs are $25,000 for software
conversion, including consulting fees, and $20,000 for additional hardware.
The Trust's share of these costs will be approximately 40%. Costs incurred
after the consummation of the merger of the Trust and Tarragon Realty
Investors, Inc. ("TRI"), as discussed below, will be borne entirely by the
consolidated entity.
The Risks of Year 2000 Issues
Potential material risks related to the Year 2000 include the following. If
the Trust's and Tarragon's computer systems and software are not
successfully upgraded prior to 2000, the ability of the Trust to provided
timely financial information may be impaired. However, the Trust is
confident that these upgrades will be completed in a timely manner.
Similarly, the Trust's ability to provide financial information could be
adversely affected if computer systems of banks with which the Trust does
business do not become Year 2000 compliant. Also, if the computer systems
of utility companies which provide services to the Trust do not become Year
2000 compliant, tenants of the Trust's properties could be inconvenienced
or even harmed. However, the Trust believes it is unlikely that these banks
and utility companies will not become Year 2000 compliant.
Contingency Plans
The Trust has not fully completed contingency plans. However, one focus of
the plans will be to source alternate third party vendors that are likely
to successfully become Year 2000 compliant. The Trust anticipates having
the contingency plans in place by mid-year 1999.
23
<PAGE> 24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Consolidation with Tarragon Realty Investors, Inc.
On February 19, 1998, the Trust and TRI jointly announced the agreement of their
respective boards to form a single consolidated entity with TRI, for
convenience, as the survivor. The surviving consolidated entity will operate
as a self-administered REIT. The consolidation transaction was approved by
shareholders of each of the Trust and TRI at special meetings held in October
1998. Under the Merger Agreement (as hereinafter defined), each shareholder of
the Trust will receive 1.97 shares of TRI common stock for each share of
beneficial interest of the Trust held. TRI, also a REIT, has a similar
opportunistic approach to real estate investment and had total consolidated
assets of approximately $37 million as of December 31, 1997. Upon the
consummation of the consolidation transaction, TRI will acquire Tarragon, the
Trust's advisor since April 1, 1994, and TRI's advisor since March 1, 1994, for
100,000 shares of common stock of TRI and options to acquire 350,000 shares of
common stock of TRI at prices ranging between $13 and $16 per share. The
resulting consolidated enterprise with TRI as the survivor will emerge from
these transactions as an integrated, self-administered, self-managed REIT
controlling approximately 14,000 apartment units and 2.1 million square feet of
retail and office space, primarily in California, Florida, and Texas. The
consolidation transaction will be accounted for as a reverse acquisition of TRI
by the Trust.
William S. Friedman, President, Chief Executive Officer, and Trustee of the
Trust, also serves as Director and Chief Executive Officer of Tarragon and as
Director, President, and Chief Executive Officer of TRI. Tarragon is owned by
Mr. Friedman and his wife, Lucy N. Friedman. The Friedman family also owns
approximately 30% of the outstanding shares of common stock of TRI and
approximately 33% of the outstanding shares of beneficial interest of the Trust.
Risks Associated with Forward-Looking Statements Included in this Form 10-Q
This form 10-Q contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, which are intended to be covered by the safe harbors
created thereby. These statements include the plans and objectives of management
for future operations, planned sources and uses of cash, and assessment and
resolution of Year 2000 issues. The forward-looking statements included herein
are based on current expectations that involve numerous risks and uncertainties.
Assumptions relating to the foregoing involve judgments with respect to, among
other things, future economic, competitive, and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Trust. Although the
Trust believes that the assumptions underlying the forward-looking statements
are reasonable, any of the assumptions could be inaccurate, and, therefore,
there can be no assurance that the forward-looking statements included in this
Form 10-Q will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by the Trust or any
other person that the objectives and plans of the Trust will be achieved.
[This space intentionally left blank.]
24
<PAGE> 25
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 20, 1998, at its Special Meeting of Shareholders, the shareholders of
National Income Realty Trust (the "Trust") voted upon a single matter which was
a proposal to incorporate the Trust into a California corporation through the
"Incorporation Procedure" described in a Proxy Statement / Prospectus dated
September 10, 1998, and approve and adopt an Agreement and Plan of Merger dated
as of June 5, 1998, (the "Merger Agreement") among Tarragon Realty Investors,
Inc., a Nevada corporation ("TRI") and National Income Realty Corporation (the
"California Corporation") as the successor to the Trust by virtue of the
Incorporation Procedure and the transactions contemplated by the Merger
Agreement, including the conversion of the shares of the California Corporation
(represented by the shares of beneficial interest of the Trust) into the right
to receive 1.97 shares of Common Stock, par value $0.01 per share, of TRI (the
"TRI Common Stock") pursuant to the Merger Agreement. As of September 4, 1998,
the record date for determination of the holders of shares of beneficial
interest of the Trust issued entitled to receive notice of and to vote at the
Special Meeting, there were 3,737,171 shares of beneficial interest of the Trust
issued and outstanding and entitled to vote, with each share of beneficial
interest of the Trust being entitled to one vote. At such meeting, a total of
2,245,673 votes were cast FOR (94.01% of the total of 2,388,803 shares voted or
60.09% of those entitled to vote), 64,210 shares were voted AGAINST such
proposal, and 78,920 shares ABSTAINED from voting.
The Trust anticipates consummating the Merger Agreement during November 1998.
ITEM 5. OTHER INFORMATION
On October 15, 1998, Robert C. Irvine resigned as Executive Vice President and
Chief Financial Officer of the Trust for personal reasons. Effective October 21,
1998, Erin D. Davis, Vice President and Chief Accounting Officer, was appointed
to the additional position of Chief Financial Officer of the Trust.
On November 2, 1998, John C. Strickland was appointed Managing Director for Real
Estate Transactions. Also, on November 1, 1998, Bruce A. Schnitz ceased to be
Chief Operating Officer of the Trust, and William S. Friedman, President and
Chief Executive Officer, also assumed the duties of Chief Operating Officer.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit No. Description
Exhibit 2.1 Agreement and Plan of Merger dated June 5, 1998,
between Tarragon Realty Investors, Inc., and National
Income Realty Trust (incorporated by reference to
Exhibit 3.6 to Registration Statement No. 333-60527
on Form S-4)
Exhibit 27.0 Financial Data Schedule
25
<PAGE> 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (Continued)
(b) Reports on Form 8-K as follows:
The following current report on Form 8-K was filed during the
period covered by this report or with respect to events which
occurred during the period covered by this report:
<TABLE>
Date of Event Date Filed Item Reported
------------- ---------- -------------
<S> <C> <C>
June 5, 1998 September 21, 1998 5. Other Events
7. Financial Statements and Exhibits
</TABLE>
[This space intentionally left blank.]
26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL INCOME REALTY TRUST
Date: November 16, 1998 By: /s/ WILLIAM S. FRIEDMAN
-------------------- ---------------------------------
William S. Friedman
President, Chief Executive
Officer, and Trustee
Date: November 16, 1998 By: /s/ ERIN D. DAVIS
-------------------- ---------------------------------
Erin D. Davis
Chief Financial Officer
(Principal Financial and Accounting
Officer)
27
<PAGE> 28
NATIONAL INCOME REALTY TRUST
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C> <C>
2.1 Agreement and Plan of Merger dated June 5, 1998, between Tarragon
Realty Investors, Inc., and National Income Realty Trust
(incorporated by reference to Exhibit 3.6 to Registration
Statement No. 333-60527 on Form S-4)
27.0 Financial Data Schedule Page 29
</TABLE>
28
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,195
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> (1,194)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 302,482
<DEPRECIATION> (51,149)
<TOTAL-ASSETS> 302,849
<CURRENT-LIABILITIES> 0
<BONDS> 218,736
0
0
<COMMON> 0
<OTHER-SE> 65,041
<TOTAL-LIABILITY-AND-EQUITY> 302,849
<SALES> 0
<TOTAL-REVENUES> 43,055
<CGS> 0
<TOTAL-COSTS> 23,545
<OTHER-EXPENSES> 6,310
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,901
<INCOME-PRETAX> 1,013
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,013
<DISCONTINUED> 0
<EXTRAORDINARY> (919)
<CHANGES> 0
<NET-INCOME> 94
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
</TABLE>
