QUARTERLY REPORT FOR THE PERIOD ENDED JUNE 30, 1996
FELLOW PARTNERS:
During the last year or two, a number of limited partners have inquired about
the timing of the liquidation of the portfolio's properties. Although three
holdings have already been sold, the Fund still owns the 11 properties shown
in the table on page 2.
Until now, we have been unable to adopt a broad-based liquidation plan
because real estate market conditions were such that it would have meant
selling at what we and LaSalle Advisors, the Fund's investment advisor, viewed
as "fire sale" prices.
However, during our most recent annual review of the strategic plan for
the Fund, we concluded that the alignment between (1) the fundamental
operating environment and (2) capital flows into real estate is the best it
has been for a number of years. And, for reasons we will discuss later, it
appears market conditions will continue to improve. As a result, we believe
the time is right to begin liquidating the Fund's remaining properties. If the
generally favorable environment continues, and barring any significant change
in local market conditions, our plan calls for the last property to be sold by
the end of 1998. While this is our target date, a variety of factors could
cause the timeframe to accelerate or be delayed.
As has been true in the past, the timing of individual sales within the
expected liquidation period will be governed by our assessment of the benefits
to our partners of holding versus selling immediately and by the availability
of interested buyers. Some properties appear to be candidates for near-term
liquidation, while others may take a little longer based on property type and
the local market.
Perhaps some historical perspective will be helpful at this point. In
October 1986, the final partners were admitted to the Fund, and the first
property, Atlantic in Gwinnett County, Georgia, was acquired. Less than two
years later, the Fund made its thirteenth, and final, acquisition - an
interest in a loan secured by Fairchild Corporate Center in Irvine,
California. We intended to hold properties for no more than seven to 10 years.
However, subsequent changes in tax legislation made income-producing real
estate unattractive to many previously active lenders and purchasers, such as
commercial banks and insurance companies.
Chart 1 - Total Debt and Equity Flows to Real Estate
As the bar graph above indicates, capital flowing into real estate
peaked and then began a freefall in 1988, exacerbating the problem caused by
overbuilding in many markets. Then, the recession in 1990-1991 as well as
corporate downsizings added to the growing imbalance between supply and
demand. The combination of weak demand and negative capital flows had a
devastating effect on values in most market sectors and in most geographic
areas. Rather than begin liquidating your portfolio at the bottom of the
market cycle, we decided to wait until conditions improved. While market
conditions did not permit broad scale portfolio liquidation, we were able to
take advantage of specific opportunities to sell three holdings - the smaller
of the two Coronado buildings in 1993, Sullyfield Circle in 1995, and Regal
Row earlier this year. Most of the proceeds from these dispositions have been
distributed to the Fund's limited partners.
Turning back to the more recent environment, we began to see some
improvement in numerous local markets and sectors about two years ago. New
construction was rather stagnant, occupancy and rental rates appeared to be
stabilizing or improving, and returns on real estate investments started to
improve. Property values also showed signs of recovery in a number of areas.
In addition, money began to flow back into real estate investments in 1993,
particularly into Real Estate Investment Trusts (REITS) which, in turn, became
active buyers. This strong capital infusion has contributed to a more
favorable environment.
NCREIF Total Return
1993 1994 1995 95Q2-96Q1
_____ _____ _____ __________
All Properties 0.6% 6.9% 8.9% 9.5%
Source: NCREIF-Classic Index, LaSalle Advisors Investment Research.
<TABLE>
Real Estate Investments (Dollars in thousands)
__________________________________________________________________________________________________
Leased Status Average Leased Status Contribution to Net Income
____________ _________________________ __________________________
Gross
Property Leasable June 30, Six Months Ended June 30, Six Months Ended June 30,
Name Area (Sq. Ft.) 1996 1995 1996 1995 1996
_____________ ____________ _________ _________ _________ _________ _________
<S> <C> <C> <C> <C> <C> <C>
Atlantic 187,844 92% 99% 92% $ 147 $ 114
Coronado 95,732 100 100 100 93 91
Oakbrook
Corners 123,948 83 70 65 (23) (50)
Baseline 100,204 92 89 91 57 64
Business
Plaza 66,342 79 88 71 203 34
Bonnie Lane 119,590 100 78 93 113 101
Glenn Avenue 82,000 100 100 100 86 81
South Point
Plaza 50,497 88 65 58 49 5
Tierrasanta 104,236 100 76 100 28 72
_________ _________ _________ _________ _________ _________
930,393 93 86 88 753 512
Held for Sale
AMCC 99,950 100 100 100 462 (1,159)
Fairchild 104,823 79 80 73 38 (16)
_________ _________ _________ _________ _________ _________
1,135,166 92 87 87 1,253 (663)
Properties Sold - - - - 125 144
_________ _________ _________ _________ _________ _________
Fund Expenses
Less Interest
Income - - - - (128) (110)
_________ _________ _________ _________ _________ _________
Total 1,135,166 92% 87% 87% $1,250 $(629)
</TABLE>
Results of Operations
The single tenant at AMCC has notified us, as expected, that it will not
renew its lease which expires in September of next year. LaSalle has been
weighing the pros and cons of re-leasing versus selling and has now
recommended that immediate sale would be preferable based on the current
tenant's lease and income stream. LaSalle has selected a broker who will
direct the marketing effort toward individual and institutional investors as
well as owner/users. AMCC's book value was $1.6 million more than we now
estimate can be realized on the sale, so a downward valuation adjustment in
that amount was taken in the second quarter. We want to point out that we
would have had to make a substantial capital investment for tenant
improvements had this lease been renewed, and this would have had a negative
effect on AMCC's 1997 operating results and the Fund's cash position.
Properties sold in 1995 and 1996 had a material effect on rental income
and expense comparisons relative to last year. Net income, however, was not
affected to any great extent, because the absence of revenues from Sullyfield
and Regal Row was almost totally offset by a corresponding lack of expenses,
including valuation adjustments, related to those properties.
Now that liquidations will play an increasing role in the Fund's
operating results, we think it is worth mentioning the effect of some
accounting requirements involved when a property is put in the "held for sale"
category. First, if the estimated sale price is less than the historical
carrying value, the latter must be adjusted downward for the difference. Then,
further adjustments may be made if, during the marketing process, the
property's value is less than estimated when it was placed for sale. If the
sales price is more than the historical carrying value, as is the case with
Fairchild, no adjustment to increase the carrying value is made. Since
depreciation has the effect of reducing book value, a property that is being
held for sale is no longer depreciated, because its adjusted carrying value
would drop below its estimated sale price.
Excluding the sold and currently held for sale properties, income from
operations was down from last year. Business Plaza had a lower average leased
status, and its depreciation this year was not offset by a recovery in value.
It does appear, however, that the property and its market are improving. South
Point Plaza also suffered from the lack of a recovery in value in the '96
year-to-date period. We are encouraged about this property's prospects on two
fronts. First, the tenant who signed a lease for 35% of the center's space
will begin paying rent this month. (Some of the positive effect on rental
income, however, will be offset by increased depreciation related to
significant improvements made for the tenant.) Second, the submarket is
improving in terms of rental rates, which could bode well for rents on new and
renewal leases at South Point.
Tierrasanta and Baseline continued to show progress. As the table on
page 2 indicates, each experienced greater income from operations relative to
the first six months of last year. Leases covering a large amount of space at
these sites expire over the remainder of the year, so the improvement in
leased status could be temporary. We are making every effort to minimize the
effect of the expiration of a lease for 38% of Tierrasanta, but want to
caution that LaSalle Advisors anticipates it will take a while to fill this
space because the market is somewhat soft. We are optimistic about Baseline
because of the strength in its market, and the same is true at Glenn Avenue,
which is currently 100% leased but which has 58% of its space under leases
which expire by December 1996.
As we let you know last quarter, we were negotiating with a tenant who
occupied 46% of Atlantic (and 100% of one of its three buildings). We are
pleased to report that the tenant renewed at a higher rental rate. Leases in
the other buildings representing 18% of the total space in the property were
renewed, also at rents which are at or above the prior levels.
A few additional comments on the status of the AMCC property are
warranted. While we have put the building up for sale, we have not abandoned
the possibility of trying to re-lease it if buyer activity is slow over the
next several months. If we were to re-lease it and decided not to actively
market it at that time, we would take the property out of the "held for sale"
category and would once again begin to depreciate it. We might also have to
make further valuation adjustments, either up or down, based on prevailing
property and market conditions.
The Fund's cash position declined by $1.4 million during the first six
months of this year compared to a $2.8 million increase last year. The
reasons, in order of magnitude, were higher distributions from sales proceeds,
lower operating profits, and greater investments in properties.
Cash Distributions
Cash from operations again allowed us to make the planned $6.50 per-unit
distribution for the second quarter. As the year progresses, we will
reevaluate this amount and report if any changes are appropriate.
Disposition Update
We had received an unsolicited offer for Fairchild Corporate Center when we
last communicated with you. A purchase and sale agreement has now been signed,
and the sale is expected to close by the end of August. Total net proceeds
from the sale are estimated at $9.76 million, and 24% of this amount,
representing the Fund's ownership interest, will be distributed to you in
November if the deal closes as anticipated. Realty Income Funds III and IV
hold the remaining interest in the property.
Now that we are in the portfolio liquidation phase, some properties may
be managed differently than if we were planning to hold them for a longer
period. For instance, if a property would require a significant infusion of
capital in order to stabilize its occupancy around the 90% to 95% level,
LaSalle might make concessions on the sale price and give the new owners the
flexibility to make their own changes. We measure our capital expenditures
against the potential for an immediate return on our investment. Obviously,
the more we put into a property, the more we expect to get out of it.
One practice which does not change, however, is our close watch on
day-to-day expenses. LaSalle will continue to re-bid service contracts, appeal
real estate tax increases or seek reassessments, and take whatever other steps
it can to pare the costs of operating the properties in order to make them
more attractive to potential buyers.
Another change we have noted in the overall commercial real estate
market is that buyers appear to have shortened their investment horizon.
Rather than the seven to 10-year holding period we envisioned when building
the Fund's portfolio, buyers are now looking at a five-year timeframe. As a
result, in negotiating new and renewal leases, LaSalle will try to manage
lease terms and expirations to achieve the five-year average cash flows and
cap rates currently demanded by the market.
Outlook
A number of factors point to continued improvement for real estate in the near
future. Within the market itself, speculative construction remains sparse in
most areas, and foreclosure rates are falling. In addition, low unemployment,
subdued inflation, favorable interest rates, and increasing returns from real
estate relative to stocks and bonds contribute to a more optimistic outlook.
The return of large institutional investors, especially the REITs, means
there is more capital available for real estate investment and, therefore, a
market more accommodating to property sales. Of equal importance, the rate of
return (or "cap" rate) required by potential buyers tends to decline as
investment dollars flow into real estate. The relationship between cap rates
and real estate values is like that between interest rates and bond prices -
lower rates mean rising values.
Future reports will update you on our progress toward liquidating the
portfolio. The purpose of this discussion is to inform you of the improving
conditions we see in the real estate market and to outline our liquidation
strategy. We are optimistic that our plan is reasonable and will continue
working hard to bring it to fruition. Our focus in selling your holdings is
the same as that we employed in acquiring and managing each property - to
serve the interests of our partners.
Sincerely,
James S. Riepe
Chairman
August 9, 1996
CONDENSED CONSOLIDATED BALANCE SHEETS
Unaudited
(In thousands)
June 30, December 31,
1996 1995
_________ ____________
Assets
Real Estate Property Investments
Land . . . . . . . . . . . . . . . . . . . . . $ 11,117 $ 14,544
Buildings and Improvements . . . . . . . . . . 36,064 45,170
________ ________
47,181 59,714
Less: Accumulated Depreciation and
Amortization. . . . . . . . . . . . . . . . (16,007) (18,049)
________ ________
31,174 41,665
Held for Sale. . . . . . . . . . . . . . . . . 8,534 3,500
________ ________
39,708 45,165
Cash and Cash Equivalents. . . . . . . . . . . . 3,400 4,782
Accounts Receivable
(less allowances of $61 and $165). . . . . . . 160 172
Other Assets . . . . . . . . . . . . . . . . . . 440 410
________ ________
$ 43,708 $ 50,529
________ ________
________ ________
Liabilities and Partners' Capital
Security Deposits and Prepaid Rents. . . . . . . $ 416 $ 493
Accrued Real Estate Taxes. . . . . . . . . . . . 530 502
Accounts Payable and Other Accrued Expenses. . . 234 433
________ ________
Total Liabilities. . . . . . . . . . . . . . . . 1,180 1,428
Partners' Capital. . . . . . . . . . . . . . . . 42,528 49,101
________ ________
$ 43,708 $ 50,529
________ ________
________ ________
See the accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
(In thousands except per-unit amounts)
Three Months Ended Six Months Ended
June 30, June 30,
1996 1995 1996 1995
________ ________ ________ ________
Revenues
Rental Income. . . . . . . . . . $ 1,475 $ 1,688 $ 3,020 $ 3,403
Interest Income. . . . . . . . . 61 58 139 112
________ ________ ________ ________
1,536 1,746 3,159 3,515
________ ________ ________ ________
Expenses
Property Operating Expenses. . . 294 282 561 456
Real Estate Taxes. . . . . . . . 195 221 413 455
Depreciation and Amortization. . 484 593 954 1,183
Decline (Recovery) of
Property Values. . . . . . . . 1,621 (275) 1,509 (237)
Management Fee to
General Partner. . . . . . . . 54 73 109 176
Partnership Management Expenses. 126 119 242 232
________ ________ ________ ________
2,774 1,013 3,788 2,265
________ ________ ________ ________
Net Income (Loss). . . . . . . . $ (1,238) $ 733 $ (629) $ 1,250
________ ________ ________ ________
________ ________ ________ ________
Activity per Limited Partnership Unit
Net Income (Loss). . . . . . . . $ (14.57) $ 8.63 $ (7.40) $ 14.71
________ ________ ________ ________
________ ________ ________ ________
Cash Distributions Declared
from Operations. . . . . . . . $ 6.50 $ 8.75 $ 13.00 $ 17.50
from Sale Proceeds . . . . . . - 31.17 42.95 31.17
________ ________ ________ ________
Total Distributions Declared . . $ 6.50 $ 39.92 $ 55.95 $ 48.67
________ ________ ________ ________
________ ________ ________ ________
Units Outstanding. . . . . . . . 84,099 84,099 84,099 84,099
________ ________ ________ ________
________ ________ ________ ________
See the accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
Unaudited
(In thousands)
General Limited
Partner Partners Total
________ ________ ________
Balance, December 31, 1995 . . . $ (275) $ 49,376 $ 49,101
Net Loss . . . . . . . . . . . . (6) (623) (629)
Cash Distributions . . . . . . . (15) (5,929) (5,944)
_________ _________ _________
Balance, June 30, 1996 . . . . . $ (296) $ 42,824 $ 42,528
_________ _________ _________
_________ _________ _________
See the accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
Six Months Ended
June 30,
1996 1995
_________ _________
Cash Flows from Operating Activities
Net Income (Loss). . . . . . . . . . . . . . . . $ (629) $ 1,250
Adjustments to Reconcile Net Income (Loss)
to Net Cash Provided by Operating Activities
Depreciation and Amortization. . . . . . . . . 954 1,183
Decline (Recovery) of Property Values. . . . . 1,509 (237)
Other Changes in Assets and Liabilities. . . . (266) 36
________ ________
Net Cash Provided by Operating Activities. . . . 1,568 2,232
________ ________
Cash Flows from Investing Activities
Proceeds from Property Dispositions. . . . . . . 3,612 2,622
Investments in Real Estate . . . . . . . . . . . (618) (382)
________ ________
Net Cash Provided by Investing Activities. . . . 2,994 2,240
________ ________
Cash Flows Used in Financing Activities
Cash Distributions . . . . . . . . . . . . . . . (5,944) (1,720)
________ ________
Cash and Cash Equivalents
Net Increase (Decrease) during Period. . . . . . (1,382) 2,752
At Beginning of Year . . . . . . . . . . . . . . 4,782 4,819
________ ________
At End of Period . . . . . . . . . . . . . . . . $ 3,400 $ 7,571
________ ________
________ ________
See the accompanying notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
The unaudited interim condensed consolidated financial statements reflect all
adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods presented. All such
adjustments are of a normal, recurring nature.
The unaudited interim financial information contained in the
accompanying condensed consolidated financial statements should be read in
conjunction with the financial statements contained in the 1995 Annual Report
to Partners.
NOTE 1 - TRANSACTIONS WITH RELATED PARTIES AND OTHER
As compensation for services rendered in managing the affairs of the
Partnership, the General Partner earns a partnership management fee equal to
9% of net operating proceeds. The General Partner earned a partnership
management fee of $109,000 during the first six months of 1996. In addition,
the General Partner's share of cash available for distribution from operations
totaled $11,000 for the first six months of 1996.
In accordance with the partnership agreement, certain operating expenses
are reimbursable to the General Partner. The General Partner's reimbursement
of such expenses totaled $57,000 for communications and administrative
services performed on behalf of the Partnership during the first six months of
1996.
An affiliate of the General Partner earned a normal and customary fee of
$8,000 from the money market mutual funds in which the Partnership made its
interim cash investments during the first six months of 1996.
LaSalle Advisors Limited Partnership ("LaSalle") is the Partnership's
advisor and is compensated for its advisory services directly by the General
Partner. LaSalle is reimbursed by the Partnership for certain operating
expenses pursuant to its contract with the Partnership to provide real estate
advisory, accounting and other related services to the Partnership. LaSalle's
reimbursement for such expenses during the first six months of 1996 totaled
$75,000.
An affiliate of LaSalle earned $57,000 in the first six months of 1996
as property manager for several of the Partnership's properties.
NOTE 2 - PROPERTY DISPOSITION
On February 14, 1996, the Partnership sold Regal Row and received net proceeds
of $3,612,000. The net book value of the property at that date was also
$3,612,000, after accumulated depreciation expense and previously recorded
property valuation adjustments. Therefore, no gain or loss is reflected in the
accompanying financial statements. The Partnership recognized a $112,000
valuation recovery in the first quarter of 1996 prior to the disposition of
Regal Row.
NOTE 3 - PROPERTIES HELD FOR SALE
Fairchild 234, a general partnership in which the Partnership holds a 24%
interest, holds a note secured by a deed of trust on Fairchild Corporate
Center. The other general partners are affiliates of the Partnership.
Fairchild 234 has entered into an agreement to sell its interest in Fairchild
Corporate Center, and the transaction is anticipated to close in the third
quarter, with estimated net proceeds to the Partnership of $2,342,000. The net
book value of the Partnership's interest in Fairchild Corporate Center is
classified as held for sale in the accompanying balance sheets and was
$1,622,000 at June 30, 1996.
The Partnership began actively marketing AMCC in June 1996 and has
classified this property as held for sale in the accompanying June 30, 1996
balance sheet. The Partnership recognized a $1.6 million decline of property
value in the second quarter of 1996, to reflect the estimated net realizable
value of AMCC.
Results of operations for these properties, after including the decline
in value of AMCC, resulted in a net loss of $1,175,000 for the six months
ended June 30, 1996 and net income of $500,000 for the six months ended June
30, 1995.
NOTE 4 - SUBSEQUENT EVENT
The Partnership declared a quarterly cash distribution of $6.50 per unit to
Limited Partners of the Partnership as of the close of business on June 30,
1996. The Limited Partners will receive $546,000, and the General Partner will
receive $6,000.
Chart 1 - Total Debt and Equity Flows to Real Estate bar graph titled "Total
Debt and Equity Flows to Real Estate" which depicts the net flow of debt and
equity in public and private markets, in billions of dollars into and from
real estate from the period 1981-1994, and forecasts such flows from
1995-1999. The graph shows a range from ($40) billion to $120 billion.
Year Dollars in Billions
1981 $30
1982 $40
1983 $50
1984 $65
1985 $80
1986 $85
1987 $90
1988 $101
1989 $79
1990 $40
1991 ($10)
1992 ($25)
1993 $10
1994 $35
1995 $55 (forecast)
1996 $65 (forecast)
1997 $75 (forecast)
1998 $77 (forecast)
1999 $79 (forecast)
Note: Includes debt and equity in public and private markets.
Source: Federal Reserve Board, Commercial Mortgage Alert, Capital Markets
Report, LaSalle Advisors Investment Research.
