<PAGE> 1
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, 1996
------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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Commission file number 0-17684
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ML/EQ Real Estate Portfolio, L.P.
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(Exact name of registrant as specified in its governing instrument)
Delaware 58-1739523
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(State of Organization) (I.R.S. Employer Identification No.)
1150 Lake Hearn Dr; Atlanta, Georgia 30342-1522
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(Address of principal executive office) (Zip Code)
(Registrant's telephone number, including area code) (404) 239-5002
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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
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<PAGE> 2
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONTENTS
PART I - FINANCIAL INFORMATION
Item 1 - Financial statements:
Consolidated balance sheets at September 30, 1996 and
December 31, 1995
Consolidated statements of operations for the three and nine
months ended September 30, 1996 and 1995
Consolidated statement of partners' capital for the nine months
ended September 30, 1996
Consolidated statements of cash flows for the nine months ended
September 30, 1996 and 1995
Notes to consolidated financial statements
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations
PART II - OTHER INFORMATION
Items 1 through 6
Signatures
<PAGE> 3
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1996 AND DECEMBER 31, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
ASSETS
REAL ESTATE INVESTMENTS:
Rental properties, net of accumulated depreciation of
$15,131,922 in 1996 and $12,431,678 in 1995.................. $ 113,274,429 $113,964,724
Zero coupon mortgage note receivable, net of valuation allowance
(Note 1)..................................................... 21,498,199 21,498,199
Mortgage loan receivable........................................ 6,000,000 6,000,000
------------- ------------
Total real estate investments........................... 140,772,628 141,462,923
------------- ------------
OTHER ASSETS:
Cash and short-term investments................................. 25,351,111 21,738,499
Deferred rent concessions....................................... 2,184,192 2,030,727
Accounts receivable and accrued investment income, net of
allowance for doubtful accounts of $495,209 in 1996 and
$460,313 in 1995............................................. 2,060,442 3,446,102
Guaranty fee, net of accumulated amortization of $2,066,148 in
1996 and $1,864,960 in 1995 (Notes 2 and 3).................. 1,676,567 1,877,755
Prepaid expenses and other assets............................... 1,020,245 495,509
Deferred leasing costs, net of accumulated amortization of
$556,200 in 1996 and $393,867 in 1995........................ 861,887 713,979
Interest receivable............................................. 102,911 150,233
Due from affiliates (Note 2).................................... 3,103 9,033
------------- ------------
Total other assets...................................... 33,260,458 30,461,837
------------- ------------
TOTAL ASSETS............................................ $ 174,033,086 $171,924,760
============= ============
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES:
Accounts payable and accrued real estate expenses............... $ 2,477,125 $ 2,221,132
Security deposits and unearned rent............................. 458,337 477,737
Due to affiliates (Note 2)...................................... 302,723 609,615
Accrued capital expenditures.................................... 108,975 2,647,092
Distributions declared.......................................... -- 542,423
------------- ------------
Total liabilities....................................... 3,347,160 6,497,999
------------- ------------
MINORITY INTEREST IN THE VENTURE.................................. 33,458,040 32,547,073
------------- ------------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 3)
PARTNERS' CAPITAL:
General partners................................................ 2,277,587 2,033,056
Initial limited partner......................................... 6,864 6,650
Limited partners (5,424,225 BACs issued and outstanding)........ 134,943,435 130,839,982
------------- ------------
Total partners' capital................................. 137,227,886 132,879,688
------------- ------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL................. $ 174,033,086 $171,924,760
============= ============
</TABLE>
See notes to consolidated financial statements.
2
<PAGE> 4
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ -------------------------
1996 1995 1996 1995
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUE:
Rental income............................ $5,233,540 $ 4,944,210 $14,816,221 $15,620,214
Lease termination income................. -- 111,205 62,171 1,487,433
Interest on loans receivable............. 1,030,690 153,750 2,753,488 1,076,194
---------- ----------- ------------ ------------
Total revenue.................... 6,264,230 5,209,165 17,631,880 18,183,841
---------- ----------- ------------ ------------
OPERATING EXPENSES:
Real estate operating expenses........... 1,998,146 2,060,464 5,946,954 5,955,116
Depreciation and amortization............ 984,346 745,203 2,892,802 2,190,933
Real estate taxes........................ 606,913 586,559 1,690,027 1,824,074
Property management fees (Note 2)........ 116,360 114,908 347,502 373,642
Provision for impairment on zero coupon
mortgage (Note 1)..................... -- 3,232,210 -- 3,232,210
---------- ----------- ------------ ------------
Total operating expenses......... 3,705,765 6,739,344 10,877,285 13,575,975
---------- ----------- ------------ ------------
INCOME FROM PROPERTY OPERATIONS............ 2,558,465 (1,530,179) 6,754,595 4,607,866
OTHER INCOME (EXPENSE):
Interest and other nonoperating income... 319,112 289,380 874,995 872,971
Asset management fees.................... (171,793) (172,264) (511,645) (511,174)
Amortization of guarantee fee............ (67,062) (67,063) (201,188) (201,188)
General and administrative, including
$391,345 and $395,640 at September 30,
1996 and 1995 respectively, to
affiliates (Note 2)................... (168,710) (163,423) (515,169) (527,555)
---------- ----------- ------------ ------------
Total other expense -- net....... (88,453) (113,370) (353,007) (366,946)
---------- ----------- ------------ ------------
INCOME BEFORE MINORITY INTEREST............ 2,470,012 (1,643,549) 6,401,588 4,240,920
MINORITY INTEREST IN NET INCOME OF
CONSOLIDATED VENTURE..................... (570,265) 253,800 (1,510,967) (1,079,796)
---------- ----------- ------------ ------------
NET INCOME................................. $1,899,747 $(1,389,749) $ 4,890,621 $ 3,161,124
========== =========== ============ ============
ALLOCATION OF NET INCOME:
General partners......................... $ 94,987 $ (69,488) $ 244,531 $ 158,056
Initial limited partner.................. 83 (61) 214 138
Limited partners......................... 1,804,677 (1,320,200) 4,645,876 3,002,930
---------- ----------- ------------ ------------
TOTAL............................ $1,899,747 $(1,389,749) $ 4,890,621 $ 3,161,124
========== =========== ============ ============
NET INCOME PER LIMITED PARTNER BAC......... $ .34 $ (.24) $ .86 $ .55
========== =========== ============ ============
WEIGHTED AVERAGE BACs OUTSTANDING.......... 5,424,225 5,424,225 5,424,225 5,424,225
========== =========== ============ ============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 5
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
INITIAL
GENERAL LIMITED LIMITED
PARTNERS PARTNER PARTNERS TOTAL
---------- ------- ------------ ------------
<S> <C> <C> <C> <C>
Balance, December 31, 1995..................... $2,033,056 $ 6,650 $130,839,982 $132,879,688
Net income..................................... 244,531 214 4,645,876 4,890,621
Distributions.................................. -- -- (542,423) (542,423)
---------- ------ ------------ ------------
Balance, September 30, 1996.................... $2,277,587 $ 6,864 $134,943,435 $137,227,886
========== ====== ============ ============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 6
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1996 1995
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Tenant rentals received.............................................. $16,091,187 $ 16,580,871
Interest received.................................................... 3,675,805 1,275,631
------------- -------------
Cash received from operations........................................ 19,766,992 17,856,502
Cash paid for operating activities................................... (9,581,002) (10,062,605)
Cash distributions to minority interest.............................. (600,000) (775,000)
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NET CASH PROVIDED BY OPERATING ACTIVITIES.............................. 9,585,990 7,018,897
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases and additions to rental properties......................... (4,572,971) (6,510,612)
Expenditures for deferred leasing costs.............................. (315,561) (276,021)
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES.................................. (4,888,532) (6,786,633)
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash distributions to limited partners............................... (1,084,846) (1,627,305)
------------- -------------
NET CASH USED IN FINANCING ACTIVITIES.................................. (1,084,846) (1,627,305)
------------- -------------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS............. 3,612,612 (1,395,041)
CASH AND SHORT-TERM INVESTMENTS, BEGINNING OF PERIOD................... 21,738,499 21,538,416
------------- -------------
CASH AND SHORT-TERM INVESTMENTS, END OF PERIOD......................... $25,351,111 $ 20,143,375
============ =============
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING
ACTIVITIES:
Net Income........................................................... $ 4,890,621 $ 3,161,124
------------- -------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization........................................ 3,093,990 2,392,121
Provision for impairment on zero coupon mortgage..................... -- 3,232,210
Minority interest in Venture operations.............................. 1,510,967 1,079,796
Cash distributions to minority interest.............................. (600,000) (775,000)
Changes in assets (increase) decrease:
Interest accrual on zero coupon mortgage note receivable............. -- (614,944)
Accounts receivable and accrued investment income.................... 1,385,660 (637,254)
Deferred rent concessions............................................ (153,465) (209,924)
Interest receivable.................................................. 47,322 (58,590)
Prepaid expenses and other assets.................................... (524,736) (338,725)
Due from affiliates.................................................. 5,930 --
Changes in liabilities increase (decrease):
Accounts payable and accrued real estate expenses.................... 255,993 (231,857)
Security deposits and unearned rent.................................. (19,400) 320,402
Due to affiliates.................................................... (306,892) (300,462)
------------- -------------
Total adjustments...................................................... 4,695,369 3,857,773
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NET CASH FLOW PROVIDED BY OPERATING ACTIVITIES......................... $ 9,585,990 $ 7,018,897
============ =============
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 7
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(UNAUDITED)
The consolidated financial statements of the Partnership included herein
have been prepared by the Partnership pursuant to the rules and regulations of
the Securities and Exchange Commission. In the opinion of Management, the
accompanying unaudited consolidated financial statements reflect all
adjustments, which are of a normal recurring nature, to present fairly the
Partnership's financial position, results of operations, and cash flows at the
dates and for the periods presented. These consolidated financial statements
should be read in conjunction with the Partnership's audited financial
statements and notes thereto included in the Partnership's Annual Report on Form
10-K for the year ended December 31, 1995, as certain footnote disclosures which
would substantially duplicate those contained in such audited financial
statements have been omitted from this report. Interim results of operations are
not necessarily indicative of results to be expected for the fiscal year.
1. BROOKDALE ZERO NOTE
EML Associates (the "Venture"), a joint venture through which the
Partnership invests in existing income-producing real properties, zero coupon or
similar mortgage notes, and fixed rate mortgage loans, holds a 71.66%
participation interest in a zero coupon mortgage note. The property which
secures this first mortgage note is Brookdale Center which is located outside of
Minneapolis, Minnesota. The Venture acquired its participation interest in 1988
from The Equitable Life Assurance Society of the United States ("Equitable")
which holds the remaining 28.34% interest. The Venture's participation interest
had an estimated fair market value (including accrued interest) at the time of
acquisition of $12,278,885. The borrower is Midwest Real Estate Shopping Center
L.P. ("Midwest"), a publicly traded limited partnership, (formerly Equitable
Real Estate Shopping Centers, L.P.). The note had an implicit interest rate of
10.2% compounded semiannually with the Venture's portion of the entire amount of
principal and accrued interest totaling $25,345,353 due on June 30, 1995.
Midwest defaulted on its obligation to repay the Brookdale zero note in
full on the maturity date. Notice of default was given to Midwest. For book
purposes, beginning with the second quarter of 1995, Management discontinued the
accrual of interest on the Brookdale zero note as the accreted value of the
mortgage approximated the estimated fair market value of Brookdale Center. Under
the terms of the mortgage agreement, however, the Venture continued to accrue
interest off the books at the effective implicit rate of 10.2% until June 30,
1995. On July 1, 1995, the Venture began to accrue interest off the books on the
Brookdale zero note at the default rate of 19.0%. Equitable and the Venture
(collectively referred to as "Lender") commenced foreclosure proceedings and a
court appointed receiver was named. The receiver was responsible for collecting
rent proceeds from the tenants at Brookdale Center and applying the proceeds to
payments of operating costs at Brookdale Center. Any remaining funds were paid
to Lender on account of the Brookdale zero note. The Venture recorded cash
received from the operation of Brookdale Center as interest income. During the
first half of 1996, approximately $1,975,000 was remitted under the terms of the
receivership. The Venture's portion of these payments was approximately
$1,415,000.
As of September 30, 1995, an internal review of the Brookdale Center was
performed for the Venture. Based on this review, the estimated fair market value
of Brookdale Center was $30,000,000. The Venture recorded a valuation allowance
of $3,232,210 to value the note at an amount equal to the Venture's
6
<PAGE> 8
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
participation interest in the note multiplied by the estimated fair market value
of Brookdale Center, or $21,498,199.
In April, 1996 the Lender agreed in principle to a workout arrangement with
Midwest on the Brookdale zero note under which Midwest would file for Chapter 11
bankruptcy protection and, with the support of Lender, submit a plan of
reorganization to the Bankruptcy Court for approval. The workout arrangement was
memorialized in a nonbinding letter agreement dated April 11, 1996 (the "Letter
Agreement") between Midwest and Equitable and approved by the Board of Directors
of EREIM Managers Corp., the general partner of the Partnership, on behalf of
the Venture.
On June 20, 1996 Midwest filed a voluntary petition for Chapter 11
bankruptcy protection, staying the Brookdale foreclosure proceeding and
terminating the receivership arrangement. However, as contemplated by the Letter
Agreement, Midwest subsequently obtained Bankruptcy Court approval to retain the
management company that had served as receiver prior to the bankruptcy filing as
Brookdale's property manager.
In addition, the Bankruptcy Court, with the agreement of Midwest and
Lender, entered a cash collateral order as contemplated by the Letter Agreement,
pursuant to which all positive cash flow generated by the property in excess of
property-related expenses and certain administrative costs of the bankruptcy,
not to exceed $25,000, will be paid to the Lender during the bankruptcy. The
Venture records cash received from the operation of Brookdale Center as interest
income. During the third quarter of 1996 approximately $1,224,000 was remitted
under the terms of the cash collateral order. The Venture's portion of these
payments was approximately $877,000.
Consistent with the Letter Agreement, Midwest filed a plan of
reorganization with the Bankruptcy Court on August 23, 1996. The material
provisions of the plan, which is subject to the approval of the Bankruptcy Court
are as follows:
- The Brookdale zero note will remain in default.
- Midwest will market the property for sale to potential third-party
purchasers through November 15, 1996.
- Lender will fund any necessary capital and leasing costs approved by
Midwest and Lender through a super-priority, non-recourse,
debtor-in-possession loan by Lender.
- The net proceeds generated through a sale of the property to a
third-party purchaser, after payment of the costs of sale and repayment of
the amounts owed to Lender under the debtor-in possession financing, first
shall be paid on a pari passu basis $750,000 to Midwest and $30,000,000 to
Lender, second shall be split 50-50 between Midwest and Lender up to a
total of $6,000,000, and third shall thereafter be remitted to Midwest.
- If Midwest receives and wishes to accept a third-party offer to purchase
the property for a price that will produce net sales proceeds of less than
$30,750,000, then Lender shall have the option either to consent to such
sale or purchase the property for an amount equal to $500,000 plus 2.5% of
the amount by which the net sales proceeds under the third-party offer
exceeds $20,000,000.
7
<PAGE> 9
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- If no third-party offer is received by November 15, 1996, or if a
third-party purchaser has failed to close its acquisition of the property
by December 1, 1996, both Midwest and Lender will have the right to cause
the property to be conveyed to Equitable and the Venture as joint tenants.
The purchase price for the property shall be $500,000, and the property
shall be conveyed to Equitable and the Venture subject to, among other
things, the mortgage securing the Brookdale zero note and the mortgage
securing Lender's debtor-in-possession financing.
- Lender will be granted certain limited rights of first refusal to
purchase the property, and Lender will be granted, during the bankruptcy,
various rights to discuss with third-parties the possible renovation of
the property should Lender acquire ownership of the property.
To date, Midwest has not received a third-party offer to purchase the
property which would produce net sales proceeds of at least $30,750,000 or any
third-party offer at a lesser price acceptable to Equitable and the Venture.
Consequently, Management believes that upon approval of the plan, it is likely
that the property will be conveyed to the Equitable and the Venture for a
purchase price of $500,000.
On October 30, 1996, the plaintiffs in one of the class action suits
previously filed against Midwest, Equitable and others (see "Legal Proceedings")
filed a claim for equitable subordination against Equitable in the Midwest
bankruptcy proceeding. The claim alleges, among other things, that Equitable
breached a fiduciary duty to Midwest's investors and violated federal securities
laws in connection with the initial sale of interests in Midwest and, as such,
that Equitable should not be entitled to preferential treatment in bankruptcy
court. If the claim were to be successful as asserted, Equitable and the Venture
would not be entitled to the benefits of the plan. Management believes, however,
that the bankruptcy court is unlikely to find in favor of the claimants and that
the claim can be disposed of without adversely impacting the Venture's
interests.
The Venture and Equitable have entered into an agreement between
themselves to support Midwest's plan of reorganization as outlined in the
Letter Agreement, to make all decisions regarding the plan of reorganization
jointly, and to share all expenses, on a pro rata basis, in connection with the
bankruptcy and all undertakings jointly agreed upon by the Venture and
Equitable in accordance with their participation interests in the Brookdale
zero note.
2. TRANSACTIONS WITH AFFILIATES
The general partners (or affiliates) are entitled to receive various
recurring fees for the supervision and administration of Partnership assets and
for providing the guaranty of minimum return to BAC holders and to be reimbursed
for certain expenses incurred on behalf of the Partnership. At September 30,
1996 and December 31, 1995 the accrued balance of these fees and reimbursements
totaled $302,723 and $609,615, respectively. For each of the nine month periods
ended September 30, 1996 and 1995, the expense for these recurring fees totaled
$902,989 and $906,814, respectively. These amounts are included in the
statements of operations as asset management fees and components of general and
administrative expense.
Properties are managed and leased by either third-party managing and
leasing agents or by affiliates of Equitable Real Estate, Compass Management and
Leasing, Inc. ("Compass") and Compass Retail, Inc. "Compass Retail"). Property
management fees are generally established at specified percentages of 1% to 5%
of gross receipts of the properties as defined in the management agreements.
Property management fees for
8
<PAGE> 10
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
properties managed by Compass and Compass Retail were $299,435 and $324,112 for
the nine months ended September 30, 1996 and 1995, respectively.
Leasing commissions are based on a percentage of the rent payable during
the term of the lease as specified in each lease agreement. Leasing commissions
incurred by the Venture and payable to Compass and Compass Retail were $62,059
and $42,063 for each of the nine month periods ended September 30, 1996 and
1995, respectively. Leasing commissions are capitalized as deferred leasing
costs on the balance sheet or expensed as real estate operating expenses on the
statements of operations in accordance with the Venture's capitalization policy.
The Venture reimbursed Compass and Compass Retail for payroll incurred of
$1,288,456 and $1,444,270 for each of the nine month periods ended September 30,
1996 and 1995, respectively. Payroll reimbursements are included in real estate
operating expenses on the statements of operations. Additionally, the Venture
paid construction management fees to Compass and Compass Retail in the amount of
$88,331 and $44,286 for each of the nine month periods ended September 30, 1996
and 1995, respectively. The construction management fees have been capitalized
as a portion of the construction projects to which they relate.
Compass Retail performed certain due diligence work with regard to the
workout arrangement with Midwest on the Brookdale zero note. Consulting fees
paid to Compass Retail for due diligence work are $72,047, of which the
Venture's portion is $51,630, for the nine month period ended September 30,
1996. The consulting fees are included in the statements of operations as a
component of real estate operating expenses.
3. GUARANTY AGREEMENT
EREIM LP Associates entered into a guaranty agreement with the Venture to
provide a minimum return to the Partnership's limited partners on their
contributions. The Venture has assigned its rights under the guaranty agreement
to the Partnership. Payments on the guaranty are due ninety days following the
earlier of the sale or other disposition of all the properties and mortgage
loans and notes or the liquidation of the Partnership.
The minimum return will be an amount which, when added to the cumulative
distributions to the limited partners, will enable the Partnership to provide
the limited partners with a minimum return equal to their capital contributions
plus a simple annual return of 9.75% on their adjusted capital contributions
calculated from the dates of the investor closings. Adjusted capital
contributions are the limited partners' original cash contributions reduced by
distributions of sale or financing proceeds and by distributions of certain
funds in reserves, as more particularly described in the Partnership Agreement.
The limited partners' original cash contributions have been adjusted by that
portion of distributions paid through September 30, 1996, resulting from cash
available to the Partnership as a result of sale or financing proceeds paid to
the Venture. The minimum return is subject to reduction in the event that
certain taxes, other than local property taxes, are imposed on the Partnership
or the Venture, and is also subject to certain other limitations set forth in
the prospectus. Based upon the assumption that the last property is sold on
December 31, 2002, upon expiration of the term of the Partnership, the maximum
liability of EREIM LP Associates to the Venture under the guaranty agreement as
of September 30, 1996 is limited to $244,892,172, plus the value of EREIM LP
Associates' interest in the Venture less any amounts contributed by EREIM LP
Associates to the Venture to fund cash deficits.
9
<PAGE> 11
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Capital contributions by the BAC Holders totaled $108,484,500. As of
September 30, 1996, the cumulative 9.75% simple annual return was $89,486,915.
As of September 30, 1996, cumulative distributions by the Partnership to the BAC
Holders totaled $16,337,751, of which $11,662,084 is attributable to income from
operations and $4,675,667 is attributable to sales of Venture assets, principal
payments on Mortgage Loans and other capital events. To the extent that future
cash distributions to the limited partners are insufficient to provide the
specified minimum return, any shortfall will be funded by the guarantor, up to
the above described maximum.
10
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the consolidated results of operations and
financial condition of the Partnership should be read in conjunction with the
consolidated financial statements and the related notes to consolidated
financial statements included elsewhere herein.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1996, the Partnership had cash and short-term
investments of approximately $2.0 million. Such cash and short-term investments
are available for distribution to the extent not required for working capital
and administration expenses.
In addition, at September 30, 1996, the Venture, in which the Partnership
owns an 80% interest, had approximately $23.3 million in short-term investments.
These funds are intended to be utilized primarily to fund the renovation work
expected on The Bank of Delaware Building, to fund possible costs incurred to
increase tenancy at Richland Mall, and to fund other general working capital
requirements. These funds, in addition to reserves from future operations, may
also be used to pay the Venture's pro rata share of costs incurred in connection
with the Brookdale zero coupon mortgage note, including legal costs with respect
to the Midwest bankruptcy proceeding as well as improvements deemed to be
necessary in the event title is transferred to the Venture and Equitable.
Management has established an enhancement, stabilization and renovation
program for The Bank of Delaware Building which was transferred to the Venture
by deed in lieu of foreclosure on November 15, 1994. Estimated costs for this
three year program total $4.3 million, of which $1.6 million was incurred in
1995, $1.3 million is expected to be incurred in 1996, and $1.4 million is
expected to be incurred in 1997. As of September 30, 1996, approximately $2.6
million of these costs have been expended. Included in the estimated $4.3
million of expenditures related to The Bank of Delaware renovation program is
approximately $2.3 million for asbestos abatement expected to be incurred evenly
over 1995, 1996, and 1997. Also included in the $4.3 million is $400,000 for
sprinkler installation and $400,000 for exterior deferred maintenance including
recaulking all four sides of the building. The other components of the
renovation program are minor interior common area and exterior plaza cosmetic
upgrades totaling approximately $600,000 to be incurred evenly over 1995 and
1996. Management expects these upgrades to give the building a fresher, more
inviting look. Additional costs not included in the above figures are estimated
tenant improvements of $2.5 million. The tenant improvement costs are directly
associated with actual leasing and will only be expended as leasing transactions
occur in the building. No significant leasing has occurred during the nine
months ended September 30, 1996.
The Venture anticipates expenditures to be incurred to increase tenancy at
Richland Mall of approximately $3.4 million, including $2.1 million for tenant
improvements in connection with leasing approximately 55,000 square feet of
space to Redner's Market. Clemens Market will vacate approximately 26,000 square
feet of space upon the expiration of its lease on December 31, 1996. Management
is negotiating a lease with Redner's Market that would involve expanding the
Clemens Market space, upon the expiration of its lease, into approximately
55,000 square feet of leasable space for Redner's Market. The Redner's Market
lease, expected to commence in March of 1998, has an anticipated term of twenty
years with renewal options thereafter. Also included in the estimated $3.4
million of expenditures is $1.3 million in connection with the relocation of
existing tenants to accommodate the Redner's store, lease
11
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
termination costs, and additional work necessary to reconfigure Richland
Mall for the Redner's Market expansion and additional, as yet unnamed, mall
stores.
Cash received from tenant-related revenues for the nine months ended
September 30, 1996 decreased approximately $500,000 compared to cash received
from tenant-related revenues for the nine months ended September 30, 1995. This
decrease is primarily due to the receipt, in the second quarter of 1995, of
approximately $1.8 million, of which the Venture's portion was approximately
$1.3 million, remitted by Kohl's Department Stores, Inc. ("Kohl's"), a former
tenant at Northland Center, pursuant to an agreement in connection with the
termination of Kohl's lease. This agreement released Kohl's from any remaining
obligation under the original lease agreement. This decrease is offset by the
receipt of tenant rentals during the first nine months of 1996.
Interest received for the nine month period ended September 30, 1996
increased approximately $2.4 million compared to interest received for the nine
month period ended September 30, 1995. This increase is primarily due to the
receipt of approximately $3.2 million, of which the Venture's portion was
approximately $2.3 million, which was remitted in connection with the Brookdale
Zero Note.
Cash paid for operating activities for the nine months ended September 30,
1996 decreased approximately $500,000 compared to cash paid for operating
activities for the nine months ended September 30, 1995. This decrease is
primarily due to the timing of the payment of operating expenses.
FINANCIAL CONDITION
Accounts receivable and accrued investment income decreased approximately
$1.4 million from December 31, 1995 to September 30, 1996. This decrease is
primarily due to the timing of the remittance of rental income. Additionally,
approximately $115,000 was received as payment for receivables in arrears in
connection with a bankruptcy settlement at 7550 Plaza Court. The Bank of
Delaware Building billed and collected approximately $130,000 in escalations
which were accrued as of December 31, 1995.
Prepaid expenses and other assets increased approximately $525,000 from
December 31, 1995 to September 30, 1996. This increase is primarily due to the
payment of real estate taxes at Northland Center.
Total liabilities decreased approximately $3.2 million from December 31,
1995 to September 30, 1996. This decrease is primarily due to the payment of
approximately $2.5 million of accrued construction costs, the payment of
semiannual distributions of $542,423 declared as of December 1995 and paid in
February 1996, and the semiannual payment of fees to affiliates of approximately
$600,000. This decrease is offset by the accrual of approximately $303,000 of
fees due to affiliates for the third quarter of 1996.
RESULTS OF OPERATIONS
Rental income for the nine months ended September 30, 1996 decreased
approximately $800,000 compared to the nine months ended September 30, 1995.
Rental income decreased approximately $1.1 million at Northland Center, of which
the Venture's portion was approximately $780,000, due to a decrease in common
area income, which resulted from a decrease in common area expenses, and the
recognition of bad debt on tenants' accounts past due.
12
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
Lease termination income for the nine months ended September 30, 1996
decreased approximately $1.4 million compared to the nine months ended
September 30, 1995. This decrease is primarily due to approximately $1.3
million of lease termination income which was recognized by the Venture during
the first quarter of 1995. Pursuant to an agreement with Kohl's, a former
tenant at Northland Center, Equitable agreed to accept approximately $1.8
million in connection with the termination of Kohl's lease on behalf of the
tenancy in common arrangement between the Venture and Equitable. The Venture's
portion of the termination payment was approximately $1.3 million. This
agreement released Kohl's from any remaining obligation under the original
lease agreement.
Interest on loans receivable for the three and nine months ended September
30, 1996 increased approximately $880,000 and $1.7 million respectively compared
to the three and nine months ended September 30, 1995. This increase is
primarily due to the receipt of cash in connection with the Brookdale zero note
of approximately $1.2 and $3.2 million for the three and nine months ended
September 30, 1996, respectively, of which the Venture's portion was
approximately $880,000 and $2.3 million, respectively. The Venture recorded cash
received under the terms of receivership and the cash collateral order as
interest income. The Venture recognized interest income of approximately
$615,000 on the Brookdale zero note for the nine months ended September 30,
1995.
Depreciation and amortization for the three and nine months ended September
30, 1996 increased by approximately $240,000 and $700,000, respectively compared
to the three and nine months ended September 30, 1995. This increase is
primarily due to the depreciation on approximately $11.0 million and $2.9
million of capital expenditures, of which the Venture's portion was
approximately $8.0 million and $2.1 million, respectively, at Northland Center
which were capitalized in the third quarter of 1995 and the first nine months of
1996, respectively. The remainder of the increase is due to the depreciation on
approximately $2.6 million which has been capitalized by the Venture in
connection with the enhancement, stabilization, and renovation program which was
established at the end of the second quarter of 1995 for the Bank of Delaware
Building.
The percentage of leased space at the Venture's properties at September 30,
1996 increased to 85.2% from the percentage of leased space at December 31, 1995
of 82.2%. This increase is primarily due to the leasing of 49,500 square feet at
7550 Plaza Court.
Under the terms of the Brookdale zero note, which is secured by Brookdale
Center, principal and interest in the aggregate amount of $35,368,572, of which
the Venture's portion is $25,345,353, was due on June 30, 1995. Midwest
defaulted on its obligation to repay the Brookdale zero note in full on the
maturity date. Notice of default was given to Midwest. For book purposes,
beginning with the second quarter of 1995, Management discontinued the accrual
of interest on the Brookdale zero note as the accreted value of the mortgage
approximated the estimated fair market value of Brookdale Center. Under the
terms of the mortgage agreement, however, the Venture continued to accrue
interest off the books at the effective implicit rate of 10.2% until June 30,
1995. On July 1, 1995, the Venture began to accrue interest off the books on the
Brookdale zero note at the default rate of 19.0%. Equitable and the Venture
(collectively referred to as "Lender") commenced foreclosure proceedings and a
court appointed receiver was named.
The receiver was responsible for collecting rent proceeds from the tenants
at Brookdale Center and applying the proceeds to payments of operating costs at
Brookdale Center. Any remaining funds were paid to
13
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
Lender on account of the Brookdale zero note. The Venture recorded cash received
from the operation of Brookdale Center as interest income. During the first
half of 1996, approximately $1,975,000 was remitted under the terms of the
receivership. The Venture's portion of these payments was approximately
$1,415,000.
As of September 30, 1995, an internal review of the Brookdale Center was
performed for the Venture. Based on this review, the estimated fair market value
of Brookdale Center was $30,000,000. The Venture recorded a valuation allowance
of $3,232,210 to value the note at an amount equal to the Venture's
participation interest in the note multiplied by the estimated fair market value
of Brookdale Center, or $21,498,199.
In April, 1996 the Lender agreed in principle to a workout arrangement with
Midwest on the Brookdale zero note under which Midwest would file for Chapter 11
bankruptcy protection and, with the support of the Lender, submit a plan of
reorganization to the Bankruptcy Court for approval. The workout arrangement was
memorialized in a nonbinding letter agreement dated April 11, 1996 (the "Letter
Agreement") between Midwest and Equitable and approved by the Board of Directors
of EREIM Managers Corp., the general partner of the Partnership, on behalf of
the Venture.
On June 20, 1996 Midwest filed a voluntary petition for Chapter 11
bankruptcy protection, staying the Brookdale foreclosure proceeding and
terminating the receivership arrangement. However, as contemplated by the Letter
Agreement, Midwest subsequently obtained Bankruptcy Court approval to retain the
management company that had served as receiver prior to the bankruptcy filing as
Brookdale's property manager. In addition, the Bankruptcy Court, with agreement
of Midwest and Lender, entered a cash collateral order, pursuant to which all
positive cash flow generated by the property in excess of property-related
expenses and certain administrative costs of the bankruptcy, not to exceed
$25,000, will be paid to the Lender during the bankruptcy. The Venture records
cash received from the operation of Brookdale Center as interest income. During
the third quarter of 1996 approximately $1,224,000 was remitted under the terms
of the cash collateral order. The Venture's portion of these payments was
approximately $877,000.
Consistent with the Letter Agreement, Midwest filed a plan of
reorganization with the Bankruptcy Court on August 23, 1996. The material
provisions of the plan, which is subject to the approval of the Bankruptcy Court
are as follows:
- The Brookdale zero note will remain in default.
- Midwest will market the property for sale to potential third-party
purchasers through November 15, 1996.
- Lender will fund any necessary capital and leasing costs approved by
Midwest and Lender through a super-priority, non-recourse, debtor in
possession loan by Lender.
- The net proceeds generated through a sale of the property to a
third-party purchaser, after payment of the costs of sale and repayment of
the amounts owed to Lender under the debtor-in possession financing, first
shall be paid on a pari passu basis $750,000 to Midwest and $30,000,000 to
Lender, second shall be split 50-50 between Midwest and Lender up to a
total of $6,000,000, and third shall thereafter be remitted to Midwest.
- If Midwest receives and wishes to accept a third-party offer to purchase
the property for a price that will produce net sales proceeds of less than
$30,750,000, then Lender shall have the option either to
14
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
consent to such sale or purchase the property for an amount equal to
$500,000 plus 2.5% of the amount by which the net sales proceeds under the
third-party offer exceeds $20,000,000.
- If no third-party offer is received by November 15, 1996, or if a
third-party purchaser has failed to close its acquisition of the property
by December 1, 1996, both Midwest and Lender will have the right to cause
the property to be conveyed to Equitable and the Venture as joint tenants.
The purchase price for the property shall be $500,000, and the property
shall be conveyed to Equitable and the Venture subject to, among other
things, the mortgage securing the Brookdale zero note and the mortgage
securing Lender's debtor-in-possession financing.
- Lender will be granted certain limited rights of first refusal to
purchase the property, and Lender will be granted, during the bankruptcy,
various rights to discuss with third-parties the possible renovation of
the property should Lender acquire ownership of the property.
To date, Midwest has not received a third-party offer to purchase the
property which would produce net sales proceeds of at least $30,750,000 or any
third-party offer at a lesser price acceptable to Equitable and the Venture.
Consequently, Management believes that upon approval of the plan, it is likely
that the property will be conveyed to Equitable and the Venture for a
purchase price of $500,000.
On October 30, 1996, the plaintiffs in one of the class action suits
previously filed against Midwest, Equitable and others (see "Legal Proceedings")
filed a claim for equitable subordination against Equitable in the Midwest
bankruptcy proceeding. The claim alleges, among other things, that Equitable
breached a fiduciary duty to Midwest's investors and violated federal securities
laws in connection with the initial sale of interests in Midwest and, as such,
that Equitable should not be entitled to preferential treatment in bankruptcy
court. If the claim were to be successful as asserted, Equitable and the Venture
would not be entitled to the benefits of the plan. Management believes, however,
that the bankruptcy court is unlikely to find in favor of the claimants and that
the claim can be disposed of without adversely impacting the Venture's
interests.
Equitable and the Venture have entered into an agreement between themselves
to support Midwest's plan of reorganization as outlined in the Letter Agreement,
to make all decisions regarding the plan of reorganization jointly, and to share
all expenses, on a pro rata basis, in connection with the bankruptcy and all
undertakings jointly agreed upon by Equitable and the Venture in accordance with
their participation interests in the Brookdale zero note.
Midwest is subject to the informational requirements under the Securities
Exchange Act, and in accordance therewith files reports and other information,
including financial statements, with the Securities and Exchange Commission
(SEC) under Commission File No. 1-9331. Such reports and other information filed
by Midwest can be inspected and copied at the public reference facilities
maintained by the SEC in Washington, D.C. and at certain Regional Offices, and
copies may be obtained from the Public Reference Section of the SEC, Washington,
D.C. 20549 at prescribed rates.
Inflation has been at relatively low levels during the periods presented in
the financial statements and, as a result, has not had a significant effect on
the operations of the Partnership, the Venture or their investments. Over the
past several years, the rate of inflation has exceeded the rate of rental rate
growth in many of the Venture's properties. During the recent real estate
downturn, rental rates dropped, indicating a negative growth rate. This negative
growth appears to have ceased, and rental rates have stabilized in many of the
properties' markets. Real recovery in rental rates, if achieved at all, will
likely occur over an extended period of time.
15
<PAGE> 17
PART II
Item 1. Legal Proceedings
There are no pending legal proceedings material to the Partnership to
which the Partnership, the Venture, any of the Properties, or to the knowledge
of the Managing General Partner, the properties that secure the Mortgage loans
are subject.
Several class action suits have been filed against Midwest, the general
partner of Midwest, certain officers of such general partner, Lehman Brothers,
Inc., Equitable, and Equitable Real Estate. The complaints allege, among other
things, that the defendants breached their fiduciary duties and violated
federal securities laws in connection with the initial sale of BAC's, the
operation of Midwest, and the sale of Northland Center to the Venture and
Equitable. Neither the Venture nor the Partnership has been named as a party to
any such suits.
On October 30, 1996, the plaintiffs in one of the class action suits
previously filed against Midwest, Equitable and others filed a claim for
equitable subordination against Equitable in the Midwest bankruptcy proceeding.
The claim alleges, among other things, that Equitable breached a fiduciary duty
to Midwest's investors and violated federal securities laws in connection with
the initial sale of interests in Midwest and, as such, that Equitable should
not be entitled to preferential treatment in bankruptcy court. If the claim
were to be successful as asserted, Equitable and the Venture would not be
entitled to the benefits of the plan. Management believes, however, that the
bankruptcy court is unlikely to find in favor of the claimants and that the
claim can be disposed of without adversely impacting the Venture's interests.
Item 2. Changes in Securities
Response: None
Item 3. Default Upon Senior Securities
Response: None
Item 4. Submission of Matters to a Vote of Security Holders
Response: None
Item 5. Other Information
Response: None
Item 6. Exhibits and Reports on Form 8-K
Response:
a) Exhibits
27 Financial Data Schedule (for SEC filing purposes only)
b) Reports
None
16
<PAGE> 18
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Partnership has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
ML/EQ Real Estate Portfolio, L.P.
By: EREIM Managers Corp.
Managing General Partner
By: /s/ Patricia C. Snedeker
-----------------------------
Patricia C. Snedeker
Vice President, Controller
and Treasurer
(Principal Accounting Officer)
Dated: November 14, 1996
17
<PAGE> 19
EXHIBIT INDEX
Exhibit No. Description
- ----------- ------------------------------------------------------
27 Financial Data Schedule (for SEC filing purposes only)
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF ML/EQ REAL ESTATE PORTFOLIO LP FOR THE PERIOD ENDED
SEPTEMBER 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 25,351,111
<SECURITIES> 0
<RECEIVABLES> 2,661,665
<ALLOWANCES> 495,209
<INVENTORY> 0
<CURRENT-ASSETS> 28,537,812
<PP&E> 128,406,351
<DEPRECIATION> 15,131,922
<TOTAL-ASSETS> 174,033,086
<CURRENT-LIABILITIES> 2,888,823
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 137,227,886
<TOTAL-LIABILITY-AND-EQUITY> 174,033,086
<SALES> 0
<TOTAL-REVENUES> 18,506,875
<CGS> 0
<TOTAL-COSTS> 7,984,483
<OTHER-EXPENSES> 2,892,802
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,401,588
<INCOME-TAX> 0
<INCOME-CONTINUING> 4,890,621
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,890,621
<EPS-PRIMARY> .86
<EPS-DILUTED> 0
</TABLE>
