ITEM 1. FINANCIAL STATEMENTS
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
|
|
|
September 30,
2019
|
|
|
December 31,
2018
|
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
|
|
|
(dollars in thousands, except par value amount)
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes and interest receivable from related parties
|
|
$
|
13,578
|
|
|
$
|
14,030
|
|
|
Total notes and interest receivable
|
|
|
13,578
|
|
|
|
14,030
|
|
|
Cash and cash equivalents
|
|
|
1
|
|
|
|
4
|
|
|
Receivable and accrued interest from related parties
|
|
|
85,629
|
|
|
|
82,089
|
|
|
Total assets
|
|
$
|
99,208
|
|
|
$
|
96,123
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders’ Equity
|
|
|
|
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|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts payable and other liabilities
|
|
$
|
24
|
|
|
$
|
26
|
|
|
Total liabilities
|
|
|
24
|
|
|
|
26
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
|
|
|
Common stock, $0.01 par value, authorized 10,000,000 shares; issued 4,173,675 and outstanding 4,168,214 shares in 2019 and 2018
|
|
|
42
|
|
|
|
42
|
|
|
Treasury stock at cost, 5,461 shares in 2019 and 2018
|
|
|
(39
|
)
|
|
|
(39
|
)
|
|
Paid-in capital
|
|
|
61,955
|
|
|
|
61,955
|
|
|
Retained earnings
|
|
|
37,226
|
|
|
|
34,139
|
|
|
Total shareholders’ equity
|
|
|
99,184
|
|
|
|
96,097
|
|
|
Total liabilities and shareholders’ equity
|
|
$
|
99,208
|
|
|
$
|
96,123
|
|
The accompanying notes are an integral part of these consolidated financial statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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|
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Three Months Ended
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|
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Nine Months Ended
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|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
|
|
|
(dollars in thousands, except per share amounts)
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative (including $61 and $67 for the three months and $209 and $201 for the nine months ended 2019 and 2018, respectively, to related parties)
|
|
$
|
99
|
|
|
$
|
83
|
|
|
$
|
407
|
|
|
$
|
359
|
|
|
Net income fee to related party
|
|
|
83
|
|
|
|
383
|
|
|
|
273
|
|
|
|
489
|
|
|
Advisory fee to related party
|
|
|
186
|
|
|
|
168
|
|
|
|
550
|
|
|
|
500
|
|
|
Total operating expenses
|
|
|
368
|
|
|
|
634
|
|
|
|
1,230
|
|
|
|
1,348
|
|
|
Net operating loss
|
|
|
(368
|
)
|
|
|
(634
|
)
|
|
|
(1,230
|
)
|
|
|
(1,348
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expenses):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income from related parties
|
|
|
1,672
|
|
|
|
1,201
|
|
|
|
4,991
|
|
|
|
3,324
|
|
|
Other Income
|
|
|
—
|
|
|
|
—
|
|
|
|
147
|
|
|
|
—
|
|
|
Total other income
|
|
|
1,672
|
|
|
|
1,201
|
|
|
|
5,138
|
|
|
|
3,324
|
|
|
Income before gain on sale of real estate land
|
|
|
1,304
|
|
|
|
567
|
|
|
|
3,908
|
|
|
|
1,976
|
|
|
Gain on sale of real estate land
|
|
|
—
|
|
|
|
7,323
|
|
|
|
—
|
|
|
|
7,323
|
|
|
Income before income taxes
|
|
|
1,304
|
|
|
|
7,890
|
|
|
|
3,908
|
|
|
|
9,299
|
|
|
Income tax expense
|
|
|
274
|
|
|
|
1,902
|
|
|
|
821
|
|
|
|
1,902
|
|
|
Net income
|
|
$
|
1,030
|
|
|
$
|
5,988
|
|
|
$
|
3,087
|
|
|
$
|
7,397
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share - basic and diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
0.25
|
|
|
$
|
1.44
|
|
|
$
|
0.74
|
|
|
$
|
1.77
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares used in computing earnings per share
|
|
|
4,168,214
|
|
|
|
4,168,214
|
|
|
|
4,168,214
|
|
|
|
4,168,214
|
|
The accompanying notes are an integral part of these consolidated financial statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Nine Months Ended September 30, 2019 and 2018
(dollars in thousands)
(Unaudited)
|
|
|
|
|
|
Common Stock
|
|
|
Treasury
|
|
|
Paid-in
|
|
|
Retained
|
|
|
|
|
Total
|
|
|
Shares
|
|
|
Amount
|
|
|
Stock
|
|
|
Capital
|
|
|
Earnings
|
|
|
Balance, December 31, 2018
|
|
$
|
96,097
|
|
|
|
4,173,675
|
|
|
$
|
42
|
|
|
$
|
(39
|
)
|
|
$
|
61,955
|
|
|
$
|
34,139
|
|
|
Net income
|
|
|
3,087
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,087
|
|
|
Balance, September 30, 2019
|
|
$
|
99,184
|
|
|
|
4,173,675
|
|
|
$
|
42
|
|
|
$
|
(39
|
)
|
|
$
|
61,955
|
|
|
$
|
37,226
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Treasury
|
|
|
Paid-in
|
|
|
Retained
|
|
|
|
|
Total
|
|
|
Shares
|
|
|
Amount
|
|
|
Stock
|
|
|
Capital
|
|
|
Earnings
|
|
|
Balance, December 31, 2017
|
|
$
|
87,887
|
|
|
|
4,173,675
|
|
|
$
|
42
|
|
|
$
|
(39
|
)
|
|
$
|
61,955
|
|
|
$
|
25,929
|
|
|
Net income
|
|
|
7,397
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
7,397
|
|
|
Balance, September 30, 2018
|
|
$
|
95,284
|
|
|
|
4,173,675
|
|
|
$
|
42
|
|
|
$
|
(39
|
)
|
|
$
|
61,955
|
|
|
$
|
33,326
|
|
The accompanying notes are an integral part of these consolidated financial statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Cash Flow From Operating Activities:
|
|
(dollars in thousands)
|
|
|
Net income
|
|
$
|
3,087
|
|
|
$
|
7,397
|
|
|
Adjustments to reconcile net income applicable to common shares to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
Gain on sale of real estate land
|
|
|
—
|
|
|
|
(7,323
|
)
|
|
(Increase) decrease in assets:
|
|
|
|
|
|
|
|
|
|
Accrued interest receivable from related parties
|
|
|
452
|
|
|
|
453
|
|
|
Other assets
|
|
|
—
|
|
|
|
725
|
|
|
Increase (decrease) in other liabilities
|
|
|
(2
|
)
|
|
|
4
|
|
|
Net cash provided by operating activities
|
|
|
3,537
|
|
|
|
1,256
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flow From Investing Activities:
|
|
|
|
|
|
|
|
|
|
Related Party Receivables
|
|
|
(3,540
|
)
|
|
|
(23,807
|
)
|
|
Proceeds from sale of real estate land
|
|
|
—
|
|
|
|
22,550
|
|
|
Net cash used in investing activities
|
|
|
(3,540
|
)
|
|
|
(1,257
|
)
|
|
Net (decrease) increase in cash and cash equivalents
|
|
|
(3
|
)
|
|
|
(1
|
)
|
|
Cash and cash equivalents, beginning of period
|
|
|
4
|
|
|
|
2
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
1
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Non Cash Items:
|
|
|
|
|
|
|
|
|
|
Non cash transfer of land to related party
|
|
$
|
—
|
|
|
$
|
(7,490
|
)
|
|
Utilization of deferred tax asset
|
|
$
|
—
|
|
|
$
|
(792
|
)
|
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
As used herein, the terms “IOR”, “the Company”, “we”, “our”, “us” refer to Income Opportunity Realty Investors, Inc., a Nevada corporation, individually or together with its subsidiaries. Income Opportunity Realty Investors, Inc. is the successor to a California business trust organized on December 14, 1984, which commenced operations on April 10, 1985. The Company is headquartered in Dallas, Texas, and its common stock trades on the NYSE American under the symbol (“IOR”).
Transcontinental Realty Investors, Inc. (“TCI”) owns approximately 81.25% of the Company’s common stock. Effective July 17, 2009, IOR’s financial results were consolidated with those of American Realty Investors, Inc. (“ARL”) and TCI and their subsidiaries. IOR is a “C” corporation for U.S. federal income tax purposes and files an annual consolidated income tax return with ARL and its ultimate parent, May Realty Holdings, Inc. (“MRHI”). We have no employees.
IOR invests in real estate through direct ownership, leases and partnerships and also invests in mortgage loans on real estate. Pillar Income Asset Management, Inc. (“Pillar”) is the Company’s external Advisor and Cash Manager. Although the Board of Directors is directly responsible for managing the affairs of IOR, and for setting the policies which guide it, the day-to-day operations of IOR are performed by Pillar, as the contractual Advisor, under the supervision of the Board. Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities and arranging debt and equity financing for the Company with third party lenders and investors. Additionally, Pillar serves as a consultant to the Board with regard to their decisions in connection with IOR’s business plan and investment policy. Pillar also serves as an Advisor and Cash Manager to TCI and ARL.
Our primary business is investing in real estate and financing real estate and real estate-related activities through investments in mortgage loans. As of September 30, 2019 and December 31, 2018, we had no real estate holdings. At September 30, 2019, the principal source of revenue for the Company is interest income on approximately $95.9 million of receivables due from related parties, out of which, $13.1 million are due from United Housing Foundation, Inc. (“UHF”) (Refer to Note 2).
Basis of Presentation
The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted in accordance with such rules and regulations, although management believes the disclosures are adequate to prevent the information presented from being misleading. In the opinion of management, all adjustments (consisting of normal recurring matters) considered necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2019, are not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year. As of September 30, 2019 and December 31, 2018, IOR was not the primary beneficiary of a variable interest entity (“VIE”).
The year-end Consolidated Balance Sheet at December 31, 2018, was derived from the audited Consolidated Financial Statements at that date, but does not include all of the information and disclosures required by U.S. GAAP for complete financial statements. For further information, refer to the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
Real Estate, Depreciation and Impairment
Real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired. Major replacements and betterments are capitalized and depreciated over their estimated useful lives. Depreciation is computed on a straight-line basis over the useful lives of the properties (buildings and improvements – 10-40 years; furniture, fixtures and equipment – 5-10 years). The Company continually evaluates the recoverability of the carrying value of our real estate assets using the methodology prescribed in ASC Topic 360, “Property, Plant and Equipment”. Factors considered by management in evaluating impairment of our existing real estate assets held for investment include significant declines in property operating profits, annually recurring property operating losses and other significant adverse changes in general market conditions that are considered permanent in nature. Under ASC Topic 360, a real estate asset held for investment is not considered impaired if the undiscounted, estimated future cash flows of an asset (both the annual estimated cash flow from future operations and the estimated cash flow from the theoretical sale of the asset) over its estimated holding period are in excess of the asset’s net book value at the balance sheet date. If any real estate asset held for investment is considered impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value.
Real Estate Held For Sale
We periodically classify real estate assets as “held for sale”. An asset is classified as held for sale after the approval of our Board of Directors, after an active program to sell the asset has commenced and if the sale is probable. One of the deciding factors in determining whether a sale is probable is whether a firm purchase commitment is obtained and whether the sale is probable within the year. Upon the classification of a real estate asset as held for sale, the carrying value of the asset is reduced to the lower of its net book value or its estimated fair value, less costs to sell the asset. Subsequent to the classification of assets as held for sale, no further depreciation expense is recorded. Real estate assets held for sale are stated separately on the accompanying Consolidated Balance Sheets. Upon a decision that the sale is no longer probable, the asset is classified as an operating asset and depreciation expense is reinstated.
Cost Capitalization
The cost of buildings and improvements includes the purchase price of the property, legal fees and other acquisition costs. Costs directly related to planning, developing, initial leasing and constructing a property are capitalized and classified as Real Estate in the Consolidated Balance Sheets. Capitalized development costs include interest, property taxes, insurance, and other direct project costs incurred during the period of development.
A variety of costs are incurred in the acquisition, development and leasing of properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. Our capitalization policy on development properties is guided by ASC 835-20 Interest – Capitalization of Interest and ASC 970 Real Estate - General. The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We consider a construction project as substantially completed and held available for occupancy upon the receipt of certificates of occupancy, but no later than one year from cessation of major construction activity. We cease capitalization on the portion (1) substantially completed and (2) occupied or held available for occupancy, and we capitalize only those costs associated with the portion under construction.
Fair Value Measurement
We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures”, to the valuation of real estate assets. These provisions define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date, establish a hierarchy that prioritizes the information used in developing fair value estimates and require disclosure of fair value measurements by level within the fair value hierarchy. The hierarchy gives the highest priority to quoted prices in active markets (Level 1 measurements) and the lowest priority to unobservable data (Level 3 measurements), such as the reporting entity’s own data.
The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and includes three levels defined as follows:
|
Level 1 –
|
Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets.
|
|
|
|
|
Level 2 –
|
Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
|
|
|
|
|
Level 3 –
|
Unobservable inputs that are significant to the fair value measurement.
|
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Related Parties
We apply ASC Topic 805, “Business Combinations”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.
Newly Issued Accounting Pronouncements
We have considered all other newly issued accounting guidance that is applicable to our operations and the preparation of our statements, including that which we have not yet adopted. We do not believe that any such guidance will have a material effect on our financial position or results of operations.
NOTE 2. NOTES AND INTEREST RECEIVABLE FROM RELATED PARTIES
Notes and interest receivable from related parties is comprised of junior mortgage loans, which are loans secured by mortgages that are subordinate to one or more prior liens on the underlying real estate. Recourse on the loans ordinarily includes the real estate which secures the loan, other collateral and personal guarantees of the borrower.
The Company has various notes receivable from Unified Housing foundation, Inc. “UHF”. UHF is determined to be a related party due to our significant investment in the performance of the collateral secured under the notes receivable. Payments are due from surplus cash flow from operations, sale or refinancing of the underlying properties. These notes are cross collateralized to the extent that any surplus cash available from any of the properties underlying these notes will be used to repay outstanding interest and principal for the remaining notes. Furthermore, any surplus cash available from any of the properties UHF owns, besides the properties underlying these notes, can be used to repay outstanding interest and principal for these notes. The allowance on the notes was a purchase allowance that was netted against the notes when acquired.
At September 30, 2019, we had mortgage loans and accrued interest
receivable from related parties, net of allowances, totaling $13.6 million. As of September 30, 2019, we recognized interest income
of $1.3 million related to these notes receivable. Below is a summary of notes and interest receivable from related parties
(dollars in thousands):
|
|
|
Maturity
|
|
Interest
|
|
|
|
|
|
|
|
|
Borrower
|
|
Date
|
|
Rate
|
|
|
Amount
|
|
|
Collateral
|
|
|
Performing loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unified Housing Foundation, Inc. (Echo Station)
|
|
12/32
|
|
|
12.00
|
%
|
|
$
|
1,481
|
|
|
Secured
|
|
|
Unified Housing Foundation, Inc. (Lakeshore Villas)
|
|
12/32
|
|
|
12.00
|
%
|
|
|
2,000
|
|
|
Secured
|
|
|
Unified Housing Foundation, Inc. (Lakeshore Villas)
|
|
12/32
|
|
|
12.00
|
%
|
|
|
6,369
|
|
|
Secured
|
|
|
Unified Housing Foundation, Inc. (Limestone Ranch)
|
|
12/32
|
|
|
12.00
|
%
|
|
|
1,953
|
|
|
Secured
|
|
|
Unified Housing Foundation, Inc. (Timbers of Terrell)
|
|
12/32
|
|
|
12.00
|
%
|
|
|
1,323
|
|
|
Secured
|
|
|
Total Notes Receivable
|
|
|
|
|
|
|
|
|
13,126
|
|
|
|
|
|
Accrued interest
|
|
|
|
|
|
|
|
|
452
|
|
|
|
|
|
Total Performing
|
|
|
|
|
|
|
|
$
|
13,578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All are related party notes.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 3. RECEIVABLE FROM AND PAYABLE TO RELATED PARTIES
From time to time, IOR and its related parties have made unsecured advances to each other which include transactions involving the purchase, sale, and financing of property. In addition, we have a cash management agreement with our Advisor. The agreement provides for excess cash to be invested in and managed by our Advisor, Pillar, a related party.
The table below reflects the various transactions between IOR, Pillar, and TCI (dollars in thousands):
|
|
|
TCI
|
|
|
Balance, December 31, 2018
|
|
$
|
82,089
|
|
|
Cash transfers
|
|
|
3,007
|
|
|
Advisory fees
|
|
|
(550
|
)
|
|
Net income fee
|
|
|
(273
|
)
|
|
Cost reimbursements
|
|
|
(2,289
|
)
|
|
Expenses Paid by Advisor
|
|
|
(4
|
)
|
|
Interest income
|
|
|
3,649
|
|
|
Balance, September 30, 2019
|
|
$
|
85,629
|
|
We have historically engaged in and will continue to engage in certain business transactions with related parties, including but not limited to asset acquisitions and dispositions. Transactions involving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in the best interest of the Company.
NOTE 4. COMMITMENTS AND CONTINGENCIES
Litigation. The Company and its subsidiaries, from time to time, have been involved in various items of litigation incidental to and in the ordinary course of its business and, in the opinion of management, the outcome of such litigation will not have a material adverse impact upon the Company’s financial condition, results of operations or liquidity.
Berger Litigation
On February 4, 2019, an individual claiming to be a stockholder holding 7,900 shares of Common Stock of Income Opportunity Realty Investors, Inc. (“IOR”) filed a Complaint in the United States District Court for the Northern District of Texas, Dallas Division, individually and allegedly derivatively on behalf of IOR, against Transcontinental Realty Investors, Inc. (“TCI”), American Realty Investors, Inc. (“ARL”), (TCI is a shareholder of IOR, ARL is a shareholder of TCI) Pillar Income Asset Management, Inc. (“Pillar”), ( collectively the “Companies”), certain officers and directors of the Companies (“Additional Parties”) and two other individuals. The Complaint filed alleges that the sale and/or exchange of certain tangible and intangible property between the Companies and IOR during the last ten years of business operations constitutes a breach of fiduciary duty by the one or more of Companies, the Additional Defendants and/or the directors of IOR. The case alleges other related claims. The Plaintiff seeks certification as a representative of IOR and all of its shareholders, unspecified damages, a return to IOR of various funds and an award of costs, expenses, disbursements (including Plaintiff’s attorneys’ fees) and prejudgment and post-judgment interest. The named Defendants intend to vigorously defend the action, deny all of the allegations of the Complaint, and believe the allegations to be wholly without any merit. The Defendants have filed motions to dismiss the case in its entirety which are currently pending.
NOTE 5. SUBSEQUENT EVENTS
The Company has evaluated subsequent events through November 14, 2019, the date the Consolidated Financial Statements were available to be issued, and has determined that there are none to be reported.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report.
This Report on Form 10-Q may contain forward-looking statements within the meaning of the federal securities laws, principally, but not only, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. We caution investors that any forward-looking statements in this report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions made by, and information currently available to, management. When used, the words “anticipate”, “believe”, “expect”, “intend”, “may”, “might”, “plan”, “estimate”, “project”, “should”, “will”, “result” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements. These statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution you that, while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update our forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.
Some of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:
|
|
●
|
general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, dependence on tenants’ financial condition, and competition from other developers, owners and operators of real estate);
|
|
|
|
|
|
|
●
|
risks associated with the availability and terms of construction and mortgage financing and the use of debt to fund acquisitions and developments;
|
|
|
|
|
|
|
●
|
demand for apartments and commercial properties in the Company’s markets and the effect on occupancy and rental rates;
|
|
|
|
|
|
|
●
|
the Company’s ability to obtain financing, enter into joint venture arrangements in relation to or self-fund the development or acquisition of properties;
|
|
|
|
|
|
|
●
|
risks associated with the timing and amount of property sales and the resulting gains/losses associated with such sales;
|
|
|
|
|
|
|
●
|
failure to manage effectively our growth and expansion into new markets or to integrate acquisitions successfully;
|
|
|
●
|
risks and uncertainties affecting property development and construction (including, without limitation, construction delays, cost overruns, inability to obtain necessary permits and public opposition to such activities);
|
|
|
|
|
|
|
●
|
risks associated with downturns in the national and local economies, increases in interest rates, and volatility in the securities markets;
|
|
|
|
|
|
|
●
|
costs of compliance with the Americans with Disabilities Act and other similar laws and regulations;
|
|
|
|
|
|
|
●
|
potential liability for uninsured losses and environmental contamination; and
|
|
|
●
|
risks associated with our dependence on key personnel whose continued service is not guaranteed.
|
The risks included here are not exhaustive. Some of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those expressed or implied by forward-looking statements, include among others, the factors listed and described in Part I, Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K, which investors should review. There have been no changes from the risk factors previously described in the Company’s Form 10-K for the fiscal year ended December 31, 2018.
Other sections of this report may also include suggested factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for management to predict all such matters; nor can we assess the impact of all such matters on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and to other materials we may furnish to the public from time to time through Forms 8-K or otherwise as we file them with the SEC.
Overview
We are an externally advised and managed real estate investment company. We have no employees.
As of September 30, 2019, our primary source of revenue is from the interest income on $95.9 million of receivables (out of which $13.1 million represents notes receivable) due from related parties.
We have historically engaged in, and may continue to engage in, certain business transactions with related parties, including but not limited to asset acquisition and dispositions. Transactions involving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in our best interest.
Pillar is the Company’s external Advisor and Cash Manager. Although the Board of Directors is directly responsible for managing the affairs of IOR, and for setting the policies which guide it, the day-to-day operations of IOR are performed by Pillar, as the contractual Advisor, under the supervision of the Board. Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities and arranging debt and equity financing for the Company with third party lenders and investors. Additionally, Pillar serves as a consultant to the Board with regard to their decisions in connection with IOR’s business plan and investment policy. Pillar also serves as an Advisor and Cash Manager to TCI and ARL.
Critical Accounting Policies
We present our Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) is the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP.
The accompanying unaudited Consolidated Financial Statements include our accounts, our subsidiaries, generally all of which are wholly-owned, and all entities in which we have a controlling interest. As of September 30, 2019, IOR is not the primary beneficiary of a VIE.
The Company does not have any entities in which we have less than a controlling financial interest or entities where it is not deemed to be the primary beneficiary.
Real Estate
Upon acquisitions of real estate, we assess the fair value of acquired tangible and intangible assets, including land, buildings, tenant improvements, “above-market” and “below-market” leases, origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities in accordance with ASC Topic 805 “Business Combinations”, and allocate the purchase price to the acquired assets and assumed liabilities, including land at appraised value and buildings at replacement cost.
We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, as well as available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant. We also consider an allocation of purchase price of other acquired intangibles, including acquired in-place leases that may have a customer relationship intangible value, including (but not limited to) the nature and extent of the existing relationship with the tenants, the tenants’ credit quality and expectations of lease renewals.
A variety of costs are incurred in the acquisition, development and leasing of properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. Our capitalization policy on development properties is guided by ASC Topic 835-20 “Interest – Capitalization of Interest” and ASC Topic 970 “Real Estate – General”. The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We cease capitalization when a building is considered substantially complete and ready for its intended use, but no later than one year from the cessation of major construction activity.
Depreciation and Impairment
Real estate is stated at depreciated cost. The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition costs. Costs directly related to the development of properties are capitalized. Capitalized development costs include interest, property taxes, insurance, and other project costs incurred during the period of development.
Management reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates impairment in value. An impairment loss is recognized if the carrying amount of its assets is not recoverable and exceeds its fair value. If such impairment is present, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods.
Recognition of Revenue
Our revenues are composed largely of interest income on notes receivable recorded in accordance with the terms of the notes.
Revenue Recognition on the Sale of Real Estate
Sales and the associated gains or losses of real estate assets are recognized in accordance with the provisions of ASC Topic 360-20, “Property, Plant and Equipment – Real Estate Sale”. The specific timing of a sale is measured against various criteria in ASC Topic 360-20 related to the terms of the transaction and any continuing involvement in the form of management or financial assistance associated with the properties. If the sales criteria for the full accrual method are not met, we defer some or all of the gain recognition and account for the continued operations of the property by applying the finance, leasing, deposit, installment or cost recovery methods, as appropriate, until the sales criteria are met.
Non-Performing Notes Receivable
We consider a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower is not making interest payments in accordance with the terms of the agreement.
Allowance for Estimated Losses
We assess the collectability of notes receivable on a periodic basis, of which the assessment consists primarily of an evaluation of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment. See Note 3 “Notes and Interest Receivable from Related Parties” for details on our notes receivable.
Fair Value of Financial Instruments
We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures and includes three levels defined as follows:”
|
Level 1 –
|
Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets.
|
|
|
|
|
Level 2 –
|
Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
|
|
|
|
|
Level 3 –
|
Unobservable inputs that are significant to the fair value measurement.
|
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Related Parties
We apply ASC Topic 805, “Business Combinations,” to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, or affiliates of the entity.
Results of Operations
The following discussion is based on our “Statement of Operations” for the three and nine months ended September 30, 2019 and 2018, as included in Part I, Item 1. “Financial Statements” of this report. It is not meant to be an all-inclusive discussion of the changes in our net income applicable to common shares. Instead, we have focused on significant fluctuations within our operations that we feel are relevant to obtain an overall understanding of the change in income applicable to common shareholders.
Our primary business is investing in real estate and financing real estate and real estate-related activities through investments in mortgage loans. As of September 30, 2019, we had no real estate holdings and our principal source of revenue is interest income generated from notes receivables due from related parties. We also receive interest income from the funds deposited with our Advisor at a rate of prime plus 1%. Our operating expenses consist mainly of general and administration costs related to the Company.
Comparison of the three months ended September 30, 2019 to the same period ended 2018:
We had net income of $1.0 million or $0.25 per diluted share for the three months ended September 30, 2019, compared to net income of $6 million or $1.44 per diluted share for the same period ended 2018.
Expenses
General and administrative expenses were $99 thousand for the three months ended September 30, 2019. This represents an increase of $16 thousand, compared to general and administrative expenses of $83 thousand for the three months ended September 30, 2018. This increase was primarily driven by an increase in legal fees of approximately $17 thousand.
Net income fee to related party was $83 thousand for the three months ended September 30, 2019. This represents a decrease of $299 thousand, compared to the net income fee of $382 thousand for the three months ended September 30, 2018. The net income fee paid to our Advisor is calculated at 7.5% of net income.
Advisory fees were $186 thousand for the three months ended September 30, 2019 compared to $168 thousand for the same period in 2018 for an increase of $18 thousand. Advisory fees are computed based on a gross asset fee of 0.0625% per month (0.75% per annum) of the average of the gross asset value.
Other income (expense)
Interest income increased to $1.7 million for the three months ended September 30, 2019 compared to $1.2 million for the same period in 2018. The increase of $500 thousand was primarily due to an increase in the receivable amount owed from our Advisor and other related parties.
Comparison of the nine months ended September 30, 2019 to the same period ended 2018:
We had net income of $3.1 million or $0.74 earnings per diluted share for the nine months ended September 30, 2019 compared to net income of $7.4 million or $1.77 earnings per diluted share for the same period in 2018.
Expenses
General and administrative expenses were $407 thousand for the nine months ended September 30, 2019 compared to $359 thousand for the prior period for an increase of $48 thousand. The increase was primarily due to an increase in legal fees of approximately $41 thousand.
Net income fee to related party decreased by $216 thousand to $273 thousand for the nine months ended September 30, 2019 compared to $489 thousand for the same period in 2018. The net income fee paid to our Advisor is calculated at 7.5% of net income.
Advisory fees were $550 thousand for the nine months ended September 30, 2019 compared to $500 thousand for the same period of 2018 for an increase of $50 thousand. Advisory fees are computed based on a gross asset fee of 0.0625% per month (0.75% per annum) of the average of the gross asset value.
Other income (expense)
Interest income was $5 million for the nine months ended September 30, 2019. This represents an increase of $1.7 million as compared to interest income of $3.3 million for the nine months ended September 30, 2018, as a result to an overall increase in the receivable amount owed from our Advisor and other related parties.
Other income of $147 thousand for the nine months ended September 30, 2019, represents a tax increment reimbursement from the City of Farmers Branch, Texas for previous infrastructure development performed by the Company.
Liquidity and Capital Resources
General
Our principal liquidity needs are to fund normal recurring expenses, and property acquisitions. And our principal sources of cash are and will continue to be the collection of mortgage notes receivables, and the collections of receivables and interests from related companies.
Cash Flow Summary
The following summary discussion of our cash flows is based on the Consolidated Statements of Cash Flows from Part I, Item 1. “Financial Statements” and is not meant to be an all-inclusive discussion of the changes in our cash flows (dollars in thousands):
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
Incr/(Decr)
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
3,537
|
|
|
$
|
1,256
|
|
|
$
|
2,281
|
|
|
Net cash used in investing activities
|
|
$
|
(3,540
|
)
|
|
$
|
(1,257
|
)
|
|
$
|
(2,283
|
)
|
The primary use of cash for operations is daily operating costs, general and administrative expenses, advisory fees, and land holding costs. Our primary source of cash for operations is from interest income on notes receivable.
Our primary cash outlays for investing activities are for investment of excess cash with our Advisor. The investing activity in the current period was mainly due to the proceeds received on the notes receivable. We invested more cash with our Advisor in the current period.
We did not pay quarterly dividends during the nine months ended September 30, 2019 and 2018.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, we may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) 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 for personal injury associated with such materials.
Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on our business, assets or results of operations.
Inflation
The effects of inflation on our operations are not quantifiable. Fluctuations in the rate of inflation affect the sales value of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new financings, as well as the cost of variable interest rate debt, will be affected.
Tax Matters
IOR is a member of the May Realty Holdings, Inc., (“MRHI”) consolidated group for federal income tax reporting. There is a tax sharing and compensating agreement between American Realty Investors, Inc. (“ARL”), Transcontinental Realty Investors, Inc. (“TCI”), and IOR
Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. IOR has taxable income for the first nine months of 2019 on a standalone basis. The income tax expense for the nine months ended September 30, 2019 was $821 thousand.