ari10q033113.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

FORM 10-Q

 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013
 
or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to ______
 
Commission File Number 001-15663
 
 

AMERICAN REALTY INVESTORS, INC.
(Exact Name of Registrant as Specified in Its Charter)

   
Nevada
75-2847135
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
1603 Lyndon B. Johnson Freeway, Suite 800, Dallas, Texas 75234
(Address of principal executive offices)
(Zip Code)
 
(469) 522-4200
(Registrant’s telephone number, including area code)

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    xYes     ¨No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)    xYes     ¨No.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
 
       
Large accelerated filer ¨
Accelerated filer
¨
     
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨Yes     xNo.
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
   
Common Stock, $.01 par value
11,525,389
(Class)
(Outstanding at May 5, 2013)

 
 
 
 

 

 
 
AMERICAN REALTY INVESTORS, INC.
FORM 10-Q
TABLE OF CONTENTS
 
     
   
    PAGE
PART I. FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets at March 31, 2013 (unaudited) and December 31, 2012
               3
     
 
Consolidated Statements of Operations for the three months ended March 31, 2013 (unaudited) and 2012
               4
     
 
Consolidated Statement of Shareholders’ Equity for the three months ended March 31, 2013 (unaudited)
               5
     
 
Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2013 (unaudited) and 2012
               6
     
 
Consolidated Statements of Cash Flows for the three months ended March 31, 2013 (unaudited) and 2012
               7
     
 
Notes to Consolidated Financial Statements
               8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
               22
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risks
               30
     
Item 4.
Controls and Procedures
               30
   
PART II. OTHER INFORMATION
 
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
               31
     
Item 6.
Exhibits
               32
   
SIGNATURES
               33
 
 
 
2

 
 
PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS

AMERICAN REALTY INVESTORS, INC.
 
CONSOLIDATED BALANCE SHEETS
 
(unaudited)
 
             
   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(dollars in thousands, except
share and par value amounts)
 
Assets
           
Real estate, at cost
  $ 1,002,403     $ 1,031,632  
Real estate held for sale at cost, net of depreciation ($10,842 for 2013 and $4,393 for 2012)
    19,510       17,040  
Real estate subject to sales contracts at cost, net of depreciation ($16,212 and $15,948 in 2013 and 2012)
    39,466       42,286  
Less accumulated depreciation
    (154,611 )     (160,525 )
Total real estate
    906,768       930,433  
Notes and interest receivable
               
Performing (including $112,582 and $114,275 in 2013 and 2012 from related parties)
    119,203       120,998  
Non-performing
    4,199       4,175  
   Less allowance for estimated losses (including $18,962 in 2013 and 2012 from related parties)
    (21,705 )     (21,704 )
Total notes and interest receivable
    101,697       103,469  
Cash and cash equivalents
    8,262       17,141  
Investments in unconsolidated investees
    10,089       8,168  
Other assets
    63,603       76,134  
Total assets
  $ 1,090,419     $ 1,135,345  
                 
Liabilities and Shareholders’ Equity
               
Liabilities:
               
Notes and interest payable
  $ 751,249     $ 769,201  
Notes related to assets held for sale
    18,183       18,915  
Notes related to subject to sales contracts
    53,838       55,976  
Stock-secured notes payable and margin debt
    25,354       25,765  
Related party payables
    1,894       10,922  
Deferred gain (including $71,303 in 2013 and 2012 from sales to related parties)
    73,148       73,148  
Accounts payable and other liabilities (including $16,443 and $15,746 in 2013 and 2012 to related parties)
    82,355       96,314  
      1,006,021       1,050,241  
                 
Shareholders’ equity:
               
Preferred stock, Series A: $2.00 par value, authorized 15,000,000 shares, issued and outstanding
3,353,954 shares in 2013 and 2012 (liquidation preference $10 per share), including 900,000 shares
in 2013 and 2012 held by subsidiaries
    4,908       4,908  
Common stock, $.01 par value, authorized 100,000,000 shares; issued 11,941,174 shares and
outstanding 11,525,389 shares in 2013 and 2012
    115       115  
Treasury stock at cost; 415,785 shares in 2013 and 2012 and 229,214 shares held by TCI (consolidated)
as of 2013 and 2012
    (6,395 )     (6,395 )
Paid-in capital
    105,005       105,700  
Retained earnings
    (52,697 )     (53,071 )
Accumulated other comprehensive income
    (786 )     (786 )
Total American Realty Investors, Inc. shareholders' equity
    50,150       50,471  
Non-controlling interest
    34,248       34,633  
Total equity
    84,398       85,104  
Total liabilities and equity
  $ 1,090,419     $ 1,135,345  
                 
The accompanying notes are an integral part of these consolidated financial statements.
 


 
3

 

AMERICAN REALTY INVESTORS, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
(unaudited)
 
   
For the Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
   
(dollars in thousands, except
share and per share amounts)
 
Revenues:
           
Rental and other property revenues (including $165 and $167 for the three months ended
2013 and 2012 respectively from related parties)
  $ 28,122     $ 28,044  
                 
Expenses:
               
Property operating expenses (including $269 and $306 for the three months ended 2013 and
2012 respectively from related parties)
    13,913       13,668  
Depreciation and amortization
    5,043       5,152  
General and administrative (including $947 and $922 for the three months ended 2013 and
2012 respectively from related parties)
    2,227       2,879  
Provision on impairment of notes receivable and real estate assets
    -       -  
Advisory fee to related party
    2,554       2,659  
     Total operating expenses
    23,737       24,358  
     Operating income
    4,385       3,686  
                 
Other income (expense):
               
Interest income (including $3,337 and $3,241 for the three months ended 2013 and 2012
respectively from related parties)
    3,541       3,340  
Other income (including $0 and $1,500 for the three months ended 2013 and 2012
respectively from related parties)
    2,536       1,740  
Mortgage and loan interest (including $910 and $922 for the three months ended 2013
and 2012 respectively from related parties)
    (11,498 )     (13,713 )
Deferred borrowing costs amortization
    (2,477 )     (913 )
Loan charges and prepayment penalties
    (3,982 )     (2,393 )
Loss on sale of investments
    -       (361 )
Earnings from unconsolidated investees
    213       117  
        Total other expenses
    (11,667 )     (12,183 )
                 
Loss before gain on land sales, non-controlling interest, and taxes
    (7,282 )     (8,497 )
Loss on land sales
    (35 )     (1,021 )
Loss from continuing operations before tax
    (7,317 )     (9,518 )
   Income tax benefit
    2,557       714  
Net loss from continuing operations
    (4,760 )     (8,804 )
Discontinued operations:
               
   Income (loss) from discontinued operations
    79       (1,547 )
   Gain on sale of real estate from discontinued operations
    7,227       3,588  
   Income tax expense from discontinued operations
    (2,557 )     (714 )
Net income from discontinued operations
    4,749       1,327  
Net loss
    (11 )     (7,477 )
Net loss attributable to non-controlling interest
    385       1,177  
Net income (loss) attributable to American Realty Investors, Inc.
    374       (6,300 )
Preferred dividend requirement
    (613 )     (613 )
Net loss applicable to common shares
  $ (239 )   $ (6,913 )
                 
Earnings per share - basic
               
   Loss from continuing operations
  $ (0.43 )   $ (0.71 )
   Income from discontinued operations
    0.41       0.12  
   Net loss applicable to common shares
  $ (0.02 )   $ (0.59 )
                 
Earnings per share - diluted
               
   Loss from continuing operations
  $ (0.43 )   $ (0.71 )
   Income from discontinued operations
    0.41       0.12  
   Net loss applicable to common shares
  $ (0.02 )   $ (0.59 )
                 
Weighted average common share used in computing earnings per share
    11,525,389       11,525,389  
Weighted average common share used in computing diluted earnings per share
    11,525,389       11,525,389  
                 
                 
Amounts attributable to American Realty Investors, Inc.
               
Loss from continuing operations
  $ (4,375 )   $ (7,627 )
Income from discontinued operations
    4,749       1,327  
Net income (loss) applicable to American Realty Investors, Inc.
  $ 374     $ (6,300 )
                 
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
 
4

 
 
AMERICAN REALTY INVESTORS, INC.
 
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
 
For the Three Months Ended March 31, 2013
 
(unaudited)
 
(dollars in thousands)
 
                                                             
                                                             
                                                             
   
Total
   
Comprehensive
   
Series A
Preferred
   
Common Stock
   
Treasury
   
Paid-in
   
Retained
   
Accumulated
Other
Comprehensive
   
Non-controlling
 
   
Equity
   
Loss
   
Stock
   
Shares
   
Amount
   
Stock
   
Capital
   
Earnings
   
Income (Loss)
   
Interest
 
                                                             
Balance, December 31, 2012
$ 85,104     $ (144,151 )   $ 4,908       11,941,174     $ 115     $ (6,395 )   $ 105,700     $ (53,071 )   $ (786 )   $ 34,633  
Net income (loss)
    (11 )     (11 )     -       -       -       -       -       374       -       (385 )
Distribution of non-controlling interest
(82 )     -       -       -       -       -       (82 )     -       -       -  
Series A preferred stock cash dividend
($1.00 per share)
  (613 )     -       -       -       -       -       (613 )     -       -       -  
Balance, March 31, 2013
$ 84,398     $ (144,162 )   $ 4,908       11,941,174     $ 115     $ (6,395 )   $ 105,005     $ (52,697 )   $ (786 )   $ 34,248  
                                                                                 
                                                                                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
 
5

 
 
AMERICAN REALTY INVESTORS, INC.
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
(unaudited)
 
             
   
For theThree Months Ended
 
   
March 31,
 
   
2013
   
2012
 
   
(dollars in thousands)
 
             
Net loss
  $ (11 )   $ (7,477 )
Other comprehensive income (loss)
    -       -  
Comprehensive loss
    (11 )     (7,477 )
Comprehensive loss attributable to non-controlling interest
    385       1,177  
Comprehensive income (loss) attributable to American Realty Investors, Inc.
  $ 374     $ (6,300 )
                 
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
 
6

 
 
AMERICAN REALTY INVESTORS, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(unaudited)
 
   
For the Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
   
(dollars in thousands)
 
Cash Flow From Operating Activities:
           
Net loss
  $ (11 )   $ (7,477 )
  Adjustments to reconcile net loss applicable to common
      shares to net cash used in operating activities:
 
                   Loss on sale of land
    35       1,021  
                   Gain on sale of income-producing properties
    (7,227 )     (3,588 )
                   Depreciation and amortization
    5,189       5,746  
                   Provision for impairment of notes receivable and real estate assets
    -       -  
                   Amortization of deferred borrowing costs
    2,479       917  
                   Earnings from unconsolidated investees
    (213 )     (117 )
      (Increase) decrease in assets:
               
                   Accrued interest receivable
    1,917       (2,544 )
                   Other assets
    -       -  
                   Prepaid expense
    (580 )     68  
                   Escrow
    11,487       7,814  
                   Earnest money
    375       -  
                   Rent receivables
    726       (302 )
                   Related party receivable
    -       -  
      Increase (decrease) in liabilities:
               
                   Accrued interest payable
    115       (1,047 )
                   Related party payables
    (9,028 )     (9,656 )
                   Other liabilities
    (14,334 )     (12,639 )
                              Net cash used in operating activities
    (9,070 )     (21,804 )
                 
Cash Flow From Investing Activities:
               
      Proceeds from notes receivables
    -       12,776  
      Origination of notes receivable
    (145 )     (9,279 )
      Acquisition of land held for development
    -       -  
      Proceeds from sales of income-producing properties
    24,267       3,842  
      Proceeds from sale of land
    2,550       7,618  
      Proceeds from sale of investment in unconsolidated real estate entities
    -       -  
      Proceeds from sale of investments
    -       114  
      Investment in unconsolidated real estate entities
    (1,708 )     2,898  
      Improvement of land held for development
    (71 )     (136 )
      Improvement of income-producing properties
    (964 )     (394 )
      Acquisition of non-controlling interest
    (81 )     (138 )
      Sale of non-controlling interest
    -       (1,468 )
      Sale of controlling interest
    -       1,262  
      Construction and development of new properties
    (115 )     (3,189 )
                              Net cash provided by investing activities
    23,733       13,906  
                 
Cash Flow From Financing Activities:
               
      Proceeds from notes payable
    78,345       60,915  
      Recurring amortization of principal on notes payable
    (4,557 )     (6,027 )
      Debt assumption by buyer, part of seller proceeds
    -       -  
      Payments on maturing notes payable
    (94,725 )     (56,474 )
      Stock-secured borrowings and margin debt
    (411 )     -  
      Deferred financing costs
    (1,581 )     (1,972 )
      Distributions to non-controlling interests
    -       (82 )
      Preferred stock dividends - Series A
    (613 )     (613 )
      Repurchase of common stock/treasury stock
    -       -  
      Issuance of common stock
    -       -  
      Conversion of preferred stock into common stock
    -       -  
                              Net cash used in financing activities
    (23,542 )     (4,253 )
                 
Net decrease in cash and cash equivalents
    (8,879 )     (12,151 )
Cash and cash equivalents, beginning of period
    17,141       20,312  
Cash and cash equivalents, end of period
  $ 8,262     $ 8,161  
                 
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest
  $ 11,173     $ 13,850  
                 
Schedule of noncash investing and financing activities:
               
Notes receivable received from related party
  $ -     $ 9,279  
                 
The accompanying notes are an integral part of these consolidated financial statements.
         
 
 
7

 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
 
Organization
 
As used herein, the terms “ARL”, “the Company”, “we”, “our” or “us” refer to American Realty Investors, Inc., a Nevada corporation, which was formed in November 1999.  In August 2000, the Company acquired American Realty Trust, Inc. (“ART”), a Georgia corporation and National Realty, L.P. (“NRLP”), a Delaware partnership.
 
The Company is headquartered in Dallas, Texas and its common stock trades on the New York Stock Exchange (“NYSE”)  under the symbol (“ARL”). Approximately 87.4% of ARL’s stock is owned by related parties.  ARL owns approximately 83.8% of the outstanding shares of common stock of Transcontinental Realty Investors, Inc. (“TCI”), a Nevada corporation, which has its common stock listed and traded on the New York Stock Exchange (“NYSE”) under the symbol (“TCI”).  ARL is a “C” corporation for U.S. federal income tax purposes and has consolidated TCI’s accounts and operations since March 2003.
 
TCI, a subsidiary of ARL, owns approximately 81.1% of the common stock of Income Opportunity Realty Investors, Inc. (“IOT”).   Effective July 17, 2009, IOT’s financial results were consolidated with those of ARL and TCI and their subsidiaries.  Shares of IOT are traded on the American Stock Exchange (“AMEX”) under the symbol (“IOT”). 

ARL 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 ARL, and for setting the policies which guide it, the day-to-day operations of ARL 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 ARL’s business plan and investment policy.  Pillar also serves as an Advisor and Cash Manager to TCI and IOT.  We have no employees.

Regis Realty Prime, LLC (“Regis”) manages our commercial properties and provides brokerage services.  ARL engages third-party companies to lease and manage its apartment properties.  TCI also has a development agreement with Unified Housing Foundation, Inc. (“UHF”) a non-profit corporation that provides management services for the development of residential apartment projects in the future.  We have no employees.
 
Properties
 
We own or had interests in a total property portfolio of 61 income-producing properties as of March 31, 2013.  The properties consisted of:
 
 
14 commercial properties consisting of 10 office buildings, one industrial warehouse, and three retail centers comprising in aggregate approximately 3.7 million rentable square feet;
 
 
47 apartment communities totaling 8,559 units, excluding apartments being developed; and
 
 
4,629 acres of developed and undeveloped land.

We join with various third-party development companies to construct residential apartment communities. We are in the predevelopment process on several residential apartment communities but have not yet begun construction.  At March 31, 2013, we had no apartment projects in development.  The third-party developer typically holds a general partner as well as a majority limited partner interest in a limited partnership formed for the purpose of building a single property while we generally take a minority limited partner interest in the limited partnership. We may contribute land to the partnership as part of our equity contribution or we may contribute the necessary funds to the partnership to acquire the land. We are required to fund all required equity contributions while the third-party developer is responsible for obtaining construction financing, hiring a general contractor and for the overall management, successful completion and delivery of the project. We generally bear all the economic risks and rewards of ownership in these partnerships and therefore include these partnerships in our consolidated financial statements. The third-party developer is paid a developer fee typically equal to a percentage of the construction costs. When the project reaches stabilized occupancy, we acquire the third-party developer’s partnership interests in exchange for any remaining unpaid developer fees.

A maritime harbor town is being constructed on the 420 acre site, of which half is water area, of the former naval base of Olpenitz between the mouth of the River Schlei and the Baltic Sea in the state of Schleswig-Holstein in North Germany. The project is located less than 30 miles from the Danish border. The town will be comprised of a marina offering several thousand moorings, premium vacation homes each with their own landing stage as well as exclusive hotels, restaurants, shops and a range of leisure activities from sailing to golfing to cross country skiing.  The development project is expected to be the biggest holiday resort in northern Europe.  Due to mismanagement by the third party developer hired to run the project, the ownership entity was forced to file for insolvency and the Company is working in cooperation with the insolvency manager in order to secure the future of our investment and the development project.
 
 
 
8

 

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, or 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 months ended March 31, 2013 are not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year.
 
The year-end consolidated balance sheet at December 31, 2012 was derived from the audited financial statements at that date, but does not include all of the information and disclosures required by GAAP for complete financial statements.  For further information, refer to the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.  Certain 2012 financial statement amounts have been reclassified to conform to the 2013 presentation, including adjustments for discontinued operations.
 
Principles of consolidation
 
The accompanying financial statements include the accounts of the Company, its subsidiaries, generally all of which are wholly-owned, and all entities in which we have a controlling interest.  Arrangements that are not controlled through voting or similar rights are accounted for as a Variable Interest Entity (“VIE”), in accordance with the provisions and guidance of ASC Topic 810 “Consolidation”, whereby we have determined that we are a primary beneficiary of the VIE and meet certain criteria of a sole general partner or managing member as identified in accordance with Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership when the Investor is the Sole General Partner and the Limited Partners have Certain Rights (“EITF 04-5”).  VIE’s are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders as a group lack adequate decision making ability, the obligation to absorb expected losses or residual returns of the entity, or have voting rights that are not proportional to their economic interests.  The primary beneficiary generally is the entity that provides financial support and bears a majority of the financial risks, authorizes certain capital transactions, or makes operating decisions that materially affect the entity’s financial results.  All significant intercompany balances and transactions have been eliminated in consolidation.
 
In determining whether we are the primary beneficiary of a VIE, we consider qualitative and quantitative factors, including, but not limited to: the amount and characteristics of our investment; the obligation or likelihood for us or other investors to provide financial support; our and the other investors’ ability to control or significantly influence key decisions for the VIE; and the similarity with and significance to the business activities of us and the other investors.  Significant judgments related to these determinations include estimates about the current future fair values and performance of real estate held by these VIE’s and general market conditions.

For entities in which we have less than a controlling financial interest or entities where we are not deemed to be the primary beneficiary, the entities are accounted for using the equity method of accounting. Accordingly, our share of the net earnings or losses of these entities is included in consolidated net income.  Our investment in Gruppa Florentina, LLC, is accounted for under the equity method. Our investment in LK-Four Hickory, LLC was accounted for under the equity method until January 17, 2012, when it was sold.
 
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 its real estate assets using the methodology prescribed in ASC Topic 360, “Property, Plant and Equipment”.  Factors considered by management in evaluating impairment of its 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.
 
 
 
9

 
 
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 the 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.  The operating results of real estate assets held for sale and sold are reported as discontinued operations in the accompanying Consolidated Statements of Operations.  Income from discontinued operations includes the revenues and expenses, including depreciation and interest expense, associated with the assets.  This classification of operating results as discontinued operations applies retroactively for all periods presented.  Additionally, gains and losses on assets designated as held for sale are classified as part of discontinued operations.
 
Cost capitalization
 
Costs related to planning, developing, leasing and constructing a property are capitalized and classified as Real Estate in the Consolidated Balance Sheets.  We capitalize interest to qualifying assets under development based on average accumulated expenditures outstanding during the period.  In capitalizing interest to qualifying assets, we first use the interest incurred on specific project debt, if any, and next use the weighted average interest rate of non-project specific debt.  We capitalize interest, real estate taxes and certain operating expenses until building construction is substantially complete and the building is ready for its intended use, but no later than one year from the cessation of major construction activity.
 
We capitalize leasing costs which include commissions paid to outside brokers, legal costs incurred to negotiate and document a lease agreement and any internal costs that may be applicable.  We allocate these costs to individual tenant leases and amortize them over the related lease term.
 
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.
 
 
 
10

 
 
Newly issued accounting standards
 
We have considered all other newly issued accounting guidance that is applicable to our operations and the preparation of our consolidated 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. REAL ESTATE ACTIVITY
 
Below is a summary of the real estate owned as of March 31, 2013 (dollars in thousands):
 
   
2013
 
       
Apartments
  $ 590,179  
Commercial properties
    217,886  
Land held for development
    194,338  
Real estate held for sale
    30,352  
Real estate subject to sales contract
    55,678  
Total real estate, at cost, less impairment
    1,088,433  
Less accumulated depreciation
    (181,665 )
Total real estate, net of depreciation
  $ 906,768  
 
The highlights of our significant real estate transactions for the three months ended March 31, 2013 are listed below:

On January 8, 2013, 14.52 acres of land known as Southwood located in Tallahassee, Florida was sold at a foreclosure auction to an independent third party for $0.5 million.  This land parcel was previously sold, on December 31, 2012, to One Realco Corporation, a related party, for a sales price of $0.6 million.  The Company did not recognize or record the sale in accordance with ASC 360-20 due to our continuing involvement, which included the potential payment of cash shortfalls, future obligations under the existing mortgage and guaranty, the buyer’s inadequate initial investment and the Company’s questionable recovery of investment cost.  The Company determined that no sale had occurred for financial reporting purposes and therefore the asset remained on the books and continued to record operating expenses and depreciation as a period cost until a sale occurred that met the requirements of ASC 360-20.  A sale to an independent third party, that met the requirements of ASC 360-20, took place on January 8, 2013, when the property was sold to a third party and sales proceeds were credited against the outstanding debt.  There was no gain or loss on the land parcel sale.

On January 28, 2013, TCI sold a 314–unit apartment complex known as Verandas at City View located in Fort Worth, Texas for a sales price of $25.3 million to an independent third party.  The buyer assumed the existing debt of $18.2 million secured by the property.  We recorded a gain of $6.2 million on the sale.

On March 14, 2013, 13.90 acres of land known as Sheffield located in Grand Prairie, Texas was sold by TCI to an independent third party for a sales price of $2.3 million.  The proceeds from the sale were used to pay off the multi-tract collateral debt, secured by the property.  We recorded a nominal loss on the sale of the property.
 
In December 2010, there were various commercial and land holdings sold to FRE Real Estate, Inc., a related party. During the first three months of 2011, many of these transactions were rescinded as of the original transaction date and were subsequently sold to related parties under the same ownership as FRE Real Estate, Inc. As of March 31, 2013, there is one commercial building, Thermalloy, that remains in FRE Real Estate, Inc.  The Company did not recognize or record the sale in accordance with ASC 360-20 due to our continuing involvement, which included the potential payment of cash shortfalls, future obligations under the existing mortgage and guaranty, the buyer’s inadequate initial investment and the Company’s questionable recovery of investment cost.  The Company determined that no sale had occurred for financial reporting purposes and therefore the asset remained on the books and continued to record operating expenses and depreciation as a period cost until a sale occurred that met the requirements of ASC 360-20.
 
The properties that we have sold to a related party and have deferred the recognition of the sale are treated as “subject to sales contract” on the Consolidated Balance Sheets.  These properties were sold to a related party in order to help facilitate an appropriate debt or organizational restructure and may or may not be transferred back to the seller upon resolution.  These properties have mortgages that are secured by the property and many have corporate guarantees.  According to the loan documents, the maker is currently in default on these mortgages primarily due to lack of payment and is actively involved in discussions with every lender in order to settle or cure the default situation.  We have reviewed each asset and taken impairment to the extent we feel the value of the property was less than our current basis.
 
 
 
11

 
 
As of March 31, 2013, there remains one apartment complex, three commercial buildings (including the Thermalloy building) and 212 acres of land that we have sold to a related party and have deferred the recognition of the sale are treated as “subject to sales contract” on the Consolidated Balance Sheets. These properties were sold to a related party in order to help facilitate an appropriate debt or organizational restructure and may or may not be transferred back to the seller upon resolution. These properties have mortgages that are secured by the property and many have corporate guarantees. According to the loan documents, the maker is currently in default on these mortgages primarily due to lack of payment and is actively involved in discussions with every lender in order to settle or cure the default situation. We have reviewed each asset and taken impairment to the extent we feel the value of the property was less than our current basis.  The Company did not recognize or record the sale in accordance with ASC 360-20 due to our continuing involvement, which included the potential payment of cash shortfalls, future obligations under the existing mortgage and guaranty, the buyer’s inadequate initial investment and the Company’s questionable recovery of investment cost.  The Company determined that no sale had occurred for financial reporting purposes and therefore the asset remained on the books and continued to record operating expenses and depreciation as a period cost until a sale occurred that met the requirements of ASC 360-20.  The buyers received no compensation for the facilitation of the bankruptcy or debt restructuring process.
 
We continue to invest in the development of apartment projects. During the three months ended March 31, 2013, we have expended $0.1 million related to the construction or predevelopment of various apartment complexes.
 
We have two income-producing properties held for sale as of March 31, 2013, Laguna Vista, a 206-unit apartment complex located in Farmers Branch, Texas and 225 Baronne, a 422,037 square foot office building in New Orleans, Louisiana.
 
 
 
12

 
 
NOTE 3. NOTES AND INTEREST RECEIVABLE
 
A portion of our assets are invested in mortgage notes receivable, principally secured by real estate. We may originate mortgage loans in conjunction with providing purchase money financing of property sales. Notes receivable are generally collateralized by real estate or interests in real estate and personal guarantees of the borrower and, unless noted otherwise, are so secured. Management intends to service and hold for investment the mortgage notes in our portfolio. A majority of the notes receivable provide for principal to be paid at maturity.
 
Our mortgage notes receivable consist of first, wraparound and junior mortgage loans (dollars in thousands):
 
               
Maturity
 
Interest
       
Borrower
           
Date
 
Rate
 
Amount
 
Security
Performing loans:
     
 
                 
 
     Miscellaneous non-related party notes
   
Various
 
Various
 
 $           4,097
 
Various security interests
 
     Miscellaneous related party notes (1)
   
Various
 
Various
 
           2,656
 
Various security interests
 
     One Realco Corporation (1) (2)
     
01/17
 
3.00%
 
            10,000
 
Unsecured
 
     Realty Advisors Management, Inc. (1)
   
12/16
 
2.28%
 
            20,387
 
Unsecured
 
     S Breeze I-V, LLC
       
09/13
 
5.00%
 
              2,735
 
6% Class A and 25% Class B Limited Partner Interests
 
     Unified Housing Foundation, Inc. (Cliffs of El Dorado) (1)
 
12/32
 
12.00%
 
              2,097
 
100% Interest in Unified Housing of McKinney, LLC
 
     Unified Housing Foundation, Inc. (Echo Station) (1)
 
12/32
 
12.00%
 
              1,481
 
100% Interest in Unified Housing of Temple, LLC
 
     Unified Housing Foundation, Inc. (Inwood on the Park) (1)
 
12/32
 
12.00%
 
              5,059
 
100% Interest in Unified Housing Inwood, LLC
 
     Unified Housing Foundation, Inc. (Kensington Park) (1)
 
12/32
 
12.00%
 
              3,936
 
100% Interest in Unified Housing Kensington, LLC
 
     Unified Housing Foundation, Inc.  (Lakeshore Villas) (1)
 
12/32
 
12.00%
 
              2,000
 
Unsecured
 
     Unified Housing Foundation, Inc.  (Lakeshore Villas) (1)
 
12/32
 
12.00%
 
              9,096
 
Membership interest in Housing for Seniors of Humble, LLC
 
     Unified Housing Foundation, Inc. (Limestone Canyon) (1)
 
12/32
 
12.00%
 
              3,057
 
100% Interest in Unified Housing of Austin, LLC
 
     Unified Housing Foundation, Inc. (Limestone Canyon) (1)
 
12/32
 
12.00%
 
              4,663
 
100% Interest in Unified Housing of Austin, LLC
 
     Unified Housing Foundation, Inc. (Limestone Ranch) (1)
 
12/32
 
12.00%
 
              2,250
 
100% Interest in Unified Housing of Vista Ridge, LLC
 
     Unified Housing Foundation, Inc. (Limestone Ranch) (1)
 
12/32
 
12.00%
 
              6,000
 
100% Interest in Unified Housing of Vista Ridge, LLC
 
     Unified Housing Foundation, Inc. (Parkside Crossing) (1)
 
12/32
 
12.00%
 
             1,936
 
100% Interest in Unified Housing of Parkside Crossing, LLC
 
     Unified Housing Foundation, Inc. (Sendero Ridge) (1)
 
12/32
 
12.00%
 
              5,174
 
100% Interest in Unified Housing of Sendero Ridge, LLC
 
     Unified Housing Foundation, Inc. (Sendero Ridge) (1)
 
12/32
 
12.00%
 
              4,812
 
100% Interest in Unified Housing of Sendero Ridge, LLC
 
     Unified Housing Foundation, Inc. (Timbers at hte Park) (1)
 
12/32
 
12.00%
 
              1,323
 
100% Interest in Unified Housing of Terrell, LLC
 
     Unified Housing Foundation, Inc. (Tivoli) (1)
 
12/32
 
12.00%
 
              7,966
 
100% Interest in Unified Housing of Tivoli, LLC
 
     Unified Housing Foundation, Inc. (Reserve at White Rock Phase I) (1)
12/32
 
12.00%
 
              2,485
 
100% Interest in Unified Housing of Harvest Hill I, LLC
 
     Unified Housing Foundation, Inc. (Reserve at White Rock Phase II) (1)
12/32
 
12.00%
 
              2,555
 
100% Interest in Unified Housing of Harvest Hill, LLC
 
     Unified Housing Foundation, Inc. (Trails at White Rock) (1)
 
12/32
 
12.00%
 
              3,815
 
100% Interest in Unified Housing of Harvest Hill III, LLC
 
     Unified Housing Foundation, Inc.(1)
   
12/13
 
5.00%
 
              6,000
 
Unsecured
 
     Accrued interest
               
           3,623
   
Total Performing
                   
 $      119,203
   
                             
Non-Performing loans:
                         
 
     Leman Development, Ltd.(2)
     
07/11
 
7.00%
 
               1,500
 
Unsecured
 
     Tracy Suttles (2)
     
12/11
 
0.00%
 
             1,077
 
Unsecured
 
     Miscellaneous non-related party notes
   
Various
 
Various
 
                 1,279
 
Various secured interest
 
     Accrued interest
               
                343
   
Total Non-Performing
                   
 $           4,199
   
                             
 
      Allowance for estimated losses
           
          (21,705)
   
Total
                     
 $       101,697
   
                             
                             
 (1)  Related party notes
                         
 (2) An allowance was taken for estimated losses at full value of note.
               
 
The company has various notes receivable from Unified Housing Foundation, Inc. (“UHF”).  UHF is determined to be a related party to the company due to our significant investment in the performance of the collateral secured under the notes receivable and its consulting agreement with TCI.
 
As of January 1, 2013, the Company agreed to extend the maturity on the surplus cash flow notes receivable from UHF for an additional term of five years in exchange for the early termination of the preferred interest rate.  The original notes gave a five-year period of preferred interest rate at 5.25%, before returning to the original note rate of 12.0%.
 
 
 
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NOTE 4. INVESTMENT IN UNCONSOLIDATED INVESTEES
 
Investments in unconsolidated investees in which we have a 20% to 50% interest or otherwise exercise significant influence are carried at cost and adjusted for the Company’s proportionate share of their undistributed earnings or losses via the equity method of accounting.
 
Investments in unconsolidated investees consist of the following:
 
   
Percentage ownership as of
 
   
March 31, 2013
   
March 31, 2012
 
Gruppa Florentina, LLC
    20.00 %     20.00 %

Gruppa Florentina, LLC is the sole member of Milano Restaurants International Corporation, (“Milano”) which operates 35 pizza parlors under the trade name “Me-N-Ed’s Pizza Parlos” located primarily in Central and Northern California.  Milano has a 100% ownership interest in SienaCorp, which operates two grills under the trade names “Me-N-Ed’s Victory Grill” and Me-N-Ed’s Coney Island Grill”.  Milano has a 100% ownership interest in Piazza del Pane, Inc., which operates three restaurants located in Central California.  Milano also has 23 franchised locations, including two operating, under the trade name Angelo & Vito’s Pizzerias.

The following is a summary of the financial position and results of operations from our investees:
 
For the three months ended March 31,
 
2013
   
2012
 
Real estate, net of accumulated depreciation
  $ 11,313     $ 11,703  
Notes receivable
    6,170       5,789  
Other assets
    30,786       30,751  
Notes payable
    (12,429 )     (13,670 )
Other liabilities
    (6,835 )     (6,342 )
Shareholders equity/partners capital
    (29,005 )     (28,231 )
                 
                 
Revenue
  $ 11,141     $ 11,609  
Depreciation
    (294 )     (334 )
Operating expenses
    (10,139 )     (10,388 )
Gain on land sales
    -       -  
Interest expense
    (270 )     (302 )
Income from continuing operations
    438       585  
Income from discontinued operations
    -       -  
Net income
  $ 438     $ 585  
 
               
Companys proportionate share of earnings
  $ 88     $ 117  
 
 
 
14

 

NOTE 5. NOTES PAYABLE

Below is a summary of our notes and interest payable (dollars in thousands):

   
Notes Payable
   
Accrued Interest
   
Total Debt
 
Apartments
    502,998       1,685       504,683  
Commercial
    115,728       247       115,975  
Land held for development
    119,447       2,073       121,520  
Real estate held for sale
    18,139       44       18,183  
Real estate subject to sales contract
    49,642       4,196       53,838  
Other
    8,666       405       9,071  
                         
Total
    814,620       8,650       823,270  

On January 24, 2013, TCI refinanced the existing mortgage on Breakwater Bay apartments, a 176-unit complex located in Beaumont, Texas, for a new mortgage of $9.8 million. TCI paid off the existing mortgage of $9.1 million and $0.3 million in closing costs and escrows. The note accrues interest at 2.50% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on February 1, 2053.

On January 25, 2013, TCI refinanced the existing mortgage on Northside on Travis apartments, a 200-unit complex located in Sherman, Texas, for a new mortgage of $13.9 million. TCI paid off the existing mortgage of $13.5 million and $1.3 million in closing costs and escrows. The note accrues interest at 2.50% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on February 1, 2053.

On January 28, 2013, TCI refinanced the existing mortgage on Capitol Hill apartments, a 156-unit complex located in Little Rock, Arkansas, for a new mortgage of $9.4 million. TCI paid off the existing mortgage of $8.8 million and $0.3 million in closing costs and escrows. The note accrues interest at 2.50% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on February 1, 2053.

On February 12, 2013, the construction loan in the amount of $17.0 million that was taken out, by TCI, on May 13, 2010 to fund the development of Toulon apartments, a 240-unit complex located in Gautier, MS, closed into permanent financing.  The note accrues interest at 5.37% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on December 1, 2051.

On February 25, 2013, TCI refinanced the existing mortgage on Mansions of Mansfield apartments, a 208-unit complex located in Mansfield, Texas, for a new mortgage of $16.3 million.  TCI paid off the existing mortgage of $15.8 million and $1.2 million in closing costs and escrows. The note accrues interest at 2.50% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on March 1, 2053.

On February 25, 2013, TCI refinanced the existing mortgage on Preserve at Pecan Creek apartments, a 192-unit complex located in Denton, Texas, for a new mortgage of $15.1 million. TCI paid off the existing mortgage of $14.6 million and $1.1 million in closing costs and escrows. The note accrues interest at 2.50% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on March 1, 2053.

On March 25, 2013, TCI refinanced the existing mortgage on Parc at Clarksville apartments, a 168-unit complex, located in Clarksville, Tennessee, for a new mortgage of $13.4 million.  TCI paid off the existing mortgage of $13.0 million and $0.7 million in closing costs and escrows.  The note accrues interest at 2.50% and payments of interest and principal are due monthly based upon a 40-year amortization schedule, maturing on April 1, 2053.
 
In conjunction with the development of various apartment projects and other developments, we drew down $.3 million in construction loans during the three months ended March 31, 2013.  This was related to the permanent closing of construction loan for Toulon apartments.
 
There are various land mortgages, secured by the property, that are in the process of a modification or extension to the original note due to expiration of the loan. We are in constant contact with these lenders, working together, in order to modify the terms of these loans and we anticipate a timely resolution that is similar to the existing agreement or subsequent modification.
 
 
 
15

 
 
The properties that we have sold to a related party and have deferred the recognition of the sale are treated as “subject to sales contract” on the Consolidated Balance Sheets.  These properties were sold to a related party in order to help facilitate an appropriate debt or organizational restructure and may or may not be transferred back to the seller upon resolution.  These properties have mortgages that are secured by the property and many have corporate guarantees.  According to the loan documents, the maker is currently in default on these mortgages primarily due to lack of payment and is actively involved in discussions with every lender in order to settle or cure the default situation.  We have reviewed each asset and taken impairment to the extent we feel the value of the property was less than our current basis.
 
NOTE 6. STOCK-SECURED NOTES PAYABLE
 
The Company has margin arrangements with various financial institutions and brokerage firms, which provide for borrowings of up to 50.0% of the market value of marketable equity securities.  We also have other notes payable secured by stock.  The borrowings under such margin arrangements and notes are secured by the equity securities of IOT, TCI, and ARL’s trading portfolio securities, and bear interest rates ranging from 4.00% to 10.00% per annum.  Stock-secured notes payable and margin borrowings were $25.4 million at March 31, 2013.
 
NOTE 7. RELATED PARTY TRANSACTIONS

The following table reconciles the beginning and ending balances of accounts receivable from and (accounts payable) to related parties as of March 31, 2013 (dollars in thousands):
 
   
Pillar
 
Related party payable, December 31, 2012
  $ (10,922 )
Cash transfers
    15,964  
Advisory fees
    (2,554 )
Net income fee
    (56 )
Fees and commissions
    (1,516 )
Cost reimbursements
    (846 )
Interest to advisor
    (58 )
POA fees
    (31 )
Expenses paid by Advisor
    (1,921 )
Financing (mortgage payments)
    46  
Related party payable, March 31, 2013
  $ (1,894 )
 
During the ordinary course of business, we have related party transactions that include, but are not limited to rent income, interest income, interest expense, general and administrative costs, commissions, management fees, and property expenses.  In addition, we have assets and liabilities that include related party amounts.  The related party amounts included in assets and liabilities, and the related party revenues and expenses received/paid are shown on the face of the financial statements.
 
NOTE 8. OPERATING SEGMENTS
 
Our segments are based on our method of internal reporting which classifies our operations by property type.  Our property types are grouped into commercial, apartments, hotels, land and other operating segments.  Significant differences among the accounting policies of the operating segments as compared to the consolidated financial statements principally involve the calculation and allocation of administrative and other expenses.  Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow.
 
Items of income that are not reflected in the segments are interest, other income, gain on debt extinguishment, gain on condemnation award, equity in partnerships, and gains on sale of real estate. Expenses that are not reflected in the segments are provision for losses, advisory, net income and incentive fees, general and administrative, non-controlling interests and net loss from discontinued operations before gains on sale of real estate.
 
The segment labeled as “Other” consists of revenue and operating expenses related to the notes receivable and corporate debt.
 

 
16

 
 
Presented below is our reportable segments’ operating income for the three months ended March 31, 2013 and 2012, including segment assets and expenditures (dollars in thousands):
 
   
Commercial
                               
For the Three Months Ended March 31, 2013
 
Properties
   
Apartments
 
Hotels
   
Land
   
Other
   
Total
 
Operating revenue
  $ 7,587     $ 20,494     $ -     $ 34     $ 7     $ 28,122  
Operating expenses
    4,865       8,702       -       369       (23 )     13,913  
Depreciation and amortization
    1,478       3,624       -       -       (59 )     5,043  
Mortgage and loan interest
    1,876       6,184       -       1,536       1,902       11,498  
Deferred borrowing costs
    24       2,356       -       61       36       2,477  
Loan charges & prepayment penalites
    -       3,982       -       -       -       3,982  
Interest income
    -       -       -       -       3,541       3,541  
Loss on land sales
    -       -       -       (35 )     -       (35 )
Segment operating income (loss)
  $ (656 )   $ (4,354 )   $ -     $ (1,967 )   $ 1,692     $ (5,285 )
Capital expenditures
    824       31       -       53       -       908  
Assets
    160,656       516,829       -       209,773       -       887,258  
                                                 
Property Sales
                                               
Sales price
  $ -     $ 25,300     $ -     $ 2,250     $ -     $ 27,550  
Cost of sale
    -       18,073       -       2,285       -       20,358  
Deferred current gain
    -       -       -       -       -       -  
Recognized prior deferred gain
    -       -       -       -       -       -  
Gain (loss) on sale
  $ -     $ 7,227     $ -     $ (35 )   $ -     $ 7,192  
                                                 
                                                 
   
Commercial
                                         
For the Three Months Ended March 31, 2012
 
Properties
   
Apartments
 
Hotels
   
Land
   
Other
   
Total
 
Operating revenue
  $ 8,899     $ 19,104     $ -     $ -     $ 41     $ 28,044  
Operating expenses
    4,992       8,009       -       279       388       13,668  
Depreciation and amortization
    1,611       3,610       -       -       (69 )     5,152  
Mortgage and loan interest
    2,877       7,113       -       1,682       2,041       13,713  
Deferred borrowing costs
    24       861       -       17       11       913  
Loan charges & prepayment penalites
    -       2,388       -       5       -       2,393  
Interest income
    -       -       -       -       3,340       3,340  
Loss on land sales
    -       -       -       (1,021 )     -       (1,021 )
Segment operating income (loss)
  $ (605 )   $ (2,877 )   $ -     $ (3,004 )   $ 1,010     $ (5,476 )
Capital expenditures
    446       198       -       5       -       649  
Assets
    166,570       528,330       -       230,550       -       925,450  
                                                 
Property Sales
                                               
Sales price
  $ -     $ 21,146     $ -     $ 11,543     $ -     $ 32,689  
Cost of sale
    -       17,558       -       12,564       -       30,122  
Recognized prior deferred gain
    -       -       -       -       -       -  
Gain (loss) on sale
  $ -     $ 3,588     $ -     $ (1,021 )   $ -     $ 2,567  
 
The table below reconciles the segment information to the corresponding amounts in the Consolidated Statements of Operations:
 
   
For Three Months Ended 
March 31,
 
   
2013
   
2012
 
Segment operating loss
  $ (5,285 )   $ (5,476 )
Other non-segment items of income (expense)
               
General and administrative
    (2,227 )     (2,879 )
Advisory fees
    (2,554 )     (2,659 )
Other income
    2,536       1,740  
Loss on sale of investments
    -       (361 )
Equity in earnings of investees
    213       117  
Income tax benefit
    2,557       714  
Loss from continuing operations
  $ (4,760 )   $ (8,804 )
 
 
 
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The table below reconciles the segment information to the corresponding amounts in the Consolidated Balance Sheets:

   
March 31,
 
   
2013
   
2012
 
Segment assets
  $ 887,258     $ 925,450  
Investments in unconsolidated investees
    10,089       7,848  
Other assets and receivables
    173,562       176,288  
Assets held for sale
    19,510       72,068  
Total assets
  $ 1,090,419     $ 1,181,654  

NOTE 9. DISCONTINUED OPERATIONS
 
We apply the provisions of ASC Topic 360, “Property, Plant and Equipment”. ASC Topic 360 requires that long-lived assets that are to be disposed of by sale be measured at the lesser of (1) book value or (2) fair value less cost to sell.  In addition, it requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions.

Discontinued operations relates to properties that were either sold or held for sale as of the period ended March 31, 2013.  Included in discontinued operations are a total of three and nine properties as of 2013 and 2012, respectively.  Properties sold in 2013 have been reclassified to discontinued operations for current and prior year reporting periods. In 2013, we sold one apartment complex (Verandas at City View), have one apartment complex held for sale (Laguna Vista) and one commercial property held for sale (225 Baronne).  In 2012, we sold two apartment complexes (Portofino and Wildflower Villas), three commercial properties (305 Baronne, Clarke Garage and Dunes Plaza), and one hotel (Comfort Inn). The gain on sale of the properties is also included in discontinued operations for those years. The following table summarizes revenue and expense information for the properties sold and held for sale (dollars in thousands):

   
For the Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Revenue
           
     Rental
  $ 1,178     $ 3,522  
     Property operations
    526       2,488  
    $ 652     $ 1,034  
Expenses
               
     Other income
    -       2  
     Interest
    (220 )     (1,820 )
     General and administration
    (208 )     (169 )
     Depreciation and amortization
    (145 )     (594 )
     Provision on impairment of real estate assets
    -       -  
    $ (573 )   $ (2,581 )
Income (loss) from discontinued operations before gains
on sale of real estate, taxes, and fees
    79       (1,547 )
     Gain on sale of discontinued operations
    7,227       3,588  
     Equity in investee
    -       -  
Income from discontinued operations
  $ 7,306     $ 2,041  
     Tax expense
    (2,557 )     (714 )
Net income from discontinued operations
  $ 4,749     $ 1,327  
 
Our application of ASC Topic 360 results in the presentation of the net operating results of these qualifying properties sold or held for sale during 2012 as income from discontinued operations.  This does not have an impact on net income available to common shareholders and only impacts the presentation of these properties within the Consolidated Statements of Operations.
 
 
 
18

 
 
NOTE 10. COMMITMENTS AND CONTINGENCIES AND LIQUIDITY
 
LK-Four Hickory, LLC
 
In conjunction with its sale of Four Hickory in November 2007, the Company agreed to fund amounts to satisfy its commitment to compensate LK-Four Hickory, LLC for move-in discounts and other concessions to existing tenants at the time of sale.  The Company also has various agreements with LK-Four Hickory, LLC related to the funding of projection shortfalls, which, to date, they have not had to provide any additional funding.  In addition, related parties of the Company have active lease agreements with LK-Four Hickory, LLC and the Company has since guaranteed amounts related to certain of these leases.

On December 17, 2007, both Limkwang Nevada, Inc., the majority owner of LK-Four Hickory, LLC, and ARL unconditionally guaranteed the punctual payment when due, whether at stated maturity, by acceleration or hereafter, including all fees and expenses incurred by the bank on collection of a $28.0 million note payable for LK-Four Hickory, LLC, which has a current outstanding balance of $23.8 million.

The Company’s investment in LK-Four Hickory, LLC at January 17, 2012 was sold and the Company has additional reserves for estimated potential amounts it could be liable for if various related parties are not able to meet their obligations to LK Four Hickory, LLC.  The Company will continue to evaluate these potential estimates and also the likelihood of having to fund any of these and adjust their reserves accordingly.  

Dynex Commercial, Inc. and Dynex Capital, Inc.

On February 13, 2013, the Court of Appeals, Fifth District of Texas at Dallas (the “Fifth Court of Appeals”) rendered an opinion involving Transcontinental Realty Investors, Inc. (the “Issuer” or “TCI”) in Case No. 05-04-01358-CV styled Basic Capital Management, Inc., American Realty Trust, Inc., Transcontinental Realty Investors, Inc., Continental Poydras Corp., Continental Common, Inc. and Continental Baronne, Inc. v. Dynex Commercial, Inc. and Dynex Capital, Inc.  The case was on appeal from the 68th Judicial District Court of Dallas County, Texas, had previously been appealed to the Fifth Court of Appeals and further appealed to the Supreme Court of the State of Texas which had remanded the instant case back to the Fifth Court of Appeals to address certain issues.  The case had its origin with Dynex Commercial making loans to Continental Poydras Corp., Continental Common, Inc. and Continental Baronne, Inc. (subsidiaries of Continental Mortgage & Equity Trust (“CMET”), an entity which merged into TCI in 1999 after the original suit was filed).  Under the original loan commitment, $160,000,000 in loans were to be made to the entities.  The loans were conditioned on the execution of a commitment between Dynex Commercial and Basic Capital Management, Inc. (“Basic”).

An original trial to a jury resulted in the jury awarding significant damages to Basic for “lost opportunity,” awarding damages in “increased costs” and “lost opportunity” damages to American Realty Trust, Inc. (“ART”) and damages of $960,646.28 in “increased costs” and $11,161,520 for “lost opportunity’ damages in favor of TCI and its subsidiaries (a total of $12,122,166.28).  The original Trial Court ignored the jury’s findings and entered a “Judgment Notwithstanding the Verdict” (“JNOV”) in Dynex’s favor; the Fifth Court of Appeals has now ruled that the JNOV was improper because there was sufficient evidence to support the jury’s findings.  As a result, the Fifth Court of Appeals ordered the Trial Court to enter a new judgment consistent with the jury’s original findings.

The Fifth Court of Appeals also determined that TCI was entitled to damages for “lost opportunities” relating to tenant improvements and awarded TCI an additional $252,577.  Issues relating to attorneys fees were also addressed with the Fifth Court of Appeals ordering the Trial Court to “re-try” the issue of attorney’s fees to determine the amount of fees to which TCI would be entitled on a “breach of commitment” claim.  In addition, as a result of the changes in amounts awarded and passage of time, the Fifth Court of Appeals also ordered the Trial Court to recalculate the correct amounts of pre and post-judgment interest owed to Appellants.

While the fifteen year old controversy is not yet fully resolved, the Fifth Court of Appeals opinion is favorable to TCI, but TCI expects continued challenges by Dynex to the Fifth Court of Appeals opinion and any ultimate award of damages by the Trial Court.

Petra CRE CDO 2007-1, Ltd..

On May 8, 2013, a Satisfaction of Consent Judgment was entered in Civil Action No. 2011-141, United States District Court, Eastern District of Louisiana, styled Petra CRE CDO 2007-1, Ltd. v. TCI Amoco Property, LLC and Transcontinental Realty Investors, Inc. (the “Proceeding”). TCI resolved such Proceeding by the issuance to the Plaintiff therein of a $5.0 million Promissory Note maturing March 5, 2015 secured by certain collateral. The recordation of the Satisfaction of Consent Judgment closed the Proceeding.
 
Liquidity.     Management believes that ARL will generate excess cash flow from property operations in 2013; such excess, however, will not be sufficient to discharge all of ARL’s obligations as they became due. Management intends to sell land and income- producing real estate, refinance real estate and obtain additional borrowings primarily secured by real estate to meet its liquidity requirements.
 
 
 
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Partnership Buyouts.    ARL is the limited partner in various partnerships related to the construction of residential properties. As permitted in the respective partnership agreements, ARL intends to purchase the interests of the general and any other limited partners in these partnerships subsequent to the completion of these projects. The amounts paid to buy out the non-affiliated partners are limited to development fees earned by the non-affiliated partners, and are set forth in the respective partnership agreements.
 
Litigation.     The ownership of property and provision of services to the public as tenants entails an inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, 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 operation or liquidity, unless noted otherwise below.
 
The Company is involved in, and vigorously defending against, a number of deficiency claims with respect to assets that have been foreclosed by various lenders.  Such claims are generally against a consolidated subsidiary as the borrower or the Company as a guarantor of indebtedness or performance.  Some of these proceedings may ultimately result in an unfavorable determination for the Company and/or one of its consolidated subsidiaries.  While we cannot predict the final result of such proceedings, Management believes that the maximum exposure to the Company and its consolidated subsidiaries, if any, will not exceed approximately $20.0 million in the aggregate and will occur, if at all, in future years.
 
American Realty Trust, Inc (“ART”) and its subsidiary ART Midwest, Inc have been engaged in litigation with a Mr. David Clapper and companies related to Mr. Clapper (“The Clapper Entities”) since 1999. The origins of the matter began in 1998 in a transaction whereby ART Midwest was to acquire eight apartments from the Clapper Entities. Through the years there have been rulings both for and against ART in this matter; however, in October 2011 a final ruling was issued whereby the Clapper Entities were awarded approximately $74.0 million, including $26.0 million in damages and $48.0 million in interest. This ruling was against ART and its subsidiary ART Midwest and not the Company or any other subsidiary of the Company.
 
ART believes there were serious errors in the judge’s ruling and has filed an appeal of the judge’s ruling. ART further believes that should the Clapper Entities ultimately prevail that it has claims against a third party who was involved in this matter. These claims cannot be pursued until the main case with the Clapper Group is ultimately resolved.

Should the Clapper Group ultimately prevail, the only defendants in this matter are ART and ART Midwest, Inc., whose total assets and net worth as of December 31, 2011 were approximately $10.0 million. Neither the Company nor any of its subsidiaries other than ART have guaranteed or indemnified either ART or ART Midwest, Inc.

In January of 2012, the Company sold all of the issued and outstanding stock of American Realty Trust, Inc. “ART” for a $10.0 million note.  The note is fully reserved by the Company and valued at zero.  Subsequent to the sale, ART filed for Chapter 11 bankruptcy protection.

ARL, through a foreign subsidiary, is developing a maritime harbor town on the 420 acre site of the former naval base of Olpenitz in Kappeln, Germany. The project is located less than 30 miles from the Denmark border.  The town will comprise of a marina offering several thousand moorings, premium vacation homes each with their own landing stage as well as exclusive hotels, restaurants, shops and a range of leisure activities from sailing to golfing to cross country skiing.  The development is expected to be the biggest holiday resort in northern Europe.  There have been disputes with the local partner related to his mismanagement of the project which resulted in replacing him as the managing partner and led to filing for bankruptcy protection in Germany to completely remove him from the project. An insolvency manager has been put into place in order to protect the creditors and ARL believes that the value of the land and development in process will satisfy the existing creditors and return ARL’s investment.  ARL is working in cooperation with the insolvency manager and expects to continue ARL’s involvement in the development of this project.

During the first quarter of the fiscal year covered by this Report, no proceeding previously reported was terminated.

 
NOTE 11. EARNINGS PER SHARE
 
Earnings per share, “EPS”, have been computed pursuant to the provisions of ASC Topic 260 “Earnings Per Share”.  The computation of basic EPS is calculated by dividing net income available to common shareholders from continuing operations, adjusted for preferred dividends, by the weighted-average number of common shares outstanding during the period.  Shares issued during the period shall be weighted for the portion of the period that they were outstanding.   As of March 31, 2013, we have 3,353,954 shares of Series A 10.0% Cumulative Convertible Preferred Stock, which are outstanding.  These shares may be converted into common stock at 90.0% of the average daily closing price of the common stock for the prior 20 trading days.  These are considered in the computation of diluted earnings per share if the effect of applying the if-converted method is dilutive.
 
 
 
20

 
 
Of the outstanding 3,353,954 shares of Series A 10.0% Cumulative Convertible Preferred Stock, 300,000 shares are owned by ART Edina, Inc. and 600,000 shares are owned by ART Hotel Equities, Inc., both wholly owned subsidiaries of ARL.  Dividends are not paid on the shares owned by ARL subsidiaries.  Realty Advisors, Inc., a related party, owns 2,451,435 shares of the outstanding shares and has accrued dividends unpaid of $11.4 million.
 
As of March 31, 2013, we have 1,000 shares of stock options outstanding, which will expire January 1, 2015 if not exercised.  The outstanding options are considered in the computation of diluted earnings per share if the effect of applying the “treasury stock” method is dilutive.  As of March 31, 2013, the preferred stock and the stock options were anti-dilutive and thus not included in the EPS calculation.
 
NOTE 12. SUBSEQUENT EVENTS

On May 18, 2010, TCI sold their 90.0% investment in TCI Eton Square, LP to TX Highland RS Corp, a related party, for a sales price of $12.3 million and IOT sold their 10.0% investment in TCI Eton Square, LP to TX Highland RS Corp, a related party, for a sales price of $1.37 million.  This entity owns a 225,566 square foot office and retail center known as Eton Square located in Tulsa, Oklahoma. A three-year note receivable for the full sales price, less the debt assumed, was given as consideration, with an interest rate of prime plus 2%, payable at maturity on May 18, 2013.  The Company did not recognize or record the sale in accordance with ASC 360-20 due to the buyer’s inadequate initial investment and the Company’s questionable recovery of investment cost.  The Company determined that no sale had occurred for financial reporting purposes and therefore the investment remained on the books.   A sale to an independent third party, that met the requirements of ASC 360-20, took place on April 8, 2013, when the existing lender took possession of the property and gave a credit against the existing mortgage.  A 3-year promissory note was executed for the balance owed on the mortgage.  No gain or loss was recorded on the sale of the investment.

On February 2, 2012, TCI and its subsidiary, 1340 Poydras, LLC, executed a guarantor settlement and consent agreement with the lender for the Amoco building, Petra CRE CDO 2007-1, Ltd (“Petra”) to transfer ownership of the Amoco building to a new entity, 1340 Owner, LLC, which is affiliated with the existing lender, Petra.  Petra and its affiliate are independent third parties.  TCI deferred the recognition of the sale in accordance with ASC 360-20 due to our continuing involvement related to the obligations under the note and guaranty agreements and the re-acquisition option.  As of May 7, 2013, TCI and Petra settled the obligations set forth under the note and guaranty and terminated the re-acquisition option.  TCI recorded the sale to the independent third party and recognized a gain of approximately $10.0 million.

In connection with the settlement of certain litigation which had been pending in the U. S. District Court, Eastern District of Louisiana, among Petra, TCI, and a subsidiary, on May 7, 2013, TCI issued a $5.0 million Promissory Note payable to the order of such lender that pledges 135,000 shares of Series K Convertible Preferred Stock of ARL issued on the same date to TCI. Such Promissory Note requires regular monthly payments, is  pre-payable, and matures the earlier of March 5, 2015 or the date on which an Event of Default occurs under such Note. The issuance of the $5.0 million Promissory Note and collateral to the Lender resolved all claims of the Lender against TCI including deficiency claims under a mortgage covering certain real property located in New Orleans, Louisiana.  The note has prepayment provisions whereby if it is paid off by March 1, 2014, the balance of $3.5 million is forgiven and if paid off after March 1, 2014 but before March 1, 2015, $2.5 million will be forgiven.
 
 
 
21

 

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 contains forward-looking statements within the meaning of the federal securities laws, principally, but not only, under the captions “Business”, “Risk Factors” and “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;
 
 
risks associated with our dependence on key personnel whose continued service is not guaranteed; and
 
 
the other risk factors identified in this Form 10-Q, including those described under the caption “Risk Factors.”
 
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 at 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, 2012.
 
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 matter 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 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.
 
 
 
22

 
 
Overview
 
We are an externally advised and managed real estate investment company that owns a diverse portfolio of income-producing properties, and land held for development.  Our portfolio of income-producing properties includes residential apartment communities, office buildings, hotels, and other commercial properties.  Our investment strategy includes acquiring existing income-producing properties as well as developing new properties on land already owned or acquired for a specific development project.  We acquire land primarily in urban in-fill locations or high-growth suburban markets.  We are an active buyer and seller of real estate and during the three months ended March 31, 2013, we sold $28.1 million of land and income-producing properties. As of March 31, 2013, we owned 8,559 units in 47 residential apartment communities and 14 commercial properties comprising almost 3.7 million rentable square feet.  In addition, we owned 4,629 acres of land held for development which includes a 420-acre holiday resort project in Germany currently in development.
 
We finance our acquisitions primarily through operating cash flow, proceeds from the sale of land and income-producing properties, and debt financing primarily in the form of property-specific first-lien mortgage loans from commercial banks and institutional lenders.  We finance our development projects principally with short-term, variable interest rate construction loans that are converted to long-term, fixed rate amortizing mortgages when the development project is completed and occupancy has been stabilized.  We will, from time to time, also enter into partnerships with various investors to acquire income-producing properties or land and to sell interests in certain of our wholly owned properties.  When we sell assets, we may carry a portion of the sales price generally in the form of a short-term, interest bearing seller-financed note receivable.  We generate operating revenues primarily by leasing apartment units to residents; leasing office, retail and industrial space to commercial tenants; and renting hotel rooms to guests.
 
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 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 ARL, and for setting the policies which guide it, the day-to-day operations of ARL 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 ARL’s business plan and investment policy.  Pillar also serves as an Advisor and Cash Manager to TCI and IOT.  We have no employees.

Regis Realty Prime, LLC (“Regis”) manages our commercial properties and provides brokerage services.  ARL engages third-party companies to lease and manage its apartment properties.  TCI also has a development agreement with Unified Housing Foundation, Inc. (“UHF”) a non-profit corporation that provides management services for the development of residential apartment projects in the future.  We have no employees.
 
Critical Accounting Policies
 
We present our financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”).  The 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 GAAP. As of the effective date, we no longer refer to the authoritative guidance dictating its accounting methodologies under the previous accounting standards hierarchy. Instead, we refer to the ASC Codification as the sole source of authoritative literature.
 
The accompanying 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.  Arrangements that are not controlled through voting or similar rights are accounted for as a Variable Interest Entity (“VIE”), in accordance with the provisions and guidance of ASC Topic 810 “Consolidation”, whereby we have determined that we are a primary beneficiary of the VIE and meet certain criteria of a sole general partner or managing member as identified in accordance with Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership when the Investor is the Sole General Partner and the Limited Partners have Certain Rights (“EITF 04-5”). VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders as a group lack adequate decision making ability, the obligation to absorb expected losses or residual returns of the entity, or have voting rights that are not proportional to their economic interests.  The primary beneficiary generally is the entity that provides financial support and bears a majority of the financial risks, authorizes certain capital transactions, or makes operating decisions that materially affect the entity’s financial results.  All significant intercompany balances and transactions have been eliminated in consolidation.
 
 
 
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In determining whether we are the primary beneficiary of a VIE, we consider qualitative and quantitative factors, including, but not limited to: the amount and characteristics of our investment; the obligation or likelihood for us or other investors to provide financial support; our and the other investors’ ability to control or significantly influence key decisions for the VIE; and the similarity with and significance to the business activities of us and the other investors.  Significant judgments related to these determinations include estimates about the current future fair values and performance of real estate held by these VIEs and general market conditions.
 
For entities in which we have less than a controlling financial interest or entities where we are not deemed to be the primary beneficiary, the entities are accounted for using the equity method of accounting.  Accordingly, our share of the net earnings or losses of these entities are included in consolidated net income.  Our investment in Gruppa Florentina, LLC is accounted for under the equity method. Our investment in LK-Four Hickory, LLC was accounted for under the equity method until January 17, 2012, when it was sold.
 
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.  Based on our acquisitions to date, our allocation to customer relationship intangible assets has been immaterial.
 
We record acquired “above-market” and “below-market” leases at their fair values (using a discount rate which reflects the risks associated with the leases acquired) equal to the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) management’s estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases.
 
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.
 
Other intangible assets acquired include amounts for in-place lease values that are based on our evaluation of the specific characteristics of each tenant’s lease.  Factors to be considered include estimates of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases.  In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions.  In estimating costs to execute similar leases, we consider leasing commissions, legal and other related expenses.
 
ASC Topic 360 “Property, Plant and Equipment” requires that qualifying assets and liabilities and the results of operations that have been sold, or otherwise qualify as held for sale, be presented as discontinued operations in all periods presented if the property operations are expected to be eliminated and we will not have significant continuing involvement following the sale.  The components of the property’s net income that is reflected as discontinued operations include the net gain (or loss) upon the disposition of the property held for sale, operating results, depreciation and interest expense (if the property is subject to a secured loan).  We generally consider assets to be held for sale when the transaction has been approved by our Board of Directors, or a committee thereof, and there are no known significant contingencies relating to the sale, such that the property sale within one year is considered probable.  Following the classification of a property as held for sale, no further depreciation is recorded on the assets.
 
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.
 
 
 
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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.
 
Investments in Unconsolidated Real Estate Ventures
 
Except for ownership interests in variable interest entities, we account for our investments in unconsolidated real estate ventures under the equity method of accounting because we exercise significant influence over, but do not control, these entities.  These investments are recorded initially at cost, as investments in unconsolidated real estate ventures, and subsequently adjusted for equity in earnings and cash contributions and distributions.  Any difference between the carrying amount of these investments on our balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in earnings of unconsolidated real estate ventures over the life of the related asset.  Under the equity method of accounting, our net equity is reflected within the Consolidated Balance Sheets, and our share of net income or loss from the joint ventures is included within the Consolidated Statements of Operations.  The joint venture agreements may designate different percentage allocations among investors for profits and losses; however, our recognition of joint venture income or loss generally follows the joint venture’s distribution priorities, which may change upon the achievement of certain investment return thresholds.  For ownership interests in variable interest entities, we consolidate those in which we are the primary beneficiary.
 
Recognition of Rental Income
 
Rental income for commercial property leases is recognized on a straight-line basis over the respective lease terms.  In accordance with ASC Topic 805 “Business Combinations”, we recognize rental revenue of acquired in-place “above-market” and “below-market” leases at their fair values over the terms of the respective leases. On our Consolidated Balance Sheets, we include as a receivable the excess of rental income recognized over rental payments actually received pursuant to the terms of the individual commercial lease agreements.
 
Reimbursements of operating costs, as allowed under most of our commercial tenant leases, consist of amounts due from tenants for common area maintenance, real estate taxes and other recoverable costs, and are recognized as revenue in the period in which the recoverable expenses are incurred.  We record these reimbursements on a “gross” basis, since we generally are the primary obligor with respect to purchasing goods and services from third-party suppliers, have discretion in selecting the supplier and have the credit risk with respect to paying the supplier.
 
Rental income for residential property leases is recorded when due from residents and is recognized monthly as earned, which is not materially different than on a straight-line basis as lease terms are generally for periods of one year or less.  For hotel properties, revenues for room sales and guest services are recognized as rooms are occupied and services are rendered.  An allowance for doubtful accounts is recorded for all past due rents and operating expense reimbursements considered to be uncollectible.
 
Revenue Recognition on the Sale of Real Estate
 
Sales and the associated gains or losses of real estate 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 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.
 
Interest Recognition on Notes Receivable
 
We record interest income as earned in accordance with the terms of the related loan agreements.
 
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” for details on our notes receivable.
 
 
 
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Fair Value of Financial Instruments
 
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.
 
Results of Operations
 
The discussion of our results of operations is based on management’s review of operations, which is based on our segments.  Our segments consist of apartments, commercial buildings, hotels, land and other.  For discussion purposes, we break these segments down into the following sub-categories; same property portfolio, acquired properties, and developed properties in the lease-up phase.  The same property portfolio consists of properties that were held by us for the entire period for both years being compared.  The acquired property portfolio consists of properties that we acquired but have not been held for the entire period for both periods being compared.  Developed properties in the lease-up phase consist of completed projects that are being leased up.  As we complete each phase of the project, we lease-up that phase and include those revenues in our continuing operations.  Once a developed property becomes leased up and is held the entire period for both periods under comparison, it is considered to be included in the same property portfolio.  Income-producing properties that we have sold during the year are reclassified to discontinued operations for all periods presented.
 
The following discussion is based on our Consolidated Statements of Operations for the three months ended March 31, 2013 and 2012 as included in Part I, Item 1. “Financial Statements” of this report.  The prior year’s property portfolios have been adjusted for subsequent sales. Continuing operations relates to income-producing properties that were held during those years as adjusted for sales in the subsequent years.
 
 
 
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Discontinued operations relates to properties that were either sold or held for sale as of the period ended March 31, 2013.  Included in discontinued operations are a total of three and nine properties as of 2013 and 2012, respectively.  Properties sold in 2013 have been reclassified to discontinued operations for current and prior year reporting periods. In 2013, we sold one apartment complex (Verandas at City View), have one apartment complex held for sale (Laguna Vista) and one commercial property held for sale (225 Baronne).  In 2012, we sold two apartment complexes (Portofino and Wildflower Villas), three commercial properties (305 Baronne, Clarke Garage and Dunes Plaza), and one hotel (Comfort Inn). The gain on sale of the properties is also included in discontinued operations for those years.  The table below shows the number of income-producing properties held at the quarter ended:

   
March 31,
 
   
2013
   
2012
 
Continuing operations
    59       59  
Held for sale/subsequent sales
    2       8  
Total property portfolio
    61       67  
 
Comparison of the three months ended March 31, 2013 to the same period ended 2012
 
For the three months ended March 31, 2013, we reported a net loss applicable to common shares of $0.2 million or $0.02 per diluted earnings per share, as compared to a net loss applicable to common shares of $6.9 million or $0.59 per diluted earnings per share for the same period ended 2012.
 
Expenses
 
Property operating expenses were $13.9 million for the three months ended March 31, 2013.  This represents an increase of $0.2 million, as compared to the prior period expense of $13.7 million.  This change, by segment, is an increase in the apartment portfolio of $0.6 million, a decrease in the commercial portfolio of $0.1 million, an increase in land of $0.1 million and a decrease in the other portfolio of $0.4 million.  Within the apartment portfolio, there was an increase of $0.6 million in the same properties due to a prior period insurance refund and an increase in real estate taxes for several properties in the current period.  Within the commercial portfolio, the same properties decreased by $0.1 million.  The other portfolio decrease related to a prior year fee for consulting services that did not reoccur in the current period.
 
General and administrative expenses were $2.2 million for the three months ended March 31, 2013.  This represents a decrease of $0.7 million, as compared to the prior period expenses of $2.9 million.  Although the apartment and commercial segments reflected a decrease in general and administrative services, it was a minimal change.  The majority of the change is due to the reduction in corporate professional services in the current period.

Other income (expense)
 
Interest income was $3.5 million for the three months ended March 31, 2013. This represents an increase of $0.2 million, as compared to the prior period interest income of $3.3 million.  The increase was due to the agreement made on January 1, 2013, where the Company extended the maturity on the surplus cash flow notes receivable from UHF for an additional term of five years in exchange for the early termination of the preferred interest rate.  The original notes gave a five-year period of preferred interest rate at 5.25%, before returning to the original note rate of 12.0%.  The increase was offset by cash received on one of the surplus cash flow notes from Unified Housing Foundation, Inc., in the prior period.  There were refinance proceeds received which allowed for the recognition of previously deferred interest income.
 
Other income was $2.5 million for the three months ended March 31, 2013.  This represents an increase of $0.8 million, as compared to the prior period other income of $1.7 million.  The current year income relates to the reduction of our estimated potential legal contingencies.  The prior year income relates to the agreement between UHF and TCI for consulting services related to the development of apartment projects.  There were no development projects in progress during the current period.
 
Mortgage and loan interest expense was $11.5 million for the three months ended March 31, 2013.  This represents a decrease of $2.2 million, as compared to the prior period interest expense of $13.7 million.  This change, by segment, is a decrease in our apartment portfolio of $0.9 million, a decrease in our commercial portfolio of $1.0 million, and a decrease in our land and other portfolios of $0.3 million.   Within the apartment portfolio, the same properties decreased $1.0 million.  Within the commercial portfolio, the same properties decreased by $1.0 million primarily due to two commercial loans that were in default status and were accruing default interest and late fees during the prior period.  After the settlement with the lenders, the loans have been accruing interest at a lower interest rate with no late fees.  The decrease in the land and other segments relates to principal payments made during the periods, thereby requiring less future interest to be paid on debt obligations.
 
 
 
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Deferred borrowing costs amortization was $2.5 million for the three months ended March 31, 2013.  This represents an increase of $1.6 million as compared to the prior period expense of $0.9 million.  This change, by segment, is an increase in the same-store apartment portfolio of $1.6 million due to the write off of prior loan deferred borrowing costs upon the refinance into a new mortgage note.
 
Loan charges and prepayment penalties were $4.0 million for the three months ended March 31, 2013.  This represents an increase of $1.6 million, as compared to the prior period expense of $2.4 million.  This change, by segment, is an increase in the same-store apartment portfolio by $1.4 million and an increase in the development properties by $0.2 million.  The same-store apartment portfolio increase was related to the prepayment penalties due from the refinancing of the existing mortgage note.  The increase related to the development portfolio was due to the closing of the construction loan for a recently completed apartment complex, into a permanent loan.  There were extension fees due to the lender for a delay in the close due to the settlement of the real estate tax protest.

Loss on land sales decreased for the three months ended March 31, 2013 as compared to the prior period. In the current period we sold 28.4 acres of land in two separate transactions for an aggregate sales price of $2.75 million and recorded a loss of $0.1 million.  In the prior period, we sold 461.17 acres of land in five separate transactions for an aggregate sales price of $8.2 million and recorded a loss of $1.0 million.

Discontinued operations relates to properties that were either sold or held for sale as of the period ended March 31, 2013.  Included in discontinued operations are a total of three and nine properties as of 2013 and 2012, respectively.  Properties sold in 2013 have been reclassified to discontinued operations for current and prior year reporting periods. In 2013, we sold one apartment complex (Verandas at City View), have one apartment complex held for sale (Laguna Vista) and one commercial property held for sale (225 Baronne).  In 2012, we sold two apartment complexes (Portofino and Wildflower Villas), three commercial properties (305 Baronne, Clarke Garage and Dunes Plaza), and one hotel (Comfort Inn). The gain on sale of the properties is also included in discontinued operations for those years.  The following table summarizes revenue and expense information for these properties sold and held for sale (dollars in thousands):

   
For the Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Revenue
           
     Rental
  $ 1,178     $ 3,522  
     Property operations
    526       2,488  
    $ 652     $ 1,034  
Expenses
               
     Other income
    -       2  
     Interest
    (220 )     (1,820 )
     General and administration
    (208 )     (169 )
     Depreciation and amortization
    (145 )     (594 )
     Provision on impairment of real estate assets
    -       -  
    $ (573 )   $ (2,581 )
Income (loss) from discontinued operations before gains
on sale of real estate, taxes, and fees
    79       (1,547 )
     Gain on sale of discontinued operations
    7,227       3,588  
     Equity in investee
    -       -  
Income from discontinued operations
  $ 7,306     $ 2,041  
     Tax expense
    (2,557 )     (714 )
Net income from discontinued operations
  $ 4,749     $ 1,327  
 
Liquidity and Capital Resources
 
Our principal liquidity needs are:
 
 
fund normal recurring expenses;
 
 
meet debt service and principal repayment obligations including balloon payments on maturing debt;
 
 
 
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fund capital expenditures, including tenant improvements and leasing costs;
 
 
fund development costs not covered under construction loans; and
 
 
fund possible property acquisitions.
 
Our principal sources of cash have been and will continue to be:
 
 
property operations;
 
 
proceeds from land and income-producing property sales;
 
 
collection of mortgage notes receivable;
 
 
collection of receivables from related party companies;
 
 
refinancing of existing debt; and
 
 
additional borrowing, including mortgage notes payable and lines of credit.
 
We draw on multiple financing sources to fund our long-term capital needs.  We generally fund our development projects with construction loans.  Management anticipates that our available cash from property operations may not be sufficient to meet all of our cash requirements.  Management intends to selectively sell land and income-producing assets, refinance or extend real estate debt and seek additional borrowing secured by real estate to meet its liquidity requirements.  Although the past cannot predict the future, historically, management has been successful at extending a portion of our current maturity obligations and selling assets as necessary to meet current obligations.
 
Cash flow summary
 
The following summary discussion of our cash flows is based on the statements of cash flows as presented in Part I Item 1. “Financial Statements” and is not meant to be an all inclusive discussion of the changes in our cash flow (dollars in thousands):
 
   
March 31,
       
   
2013
   
2012
   
Variance
 
                   
Net cash used in operating activities
  $ (9,070 )   $ (21,804 )   $ 12,734  
Net cash provided by investing activities
  $ 23,733     $ 13,906     $ 9,827  
Net cash used in financing activities
  $ (23,542 )   $ (4,253 )   $ (19,289 )
 
Our 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 from operating activities is from rental income on properties. In addition, we have a related party account in which excess cash is transferred to or from.

Our primary cash outlays for investing activities are for construction and development, acquisition of land and income-producing properties, and capital improvements to existing properties.  Our primary sources of cash from investing activities are from the proceeds on the sale of land and income-producing properties.   In the current period, we received more proceeds on the sale of land and income-producing properties.  The majority of the proceeds from sales were used to cover the loan obligations.  In the prior period, we spent more on the construction and development of new properties, with the completion of five apartment complexes in 2011.

Our primary sources of cash from financing activities are from proceeds on notes payables. Our primary cash outlays are for recurring debt payments and payments on maturing notes payable. Proceeds from notes payable associated with the new loans and refinancing provided $78.3 million. We used $4.6 million to make recurring note payments and $94.7 million for maturing notes, including payoffs required on sold properties.

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.