Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-K

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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)

 

(IRS Employer

Identification Number)

1800 Valley View Lane, Suite 300

Dallas, Texas

  75234
(Address of principal executive offices)   (Zip Code)

(469) 522-4200

Registrant’s Telephone Number, including area code

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class   Name of each exchange on which registered
Common Stock, $0.01 par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.    Yes  ¨    No  x

The aggregate market value of the shares of voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the closing price at which the common equity was last sold which was the sales price of the Common Stock on the New York Stock Exchange as of June 30, 2006 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $14,986,643 based upon a total of 1,746,695 shares held as of June 30, 2006 by persons believed to be non-affiliates of the Registrant. The basis of the calculation does not constitute a determination by the Registrant as defined in Rule 405 of the Securities Act of 1933, as amended, such calculation, if made as of a date within sixty days of this filing, would yield a different value.

As of March 23, 2007, there were 10,892,372 shares of common stock outstanding, which includes 746,972 shares issued to and owned by Transcontinental Realty Investors, Inc.

Documents Incorporated By Reference:

Consolidated Financial Statements of Income Opportunity Realty Investors, Inc.; Commission File No. 001-14784

 



Table of Contents

INDEX TO

ANNUAL REPORT ON FORM 10-K

 

          Page
     PART I     
Item 1.    Business.    3
Item 1A.    Risk Factors.    8
Item 1B.    Unresolved Staff Comments    12
Item 2.    Properties.    12
Item 3.    Legal Proceedings.    27
Item 4.    Submission of Matters to a Vote of Security Holders.    29
   PART II   
Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.    30
Item 6.    Selected Financial Data.    32
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.    33
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.    46
Item 8.    Consolidated Financial Statements and Supplementary Data.    47
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.    104
Item 9A(T).    Controls and Procedures.    104
Item 9B.    Other Information.    105
   PART III   
Item 10.    Directors and Executive Officers of the Registrant.    106
Item 11.    Executive Compensation.    114
Item 12.    Security Ownership of Certain Beneficial Owners and Management..    117
Item 13.    Certain Relationships and Related Transactions.    118
Item 14.    Principal Accountant Fees and Services.    121
   PART IV   
Item 15.    Exhibits and Financial Statement Schedules.    123
Signature Page    125

 

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FORWARD-LOOKING STATEMENTS

Certain Statements in this Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words “estimate,” “plan,” “intend,” “expect,” “anticipate,” “believe,” and similar expressions are intended to identify forward-looking statements. The forward-looking statements are found at various places throughout this Report and in the documents incorporated herein by reference. The Company disclaims any intention or obligations to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that our expectations are based upon reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause our actual results to differ from estimates or projections contained in any forward-looking statements are described in Item 1A. “Risk Factors” beginning on page 8.

PART I

 

ITEM 1. BUSINESS

American Realty Investors, Inc., a Nevada corporation (“ARI” or the “Company” or “we” or “us”), was organized in 1999, and in August 2000, through mergers into wholly-owned subsidiaries of ARI, acquired American Realty Trust, Inc., a Georgia corporation (“ART”), and National Realty LP, a Delaware limited partnership (“NRLP”). ART was the successor to a District of Columbia business trust organized July 14, 1961, to provide investors with a professionally managed, diversified portfolio of equity real estate and mortgage loan investments selected to provide opportunities for capital appreciation, as well as current income. The business trust merged into ART on June 24, 1988. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the liabilities of several public and private limited partnerships. NRLP also owned a portfolio of real estate and mortgage loan investments.

On December 31, 2006, ARI subsidiaries owned 82.2% of the outstanding shares of common stock of Transcontinental Realty Investors, Inc., a Nevada corporation (“TCI”), which has its common stock listed and traded on the New York Stock Exchange, Inc. (“NYSE”). The ownership of the TCI shares was achieved through a series of transactions, including a cash tender offer completed March 19, 2003, an exchange by certain ARI subsidiaries of securities with Basic Capital Management, Inc. (“BCM”) and a sale of a participating interest in a line of credit receivable from One Realco Corporation (“One Realco”) to BCM, as well as certain open market purchases of TCI shares in December 2003. See Note 1 to the Consolidated Financial Statements. ARI has consolidated TCI’s accounts and operations since March 31, 2003. At December 31, 2006, TCI owned 24.9% of Income Opportunity Realty Investors, Inc., (“IORI”) shares of common stock, and TCI owned 746,972 shares of common stock of ARI.

Effective July 1, 2003, Prime Asset Management, Inc. (“PAMI”) became the advisor to ARI and TCI. PAMI is owned by Realty Advisors, Inc. (80.0%) and Syntek West, Inc. (“Syntek West”) (20.0%), related parties. Syntek West is owned by Gene E. Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc. (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is 100% owned by PIAMI, replaced PIAMI as the advisor to ARI and TCI.

Business Plan and Investment Policy

ARI’s primary business is investing in equity interests in real estate (including equity securities of real estate-related entities), leases, joint venture development projects, and partnerships and, to a lesser extent, financing real estate and real estate activities through investments in mortgage loans, including first, wraparound and junior mortgage loans. Information regarding the real estate and mortgage notes receivable portfolios of ARI is set forth in ITEM 2. “PROPERTIES” NOTE 3. “NOTES AND INTEREST RECEIVABLE” and in Schedules III and IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED

 

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FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” ARI has six operating segments: apartments, commercial properties, hotels, land ownership, quick-service restaurants, and notes receivable. For additional information, see NOTE 18 to the Consolidated Financial Statements.

ARI’s business objective is to maximize long-term value for its stockholders by investing in commercial real estate through the ownership, management, development, and acquisition of apartments, commercial properties, hotels, and land. ARI intends to achieve this objective through acquiring and developing properties in multiple markets and operating as an industry-leading landlord. ARI believes this objective will provide the benefits of enhanced investment opportunities, economies of scale, risk diversification, both in terms of geographic market and real estate product type, and continuing access to both debt and equity capital. In pursuing its business objective, ARI seeks to achieve a combination of internal and external growth, maintain a strong balance sheet, and pursue a strategy of financial flexibility. ARI maximizes the value of its apartments and commercial properties by maintaining high occupancy levels while charging competitive rental rates, controlling costs, and focusing on tenant retention.

ARI generates increased operating cash flow through annual contractual increases in rental rates under existing leases. ARI also seeks to identify best practices across operating platforms in order to enhance cost savings and other efficiencies. ARI and its subsidiaries employ capital improvement and preventive maintenance programs designed to reduce operating costs and to increase the long-term value of its real estate investments.

ARI also pursues attractive development opportunities, focusing primarily on new construction or development, either directly or in a concerted effort with unaffiliated parties or affiliates. A summary of the properties under construction is set forth under ITEM 2. “PROPERTIES” below.

ARI also seeks to acquire properties consistent with its business objectives and strategies. ARI executes its acquisition strategy by purchasing properties which management believes will create stockholder value over the long-term. ARI will also sell properties when management believes value has been maximized or when a property is no longer considered an investment to be held long-term. During the year ended December 31, 2006, ARI, through its subsidiaries, acquired 51 properties and sold 25 properties.

ARI is continuously in various stages of discussions and negotiations with respect to development, acquisition, and disposition projects. The consummation of any current or future development, acquisition, or disposition, if any, and the pace at which any may be completed cannot be assured or predicted.

Substantially all properties are owned by subsidiaries of ARI, many of which are single-asset entities. This ownership structure permits greater access to financing for individual properties and permits flexibility in the type of transaction available for future disposition of each property by permitting a sale of either the asset or the equity ownership in the entity owning the asset. From time-to-time, subsidiaries have invested in joint ventures with others, creating the possibility of risks that do not exist with properties solely owned by an ARI subsidiary. In those instances where other investors are involved, those other investors may have business, economic, or other objectives that are inconsistent with ARI’s objectives, which may in turn require ARI to make investment decisions different than it might if ARI was the sole investor.

Real estate generally cannot be sold quickly. ARI and its subsidiaries may not be able to promptly dispose of properties in response to economic or other conditions. To offset this challenge, selective dispositions have been a part of ARI’s strategy to create an efficient portfolio and to provide additional sources of capital for future use. See the discussion under “LIQUIDITY AND CAPITAL RESOURCES” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for information concerning sales of properties during the past year. ARI and its subsidiaries finance acquisitions through non-recourse mortgages, internally generated funds, and, to a lesser extent, property sales. Those sources provide the bulk of funds for future acquisitions. ARI, from time-to-time, acquires properties subject to existing indebtedness by a subsidiary assuming such indebtedness. When properties are acquired in such a manner, ARI and its subsidiaries customarily seek to refinance the asset in order to properly leverage the asset for future operation.

 

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ARI, through its interest in Milano Restaurants International Corporation (“Milano”), operated and franchised several quick-service restaurant concepts including pizzerias featuring pizza delivery, carryout and dine-in under the trademarks “Me-N-Ed’s Pizzerias,” “Me-N-Ed’s Slices,” and “Angelo & Vito’s Pizzerias,” (collectively “the Pizzerias”). In July 2003, ARI sold its interest in Milano to Gruppa Florentina, LLC (“Gruppa”), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million. ARI owns 20.0% of Gruppa, thereby retaining a 20.0% interest in Milano. In conjunction with this transaction, ARI had guaranteed $8.7 million of assumed debt and $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in Milano, management determined that the sale should be accounted for as a financing transaction. On November 27, 2006, Gruppa refinanced all of the notes payable at which time, ARI was released as the guarantor of all the above mentioned debt. The Company has determined that the sale was completed and recorded a gain of $1.9 million for the sale of its 80% interest in Gruppa. The Company accounts for its 20% interest in Gruppa using the equity method of accounting.

ARI’s businesses are not generally seasonal with regard to real estate investments. ARI’s investment strategy seeks both current income and capital appreciation. ARI’s plan of operation is to continue, to the extent its liquidity permits, to make equity investments in income-producing real estate such as hotels, apartments, and commercial properties, including equity securities of real estate-related entities. ARI also intends to continue to pursue higher risk, higher reward investments, such as improved and unimproved land where it can obtain financing of substantially all of a property’s purchase price. ARI intends to seek selected dispositions of certain of its assets, including in particular selected income producing properties in stabilized markets and certain of its land holdings where the prices obtainable for such assets justify their disposition. ARI has determined that it will no longer actively seek to fund or purchase mortgage loans. However, it may, in selected instances, originate mortgage loans or it may provide purchase money financing in conjunction with a property sale. See ITEM 2. “PROPERTIES,” NOTE 3. “NOTES AND INTEREST RECEIVABLE” and Schedules III and IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”

ARI’s Board of Directors has broad authority under ARI’s governing documents to make all types of investments, and may devote available assets to particular investments or types of investments, without restriction on the amount or percentage of assets that may be allocated to a single investment or to any particular type of investment, and without limit on the percentage of securities of any one issuer that may be acquired. Investment objectives and policies may be changed at any time by the Board without stockholder approval.

The specific composition from time-to-time of ARI’s real estate portfolio owned through subsidiaries depends largely on the judgment of management to changing investment opportunities and the level of risk associated with specific investments or types of investments. Management intends to attempt to maintain a real estate portfolio diversified by location and type of property.

In addition to its equity investments in real estate, ARI and/or its subsidiaries have also invested in private and open market purchases of the equity securities of IORI and TCI, both affiliates of ARI. See ITEM 2. “PROPERTIES—Investments in Real Estate Companies and Real Estate Partnerships.”

Management of the Company

Although the Board of Directors is directly responsible for managing the affairs of ARI and for setting the policies which guide it, its day-to-day operations are performed by Prime, a contractual advisor under the supervision of the Board. The duties of Prime include, among other things, locating, investigating, evaluating, and recommending real estate and mortgage note investments and sales opportunities, as well as financing and refinancing sources. Prime also serves as a consultant in connection with ARI’s business plan and investment policy decisions made by the Board. Prime is a single-member limited liability company, the sole member of which is PIAMI, which is owned 80% by Realty Advisors, Inc. and 20% by Syntek West, Inc. Realty Advisors, Inc. is owned 100% by a trust for the benefit of the children of Gene E. Phillips. Syntek West, Inc. is owned 100% by Gene E. Phillips. Mr. Phillips is not an officer or director of Prime but serves as a representative of the

 

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Trust, is involved in daily consultation with the officers of Prime and has significant influence over the conduct of Prime's business, including the rendering of advisory services and the investment decisions for Prime and for ARI. As of March 23, 2006, PIAMI, Prime’s parent, owned 1,437,208 shares of ARI’s common stock, approximately 14.1% of the shares then outstanding. Prime is more fully described in ITEM 10. “DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT—The Advisor.”

Prime has been providing advisory services to ARI since October 1, 2003. Prime also serves as advisor to TCI. The officers of ARI are also officers of IORI, TCI, and Prime. The directors of ARI also serve as directors of TCI. The Chairman of the Board of Directors of ARI also serves as the Chairman of the Board of Directors of TCI and IORI. One other director of ARI also serves as a director of TCI and IORI. Affiliates of Prime have provided property management services to ARI. Currently, Triad Realty Services, Ltd. (“Triad”), an affiliate, and Carmel Realty, Inc. (“Carmel”) provide such property management services. Triad and Carmel subcontract with other entities for property-level management services. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”). Triad subcontracts the property-level management and leasing of 30 of ARI’s commercial properties (shopping centers, office buildings, and industrial warehouses) to Regis Realty I, LLC (“Regis I”) which is owned by Highland. Regis I receives property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Regis Hotel I, LLC, manages ARI’s 10 hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. Carmel is owned by Regis I.

Regis I is also entitled to receive real estate brokerage commissions in accordance with the terms of the Advisory Agreement as discussed in ITEM 10. “DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT—The Advisor.”

ARI has no employees. Under the terms of the Advisory Agreement, employees of Prime render services to ARI.

Competition

Real Estate.    The real estate business is highly competitive and ARI competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions”), some of which have greater financial resources than ARI. Management believes that success against such competition is dependent upon the geographic location of the property, the performance of property-level managers in areas such as leasing and marketing, collections and control of operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors include ease of access to the property, the adequacy of related facilities, such as parking and other amenities, and sensitivity to market conditions in determining rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the residents. With respect to hotels, competition is also based upon the market served, i.e., transient, commercial, or group users. Management believes that beyond general economic circumstances and trends, the degree to which properties are renovated or new properties are developed in the competing submarket are also competitive factors. See also ITEM 1A. “RISK FACTORS.”

To the extent that ARI seeks to sell any of its properties, the sales prices for the properties may be affected by competition from other real estate entities and financial institutions, also attempting to sell properties in areas where ARI’s properties are located, as well as aggressive buyers attempting to dominate or penetrate a particular market.

As described above and in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions,” the officers and directors of ARI also serve as officers and directors of TCI and the officers of ARI also serve as the officers of IORI and two directors of ARI are also directors of IORI. Both TCI and IORI have business objectives similar to ARI’s. ARI’s officers and directors owe fiduciary duties to both IORI and TCI as well as to ARI under applicable law. In determining whether a particular investment opportunity will be allocated to ARI, IORI, or TCI, management considers the respective investment objectives of each Company and the appropriateness of a particular investment in light of each

 

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Company’s existing real estate and mortgage notes receivable portfolio. To the extent that any particular investment opportunity is appropriate to more than one of the entities, the investment opportunity may be allocated to the entity which has had funds available for investment for the longest period of time, or, if appropriate, the investment may be shared among all three or two of the entities.

In addition, also as described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,” ARI competes with affiliates of Prime having similar investment objectives, in the purchasing, selling, leasing, and financing of real estate and real estate-related investments. In resolving any potential conflicts of interest which may arise, Prime has informed ARI that it intends to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.

ARI is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, but are not limited to, changes in general or local economic conditions, changes in interest rates and availability of permanent mortgage financing which may render the purchase, sale, or refinancing of a property difficult or unattractive, and which may make debt service overly burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of management or the advisor. The illiquidity of real estate investments may also impair the ability of management to respond promptly to changing circumstances. Management believes that such risks are partially mitigated by the diversification by geographic region and property type of ARI’s real estate and mortgage notes receivable portfolios. However, to the extent that property sales, new property investments, in particular improved and unimproved land, or mortgage lending are concentrated in any particular region, the advantages of geographic diversification are mitigated.

Virtually all of ARI’s real estate, equity security holdings in TCI, and its portfolio of equity securities are held subject to secured indebtedness. Such borrowings increase the risk of loss because they represent a prior claim on ARI’s assets and require fixed payments regardless of profitability. In the event of default, the lender may foreclose on the assets securing such indebtedness, and ARI could lose its investment in the pledged assets.

Quick-Service Restaurants.    The pizza parlor business is highly competitive and is affected by changes in consumer tastes and eating habits, as well as national, regional, and local economic conditions, and demographic trends. The performance of an individual pizza parlor can be affected by changes in traffic patterns, demographics, and the type, number and location of competing restaurants.

At December 31, 2006, Milano owned and operated 60 pizza parlors under the trademarks “Me-N-Ed’s Pizzerias,” and “Angelo & Vito’s Pizzerias” (collectively “the Pizzerias”). The results achieved by Milano’s relatively small pizza parlor base may not be indicative of the results of a larger number of pizza parlors in a more geographically dispersed area. Because of Milano’s relatively small pizza parlor base, an unsuccessful pizza parlor has a more significant effect on Milano’s results of operations than would be the case in a company owning more pizza parlors. ARI owns a 20% equity interest in the Pizzerias.

Available Information

ARI maintains an Internet site at http://www.amrealtytrust.com. Available through the website, free of charge, are Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, reports filed pursuant to Section 16, and amendments to those reports, as soon as reasonably practicable after they are electronically filed or furnished to the Securities and Exchange Commission. In addition, ARI has posted the charters for the Audit Committee, Compensation Committee, and Governance and Nominating Committee, as well as the Code of Business Conduct and Ethics, Corporate Governance Guidelines on Director Independence, and other information on the website. These charters and principles are not incorporated in this report by reference. ARI will also provide a copy of these documents free of charge to stockholders upon written request. ARI issues Annual Reports containing audited financial statements to its common stockholders.

 

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ITEM 1A.    RISK FACTORS

An investment in our securities involves various risks. All investors should carefully consider the following risk factors in conjunction with the other information in this report before trading our securities.

Risk Factors Related to ARI’s Business

Adverse events concerning existing tenants, or negative market conditions that may affect existing tenants could have an adverse impact on ARI’s ability to attract new tenants, relet space, collect rent or renew leases, and thus could adversely affect cash flow from operations and inhibit growth.    Cash flow from operations depends in part on the ability to lease space to tenants on economically favorable terms. ARI could be adversely affected by various facts and events over which the Company has limited or no control, such as:

 

   

lack of demand for space in areas where the Company’s properties are located;

 

   

inability to retain existing tenants and attract new tenants;

 

   

oversupply of or reduced demand for space and changes in market rental rates;

 

   

defaults by tenants or failure to pay rent on a timely basis;

 

   

the need to periodically renovate and repair marketable space;

 

   

physical damage to properties;

 

   

economic or physical decline of the areas where properties are located;

 

   

potential risk of functional obsolescence of properties over time.

At any time, any tenant may experience a downturn in its business that may weaken its financial condition. As a result, a tenant may delay a lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent or declare bankruptcy. Any tenant bankruptcy or insolvency, leasing delay or failure to make rental payments when due could result in the termination of the tenant’s lease and material losses to the Company.

If tenants do not renew their leases as they expire, ARI may not be able to rent the space. Furthermore, leases that are renewed, and some new leases for space that is relet, may have terms that are less economically favorable than expiring lease terms, or may require ARI to incur significant costs, such as renovations, tenant improvements, or lease transaction costs.

Any of these events could adversely affect cash flow from operations and ARI’s ability to make distributions to shareholders and service indebtedness.

A significant portion of the costs of owning property, such as real estate taxes, insurance costs, and debt service payments are not necessarily reduced when circumstances cause a decrease in rental income from the properties.

ARI may not be able to compete successfully with other entities that operate in our industry.    ARI experiences a great deal of competition in attracting tenants for its properties and in locating land to develop and properties to acquire.

In ARI’s effort to lease its properties, ARI competes for tenants with a broad spectrum of other landlords. These competitors include, among others, publicly-held REITs, privately-held entities, individual property owners and tenants who wish to sublease their space. Some of these competitors may be able to offer prospective tenants more attractive financial terms than ARI is able to offer.

If the availability of land or high quality properties in ARI’s markets diminishes, operating results could be adversely affected.

 

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ARI may experience increased operating costs, which could adversely affect our financial results and the value of our properties.    ARI’s properties are subject to increases in operating expenses such as insurance, cleaning, electricity, heating, ventilation and air conditioning, administrative costs and other costs associated with security, landscaping, repairs, and maintenance of the properties. While some current tenants generally are obligated by their leases to reimburse ARI for a portion of these costs, there is no assurance that these tenants will make such payments or agree to pay these costs upon renewal or new tenants will agree to pay these costs. If operating expenses increase in ARI’s markets, ARI may not be able to increase rents or reimbursements in all of these markets to offset the increased expenses, without at the same time decreasing occupancy rates. If this occurs, ARI’s ability to make distributions to shareholders and service indebtedness could be adversely affected.

ARI’s ability to achieve growth in operating income depends in part on its ability to develop properties.    ARI intends to continue to develop properties where warranted by market conditions. ARI has a number of ongoing development and land projects being readied for commencement.

Additionally, general construction and development activities include the following risks:

 

   

construction and leasing of a property may not be completed on schedule, which could result in increased expenses and construction costs, and would result in reduced profitability for that property;

 

   

construction costs may exceed original estimates due to increases in interest rates and increased cost of materials, labor or other costs, possibly making the property less profitable because of inability to increase rents to compensate for the increase in construction costs;

 

   

some developments may fail to achieve expectations, possibly making them less profitable;

 

   

ARI may be unable to obtain, or face delays in obtaining, required zoning, land-use, building, occupancy, and other governmental permits and authorizations, which could result in increased costs and could require ARI to abandon its activities entirely with respect to a project;

 

   

ARI may abandon development opportunities after the initial exploration, which may result in failure to recover costs already incurred. If ARI determines to alter or discontinue its development efforts, future costs of the investment may be expensed as incurred rather than capitalized and ARI may determine the investment is impaired resulting in a loss;

 

   

ARI may expend funds on and devote management’s time to projects which will not be completed;

 

   

occupancy rates and rents at newly-completed properties may fluctuate depending on various factors including market and economic conditions, and may result in lower than projected rental rates and reduced income from operations.

ARI faces risks associated with property acquisitions.    ARI acquires individual properties and various portfolios of properties and intends to continue to do so. Acquisition activities are subject to the following risks:

 

   

when ARI is able to locate a desired property, competition from other real estate investors may significantly increase the seller’s offering price;

 

   

acquired properties may fail to perform as expected;

 

   

the actual costs of repositioning or redeveloping acquired properties may be higher than original estimates;

 

   

acquired properties may be located in new markets where ARI faces risks associated with an incomplete knowledge or understanding of the local market, a limited number of established business relationships in the area and a relative unfamiliarity with local governmental and permitting procedures;

 

   

ARI may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into existing operations, and results of operations and financial condition could be adversely affected.

 

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ARI may acquire properties subject to liabilities and without any recourse, or with limited recourse, with respect to unknown liabilities. However, if an unknown liability was later asserted against the acquired properties, ARI might be required to pay substantial sums to settle it, which could adversely affect cash flow.

Many of ARI’s properties are concentrated in our primary markets, and the Company may suffer economic harm as a result of adverse conditions in those markets.    ARI’s properties are located principally in specific geographic areas in the Southwestern, Southeastern, and Midwestern United States. The Company’s overall performance is largely dependent on economic conditions in those regions.

ARI is leveraged and we may not be able to meet our debt service obligations.    ARI had total indebtedness at December 31, 2006 of approximately $1.25 billion. Substantially all assets have been pledged to secure debt. These borrowings increase the risk of loss because they represent a prior claim on assets and most require fixed payments regardless of profitability. ARI’s leveraged position makes it vulnerable to declines in the general economy and may limit the Company’s ability to pursue other business opportunities in the future.

The Company may not be able to access financial markets to obtain capital on a timely basis, or on acceptable terms.    ARI relies on proceeds from property dispositions and third party capital sources for a portion of its capital needs, including capital for acquisitions and development. The public debt and equity markets are among the sources upon which the Company relies. There is no guarantee ARI will be able to access these markets or any other source of capital. The ability to access the public debt and equity markets depends on a variety of factors, including:

 

   

general economic conditions affecting these markets;

 

   

ARI’s own financial structure and performance;

 

   

the market’s opinion of real estate companies in general;

 

   

the market’s opinion of real estate companies that own properties like ARI.

ARI may suffer adverse effects as a result of terms and covenants relating to the Company’s indebtedness.    Required payments on ARI’s indebtedness generally are not reduced if the economic performance of the portfolio declines. If the economic performance declines, net income, cash flow from operations and cash available for distribution to stockholders may be reduced. If payments on debt cannot be made, ARI could sustain a loss or suffer judgments, or in the case of mortgages, suffer foreclosures by mortgagees. Further, some obligations contain cross-default and/or cross-acceleration provisions, which means that a default on one obligation may constitute a default on other obligations.

ARI anticipates only a small portion of the principal of its debt will be repaid prior to maturity. Therefore, ARI is likely to refinance a portion of its outstanding debt as it matures. There is a risk that ARI may not be able to refinance existing debt or the terms of any refinancing will not be as favorable as the terms of the maturing debt. If principal balances due at maturity cannot be refinanced, extended, or repaid with proceeds from other sources, such as the proceeds of sales of assets or new equity capital, cash flow may not be sufficient to repay all maturing debt in years when significant “balloon” payments come due.

ARI’s credit facilities and unsecured debt contain customary restrictions, requirements and other limitations on the ability to incur indebtedness, including total debt to asset ratios, secured debt to total asset ratios, debt service coverage ratios, and minimum ratios of unencumbered assets to unsecured debt, which ARI must maintain. ARI’s continued ability to borrow is subject to compliance with financial and other covenants. In addition, failure to comply with such covenants could cause a default under credit facilities, and ARI may then be required to repay such debt with capital from other sources. Under those circumstances, other sources of capital may not be available, or be available only on unattractive terms.

ARI’s leverage could affect the Company’s ability to obtain additional financing for working capital, capital expenditures, acquisitions, development, or other general corporate purposes. The degree of leverage could also

 

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make ARI more vulnerable to a downturn in business or the economy or could affect the market price of the Company’s common stock.

An increase in interest rates would increase interest costs on variable rate debt and could adversely impact the Company’s ability to refinance existing debt.    ARI currently has, and may incur more, indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will the interest costs, which would adversely affect cash flow and the ability to pay principal and interest on ARI’s debt and the ability to make distributions to shareholders. Further, rising interest rates could limit ARI’s ability to refinance existing debt when it matures.

Unbudgeted capital expenditures or cost overruns could adversely affect business operations and cash flow.    If capital expenditures for ongoing or planned development projects or renovations exceed expectations, the additional cost of these expenditures could have an adverse effect on business operations and cash flow. In addition, ARI might not have access to funds on a timely basis to pay the unexpected expenditures.

Construction costs are funded in large part through construction financing, which the Company may guarantee and the Company’s obligation to pay interest on this financing continues until the rental project is completed, leased up, and permanent financing is obtained, or the for sale project is sold or the construction loan is otherwise paid. Unexpected delays in completion of one or more ongoing projects could also have a significant adverse impact on business operations and cash flow.

ARI may need to sell properties from time-to-time for cash flow purposes.    Because of the lack of liquidity of real estate investments generally, ARI’s ability to respond to changing circumstances may be limited. Real estate investments generally cannot be sold quickly. In the event that ARI must sell assets to generate cash flow, ARI cannot predict whether there will be a market for those assets in the time period desired, or whether ARI will be able to sell the assets at a price that will allow the Company to fully recoup its investment. ARI may not be able to realize the full potential value of the assets and may incur costs related to the early pay-off of the debt secured by such assets.

The Company intends to devote resources to the development of new projects.    ARI plans to continue developing new projects as opportunities arise in the future. Development and construction activities entail a number of risks, including but not limited to the following:

 

   

ARI may abandon a project after spending time and money determining its feasibility;

 

   

construction costs may materially exceed original estimates;

 

   

the revenue from a new project may not be enough to make it profitable or generate a positive cash flow;

 

   

ARI may not be able to obtain financing on favorable terms for development of a property, if at all;

 

   

the Company may not complete construction and lease-ups on schedule, resulting in increased development or carrying costs;

 

   

ARI may not be able to obtain, or may be delayed in obtaining, necessary governmental permits.

The overall business is subject to all of the risks associated with the real estate industry.    ARI is subject to all risks incident to investment in real estate, many of which relate to the general lack of liquidity of real estate investments, including, but not limited to:

 

   

ARI’s real estate assets are concentrated primarily in the Southwest and any deterioration in the general economic conditions of this region could have an adverse effect;

 

   

changes in interest rates may make the ability to satisfy debt service requirements more burdensome;

 

   

lack of availability of financing may render the purchase, sale or refinancing of a property more difficult or unattractive;

 

   

changes in real estate and zoning laws;

 

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increases in real estate taxes and insurance costs;

 

   

federal or local economic or rent control;

 

   

acts of terrorism, and

 

   

hurricanes, tornadoes, floods, earthquakes and other similar natural disasters.

Risks Related to the Real Estate Industry

Real estate investments are illiquid, and the Company may not be able to sell properties if and when it is appropriate to do so.    Real estate generally cannot be sold quickly. ARI may not be able to dispose of properties promptly in response to economic or other conditions. In addition, provisions of the Internal Revenue Code may limit ARI’s ability to sell properties (without incurring significant tax costs) in some situations when it may be otherwise economically advantageous to do so, thereby adversely affecting returns to stockholders and adversely impacting ARI’s ability to meet it’s obligations.

 

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

ARI’s principal offices are located at 1800 Valley View Lane, Suite 300, Dallas, Texas 75234 and are, in the opinion of management, suitable and adequate for ARI’s present operations.

Details of ARI’s and its subsidiaries’ real estate and mortgage notes receivable portfolios at December 31, 2006, are set forth in SCHEDULES III and IV, respectively, to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” The discussions set forth below under the headings “Real Estate” and “Mortgage Loans” provide certain summary information concerning ARI’s real estate and mortgage notes receivable portfolios.

At December 31, 2006, no single asset accounted for 10.0% or more of total assets. At December 31, 2006, 85.2% of ARI’s assets consisted of real estate, and 3.5% consisted of notes and interest receivable. The remaining 11.3% of ARI’s assets were cash, cash equivalents, marketable equity securities, restaurant equipment, investments in equity investees, goodwill and other intangibles, and other assets. The percentage of assets invested in any one category is subject to change and no assurance can be given that the composition of ARI’s assets in the future will approximate the percentages listed above.

ARI’s real estate is geographically diverse with concentrations in the Southwest, Southeast, and Midwest regions. At December 31, 2006, ARI’s real estate was located in all geographic regions of the continental United States, other than the Northeast region, as shown more specifically in the table under “Real Estate” below. ARI also holds mortgage notes receivable secured by real estate located in the Southwest, Pacific, and Midwest regions of the continental United States. See SCHEDULE IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of ARI’s notes receivable portfolio.

Real Estate

At December 31, 2006, 85.2% of ARI’s assets were invested in real estate and the equity securities of IORI and other equity investees. ARI invests in real estate located throughout the continental United States, either on a leveraged or non-leveraged basis. ARI’s real estate portfolio consists of properties held for investment, properties held for sale, investments in partnerships, and investments in equity investees.

Types of Real Estate Investments.    ARI’s real estate consists of apartments, commercial properties (office buildings, industrial warehouses, shopping centers, and a merchandise mart), hotels, and improved and

 

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unimproved land. In selecting real estate for investment, the location, age, and type of property, gross rents, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values, and physical condition are among the factors considered. Properties may be purchased subject to debt, or existing debt may be assumed and properties may be mortgaged, pledged or otherwise collateralized to obtain financing. The Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.

Although ARI has typically invested in developed real estate, it may also invest in new construction or development either directly or in partnership with unaffiliated parties or affiliates (subject to approval by the Board of Directors). To the extent that it invests in construction and development projects, such as the apartments described below, ARI is subject to business risks, which include cost overruns and construction delays, associated with higher risk projects.

At December 31, 2006, ARI had the following properties under construction.

 

Property

  

Location

   Units    Amount
Expended
   Additional
Amount to
Expend
    Construction
Loan
Funding

Apartments

             

Bolivar Homes

   Cleveland, MS    65 Units    $ 1,218    $ 7,390     $ 1,300

Broadway Estates

   Greenville, MS    104 Units      788      7,569       850

Lago Vista

   Farmers Branch, TX    212 Units      5,091      21,359       2,079

Laguna Vista

   Farmers Branch, TX    206 Units      9,969      11,137       17,741

Legends of El Paso

   El Paso, TX    240 Units      6,430      15,461       14,988

Mason Park

   Houston, TX    312 Units      1,991      17,409       3,349

Mission Oaks

   San Antonio, TX    228 Units      14,241      (2,266 )     11,376

Parc at Clarksville

   Clarksville, TN    206 Units      889      13,002       5,624

Parc at Maumelle

   Maumelle, AR    240 Units      12,419      5,782       13,015

Parc at Metro Center

   Nashville, TN    144 Units      4,373      6,768       8,340

Parc at Rogers

   Rogers, AR    152 Units      973      19,852       3,563

Pecan Pointe

   Temple, TX    232 Units      1,991      14,846       180

Sunflower Estates

   Indianola, MS    65 Units      755      7,674       810

Yazoo Estates

   Yazoo City, MS    96 Units      31      8,314       835

In 2005, ARI completed the 70 unit Blue Lake Villas II in Waxahachie, Texas, the 272 unit Bluffs at Vista Ridge in Lewisville, Texas, the 232 unit Bridges on Kinsey in Tyler, Texas, the 208 unit Dakota Arms in Lubbock, Texas, the 240 unit Lake Forest in Houston, Texas, the 220 unit Wildflower Villas in Temple, Texas, the 398 unit Kingsland Ranch Apartments in Houston, Texas, the 240 unit Stonebridge at City Park Apartments in Houston, Texas, and the 240 unit Vistas of Vance Jackson in San Antonio, Texas.

The Company’s three office buildings in downtown New Orleans suffered extensive damage from Hurricane Katrina. Management has worked with the Company’s insurance carriers to finalize all related claims. Repairs have nearly been completed for the Amoco and 1010 Common buildings. The building at 225 Baronne is not open and few repairs have been completed. ARI intends to redevelop 225 Baronne as an urban residential facility, which it considers the best and most profitable use of the property. In August 2006, to facilitate the marketability of the property, ARI acquired the Clarke Garage and 305 Baronne for approximately $14.0 million to provide additional parking and retail for the residential development.

The following table sets forth the percentages, by property type and geographic region, of owned real estate (excluding 92 parcels of improved and unimproved land, a hotel in Wroclaw, Poland, and a single-family residence, described below) at December 31, 2006.

Region

   Apartments     Commercial
Properties
    Hotels  

Midwest

   8 %   18 %   33 %

Mountain

   —       13     11  

Pacific

   —       —       45  

Southeast

   7     35     11  

Southwest

   85     34     —    
                  
   100 %   100 %   100 %
                  

 

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The foregoing table is based solely on the number of apartment units, amount of commercial square footage, and number of hotel rooms owned, and does not reflect the value of ARI’s investment in each region. See SCHEDULE III to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of owned real estate.

Excluded from the table above are a 165 room hotel in Wroclaw, Poland, a single family residence in Dallas, Texas, and 92 parcels of improved and unimproved land. See “Land Properties” table below for a listing of properties, locations, and acres.

A summary of the activity in the owned real estate portfolio during 2006 is as follows:

 

Owned properties at January 1, 2006

   212  

Properties purchased (excluding additions to existing land parcels)

   44  

Properties added from consolidation of partnerships

    

Properties sold (excluding partial sales)

   (20 )
      

Owned properties at December 31, 2006

   236  
      

Operating Properties.    Set forth below are ARI’s operating properties and the monthly rental rate for apartments, the average annual rental rate for commercial properties, the average daily room rate and room revenue divided by total available rooms for hotels, and occupancy at December 31, 2006, 2005 and 2004 for apartments and commercial properties and average occupancy during 2006, 2005, and 2004 for hotels.

 

Property

  Location    Units/Square Footage  

Rent Per

Square Foot

  Occupancy %  
       2006   2005   2004   2006     2005     2004  

Apartments

                

4400

  Midland, TX    92 Units/94,472 Sq. Ft.   $   .60   $   .55   $   .51   94 %   97 %   97 %

Anderson Estates

  Oxford, MS    48 Units/71,760 Sq. Ft.     .49     *     *   98     *     *  

Arbor Point

  Odessa, TX    195 Units/178,920 Sq. Ft.     .54     .50     .47   96     92     90  

Arlington Place

  Pasadena, TX    230 Units/205,476 Sq. Ft.     .76     .76     .76   93     96     97  

Ashton Way

  Midland, TX    178 Units/138,964 Sq. Ft.     .53     .48     .45   96     96     95  

Autumn Chase

  Midland, TX    64 Units/58,652 Sq. Ft.     .68     .61     .57   100     95     98  

Bay Walk

  Galveston, TX    192 Units/153,120 Sq. Ft.     .75     .75     .75   91     94     90  

Blue Lake Villas

  Waxahachie, TX    186 Units/169,746 Sq. Ft.     .95     .93     .91   95     95     90  

Blue Lake Villas II

  Waxahachie, TX    70 Units/69,768 Sq. Ft.     .81     .79     *   94     99     *  

Bluffs at Vista Ridge

  Lewisville, TX    272 Units/257,432 Sq. Ft.     .99     .98     *   95     89     *  

Breakwater Bay

  Beaumont, TX    176 Units/145,688 Sq. Ft.     .98     .94     .93   96     99     87  

Bridges on Kinsey

  Tyler, TX    232 Units/209,888 Sq. Ft.     .91     .87     *   100     98     *  

Bridgestone

  Friendswood, TX    76 Units/65,519 Sq. Ft.     .74     .74     .74   95     96     96  

Capitol Hill

  Little Rock, AR    156 Units/151,116 Sq. Ft.     .77     .76     .88   94     98     70  

Château

  Bellevue, NE    115 Units/99,220 Sq. Ft.     .74     .74     .73   92     91     86  

Château Bayou

  Ocean Springs, MS    122 Units/105,536 Sq. Ft.     .74     .70     .67   100     100     94  

Courtyard

  Midland, TX    133 Units/111,576 Sq. Ft.     .56     .49     .47   99     96     94  

Coventry

  Midland, TX    120 Units/105,608 Sq. Ft.     .58     .51     .45   98     98     96  

Dakota Arms

  Lubbock, TX    208 Units/178,776 Sq. Ft.     .88     .88     *   99     93     *  

David Johnson Phase II

  Greenwood, MS    32 Units/27,840 Sq. Ft.     .35     *     *   100     *     *  

David Johnson Phase III

  Greenwood, MS    40 Units/35,240 Sq. Ft.     .41     *     *   95     *     *  

DeSoto Ranch

  DeSoto, TX    248 Units/240,718 Sq. Ft.     .96     .97     .95   92     96     98  

 

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Property

   Location    Units/Square Footage   

Rent Per

Square Foot

   Occupancy %
         2006    2005    2004    2006    2005    2004

Apartments (Continued)

                       

El Chapparal

   San Antonio, TX    190 Units/174,220 Sq. Ft.    .79    .76    .75    89    93    94

Fairway View Estates

   El Paso, TX    264 Units/204,000 Sq. Ft.    .69    .67    .65    95    95    90

Fairways

   Longview, TX    152 Units/134,176 Sq. Ft.    .63    .61    .59    93    91    96

Falcon Lakes

   Arlington, TX    284 Units/207,960 Sq. Ft.    .97    .97    .96    97    96    94

Fountain Lake

   Texas City, TX    166 Units/161,220 Sq. Ft.    .62    .62    .62    90    92    86

Fountains of Waterford

   Midland, TX    172 Units/129,200 Sq. Ft.    .69    .61    .55    95    96    96

Foxwood

   Memphis, TN    220 Units/212,000 Sq. Ft.    .61    .61    .61    88    95    83

Governor’s Square

   Tallahassee, FL    169 Units/146,550 Sq. Ft.    .70    .69    .73    97    98    95

Harper’s Ferry

   Lafayette, LA    122 Units/112,500 Sq. Ft.    .65    .61    .61    98    98    95

Heather Creek

   Mesquite, TX    200 Units/170,212 Sq. Ft.    .96    .95    .94    97    94    93

Hunters Glen

   Midland, TX    260 Units/174,180 Sq. Ft.    .51    .45    .42    100    100    93

Island Bay

   Galveston, TX    458 Units/374,784 Sq. Ft.    .84    .84    .83    88    94    93

Kingsland Ranch

   Houston, TX    398 Units/350,574 Sq. Ft.    .96    .96    *    91    97    *

Laguna Vista

   Dallas, TX    202 Units/188,009 Sq. Ft.    .31    *    *    16    *    *

Lake Forest

   Houston, TX    240 Units/193,872 Sq. Ft.    .97    .97    *    93    95    *

Leflore Estates

   Greenwood, MS    104 Units/94,256 Sq. Ft.    .39    *    *    98    *    *

Limestone Canyon

   Austin, TX    260 Units/216,000 Sq. Ft.    1.06    1.06    1.06    90    94    96

Limestone Ranch

   Lewisville, TX    252 Units/219,600 Sq. Ft.    .98    .97    .95    93    94    95

Marina Landing

   Galveston, TX    256 Units/205,504 Sq. Ft.    .83    .83    .83    90    97    92

Mariposa Villas

   Dallas, TX    216 Units/199,656 Sq. Ft.    .90    .89    .89    95    92    95

Mediterranean Villas

   San Antonio, TX    140 Units/158,960 Sq. Ft.    .60    .58    .56    85    99    92

Mission Oaks

   San Antonio, TX    228 Units/195,716 Sq. Ft.    .88    *    *    87    *    *

Monticello Estates

   Monticello, AR    32 Units/27,840 Sq. Ft.    .39    *    *    94    *    *

Mountain Plaza

   El Paso, TX    188 Units/220,710 Sq. Ft.    .59    .54    .52    82    97    90

Oak Park IV

   Clute, TX    108 Units/78,708 Sq. Ft.    .56    .56    .56    92    93    93

Paramount Terrace

   Amarillo, TX    181 Units/123,840 Sq. Ft.    .64    .62    .61    97    96    91

Parc at Maumelle

   Little Rock, AR    240 Units/208,800 Sq. Ft.    .89    *    *    78    *    *

Parc at Metro

   Nashville, TN    144 Units/130,338 Sq. Ft.    .44    *    *    64    *    *

Quail Oaks

   Balch Springs, TX    131 Units/72,848 Sq. Ft.    .85    .83    .83    86    97    95

River Oaks

   Wylie, TX    180 Units/164,604 Sq. Ft.    .90    .96    .86    94    95    95

Riverwalk I

   Greenville, MS    32 Units/27,840 Sq. Ft.    .38    *    *    100    *    *

Riverwalk II

   Greenville, MS    72 Units/63,520 Sq. Ft.    .47    *    *    94    *    *

Sendero Ridge

   San Antonio, TX    384 Units/340,880 Sq. Ft.    1.03    .95    1.02    93    90    94

Somerset

   Texas City, TX    200 Units/163,368 Sq. Ft.    .68    .68    .68    90    92    85

Southgate

   Odessa, TX    180 Units/151,656 Sq. Ft.    .58    .51    .46    98    95    98

Spy Glass

   Mansfield, TX    256 Units/239,264 Sq. Ft.    .98    .97    .96    95    93    92

Stonebridge at City Park

   Houston, TX    240 Units/207,424 Sq. Ft.    .97    .97    *    94    96    *

Sunchase

   Odessa, TX    300 Units/223,048 Sq. Ft.    .59    .54    .51    94    96    97

Tivoli

   Dallas, TX    190 Units/168,862 Sq. Ft.    .97    .96    .95    95    93    92

Treehouse

   Irving, TX    160 Units/153,072 Sq. Ft.    .80    .80    .80    86    95    96

Verandas at City View

   Fort Worth, TX    314 Units/295,170 Sq. Ft.    .94    .92    .92    97    96    93

Villa Del Mar

   Wichita, KS    162 Units/128,004 Sq. Ft.    .64    .62    .62    90    91    89

Villager

   Ft. Walton, FL    33 Units/22,840 Sq. Ft.    .92    .88    .79    100    97    100

Vistas at Pinnacle Park

   Dallas, TX    332 Units/276,928 Sq. Ft.    .94    .93    .91    94    93    96

 

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Table of Contents

Property

  Location   Units/Square Footage  

Rent Per

Square Foot

  Occupancy %
      2006   2005   2004   2006   2005   2004

Apartments (Continued)

               

Vistas at Vance Jackson

  San Antonio, TX   240 Units/196,272 Sq. Ft.   1.02   .72   *   97   94   *

Westwood

  Mary Ester, FL   120 Units/93,000 Sq. Ft.   .97   .83   .74   100   99   100

Westwood

  Odessa, TX   79 Units/49,001 Sq. Ft.   .60   .54   .46   92   100   91

Whispering Pines

  Topeka, KS   320 Units/299,264 Sq. Ft.   .57   .55   .55   92   91   91

Wildflower Villas

  Temple, TX   220 Units/201,536 Sq. Ft.   .90   .85   *   90   92   *

Willow Creek

  El Paso, TX   112 Units/103,140 Sq. Ft.   .62   .59   .58   91   97   97

Windsong

  Ft. Worth, TX   188 Units/169,464 Sq. Ft.   .92   .90   .89   89   96   91

Woodlake

  Carrollton, TX   256 Units/210,208 Sq. Ft.   .87   .87   .87   93   94   92

Woodview

  Odessa, TX   232 Units/165,840 Sq. Ft.   .61   .56   .53   96   96   93

Office Buildings

               

1010 Common

  New Orleans, LA   494,579 Sq. Ft.   14.08   14.09   14.08   77   85   84

225 Baronne

  New Orleans, LA   416,834 Sq. Ft.   10.43   10.62   10.70   47   68   69

305 Baronne

  New Orleans, LA   37,087 Sq. Ft.   4.64   *   *   90   *   *

600 Las Colinas

  Las Colinas, TX   509,829 Sq. Ft.   20.67   21.88   *   92   88   *

Amoco

  New Orleans, LA   378,244 Sq. Ft.   14.02   13.78   13.66   74   72   69

Cooley Building

  Farmers Branch, TX   27,000 Sq. Ft.   14.00   13.63   12.63   50   100   100

Durham Center

  Durham, NC   207,171 Sq. Ft.   17.00   16.60   17.73   66   55   83

Eton Square

  Tulsa, OK   222,654 Sq. Ft.   10.70   10.51   11.09   90   60   75

Executive Court

  Memphis, TN   41,840 Sq. Ft.   4.23   4.51   8.00   0   10   *

Forum

  Richmond, VA   79,791 Sq. Ft.   13.96   13.86   13.68   90   90   76

Four Hickory Centre

  Farmers Branch, TX   226,911 Sq. Ft.   20.00   18.41   18.70   43   11   4

GNB

  Farmers Branch, TX   200,000 Sq. Ft.   ***   *   *   ***   *   *

Lexington Center

  Colorado Springs, CO   74,603 Sq. Ft.   11.20   10.88   10.56   39   58   58

One Hickory Centre

  Farmers Branch, TX   102,615 Sq. Ft.   11.16   *   *   100   *   *

Park West

  Farmers Branch, TX   243,416 Sq. Ft.   16.97   10.00   *   64   0   *

Parkway North

  Dallas, TX   71,041 Sq. Ft.   14.55   15.26   16.58   69   31   60

Signature Building

  Dallas, TX   56,532 Sq. Ft.   10.42   10.00   **   100   100   **

Two Hickory Centre

  Farmers Branch, TX   96,127 Sq. Ft.   20.63   18.29   21.47   97   89   100

University Square

  Anchorage, AK   22,260 Sq. Ft.   20.00   19.73   14.64   81   77   100

Westgrove Air Plaza

  Addison, TX   78,326 Sq. Ft.   11.29   11.29   12.68   76   79   74

Industrial Warehouses

               

5360 Tulane

  Atlanta, GA   30,000 Sq. Ft.   2.85   2.85   2.85   100   100   100

Addison Hangar

  Addison, TX   23,650 Sq. Ft.   7.80   7.83   7.54   100   100   67

Addison Hangar II

  Addison, TX   29,000 Sq. Ft.   7.72   9.05   9.24   100   100   92

Clarke Garage

  New Orleans, LA   6,869 Sq. Ft.   11.15   *   *   70   *   *

Encon

  Fort Worth, TX   256,410 Sq. Ft.   2.80   2.93   3.12   0   100   100

Space Center

  San Antonio, TX   101,500 Sq. Ft.   3.36   3.36   3.41   61   61   61

Shopping Centers

               

Bridgeview Plaza

  LaCrosse, WI   116,008 Sq. Ft.   7.63   7.23   6.97   88   89   89

Cross County Mall

  Mattoon, IL   304,575 Sq. Ft.   6.00   5.59   5.44   74   88   88

Cullman

  Cullman, AL   92,466 Sq. Ft.   5.08   5.15   3.55   48   27   27

Dunes Plaza

  Michigan City, IN   223,869 Sq. Ft.   5.75   5.92   5.91   48   53   64

Fruitland Park

  Fruitland, FL   6,722 Sq. Ft.   7.23   *   *   100   *   *

Willowbrook Village

  Coldwater, MI   179,741 Sq. Ft.   5.97   5.95   *   94   93   *

Merchandise Mart

               

Denver Mart

  Denver, CO   320,466 Sq. Ft.   17.00   18.56   11.75   94   95   92

Single Family Residence

               

Tavel Circle

  Dallas, TX   2,271 Sq. Ft.            

* Property was purchased or constructed.
** Not applicable data. ARI sold the Signature Athletic Club in November 2004, but retained the Signature Building.
*** Property is unoccupied.

 

16


Table of Contents
             Average Room Rate   Occupancy %     Total Room Revenues
Divided By
Total Available Rooms

Property

  Location   Rooms   2006   2005   2004   2006     2005     2004     2006   2005   2004

Hotels

                     

Akademia

  Wroclaw, Poland   165 Rooms   $ 87.21   $ 63.00   $ 55.33   62 %   73 %   65 %   $ 81.34   $ 45.09   $ 35.98

Château Inn

  Fresno, CA   78 Rooms     77.16     71.88     63.42   64     60     58       64.10     43.01     36.52

City Suites

  Chicago, IL   45 Rooms     168.24     144.21     126.29   64     63     58       108.50     96.18     71.60

Comfort Inn

  Denver, CO   161 Rooms     67.89     56.10     56.10   55     55     55       55.37     35.49     30.80

Ocean Beach

  Virginia Beach, VA   110 Rooms     120.92     120.26     108.92   38     48     65       37.80     57.62     70.56

Picadilly Airport

  Fresno, CA   185 Rooms     90.14     81.15     79.25   64     62     63       63.93     53.49     50.50

Picadilly Shaw

  Fresno, CA   194 Rooms     95.48     83.46     81.19   63     66     69       63.26     59.01     58.10

Picadilly University

  Fresno, CA   190 Rooms     82.31     77.68     68.21   55     57     63       54.73     44.19     43.03

The Majestic

  Chicago, IL   55 Rooms     177.11     151.17     129.64   57     52     52       102.34     75.50     65.91

Willows

  Chicago, IL   52 Rooms     167.47     141.10     119.84   59     57     57       98.19     86.14     67.62

Occupancy presented above and throughout this ITEM 2. is without reference to whether leases in effect are at, below, or above market rates.

 

17


Table of Contents

In 2006, ARI purchased the following properties:

 

Property

 

Location

 

Units/

Sq. Ft./Acres

 

Purchase

Price

  Net Cash
Paid/
(Received)
  Debt
Incurred
  Interest
Rate
    Maturity
Date

Apartments

             

Anderson Estates

  Oxford, MS   48 Units   $ 1,144   $ 148   $ 996   9.50 %(1)   12/07

David Jordan Phase II

  Greenwood, MS   32 Units     743     98     645   8.50 (1)   4/07

David Jordan Phase III

  Greenwood, MS   40 Units     812     122     690   8.75 (1)   7/07

Leflore Estates

  Greenwood, MS   104 Units     2,114     337     1,777   7.00 (1)   2/07

Monticello III Estates

  Monticello, AR   32 Units     644     96     548   7.00     1/07

Riverwalk Phase I

  Greenwood, MS   32 Units     455     99     356   8.50     2/07

Riverwalk Phase II

  Greenwood, MS   72 Units     1,584     226     1,358   8.25 (1)   2/07
                         
        7,496     1,126     6,370    
                         

Land

             

Bolivar Estates

  Bolivar City, MS   24.8 Acres     650     649     —     —       —  

Broadway Estates

  Broadway City, MS   12.2 Acres     210     222     —     —       —  

Carmichael Tract

  Greenwood, MS   6.0 Acres     290     364     —     —       —  

Castleglen

  Garland, TX   10.6 Acres     723     690     —     —       —  

Circle C Ranch

  Austin, TX   1,092 Acres     25,569     —       25,569   8.75 (1)   3/07

Copperridge Condo #114

  Dallas, TX   1 Unit     53     54     —     —       —  

Copperridge Condo #211

  Dallas, TX   1 Unit     41     41     —     —       —  

Copperridge Condo #323

  Dallas, TX   1 Unit     42     40     —     —       —  

Creekside Land

  Ft. Worth, TX   30.1 Acres     2,105     2,097     —     —       —  

Crowley Land

  Ft. Worth, TX   24.9 Acres     1,500     6     —     —       —  

Dedeaux Road

  Gulfport, MS   9.9 Acres     1,500     —       1,520   —       —  

Ewing Land

  Addison, TX   16.7 Acres     15,361     3,444     10,752   5.50     12/09

Forney Land

  Forney, TX   34.8 Acres     3,945     3,926     —     —       —  

Galleria East/Showcase

  Dallas, TX   15.0 Acres     25,161     7,106     18,362   6.00     12/07

GNB Land

  Farmers Branch, TX   45.5 Acres     9,800       10,000   —       —  

Keller Springs Lofts

  Addison, TX   1.7 Acres     698     —       690   8.25     10/07

Kinwest/Hackberry Creek Office Park

  Irving, TX   7.9 Acres     1,737     101     1,580   10.25     10/07

Lincoln Estates II

  Carthage, MS   18.0 Acres     32     32     —     —       —  

Longfellow

  Longview, TX   13.7 Acres     696     719     1,345   10.25     5/08

Milner Tract

  Greenwood, MS   14.0 Acres     392     —       487   8.50     1/07

Parc at Clarksville

  Clarksville, TN   10.4 Acres     541     —       547   8.00     8/07

Parkway Estates

  Greenwood, MS   20.1 Acres     682     364     487   8.50     1/07

Pecan Pointe

  Temple, TX   12.7 Acres     1,198     1,195     1,650   8.25     12/07

Pioneer Crossing

  Travis County, TX   38.5 Acres     614     614     —     —       —  

RB Land

  Dallas, TX   86.1 Acres     668     673     —     —       —  

Ridgepoint Drive

  Irving, TX   .6 Acres     179     172     —     —       —  

Ritchie Road

  Waco, TX   350.0 Acres     2,677     897     1,735   8.61     9/07

Senlac Hutton

  Farmers Branch, TX   5.9 Acres     1,050     949     —     —       —  

Southwood Plantation

  Tallahassee, FL   14.5 Acres     1,150     477     748   8.50 (1)   2/07

Sunflower Estates

  Sunflower City, MS   18.7 Acres     187     212     —     —       —  

Texas Land Plaza

  Irving, TX   10.3 Acres     1,646     429     1,069   8.25     12/08

Valley Ranch 20

  Farmers Branch, TX   20.0 Acres     4,673     1,892     3,038   8.50 (1)   2/07

Valwood Park

  Farmers Branch, TX   11.6 Acres     1,422     —       —     —       —  

Waco 42

  Waco, TX   42.8 Acres     531     112     398   8.00     5/07

Waco Swanson/Ritchie Road

  Waco, TX   350.0 Acres     2,677     897     1,735   —       9/09

WindMill Farms

  Kaufman County, TX   3,035.5 Acres     52,038     —       39,053   9.25     11/09

Woodmont Fairway Office

  Dallas, TX   5.8 Acres     3,833     1,014     3,000   8.25 (1)   1/07

Woodmont Galleria West

  Farmers Branch, TX   7.1 Acres     5,846     808     5,230   9.25     12/07

Woodmont Galleria West

  Farmers Branch, TX   1.9 Acres     1,604     184     1,475   9.25     12/07

Woodmont Merit Drive

  Dallas, TX   9.3 Acres     4,560     1,868     2,964   8.00     3/07

Yazoo Estates

  Yazoo City, MS   15.1 Acres     120     213     —     —       —  
                         
        178,401     32,461     133,434    
                         

Office Buildings

             

305 Baronne & 217 Rampart

  New Orleans, LA   49,000 Sq. Ft.     3,985     3,483     —     —       —  

Clark Garage

  New Orleans, LA   7,877 Sq. Ft.     9,925     564     9,025   9.25     6/07

GNB Building

  Farmers Branch, TX   200,000 Sq.Ft.     5,200     —       —     —       —  
                         
        19,110     4,047     9,025    
                         
      $ 205,007   $ 37,634   $ 148,829    
                         

(1) Exchanged for note receivable. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”

 

18


Table of Contents

In 2006, ARI sold the following properties:

 

Property

  

Location

  

Units/Acres/

Sq. Ft.

  

Sales

Price

   Net Cash
Received/
(Paid)
    Debt
Discharged
   Gain on
Sale

Apartments

                

Apple Lane

   Lawrence, KS    75 Units    $ 2,600    $ 1,173     $ 1,290    $ 1,589

Oak Tree Square Apartments

   Grandview, MO    189 Units      5,480      1,289       3,802      3,982

Plantation Apartments

   Tulsa, OK    138 Units      2,750      638       2,191      432

Timbers on Broadway

   Tyler, TX    180 Units      3,500      —         2,224      1,124

Williamsburg Hotel

   Williamsburg, VA    296 Units      27,500      10,308       16,597      10,506

Will-O-Wick Gardens

   Pensacola, FL    152 Units      6,500      2,806       2,827      3,049
                                  
           48,330      16,214       28,931      20,682
                                  

Land

                

Chase Oaks

   Plano, TX    1.8 Acres      555      503       —        340

Elm Fork

   Carrollton, TX    27.6 Acres      3,500      (827 )     2,800      —  

Elm Fork

   Carrollton, TX    8.5 Acres      1,674      (755 )     1,135      —  

Elm Fork Land

   Carrollton, TX    25.3 Acres      4,417      591       3,551      2,608

Fruitland Land

   Fruitland, FL    3.9 Acres      1,550      1,462       —        1,279

Hollywood Casino

   Farmers Branch, TX    10.5 Acres      3,225      1,207       —        1,411

Hollywood Casino

   Farmers Branch, TX    3.4 Acres      2,006      1,087       900      1,579

Mandahl Bay

   U.S. Virgin Islands    1.5 Acres      525      265       213      236

McKinney Ranch Land

   McKinney, TX    123.9 Acres      16,591      6,004       10,051      3,389

McKinney Ranch Land

   McKinney, TX    44.5 Acres      10,289      10,031       —        5,292

Metro Land

   Nashville, TN    1.2 Acres      215      —         160      144

Nashville

   Nashville, TN    2.4 Acres      462      —         429      323

Nashville

   Nashville, TN    16.4 Acres      2,512      —         2,416      1,700

Stagliano

   Farmers Branch, TX    3.1 Acres      1,373      187       —        715

Vineyards II

   Grapevine, TX    1.5 Acres      1,272      429       745      578

Vista Ridge Land

   Lewisville, TX    14.5 Acres      2,526      2,355       —        870

Vista Ridge Land

   Lewisville, TX    18.9 Acres      4,950      2,996       1,669      2,765

Vista Ridge Land

   Lewisville, TX    3.8 Acres      755      698       —        306

Woodmont Group I & II

   Addison, TX    4.9 Acres      3,648      1,518       1,806      1,129
                                  
           62,045      27,751       25,875      24,664
                                  
         $ 110,375    $ 43,965     $ 54,806    $ 45,346
                                  

 

19


Table of Contents

In 2006, ARI financed/refinanced or obtained second mortgage financing on the following:

 

Property

 

Location

 

Sq. Ft./Units/

Rooms/Acres

  Debt
Incurred
   

Debt

Discharged

 

Net Cash

Received

    Interest
Rate
    Maturity
Date

Apartments

             

4400

  Midland, TX   92 Units   $ 2,825     $ 945   $ 2,686     6.75 %   1/37

Ashton Way

  Midland, TX   178 Units     2,600       945     2,474     6.75     1/37

Hunters Glen

  Midland, TX   212 Units     2,475       1,804     421     7.23     2/07

Woodview.

  Odessa, TX   232 Units     5,229       1,839     1,123     6.75     1/37
                             
        13,129       5,533     6,704      
                             

Office Buildings

             

Cooley Bldg. .

  Farmers Branch, TX       3,045       —       470     —       —  

Forum OB

  Richmond, VA   79,791 Sq. Ft.     6,000       4,721     1,152     7.75     7/07

Two Hickory

  Farmers Branch, TX   96,127 Sq. Ft.     9,500       7,257     74     7.03     9/07

University Square

  Anchorage, AK   20,715 Sq. Ft.     1,360       1,068     271     8.25     5/07
                             
        19,905       13,046     1,967      
                             

Shopping Centers

             

Cross County Mall

  Mattoon, IL   307,266 Sq. Ft.     9,500       4,399     4,773     7.18     7/07
                             
        9,500       4,399     4,773      
                             

Land

             

Diplomat Tract I

  Farmers Branch, TX   3.9 Acres     309       —       293     10.25     5/08

Diplomat Tract II

  Farmers Branch, TX   4.1 Acres     321       —       304     10.25     5/08

Diplomat Tract III

  Farmers Branch, TX   3.7 Acres     293       —       278     10.25     5/08

Elm Fork

  Carrollton, TX   69.4 Acres     6,500       3,805     2,015     9.25     7/07

Hutton Tract

  Farmers Branch, TX   2.4 Acres     281       —       265     10.25     5/08

LaDue/Walker

  Farmers Branch, TX   99.0 Acres     13,948       —       333     10.25     5/08

Nashville

  Nashville, TN   100.9 Acres     2,500       —       2,500     12.50     5/07

Nashville Land

  Nashville, TX   82.2 Acres     6,500       2,776     3,561     7.50     7/07

Palmer Lane

  Austin, TX   367.4 Acres     14,000       14,300     (893 )   8.50     8/07

Payne I Land

  Las Colinas, TX   109.9 Acres     5,683       —       5,591     9.00     12/07

Pioneer Crossing

  Austin, TX   235.0 Acres     11,750 (3)     4,000     —       12.50     4/07

Wells Fargo Foothills

  Kaufman County, TX   2,764.0 Acres     6,440       —       6,156     10.25     5/08

Wells Fargo Foothills

  Valley Ranch, TX   68.0 Acres     7,323       —       7,014     10.25     5/08

West End Land

  Dallas, TX   5.3 Acres     9,000       2,000     6,079     8.00     3/07
                             
        84,848       26,881     33,496      
                             
      $ 127,382     $ 49,859   $ 46,940      
                             

 

20


Table of Contents

Land Properties.    Set forth below are ARI’s land properties, consisting of both improved and unimproved land:

 

Property

   Location    Acres

1013 Common

   New Orleans, LA    0.4

2301 Valley Branch

   Farmers Branch, TX    23.8

Alliance 8

   Tarrant County, TX    8.0

Alliance 52

   Tarrant County, TX    51.9

Alliance Airport

   Tarrant County, TX    12.7

Backlick

   Springfield, VA    4.0

Bolivar Estates

   Bolivar County, MS    24.8

Bonneau

   Dallas County, TX    8.4

Broadway Estates

   Broadway County, MS    12.3

Castleglen

   Garland, Dallas County, TX    10.6

Centura

   Farmers Branch, TX    8.8

Chase Oaks

   Plano, TX    10.0

Circle C Ranch

   Austin, TX    1,092.0

Cooks Lane

   Ft. Worth, TX    23.2

Creekside Land

   Ft. Worth, TX    30.1

Crowley Land

   Ft. Worth, TX    24.9

Croslin

   Dallas County, TX    0.8

Dalho

   Farmers Branch, TX    3.4

Denton

   Denton, TX    25.9

Dedeaux Road

   Gulfport, MS    10.0

Denton—Andrew B

   Denton, TX    22.9

Denton—Andrew C

   Denton, TX    5.2

Denton-Coonrod

   Denton, TX    82.2

DeSoto

   DeSoto, TX    21.9

Diplomat Drive

   Farmers Branch, TX    11.7

Dominion

   Dallas, TX    14.4

Elm Fork

   Denton County, TX    44.0

Ewing 8

   Addison, TX    16.8

Fiesta

   San Angelo, TX    0.7

Folsom

   Dallas, TX    36.8

Fort Wayne

   Fort Wayne, IN    18.9

Forney Land

   Kaufman County, TX    34.9

Fruitland

   Fruitland Park, FL    0.7

Hollywood Casino

   Farmers Branch, TX    29.0

GNB Land

   Farmers Branch, TX    45.5

HSM

   Farmers Branch, TX    6.2

JHL Connell

   Carrollton, TX    3.9

Katrina

   Palm Desert, CA    22.4

Kaufman Cogen

   Kaufman County, TX    2,567.0

Kaufman Taylor

   Kaufman County, TX    31.0

Keenan Bridge

   Farmers Branch, TX    7.5

Keller Springs Lofts

   Addison, TX    1.8

Kelly Lots

   Collin County, TX    0.8

Kinwest /Hackberry Creek Office Park

   Irving, TX    8.0

Lacy Longhorn

   Farmers Branch, TX    17.1

Lakeshore Villas

   Humble, TX    1.4

Lamar/Parmer

   Austin, TX    17.1

Las Colinas

   Las Colinas, TX    1.6

 

21


Table of Contents

Property

  

Location

   Acres

Las Colinas

   Las Colinas, TX    4.7

LCLLP

   Las Colinas, TX    41.2

Leone

   Irving, TX    8.2

Limestone Canyon

   Austin, TX    10.0

Lincoln Estates

   Carthage, MS    18.0

Longfellow Land

   Longview, TX    13.7

Lubbock

   Lubbock, TX    2.9

Luna Road

   Farmers Branch, TX    2.6

Mandahl Bay

   US Virgin Islands    109.2

Manhattan

   Farmers Branch, TX    108.9

Mansfield

   Mansfield, TX    21.9

Marine Creek

   Ft. Worth, TX    43.3

Mason Park

   Houston, TX    18.0

Mason/Goodrich

   Houston, TX    17.2

McKinney 36

   Collin County, TX    34.6

McKinney Corners

   Collin County, TX    18.5

McKinney Ranch

   McKinney, TX    264.3

Meloy

   Kent, OH    54.2

Mendoza

   Dallas County, TX    0.4

Mira Lago

   Farmers Branch, TX    4.2

Nashville ARI

   Nashville, TN    81.2

Nashville TCI

   Nashville, TX    6.2

Pac Trust

   Farmers Branch, TX    7.1

Palmer Lane

   Austin, TX    367.4

Pantaze

   Dallas, TX    6.0

Parc at Clarksville

   Clarksville, TN    10.4

Parkway Estates

   Greenwood, MS    20.1

Payne I

   Las Colinas, TX    109.9

Payne II

   Las Colinas, TX    39.9

Pecan Pointe

   Temple, TX    12.8

Pioneer Crossing

   Austin, TX    400.1

Pioneer Crossing

   Travis County, TX    38.5

Pulaski

   Pulaski County, AR    21.9

Railroad

   Dallas, TX    .3

RB Land

   1701 East Beltline Road    86.2

Ridgepoint Drive

   Irving, TX    0.6

Ritchie Road

   Waco, TX    350.0

Rochelle I

   Las Colinas, TX    10.1

Rochelle II

   Las Colinas, TX    21.3

Rogers

   Rogers, AR    20.1

Seminary West

   Ft. Worth, TX    5.4

Senlac

   Farmers Branch, TX    11.9

Senlac Hutton

   Farmers Branch, TX    5.9

Senlac VHP

   Farmers Branch, TX    4.0

Sheffield Village

   Grand Prairie, TX    13.9

Siskiyou

   Siskiyou County, CA    20.7

Sladek

   Travis County, TX    63.3

Southwood Plantation

   Tallahassee, FL    13.0

Southwood Plantation

   Tallahassee, FL    14.5

Sunflower Estates

   Sunflower County, MS    18.7

 

22


Table of Contents

Property

   Location    Acres

Texas Land Plaza

   Irving, TX    10.3

Thompson

   Farmers Branch, TX    4.0

Thompson II

   Dallas County, TX    3.3

Tomlin

   Farmers Branch, TX    9.2

Valley Ranch

   Irving, TX    29.9

Valley Ranch 20

   Irving, TX    20.0

Valley View 34

   Farmers Branch, TX    33.9

Valwood

   Dallas County, TX    223.4

Valwood Park

   Farmers Branch, TX    11.6

Vineyards II

   Grapevine, TX    8.1

Vineyards (Grapevine)

   Grapevine, TX    11.2

Vista Ridge

   Lewisville, TX    5.2

Waco 42

   Waco, TX    42.8

Walker

   Dallas County, TX    147.1

West End

   Dallas, TX    5.3

Whorton

   Benton County, AR    79.7

Wilmer 88

   Dallas, TX    87.6

Windmill Farms

   Kaufman County, TX    3,035.5

Woodmont Fairway

   Dallas, TX    5.9

Woodmont Galleria East

   Dallas, TX    15.0

Woodmont Galleria West

   Farmers Branch, TX    9.2

Woodmont Merit Drive

   Dallas, TX    9.3

Yazoo Estates

   Yazoo County, MS    15.1
       
      10,857.4
       

Partnership Properties.    ARI accounts for partnership properties using the equity method. ARI had no property information for properties owned by partnerships.

In December 2004, ARI sold to an unrelated investment group a 95% partnership interest in Garden Centura, L.P. that owns the 410,901 sq. ft. Centura Tower office building located in Farmers Branch, Texas. ARI retained a non-controlling 1% general partner and 4% limited partner interest in Garden Centura, L.P. ARI accounts for its investment in this partnership on the equity method.

Mortgage Loans

In addition to real estate, a portion of ARI’s assets are invested in mortgage notes receivable, secured by income-producing real estate, unimproved land and partnership interests. Management expects the percentage of ARI’s assets invested in mortgage loans will decline, as ARI will no longer seek to fund or acquire new mortgage loans. However, ARI may, in selected instances, originate mortgage loans or it may provide purchase money financing in conjunction with a property sale. Management intends to service and hold for investment the mortgage notes currently in the portfolio. Mortgage notes receivable consist primarily of first mortgage loans.

Types of Properties Subject to Mortgages.    The types of properties securing mortgage notes receivable at December 31, 2006, consisted of four commercial buildings, unimproved land and partnership interests. The type of properties subject to mortgages in which ARI invests may be altered without a vote of stockholders.

As of December 31, 2006, the obligors on $43.8 million or 81.8% of the mortgage notes receivable portfolio were affiliates of ARI. Also at that date, $2.9 million or 5.5% of the mortgage notes receivable portfolio was non-performing.

The following table sets forth the percentages (based on the outstanding mortgage loan balance at December 31, 2006), by property type and geographic region, of the income producing properties that serve as

 

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collateral for ARI’s mortgage notes receivable. Excluded are $61.8 million of mortgage notes that are secured by unimproved land and other security, or are unsecured. See SCHEDULE IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for additional details of ARI’s mortgage notes receivable portfolio.

 

Region

   Commercial
Properties
 

Southwest

   100 %
      
   100 %
      

A summary of the activity in the mortgage notes receivable portfolio during 2006 is as follows:

 

Mortgage notes receivable at January 1, 2006

   55  

Loans funded

   11  

Loans collected in full

   (10 )

Loans sold

   (3 )
      

Mortgage notes receivable at December 31, 2006

   53  
      

First Mortgage Loans.    These loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan at or prior to maturity, but may involve interest-only payments, moderate or negative amortization of principal, or all interest and a “balloon” principal payment at maturity. With respect to first mortgage loans, it is ARI’s general policy to require that the borrower provide a title policy or an acceptable legal opinion of title as to the validity and the priority of ARI’s mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders. ARI may grant participations in first mortgage loans that it originates to other lenders.

The following discussion briefly describes first mortgage loans funded in 2006, as well as events during 2006 that affected previously funded mortgage loans.

In February 2005, ARI sold a 9.9 acre tract of its Katrina (California) land parcel for $2.6 million, receiving $574,000 after payment of closing costs and providing purchase money financing of $2.0 million. The loan accrued interest at 8.0%, required quarterly payments of interest, and matured in February 2008. In March 2005, ARI sold the loan for $2.0 million, receiving $2.0 million in cash after payment of closing costs.

In February 2005, ARI sold a 13.6 acre tract of its Katrina (California) land parcel for $3.7 million, receiving $591,000 after payment of closing costs and providing purchase money financing of $2.8 million. The loan accrued interest at 8.0%, required quarterly payments of interest, and matured in February 2008. In March 2005, ARI sold the loan for $2.8 million, receiving $2.8 million in cash after payment of closing costs.

In February 2005, ARI sold a 6.5 acre tract of its Katrina (California) land parcel for $1.7 million, receiving $340,000 after payment of closing costs and providing purchase money financing of $1.3 million. The loan accrued interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $1.3 million, receiving $1.3 million in cash after payment of closing costs.

In February 2005, ARI sold a 7.4 acre tract of its Katrina (California) land parcel for $2.0 million, receiving $455,000 after payment of closing costs and providing purchase money financing of $1.5 million. The loan accrued interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $1.5 million, receiving $1.5 million in cash after payment of closing costs.

In February 2005, ARI sold an 81.2 acre tract of its Katrina (California) land parcel for $19.9 million, paying $814,000 after payment of debt and closing costs and providing purchase money financing of

 

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$14.9 million. The loan accrued interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $14.9 million, receiving $14.9 million in cash after payment of closing costs.

In March 2005, ARI sold a 24.8 acre tract of its Katrina (California) land parcel for $6.4 million, receiving $1.0 million after payment of closing costs and providing purchase money financing of $4.8 million. The loan accrued interest at 8.0%, required quarterly payments of interest, and matured in March 2007. In March 2005, ARI sold the loan for $4.8 million, receiving $4.8 million in cash after payment of closing costs.

In August 2005, ARI sold a 7.6 acres tract of its Vineyards (Texas) land parcel for $4.3 million, receiving $874,000 after payment of closing costs and providing purchase money financing of $3.2 million. The secured note accrued interest at 8.0% per annum and matured in August 2006. In September 2005, ARI sold the note for $3.2 million plus accrued but unpaid interest, receiving $3.3 million in cash after payment of closing costs.

In September 2005, ARI sold a 5.2 acre tract of its Vineyards and Vineyards II (Texas) land parcels for $2.3 million, receiving $160,000 after payment of closing costs and debt paydown, and providing purchase money financing of $1.7 million. The secured note accrued interest at 8.0% per annum and matured in September 2006. In September 2005, ARI sold the note for $1.7 million plus accrued but unpaid interest, receiving $1.7 million in cash after payment of closing costs.

In August 2005, ARI sold a 16.0 acre tract of its Mason Goodrich (Texas) land parcel for $2.1 million, receiving $935,000 after payment of closing costs and providing purchase money financing of $1.0 million. The secured note accrued interest at 8.0%, required monthly interest payments, and matured in November 2005. In November 2005, the note was collected in full, including accrued but unpaid interest.

In March 2004, ARI sold an 8.0 acre tract of its Mason Goodrich (Texas) land parcel for $1.0 million, receiving $251,000 after payment of closing costs and providing purchase money financing of $523,000. The secured loan bears interest at 10.0% per annum, requires monthly payments of accrued interest and matures in March 2006. All principal and accrued but unpaid interest is due at maturity. In 2005, $117,000 in principal was collected. In March 2006, the note was extended to March 2007 by paying a 1% extension fee and making a 10% principal reduction.

In October 2004, ARI sold the In The Pines apartments to a third party and provided $1.0 million of the purchase price as seller financing in the form of two notes. The first note accrued interest at 7.0% per annum, required monthly interest only payments, and matured in January 2005. The second note was unsecured, accrued interest at 8.5% per annum, required monthly interest only payments, and matured in January 2005. Both loans were paid in full, including unpaid interest, in October 2005.

In March 2005, ARI entered into an agreement to advance a third party $3.2 million for development costs relating to single-family residential lots in Austin, Texas. These advances are secured by stock in the borrower and hold a second lien on the undeveloped land. The secured note bears interest at 10 percent, requires semi-annual payments and matures in March 2008. In September 2005, the total amount authorized under this advance was increased to $5.0 million. As of March 31, 2006, ARI had advanced $3.2 million to the borrower. ARI also guaranteed an $18 million loan secured by a first lien on the undeveloped land. In September 2005, ARI purchased for $4.1 million a subsidiary of Tacco Universal, a related party that holds two notes receivable from the borrower for $3.0 and $1.0 million, respectively. These notes are secured by approximately 142 acres of undeveloped land and membership interest in the borrower. These secured notes bear interest at 12 percent, have an interest reserve for payments that is added to the principal balance on a monthly basis and matured in June 2005. Both loans were extended to September 2005 and upon maturity were paid under the advance referred to at the beginning of this paragraph. In March 2006, ARI acquired all of the interests in the borrower, including ownership of the Austin, Texas land. The land is secured by the $18 million first mortgage and a $3 million subordinated loan. In March 2006, ARI secured a development loan of $31.3 million (secured by the Austin,

 

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Texas land), of which $18 million was used to pay the existing first mortgage. The development loan matures in March 2008 and bears interest at Prime plus one percent. The Company intends to develop the land for sale to single-family residential builders.

In July 2003, ARI advanced $2.3 million to the Class A Limited Partners of TCI Countryside, L.P. of which ARI is the general partner. This loan bears interest at 7.25% and matures in January 2007. ARI also agreed to advance $1.1 million to the Class A Limited Partners by advancing $105,000 in July 2003 and every year thereafter for ten years. This loan bears interest at 7.25% and matures in July 2012. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. In October 2005, ARI agreed to settle the remaining obligations under this loan by paying a lump sum of $425,000, making the total advanced $740,000. After January 2007, ARI may redeem the Class A Limited Partners interests in exchange for cancellation of both notes.

In September 2005, ARI sold 10 acres of unimproved land to a third party for $1.5 million and provided $1.1 million of the purchase price as seller financing. The secured note accrued interest at 10%, required monthly interest only payments, and matured in September 2008. In December 2005, ARI sold this note to a financial institution for full face value less closing costs, plus accrued interest. ARI and other related parties have also guaranteed the full payment of the note balances, including any outstanding interest and costs incurred by the financial institution.

In December 2005, ARI sold 27.192 acres and 3.73 acres to a third party for $10.1 million and $1.4 million, and provided $7.6 million and $1.0 million of seller financing, respectively. Both notes bear interest at 8.0% per annum, require monthly interest only payments, and mature in December 2008. In January 2006, ARI sold both notes to a financial institution for full face value less closing costs, plus accrued interest. The financial institution has a Put Option that would require ARI to purchase both notes back under the following conditions: (1) failure to construct agreed upon roads on the property by December 2006 (the work is substantially complete); (2) there occurs any event of default by the buyer; (3) certain escrow deposits for the road completion are not sufficient to cover the cost of the road construction; (4) any amendment, modification or assignment of certain development and escrow agreements between ARI and the buyer; and (5) failure of ARI to deliver certain documents to the financial institution within a timely manner. ARI and other related parties have also guaranteed the full payment of the note balances, including any outstanding interest and costs incurred by the financial institution.

In December 2004, ARI sold the Centura Tower office building to a partnership and retained a 1% non-controlling general partner interest and a 4% limited partner interest. ARI has certain obligations to fund the partnership for rent abatements, tenant improvements, leasing commissions and other cash shortfalls. $4.1 million of these obligations were escrowed by ARI with the lender at loan closing. Through December 31, 2006, ARI has funded $6.5 million of these obligations, with $6.5 million recorded in the form of a note receivable from the partnership. The note bears interest at a fixed rate of 7.0% per annum. The note will be paid out of excess cash flow or from sales proceeds, but only after certain partner preferred returns are paid.

In August 2001, ARI agreed to loan Dallas Fund XVII LP up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable initially had a variable interest rate, required monthly interest payments and originally matured in January 2003. ARI funded a total of $4.3 million on this note. In January 2003, ARI agreed to extend the maturity date to May 2003. The collateral used to secure ARI’s second lien was subsequently seized by the first lien holder. In March 2004, ARI agreed to accept an assignment of claims in litigation as additional security for the note. ARI later agreed to a modification agreement with the borrower effective November 2003. As of the modified effective date, accrued interest of $582,000 was added to the principal balance of the note; the interest rate was fixed at nine percent per annum with all principal and interest due November 2005. ARI also received certain pledge and security agreements in various partnership interests belonging to the borrower and received various assignments of proceeds from asset sales in certain entities owned by the borrower. ARI reduced accrued interest and principal by $1.5 million from the receipt of notes receivable assigned to ARI by the borrower and by $605,000 from cash received. ARI also received $1.4 million in January 2005 that was applied to accrued interest and principal effective December 30, 2004. ARI

 

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received $1.8 million in September 2006 that was applied to accrued interest and principal. Through December 31, 2006, ARI has advanced an additional $3.0 million to the borrower. The following notes were assigned to ARI as payment on the note.

 

   

$678,000 from a partnership that owns an apartment building. This note is unsecured, bears no interest and has no maturity date. Distributions made from the partnership operations will be used to pay the principal on the note. ARI received $132,000 in distributions in 2005 and $27,000 in 2006.

 

   

$264,000, including accrued interest, secured by a second lien on 13 acres of unimproved land. This note bears interest at 9.0% and matured in February 2003. This note is considered performing and no allowance has been established.

 

   

$466,000 secured by a second lien on 23.3 acres of unimproved land. This note bears interest at 4.0% and is payable upon demand.

 

   

$125,000 secured by a 100% interest in an affiliated company that owns an apartment building. This note bears interest at 12.0% and requires payments only if surplus cash is available and matures in April 2009.

In March 2004, ARI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. ARI also provided $1.5 million of the purchase price as seller financing. The unsecured note bears interest at 2.0% over the prime rate, currently 9.5%, and matured in April 2005. In April 2005, the note was extended to April 2008.

In March 2004, ARI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. ARI also provided $1.3 million of the purchase price as seller financing. The unsecured note bears interest at 2.0% over the prime rate, currently 9.5%, and matured in April 2005. In April 2005, the note was extended to April 2008.

Investments in Real Estate Companies

Real estate entities.    ARI’s investment in real estate entities includes, through its ownership of 82.2% of the common stock of TCI, the equity securities of a publicly traded real estate company, IORI, and interests in real estate joint venture partnerships.

The Board of Directors authorized the expenditure of up to an aggregate of $50.0 million to acquire, in open market purchases, shares of IORI, excluding private purchase transactions which were separately authorized. Through December 31, 2006, ARI had expended an aggregate of $10.0 million to acquire shares of IORI, in open market purchases, in accordance with these authorizations. As of December 31, 2006, ARI and its subsidiaries, other than TCI, owned no shares of common stock of IORI, but TCI continued to own 345,728 IORI shares (approximately 24.9% of the outstanding IORI shares). ARI may make additional investments in the equity securities of IORI to the extent its liquidity permits.

ARI owns an approximate 24.0% interest in IORI, a publicly held real estate company. Based on the ownership percentage of ARI’s investment in IORI and IORI’s market value, ARI’s investment in IORI has a market value of approximately $6.9 million at December 31, 2006. The carrying value of this investment is approximately $6.3 million at December 31, 2006.

 

ITEM 3. LEGAL PROCEEDINGS

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

Sunset Management LLC.    Three separate but consolidated legal proceedings exist which involve matters between Sunset Management LLC (“Sunset”) and Company and/or Basic Management, Inc. (“BCM”) over a

 

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pledge as collateral for certain loans of a number of shares of Common Stock of Transcontinental Realty Investors, Inc. (“TCI”). At least five items of litigation have terminated involving substantially the same issues with all relief sought by Sunset in those proceedings being denied. The three cases which continue are all pending in the United States District Court, Eastern District of Texas, Sherman division under master case No. 4:06-CV-00018 which consist of (i) American Realty Trust, Inc. v. Sunset Management LLC, case No. 4:06-CV-00361, (ii) American Realty Trust, Inc., et al, v. Sunset Management LLC, et al, case No. 4:06-CV-00483 (formerly 6:06-CV-315) and (iii) Sunset Management LLC v. American Realty Investors, Inc., et al, case No. 4:06-CV-00018. The three consolidated cases involve (a) a suit on the Sunset promissory note and the Company’s argument that the note was modified or extended along with arguments concerning the enforceability of certain late fees and Sunset’s failure to properly disclose the imposition and effect of late fees until months after it had supposedly been imposed, (b) a securities fraud case alleging that the Note was a security and that Sunset violated the securities law, principally Rule 10b-5 in the process of procuring a Note, and (c) Sunset’s argument that the Company improperly transferred pledged stock among various pledgors but which had no damage to Sunset since the certificates were always held by an independent third party and all of the parties to whom such certificates were transferred were either promissors or guarantors on such note. The cases are in the process of scheduling additional depositions and discovery.

Fansler.    On February 12, 2004, The Fansler Foundation (“Fansler”) instituted an action in the U.S. District Court, Eastern District of California, against the Company and Basic Capital Management, Inc. styled The Fansler Foundation v. American Realty Investors, Inc. and Basic Capital Management, Inc. The Fansler complaint, as amended September 7, 2004, demands a jury trial and alleges that in 1997, Fansler sold its interests in four hotels (commonly known as The Piccadilly Inn Hotels in Frenso, California) to American Realty Trust, Inc. (“ARI”) for 1,600,000 shares of ART Series F 10% Cumulative Convertible Preferred Stock (the “ART Series F Preferred Stock”) which was, in August 2000, converted into 1,600,000 shares of ARI Series A 10% Cumulative Convertible Preferred Stock (the “ARI Series A Preferred Stock”). Fansler’s amended complaint alleges that it received “multiple assurances” that the ART Series F Preferred Stock (and subsequently the ARI A Preferred Stock) would be separately “listed on the NYSE,” which (although attempts were made to do so) did not and has not occurred because the stock does not meet the minimum distribution requirements of the NYSE. Fansler alleges that if the ARI Series A Preferred Stock were listed on the NYSE, the fair value of the shares held by Fansler would exceed $20 million. Fansler’s amended complaint alleges breach of fiduciary duty, breach of express and implied obligations arising under a written contract, promissory estoppel, misrepresentation, negligent fraud and misrepresentation and concealment and seeks rescission, unspecified, compensatory damages, interest, attorneys’ fees and unspecified exemplary damages. The Company and BCM have denied all material allegations and intend to vigorously defend this action. Due to the existence of this litigation and, among other things, the inclusion in the Amended Complaint of a claim for rescission (that is, to restore the parties to their respective positions prior to the exchange of ART and ARI shares, which would require an accounting for and potential return of dividends paid thereafter), and ARI’s rights to setoff asserted in this litigation, the Company has suspended the delivery of funds to Fansler representing declared dividends on the 1,600,000 shares of ARI Series A Preferred Stock held by Fansler, but all other eligible holders of ARI Series A Preferred Stock have received all funds representing declared dividends on the ARI Series A Preferred Stock.

Waters Edge.    Shortly before the advent of Hurricane Katrina, an apartment complex in Mississippi was sold to Waters Edge Living, LLC but notwithstanding such sale, the property continued on insurance coverage applicable to American Realty Investors, Inc. (“ARI”) and others. As a result of sorting out various claims, two items of litigation exist, Waters Edge Living, LLC v. RUSI Indemnity Co., et al, civil action No. 4:06-CV-00334-RH-WCS pending in the United States District Court for the Northern district of Florida and Prime Income Asset Management, Inc., et al v. Waters Edge Living, LLC, et al, civil action No. 3:07-CV-0102-D pending in the United States District Court for the Northern district of Texas. ARI is not a direct party in either case. In the Texas case, three subsidiaries of ARI are plaintiffs, Continental Baronne, Inc., Continental Common, Inc. and Continental Amoco, Inc. which own three New Orleans office buildings damaged by Hurricane Katrina. RUSI Indemnity Co. has paid approximately $50.0 million into a trust account held by Merrill Lynch under the supervision of the Florida Court. Of that amount, approximately $32.5 million is money paid on account of the

 

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Waters Edge Living, LLC claim and $17.5 million is money paid on the claims of Continental Baronne, Inc. and the other three New Orleans office buildings. Three ARI subsidiaries are intending to intervene in the near future in the Florida proceeding to attempt to obtain prompt return of the $17.5 million, although Prime Income Asset Management, Inc. (“PIAMI”) has pending an emergency motion for return of those funds (which has been pending since February 1, 2007). Of the $32.5 million allegedly allocable to Waters Edge Living, LLC, PIAMI et al are entitled to a refund, at a minimum, of approximately $6.0 million (consisting of $1.9 million previously advanced from PIAMI against the payment of the claim and $4.0 million for flood insurance proceeds, which should be credited against the $32.5 million) and potentially more, depending upon the amount by which the total claims exceed a $100.0 million cap under the applicable policies. While this case is a plaintiff’s case form the perspective of the ARI subsidiaries, funds belonging to the ARI subsidiaries are being withheld from those subsidiaries aggregating at least $17.5 million. There is no significant prospect from these cases that ARI will have to pay any additional funds to Waters Edge Living, LLC.

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 operations or liquidity.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Annual Meeting of Stockholders was held on November 20, 2006, at which proxies were solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). There was no solicitation in opposition to Management’s nominees listed in the Proxy Statement, all of which were elected. At the Annual Meeting stockholders were asked to consider and vote upon the election of Directors and the ratification of the selection of the independent public accountants for ARI for the fiscal year ending December 31, 2006. At the Meeting, stockholders elected the following individuals as Directors:

 

     Shares Voting

Director

   For    Withheld
Authority

Henry A. Butler

   10,531,502    84,967

Sharon Hunt

   10,530,516    85,953

Robert A. Jakuszewski

   10,531,359    85,110

Ted R. Munselle

   10,531,499    84,970

Ted P. Stokely

   10,531,179    85,290

There were no abstentions or broker non-votes on the election of Directors. With respect to the ratification of the appointment of Farmer, Fuqua & Huff, P.C. as independent auditors of the Company for the fiscal year ending December 31, 2007, and any interim period, at least 10,554,195 votes were received in favor of such proposal, 19,053 votes were received against such proposal, and 43,221 votes abstained.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ARI’s common stock is listed and traded on the New York Stock Exchange under the symbol “ARL." The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the New York Stock Exchange.

 

Quarter Ended

   High    Low

March 31, 2007 (through March 21, 2007)

   $ 8.22    $ 8.20

December 29, 2006

     7.87      7.50

September 26, 2006

     8.70      8.00

June 30, 2006

     8.58      8.58

March 31, 2006

     8.76      8.76

December 30, 2005

     8.10      7.75

September 28, 2005

     9.61      9.53

June 30, 2005

     9.99      9.97

March 31, 2005

     9.00      9.00

On of March 21, 2007, the closing market price of ARI’s common stock on the New York Stock Exchange was $8.20 per share.

As of March 21, 2007, ARI’s common stock was held by approximately 2,542 stockholders of record.

During the second quarter of 1999, the Board of Directors established the policy that dividend declarations on ARI’s common stock would be determined on an annual basis following the end of each year. In accordance with that policy, the Board determined not to pay any dividends in 2006. Future distributions to common stockholders will be dependent upon ARI’s realized income, financial condition, capital requirements and other factors deemed relevant by the Board.

15,000,000 shares of Series A 10.0% Cumulative Convertible Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share and a liquidation preference of $10.00 per share plus accrued and unpaid dividends. Dividends are payable at the annual rate of $1.00 per share, or $.25 per share quarterly, to stockholders of record on the last day of each March, June, September, and December, when and as declared by the Board of Directors. The Series A Preferred Stock may be converted into common stock at 90.0% of the average daily closing price of ARI’s common stock for the prior 20 trading days. At December 31, 2006, 3,390,913 shares of Series A Preferred Stock were outstanding and 869,808 shares were reserved for issuance as future consideration in various business transactions. Of the outstanding shares, 300,000 shares are owned by ART Edina, Inc., and 600,000 shares are owned by ART Hotel Equities, Inc., wholly-owned subsidiaries of ARI. Dividends are not paid on the shares owned by ARI subsidiaries.

231,750 shares of Series C Cumulative Convertible Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share and liquidation preference of $100.00 per share plus accrued and unpaid dividends. The Series C Preferred Stock bears a quarterly dividend of $2.50 per share to stockholders of record on the last day of March, June, September and December when and as declared by the Board of Directors. The Series C Preferred Stock is reserved for conversion of the Class A limited partner units of ART Palm, L.P. (“Art Palm”). At December 31, 2006, 5,192,870 Class A units were outstanding. The Class A units may be exchanged for Series C Preferred Stock at the rate of 100 Class A units for each share of Series C Preferred Stock. After December 31, 2005, all outstanding shares of Series C Preferred Stock may be converted into ARI common stock. All conversions of Series C Preferred Stock into ARI common stock will be at 90.0% of the average daily closing price of ARI’s common stock for the prior 20 trading days. In January 2006, 1.6 million Class A limited partner units were redeemed for $1,620,880 million in cash. At March 21, 2007, no shares of Series C Preferred Stock was outstanding.

 

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91,000 shares of Series D 9.50% Cumulative Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share, and a liquidation preference of $20.00 per share. Dividends are payable at the annual rate of $1.90 per year or $.475 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series D Preferred Stock is reserved for the conversion of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units may be exchanged for Series D Preferred Stock at the rate of 20 Class A units for each share of Series D Preferred Stock. No more than one-third of the Class A units could be exchanged prior to May 31, 2001. Between June 1, 2001 and May 31, 2006, all unexchanged Class A units are exchangeable. At March 21, 2007, no shares of Series D Preferred Stock was outstanding.

500,000 shares of Series E 6.0% Cumulative Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value $2.00 per share and a liquidation preference of $10.00 per share. Dividends are payable at the annual rate of $.60 per share or $.15 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. At March 21, 2007, no Series E Preferred Stock was outstanding.

100,000 shares of Series J 8% Cumulative Convertible Preferred Stock have been designated pursuant to a Certificate of Designation filed March 16, 2006, as an instrument amendatory to ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share, and a liquidation preference of $1,000 per share. Dividends are payable at the annual rate of $80 per share, or $20 per quarter, to stockholders of record on the last day of each of March, June, September and December, when and as declared by the Board of Directors. Although the Series J 8% Cumulative Convertible Preferred Stock has been designated, no shares have been issued as of March 21, 2007.

The following table sets forth information regarding purchases made by ARI of shares of ARI common stock on a monthly basis during the fourth quarter of 2006:

 

Period

   Total Number of
Shares Purchased
  

Average Price

Paid per Share

  

Total Number of

Shares Purchased

as Part of Publicly

Announced Program

  

Maximum Number of

Shares that May

Yet be Purchased

Under the Program(1)

October 2006

           —        $        —              —      129,493

November 2006

   —        —      —      129,493

December 2006

   —        —      —      129,493
                   

Total

   —      $ —      —     
                   

(1) The repurchase program was announced in September 2000. 1,000,000 shares may be repurchased through the program. The program has no expiration date.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

     For the Years Ended December 31,  
     2006     2005     2004     2003     2002  
     (dollars in thousands)  

EARNINGS DATA

          

Total operating revenues

   $ 182,344     $ 159,200     $ 137,452     $ 153,073     $ 87,779  

Total operating expenses

     (170,453 )     (156,277 )     (150,615 )     (164,802 )     (95,853 )
                                        

Operating (loss) income

     11,891       2,923       (13,163 )     (11,729 )     (8,074 )

Other income (expense)

     (47,523 )     (57,213 )     (49,979 )     (43,150 )     (41,389 )
                                        

Loss before gain on real estate sales, minority interest, and equity in earnings of investees

     (35,632 )     (54,290 )     (63,142 )     (54,879 )     (49,463 )

Gain on land sales

     23,973       39,926       11,781       43,831       16,727  

Minority interest

     672       (3,056 )     (7,270 )     (771 )     (1,346 )

Equity in income (loss) of investees

     1,540       397       (41 )     (4,441 )     (20,914 )
                                        

Net income (loss) from continuing operations

     (9,447 )     (17,023 )     (58,672 )     (16,260 )     (54,996 )

Net income from discontinued operations

     22,513       64,440       91,866       28,123       46,532  
                                        

Net income (loss)

     13,066       47,417       33,194       11,863       (8,464 )

Preferred dividend requirement

     (2,491 )     (2,572 )     (2,601 )     (2,351 )     (2,401 )
                                        

Income (loss) applicable to common shares

   $ 10,575     $ 44,845     $ 30,593     $ 9,512     $ (10,865 )
                                        

PER SHARE DATA

          

Basic earnings per share

          

Net income (loss) from continuing operations

   $ (1.18 )   $ (1.93 )   $ (5.80 )   $ (1.73 )   $ (5.05 )

Net income from discontinued operations

     2.22       6.35       8.70       2.61       4.09  
                                        

Net income (loss) applicable to common shares

   $ 1.04     $ 4.42     $ 2.90     $ .88     $ (.96 )
                                        

Weighted average shares outstanding

     10,149,000       10,149,000       10,559,571       10,789,352       11,375,127  

BALANCE SHEET DATA

          

Real estate, net

   $ 1,272,424     $ 1,113,105     $ 983,422     $ 1,054,735     $ 466,042  

Notes and interest receivable, net

     52,631       81,440       72,661       70,595       82,133  

Total assets

     1,493,671       1,345,795       1,190,843       1,240,880       711,330  

Notes and interest payable

     1,124,765       1,021,822       939,921       986,769       475,433  

Stock-secured notes payable

     22,452       22,549       18,663       21,194       8,558  

Stockholders’ equity

     160,489       148,397       103,009       76,871       79,527  

Book value per share

   $ 15.81     $ 12.80     $ 8.89     $ 6.75     $ 6.99  

 

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ITEM 7. 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-K 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 financing and the use of debt to fund acquisitions and developments;

 

   

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-K, including those described under the caption “Risk Factors.”

The risks included here are not exhaustive. Other sections of this report, including “Part I, Item 1A. Risk Factors,” include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual

 

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results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and current reports on Form 8-K as we file them with the SEC, and to other materials we may furnish to the public from time to time through Forms 8-K or otherwise.

Overview

ARI was organized in 1999. In August 2000, ARI acquired American Realty Trust, Inc. (“ART”) and National Realty, L.P. (“NRLP”). ART was the successor to a business trust organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income. The business trust merged into ART in 1987. ART owns a portfolio of real estate and mortgage loan investments. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the liabilities of 35 public and private limited partnerships. NRLP also owned a portfolio of real estate and mortgage loan investments.

At December 31, 2006, ARI subsidiaries owned approximately 82% of the outstanding shares of common stock of Transcontinental Realty Investors, Inc., a Nevada corporation (“TCI”), which has its common stock listed and traded on the New York Stock Exchange, Inc. (“NYSE”). The ownership of the TCI shares was achieved through a series of transactions, including a cash tender offer completed March 19, 2003, an exchange by certain ARI subsidiaries of securities with Basic Capital Management, Inc. (“BCM”) and a sale of a participating interest in a line of credit receivable from One Realco Corporation (“One Realco”) to BCM, as well as certain open market purchases of TCI shares in December 2003. See Note 1 to the Consolidated Financial Statements. ARI has consolidated TCI’s accounts and operations since March 31, 2003. At December 31, 2006, TCI owned approximately 25% of the outstanding common stock of Income Opportunity Realty Investors, Inc., (“IORI”), a public company whose shares are listed and traded on the American Stock Exchange. At December 31, 2006, TCI owned 746,972 shares of common stock of ARI.

ARI is an externally advised and managed real estate investment company that owns a diverse portfolio of income-producing properties and land held for development. The Company’s portfolio of income-producing properties includes residential apartment communities, office buildings, hotels, a trade mart located in Denver, Colorado and other commercial properties. ARI’s 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. ARI acquires land primarily in in-fill locations or high-growth suburban markets. ARI is an active buyer and seller and during 2006 acquired over $204 million and sold over $110 million of land and income-producing properties. As of December 31, 2006, the Company owned approximately almost 14,000 units in 75 residential apartment communities, 34 commercial properties comprising almost 5.3 million rentable square feet and ten hotels containing a total of 1,235 rooms. In addition, at December 31, 2006, ARI owned almost 10,900 acres of land held for development and had over 2,500 apartment units in 14 projects under construction. The Company currently owns income-producing properties and land in 19 states as well as in the U.S. Virgin Islands and Wroclaw, Poland. ARI finances its 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. ARI finances it 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. The Company 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 its wholly-owned properties. When the Company sells assets, it may carry a portion of the sales price generally in the form of a short-term, interest bearing seller-financed note receivable. The Company generates operating revenues primarily by leasing apartment units to residents; leasing office, retail and industrial space to commercial tenants; and renting hotel rooms to guests. ARI is advised by Prime under a contractual arrangement that is reviewed annually by ARI’s Board of Directors. ARI’s commercial properties are managed by Regis Commercial while the Company’s hotels are managed by Regis Hotel. ARI currently contracts with five third-party

 

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companies to manage the Company’s apartment communities. Approximately 62% of ARI’s common stock is owned by BCM; an additional 13% is owned by Prime and TCI owns approximately seven percent of the outstanding common shares of ARI. Other affiliated companies own approximately two percent of ARI’s outstanding common shares. ARI is a “C Corporation” for U.S. federal income tax purposes and files an annual consolidated income tax return with TCI. ARI does not qualify as a Real Estate Investment Trust (“REIT”) for federal income tax purposes primarily due to ARI’s majority ownership of the Company.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of our financial statements. From time to time, we evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. Below is a discussion of accounting policies that we consider critical in that they may require complex judgment in their application or require estimates about matters that are inherently uncertain.

Real Estate

Upon acquisitions of real estate, ARI assesses the fair value of acquired tangible and intangible assets, including land, buildings, tenant improvements, “above-” and “below-market” leases, origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and allocates 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-” 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.

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.

 

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Real estate is stated at depreciated cost. The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition costs. Costs directly related to the development of properties are capitalized. Capitalized development costs include interest, property taxes, insurance, and other project costs incurred during the period of development.

Management reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates an 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.

SFAS No. 144 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 the Company 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.

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 judgement. Our capitalization policy on development properties is guided by SFAS No. 34 “Capitalization of Interest Cost” and SFAS No. 67 “Accounting for Costs and the Initial Rental Operations of Real Estate Properties.” The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We consider a construction project as substantially completed and held available for occupancy upon the receipt of certificates of occupancy, but no later than one year from cessation of major construction activity. We cease capitalization on the portion (1) substantially completed and (2) occupied or held available for occupancy, and we capitalize only those costs associated with the portion under construction.

Investment in Unconsolidated Real Estate Ventures

Except for ownership interests in variable interest entities, ARI accounts for our investments in unconsolidated real estate ventures under the equity method of accounting because the Company exercises significant influence over, but does 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 the Company’s 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, ARI’s 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, ARI’s 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, the Company consolidates those in which we are the primary beneficiary.

 

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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 SFAS 141, we recognize rental revenue of acquired in-place “above-”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 of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”), as amended by SFAS No. 144. Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using the deposit, installment, cost recovery or financing method, whichever is appropriate. When ARI provides seller financing, gain is not recognized at the time of sale unless the buyer’s initial investment and continuing investment are deemed to be adequate as determined by SFAS 66 guidelines.

Non-performing Notes Receivable

ARI considers a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower is not making interest payments. Any new note receivable that results from a modification or extension of a note considered non-performing will also be considered non-performing, without regard to the borrower’s adherence to payment terms.

Interest Recognition on Notes Receivable

Interest income is not recognized on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.

Allowance for Estimated Losses

A valuation allowance is provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the extent that the investment in the note exceeds management’s estimate of fair value of the collateral securing such note.

 

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Fair Value of Financial Instruments

The following assumptions were used in estimating the fair value of ARI’s notes receivable, marketable equity securities and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For non-performing notes receivable, the estimated fair value of ARI’s interest in the collateral property was used. For marketable equity securities, fair value was based on the year-end closing market price of each security. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities

Results of Operations

2006 Compared to 2005.    ARI had net income of $13.1 million in 2006, including gains on land sales totaling $24.0 million and net income from discontinued operations of $22.5 million, compared to net income of $47.4 million in 2005, including gains on land sales of $39.9 million and income from discontinued operations of $64.4 million. ARI defines its same-store universe for each income-producing asset type (apartments, commercial properties and hotels) as properties with stabilized occupancy owned and operated for the entire two-year period beginning January 1, 2005 and ending December 31, 2006. For this time period, ARI had 54 apartment communities, 26 commercial properties and ten hotels in its same-store universe.

Rents and other property revenues were $182.3 million in 2006 compared to $159.2 million in 2005, an increase of $23.1 million or 15 percent. The overall increase is due to a $10.0 million increase in rental revenues from the Company’s apartment communities, a $10.9 million increase in rental and other property revenues from the Company’s commercial portfolio, a $300,000 increase in land-related rents and royalty income and a $1.9 million increase in same-store hotel revenues. Within the apartment communities portfolio, $4.3 million of the increase from 2005 to 2006 is due to better performance in ARI’s same store apartment universe (a seven percent increase from 2005 to 2006); $1.5 million is due to acquisitions; and $4.2 million is due to developed projects placed in service during 2005 and 2006. The improvement in rents and other property revenues within ARI’s commercial portfolio was principally comprised of an increase of $10.8 million due to acquisitions of commercial properties in 2005 and 2006 (including ARI’s August 2005 acquisition of 600 Las Colinas Boulevard which represented almost $6.8 million of the $10.8 million increase) and a $4.1 million increase in same-store rental revenues. ARI’s commercial properties in New Orleans, which suffered extensive damage in 2005 from Hurricane Katrina, are included in the same-store universe and were closed for a period of time in 2005 while repairs were made (approximately $4.0 million of business interruption insurance proceeds were received in 2006 to compensate ARI for lost rents in New Orleans and these amounts have been included in 2006 same-store rental revenues). ARI’s same-store hotels increased revenues by eight percent or $1.9 million in 2006 compared to 2005, due to both occupancy gains and increases in average room rates. TCI acquired no hotels in 2005 or 2006 and sold one hotel in 2005 and one hotel in 2006.

Property operations expenses increased $16.0 million from $106.9 million in 2005 to $122.9 million in 2006. The overall increase is due to a $4.9 million increase in operating expenses from the Company’s apartment communities, a $8.1 million increase in operating expenses from the Company’s commercial portfolio, a $2.7 million increase in hotel operating expenses and a $300,000 increase in operating expenses (principally real estate taxes) related to the Company’s land portfolio. Within the apartment communities portfolio, $2.0 million of the increase from 2005 to 2006 is due to ARI’s same store apartment universe (a five percent increase from 2005 to 2006); $900,000 is due to acquisitions of existing apartment communities; and $2.0 million is due to developed projects placed in service during 2005 and 2006. The increase in operating expenses within ARI’s commercial portfolio was due in part to an increase in same-store operating expenses of $3.0 million from 2005 to 2006 (primarily due to lower 2005 operating expenses at ARI’s New Orleans office buildings which were closed while hurricane-related repairs were being made); $5.1 million of the increase was due to acquisitions of commercial properties in 2005 and 2006 (including ARI’s August 2005 acquisition of 600 Las Colinas Boulevard which represented $4.0 million of the $5.3 million increase). Operating expenses for ARI’s same-store hotels increased by $2.7 million in 2006 compared to 2005 driven by higher variable expenses due to increased occupancy.

 

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Depreciation and amortization expense increased $3.1 million, to $25.4 million in 2006 from $22.3 million in 2005. Depreciation on ARI’s apartment portfolio increased $1.9 million while depreciation expense for the commercial portfolio increased $1.6 million and depreciation for the hotel group declined $400,000. Depreciation expense for the apartment portfolio increased due to 2005 and 2006 acquisitions ($800,000), developed projects placed in service during 2005 and 2006 ($1.0 million) and additions to depreciable assets in the same-store universe ($100,000). Depreciation expense for the commercial portfolio increased due to 2005 and 2006 acquisitions ($1.9 million, of which $1.0 million related to the August 2005 acquisition of 600 Las Colinas Boulevard), offset by 2005 revisions to depreciable lives for certain commercial properties ($300,000). Depreciation expense for the hotel portfolio declined $400,000, due principally to certain improvements being fully depreciated in 2005.

General and administrative expenses were $9.5 million in 2006 compared to $17.7 million in 2005. The decrease in 2006 was due to lower legal and professional fees and reduced state income tax expense, combined with the proceeds of a litigation settlement received in 2006.

Advisory fee expense was $12.7 million in 2006 compared to $9.3 million in 2005. The increase from 2005 was due to higher gross assets in 2006 and a 2005 refund of 2004 Advisor cost reimbursements received from Prime. ARI’s advisory agreement with Prime limits the amount of cost reimbursements payable by ARI to Prime. See NOTE 12. “ADVISORY AGREEMENT.”

The 2006 gain on involuntary conversion of $20.5 million relates to damage sustained at the Company’s New Orleans commercial properties from Hurricane Katrina during 2005. ARI’s 225 Baronne property was closed immediately after the storm and the Company intends to redevelop 225 Baronne as a residential property. ARI’s 1010 Common and Amoco buildings suffered hurricane damage as well but have been repaired and have reopened. 1010 Common is presently 77% occupied and Amoco is 89% occupied. In 2005 the Company received $4.2 million in business interruption insurance proceeds which was included in 2005 rental revenues. ARI received approximately $45 million of insurance proceeds in 2006, of which $4.0 million related to business interruption claims and has been included in 2006 rental revenues.

Interest expense increased $15.5 million to $76.5 million in 2006 from $61.0 million in 2005. The overall increase in interest expense is due to a $2.3 million increase within the apartment portfolio, a $4.0 million increase in the commercial portfolio, a $6.5 million increase in the land portfolio and a $3.0 million increase in other interest expense, offset by $300,000 decline in interest expense for the hotel group. Within the apartment portfolio, $600,000 of the increase is due to additional debt incurred as a result of 2005 and 2006 acquisitions while $1.7 million is due to increased debt related to developed projects placed in service in 2005 and 2006. The increase in interest expense for the commercial portfolio is due to a $800,000 increase for the same-store universe (primarily due to rising variable interest rates) and $3.2 million for 2005 and 2006 acquisitions (of which $1.7 million relates to the August 2005 acquisition of 600 Las Colinas Boulevard). Interest expense within the land portfolio increased due to rising variable interest rates, increased debt from refinancing existing land parcels and additional debt incurred to finance 2005 and 2006 land acquisitions. Other interest expense increased primarily due to additional borrowings of non-real estate specific debt.

Gain on land sales decreased $15.9 million, to $24.0 million in 2006 from $39.9 million in 2005. During 2006 ARI sold approximately 318 acres of land in 19 separate transactions at an average sales price of $347,000 per acre. The largest land sales in 2006 were the sale of a) 123.9 acres in McKinney, Texas for $134,000 per acre, generating net cash proceeds of $6.0 million and a recognized gain of $3.4 million and b) 44.5 acres in McKinney, Texas for $231,000 per acre, generating net cash proceeds of $10.0 million and a recognized gain of $5.3 million. In 2005 the Company sold 411 acres of land in 27 separate transactions at an average sales price of $235,000 per acre, generating net cash proceeds of $23.8 million.

Minority interest was $672,000 in 2006 compared to $(3.1) million in 2005. Fully consolidated ventures where ARI owns less than 100 percent ownership swung to a net loss in 2006 compared to net income in 2005.

 

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Income from discontinued operations was $22.5 million in 2006 compared to $64.4 million in 2005. For 2006 and 2005, income from discontinued operations relates to 27 properties sold by ARI in 2004, 18 properties sold in 2005 and seven properties sold during 2006 or held for sale at December 31, 2006. Operating results for the Pizza World restaurants are also included in discontinued operations.

 

     2006    2005

Revenue

     

Rental

   $ 17,143    $ 28,099

Restaurant sales

     34,509      36,818
             
     51,652      64,917

Cost of Sales

     

Property operations

     13,023      23,146

Restaurant cost of sales

     28,526      27,906
             
     41,549      51,052
     10,103      13,865

Expenses

     

Interest

     6,062      10,390

Depreciation

     3,687      1,652
             
     9,749      12,042

Income (loss) from discontinued operations

     354      1,823

Gain on sale of real estate

     22,159      62,617

Write-down of assets held for sale

     —        —  

Equity in gain on sale of real estate by equity investees

     —        —  
             

Income from discontinued operations

   $ 22,513    $ 64,440
             

2005 Compared to 2004.    ARI had net income of $47.4 million in 2005, including gains on land sales totaling $39.9 million and net income from discontinued operations of $64.4 million, compared to net income of $33.2 million in 2004, including gains on land sales of $11.8 million and income from discontinued operations of $91.9 million. ARI defines its same-store universe for each income-producing asset type (apartments, commercial properties and hotels) as properties with stabilized occupancy owned and operated for the entire two-year period beginning January 1, 2004 and ending December 31, 2005. For this time period, ARI had 50 apartment communities, 25 commercial properties and 11 hotels in its same-store universe.

Rents and other property revenues were $159.2 million in 2005 compared to $137.4 million in 2004, an increase of $21.8 million or 16 percent. The overall increase is due to a $15.8 million increase in rental revenues from the Company’s apartment communities, a $2.4 million increase in rental and other property revenues from the Company’s commercial portfolio, a $100,000 increase in land-related rents and royalty income and a $3.5 million increase in hotel revenues. Within the apartment communities portfolio, $1.5 million of the increase from 2004 to 2005 is due to better performance in ARI’s same store apartment universe (a three percent increase from 2004 to 2005); $1.1 million is due to acquisitions; and $13.2 million is due to developed projects placed in service during 2004 and 2005. The improvement in rents and other property revenues within ARI’s commercial portfolio was principally comprised of an increase of $2.2 million due to acquisitions of commercial properties in 2004 and 2005 (including ARI’s August 2005 acquisition of 600 Las Colinas Boulevard which represented almost all of the increase) and a $200,000 increase in same-store rental revenues (a two percent increase over 2005). ARI’s commercial properties in New Orleans, which suffered extensive damage in 2005 from Hurricane Katrina, are included in the same-store universe. Approximately $4.2 million of business interruption insurance proceeds related to Hurricane Katrina are included in 2005 same-store rental revenues. ARI’s same-store hotels increased revenues by $3.5 million in 2005 compared to 2004, due to both occupancy gains and increases in average room rates. ARI acquired no hotels in 2004 or 2005 and sold one hotel in 2005.

Property operations expenses increased $4.3 million from $102.6 million in 2004 to $106.9 million in 2005. The overall increase is due to a $8.0 million increase in operating expenses from the Company’s apartment

 

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communities and a $1.3 million increase in hotel operating expenses, offset by a decline in commercial property expenses of $3.3 million and a $1.7 decrease in operating expenses (principally real estate taxes) related to the Company’s land portfolio. Within the apartment communities portfolio, $1.2 million of the increase from 2004 to 2005 is due to ARI’s same store apartment universe (a four percent increase from 2004 to 2005); $600,000 is due to acquisitions of existing apartment communities; and $6.2 million is due to developed projects placed in service during 2004 and 2005. The decrease in operating expenses within ARI’s commercial portfolio was due to a decrease in same-store operating expenses of $4.0 million from 2004 to 2005 (primarily from lower 2005 expenses in New Orleans due to TCI’s three office buildings being closed for a portion of 2005) offset by a $700,000 increase due to 2004 and 2005 acquisitions (including ARI’s August 2005 acquisition of 600 Las Colinas Boulevard which represented almost all of the increase). Operating expenses for ARI’s same-store hotels increased by $1.3 million in 2005 compared to 2004.

Depreciation and amortization expense increased $900,000, to $22.3 million in 2005 from $21.4 million in 2004. Depreciation on ARI’s apartment portfolio increased $2.4 million (due to developed projects placed in service in 2004 and 2005) while depreciation expense for the hotel portfolios increased $200,000; depreciation for the commercial properties declined $1.7 million due to 2004 and 2005 property sales.

General and administrative expenses were $17.7 million in 2005 compared to $15.8 million in 2004. The increase in 2005 was due to higher legal and professional fees.

Advisory fee expense was $9.3 million in 2005 compared to $10.7 million in 2004. The decrease from 2004 was due primarily to a 2005 refund of 2004 Advisor cost reimbursements received from Prime. ARI’s advisory agreement with Prime limits the amount of cost reimbursements payable by ARI to Prime. See NOTE 12. “ADVISORY AGREEMENT.”

Gains related to foreign currency transactions were $292,000 in 2005 compared to $3.8 million in 2004. Gains related to foreign currency transactions are the result of ARI’s Hotel Akademia (located in Wroclaw, Poland) converting its Euro-denominated debt into the functional currency (Polish Zloty).

ARI recorded no gains on the settlement of debt in 2005. The 2004 gain on settlement of debt of $10.6 million results from negotiated settlements regarding mortgage loans on the Four Hickory office building in Farmers, Branch, Texas ($8.4 million) and certain Texas land parcels ($2.2 million).

Interest expense increased $1.3 million to $61.0 million in 2005 from $59.7 million in 2004. The overall increase in interest expense is due to a $7.2 million increase within the apartment portfolio (driven by development projects placed in service in 2004 and 2005) plus an increase of $900,000 for hotels, offset by a $2.3 million decrease in the land portfolio (due to 2004 and 2005 land sales), $4.4 million decrease in other interest expense (due to repayments of non-real estate specific debt) and a $100,000 decrease in the commercial portfolio.

Litigation settlement expense decreased from $4.3 million in 2004 to $130,000 in 2005 due primarily to the one-time payment in 2004 related to the negotiated settlement of mortgage loans on the Four Hickory office building in Farmers Branch, Texas.

The Company recorded no provision for loan losses in 2005. Provision for loan losses of $(2.8) million in 2004 related to the reversal of excess loan reserves.

ARI recorded no provision for asset impairment in 2005. In 2004 the carrying values for an office building in Farmers Branch, an office building in New Orleans and a one-acre tract of land in Farmers Branch were reduced to their respective net realizable values.

Gain on land sales decreased $28.1 million, to $39.9 million in 2005 from $11.8 million in 2004. In 2005 the Company sold 411 acres of land in 27 separate transactions at an average sales price of $235,000 per acre,

 

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generating net cash proceeds of $23.8 million. In 2004 ARI sold 573 acres of land in 14 separate transactions at an average sales price of $70,000 per acre, generating net cash proceeds of $16.5 million.

Minority interest was $(3.1) million in 2006 compared to $(7.3) million in 2005. Fully consolidated ventures where ARI owns less than 100 percent ownership generated lower net income in 2005 as compared to 2004.

Income from discontinued operations was $64.4 million in 2005 compared to $91.9 million in 2006. For 2005 and 2004, income from discontinued operations relates to 27 properties sold by ARI in 2004, 18 properties sold in 2005 and seven properties sold during 2006 or held for sale at December 31, 2005. Operating results for the Pizza World restaurants are also included in discontinued operations.

 

     2005    2004  

Revenue

     

Rental

   $ 28,099    $ 58,334  

Restaurant sales

     36,818      34,525  
               
     64,917      92,859  

Cost of Sales

     

Property operations

     23,146      41,675  

Restaurant cost of sales

     27,906      26,713  
               
     51,052      68,388  
     13,865      24,471  

Expenses

     

Interest

     10,390      20,324  

Depreciation

     1,652      8,989  
               
     12,042      29,313  

Income (loss) from discontinued operations

     1,823      (4,842 )

Gain on sale of real estate

     62,617      96,994  

Write-down of assets held for sale

     —        (2,498 )

Equity in gain on sale of real estate by equity investees

     —        2,212  
               

Income from discontinued operations

   $ 64,440    $ 91,866  
               

The $2.5 million 2004 write-down of assets held for sale relates to impairment losses recorded for certain apartment communities. The contract sales price was deemed to be fair value.

The 2004 $2.2 million equity in investee’s gain on sale of real estate relates primarily to ARI’s portion of gain on income-producing properties sold by IORI.

Liquidity and Capital Resources

General.    Cash and cash equivalents at December 31, 2006 totaled $7.0 million, compared with $13.9 million at December 31, 2005 and $22.4 million at December 31, 2004. ARI’s principal sources of cash have been and will continue to be from property operations, proceeds from property sales, and the collection of mortgage notes receivable, borrowings and, to a lesser extent, distributions from partnerships. Management anticipates that ARI’s cash at December 31, 2006, along with cash that will be generated in 2006 from property operations, may not be sufficient to meet all of ARI’s cash requirements. Management intends to selectively sell land and income producing assets, refinance or extend real estate debt and seek additional borrowings secured primarily by real estate to meet its liquidity requirements. Historically, management has been successful at extending its current maturity obligations. Management also anticipates funding ongoing real estate construction projects and the acquisition of new real estate from cash generated by property sales, debt refinancings or extensions, and additional borrowings.

 

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ARI reported a net loss from continuing operations of $(9.4) million for 2006, which included, among other items, the following non-cash charges and credits: gain on sale of real estate of $24.0 million, depreciation and amortization of real estate held for investment and intangible assets of $25.4 million, amortization of deferred borrowing costs of $3.0 million and discount on sale of notes receivable of $1.2 million. Other 2006 changes in working capital increased cash used in operating activities by $14.7 million. Net cash used in operating activities for 2006 was $19.4 million compared to $12.4 million in 2005.

Net cash used in 2006 investing activities of $117.6 million was primarily due to real estate acquisitions of $142.5 million, investments in real estate entities of $39.3 million, earnest money deposits of $9.4 million, funding of notes receivable of $5.1 million, distributions to equity investees of $5.0 million and advisory payments of $1.7 million. These outflows were offset by proceeds from the sale of real estate of $66.7 million, proceeds from the sale of notes receivable of $6.8 million, and collection of notes receivable of $12.4 million.

Net cash provided by 2006 financing activities of $123.1 million was primarily due to proceeds from the funding or refinancing of notes payable of $245.8 million, offset by $99.5 million to pay down existing notes payable, $6.5 million for financing costs, $8.2 million for cash advances to affiliates, $2.5 million in dividends paid, and $6.0 million to repurchase preferred stock.

In 2006, ARI purchased approximately 4,400 acres of land primarily in North Texas, but including land in Florida and Mississippi. The aggregate purchase price was $177.8 million and ARI paid $11.8 million in cash, including closing costs. ARI also purchased six apartments and three commercial properties for a total of $26.6 million. ARI paid $5.2 million in cash, including closing costs.

In 2006, ARI sold approximately 318 acres of land primarily in North Texas, but including land in Florida, Tennessee and the U.S. Virgin Islands. The aggregate sales price was $62.0 million and ARI received net cash of $27.8 million after closing costs and paying off or paying down $25.9 million in mortgage debt. ARI also sold six apartments for a total of $48.3 million and received net cash of $16.2 million after the payoff or assumption of mortgage debt by the purchasers.

ARI expects that funds from existing cash resources, aggressive sales of land and selected income producing property sales, refinancing of real estate, and borrowings against its real estate will be sufficient to meet the cash requirements associated with ARI’s current and anticipated level of operations, maturing debt obligations and existing commitments. To the extent that ARI’s liquidity permits or financing sources are available, ARI will make investments in real estate, primarily in improved and unimproved land, will continue making investments in real estate entities and marketable equity securities, and will develop and construct income-producing properties.

Equity Investments.    Since 1988, ARI has from time to time purchased shares of IORI and TCI, both of which had the same advisor as ARI until June 2003. The Company may purchase additional equity securities of IORI and TCI through open market and negotiated transactions to the extent ARI’s liquidity permits.

Equity securities of TCI held by ARI (and of IORI held by TCI) may be deemed “restricted securities” under Rule 144 of the Securities Act of 1933 (“Securities Act”). Accordingly, ARI may be unable to sell such equity securities other than in a registered public offering or pursuant to an exemption under the Securities Act for a one-year period after they are acquired. Such restrictions may reduce ARI’s ability to realize the full fair market value of such investments if ARI attempted to dispose of such securities in a short period of time.

In 2006, ARI declared dividends to its Preferred stockholders totaling $2.5 million, of which approximately $1 million was paid.

Management reviews the carrying values of ARI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without

 

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interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings to the extent that the investment in the note exceeds management’s estimate of the fair value of the collateral securing such note. The mortgage note receivable review includes an evaluation of the collateral property securing each note. The property review generally includes: (1) selective property inspections, (2) a review of the property’s current rents compared to market rents, (3) a review of the property’s expenses, (4) a review of maintenance requirements, (5) a review of the property’s cash flow, (6) discussions with the manager of the property, and (7) a review of properties in the surrounding area.

Contractual Obligations

ARI has contractual obligations and commitments primarily with regards to the payment of mortgages.

The following table aggregates ARI’s expected contractual obligations and commitments subsequent to December 31, 2006.

 

     Payments Due by Period

Contractual Obligations

   Total   

Less than

1 year

   1-3 years    3-5 years   

More than

5 years

     (dollars in thousands)

Long-Term Debt Obligations(1)

   $ 1,035,219    $ 298,197    $ 208,697    $ 60,605    $ 467,720

Capital Lease Obligations

     —        —        —        —        —  

Operating Lease Obligations

     15,747      2,396      4,912      3,480      4,959

Purchase Obligations

     —        —        —        —        —  

Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP

     2,163      2,163      —        —        —  
                                  

Total

   $ 1,053,129    $ 302,756    $ 213,609    $ 64,085    $ 472,679
                                  

(1) ARI’s long-term debt may contain financial covenants that, if certain thresholds are not met, could allow the lender to accelerate principal payments or cause the note to become due immediately.

Other long-term liabilities represent ARI’s intentions to purchase the interests of general and limited purchases of partnerships formed to construct residential properties.

Environmental Matters

Under various federal, state and local environmental laws, ordinances and regulations, ARI 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 ARI’s business, assets or results of operations.

Newly Issued Accounting Standards

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an Amendment of FASB Statements No. 133 and 140” (“SFAS No. 155”). The purpose of SFAS No. 155 is to simplify the accounting for certain hybrid financial instruments by permitting fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation.

 

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SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS No. 155 to have a material impact on our cash flows, results of operations, financial position or liquidity.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an Amendment of FASB Statement No. 140” (“SFAS No. 156”). SFAS No. 156 requires recognition of a servicing asset or a servicing liability each time an entity undertakes an obligation to service a financial asset by entering into a servicing contract. SFAS No. 156 also requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value and subsequently measured at fair value at each reporting date. SFAS No. 156 is effective as of the beginning of any entity’s first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS No. 156 to have a material impact on our cash flows, results of operations, financial position or liquidity.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position take or expected to be taken in a tax return. FIN No. 48 also provides guidance on description, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of FIN No. 48 to have a material impact on our cash flows, results of operations, financial position or liquidity.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements.” SAB 108 provides guidance on the consideration of the effects of prior period misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 requires the quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as the “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods. The roll-over method focuses primarily on the impact of a misstatement on the income statement—including the reversing effect of prior year misstatements—but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. SAB 108 was effective for financial statements for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on our cash flows, results of operations, financial position or liquidity.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. The new FASB rule defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, or GAAP, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact, if any, to our financial condition or results of operations from the adoption of SFAS No. 157.

Inflation

The effects of inflation on ARI’s operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new financings as well as the cost of variable interest rate debt will be affected.

 

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ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

ARI’s future operations, cash flow and fair values of financial instruments are partially dependent upon the then existing market interest rates and market equity prices. Market risk is the changes in the market rates and prices and the affect of the changes on the future operations. Market risk is managed by matching a property’s anticipated net operating income to an appropriate financing.

ARI is exposed to interest rate risk associated with variable rate notes payable and maturing debt that has to be refinanced. ARI does not hold financial instruments for trading or other speculative purposes, but rather issues these financial instruments to finance its portfolio of real estate assets. ARI’s interest rate sensitivity position is managed by ARI’s capital markets department. Interest rate sensitivity is the relationship between changes in market interest rates and the fair value of market rate sensitive assets and liabilities. ARI’s earnings are affected as changes in short-term interest rates impact its cost of variable rate debt and maturing fixed rate debt. A large portion of ARI’s market risk is exposure to short-term interest rates from variable rate borrowings. The impact on ARI’s financial statements of refinancing fixed debt that matured during 2006 was not material. As permitted, management intends to convert a significant portion of those borrowings from variable rates to fixed rates. If market interest rates for variable rate debt average 100 basis points more in 2007 than they did during 2006, ARI’s interest expense would increase and net income would decrease by $2.3 million. This amount is determined by considering the impact of hypothetical interest rates on ARI’s borrowing cost. The analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no change in ARI’s financial structure.

The following table contains only those exposures that existed at December 31, 2006. Anticipation of exposures of risk on positions that could possibly arise was not considered. ARI’s ultimate interest rate risk and its effect on operations will depend on future capital market exposures, which cannot be anticipated with a probable assurance level. Dollars in thousands.

 

     2006     2007     2008     2009     2010     Thereafter    Total

Assets

               

Marketable securities at market value

                $ 9,038

Notes receivable

               

Variable interest rate-fair value

                $ 22,326

Instrument’s maturities

   $ 5,633     $ 14,845     $ 2,775     $ —       $ —       $ —      $ 23,253

Instrument’s amortization

     —         —         —         —         —         —        —  

Interest

     2,418       706       284       —         —         —        3,408

Average rate

     10.3 %     5.1 %     8.7 %     —         —         —     

Fixed interest rate-fair value

                $ 53,318

Instrument’s maturities

   $ 35,884     $ 2,463     $ 7,190     $ 600     $ —       $ 10,109    $ 56,246

Instrument’s amortization

     111       50       —         —         —         —        161

Interest

     4,721       2,653       1,517       1,384       1,380       5,879      17,534

Average rate

     8.2 %     9.5 %     9.6 %     9.3 %     9.5 %     —     

Liabilities

               

Notes payable

               

Variable interest rate-fair value

                $ 222,726

Instrument’s maturities

   $ 132,387     $ 46,767     $ 15,323     $ 6,737     $ 22,360     $ 10,993    $ 234,567

Instrument’s amortization

     2,628       1,735       1,645       1,574       1,346       14,700      23,628

Interest

     14,116       6,878       4,476       3,664       2,456       11,710      43,300

Average rate

     7.7 %     7.0 %     6.8 %     6.8 %     6.5 %     —     

Fixed interest rate-fair value

                $ 723,570

Instrument’s maturities

   $ 152,468     $ 58,749     $ 65,226     $ 8,353     $ 2,186     $ 121,184    $ 408,166

Instrument’s amortization

     10,714       10,034       9,218       9,076       8,973       320,843      368,858

Interest

     50,641       41,454       36,076       31,387       30,278       443,380      633,216

Average rate

     7.1 %     7.0 %     7.1 %     6.7 %     6.7 %     —     

 

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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Financial Statements

  

Reports of Independent Registered Public Accounting Firms

   48

Consolidated Balance Sheets—December 31, 2006 and 2005

   49

Consolidated Statements of Operations—Years Ended December 31, 2006, 2005 and 2004

   50

Consolidated Statements of Stockholders’ Equity—Years Ended December 31, 2006, 2005 and 2004

   51

Consolidated Statements of Cash Flows—Years Ended December 31, 2006, 2005 and 2004

   52

Notes to Consolidated Financial Statements

   54

Financial Statement Schedules

  

Schedule III—Real Estate and Accumulated Depreciation

   87

Schedule IV—Mortgage Loans on Real Estate

   98

All other schedules are omitted because they are not required, are not applicable, or the information required is included in the Consolidated Financial Statements or the notes thereto.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors of

American Realty Investors, Inc.

Dallas, Texas

We have audited the accompanying consolidated balance sheets of American Realty Investors, Inc. as of December 31, 2006 and 2005 and the related consolidated statements of income, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 22, American Realty Investors, Inc.’s management intends to both sell land and income producing properties and refinance or extend debt secured by real estate to meet the Company’s liquidity needs.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Realty Investors, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedules III and IV are presented for the purpose of complying with the Securities and Exchange Commission’s rules and is not a required part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.

Farmer, Fuqua & Huff, PC

Plano, Texas

March 30, 2007

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

 

    

December 31,

2006

   

December 31,

2005

 
     (dollars in thousands)  
Assets             

Real estate held for investment

   $ 1,249,833     $ 1,025,661  

Less—accumulated depreciation

     (178,029 )     (153,597 )
                
     1,071,804       872,064  

Real estate held for sale, net of depreciation

     134,593       172,303  

Real estate subject to sales contract

     66,027       68,738  

Notes and interest receivable

    

Performing ($28,541 in 2006 and $44,500 in 2005 from affiliates)

     50,668       70,894  

Non-performing

     2,963       11,546  
                
     53,631       82,440  

Less—allowance for estimated losses

     (1,000 )     (1,000 )
                
     52,631       81,440  

Marketable securities, at market value

     9,038       7,446  

Cash and cash equivalents

     7,035       13,904  

Restricted cash

     6,000       —    

Investments in equity investees

     25,056       13,521  

Goodwill, net of accumulated amortization ($1,763 in 2005)

     —         11,858  

Other intangibles, net of accumulated amortization ($926 in 2005)

     —         1,449  

Other assets ($52,793 in 2006 and $30,441 in 2005 from affiliates)

     121,487       103,072  
                
   $ 1,493,671     $ 1,345,795  
                
Liabilities and Stockholders’ Equity             

Liabilities:

    

Notes and interest payable ($7,499 in 2006 and $45,590 in 2005 to affiliate)

   $ 1,022,370     $ 817,944  

Liabilities related to assets held-for-sale

     43,579       144,555  

Liabilities subject to sales contract

     58,816       59,323  

Stock-secured notes payable

     22,452       22,549  

Accounts payable and other liabilities ($10,542 in 2006 and $4,667 in 2005 to affiliates)

     107,771       93,842  
                
     1,254,988       1,138,213  

Commitments and contingencies

    

Minority interest

     78,194       59,185  

Stockholders’ equity:

    

Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding Series A, 3,390,913 shares in 2006 and 2005 (liquidation preference $33,909), including 900,000 shares in 2006 and 2005 held by subsidiaries

     4,979       4,982  

Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,592,272 shares in 2006 and 2005

     114       114  

Treasury stock, at cost, 1,443,272 shares in 2006 and 2005

     (15,146 )     (15,146 )

Paid-in capital

     93,378       93,389  

Retained earnings

     75,380       64,805  

Accumulated other comprehensive income

     1,784       253  
                
     160,489       148,397  
                
   $ 1,493,671     $ 1,345,795  
                

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Years Ended December 31,  
     2006     2005     2004  
     (dollars in thousands)  

Revenues:

      

Rental and other property revenues ($1,423 in 2006, $1,091 in 2005 and $1,223 in 2004 from affiliates)

   $ 182,344     $ 159,200     $ 137,452  

Expenses

      

Property operating expenses ($8,212 in 2006, $7,646 in 2005 and $5,182 in 2004 to affiliates)

     122,916       106,930       102,631  

Depreciation and amortization

     25,394       22,328       21,452  

General and administrative ($4,481 in 2006, $4,407 in 2005 and $2,470 in 2004 to affiliates)

     9,465       17,683       15,804  

Advisory fee to affiliate

     12,678       9,336       10,728  
                        

Total operating expenses

     170,453       156,277       150,615  
                        

Operating income (loss)

     11,891       2,923       (13,163 )

Other income (expense)

      

Interest income ($2,692 in 2006, $2,379 in 2005 and $3,258 in 2004 from affiliates)

     5,950       5,439       5,347  

Gain (loss) on foreign currency transaction

     2       292       3,766  

Gain on settlement of debt

     —         —         10,649  

Gain on involuntary conversion

     20,479       —         —    

Other income

     6,181       3,007       1,846  

Mortgage and loan interest ($1,857 in 2006, $2,510 in 2005 and $2,825 in 2004 to affiliates)

     (76,518 )     (60,966 )     (59,684 )

Discount on sale of notes receivable

     (1,170 )     (15 )     (389 )

Net income fee to affiliate

     (972 )     (3,712 )     (1,933 )

Incentive fee to affiliate

     (1,490 )     (1,128 )     —    

Litigation settlement

     15       (130 )     (4,348 )

Provision for loan losses

     —         —         2,768  

Provision for asset impairment

     —         —         (8,001 )
                        

Total other income (expense)

     (47,523 )     (57,213 )     (49,979 )
                        

Loss before gain on land sales, minority interest, and equity in earnings of investees

     (35,632 )     (54,290 )     (63,142 )

Gain on land sales

     23,973       39,926       11,781  

Minority interest

     672       (3,056 )     (7,270 )

Equity in income (loss) of investees

     1,540       397       (41 )
                        

Income (loss) from continuing operations

     (9,447 )     (17,023 )     (58,672 )

Income from discontinued operations (NOTE 19)

     22,513       64,440       91,866  
                        

Net income

     13,066       47,417       33,194  

Preferred dividend requirement

     (2,491 )     (2,572 )     (2,601 )
                        

Net income applicable to common shares

   $ 10,575     $ 44,845     $ 30,593  
                        

Earnings per share—basic

      

Income (loss) from continuing operations

   $ (1.18 )   $ (1.93 )   $ (5.80 )

Discontinued operations

     2.22       6.35       8.70  
                        

Net income applicable to common shares

   $ 1.04     $ 4.42     $ 2.90  
                        

Earnings per share—diluted

      

Income (loss) from continuing operations

   $ (1.18 )   $ (1.93 )   $ (5.80 )

Discontinued operations

     2.22       6.35       8.70  
                        

Net income applicable to common shares

   $ 1.04     $ 4.42     $ 2.90  
                        

Weighted average common shares used in computing earnings per share

     10,149,000       10,149,000       10,559,571  

Convertible Preferred Stock (2,490,913, 2,490,913 and 2,569,350 shares) and options to purchase 70,750, 70,750 and 76,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for 2006, 2005 and 2004 respectively, because the effect of their inclusion would be antidilutive.

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

    Series A
Preferred
Stock
    Series E
Preferred
Stock
    Common
Stock
 

Treasury

Stock

    Paid-in
Capital
   

Retained

Earnings

    Accumulated
Other
Comprehensive
Income/(Loss)
    Stockholders’
Equity
 
    (dollars in thousands)  

Balance, January 1, 2004

  $ 4,651     $ 100     $ 114   $ (9,924 )   $ 92,464     $ (10,635 )   $ 101     $ 76,871  

Unrealized gain on foreign Currency translation

    —         —         —       —         —         —         (3,229 )     (3,229 )

Unrealized gains marketable securities

    —         —         —       —         —         —         1,580       1,580  

Net income

    —         —         —       —         —         33,194       —         33,194  
                     
                  31,545  

Repurchase of common stock

    —         —         —       (5,222 )     —         —         —         (5,222 )

Common stock dividends (pre-merger)

    —         —         —       —         —         (26 )     —         (26 )

Repurchase of series A preferred stock

    (12 )     —         —       —         (48 )     2       —         (58 )

Issuance of series A preferred affiliates

    500       —         —       —         2,000       —         —         2,500  

Series A preferred stock cash dividend ($1.00 per share)

    —         —         —       —         —         (2,571 )     —         (2,571 )

Series E preferred stock cash dividend ($0.60 per share)

    —         —         —       —         —         (30 )     —         (30 )
                                                             

Balance, December 31, 2004

  $ 5,139     $ 100     $ 114   $ (15,146 )   $ 94,416     $ 19,934     $ (1,548 )   $ 103,009  

Unrealized loss on foreign Currency translation

    —         —         —       —         —         —         935       935  

Unrealized gain on marketable securities

    —         —         —       —         —         —         866       866  

Net income

    —         —         —       —         —         47,417       —         47,417  
                     
                  49,218  

Common stock dividends (pre- merger)

    —         —         —       —         —         (1 )     —         (1 )

Repurchase of series A preferred Stock

    (157 )     —         —       —         (1,027 )     27       —         (1,157 )

Repurchase of series E preferred Stock

    —         (100 )     —       —         —         —         —